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Covered bond Guide

n With a total outstanding volume in excess of €2.8trn euro equivalent globally, coveredbonds are one of the largest asset classes. The remarkable stability with which coveredbonds have proven themselves in the global financial crisis and the broad basedregulatory acknowledgment of covered bonds has boosted investor demand on a globalscale. Within this publication we look at the growing complexity of regulatory treatmentof covered bonds, defining features of covered bonds as well as the latest developmentsin rating methodologies. The comparison of covered bond frameworks focusses on the key markets that provide covered bond issuance in benchmark format.

Heiko [email protected]+44 20 7595 8569

www.GlobalMarkets.bnpparibas.com Please refer to important information found at the end of the report

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EUROPE

AmsterdamHerengracht 595Amsterdam 1017 CE, NetherlandsTelephone: +31 20 550 1212

Athens94 Vassilissis Sofias Avenue & Kerasountos1Athens 11528, GreeceTelephone: +30 210 74 68 000

BrusselsMontagne du Parc 31000 Brussels, BelgiumTelephone: +32 2 565 11 11

BudapestRoosevelt ter 7-8H-1051, Budapest, HungaryTelephone: +36 1 374 63 00

Dublin5 George’s Dock IFSCDublin 1, IrelandTelephone: +353 1 612 5000

FrankfurtEuropa, Allee 12Frankfurt, GermanyTelephone: +49 69 71930

Geneva2 Place de Hollande1211 Geneva 11, SwitzerlandTelephone: +41 22 787 7111

London10 Harewood AvenueLondon NW1 6AA, United KingdomTelephone: +44 20 7595 2000

LuganoRiva A, Caccia 1ALugano 6907, SwitzerlandTelephone: +41 58 212 4111

Luxembourg10A Boulevard RoyalLuxembourg L-2093Telephone: +352 46 47 1

New YorkThe Equitable Building, 787 Seventh AvenueNew York, NY 10019, USATelephone: +1 212 841 2000

San FranciscoOne Front Street, 23rd FloorSan Francisco, CA 94111, USATelephone: +1 415 772 1300

São PauloAv. Pres. Juscelino Kubitschek, 510, 12 andarSão Paulo 04543-906, BrazilTelephone: +55 11 3841 3100

ASIA-PACIFIC

Bangkok29th Floor, Abdulrahim Place990 Rama IV Road, BangrakBangkok 10500, ThailandTelephone: +66 2 636 1900

Beijing2001 China World Tower1 Jianguomenwai AvenueBeijing 100004, People’s Republic of ChinaTelephone: +8610 6535 0888

Ho Chi Minh CitySaigon Tower, 29 Le Duan, Suite 504, Dist. 1Ho Chi Minh City, VietnamTelephone: +848 823 1265

Hong Kong63/F Two International Finance Centre8 Finance Street, Hong KongTelephone: +852 2909 8888

JakartaMenara BCA, 35th Floor, Grand IndonesiaJl. MH. Thamrin No. 1, Jakarta 10310IndonesiaTelephone: +62 21 2358 6262

Kuala Lumpur348 Jalan Tun RazakVista Tower, Level 48A, The Intermark50400 Kuala LumpurMalaysiaTelephone: +603 2179 8383

MadridCalle Serrano 735a Planta, Madrid 28006, SpainTelephone: +34 91 388 8300

MilanPiazza San Fedele 2Milan 20121, ItalyTelephone: +39 02 72471

Moscow1-2 Bolshoy, Gnezdnikovsky, Pereoulok125009 Moscow, RussiaTelephone: +7 095 785 6000

Paris3 rue d’AntinParis 75002, FranceTelephone: +33 1 42 98 12 34

Sofia2 Tzar Osvoboditel BlvdSofia 1000, BulgariaTelephone: +359 2 9218 640

WarsawPl. Pilsudskiego 1Warsaw 00-078, PolandTelephone: +48 22 697 2300

ZurichSelnaustrasse 16Zurich 8022, SwitzerlandTelephone: +41 58 212 6111

AMERICAS

Buenos AiresBouchard 547, 26th FloorBuenos Aires C1106ABG, ArgentinaTelephone: +54 11 4875 4300

Chicago155N. Wacker Drive, Suite 4450Chicago, IL 60606, USATelephone: +1 312 977 2200

Montreal1981 McGill College Avenue, MontrealQuebec H3A 2W8, CanadaTelephone: +1 514 285 6100

Mumbai8th Floor, BNP Paribas House1 North Avenue, Maker MaxityBandra - Kurla ComplexBandra (East) Mumbai 400 051, IndiaTelephone: +91 22 3370 4000

Manila30th Floor Philamlife Tower8767 Paseo de Roxas AveMakati City, Metro Manila, Philippines 1226Telephone: +632 814 8700

Seoul23rd & 24th Floor, Taepyeongno Building310 Taepyeongno 2-ga, Jung-gu, Seoul 100-767, KoreaTelephone: +82 2 317 1700

Shanghai25F Shanghai World, Finance Centre100 Century Avenue, Shanghai 200120People’s Republic of ChinaTelephone: +86 21 2896 2888

Singapore10 Collyer Quay, #31-00 Ocean Financial CentreSingapore 049315Telephone: +65 6210 1288

Sydney60 Castlereagh StreetSydney, NSW 2000, AustraliaTelephone: +61 2 9216 8633

Taipei72F, Taipei 101, No.7 Xin Yi Road Sec.5Taipei 110, TaiwanTelephone: +886 2 8758 3101

TokyoGranTokyo North Tower, 1-9-1 MarunouchiChiyoda-ku, Tokyo 100-6740, JapanTelephone: +81 3 6377 2000

MIDDLE EAST & ASIA

ManamaBahrain Financial HarbourFinancial Center - West TowerPO Box 5253, Manama, Bahrain Telephone: +973 1786 6666

2 European Covered Bond Research

Contents Covered Bonds in high demand 3

Australian Covered Bonds 21

Austrian Fundierte Anleihen 24

Austrian Pfandbriefe 27

Belgian Covered Bonds

Canadian Covered Bonds

29

32

Cypriot Covered bonds 35

Danish Covered Bonds 38

Dutch Covered Bonds 41

Finnish Covered Bonds 44

French Obligations Foncières 46

French Obligations de Financement de l’Habitat 50

Caisse de Refinancement de l’Habitat 54

German Pfandbriefe 56

Greek Covered Bonds 61

Hungarian Covered Bonds 63

Irish Asset Covered Securities 65

Italian Covered Bonds 68

Korean Covered Bonds 71

Luxembourgian Lettres de Gage 73

New Zealand Covered Bonds 75

Norwegian Covered Bonds 77

Portuguese Covered Bonds 80

Spanish Cédulas 83

Swedish Säkerställda Obligationer 86

Swiss Covered bonds 89

UK Covered Bonds 91

US Covered Bonds 94

Appendix - Glossary 97


Covered bonds in high demand Covered bonds have been the asset class of remarkable stability during the global financial crisis. Rating and spread volatility of covered bonds have been significantly below the levels seen in comparable unsecured bank bonds and government bonds. On the issuer side, covered bonds have provided access to funding, be it through market directed or retained issuance, even at times of greater overall market volatility. The relative strength of covered bonds and the long track record of the asset class can be seen as the main reasons behind the preferential regulatory treatment that covered bonds enjoy in a number of areas. Such treatment ranges from lower haircuts for covered bonds as repo collateral with central banks, reduced risk weightings, lower capital charges for insurance companies under Solvency 2 to eligibility of covered bonds as liquid assets for the planned Liquidity Coverage Requirement (LCR).

Benchmark covered bond issuance denominated in euro

020406080

100120140160180200

2010 2011 2012 30-Sep-13

OthersAustraliaAustriaFinlandSwedenNetherlandsNorwayItalyUKSpainGermanyFrance

EUR bn

Source – BNP Paribas The preferential treatment of covered bonds has noticeably increased demand from investors. The fact that Basel 3 will make covered bonds LCR eligible also outside the EU has already led to increased investor interest on a more global scale. This development should also help to expand benchmark issuance in currencies other than euro.

The increased demand for covered bonds has hit the market at a time when issuance volumes are significantly below levels seen in 2011 and before. Reduced issuance activity in a world where more banks than ever before have covered bond programmes sounds somewhat counter intuitive. However, with most banks having lower funding requirements due to ongoing deleveraging and stagnating mortgage markets in several countries it is understandable that covered bond issuance is below record volumes of previous years. Another factor that has reduced issuance volumes is the increased reliance of banks on central bank funding. The two LTROs of the ECB and the Funding for Lending Programme of the Bank of England are the most prominent examples. Offering cheap central bank funding has caused a larger number of banks to channel the already reducing funding volumes away from the covered bond market. It is important to recognise that both factors are of a temporary nature. A stronger reliance on market


based funding and a recovery of local mortgage markets could result in a resurgence of covered bond issuance volumes. Until then, the imbalance between supply and demand is likely to continue which should be supportive for relatively tight spread levels within the covered bond market.

Use of covered bonds as collateral within the ECB Eurosystem

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2004 2005 2006 2007 2008 2009 2010 2011 2012 Q2 2013

EUR bn

Source – ECB Despite the greater importance of secured funding and a very protracted recovery of the securitisation sector, product innovation within the covered bond market has remained relatively limited in recent years. The use of alternative asset classes (i.e. other than public sector debt or mortgage loans) as collateral for covered bonds has only occurred sporadically since the outbreak of the global financial crisis. One of the most recent examples has been the issuance of a covered bond secured by loans to small and medium sized enterprises (SME loans) by Commerzbank in Germany. At the time of writing there had been no follow-up issuance from the same or other issuers despite the positive market resonance of the inaugural bond. The pace of future product innovation in the covered bond market will, in our view, depend mainly on increasing funding needs, the availability of funding alternatives (i.e. central bank funding or securitisation) as well as risk appetite from investors. Given that preferential regulatory treatment of covered bonds will likely remain an important driver of covered bond demand, reliance on non-legislative or structured covered bonds for alternative collateral usage may impact the competitiveness of covered bonds over securitisation. Broadening asset definitions within the covered bond frameworks may lead to a better regulatory treatment of covered bonds with alternative collateral but ultimately bears the risk of a dilution of the covered bond product.

The covered bond concept The expansion of the covered bond sector also means that heterogeneity within the sector potentially increases as covered bond frameworks or programmes are tailored to meet the requirements set by the local market or issuers. Nevertheless, the defining core features of a covered bond have not changed:

Preferential claim of the covered bondholder on a segregated pool of assets. In the event of the issuer’s bankruptcy, the assets in the cover pool are used exclusively to satisfy the claims of covered


bondholders. Other creditors typically have no access to these assets until all covered bondholders have been fully repaid.

Full recourse against a bank, acting as an issuer or asset originator. Covered bonds are senior obligations of the issuer/originator. In a pre-bankruptcy scenario, interest and capital on the outstanding covered bonds are paid through the overall cash flow of the issuer and are not limited to the cash flows arising from the cover pool. In the event of an issuer’s bankruptcy, claims from covered bondholders which cannot be satisfied from the cover pool rank pari passu with unsecured creditors of the issuer.

Dynamic nature of the cover pool. Maturing or defaulting assets within the cover pool are replaced by the issuer to ensure that there is always sufficient cover for the outstanding covered bonds. In many frameworks, the composition and value of the cover pool is observed by an independent cover pool monitor, which usually reports to the banking supervisory authority. In the case of structured covered bonds, the monitoring of the cover pool is mainly conducted by the rating agencies. Auditing firms usually run annual checks on the validity of the asset cover test calculations.

Non-acceleration in the event of the issuer’s/originator’s bankruptcy. In the event of the issuer’s bankruptcy, cash flows arising from the segregated pool of assets will be used to make interest and capital payments on the outstanding covered bonds as originally scheduled. Even though this sounds relatively straightforward it can lead to a number of questions about management of the segregated pool, as well as mismatches between cover assets and covered bonds in terms of interest rates, currencies and maturities. These problems are addressed mainly in the post-bankruptcy procedures and the asset/liability matching requirements contained in the covered bond framework. Increasing penalisation of asset liability mismatches through rating agencies have recently led to the issuance of covered bonds where the payment structure of the covered bonds can turn from a bullet repayment into a pass through under certain conditions in a post-bankruptcy environment. As a result, issuers can achieve a higher rating uplift for their covered bonds over their unsecured rating.

The way in which these core features are implemented differs significantly between frameworks, with the segregation of cover assets being the main point of differentiation. Currently, one can identify four main systems of asset segregation in the covered bond universe, namely:

On-balance sheet register The classic form of asset segregation relies on the earmarking of cover assets through a special cover register. Respective bankruptcy or covered bond legislation provides a preferential claim of the covered bondholders on the registered cover assets in the event of the issuer’s bankruptcy. The register is usually kept by an independent monitor which ensures that only eligible assets are entered and that there is always enough collateral to secure the outstanding covered bonds. The cover assets remain on the balance sheet of the issuer/originator and are only segregated in the event of the issuer’s bankruptcy. Covered bondholders have full recourse against the issuer/originator. A typical example for this type of asset segregation would be the German Pfandbrief.


Bankruptcy remote subsidiary This method is based on the segregation of assets outside the originator’s balance sheet. In this case the cover assets are transferred to a bankruptcy remote subsidiary which uses these assets as collateral for the covered bonds. It is important to note that the subsidiary cannot be affected by the bankruptcy of the parent company. On the other hand, covered bondholders only have access to the assets held by the subsidiary and no further direct recourse against the parent company. Typically, all of the assets held by the subsidiary are collateral assets. A typical example for this type of asset segregation would be French Obligations Foncières.

Assignment to a guaranteeing vehicle This segregation method uses a transfer of cover assets to an SPV or trust based on an equitable or silent assignment. Instead of issuing a covered bond itself, the SPV or trust will issue a guarantee for a senior unsecured bond from the originating bank. The equitable or silent assignment means that the transfer of assets to the SPV or trust is only completed upon certain trigger events such as the issuer’s default. From that moment on, the SPV or trust will take over payment of interest and capital to the covered bondholders. The bondholders have full recourse against the issuer/originator based on the senior bond and additional recourse against the SPV or trust based on the guarantee. A typical example for this type of asset segregation would be UK Covered Bonds or Canadian Covered Bonds.

Using secured loans or secured bonds as collateral Within this method, the actual collateral (e.g. mortgage loans) stays with the originating bank and is used as collateral for a loan that is extended from, or a bond that is sold to, a separate entity. This entity can be a Special Purpose Vehicle (SPV) or a specialised banking subsidiary. The SPV or subsidiary then issues a covered bond that matches the terms of the secured loan or bond (i.e. same amount, coupon and payment dates). Each covered bond is thus secured by one or several secured bonds or loans with identical terms. However, all secured loans or bonds are collateralised by the same pool of assets which is held by the originating bank. While the covered bond issuer is merely passing on cash flows to the covered bondholders, asset substitution is conducted at the level of the originator, which has to ensure that the secured bonds/loans are sufficiently collateralised. As the secured bonds/loans are full recourse obligations of the originator, this recourse is passed on to the covered bondholders through the covered bond issuer. A typical example for this type of asset segregation would be French Obligations de Financement de l’Habitat or US Covered Bonds.

In some cases, the above-mentioned segregation methods can be combined. This is usually the case where a special bank principle requires the establishment of an issuing subsidiary, which in turn needs to segregate assets within its balance sheet via a cover register. The segregation within the issuing subsidiary becomes necessary if the subsidiary also holds other types of assets which are funded via senior unsecured debt. A typical example for this type of asset segregation would be Irish Asset Covered Securities.


Although the asset segregation is such a vital part of the covered bond concept, it tells little about the quality of the covered bond. Composition of the cover pool, matching requirements, supervision, post-bankruptcy procedures and, to a varying extent, the creditworthiness of the issuer are important factors for the quality of a covered bond. However, the asset segregation largely impacts the dynamics of a covered bond, and thus influences the effectiveness of the other security features.

Rating Divergence of ratings within the covered bond sector has continued to increase during 2012 and, year to date in 2013. The ongoing pressure on sovereign and senior bank ratings has been the main driver of this development. The scale of the rating migration can be illustrated with the following example given by Moody’s. In Q1 2011 over 70% of covered bonds rated Aa3 or higher by Moody’s in countries with a sovereign rating of A1 and below were rated. In Q4 2012 no covered bonds in countries with a sovereign rating of A1 or below were rated Aa3 or above. The downward trend of ratings was also observable at S&P and Fitch as well as within rating brackets other than the single-A bracket. While a larger number of covered bonds have moved from the AAA rating bracket to the single-A and double-A rating bracket, there has also been a small but increasing number of covered bonds with sub-Investment Grade ratings.

When sovereign and bank ratings are under pressure, the rating uplift on covered bonds of an issuer’s unsecured rating often decreases, this was a key driver of the rating volatility seen during the crisis. When focussing purely on credit risk, the decline in rating difference between covered bonds and senior unsecured debt of the issuer in times of stress is somewhat counter intuitive. One would expect that the asset quality within the cover pool would deteriorate at a slower rate than outside of the cover pool, especially considering that the issuer would have to substitute assets in the cover pool that no longer meet the eligibility criteria. This should lead to a scenario where the rating gap between covered bonds and unsecured debt would actually increase rather than decrease. The reason why we have seen the opposite development is linked to the fact that liquidity risk and counterparty risk have gained significant weight in the rating process during the crisis. The fact that covered bonds typically have a mismatch of cash flows between cover assets and outstanding liabilities means potential liquidation of cover assets in a post-bankruptcy scenario can lead to cash flow shortfalls depending on achievable prices. Thus, the need to sell assets in order to repay maturing covered bonds in a post-bankruptcy scenario exposes covered bondholders to market risk. The deteriorating credit worthiness of a sovereign and its banking sector can cause the rating agencies to change their assumptions about how difficult it may be to liquidate cover assets and thus impact the rating uplift granted to covered bonds above the issuer’s unsecured rating. In addition, the lowering of rating ceilings for covered bonds (or structured finance products in general) in connection with declining sovereign ratings can also reduce the rating uplift provided for covered bonds.


Relevance of covered bond ratings remains high Despite the call from regulators and politicians to curb the power of the rating agencies, the relevance of ratings and their ability to impact the market abides. Minimum rating requirements contained in the investment criteria of certain institutional investors may be one of the reasons for the strong rating impact. However, we regard the linking of regulatory treatment to certain rating levels as the significant driver behind the strong impact of rating levels. Preferential risk weighting, eligibility for Liquidity Coverage Ratio (LCR) and eligibility for liquidity operations with central banks are the most important examples where regulatory treatment is linked to a certain minimum rating. Losing such preferential treatment due to a rating downgrade can lead to selling pressure and increased spread volatility. While this development is not desirable, it is likely that future regulation will also rely on minimum ratings as one of the criteria that need to be met for preferential treatment.

Average euro benchmark covered bond swap spreads (2018-2021)

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600

Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13 Oct 13

GermanyFranceSpainItalyNordic Region

bp

Source – BNP Paribas S&P Since 2010, S&P’s rating methodology for covered bonds links the covered bond rating to the creditworthiness of the issuer. Previously, the agency had employed a delinked approach for most covered bond products. Linking the covered bond rating to the rating of the issuer is based on the assumption that payments on covered bonds may be affected by the failure of the issuing bank. One key element of linking the covered bond rating to the issuer rating is determining asset-liability mismatch (ALMM) between the covered bonds and the cover pool.

Before the ALMM risk is determined S&P looks at legal, regulatory and administrative risks to ascertain how likely a default for the issuer will impact its covered bonds. The aim is to determine if the covered bonds can be rated higher than the issuer and to what extent additional structural mitigants might be necessary to get to a better rating.

The analysis of cover pool specific factors include credit quality check of the cover assets and a cash flow analysis that looks at ALMM risk.


Asset-liability mismatch: S&P classifies ALMM risk in three categories: low, moderate or high. The classification is based on the magnitude of the ALMM risk (considering cash flow mismatches but also potential credit risk) and the timing of the mismatch. Mismatches occurring later have a less severe impact than mismatches that occur earlier.

Programme categorisation: S&P will segment the covered bond programme country by country, based on the external funding options available to the programme as well as the track record and systemic importance of the covered bond product in the its country. S&P uses three categories (see table below); the higher the category, the higher the potential rating uplift.

Based on the ALMM risk and the programme categorisation, S&P determines the maximum achievable rating uplift of the covered bonds from the issuer’s unsecured rating. Following that, S&P calculates the amount of credit enhancement necessary to achieve the maximum possible uplift.

Maximum achievable rating uplift (notches) Programme Category

ALMM risk 1 2 3

Zero Unrestricted Low 7 6 5 Moderate 6 5 4 High 5 4 3

Source – S&P At the final stage, S&P determines whether other external factors such as counterparty risk or country risk can limit the level of achievable ratings for covered bonds. Depending on the counterparty criteria, S&P may link the rating of the covered bonds to the rating of one or more counterparties (typically derivative counterparties or bank account providers). One way to avoid such a linking, which could result in a lower covered bond rating, would be the use of appropriate counterparty replacement clauses within the programme that act upon the breach of certain rating triggers.

Country risk can limit the achievable covered bond rating either through the jurisdiction of the issuer or the assets in the pool (or both). Specifically, for public sector covered bonds, S&P limits the achievable covered bond rating to one notch above the rating of the country under which jurisdiction a substantial part of the cover assets fall. In October 2013, S&P launched a request for comment on a planned amendment of its structured finance rating methodology. The proposed changes could cap the rating level that mortgage covered bonds can achieve to two to four notches above the sovereign rating, depending on the level of asset liability mismatch. If implemented as proposed, the amendment would mainly affect covered bonds of higher rated issuers in peripheral countries such as Italy and Spain where covered bonds are currently rated up to six notches above the sovereign rating.


Moody’s Moody’s employs a two-step approach when rating covered bonds. In the first step Moody’s applies its expected loss method. The second step consists of applying a cap to the rating that resulted from the first step on the basis of Moody’s Timeliness of Payment Indicator (TPI) framework.

Moody’s expected loss model looks at the credit strength of the issuer prior to the issuer’s default and the value of the cover pool following the issuer’s default. The value of the cover pool is determined through three main categories: credit quality of the pool, refinancing of the pool and interest rate and currency mismatches. The credit quality of the pool determines the amount of loss due to credit deterioration after an issuer default. It can also have an impact on refinancing risk as Moody’s assumes that lower quality or non-standard assets may be more difficult to liquidate. Moody’s measures the credit quality of the pool though the Collateral Score. Refinancing risk looks at cash flow mismatches between the cover pool and the outstanding covered bonds. Moody’s applies haircuts to the collateral value to reflect market risk which can reduce the price achievable in an asset sale. Finally, Moody’s incorporates interest rate and currency risk by running stressed scenarios.

The Timely Payment Indicator (TPI) measures the likelihood of timely covered bond payments after the default of the issuer. The TPI limits the maximum number of notches between the covered bond rating and the rating of the issuer. The TPI has six categories ranging from very improbable to very high. The higher the TPI, the higher the delinkage between the sponsor bank and the covered bond ratings. In order to determine the TPI Moody’s looks at the relevant jurisdiction (including the level of potential systemic support) as well as programme specific features (such as maturity extensions or reserve funds). For each covered bond programme, an individual TPI is published. The TPI in connection with the issuer’s unsecured rating can be used to determine how much (if at all) a downgrade of the issuer would affect the covered bond rating. However, there has been incidents where Moody’s has lowered the TPI in the case of significant downgrades of the sovereign rating, which led to stronger downgrades of the covered bonds in that country than otherwise expected.

In September 2013, Moody’s published a request for comment (RFC) on a planned change of its rating methodology for covered bonds. The main reason for the RFC is the expected explicit exemption of covered bonds from a bail-in as stipulated in the latest proposal of the EU Bail-In Directive. In order to reflect the support that covered bonds may receive in a bail-in through the burden-sharing of unsecured creditors as well as the increased probability that the issuer will end up in an orderly wind down rather than bankruptcy, Moody’s proposes an alternative anchor point for the issuer’s covered bond rating. This alternative anchor point is the adjusted Baseline Credit Assessment (BCA), which reflects the bank’s standalone financial strength relative to other banks including potential parental support. Based on the availability of bail-inable debt, Moody’s intends to add up to two notches to the adjusted BCA in order to determine the anchor point for the covered bonds. Since Moody’s acknowledges that some banks may still benefit from public sector support, the senior unsecured ratings (which incorporates public sector support) will still be used as an alternative rating


anchor for covered bonds in such cases. The agency expects that the majority of European covered bonds which are not yet Aaa rated or capped by a sovereign ceiling could be upgraded by a notch or two as a result of the proposed changes.

Fitch In its rating methodology Fitch generally links the covered bond rating to the Issuer Default Rating (IDR) of the issuing bank. The rating agency mainly addresses probability of default but also gives some rating uplift on a recovery basis. The risk that the default of the issuer will cause a default of the covered bonds is evaluated in Fitch’s Discontinuity Caps (D-Caps). D-Caps determine the maximum rating notch uplift for the covered bonds from the IDR. Fitch has eight different D-Caps categories which correspond with the number of achievable notches of rating uplift for the covered bonds. The D-Caps rank from zero (full discontinuity) to eight (minimal discontinuity). The D-Caps are driven by five risk components: asset segregation, liquidity gap and systemic risk, systemic alternative management, cover pool specific alternative management and privileged derivatives.

The first step is for Fitch to determine the maximum achievable covered bond rating on a probability of default basis which corresponds with a certain level of overcollateralisation using its D-Caps categorisation. The second step comprises the stress testing of the overcollateral using certain assumptions in a wind down scenario of the issuer. The stresses include, among other factors, credit losses, cost for bridging maturity gaps, adverse interest rate and currency scenarios as well as expenses for cover pool managers. In the final step, Fitch determines the level of expected recovery from the cover pool and applies a notching to the rating level, which has been determined by the covered bond probability of default. Depending on the outcome of the stressed recovery assessment, Fitch can provide a further uplift of up to two or three notches.

In addition to the above mentioned parameters, the sovereign rating of the jurisdiction of the issuer or a substantial part of the cover pool can limit the maximum achievable rating. It is also worth noting that Fitch gives less credit to overcollateralisation where the programme is dormant or in wind down, which could lead to rating pressure in cases where an issuer receives support and subsequently is put into wind down.

Regulatory treatment of covered bonds Due to their relatively high safeguards and stability covered bonds offer compared to other categories of bank debt, they are enjoying preferential regulatory treatment in a number of cases. Within the EU, preferential treatment of covered bonds has been known since the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive which granted higher investment limits for certain institutional investors and laid the foundation for lower risk weighting of covered bonds. More recent regulation such as Basel III has broadened the recognition of covered bonds beyond the borders of the EU area by granting them eligibility for the upcoming Liquidity Coverage Requirement (LCR). This in turn has given demand for covered bonds from investors located outside Europe a significant push. As the regulatory environment is still very much in flux and the implementation of new regulation may lead to further changes in some cases, it is difficult to


predict which covered bonds exactly will be affected and what market impact it will bring. It is clear though that regulatory treatment has become a significantly bigger driver of market dynamics for covered bonds, which also bears the risk that future changes to the regulatory environment may lead to more significant price movements. In this chapter we are looking at the current status of main regulation which grants preferential treatment to covered bonds.

Risk weighting Covered bonds are bank obligations and thus have the same risk weighting as senior bank debt unless there is a preferential regulatory treatment in place. Within the EU this preferential treatment is granted to covered bonds based on the European Capital Requirements Directive (CRD) of 2006. This regulation is being replaced by the CRD4 Package which will be applicable from 2014 onwards.

The CRD4 Package, which consists of the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD) continues to refer to the UCITS directive in order to define covered bonds. Article 52 (4) of the UCITS directive requires that:

Issuer is an EU credit institution; Bonds are issued on the basis of a legal provision to protect

bondholders; Special supervision by public authorities; Sums deriving from the issuance must be invested according to the law

in assets which cover the claims of the bondholders; Bondholders have a preferential claim on assets if the issuer fails; The member states must notify the EU Commission. In addition to the referral to Article 52(4) of the UCITS directive, the CRD4 Package (Specifically Article 129 of the CRR) holds another set of requirements which focus predominantly on the quality of the cover assets. Article 129 of the CRR contains the following collateral criteria:

Exposures to or guaranteed by central governments, EU central banks, public sector entities, regional governments or local authorities in the EU;

Exposures to or guaranteed by Non-EU public sector entities if they qualify for the credit quality assessment step 1 (minimum rating of AA-). Non-EU public sector entities that qualify for the credit quality assessment step 2 (rated between A+ and A-) are limited to 20% of the nominal amount of outstanding covered bonds;

Exposures to credit institutions that qualify for the credit quality assessment step 1 (minimum rating of AA-) if the total exposure to these types of institutions does not exceed 15% of the nominal amount of outstanding covered bonds. Exposures to credit institutions within the EU with a maturity not exceeding 100 days shall not be comprised by the AA- minimum rating requirement. Supervisory authorities, after the consultation with the EBA, may allow the inclusion of exposures to credit institutions rated at least A- of up to 10% of the amount of outstanding covered bonds if it helps to avoid concentration risk which would occur by limiting exposure to AA- rated institutions;


Residential mortgage loans with a maximum LTV of 80%; French home loans with a maximum LTV of 80% and with a loan-to-

income ratio of not more than 33% at the time of granting. The protection provider of the home loans must have a minimum rating of A-;

Commercial mortgage loans with a maximum LTV of 60%. Commercial mortgage loans with a maximum LTV of 70% are permitted if the covered bonds provide for a minimum over-collateralisation of 10%;

RMBS which are secured by at least 90% with mortgages with a maximum LTV of 80%, as long as the share of these RMBS does not exceed 10% of the outstanding covered bonds and the RMBS tranches are rated Aa3/AA- or higher;

CMBS which are secured by at least 90%, with mortgages with a maximum LTV of 60%, as long as the share of these CMBS does not exceed 10% of the outstanding covered bonds and the CMBS tranches are rated Aa3/AA- or higher;

Ship mortgage loans with an LTV of up to 60%. The CRD4 Package also sets a certain minimum disclosure standard for covered bonds to receive preferential treatment. On a semi-annual basis information must be available on:

The value of the cover pool and outstanding covered bonds; The geographical distribution and type of cover assets, loan size,

interest rate and currency risk; The maturity structure of cover assets and covered bonds; and The percentage of loans more than ninety days past their due date. Credit institutions investing in covered bonds have to demonstrate to the regulators that they receive the above listed information as part of their due diligence in order to benefit from the preferential risk weighting.

Until the end of 2017, the share of RMBS and CMBS is not limited if the underlying residential or commercial mortgage loans were originated by a member of the same consolidated group of which the issuer is also a member. Before the end of 2016 this regulation will be reviewed and potentially amended. Covered bonds meeting the above listed requirements qualify for preferential treatment when determining the risk weighting under the Standardised Approach as well as the Internal Ratings Based Approach.

Standardised Approach: With the implementation of the CRD4 Package the risk weighting of the covered bonds is no longer linked to the rating of the issuer (or the country the issuer is located in) but to the rating of the covered bond itself. Only in cases where there is no covered bond rating, the risk weighting still depends on the rating of the issuing entity.

Risk weighting of covered bonds under the Standardised Approach Covered Bond Rating

AAA to AA-

A+ to A- BBB+ to BBB-

BB+ to BB-

B+ to B- CCC+ or lower

Risk weighting 10% 20% 20% 50% 50% 100%

Source - European Commission, BNP Paribas


Internal Ratings Based Approach (IRB): Within the IRB, the risk weighting is based on the following parameters: Probability of Default (PD), Loss Given Default (LGD), Maturity of the bond and Exposure at default. The Foundation IRB allows the bank that holds the covered bond to assess PD itself, provided that it will not reach a value of less than 0.03%. LGD and maturity are set by the regulator. With the amendment of CRD in June 2010, an LGD level of 11.25% was introduced for all covered bonds. Previously covered bonds could only reach a LGD level of 11.25% in special circumstances, while the general LGD level for covered bonds was set at 12.5%. The maturity is set at 2.5 years for all covered bonds. Under the Advanced IRB, both PD and LGD have to be estimated by the credit institution. The maturity can be set within a range of one to five years. The use of the IRB will, in most cases, result in risk weightings for covered bonds which are below 10%, as long as the issuer is rated single-A or better. For covered bonds of issuers, which are rated in the BBB area, the risk weighting will be higher than 10%.

Covered bonds issued before 31 December 2007 which meet the requirements of article 52(4) UCITS but not the CRD4 requirements, still benefit from preferential treatment until their maturity.

Liquidity Coverage Requirement According to Basel regulation and its EU equivalent CRD4 banks will be required to hold a stock of high quality liquid assets to cover the total assumed volume of net cash outflows over a 30 day period in a stressed scenario. The assets must be unencumbered, i.e. cannot be used as collateral for other transactions (including repo transactions with central banks). Under Basel rules, high quality liquid assets are split into Level 1 Assets and Level 2 Assets. Level 2 Assets are split again into Level 2A and Level 2B Assets. At least 60% of the total stock of liquid assets must be comprised of Level 1 assets.

The following assets are considered Level 1 Assets:

Cash. Central bank reserves. Marketable securities issued or guaranteed by: sovereigns, central

banks, non-central government public sector entities, the BIS, the IMF, the European Commission or multilateral development banks. The aforementioned securities need to be 0% risk weighted, traded in large, deep and active repo or cash markets characterised by low levels of concentration. The securities must have a proven track record as a reliable source of liquidity in the markets even during stressed market conditions. The securities must not be an obligation of a financial institution or any of its affiliated entities.

The following assets are considered Level 2A Assets:

Marketable securities issued or guaranteed by: sovereigns, central banks, non-central government public sector entities or multilateral development banks. The aforementioned assets need to be 20% risk weighted, traded in large, deep and active repo or cash markets characterised by a low level of concentration. The securities need to have a proven track record as a reliable source of liquidity in the markets


even during stressed market conditions (the Basel paper names a maximum decline of price, or increase in haircut over a 30-day period during a relevant period of significant liquidity stress not exceeding 10% as a measure for this). The securities must not be an obligation of a financial institution or any of its affiliated entities.

Covered bonds and corporate bonds if they are rated at least AA-; such bonds need to have the same track record in trading and liquidity as the other marketable securities in the Level 2 bucket.

Senior bank debt is not eligible. All Level 2A Assets are subject to a 15% haircut. Level 2B Assets can comprise RMBS (25% haircut), corporate debt securities rated between A+ and BBB- (50% haircut) or common equity shares (50% haircut). Level 2B Assets must not account for more than 15% of the total stock of liquid assets. Level 2A and 2B Assets together must not account for more than 40% of the liquid buffer.

The CRD4 Package which implements the Basel regulation on an EU level defines covered bonds that are eligible for the LCR as those which meet the requirements of article 52(4) of the UCITS directive. Instead of Level 1 Assets and Level 2 Assets, the CRD4 Package refers to assets of “extremely high liquidity and credit quality” and assets of “high liquidity and credit quality”. Covered bonds could be considered as assets of extremely high liquidity and credit quality under certain circumstances, which would mean that no 40% limit and a lower or no haircut or would be applied. However, it will be up to the EBA to advise the European Commission on which liquidity category covered bonds will fall into and under which conditions. The EBA will also determine haircuts of the different asset groups, taking the haircuts set by the Basel group as a minimum. The EBA will base its assessment, to a large extent, on quantitative factors such as trade volume, maximum bid/ask spread and other metrics of price transparency and volatility. In a public hearing in October 2013, the EBA presented “very preliminary results” of its assessment in which covered bonds ranked at the same level as government bonds. While this does not guarantee that covered bonds will be considered assets of extremely high liquidity and credit quality in the final report, it increases the chances for a favourable treatment of the asset class. The final EBA report is due by 31 December 2013.

Implementation of the LCR requirement will happen gradually starting from the beginning of 2015 with 60% of the requirement with full implementation at the beginning of 2018.

Bail-in Covered bonds enjoy preferential treatment under the proposed Bail-In Directive of June 2012. The proposed directive aims at providing the necessary tools to resolve a failing financial institution in an orderly manner while minimising the burden-sharing on taxpayers. One key tool is Bail-In, which means the authority’s ability to write down and convert into equity claims of shareholders and debtors.


The proposed Bail-In Directive explicitly exempts secured liabilities, including covered bonds, from bail-in. In cases where the collateral does not fully cover the secured liabilities, burden sharing can be applied to the uncovered part of the secured liabilities. The proposed directive does not specify how it should be determined whether there are sufficient cover assets for the outstanding covered bonds. Unless nominal values are used to make such an assessment at the time of bail-in, the decision whether or not covered bondholders may be affected by the bail-in could depend on the valuation of the cover pool. According to the proposal, EU countries have the option to exempt UCITS compliant covered bonds from bail-in completely, i.e. also in the case of the collateral being insufficient to secure all covered bonds. The proposed directive stipulates the application of the bail-in tool effective from January 2018.

Solvency II Solvency II aims to provide a regulatory framework for insurance companies that provides capital requirements and risk management standards. One key element of Solvency II focuses on market risk associated with the assets held by insurance companies and the capital necessary to cover such risk. Covered bonds that comply with article 52(4) of the UCITS directive are eligible for preferential treatment under Solvency II. The most important preferential treatment is the reduced capital charge for spread risk which applies to covered bonds rated at least AA-. Covered bonds rated below AA- are treated like senior unsecured exposure. According to the current proposal the difference in spread risk capital charge for covered bonds compared to unsecured exposure ranges from 0.2 percentage points for bonds with one year duration (both for AAA and AA rated covered bonds) to 1.1 percentage points for bonds with 10 year duration (1.4 percentage points for AA rated covered bonds). Implementation of Solvency II is not expected before 2016.

Covered bonds within the ECB collateral framework Covered bonds receive a preferential treatment over unsecured bank bonds and ABS within the collateral framework of the ECB. The preferential treatment of covered bonds results in the assignment to a lower haircut category. The collateral framework has five haircut categories. Government bonds and central bank debt falls within Category I. Jumbo covered bonds, together with local and regional government debt as well as agency and supranational debt fall in Category II. Category III contains traditional covered bonds (i.e., non Jumbo format), structured covered bonds Spanish multi-Cédulas, as well as corporate bonds. Unsecured bank debt falls in Category IV, while ABS falls in Category V.


ECB haircuts by liquidity category and residual maturity

Residual maturity (years)

Fixed coupon

zero coupon

Fixed coupon

zero coupon

Fixed coupon

zero coupon

Fixed coupon

zero coupon

0-1 0.5 0.5 1.0 1.0 1.0 1.0 6.5 6.51-3 1.0 2.0 1.5 2.5 2.0 3.0 8.5 9.03-5 1.5 2.5 2.5 3.5 3.0 4.5 11.0 11.55-7 2.0 3.0 3.5 4.5 4.5 6.0 12.5 13.5

7-10 3.0 4.0 4.5 6.5 6.0 8.0 14.0 15.5>10 5.0 7.0 8.0 10.5 9.0 13.0 17.0 22.5

Residual maturity (years)

Fixed coupon

zero coupon

Fixed coupon

zero coupon

Fixed coupon

zero coupon

Fixed coupon

zero coupon

0-1 6.0 6.0 7.0 7.0 8.0 8.0 13.0 13.01-3 7.0 8.0 10.0 14.5 15.0 16.5 24.5 26.53-5 9.0 10.0 15.5 20.5 22.5 25.0 32.5 36.55-7 10.0 11.5 16.0 22.0 26.0 30.0 36.0 40.0

7-10 11.5 13.0 18.5 27.5 27.0 32.5 37.0 42.5>10 13.0 16.0 22.5 33.0 27.5 35.0 37.5 44.0

22.0

Category V

Category I Category II Category III Category IV Category V

10.0

Category IV

Credit quality Step 3

(BBB+ to BBB)

Credit quality Steps 1 and 2 (AAA to A-)

Category I Category II Category III

Source – ECB, BNP Paribas

The ECB applies an additional valuation haircut to ABS, covered bonds and unsecured bank bonds if no market price can be obtained and the Eurosystem has to define a theoretical price. In July 2013, the ECB announced the introduction of an additional markdown for retained covered bonds, i.e. covered bonds that are used by the issuer as collateral for repo transactions instead of being sold to investors. The ECB will introduce a valuation markdown of 8% for retained covered bonds rated A- or better and 12% for retained covered bonds rated between BBB- and BBB+.

The ECB currently accepts covered bonds from issuers located in EEA countries or non-EEA G10 countries. The bonds can be denominated in EUR, USD, GBP or JPY. Meeting the requirements of Article 52(4) of the UCITS directive is not a requirement as the ECB currently also accepts covered bonds that are not issued under a specific legal framework or where the issuer is located outside of the EU. Since March 2013, covered bonds that contain external, non-intra group MBS as well as public sector ABS (external and internal) are no longer accepted in the Eurosystem as covered bonds. Bonds that were already on the list of eligible assets in March 2013 will benefit from a grandfathering period until 28 November 2014.

Benchmark covered bonds In 1995 the first covered bond in Jumbo format was issued out of Germany. The Jumbo segment was created to enable German Pfandbrief issuers to broaden their investor base domestically and internationally by increasing the liquidity and standardisation of the market sector. Issuers from other European countries followed soon after, making the Jumbo format the standard for benchmark issuance in Europe. Choosing a minimum issuance size and providing standardised market-making through at least three underwriting banks were the key features of this benchmark standard. Underwriting banks agreed to quote two-way prices with a fixed bid-offer spread for a ticket size of at least €15mn. The actual bid-offer spread depended on the remaining maturity of the Jumbo covered bond and ranged from 5 to 25 cents. With the outbreak of the global financial crisis, the


standard market-making was severely disrupted as liquidity in most market sectors dropped. Subsequently, secondary market liquidity improved again; however, market-making in Jumbo covered bonds remains differentiated with bid offer spreads being wider and tradable sizes being smaller for covered bonds of lower rated issuers or within non-core markets.

Large scale deleveraging of banks, reduced demand for mortgage lending in a number of countries and increasing use of central bank liquidity have reduced issuance volumes of covered bonds in general and average issuance sizes in particular. As of September 2013, the share of new benchmark covered bonds issued with a size of €500mn has increased to 45% from 14% in 2011. Market acceptance of smaller sized benchmark bonds was also supported by Index providers such as Markit lowering the minimum issue size for covered bonds to be included in the iBoxx EUR indices to €500mn at the beginning of 2012.

Share of new Jumbo issuance by size (excl. increases)

0%

20%

40%

60%

80%

100%

2011 Jan-Sep 2013

1bn and larger

500mn

Source – BNP Paribas

Another factor that has supported the increasing use of smaller sized benchmark transactions is the stronger focus of rating agencies on liquidity and refinancing risk. When rating agencies changed assumptions about achievable prices when selling cover assets to repay maturing covered bonds in a post-bankruptcy scenario, maturity mismatches between cover assets and covered bonds led to higher over-collateralisation requirements for issuers of covered bonds. One way to reduce such mismatches and lower over-collateralisation requirements is to spread liabilities of covered bonds more evenly across the curve with smaller sized bonds.


Average issue size of Jumbo covered bonds (excl. increases)

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2009 2010 2011 2012 Sep-13

EUR bn

Source – BNP Paribas The US dollar market In just under four years, the USD covered bond market has grown to an outstanding volume of more than $120bn. A key driver of this development has been covered bond issuance from Canadian banks especially within the years 2010 to 2012. Other important contributors to the market sector have been banks from Australia and Northern Europe. While it is not surprising to see mainly issuers from outside the euro area at the forefront of USD covered bond issuance, there has also been issuance from French, German and Dutch banks in the dollar market.

Breakdown of USD covered bond issuance in 2013 by country

05

101520253035404550

2010 2011 2012 30-Sep-13

South KoreaGermanyNetherlandsUKSwitzerlandSwedenFranceNorwayAustraliaCanada

USD bn

Source – BNP Paribas As the chart above shows, issuance volumes in USD until the end of September 2013 have been significantly below the levels seen in 2012. The main reason for the reduced supply is the introduction of a legislative covered bond framework in Canada, which no longer allows Canadian banks to use CMHC insured mortgages as collateral for covered bonds.

Apart from changing regulation in Canada, a tightening EURUSD cross currency basis is affecting issuance volumes in the USD covered bond market. While a tighter basis primarily affects supply from issuers based in the euro area as USD denominated funding becomes less attractive, we have also seen that Canadian issuers have recently returned to the euro market as the tighter basis leads to funding advantages.


We expect the dollar covered bond market to grow further albeit at a potentially reduced pace in the near term. At the same time, we expect the market to become more diversified as the dominance of Canadian issuance seen in 2010, 2011 and 2012 begins to wane. One driver of greater diversification could come from new covered bond jurisdictions emerging from areas such as the Asian Pacific region, which may issue predominantly in USD due to investor preference within the region.

The GBP market Significant benchmark issuance denominated in GBP started in 2011 with a strong focus on longer dated maturities. Demand from UK based insurance companies which were aiming to increase their covered bond exposure mainly in anticipation of Solvency II regulation (see above) was filled predominantly by UK based issuers. Supply from UK banks stopped relatively abruptly when the Funding For Lending programme was announced by the Bank of England. More recent issuance of shorter dated GBP denominated covered bonds was mainly driven by Australian, German and French banks.

Despite the disruptions that were caused in the secondary market by the financial crisis, the benchmark sector continues to be an important part of the covered bond market. The importance of the benchmark sector has actually increased since it became clear that covered bonds will be eligible for the LCR. It is likely that regulatory treatment of covered bonds will remain a key driver of developing benchmark issuance in currencies other than euro.

The Covered Bond Label In January 2013, the European Covered Bond Council (ECBC) created the Covered Bond Label. The Covered Bond Label is an initiative to increase transparency within the market and to outline core standards that apply to covered bonds that are certified through the label. The standards that define covered bonds under the label are set out in the Covered Bond Label Convention. These standards include, among other things, certain asset types that can be used as collateral, the existence of a dedicated legislative framework, a dynamic cover pool with ongoing asset substitution and a dual claim of bondholders. In addition the Covered Bond Label provides a template for the regular publication of cover pool data through the issuers that have their covered bonds certified through the label. Further information on the label as well as links to the cover pool data of participating issuers can be found at www.coveredbondlabel.com.


Australian Covered Bonds Legal basis Australian Covered Bonds can be issued on the basis of the Banking Amendment (Covered Bonds) Bill 2011 which was passed into law on 17 October 2011. The law is complemented by regulations and guidelines from the Australian Prudential Regulation Authority (APRA) which were issued as Prudential Standard APS 121.

The issuers Any deposit taking institution in Australia (ADI), which includes banks, credit unions and building societies, is allowed to issue covered bonds. The legal framework requires that the cover assets are owned by a Special Purpose Vehicle (SPV), i.e. an entity that is different from the issuer. The law does not specify the legal form of the SPV, which means that it could be a company or a trust. The SPV holds the cover assets for the benefit of the covered bondholders. The covered bonds represent a dual claim: a senior unsecured claim against the issuing ADI and a secured claim against the SPV, in case the issuer cannot fulfil its payment obligations towards the covered bondholders.

The law also allows for the issuance of grouped or aggregated covered bonds. For this purpose, a number of ADIs establish an aggregating entity which buys covered bonds from those ADIs and uses them as security for a bond issue. This means that an ADI is not liable in the case that the collateral provided by another ADI of the grouped issue underperforms. This method is not dissimilar from that used by Spanish multi-issuer Cédulas, where a number of different covered bonds are pooled together in one large issue.

Cover assets Australian Covered Bonds can be secured by the following assets:

Call deposits held with an ADI and convertible into cash within 2 business days;

Bank accepted bill or certificate of deposit that: 1. Matures within 100 days;

2. Is eligible for repurchase transactions with the Reserve Bank; and

3. Was not issued by the ADI that issued the covered bonds.

A bond, note, debenture or other instrument issued or guaranteed by Australia, or a State or Territory within Australia;

Loans secured by a mortgage, charge or other security interest over residential property in Australia;

Loans secured by a mortgage, charge or other security interest over commercial property in Australia;

Derivatives used for hedging purposes.


Claims from mortgage insurance policies and other compensation claims relating to a cover asset, can also be included in the cover pool. Bank accepted bills and certificate of deposits must not account for more than 15% of the value of the outstanding covered bonds. The law does not contain a provision regarding the use of separate pools for different cover asset classes, i.e. different asset types could be mixed within one pool.

Loan to value limits (LTV limits) for residential and commercial mortgage loans are set at 80% and 60%, respectively. This means that loans only count as collateral for up to 80% or 60% of the value of the property. Outstanding amounts of other loans ranking prior or equal to the loan included in the cover pool, are taken into consideration when calculating the LTV limit.

Each cover pool must have a cover pool monitor. The monitor must be independent from the issuing ADI. Its main tasks are to keep a register of the cover assets, assess compliance of the pools with the asset eligibility criteria and the 3% over-collateralisation requirement, as well as produce cover pool reports. On request, the cover pool monitor also provides cover pool reports to the APRA.

Matching requirements The law requires a minimum over-collateralisation of 3% on a nominal basis. An ADI must not issue covered bonds if the combined value of assets in the cover pools of that ADI would exceed 8% of the value of the ADI’s assets in Australia. The issuance cap can be changed by the APRA at any time by way of regulation and is intended to limit structural subordination of unsecured creditors of the ADI. Other matching requirements referring to interest rate or currency mismatch are not contained in the law.

Post-bankruptcy procedures In the event of a failing ADI that has issued covered bonds, the external administrator has no power over the assets held by the SPV. Cash flows deriving from the pool of cover assets will be used to make payments to covered bondholders. Covered Bonds do not automatically accelerate in the case of the issuer’s insolvency. The documentation of individual covered bond programmes contains asset cover tests and amortisation tests as well as trigger events that outline various steps and procedures before and after an issuer’s insolvency.

Risk weighting Australian covered bonds do not meet the requirements of Article 52(4) of the UCITS directive, and therefore do not qualify for preferential treatment under CRD.

Market development The first Australian covered bond was issued in November 2011 denominated in USD. Since then five Australian banks have issued covered bonds in various currencies including EUR, AUD and GBP. All issuers have so far only used Australian residential mortgage loans as collateral for their covered bonds.


Australian Covered Bonds – Rating Overview Issuer Australian Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch ANZ n.a. Aaa AAA AA- Aa2 AA-

CBAAU n.a. Aaa AAA AA- Aa2 AA-

NAB n.a. Aaa AAA AA- Aaa2 AA-

SUNAU n.a. Aaa AAA A+ A1 A+

WSTP n.a. Aaa AAA AA- Aaa2 AA-

Source - S&P, Moody’s, Fitch

Jumbo Australian CB Gross Issuance Jumbo Australian CB Maturity Profile (Sep 13)

02468

1012141618

2011 2012 Sep-13

US$ bmk

€ bmk€bn

0

2

4

6

8

2015 2016 2017 2018 2019 2020 2022 2025

US$

€

€bn

Source - BNP Paribas Source – BNP Paribas


Austrian Fundierte Anleihen Legal basis The law regarding the issuance of Austrian Fundierte Anleihen (FA) dates back to 1905. It was last amended in June 2005, mainly adding more detailed post-bankruptcy procedures. As a result, payments made under FA no longer accelerate in the event of the issuer’s bankruptcy. However, issuers can specify in their articles of association that the FA will be pre-paid at their net present value (NPV) upon bankruptcy of the issuer.

The issuers Any Austrian bank which has been granted a special license can issue FA. There is no special bank principle. FA represents full recourse against the issuing bank and a preferential claim on the cover pool in the event of the issuer’s bankruptcy.

Cover assets Austrian FA may be covered by mortgages and public sector debt. In addition, Pfandbriefe and other FA may be used as collateral. So far, only FA secured by public sector collateral have been issued. Loans and bonds which are issued or guaranteed by public sector entities in the EU, the EEA and Switzerland are eligible as collateral. Substitute collateral is limited to a maximum of 15%, and can consist of cash or deposits with central banks and other approved credit institutions. The cover assets have to be entered into a special register known as the cover register. An independent cover monitor has to approve any asset that is entered into or taken out of the cover register. Derivatives used for hedging purposes can also be entered into the cover register. In this case, claims of derivative counterparts rank pari passu with those of covered bondholders.

Matching requirements The cover assets must at all times cover at least the repayments and interest payments of the outstanding FA. In addition, potential administration costs occurring in the event of the issuer’s bankruptcy must also be covered. Issuers may commit themselves to provide cover for the FA on an NPV basis including 2% over-collateralisation. This commitment has to be included in the issuer’s articles of association. BAWAG and KA have both committed themselves to NPV coverage including a 2% over-collateralisation.

Post-bankruptcy procedures In the event of the issuer’s bankruptcy, the cover pools and pertaining covered bonds are split from the issuer’s balance sheet and run on their own. A special administrator will be appointed by the bankruptcy court in order to manage the segregated pools. The administrator’s task is to satisfy the claims of covered bondholders using payments coming from the cover pool by selling assets or by engaging in bridge financing. If possible, the administrator will transfer the cover pool and the covered bonds to another sound bank. Alternatively, the covered bonds accelerate and will be repaid at their net present value if this has been specified in the articles of association of the issuer. Both issuers of FA have included in their articles of association the possibility of acceleration and repayment at net present value in the event of the issuer’s bankruptcy.


Risk weighting Austrian FA meet the requirements of Article 52(4) of the UCITS directive as well as the CRD requirements, and qualify for preferential treatment under CRD as long as other covered bonds are not used as collateral.

Market development There are currently four issuers that have FA in benchmark format outstanding. BAWAG P.S.K. Bank für Arbeit und Wirtschaft und Österreichische Postsparkasse Aktiengesellschaft (BAWAG), Kommunalkredit Austria (KA), Raiffeisenlandesbank Niederoesterreich-Wien (RFLBNI) and Raiffeisen-Landesbank Steiermark AG (RFLBST). We expect issuance activity in this market sector to remain stable going forward. There are plans to combine the existing covered bond products in Austria (i.e. Fundierte Anleihen and Pfandbriefe) into one single product governed by a single covered bond law.

Fundierte Anleihen – Rating Overview Issuer Public Sector Fundierte Anleihen Mortgage Fundierte Anleihen Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch S&P Moody’s Fitch BAWAG n.a. Aa1 n.a. n.a. Aa2 n.a. n.a. Baa3 n.a. KA n.a. Aa2 n.a. n.a. n.a. n.a. n.a. Baa3 A RFLBNI n.a. n.a. n.a. n.a. Aaa n.a. n.a. A2 n.a. RFLBST n.a. Aaa n.a. n.a. Aaa n.a. n.a. A2 n.a. Source – S&P, Moody’s, Fitch


Total Outstanding Jumbo FA Outstanding Jumbo FA By Issuer (Sep 13)

0123456789

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0

1

2

3

4

BAWAG KA RFLBNI RFLBST

€bn

Source – BNP Paribas Source – BNP Paribas

Jumbo FA Gross Issuance Jumbo FA Maturity Profile (Sep 13)

0.0

0.5

1.0

1.5

2.0

2.5

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0

1

2

2014 2015 2016 2018 2019 2020 2022 2028

€bn



Austrian Pfandbriefe Legal basis Austrian Pfandbriefe are issued either in accordance with the Austrian Pfandbrief Law from 1927 or Austrian Mortgage Banking Act from 1899. The legal framework applicable depends on the legal structure of the issuer (see below). Both legal frameworks were last amended in 2005.

The issuers Pfandbriefe can either be issued by public sector banks, in accordance with the Pfandbrief Law, or by specialised mortgage banks in accordance with the Mortgage Banking Act. While the Mortgage Banking Act stipulates a special banking provision, the two existing banks (Erste Group Bank (ERSTBK) and Unicredit Bank Austria (BACA)) using this framework are exempt from this regulation for historic reasons. Any new issuer that wants to use the Mortgage Banking Act, would have to adhere to the special bank principle.

Cover assets Austrian Pfandbriefe may be covered by mortgages or public sector debt. Both types of collateral have to be kept in separate pools. Commercial and residential mortgage loans only count as collateral up to a LTV level of 60%. Geographically, lending is limited to Austria, other EEA states as well as Switzerland. Mortgage loans to countries where the preferential treatment of claims of Pfandbrief holders is not comparable to that in Austria, must not exceed 10% of the volume of domestic mortgage loans. For public sector collateral the same geographical restrictions apply. In addition, eligible public sector debt must not have a risk weighting of more than 20%. Substitute collateral is limited to a maximum of 15%, and can consist of cash or deposits with central banks and other approved credit institutions. Derivatives used for hedging purposes can also be entered into the cover register. In this case, claims of derivative counterparts rank pari passu with those of covered bondholders. An independent cover pool monitor is appointed by the Austrian Ministry of Finance. The monitor has to ensure that the cover required for the Pfandbriefe is available at all times.

Matching requirements The cover assets must at all times cover at least the repayments and interest payments of the outstanding Pfandbriefe. In addition, there is a legal minimum over-collateralisation of 2%. Issuers may commit themselves to provide cover for the Pfandbriefe on an NPV basis. This commitment has to be included in the issuer’s articles of association.

Post-bankruptcy procedures In the event of the issuer’s bankruptcy, the cover pools and pertaining covered bonds are split from the issuer’s balance sheet and run on their own. A special administrator will be appointed by the bankruptcy court in order to manage the segregated pools. The administrator’s task is to satisfy the claims of covered bondholders using payments coming from the cover pool by selling assets or by engaging in bridge financing. If possible, the administrator will transfer the cover pool and the covered bonds to another sound bank.


Risk weighting Austrian Pfandbriefe meet the requirements of Article 52(4) of the UCITS directive as well as the CRD requirements and qualify for a preferential treatment under CRD.

Market development Since 2010 the number of benchmark issuing institutions has remained stable. BACA and ERSTBK have issued Mortgage Pfandbriefe as well as Public Sector Pfandbriefe, while HYPO NOE Gruppe Bank AG (HYNOE) has issued exclusively Public Sector Pfandbriefe. There are plans to combine the existing covered bond products in Austria (i.e. Fundierte Anleihen and Pfandbriefe) into one single product governed by a single covered bond law.

Austrian Pfandbriefe – Rating Overview Issuer Public Sector Pfandbriefe Mortgage Pfandbriefe Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch S&P Moody’s Fitch BACA n.a. Aaa n.a. n.a. n.a. n.a. A- A3 A ERSTBK n.a. Aaa n.a. n.a. Aaa n.a. A A3 A HYNOE n.a. Aaa n.a. n.a. n.a. n.a. n.a. A n.a. Source – S&P, Moody’s, Fitch

Total Outstanding Jumbo Pfandbriefe Outstanding Jumbo Pfand. By Issuer (Sep 13)

0

2

4

6

8

10

12

2009 2010 2011 2012 Sep-13

Public Pfand.

Mortgage Pfand.

€bn

0

1

2

3

4

5

BACA ERSTBK NDOLB

Public Pfand.

Mortgage Pfand.

€bn


Jumbo Pfandbrief Gross Issuance Jumbo Pfandbrief Maturity Profile (Sep 13)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2009 2010 2011 2012 Sep-13

Public Pfand.

Mortgage Pfand.€bn

0

1

2

2014 2015 2016 2018 2019 2021 2022

Public Pfand.

Mortgage Pfand.

€bn



Belgian Covered Bonds Legal basis Belgian covered bonds can be issued on the basis of the Covered Bond Act of 3 August 2012. The law is complemented by two Royal Decrees which were issued in October 2012. Furthermore, the National Bank of Belgium has issued regulations regarding the application of the covered bond framework.

The issuers

Any Belgian bank is able to issue covered bonds, provided that it has received the necessary authorisation from the National Bank of Belgium. This means that there is no special banking principle in the Belgian covered bond framework and that covered bonds can be issued directly from the originating bank’s balance sheet. The covered bonds will be full recourse obligations of the issuing bank, providing a preferential claim for the bondholders against a pool of segregated assets in the case of the bank’s insolvency.

Cover assets Belgian covered bonds can be secured by the following assets:

Residential mortgage loans where the underlying property is located within the European Economic Area (EEA);

Commercial mortgage loans where the underlying property is located within the EEA;

Public Sector Debt from issuers within the OECD area; MBS/ABS tranches, where at least 90% of the underlying assets

consist of assets that meet the eligibility criteria for one of the three asset classes mentioned above and where such assets have been originated by an entity which is part of the same group as the covered bond issuer.

At least 85% of the outstanding covered bonds have to be secured exclusively either by residential mortgage loans, commercial mortgage loans or public sector debt (or by MBS/ABS with respective underlying assets). Up to 15% of the outstanding covered bonds can be secured by deposits with credit institutions or other eligible assets. Consequently, it is not possible to have a cover pool that contains 50% commercial and 50% residential mortgage loans. A residential mortgage pool could, however, contain up to 15% of commercial mortgage loans. Derivatives used for hedging purposes can be included in the cover pool as well.

Residential mortgage loans count as collateral up to a maximum of 80% of the value of the underlying property, while the limit is 60% for commercial mortgage loans. Residential mortgage loans, where the mortgage is supplemented by a mortgage mandate, can be used as collateral as well. If the value of the mortgage mandate exceeds 40% of the loan amount, only a part of the loan can be taken into consideration when applying the 80% LTV cut off to calculate the eligible amount.


A mortgage mandate gives the bank the right to register a mortgage at any time in the future. In Belgium, mortgage mandates are used to reduce registration costs in mortgage lending by registering only a part of the loan amount as a mortgage, while the remainder is covered by the mortgage mandate. If the mortgage loan is repaid without the bank seeing any need to register for the full amount, the borrower has saved part of the registration costs.

Cover assets which are in arrears for more than 30 days only count for 50% of their original value. Defaulted cover assets do not count as collateral.

Matching requirements The legal minimum over-collateralisation amounts to 5% calculated on a nominal basis. The framework also provides for an issuance limit, which requires banks to obtain special authorisation from the National Bank of Belgium if any new covered bond issuance would result in the cover pool exceeding 8% of the issuer’s total assets.

Belgian covered bond issuers have to provide a liquidity buffer within the cover pool that is sufficient to cover payment obligations arising from the covered bonds within a period of six months. Issuers are also allowed to use third party liquidity lines to provide the liquidity buffer.

Issuers have to ensure that potential interest rate and currency risks between the cover pool and covered bonds are adequately managed. A specific controller monitors compliance with the collateralisation requirements and reports regularly to the National Bank of Belgium.

Post-bankruptcy procedures Cover assets are earmarked as collateral by entry into a special cover register. In the case of the issuer’s insolvency, the assets contained in the register will not become part of the insolvent estate, but are used to satisfy the claims of covered bondholders. A special portfolio manager is appointed for the segregated assets. The covered bonds do not automatically accelerate in the case of the issuer’s insolvency.

Risk weighting Belgian covered bonds fulfil the requirements of Article 52(4) of the UCITS directive. Depending on the composition of the cover pool, they can also meet the CRD requirements and qualify for a preferential risk weighting within the EU.

Market development The first Belgian covered bond was issued in November 2012 by Belfius Bank (CCBGBB). KBC followed shortly thereafter with its own covered bond issue. Both issuers have so far only used Belgian residential mortgage loans (partially secured by mortgage mandates). At the date of writing no other Belgian issuer has joined the market. We expect both issuers to continue to build a curve in euros, while the number of issuers is unlikely to grow in the near term.


Belgian Covered Bonds – Rating Overview Issuer Belgian Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch CCBGBB AAA n.a. AAA A- Baa1 A-

KBC n.a. Aaa AAA A- A3 A-


Outstanding Belg. bmk. CB by issuer (Sep 13) Belgian benchmark CB Maturity Profile (Sep 13)

0

1

2

3

4

CCBGBB KBC

€bn

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2016 2017 2020 2023

€bn



Canadian Covered Bonds Legal basis In mid-2012, the Canadian government introduced the long awaited covered bond legislation through the amendment of the National Housing Act (NHA). Previously, Canadian banks had issued covered bonds without a specific legal framework, i.e. based on contractual agreements. The new legislative framework, which is complemented by the Canadian Registered Covered Bond Programs Guide (the “Guide”), allows Canadian banks to issue registered covered bonds. With the introduction of the legislative framework, Canadian banks are no longer allowed to issue non-registered (i.e. structured) covered bonds.

The issuers The overall issuance structure for Canadian covered bonds remained largely unaffected by the introduction of a legislative framework. The covered bonds are issued by the originating bank. The bonds are full recourse obligations of the bank and, in addition, benefit from the covered bond guarantee issued by a vehicle (the “Covered Bond Guarantor”) which acquires the cover assets from the originating bank. The purchase of the assets is funded by a loan from the bank to the vehicle. This loan is split in two tranches, i.e. the guarantee loan and the demand loan. The guarantee loan represents the amount needed to fund the collateral necessary to pass the asset cover test, which includes any over-collateral provided through this test. The demand loan is equal to the amount of any voluntary over-collateral that may be contained in the pool and which is not necessary to pass the asset cover test. The originating bank can request repayment of the demand loan at any time and thus reduce voluntary over-collateral that is not needed to pass the monthly asset cover test.

Federally regulated financial institutions as well as cooperative credit societies in Canada can register their covered bond programmes with the Canada Mortgage and Housing Corporation (CMHC). CMHC is sponsored by the Canadian Government and has full recourse to government funds. It is rated AAA by S&P, Moody’s and Fitch. CMHC has been given responsibility to administer the legal framework for Canadian registered covered bonds. It has supervisory powers that include suspension of registered issuers in case of non-compliance of an issuer with the legal framework. In June 2007, the Office of the Superintendent of Financial Institutions (OSFI) set a limit to the issuance of Canadian Covered Bonds. The outstanding covered bonds must not exceed 4% of the issuer’s total assets. Registered covered bonds are subject to the same 4% issuance limit as previously issued non-registered covered bonds

Cover assets The cover assets for registered covered bonds consist of first lien Canadian residential mortgage loans with an initial LTV ratio of not more than 80%. Insured mortgage loans do not qualify as collateral for registered covered bonds. This means that covered bonds that have been issued before the implementation of the legal framework and that are secured by insured mortgage loans cannot be registered with the CMHC. Instead, issuers have to establish new programmes that meet the requirements of the legislative framework.


The cover pool is dynamic and subject to a monthly Asset Coverage Test (ACT). Within the ACT, mortgage loans are only taken into account up to a maximum LTV ratio of 80%. From July 2014 onwards, indexation of underlying house prices is mandatory at least on a quarterly basis. The ACT has to contain a minimum and a maximum asset percentage, resulting in maximum and minimum over-collateralisation. The legal framework does not quantify the levels of maximum and minimum over-collateralisation.

Substitution assets can consist of securities issued by the Government of Canada, repos of Government of Canada securities having terms acceptable to CMHC and sums derived from Government of Canada securities or repos of Government of Canada securities. The volume of substitution assets must not account for more than 10% of the cover pool.

Matching requirements In order to mitigate interest rate and currency exchange rate risk, the Covered Bond Guarantor is required to enter into hedge transactions. Instead of entering into hedge contracts at the time of inclusion of the cover assets, the Covered Bond Guarantor may use Contingent Covered Bond Collateral Hedges to mitigate risks stemming from mismatches between outstanding covered bonds and the cover assets. These contingent hedges do not become effective until the rating of the contingent hedge counterparty falls below a predetermined level or an issuer event of default occurs. The covered bond guarantor is required to perform valuation calculations on a monthly basis. The aim of such calculations is to determine the net present value differences between outstanding covered bonds and the cover assets.

Most Canadian programmes allow for the issuance of covered bonds either with a hard bullet maturity (in conjunction with a pre-maturity test) or with a soft bullet maturity. For covered bonds issued under programmes with both repayment types, the respective transaction documents need to be checked to identify whether it’s a hard or soft bullet repayment.

Post-bankruptcy procedures Following an issuer event of default, the assignment of mortgage loans to the Covered Bond Guarantor is completed and the Covered Bond Guarantor will take over payments of capital and interest to the covered bondholders. Substitution of assets would stop and the cover pool would become static. Cash flows arising from the pool would be passed on to the covered bondholders as originally scheduled, as long as the pool is solvent. The Guide sets a number of minimum events of defaults for the issuer or the guarantor that registered covered bond programmes must contain. These events include the impending or actual insolvency of the issuer, failure to pay principal, interest or any other amount under the covered bonds when due, failure to comply with the remedial action contemplated by a ratings trigger and failure to meet an Amortisation Test (AT) by the guarantor. Registered covered bond programmes may contain additional events of defaults.

Solvency of the pool is determined by a monthly AT, which replaces the ACT after the issuer event of default. In principle, the AT is a simplified ACT. If the AT is breached, the assets held by the Covered Bond Guarantor will be liquidated and the covered bonds accelerated. The purpose of the AT is to


limit subordination of holders of covered bonds maturing at a later date. Covered bondholders continue to have a claim against the issuer, which ranks pari passu with other unsecured creditors.

Risk weighting Registered Canadian covered bonds do not meet the requirements of Article 52(4) of the UCITS directive, and therefore do not qualify for preferential treatment under CRD.

Market development The implementation of a legislative framework for the issuance of Canadian covered bonds has been a significant event for the Canadian covered bond market. The fact that insured mortgage loans are no longer eligible as collateral for new covered bond issuance has caused a drop in issuance activity in the Canadian market. As more Canadian banks establish new registered covered bond programmes, issuance levels are likely to increase again. It remains to be seen, however, if Canadian banks will have similar funding needs for uninsured mortgages as they had for insured mortgages. The fact that there will be a noticeable increase in maturing Canadian covered bonds in the coming years will not necessarily lead to increased covered bond issuance since the insured collateral of the maturing bonds cannot be used again for new registered bonds. At the time of writing, four Canadian banks (CIBC, RY, BNS and NACN) had their covered bond programmes officially registered with the CMHC.

Canadian Covered Bonds – Rating Overview Issuer Canadian Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch BMO AAA Aaa AAA A+ Aa3 AA-

BNS* n.a. Aaa AAA A+ Aa2 AA-

CCDJ n.a. Aaa AAA A+ Aa2 AA-

CM* n.a. Aaa AAA A+ Aa3 AA-

NACN* n.a. Aaa AAA A Aa3 A+

RY* AAA Aaa AAA AA- Aa3 AA

TD n.a. Aaa n.a. AA- Aa1 AA-

Source - S&P, Moody’s, Fitch *) registered programme

Outstanding Benchmark Canadian CB Outstanding Canadian benchmark CB (Sep 13)

05

1015202530354045

2007 2008 2009 2010 2011 2012 Sep-13

US$ bmk

€ bmk

€bn

0

2

4

6

8

10

BMO BNS CCDJ CM NACN RY TD

US$

€

€bn



Cypriot Covered Bonds Legal basis Cypriot Covered Bonds (Kalymmena Axiografa) are issued on the basis of the Covered Bond Law of 2010 (130 (I)/2010), which came into force on 23 December 2010. The law is complemented by a Directive (Administrative Decision 463/2006) which was issued by the Central Bank of Cyprus and came into force on the same day as the covered bond law.

The issuers Issuers need to be credit institutions registered in the Republic of Cyprus and supervised by the Central Bank of Cyprus or the CSSDA. There is no special banking principle, but banks need a special registration as issuers of covered bonds. Covered bond issuance is subject to certain limits. Banks are not allowed to use more than 90% of their eligible assets as cover assets for the covered bonds. In addition, the total value of cover assets in the cover pool must not exceed 25% of the value of all assets of the issuer.

Cover assets The collateral for the covered bonds can consist of residential mortgage loans, commercial mortgage loans, public sector debt and maritime loans. The four asset types must be kept in separate cover pools and thus funded by different types of covered bonds. Derivatives used for hedging purposes can be included in the cover pool. Continuing compliance with the coverage requirements is supervised by the Cover Pool Monitor. The Cover Pool Monitor is appointed by the issuer and approved by the regulator.

Mortgage loans: Only loans secured by first rank mortgages on a property located within Cyprus or any other member state of the EEA can be used as mortgage collateral. Mortgages secured by property in a state where the issuer has no physical presence (i.e. a subsidiary or branch) must not exceed 10% of the value of the cover pool. Issuers are encouraged by the regulator to use separate cover pools for domestic and international mortgage loans. Residential mortgage loans can only be used as collateral if the LTV does not exceed 75%. Residential mortgages with an LTV above 75% but below 100% can be used as collateral as well but only if their total value does not exceed 25% of the value of the cover pool and their inclusion would not result in the weighted LTV of the cover pool exceeding 80%. Commercial mortgage loans can only be used as collateral if the LTV does not exceed 60%. Commercial mortgages with an LTV above 60% but below 80% can be used as collateral as well but only if their total value does not exceed 25% of the value of the cover pool and their inclusion would not result in the weighted LTV of the cover pool exceeding 65%. The value of the underlying property has to be monitored at least once every year for commercial real estate and once every three years for residential real estate.

Public Sector Collateral: Debt issued or guaranteed by central governments, local authorities and regional governments within the EEA qualifies as collateral. Public sector collateral from Australia, Canada, Japan, Switzerland and USA where the claims are denominated and funded in the domestic currency of the said countries and the rating is AA- or higher is also eligible.


Maritime loans: Loans that are secured by a first mortgage on ships can also be used as collateral, provided that the loans have not been granted after the twentieth year of use of the ship. These loans can only be used as collateral if the LTV does not exceed 60%. Loans with an LTV above 60% but below 70% can still be used as collateral if their total value does not exceed 25% of the value of the cover pool and their inclusion would not result in the weighted LTV of the cover pool exceeding 65%. The underlying ship securing the loan needs to be insured for an amount equal to at least 110% of the outstanding balance of the loan.

Substitution assets for public sector covered bonds include government bonds of the Republic of Cyprus, deposits with the ECB or other central banks within the EEA, deposits with credit institutions in the EEA, Australia, Canada, Japan, Switzerland or USA with a rating of AA- or better (if the maturity of those deposits does not exceed 100 days, a minimum rating of A- is sufficient). The deposits with each credit institution shall not exceed 2% of the outstanding balance of covered bonds secured by public claims.

Substitution assets for other types of covered bonds include, in addition to the assets mentioned above, government bonds from other member states of the EEA, government bonds from Australia, Canada, Japan, Switzerland or USA with a rating of AA- or better. Deposits with central banks in Australia, Canada, Japan, Switzerland or USA and deposits with 0% risk weighted multilateral banks and international organisations qualify as substitution assets as well. The total value of substitution assets shall not exceed 15% of the total value of outstanding covered bonds.

Matching requirements The legal framework requires a minimum over-collateralisation of 5% on a net present value basis, which has to withstand a stress test that simulates certain interest rate and currency rate changes. Issuers will be required to maintain a reserve to cover potential set-off risk originating from cover assets where the creditor also has a claim (e.g. from a deposit) against the bank. The weighted duration of the cover assets needs to be longer than the weighted duration of the outstanding covered bonds. Issuers have to provide a liquidity buffer that covers amounts needed for the repayment of covered bonds maturing within the next 180 days (50% of the amount between 180 days to 30 days before the repayment and 100% during the last 30 days before repayment). The buffer can be provided through substitution assets within the pool or through liquid assets outside the pool provided that those assets are exclusively earmarked for the repayment of the covered bonds.

Post-bankruptcy procedures In the case of the issuer’s insolvency the supervisory authority will appoint a Covered Bond Business Administrator. The task of the administrator is to ensure that the claims of the covered bondholders are met using cash flow generated from the assets in the cover pool. The covered bonds do not automatically accelerate in the case of the issuer’s insolvency, however, the Covered Bond Administrator may, with the approval of the regulator, require the immediate settlement of the covered bonds (e.g. if it becomes obvious that cover assets are insufficient to repay all covered bonds in full) or the transfer of the covered bond business to another institution.


Risk weighting The covered bonds meet the requirements of Article 52(4) of the UCITS directive. In addition, they meet the requirements of the CRD and thus qualify for a preferential risk weighting under CRD.

Market development In March 2013, resolution measures were implemented on Laiki Bank (CPBCY) which resulted in the absorption of insured deposits and the majority of assets and loans by Bank of Cyprus (BOCYCY). At the time of writing, there is only one covered bond outstanding under the programme of Bank of Cyprus.

Cypriot Covered Bonds – Rating Overview Issuer Cypriot Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch BOCYCY n.a. Caa2 B n.a. Ca RD



Danish Covered Bonds Legal basis The issuance of covered bonds in Denmark is regulated by the Danish Financial Business Act and Executive Orders. The framework was amended in 2007, mainly in order to achieve compliance with CRD requirements. In addition, the amendment resulted in the abolition of the special banking principle. Before the amendment, only specialised mortgage banks were able to issue covered bonds (Realkredit Obligationer, RO). The amendment of the framework introduced two other types of covered bonds, namely Covered Mortgage Bonds (Særligt Dækkede Realkredit Obligationer, SDRO) and Covered Bonds (Særligt Dækkede Obligationer, SDO). The main difference between the old RO and the new SDRO is compliance with CRD requirements by the latter. In order to achieve this, a requirement to monitor and comply with LTV limits of mortgages in the cover pool was introduced. As a further change, a new type of balance principle was introduced, allowing issuers a greater mismatch between covered bonds and the cover pool.

The issuers Issuers can be either mortgage banks or commercial banks, provided that they have obtained a special license. The issuers are under the special supervision of the Danish Financial Services Authority (DFSA).

Cover assets The collateral for RO and SDRO can consist of commercial, agricultural and residential mortgage loans with a maximum LTV limit of 60%, 70% and 80%, respectively, as well as public sector debt. SDO can be collateralised by mortgage loans with the same LTV limits, as well as ship mortgage loans with an LTV limit of 70%. Ship mortgage loans must be kept in a separate cover pool and cannot be mixed with other mortgage loans. The geographical range of eligible mortgage loans is generally limited to Denmark, although the DFSA can authorise the issuer to include mortgage loans which have been originated outside of Denmark. In addition, public sector debt as well as bank debt which meet the requirements of CRD can be used as collateral. The volume of bank debt used as collateral must not exceed 15% of the volume of outstanding covered bonds. Derivatives used for hedging purposes can also be included in the cover pool.

Matching requirements Matching requirements for Danish covered bonds (RO, SDRO and SDO) follow the balance principle, which limits mismatches between the cover assets and the outstanding covered bonds. Danish issuers have the possibility to choose between a specific and a general balance principle for their covered bonds. The specific balance principle allows very little mismatch in interest rate, currency, option or liquidity risk, while the general balance principle allows greater mismatches through wider limits in its stress tests. The main difference between the two principles is that the general principle allows maturity mismatches, which enables issuers to issue Jumbo style covered bonds, i.e., non-callable and with a bullet maturity.


Post-bankruptcy procedures In the event of the insolvency of the issuer, substitution of assets would stop and the cover pools would become static. The outstanding covered bonds would not automatically accelerate. An administrator would be appointed with the right to sell assets in the cover pool (to the extent that the contractual provisions of the respective mortgage agreements allow this) in order to bridge liquidity gaps. In addition, the administrator can raise liquidity by taking out a loan. Should the proceeds from the cover assets not be sufficient to fully repay all covered bonds, remaining claims will rank pari passu with the claims of the other unsecured creditors of the issuer if it is a commercial bank. If the issuer is a mortgage bank, remaining claims of covered bondholders rank above claims of other unsecured creditors.

Risk weighting SDRO and SDO meet the requirements of Article 52(4) of the UCITS directive as well as the CRD requirement, and qualify for preferential treatment under CRD. RO do not meet the CRD requirements.

Market development The SDO market continues to be dominated by Danske Bank (DANBNK), which so far is the only issuer that has issued in € benchmark format. The bank can issue covered bonds which are either secured by domestic or international residential mortgages as well as a mix of residential and commercial international mortgages. Other Danish issuers continue to focus on the SDRO market, which is mostly denominated in DKK and has a total outstanding volume which is equivalent to more than €300bn. According to the Association of Danish Mortgage Banks, close to 80% of the outstanding bond volume is held by Danish institutional investors.

In 2010, the first Junior Covered Bond (JCB) denominated in € was issued by Nykredit Realkredit A/S. JCBs are issued in accordance with section 33e of the Danish Mortgage-Credit Loans and Mortgage-Credit bonds etc. Act. Holders of JCBs have a secondary secured claim on the cover assets within a capital centre or cover pool. This claim ranks below the claim of covered bondholders within that capital centre or cover pool. If the issuer breaches the balance principle or faces bankruptcy, all payments to JCB holders are deferred on a cumulative basis. Payments to holders of JCB only resume after all covered bonds have been repaid. JCBs are issued to fund the purchase of additional collateral which is needed to compensate for a potential shortfall in collateral due to rising LTV ratios (usually caused by falling house prices). The proceeds from issuing a JCB must be used to purchase mortgage assets, public sector assets, government bonds or claims against credit institutions.

Danish Covered Bonds (SDO) – Rating Overview Issuer Danish Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch DANBNK AAA n.a. AAA A- Baa1 A



Outstanding Danish SDO By Issuer (Sep 13) Jumbo Danish SDO Maturity Profile (Sep 13)

0

2

4

6

8

10

DANBNK

€bn

0.0

0.5

1.0

1.5

2.0

2.5

2015 2016 2018 2019 2020 2022

€bn



Dutch Covered Bonds Legal basis Issuance of Dutch Covered Bonds started in 2005, based on contractual agreements in the absence of a specific legal framework. In the summer of 2008 a regulatory framework for the issuance of covered bonds was introduced. The Dutch regulation follows a principles based approach and does not contain detailed rules regarding eligible assets. Instead Netherlands-based banks can register their covered bonds with the Dutch Central Bank. The central bank will then assess whether the covered bonds provide a high degree of certainty that the obligations to bondholders may be met at all times. In doing so, the central bank looks at the cover assets as well as procedures of the issuing bank regarding the pledging of collateral during the life of the bonds. In addition, the central bank relies on credit ratings given to the covered bonds by recognised credit rating agencies. Registered covered bonds must be rated at least AA- (or equivalent) by a recognised rating agency. The central bank made it clear that a breach of the registration requirements (e.g. a downgrade below AA-), does not automatically lead to a deregistration (and thus loss of supervision) of the covered bonds. Instead, the issuer would be unable to issue new covered bonds until the central bank is of the opinion that the situation has improved.

Banks also have the opportunity to issue covered bonds that are not registered with the central bank and therefore do not fall under the supervision of the central bank.

The issuers Dutch Covered Bonds are issued by the bank that also originates the cover assets. The cover assets are then assigned to a special entity, the Covered Bond Company (CBC). The assignment does not require notification of the mortgage borrower, which continues to make payments to the originating bank until notified of the transfer. The bank issues a senior unsecured bond, which is then guaranteed by CBC. Under the guarantee agreement, the CBC agrees to take over payments of interest and capital to the covered bondholders in the event of a default. Covered bondholders have full recourse against the bank, as well as a secured claim against CBC under the covered bond guarantee.

Cover assets As mentioned above, the regulatory framework does not contain any eligibility criteria for covered assets. It is thus up to the issuers to define individual eligibility criteria in their covered bond programmes. At the time of writing, all issuers use only Dutch residential mortgage loans as collateral. A quarterly Asset Coverage Test (ACT) ensures that there is sufficient collateral for the outstanding covered bonds. Mortgage loans only count as collateral up to a loan-to-value ratio of 80%. Valuation of the underlying property is linked to a Dutch house price index. In addition to the 80% loan to value ratio within the ACT, the programmes also provide a loan to value cut-off in the eligibility criteria, which ranges between 125% and 130%. If mortgage loans have a higher LTV they do not count as collateral at all. The ACT also provides for a minimum over-collateralisation, and considers potential set-off risk. A breach of the ACT does not constitute an issuer


event of default, but would prevent the bank from issuing further covered bonds under the programme. If the breach is not remedied until the next calculation date, the transfer of the cover assets to the CBC will be completed.

Substitution assets include exposures to 0% risk-weighted public sector entities and central banks, as well as exposures to 10% risk-weighted institutions. Exposures to 20% risk-weighted institutions and AAA-rated RMBS tranches can also be used, but only if their value does not exceed 10% of the value of outstanding covered bonds.

Matching requirements Interest rate mismatches are hedged via a total return swap between the bank and CBC. Potential currency risks will be hedged via swaps with suitably rated counterparts. Swap counterparties need to be exchanged if their rating level falls below a specified level.

Programmes of AAB and ING allow for covered bond issuance with soft or hard bullet maturities, while ACHMEA and SNS only issue covered bonds with soft bullet maturities. In September 2013, NIBCAP issued its first covered bond with a conditional pass through structure.

In its supervisory role for registered covered bonds, the Dutch Central Bank determines a healthy ratio of covered bonds to disposable assets. While there is no explicit issuance limit for covered bonds (as is the case in Australia, Belgium and Canada), this regulation aims to ensure that the issuer has enough available assets on its balance sheet to honour the coverage requirements. At the same time, the central bank wants to prevent excessive over-collateralisation in order to protect unsecured creditors.

Post-bankruptcy procedures In the event of the issuer’s default, the transfer of mortgage assets to the CBC will be completed by notification of the mortgage borrowers. The CBC takes over payment of interest and capital to the covered bondholders as originally scheduled. In the event of the bank’s default, the ACT would be replaced by the Amortisation Test (AT), which is designed to ensure that the CBC can meet its obligations under the covered bond guarantee. A breach of the AT would result in a default of the CBC and acceleration of payments under the covered bond guarantee. In the case of NIBCAP’s covered bonds with a conditional pass through structure a breach of the AT would turn the bullet repayment of outstanding covered bonds into pass through repayment with a maturity extension of up to 32 years.

Covered bondholders have a residual claim against the issuer in the event that CBC cannot satisfy all claims under the covered bonds. The residual claims rank pari passu with other unsecured creditors of the issuer.

Risk weighting Registered Dutch Covered Bonds meet the requirements of Article 52(4) of the UCITS directive. However, it is up to the individual issuer to fulfil the requirements of CRD (mainly by the choice of cover assets). The mere fact that Dutch Covered Bonds are registered does not automatically lead to preferential treatment under CRD.


Market development The Dutch Covered Bond market has shown significant growth in recent years, taking total benchmark market size to over €42bn as of September 2013. The Dutch government has announced plans to establish a National Mortgage Institute which will buy RMBS tranches from Dutch banks and use them as collateral in conjunction with a state guarantee for its funding. The aim is to support mortgage lending in the Netherlands and to increase the involvement of Dutch institutional investors in funding the Dutch mortgage market. It remains to be seen if such an initiative will have a limiting impact on covered bond issuance volumes in the Netherlands

Dutch Covered Bonds – Rating Overview Issuer Dutch Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch

AAB AAA Aaa AAA A A2 A+ ACHMEA n.a. Aa2 AAA A n.a. A- INTNED AAA Aaa AAA A+ A2 A+ NIBCAP AAA** n.a. AAA** BBB- Baa3* BBB- SNSSNS n.a. A1 AA+ BBB Baa3 BBB+ Source - S&P, Moody’s, Fitch *) unsolicited **) conditional pass through covered bonds

Total Outstanding Jumbo CB Outstanding Jumbo CB By Issuer (Sep 13)

05

1015202530354045

2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

02468

10121416182022

ABNANV ACHMEA INTNED SNSSNS

€bn


Jumbo CB Gross Issuance Jumbo CB Maturity Profile (Sep 13)

0

2

4

6

8

10

12

2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0

2

4

6

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

€bn



Finnish Covered Bonds Legal basis Finnish Covered Bonds (FCB) are issued on the basis of the Finnish Covered Bond Act (statute 688/2010), which came into effect in August 2010. The 2010 Act replaces the original Covered Bond Act that was established in 1999. The law is supplemented by a regulation issued by the Finnish Financial Supervision Authority.

The issuers With the modernisation of the Finnish Covered bond framework the special banking principle was dropped. This means that FCB can now also be issued by banks that are not specialised mortgage lenders as long as they have been specially licensed by the supervisory authority.

Cover assets FCB can either be secured by public sector debt or mortgage loans. According to the amended legal framework both types of assets can be mixed within one cover pool. Residential mortgages can only be used as collateral up to an LTV of 70%, while the LTV limit for commercial mortgages is 60%. The share of commercial mortgages within the cover pool is limited to 10% of the total pool. Public sector collateral can consist of debt from the central governments, regional governments and municipalities of a state belonging to the EEA.

The change of the Finnish legislation also provided issuers with the possibility to provide intermediary credit to other deposit banks or credit entities. Intermediary credits have to be secured by assets that are also eligible as collateral for Finnish covered bonds. The assets securing the intermediary credit have to be entered into the cover register of the lending institution. These assets count as collateral for the covered bonds despite still being on the balance sheet of the bank that received the intermediary credit. The concept of intermediary credit has been introduced to allow smaller banks to pool their collateral and funding needs into one bank (the lender of intermediary credit), which then issues large sized covered bonds. At the time of writing no pooled covered bond issuance has occurred in Finland.

Substitute collateral consisting of bonds or debt obligations from public sector entities which are also eligible as ordinary collateral, as well as debt from banks which are outside the consolidation group of the issuer may temporarily be used as collateral for FCB up to a maximum of 20%. Derivatives used for hedging purposes can also be included in the cover pool. The Finnish framework does not provide for an independent cover monitor.

Matching requirements The covered bond framework requires nominal and net present value matching. Within the updated framework, a 2% minimum over-collateralisation has been introduced. The over-collateral is calculated on a net present value basis. The total amount of interest receivable from the cover pool within a 12 month period must be higher than the total amount of


interest payable on the outstanding covered bonds within the same period. Currency risks have to be hedged.

Post-bankruptcy procedures Covered bondholders have a preferential claim from the proceeds of the cover pool in the event of the issuer’s bankruptcy. Cover pools and covered bonds are split from the issuer’s balance sheet in the event of its bankruptcy and run independently. FCB do not accelerate in the event of the issuer’s bankruptcy.

Claims of covered bondholders that cannot be satisfied from the cover pool rank pari passu with unsecured claims against the issuer.

Risk weighting FCB meet the requirements of Article 52(4) of the UCITS directive. In addition, FCB meet the requirements of the CRD provided that non-guaranteed bank debt does not exceed 15% of the cover pool and thus qualify for a preferential risk weighting under CRD.

Market development Following the abolishment of the special banking principle Aktia Bank (AKTIA) and Danske Bank plc (SAMBNK) decided to move the covered bond issuing business to the parent bank level. In the case of AKTIA, a new programme was set up by the parent bank while the outstanding covered bonds remained with the mortgage bank subsidiary (Aktia Real Estate Mortgage Bank). Sampo Housing Loan Bank plc was merged with Sampo Bank plc, which was subsequently renamed Danske Bank plc. Outstanding covered bonds and cover pools were moved to the merged entity.

Finnish Covered Bonds – Rating Overview Issuer Finnish Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch AKTIA (MB) n.a. Aa3 n.a. A- A3* n.a.

AKTIA (PLC) n.a. Aaa n.a. A- A3 n.a.

NDASS n.a. Aaa n.a. AA- Aa3 AA-

POHBK AAA Aaa n.a. AA-* Aa3* A+*

SAMBNK n.a. Aaa n.a. A- A2 n.a.

Source - S&P, Moody’s, Fitch *) Parent rating

Outstanding Finnish CB By Issuer (Sep 13) Jumbo Finnish CB Maturity Profile (Sep 13)

0

2

4

6

8

10

12

AKTIA NDASS POHBK SAMBNK

€bn

0

1

2

3

4

2014 2015 2016 2017 2018 2019 2020 2021

€bn



French Obligations Foncières Legal basis In 1999, France introduced a legal framework for the issuance of covered bonds, called Obligations Foncières (OF). The law was amended in 2001 with the main changes being the geographical expansion of the cover assets outside the European Economic Area and the acceptance of public sector bonds (in addition to loans) as collateral. In 2007, the framework was amended once more, increasing the maximum of prêts cautionnés (guaranteed home loans) within the cover pool to 35% from 20%, amending revaluation criteria as well as aligning some collateral restrictions with CRD requirements. The legal framework for OF was again amended in October 2010. The main changes comprised the introduction of minimum over-collateralisation, mandatory liquidity buffers and the ability to use its own covered bonds to raise liquidity with central banks.

The issuers Obligations Foncières can only be issued by specialised credit institutions (Société de Crédit Foncier, [SCF]) the business activities of which are restricted by law. Business activities are limited to mortgage and public sector lending as well as the issuance of covered bonds and other non-preferred (i.e. unsecured) debt. As a result of this very strict special bank principle, all assets on the SCF’s balance sheet are cover assets. There is no earmarking of cover assets by entry into a cover register. The specialised character of the SCF is further underlined by the fact that the issuer usually does not have its own staff, but is managed by its parent company. The parent company, which has to be a bank, is also conducting the asset origination for the SCF. The assets are then transferred to the SCF which funds them through the issuance of OF. The transfer of mortgage assets from the parent bank to the SCF is facilitated by the fact that, under French law, the transfer does not require a change in the land registry or even the notification of the mortgagee. In some cases the asset transfer is conducted through the use of Mortgage Backed Securities (MBS), where the parent company first securitizes the cover assets then transfers the MBS tranche to the SCF. The SCF is under the special supervision of the French Autorité de Contrôle prudential (ACP), which ensures that the SCF is compliant with the covered bond framework.

Cover assets Obligations Foncières can be collateralised by mortgages (and guaranteed home loans), public sector debt, Asset Backed Securities (ABS) and MBS. ABS/MBS are only eligible as collateral if at least 90% of the underlying assets meet the eligibility criteria for OF. There are no separate cover pools for the respective asset classes. Thus, OF can be secured by a mix of public and mortgage assets as well as ABS/MBS. An independent cover monitor (Controlleur Specifique) ensures that the SCF adheres at all times to the requirements for the covered bond framework. The monitor reports directly to the ACP.


Generally, mortgages with a maximum LTV ratio of 60% are eligible as collateral. If the mortgage loan has been granted to individuals in order to finance the building or acquisition of housing, a maximum LTV ratio of 80% applies. Mortgages can have a 100% LTV ratio if they benefit from a guarantee from the Fonds de Garantie de l’Accession Sociale (FGAS), which is equivalent to a public sector guarantee. The collateral can also contain up to 35% of home loans which are not secured by a mortgage but by a guarantee from a bank or insurance company. If the guaranteeing entity is not part of the same group as the issuer, the following weightings are given to the guaranteed home loans as collateral:

100% weighting is given to secured home loans if the guaranteeing or insuring institution is rated at least A3/A-.

80% weighting is given to secured home loans if the guaranteeing or insuring institution is rated at least Baa3/BBB-.

0% weighting for loans secured by other institutions. If the guaranteeing entity is part of the same group as the issuer, the following weightings are given to the loans as collateral:



0% weighting for loans secured by other institutions. Geographically, the range of eligible mortgages is limited to the EEA, as well as countries that benefit from the highest level of credit ratings.

The valuation of mortgages used as collateral has to take into account the long-term lasting characteristics of the building, normal and local market conditions as well as the current and possible alternative use of the property.

Loans and bonds issued or guaranteed by central and regional governments within the EEA, Switzerland, USA, Canada, Japan, Australia and New Zealand qualify as public sector collateral for OF. Public sector bonds must be acquired with the intention of holding them until maturity. The French framework allows ABS and MBS to be included in the collateral if at least 90% of the underlying assets consist of eligible mortgage or public sector debt. To what extent ABS/MBS count as collateral within the pool depends on the originator, the rating of the securitisation and the time at which the securities have been acquired by the issuer. If the underlying assets of the ABS/MBS have been transferred by an institute that is a member of the same group as the issuer of the covered bonds:

As long as the securities have been acquired by the issuer after 31 December 2011 but before 31 December 2014 the securities count as collateral with the following weightings: 100% as long as they are rated AAA. 80% if the rating is between AA- and AA+. 0% if the rating is below AA-.

If the securities have been acquired by the issuer before 31 December 2011 or after 31 December 2014 the securities count as collateral with the following weightings:


100% as long as they are rated AAA. 50% if the rating is between AA- and AA+. 0% if the rating is below AA-.

If the underlying assets of the ABS/MBS have been transferred by an institute that is not a member of the same group as the issuer of the covered bonds:


If the securities have been acquired by the issuer before 31 December 2011 or after 31 December 2014 the securities count as collateral with the following weightings: 100% as long as they are rated AAA. 0% if the rating is below AAA.

Substitution assets are limited to securities, which are eligible for repo with the ECB. The share of substitution assets within all cover assets must not be greater than 15%.

Matching requirements With the latest amendment of the legal framework, a minimum over-collateralisation of 2% was introduced for OF. In addition, the regulation contains provisions for the establishment of a liquidity buffer. Within each issuer cash flow mismatches occurring within the next 180 days on a rolling basis have to be covered by liquid assets. Liquid assets can be assets that meet the criteria for substitution assets as well as assets that are eligible as collateral for liquidity operations with the Banque de France. The new regulation also allows SCF to issue covered bonds, retain (i.e. not sell to any third party) and use them as collateral for liquidity operations with the central bank. This option will only be available if the issuer cannot raise liquidity in any other way. Issuance of retained covered bonds will be limited to a maximum of 10% of the issuer’s balance sheet size.

Post-bankruptcy procedures In the event of the issuer’s insolvency, the assets will be used to make interest and capital payments to the covered bondholders. There is no split of assets from the issuer’s balance sheet: therefore, the whole issuer will become static. Other creditors of the SCF will have no access to the assets as long as there are OF outstanding. If the assets on the balance sheet of the issuer are not sufficient to cover all claims of the covered bondholders, they have no further claim against the parent company of the SCF. However, there is a high probability that the regulator will urge the parent companies to support its banking subsidiaries.

Risk weighting French OF meet the requirements of Article 52(4) of the UCITS directive. Compliance with CRD depends on the use of ABS/MBS as collateral. Until


the end of 2017 OF secured with ABS/MBS are CRD compliant as long as the underlying residential or commercial mortgage loans were originated by a member of the same consolidated group of which the issuer is also a member.

Market development Issuance volumes in the OF market dropped significantly in 2012 and to date in 2013. Limited funding needs of existing issuers and the fact that no new issuers have entered the OF market recently are the main reasons for the drop in supply. The return of CAFFIL to the OF market may slightly increase issuance volumes. On the other side, we do not expect CIFEUR to return to the primary market in the foreseeable future.

French Obligations Foncières – Rating Overview Issuer Obligations Foncières Unsecured Debt Of Parent


ACASCF AAA Aaa n.a. A A2 A+

AXASA n.a. Aaa AAA n.a. A2 n.a.

BNPSCF AAA n.a. AA+ A+ A2 A+

CAFFIL AAA Aaa AA+ AA+ Aa2 AA+

CFF AAA Aaa AAA A- A2 A

CIFEUR n.a. Aa2 AAA n.a. Baa2 A

CMARK AAA n.a. n.a. A Aa3 n.a.

GE AAA Aaa n.a. AA+ A1 n.a.

SOCSCF AAA Aaa n.a. A A2 A


Total Outstanding Jumbo OF Outstanding Jumbo OF By Issuer (Sep 13)

0102030405060708090

100

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0

5

10

15

20

25

30

35

ACASCF AXASA BNPSCF CAFFIL CFF CIFEUR CMARK GE SOCSCF

€bn

Source – BNP Paribas Source - BNP Paribas

Jumbo OF Gross Issuance Jumbo OF Maturity Profile (Sep 13)

0

5

10

15

20

25

30

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0

2

4

6

8

10

12

14

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2028 2055

€bn

Source - BNP Paribas Source - BNP Paribas


French Obligations de Financement de l’Habitat Legal basis The first structured covered bond was issued in late 2006 using contractual agreements instead of the existing OF framework. In order to provide a statutory framework for the growing number of French covered bonds that were not based on the OF framework, a new law on banking and regulation was adopted by the French Parliament on 11 October 2010. The law established a new type of covered bond issuer, the Société de Financement de l’Habitat (SFH). Covered Bonds issued by SFH are called Obligations de Financement de l’Habitat (OH) and represent another regulated covered bond type next to Obligations Foncières (OF). The framework is complemented by a separate decree which was issued at the beginning of 2011. Segregation of collateral assets will continue to be based on the European Collateral Directive which has been transposed into the French Monetary and Financial Code.

The issuers SFH are specialised credit institutions under the supervision of the French Autorité de Contrôle Prudential (ACP), which also supervises issuers of OF. Similar to SCF, SFH are usually not engaged in any direct lending activities. The main purpose of the SFH is to make advances to the originator or sponsor bank and finance these advances through the issuance of covered bonds. Payments to the covered bondholders are made on the basis of the amounts the issuer receives from the sponsor bank (or the cover pool in the event of a sponsor bank’s default) under the advance agreement. The covered bonds represent limited recourse obligations of the issuer. The secured claims under the advance agreement constitute a full recourse obligation of the sponsor bank towards the SFH.

Cover assets OH can be collateralised by secured loans granted to credit institutions. The collateral for the secured loans can consist of home loans for which either a first ranking mortgage (or real estate security) is in place or of home loans secured by a guarantee issued by a credit institution or an insurance company. SFH are also able to grant home loans directly and use those as collateral for OH if they meet the eligibility criteria. There is no limit on the amount of home loans used as collateral.

The framework contains the same rating limits for institutions that guarantee or insure the home loans as the OF framework. If the guaranteeing entity is not part of the same group as the issuer, the following weightings are given to the loans as collateral:



0% weighting for loans secured by other institutions.


If the guaranteeing entity is part of the same group as the issuer, the following weightings are given to the loans as collateral:



0% weighting for loans secured by other institutions. Only home loans used to finance residential real estate property located within the EU, the EEA or any other AAA-rated country will be eligible as collateral. Loans secured by commercial property are not eligible as collateral. The LTV limit for home loans used to finance residential property is set at 80%.

ABS/MBS can also be included in the collateral if at least 90% of the underlying assets consist of eligible mortgage loans or home loans. To what extent ABS/MBS count as collateral within the pool depends on the originator, the rating of the securitisation and the time at which the securities have been acquired by the issuer. If the underlying assets of the ABS/MBS have been transferred by an institute that is a member of the same group as the issuer of the covered bonds:


If the securities have been acquired by the issuer before 31 December 2011 or after 31 December 2014 the securities count as collateral with the following weightings: 100% as long as they are rated AAA. 50% if the rating is between AA- and AA+. 0% if the rating is below AA-.

If the underlying assets of the ABS/MBS have been transferred by an institute that is not a member of the same group as the issuer of the covered bonds:


If the securities have been acquired by the issuer before 31 December 2011 or after 31 December 2014 the securities count as collateral with the following weightings: 100% as long as they are rated AAA. 0% if the rating is below AAA.


Substitution assets are limited to securities, which are eligible for repo with the ECB. The share of substitution assets within all cover assets must not be greater than 15%.

Even though the legal framework does not contain provisions that require issuers to conduct an ACT, issuers have kept such ACT in their programmes as they were converted from contractual to legislative basis. If the ACT is not passed, the sponsor bank has to add additional collateral accordingly. In the case that the ACT is not passed on the following test date, a borrower’s event of default occurs which enables the issuer to enforce its security in the cover pool. While the breach of the ACT does not lead to an issuer event of default, it prevents the issuer from issuing further covered bonds.

Matching requirements At an initial stage there will be no hedging at the issuer level. Hedging of interest rate and currency mismatches will be conducted within the general treasury and hedging operations of the sponsor bank. Since the payments received by the issuer under the borrower facility match the payments to the covered bondholders, the issuer is not exposed to any currency or interest rate risk. This can change if the issuer has to enforce its security in the cover assets, which will result in the issuer receiving unmatched payments from the cover pool. In order to avoid such a scenario, the issuer has to enter into a series of swaps in order to hedge currency and interest rate risk once the rating of the sponsor bank falls below a certain level. In order to match the cash flows from these swaps, the issuer will enter into back-to-back swaps with the sponsor bank. If the issuer has to enforce its security, it has the right to cancel the back-to-back swaps with the sponsor bank at no cost, leaving it only with the swap agreements it has entered to hedge the cash flows arising from the collateral.

The framework provides for a legal minimum over-collateralisation of 2%. The over-collateralisation has to be held at the level of the parent company or sponsor bank within the pool of assets that secures the advances from the SFH. The same applies to the liquidity buffer, which is not provided at the level of the issuer. Like SCF, SFH are allowed to issue covered bonds, withhold them (i.e. not sell to any third party) and use as collateral for liquidity operations with the central bank.

Post-bankruptcy procedures In the event of a default of the sponsor bank, the issuer has the right to enforce its security interest in the cover pool. The outstanding covered bonds will not automatically accelerate in such a scenario. The issuer will use the cash flows, which are hedged by the swap agreements mentioned above, to continue to make payments to the covered bondholders. With the borrower’s event of default, substitution of collateral assets stops and the pool becomes static. Liquidity needed to repay maturing covered bonds will most likely have to be raised by selling or securitising cover assets.

Risk weighting OH meet the requirements of Article 52(4) of the UCITS directive, and from January 2014 will qualify for preferential treatment under CRD.


Market development Since the introduction of the legislative framework the number of issuers increased further with Banque Postale (LBPSFH) being the latest issuer to join this market segment. New issue volumes declined in line with the overall market development in 2012 and year to date in 2013. Improved regulatory treatment of OH from 2014 onwards and larger volumes of maturing bonds going forward could lead to a slight increase in issuance activity.

OH / French Covered Bonds – Rating Overview Issuer Obligations de Fin. de l’Habitat Sponsor Bank Rating


ACACB AAA Aaa AAA A A2 A+

BNPPCB AAA n.a. AAA A+ A2 A+

BPCECB AAA Aaa n.a. A A2 A+

CMARK AAA n.a. n.a. A Aa3 n.a.

CMCICB AAA Aaa AAA A+ Aa3 A+

HSBC AAA Aaa n.a. AA- A1 AA-

LBPSFH AAA n.a. n.a. A+ n.a. A+

SOCSFH n.a. Aaa AAA A A2 A

Issuer French Covered Bonds Sponsor Bank Rating S&P Moody’s Fitch S&P Moody’s Fitch

BPCOV AAA AAA n.a. A A2 A+

CDEE AAA Aaa n.a. A A2 A+


Total Outstanding Jumbo OH Outstanding Jumbo OH By Issuer (Sep 13)

0

10

20

30

40

50

60

70

80

2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

02468

1012141618

ACACB BNPPCB BPCECB CMARK CMCICB HSBC LBPSFH SOCSFH

€bn


Jumbo OH Gross Issuance Jumbo OH Maturity Profile (Sep 13)

0

5

10

15

20

2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0

2

4

6

8

10

12

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

€bn



Caisse de Refinancement de l’Habitat Legal basis Caisse de Refinancement de l’Habitat (CRH) issues collateralised bonds with a minimum over-collateralisation of 25%. Its issue activity is governed by the Articles L. 313-42 to L. 313-49 of the French Monetary and Financial Code. The selection of mortgage assets used as collateral is governed by Article 515-14, which is also part of the legal framework of Obligations Foncières.

The issuer CRH is established as a Société Financière and is subject to French banking law and supervision by the Autorité de Contrôle Prudential (ACP). CRH’s sole purpose is to refinance housing loans granted by its shareholders, which consist of a group of 20 financial institutions. For this purpose, CRH buys discountable bills (billets de mobilisation or BDM) from its shareholders and issues bonds in the capital markets. The BDMs are secured by residential mortgage loans which remain on the balance sheet of the respective shareholder. The shareholders are responsible for the solvency of CRH and have to make liquidity advances of up to 5% of the funding volume they conduct via CRH.

Cover assets The collateral for the BDMs consists of a dynamic pool of residential mortgage loans and guaranteed home loans (prêts cautionnés) on the balance sheet of the shareholder. The share of prêts cautionnés within the cover pool is limited to 35% (same as with Obligations Foncières). The maximum LTV ratio is limited to 90%. The geographical range of underlying properties is limited to the EU. Senior tranches of securitisation transactions (i.e. MBS) are also eligible if at least 90% of the underlying assets are also directly eligible by law. However, internal rules of CRH exclude the use of MBS as collateral. CRH monitors the underlying collateral through audits that it conducts at least once every two years.

Matching requirements There is a full matching between the bonds issued by CRH and the underlying BDMs. Matching between the property loan portfolio and the respective BDMs is conducted through the general balance sheet management of the bank that sold the BDMs to CRH. The property loan portfolio has to cover at least 125% of the value of the outstanding BDMs. In the case of property loans with variable rates, CRH requires a collateralisation of 150%.

Post-bankruptcy procedures In the event of a default of one of the shareholders on their BDMs, CRH automatically becomes the owner of the pledged collateral. The collateral assets would then be sold to another shareholder and CRH would buy back an equivalent part of its outstanding bonds. CRH solvency is supported by its shareholders


Risk weighting CRH bonds meet the requirements of Article 52(4) of the UCITS directive and qualify for preferential treatment under CRD.

Market development At the end of 2012, CRH had bonds outstanding with a total volume in excess of €52bn. Most of the funding is conducted in benchmark form with frequent tapping of outstanding bonds. Five of CRH’s benchmark bonds have reached an outstanding volume of €4bn or more each. The growing number of French banks that issue covered bonds has had no significant impact on CRH’s issuance activity. CRH provides a straightforward and low-cost funding alternative for its shareholders that can also be complementary to direct covered bond issuance of these institutions.

CRH € benchmark maturity profile (Sep 13)

0

1

2

3

4

5

6

7

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

€bn

Source - BNP Paribas


German Pfandbriefe Legal basis German Pfandbriefe are issued on the basis of the German Pfandbrief Act which came into effect on 19 July 2005. The Pfandbrief Act replaced a number of covered bond laws which had been in place for several issuer groups, namely specialised mortgage banks, public sector banks and ship-mortgage banks. The amendment of the Pfandbrief Act in May 2009 widened the scope of cover assets, allowing for the first time the issuance of Pfandbriefe secured by aircraft financing loans. Later amendments focussed on the improvement of transparency as well as strengthening the powers of the cover pool administrator.

The issuers The Pfandbrief Act allows every German bank, which has received a special license, to issue Pfandbriefe. Until July 2005, German Pfandbrief issuers were subject to the special bank principle. In order to receive a Pfandbrief issuing license, issuers have to fulfil certain minimum standards, such as a core capitalisation of at least €25mn or adequate systems to manage the risks inherent in the cover pools and the Pfandbrief issuing business. The German Pfandbrief Act contains detailed reporting requirements for the issuers. On a quarterly basis, information on the composition of the cover pools is published, including a regional breakdown of assets, maturity profile and over-collateralisation of the outstanding Pfandbriefe.

Cover assets Pfandbriefe can be collateralised by public sector debt, mortgages, ship mortgages or aircraft loans. The cover assets are held in separate collateral pools (one for each collateral type) on the balance sheet of the issuer. A separate register has to be kept for each pool, and an independent cover pool monitor checks the registers and ensures that there is always sufficient collateral for the outstanding Pfandbriefe. The cover pool monitor reports directly to the German Banking Supervisory Authority (BaFin).

Depending on the type of collateral used, Public Pfandbriefe, Mortgage Pfandbriefe, Ship Mortgage Pfandbriefe or Aircraft Pfandbriefe are issued to fund these assets.

Mortgage loans only count as collateral up to a loan-to-value ratio of 60%. Both residential and commercial mortgages from the EU, EEA, Switzerland, USA, Canada and Japan qualify as collateral for Mortgage Pfandbriefe. Mortgages from outside the EU must not account for more than 10% of the collateral pool unless the preferential claim of the Pfandbrief holder is acknowledged in the country where the underlying property is located.

Public sector collateral can consist of loans and bonds issued or guaranteed by public sector entities within the EU, EEA, Switzerland, USA, Canada and Japan. The 10% limit for non-EU assets applies accordingly. Non-EU/EEA assets must fulfil credit quality step 1 of the European Capital Requirement Directive (i.e. a minimum rating of AA-/Aa3). In the case of a downgrade of these assets to a level between A+/A1 and A-/A3 (i.e. credit quality step 2) the assets can stay in the cover pool if they do not exceed 20% of the value of outstanding Public Sector Pfandbriefe.


Ship mortgage loans only count as collateral up to a loan-to-value ratio of 60%. The underlying ships have to be recorded in a public register. Eligible ship mortgage loans must not have a maturity in excess of 15 years. Geographically, ship mortgage loans are limited by the country in which the ship is registered. Mortgage loans on ships which are registered in non-EU countries where the preferential claim of the Pfandbrief holder is not recognised is limited to a maximum of 20% of loans where the preferential claim is recognised. All ships need to be insured for an amount which represents at least 120% of the outstanding mortgage loan.

Aircraft loans used as Pfandbrief collateral have to be secured by a registered mortgage or a similar security claim on the aircraft financed by the loan. The loan is eligible as Pfandbrief collateral up to 60% of the value of the aircraft. The age of the aircraft must not exceed 20 years. For the duration of the loan, the aircraft has to be insured for at least 110% of the outstanding loan amount. Loans secured by aircraft registered outside the EU, where the preferential claim of the Pfandbrief holder is not recognised, must not account for more than 20% of the cover pool.

Public sector, mortgage, ship mortgage and aircraft cover pools may also contain substitute collateral up to a maximum of 10%. Substitute collateral can consist of liquid, high-quality assets such as debt from the ECB or other central banks within the EU, as well as other suitable credit institutions. Mortgage, ship mortgage and aircraft cover pools can contain substitute collateral of up to 20% if the latter consists of bonds meeting requirements for Public Sector collateral.

Hedging contracts such as swaps, can also be included in the collateral pool, but must not account for more than 12% of the net present value of the collateral pool.

Matching requirements The German Pfandbrief framework contains specific provisions about the limitation of interest rate and currency risks. The issuer must ensure that the net present value coverage of the Pfandbriefe is also maintained under a stress scenario which includes shifts of the yield curve and changes in the currency positions. Nominal volume and payable interest of the outstanding Pfandbrief must always be covered by the nominal volume and interest income from the cover assets. In addition, the Pfandbrief Act requires a minimum over-collateralisation of 2% on a net present value basis.

The amendment of May 2009 introduced for the first time a mandatory liquidity buffer to be held within each cover pool. The buffer has to cover cumulative liquidity shortfalls or mismatches between the cover pool and the outstanding covered bonds for a period of 180 days. The buffer has to consist of liquid public sector assets and ECB eligible assets. It is not necessary to provide cash as a liquidity buffer.


Post-bankruptcy procedures In the event of the issuer’s bankruptcy, the Pfandbriefe and pertaining cover pools are split from the issuer’s balance sheet. There is no automatic acceleration of payments. A special cover pool administrator is appointed to take over the management of the standalone pool and outstanding Pfandbriefe. The segregated cover pools and Pfandbriefe will have the status of a non insolvent partial bank of the insolvent issuer. As a result, the segregated cover pool and Pfandbriefe can access central bank liquidity. Also, after the issuer’s insolvency the cover pool administrator can issue new Pfandbriefe in such a scenario. However, there is no ongoing asset substitution since the segregated entity will not conduct any asset originating business. In addition to issuing Pfandbriefe, the cover pool administrator can also engage in bridge financing to close liquidity gaps as well as transferring the cover pool and the Pfandbriefe to another bank upon which the pool can become dynamic again. The duties of the cover pool monitor are not affected by the bankruptcy of the issuer. Claims of covered bondholders that were not satisfied from the cover pools rank pari passu with the unsecured creditors.

Risk weighting German Pfandbriefe meet the requirements of Article 52(4) of the UCITS directive, as well as the CRD requirements, and qualify for preferential treatment under CRD.

Market development Issuance activity in the German Pfandbrief market increased slightly in 2013 mainly due to stronger Public Sector Pfandbrief issuance. The significant recovery of German property prices seen since 2012 has not led to a greater supply of Mortgage Pfandbriefe. In February 2013, the first German covered bond secured by SME loans was issued by Commerzbank. Since SME loans are not permitted as collateral for Pfandbriefe by the Pfandbrief Act, the bond was issued based on contractual agreements. At the time of writing, no Aircraft Pfandbrief had been issued.


German Pfandbriefe – Rating Overview Issuer Public Sector Pfandbriefe Mortgage Pfandbriefe Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch S&P Moody’s Fitch AARB n.a. n.a. AAA n.a. n.a. AAA n.a. n.a. A- BHH n.a. Aa1 AA- n.a. Aa1 AA+ n.a. n.a. A+ BYLAN n.a. Aaa AAA n.a. Aaa AAA n.a. Baa1 A+ CMZB n.a. Aa1 AAA n.a. n.a. n.a. A- Baa1 A+ COREAL n.a. n.a. n.a. n.a. n.a. AA- n.a. n.a. BBB- DB n.a. n.a. n.a. AAA Aaa n.a. A A2 A+ DEKA AAA Aaa n.a. n.a. n.a. n.a. A A1 n.a. DEXGRP A+ n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. DGHYP AAA n.a. n.a. AAA n.a. n.a. A+ n.a. A+ DHY n.a. Aa2 n.a. n.a. Aa2 n.a. n.a. Baa1 n.a. DKRED n.a. Aa1 n.a. n.a. Aa2 n.a. n.a. n.a. n.a. DPB n.a. Aaa AA n.a. Aaa AAA n.a. A2 A+ DUSHYP n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. BBB- HESLAN n.a. Aaa AAA n.a. n.a. AAA A A2 A HSHN n.a. Aa2 n.a. n.a. Aa3 n.a. n.a. Baa3 A- HVB AAA Aaa AAA n.a. Aa1 AAA A- A3 A+ HYPFRA n.a. Aa3 n.a. n.a. Aa3 n.a. n.a. Baa3 A- INGDIB n.a. n.a. n.a. n.a. Aaa n.a. n.a. A2 n.a. LBBER n.a. Aaa AAA n.a. Aaa n.a. n.a. A1 A+ LBBW n.a. Aaa AAA n.a. Aaa n.a. n.a. A3 A+ MUNHYP n.a. Aaa n.a. n.a. Aaa n.a. n.a. A2 n.a. NDB n.a. Aaa AAA n.a. Aaa n.a. n.a. A3 A PBBGR AA+ Aa1 n.a. AA+ Aa2 n.a. BBB Baa2 A- SEBAG n.a. Aa1 n.a. n.a. Aa2 n.a. A Baa1 n.a. WESTIB A n.a. n.a. AA n.a. n.a. BBB- n.a. n.a. WLBANK AAA n.a. n.a. AAA n.a. n.a. A+ n.a. A+

Source – S&P, Moody’s, Fitch *) non-guaranteed rating, **) unsolicited


Total Outstanding Jumbo Pfandbriefe Outstanding Jumbo Pfandbriefe By Issuer (Sep 13)

050

100150200250300350400450

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Sep-

13

Ship Pfand.

Public Pfand.

Mortgage Pfand.

€bn

02468

101214161820

AARB BH

H

BYLA

N

CMZB

CORE

AL DB

DEXG

RP

DGHY

P

DHY

DKRE

D

DPB

HYPF

RA

HESL

AN

HSHN HV

B

INGD

IB

LBBW

MUNH

YP NDB

PBBG

R

WES

TIB

WLB

ANK

Public Sector Pfand.

Mortgage Pfand.

€bn


Jumbo Pfandbrief Gross Issuance Jumbo Pfandbrief Maturity Profile (Sep 13)

0

20

40

60

80

100

120

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Sep-

13

Ship Pfand.

Public Pfand.

Mortgage Pfand.

€bn

0

5

10

15

20

25

30

35

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2028

Public Sector Pfandbrief

Mortgage Pfandbrief

€bn



Greek Covered Bonds Legal basis The issuance of Greek Covered Bonds is based on Article 91 of Law 3601/2007, which came into effect on 1 August 2007. The law is complemented by Act no. 2598/2.11.2007 which was issued by the Bank of Greece.

The issuers Greek Covered Bonds can be issued directly by a bank, with the cover assets being ring-fenced on the balance sheet of the issuer through entry in a special register. Alternatively, the law allows issuance via an SPV, which acquires the cover assets from the parent bank and funds the purchase through the issuance of covered bonds. The debt issued by the SPV would also benefit from a guarantee from the parent bank. Banks issuing covered bonds must have a minimum regulatory capital of €500mn and a capital adequacy ratio of at least 9%. In addition, they need to fulfil certain risk management and internal control criteria. Banks that use more than 20% of unencumbered assets as collateral for covered bonds may face additional capital requirements from the Bank of Greece.

Cover assets Cover assets can consist of domestic residential mortgage loans, domestic commercial mortgage loans, ship mortgage loans as well as public sector debt. Residential mortgage loans only count as collateral up to 80% of the value of the underlying property. The LTV limit for commercial mortgage loans is 60% and for ship mortgage loans 60%. Substitute collateral must not exceed 15% of the value of outstanding covered bonds. Derivatives used to hedge interest and currency risk can be included in the cover pool.

Matching requirements The legal framework requires a minimum over-collateralisation of 5% based on the nominal value of cover assets and outstanding covered bonds. Net present value of cover assets needs to be at least as high as the net present value of covered bonds outstanding. The NPV coverage has to withstand a stress test that involves a parallel shift of the yield curve by 200bp. Interest payable on outstanding covered bonds has to be covered by interest received from the cover pool on a 12 month basis.

Post-bankruptcy procedures Greek Covered Bonds do not automatically accelerate in the case of the insolvency of the issuer (direct issuance) or the guarantor (indirect issuance). Instead, cash flows originated from the cover pool are used to make payments to the covered bondholders as scheduled.

Risk weighting Directly issued covered bonds meet the requirements of Article 52(4) of the UCITS directive and qualify for a preferential risk weighting as long as the cover assets meet CRD requirements. Covered bonds issued indirectly do not meet the requirements of Article 52(4) of the UCITS directive since the issuer is not a credit institution.


Market development Since the National Bank of Greece (ETEGA) issued the first Greek covered bond in 2009 no further publicly placed covered bond issuance has occurred. We do not expect any further covered bond issuance in the near term.

Greek Covered Bonds – Rating Overview Issuer Greek Covered Bonds Unsecured Debt


ETEGA (Prog. 1) n.a. Caa2 B CCC Caa2 B-



Hungarian Covered Bonds Legal basis Hungarian Covered Bonds are issued on the basis of Act No. XXX of 1997 on Mortgage Banks and Mortgage Bonds. The legal framework is complemented by several ministerial decrees that regulate technical procedures.

The issuers Issuers of Hungarian Covered Bonds are subject to a special bank principle. Their activities are limited to mortgage lending within Hungary and the EEA as well as issuance of covered bonds. Hungarian mortgage banks are not allowed to take deposits. The incorporation of a mortgage bank requires registered capital of at least 3bn Hungarian Forints.

Cover assets Cover assets can consist of commercial and residential mortgage loans originated in Hungary as well as the EEA. Residential mortgage loans count as collateral up to a LTV level of 70%, while commercial mortgages only count as collateral up to a LTV level of 60%. Substitute collateral can consist of liquid assets, such as cash or government bonds and is limited to 20% of the cover assets. Derivatives used for hedging purposes can be used as collateral as well, but must not exceed 12% of the net present value of the cover assets. A coverage supervisor is appointed by the mortgage bank and approved by the Hungarian FSA (HFSA). The coverage supervisor is responsible for monitoring compliance with the coverage requirements.

Matching requirements The nominal value of cover assets always has to exceed the nominal value of outstanding covered bonds. In addition, there is a NPV coverage requirement. Currency mismatches between cover assets and outstanding covered bonds need to be hedged. There is no limit on interest rate or maturity mismatches; however, loan portfolios of Hungarian mortgage banks need to hold a share of 80% or more of mortgage loans with a maturity of 5 years or longer at the time of origination.

Post-bankruptcy procedures In the case of a liquidation of a mortgage bank, covered bondholders have a preferential claim from the proceeds of the cover assets. Payments in relation to the outstanding covered bonds do not accelerate. A specific cover pool administrator will be appointed by the court. The administrator will satisfy the claims arising from the covered bonds using the cover assets. The administrator has the exclusive right to sell cover assets.

Alternatively to the above procedure, outstanding covered bonds and cover assets can be transferred to another mortgage bank if the issuer is to be liquidated. The transfer requires the permission of the HFSA.


Risk weighting Hungarian covered bonds meet the requirements of Article 52(4) of the UCITS directive, as well as the CRD requirements, and qualify for preferential treatment under CRD.

Market development The majority of Hungarian Covered Bonds are denominated in local currency. However, there has been sporadic benchmark issuance denominated in € in recent years as well. There are currently three issuers of Hungarian covered bonds contributing to an approximate total market volume equivalent to €5bn. We do not expect the number of issuers to increase significantly in the future, thus issuance volumes are likely to remain at moderate levels.

Hungarian Covered Bonds – Rating Overview Issuer Hungarian Covered Bonds Unsecured Debt


FHBHU n.a. Ba3 n.a. n.a. B2 n.a.

OTP n.a. Baa3 n.a. BB Ba2 n.a.

UCJB n.a. n.a. n.a. n.a. n.a. n.a.



Irish Asset Covered Securities Legal basis Irish Asset Covered Securities (ACS) are issued on the basis of the Asset Covered Securities Bill, which was enacted in 2001. The law is supplemented by a set of side regulations issued by the Central Bank of Ireland. The side regulations contain provisions such as matching requirements, qualification of the cover asset monitor as well as valuation criteria for mortgage assets. In 2007, the framework was amended, mainly to achieve compliance with CRD regulations. In addition, the geographical range of eligible assets was broadened and ACS covered by commercial mortgages were introduced.

The issuers Issuers of Irish ACS, so called Designated Credit Institutions, are subject to a special bank principle and are specially licensed by the central bank. This means that their business activities are limited mainly to public sector and mortgage lending, as well as the issuance of covered bonds. Typically, the covered bond issuer acts as the funding subsidiary of its parent company, which also requires a banking license.

Cover assets Irish ACS can be collateralised either by residential mortgages, commercial mortgages or by public sector debt. The assets are held in separate collateral pools. Depending on the type of collateral used, either Residential Mortgage ACS, Commercial Mortgage ACS or Public Sector ACS are issued to fund these assets. Residential Mortgages used as collateral must not exceed a LTV of 75%, while commercial mortgages are limited at a LTV of 60%. A residential mortgage cover pool must consist of at least 90% residential mortgages, allowing a maximum of 10% of commercial mortgages. While AIB, BKIR and EBSBLD have so far only used residential mortgage loans as ordinary collateral, ANGIRI has used solely commercial mortgage loans as ordinary collateral for its covered bonds. The valuation of mortgages is based on the market value at the time of inclusion in the cover pool. Revaluation of existing residential mortgages in the pool can be index-linked. In the case of commercial mortgage loans, the market value of the underlying property needs to be recalculated at least every three months.

Debt issued or guaranteed by public entities within the EEA, Canada, USA, Switzerland, Australia, New Zealand and Japan is eligible as collateral for Public Sector ACS. The 15% limit on non-EEA assets within the pool was removed within the amendment of 2007. The same geographic restriction applies to collateral for Mortgage ACS. Securitised public sector and mortgage collateral (i.e. ABS/MBS) is also eligible as collateral. Substitute collateral, consisting mainly of high quality liquid public sector assets is limited to 15%.

An independent Cover Asset Monitor (CAM) monitors an issuer’s compliance with the coverage requirements and other provisions of the covered bond framework. CAM reports any breach of coverage requirements directly to the central bank. As a unique feature, CAM also ensures that the issuer maintains voluntary over-collateral, to which the


issuer may have publicly committed itself. Derivatives used for hedging purposes can also be included in the cover pool.

Matching requirements With the amendment of 2007, a mandatory minimum over-collateralisation of 3% was introduced. Interest arising from the cover assets within a twelve month period needs to be at least as high as interest payable on outstanding ACS in the same period. Currency mismatches have to be hedged. The ACS framework also provides for a duration matching and an interest rate stress test aiming to limit interest rate mismatches.

Post-bankruptcy procedures In the event of the issuer’s bankruptcy, the cover pool and the covered bonds are split from the balance sheet. Outstanding covered bonds do not accelerate and covered bondholders continue to receive interest and capital payments as scheduled. The National Treasury Management Agency (NTMA) will appoint a qualified person or organisation that will take over the management of the cover pools. If such a person cannot be found, the NTMA itself will take over the management of the cover pool. Claims of covered bondholders which are not satisfied from the cover pools rank pari passu with the unsecured creditors of the issuing entity.

Risk weighting Irish ACS meet the requirements of Article 52(4) of the UCITS directive as well as the CRD requirements, and qualify for preferential treatment under CRD.

Market development After three years without new covered bond issuance the Irish market reopened at the end of 2012. Both AIB and BKIR have since then issued several benchmark covered bonds. As expected, Public Sector ACS issuance did not resume. It remains to be seen if the planned sale of DEPFA will result in a resumption of covered bond issuance activity. For the foreseeable future we expect Irish ACS issuance to be concentrated on Mortgage ACS.

Irish Asset Covered Securities – Rating Overview Issuer Public Sector ACS Mortgage ACS Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch S&P Moody’s Fitch AIB n.a. n.a. n.a. A Baa3 A BB Ba2 BBB

BKIR n.a. n.a. n.a. n.a. Baa3 n.a. BB+ Ba2 BBB

DEPFA BBB A3 A n.a. n.a. n.a. BBB Baa3 BBB+

EBSBLD n.a. n.a. n.a. n.a. Baa3 A n.a. Ba3 n.a.

ERSTAA n.r. A3 n.a. n.a. n.a. n.a. AA- Aa1 AAA

Source – S&P, Moody’s, Fitch


Total Outstanding Jumbo ACS Outstanding Jumbo ACS By Issuer (Sep 13)

05

1015202530354045

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

Public ACS

Mortgage ACS

€bn

0

1

2

3

4

5

6

DEPF

A

BKIR AIB

ERST

AA

Publ. ACS

Mortg. ACS

€bn


Jumbo ACS Gross Issuance Jumbo ACS Maturity Profile (Sep 13)

0

5

10

15

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

Mortgage ACS

Public ACS

€bn

0

1

2

3

4

5

6

7

2014

2015

2016

2017

2018

2020

Publ. ACS

Mortg. ACS

€bn



Italian Covered Bonds Legal basis The framework for the issuance of Italian Covered Bonds (Obbligazioni Garantite) is based on the Italian securitisation law (Law no. 130/1999), which was amended in May 2005 accordingly. The Ministry of Economy and Finance issued a set of secondary regulations in December 2006, which were followed by the implementing measures that were issued by the Bank of Italy in May 2007.

The issuers Any Italian bank that fulfils the minimum requirements set by the Bank of Italy can issue covered bonds. Banks need to have a minimum regulatory capital of €500mn and a total capital ratio of at least 9%. The bank would transfer eligible cover assets to an SPV which, in turn, guarantees the senior unsecured bond issued by the bank. The regulation by the Bank of Italy limits the amount of cover assets that can be transferred to the SPV, depending on the capitalisation of the transferring bank.

Transfer limits for eligible cover assets Regulatory Capital Level Transfer Limit

Total capital ratio ≥ 11% and Tier 1 ratio ≥ 7% No limit

Total capital ratio ≥ 10% and < 11% and Tier 1 ratio ≥ 6.5% 60% of all eligible assets

Total capital ratio ≥9% and < 10% and Tier 1 ratio ≥ 6% 25% of all eligible assets

Source – Italian Ministry of Finance Cover assets Italian Covered Bonds can be secured by residential and commercial mortgage loans with a maximum LTV ratio of 80% and 60%, respectively. The geographical scope of mortgage collateral includes the EU and Switzerland. Public sector collateral can consist of debt issued or guaranteed by public sector authorities within the EU and Switzerland as long as their risk weighting is not higher than 20% under the revised standardised approach. Sovereign and sub-sovereign debt from outside the EU and Switzerland must have a risk weighting of 0% and 20%, respectively, under the revised standardised approach and must not account for more than 10% in the cover pool. ABS and MBS are also eligible as collateral if at least 95% of the underlying assets fulfil the eligibility criteria of Italian covered bonds. Substitute collateral is limited to a maximum of 15% in the cover pool and can consist of public sector debt, bank deposits and bonds of the issuing bank with a maximum residual maturity of one year. Hedging derivatives can also be included in the cover pool. An asset monitor appointed by the issuing bank oversees the quality of the cover pool as well as compliance with coverage requirements and transfer limits.


Matching requirements The nominal and net present value of the cover assets must at all times be at least as high as the nominal and net present value of the outstanding covered bonds. Interest payments arising from the cover pool have to be at least as high as interest payable on the outstanding covered bonds.

Post-bankruptcy procedures In the event of the issuing bank’s insolvency, the SPV would take over payments to covered bondholders according to the guarantee. Asset substitution would stop and the pool would become static. The covered bonds would not automatically accelerate. Should cash flows arising from the cover pool not be sufficient to repay all covered bonds, unsatisfied claims would rank pari passu with claims of unsecured creditors of the issuing bank.

Risk weighting Italian covered bonds meet the requirements of Article 52(4) of the UCITS directive as well as the CRD requirement and qualify for preferential treatment under CRD.

Market development Issuance of Italian Covered Bonds dropped significantly as a result of the intensifying sovereign debt crisis. However, 2013 has seen a bounce back of primary market activity as banks relied less on central bank funding. As the Italian market is still relatively young, maturing covered bonds currently do not have a significant impact on issuance volumes. This could change from 2015 onwards, when we will see a significant increase in the volume of maturing covered bonds.

Italian Covered Bonds – Rating Overview Issuer Public Sector Covered Bonds Mortgage Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch S&P Moody’s Fitch BACRED n.a. n.a. n.a. A n.a. n.a. BBB n.a. n.a.

BANCAR n.a. n.a. n.a. n.a. Baa1 BBB+ B+ B2 BB

BPEIM n.a. n.a. n.a. n.a. Baa2 n.a. BB- n.r. BB+

BPIM n.a. n.a. n.a. n.a. Baa2 BBB+ BB Ba3 BBB

CRDEM n.a. n.a. n.a. n.a. A2 A+ BBB- Baa3 BBB+

ISPIM n.a. A3 n.a. n.a. A2 n.a. BBB Baa2 BBB+

MONTE n.a. n.a. n.a. n.a. Ba1 A n.a. B2 BBB

PMIIM n.a. n.a. n.a. n.a. Baa2 A- BB B1 A-

UBIIM n.a. n.a. n.a. n.a. A2 A+ BBB- Baa2 BBB+

UCGIM n.a. n.a. n.a. AA A2 A+ BBB Baa2 BBB+



Total outstanding Jumbo Italian CB Outstanding Italian CB By Issuer (Sep 13)

05

1015202530354045

2008 2009 2010 2011 2012 Sep-13

Public Sector CB

Mortgage CB

€bn

0

2

4

6

8

10

12

14

BANC

AR

BPIM

CRDE

M

ISPI

M

MONT

E

PMIIM

UBIIM

UCGI

M

Publilc Sector CB

Mortgage CB

€bn


Jumbo Italian CB Gross Issuance Jumbo Italian CB Maturity Profile (Sep 13)

0

2

4

6

8

10

12

14

16

2008 2009 2010 2011 2012 Sep-13

Public Sector CB

Mortgage CB

€bn

0

2

4

6

8

10

12

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2025

Public Sector CB

Mortgage CB

€bn



Korean Covered Bonds Legal basis There is currently no statutory framework for the issuance of covered bonds by private sector banks in the Republic of Korea (Korea). So far, Korea Housing Finance Corporation (KHFC), which is a government controlled institution, is the only Korean institution that can issue covered bonds based on a statutory framework. The framework for the issuance of covered bonds is provided by the KHFC Act, which came into force in 2004. In addition, KHFC employs several structural enhancements, based on contractual agreements.

The issuers KHFC was established in 2004 through the KHFC Act in order to provide a stable source of housing finance in Korea. The issuer is government-controlled, but its debt is not explicitly guaranteed by the government. Instead, the government will cover any losses of KHFC which are not otherwise covered by KHFC’s reserves. KHFC is not engaged directly in mortgage lending activities; instead it purchases the mortgage loans used as collateral for the covered bonds from Korean mortgage lenders.

Cover assets Covered Bonds issued by KHFC are secured by a pool of residential mortgage loans. Only first ranking mortgages over a private residential property in Korea qualify as collateral. At time of origination, a maximum LTV level of 70% applies, while the outstanding volume of the mortgage loan can range between KRW10mn and KRW500mn. All mortgage loans have to be denominated in KRW.

A monthly Asset Coverage Test (ACT) is conducted by the issuer to ensure that the amount of available collateral exceeds the volume of outstanding covered bonds. The calculation of the ACT is checked by an independent Asset Monitor on an annual basis. Mortgages generally count as collateral only up to 70% of the indexed property value. Within the ACT, mortgage loans which are in arrears for more than three months are only counted as collateral up to 70% of the outstanding loan amount or 70% of the property value, whichever is lower. Mortgages which are in arrears for more than six months do not count as collateral at all. The ACT ensures a minimum over-collateralisation of 19%. If the ACT is not passed on two consecutive months an Issuer Event of Default occurs.

Matching requirements The KHFC Act does not contain any matching requirements for the covered bonds. Currency and interest rate mismatches between the KRW denominated mortgage pool and USD denominated covered bonds are hedged by a number of swaps. A monthly Portfolio Yield Test (PYT) ensures that interest collections from the cover pool are sufficient to cover coupon payments and fees. If a breach of the PYT is not remedied within two months, an Issuer Event of Default occurs.


Post-bankruptcy procedures In the case of an Issuer Event of Default, the covered bonds will not automatically accelerate. Instead, all cash flows arising from the cover pool will be collected by the Covered Bond Administrator, swapped and then passed on to the Bond Trustee which pays principal and interest to the covered bondholders according to the original schedule. The covered bonds will only accelerate in the case of a Covered Bond Event of Default (e.g. failure to pay interest or principal on the covered bonds) or if at least two thirds of the bondholders vote in favour of an early acceleration.

Risk weighting Korean Covered Bonds do not meet the requirements of Article 52(4) of the UCITS directive, and thus do not benefit from any preferential treatment in terms of their risk weighting in the EU.

Market development So far, KHFC has issued three benchmark covered bonds with a total volume of US$1.5bn. The issuer has stated that it intends to access the covered bond market regularly in the future. Although Kookmin Bank (CITNAT) had on an earlier occasion issued a covered bond that was fully based on contractual agreements (i.e. structured), issuance on a broader basis has so far not emerged in Korea. In June 2011, the Korean regulator (Financial Services Commission and Financial Supervisory Service) published guidelines for the issuance of covered bonds. The intention was to provide a framework without implementing a specific covered bond law. Within the guidelines banks that issue covered bonds need to have a BIS capital ratio of more than 10%, while total issuance of covered bonds must not exceed 4% of each issuer’s total liabilities. Collateral can consist of mortgage loans with a maximum LTV of 70%. The guidelines also require issuers to provide a minimum over-collateralisation of 5%. Eligibility of cover assets need to be checked on a quarterly basis. At the beginning of 2013, the establishment of a dedicated legal framework for the issuance of covered bonds was proposed and a bill was submitted to the National Assembly. At the time of writing, the bill had not yet been passed by the National Assembly.

Korean Covered Bonds – Rating Overview Issuer Korean Covered Bonds Unsecured Debt


CITNAT AA Aa1 n.a. A A1 A

KHFC n.a. Aa1 n.a. A+ Aa3 AA-



Luxembourgian Lettres de Gage Legal basis Luxembourgian Lettres de Gage (LDG) are issued on the basis of a law that was introduced in 1997 and subsequently amended in 2000. In October 2008, further changes to the LDG legislation were introduced, which aimed at increasing flexibility for issuers and protection for investors. The most recent amendment of the framework occurred in June 2013, which led to the introduction of a new type of covered bonds (Lettres de Gage Mutuelles) and additional transparency requirements.

The issuers Issuers of LDG are subject to a special bank principle. By law, their business activities are mainly restricted to public sector lending, mortgage lending as well as the financing of certain movable assets. The funding of these activities is mainly conducted through issuance of covered bonds. Other activities, such as buying and selling securities in their own name are also permitted, but only insofar as they are auxiliary to their main business.

Cover assets LDG may be covered either by mortgage loans, public sector debt, loans backed by movable assets (e.g. ships, planes, trains) or loans to credit institutions that are part of a system of mutual guarantees. Covered bonds that meet the 52(4) UCITS criteria as well as senior tranches of ABS and MBS where at least 90% of the underlying assets fulfil the eligibility criteria for LDG, can be used as collateral as well. ABS/MBS tranches must have a minimum rating of AA-/Aa3. ABS/MBS where at least 50% of the underlying assets fulfil the eligibility criteria for LDG can be used as collateral if all ABS/MBS in the pool do not account for more than 20%.

With the amendment of the legal framework in 2013, the geographical restriction of cover assets to the EU, the EEA and the OECD was dropped for public sector debt, mortgage debt and movable assets. 50% of the cover pool can consist of assets originating from outside the EU, the EEA or the OECD if they have a minimum rating of AA-/Aa3. The allowed share of such assets drops to 10% if they are rated below AA-/Aa3 but at least A-/A3. Loans to credit institutions that are part of a system of mutual guarantees can only be used as collateral if those banks are located within the EU, the EEA or the OECD. Public sector collateral can include debt from public authorities, which also includes debt from entities which are publicly owned but do not benefit from an explicit public sector guarantee. Residential and commercial mortgages must not have a LTV in excess of 80% and 60%, respectively. Substitute collateral, which can consist of cash, central bank debt and bank debt within the EU, the EEA and the OECD as well as covered bonds is limited to a maximum of 20%. Derivatives used for hedging purposes can also be included in the cover pool.

Mortgage assets, public sector assets, movable assets and loans to credit institutions are kept in separate pools covering either Mortgage LDG, Public LDG, Movable LDG or Mutual LDG. For each pool, a special register has to be kept. An independent cover pool monitor (Reviseur Special) monitors the bank’s compliance with the coverage requirements. Any breach of coverage


or matching requirements will be reported by the cover pool monitor to the banking supervisory authority.

Matching requirements With the amendment of 2008, a minimum over-collateralisation of 2% was introduced. The over-collateral has to be provided on a nominal as well as net present value basis. Interest income from the cover pool has to be at least as high as the interest payable on the outstanding LDG. The net present value of the cover pool has to be at least as high as the net present value of the outstanding LDG. The limitation on outstanding LDG to 60 times the issuer’s capital was abolished in 2008.

Post-bankruptcy procedures In the event of the issuer’s bankruptcy, the cover pools and pertaining covered bonds are split from the issuer’s balance sheet and run on their own. The Luxembourg banking supervisor (Commission de Surveillance du Secteur Financier) will take over the administration of the segregated cover pools. Claims by covered bondholders who were not covered by the cash flows from the cover pool rank pari passu with unsecured creditors of the issuer.

Risk weighting Luxembourgian LDG meet the requirements of Article 52(4) of the UCITS directive. However, several features of the framework do not comply with the definitions of CRD. Preferential treatment under CRD thus depends on the composition of the respective cover pool.

Market development Issuance volumes in the Luxembourgian covered bond market have remained stable at relatively low levels. Since the range of eligible cover assets was extended in 2008 no Movable LDG has been issued to the date of publishing. Despite sporadic benchmark issuance in recent years, the Luxembourgian LDG market remains focussed on smaller sized bonds in various currencies.

Luxembourgian Lettres de Gage – Rating Overview Issuer Public LDG Unsecured Debt


DEXGRP BBB n.a. n.a. n.a. n.a. n.a.

EEPK A+ n.a. n.a. n.a. n.a. n.a.

HYPFRA n.a. n.a. A n.a. n.a. A-

NDB AA+ n.a. AAA BBB+ n.a. A

PBINTL A- n.a. n.a. BBB n.a. n.a.



New Zealand Covered Bonds Legal basis At the time of writing issuance of covered bonds in New Zealand has been based on contractual agreements in the absence of a legislative covered bond framework. Segregation of assets is achieved by transferring them to a Special Purpose Vehicle (the Covered Bond Guarantor), which guarantees a senior unsecured bond issued by the bank. The government is currently in the process of establishing such a legislative framework. Once this is achieved, only legislative covered bonds can be issued and existing programmes will have to be converted.

The issuers In the structures used so far, the covered bonds are issued by the originating bank, which acts through a fully guaranteed offshore funding vehicle. The bonds are full recourse obligations of the issuer and, through the unconditional guarantee, also full recourse obligations of the originating bank. The specific backing of the covered bonds comes from the covered bond guarantee which is given by a special purpose vehicle. This vehicle acquires mortgage loans, on a silent assignment, from the originating bank. The purchase of the assets is funded by a loan from the bank to the guarantor, this loan is split in two tranches, i.e. the guarantee loan and the demand loan. The guarantee loan represents the amount needed to fund the collateral necessary to pass the asset cover test, which includes any over-collateral provided through this test. The demand loan is equal to the amount of any voluntary over-collateral that may be contained in the pool and which is not necessary to pass the asset cover test. The originating bank can request repayment of the demand loan at any time and thus reduce voluntary over-collateral that is not needed to pass the monthly asset cover test.

Cover assets The collateral for covered bonds can consist of mortgage loans which are secured by a first ranking mortgage over residential property in New Zealand. The loan needs to be denominated in New Zealand Dollars and must not have an outstanding balance in excess of NZ$1.5mn. At the time of transfer, the mortgage loans must be performing. Also the borrower must be a resident of New Zealand. The volume of substitution assets within the cover pool is limited to a maximum ranging between 10% and 20% depending on the programme. The cover pool is dynamic and is subject to a monthly asset cover test. Within the asset cover test, mortgage loans only count as collateral up to 75% (ASBBNK, WSTP) or 80% (ANZNZ, BZLNZ, KIWI) of the value of the underlying property or the outstanding amount of the loan, whichever is lower. Defaulted loans will be given a zero weighting in the calculation of the asset cover test.

Matching requirements In order to hedge interest and currency risk between the mortgage loans and the outstanding covered bonds, the Covered Bond Guarantor enters into several swap agreements. The swap counterparties are subject to certain minimum ratings. If the rating of the swap counterparty falls below a certain


level, payment obligations under the swap need to be collateralised or a new, sufficiently rated swap counterparty needs to be found. Both programmes allow the issuers to either use a hard bullet repayment (in conjunction with a pre-maturity test), or a soft bullet repayment (i.e. with maturity extension), depending on what is specified in the relevant transaction documents.

Post-bankruptcy procedures Following an issuer event of default, the assignment of mortgage loans to the Covered Bond Guarantor is completed and the Covered Bond Guarantor will take over payments of capital and interest to the covered bondholders. Substitution of assets would stop and the cover pool would become static. Cash flows arising from the pool would be passed on to the covered bondholders as originally scheduled, as long as the pool is solvent. Solvency of the pool is determined by a monthly Amortisation Test (AT), which replaces the ACT. The principle of the AT is similar to that of the ACT, but with a less strict valuation basis. If the AT is breached, the assets held by the Covered Bond Guarantor will be liquidated and the covered bonds accelerated. The purpose of the AT is to limit subordination of holders of covered bonds maturing at a later date. Covered bondholders continue to have a claim against the issuer, which ranks pari passu with other unsecured creditors.

Risk weighting New Zealand Covered Bonds do not meet the requirements of Article 52(4) of the UCITS directive, and therefore do not qualify for preferential treatment under CRD.

Market development At the time of writing, there are five active issuers in the New Zealand Covered Bond market. Four of these issuers have launched € benchmark covered bonds. The planned implementation of a legislative framework should improve investor protection through specific supervision of the covered bond issuance business.

New Zealand Covered Bonds – Rating Overview Issuer New Zealand Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch ANZNZ n.a. Aaa AAA AA- Aa3 AA-

ASBBNK n.a. Aaa AAA AA- Aa3 AA-

BZLNZ n.a. Aaa AAA AA- Aa3 AA-

KIWI n.a. Aaa AAA A+ Aa3 AA

WSTP n.a. Aaa AAA AA- Aa3 AA-



Norwegian Covered Bonds Legal basis The issuance of Norwegian Covered Bonds is based on the Norwegian Financial Services Act, which was accordingly amended (Articles 2-28 to 2-35) in March 2007. In addition, a set of side regulations was published by the Ministry of Finance during the same year.

The issuers Issuers of Norwegian Covered Bonds are subject to the special bank principle, i.e. their business activity is limited to mainly originating and holding mortgage loans and public sector debt, as well as the issuance of covered bonds. The issuers are under the special supervision of the Norwegian Financial Supervisory Authority (Kredittilsynet). Banks must notify Kredittilsynet at least 30 days before the first issuance of covered bonds.

Cover assets The cover pool for Norwegian Covered Bonds may consist of residential and commercial mortgage loans. Residential and commercial mortgage loans must not have a LTV ratio in excess of 75% and 60%, respectively. The underlying property which secures the mortgage loan must be located within the EEA or the OECD area. The country where the underlying loan is located needs to be rated at least AA- (Credit Quality Step 1). Public sector debt is also eligible as collateral. There are no separated pools for mortgage and public sector assets. Geographically, public sector debt is limited to the EEA and the OECD area. Public sector assets from outside the EEA need to have a minimum rating of AA- (Credit Quality Step 1). If the rating of these assets is below AA- but at least A- (Credit Quality Step 2), the amount of these assets in the cover pool is limited to 20%. Substitute collateral, which has to be of a secure and liquid nature, is limited to a maximum 20% within the cover pool. The limit can be increased to 30% for a limited period with the permission of Kredittilsynet. Derivatives used for hedging purposes can also be included in the cover pool.

For each issuing institute, an independent cover pool inspector will be appointed by Kredittilsynet. The inspector monitors the maintenance of the cover register and regularly reviews its compliance with the coverage requirements. The inspector reports directly to Kredittilsynet.

Matching requirements The value of the cover pool has to exceed the value of the outstanding covered bonds at all times. However, the legal framework does not require a specific level of over-collateralisation. Interest income on the cover pool shall at all times exceed interest payable on the outstanding covered bonds. Issuers have to establish limit systems in order to control and limit interest rate, liquidity and foreign exchange risk. So far, all issuers have chosen to issue covered bonds with a soft bullet maturity with a 12 month extension period.


Post-bankruptcy procedures In the event of the issuer’s insolvency a bankruptcy administrator will be appointed. Together with a creditors’ committee the administrator shall ensure that the covered bondholders continue to receive timely payments from the cover assets. The covered bonds do not automatically accelerate in the event of the issuer’s bankruptcy. The administrator and the creditor’s committee are entitled to sell assets or even issue new covered bonds in order to ensure timely payments to the covered bondholders. If the cover pool is not sufficient to cover all preferential claims, the administrator will declare default of the pool. Claims of covered bondholders that have not been satisfied rank pari passu with claims of unsecured creditors of the issuer.

Risk weighting Norwegian Covered Bonds meet the requirements of Article 52(4) of the UCITS directive as well as the CRD requirement and qualify for preferential treatment under CRD.

Market development The Norwegian Covered Bond market has continued to grow in recent years, also fuelled by the strong performance of the domestic residential housing market. Apart from issuing € denominated and $ denominated benchmark bonds, Norwegian issuers also rely on the domestic NOK market. We expect market growth to slow down somewhat in the near to medium term as the market enters a maturing phase, where less new issuers enter the market. A possible cool down of the housing market may also lead to less demand for mortgage lending.

Norwegian Covered Bonds – Rating Overview Issuer Norwegian Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch DNBNO AAA Aaa AAA A+ A1 n.a.

EIKBOL n.a. Aa2 n.a. n.a. n.a. n.a.

NDASS n.a. Aaa n.a. n.a. n.a. n.a.

SPABOL n.a. Aaa AAA n.a. n.a. A-

STBNO n.a. Aaa n.a. n.a. n.a. n.a.

SVEGNO n.a. Aaa n.a. n.a. A2 A-



Total Outstanding Jumbo Covered Bonds Outstanding Jumbo CB By Issuer (Sep 13)

0

5

10

15

20

25

30

35

40

2007 2008 2009 2010 2011 2012 Sep-13

€bn

02468

101214161820

DNBN

O

EIKB

OL

SPAB

OL

SVEG

NO

€bn


Jumbo Covered Bonds Gross Issuance Jumbo Covered Bonds Maturity Profile (Sep 13)

0

2

4

6

8

10

12

14

2007 2008 2009 2010 2011 2012 Sep-13

€bn

0123456789

2015

2016

2017

2018

2019

2020

2021

2022

2023

€bn



Portuguese Covered Bonds Legal basis Portuguese Covered Bonds (PTCB) are issued on the basis of the Decree-Law 59/2006, which was passed in March 2006. The law is supplemented by a set of side regulations (Aviso) which were issued by the Bank of Portugal in October 2006.

The issuers PTCB can be issued by any Portuguese bank which is legally authorised to grant mortgage credits and which has a minimum capitalisation of €7.5mn. Although there is no compulsory special bank principle in Portugal, the framework also provides the possibility to issue PTCB via specialised institutions, so-called mortgage credit institutions. The allowed business activities of mortgage credit institutions are defined within the covered bond law. So far, PTCB have not been issued via specialised mortgage credit institutions.

Cover assets The collateral for PTCB can consist of mortgage loans or public sector debt. Both collateral types have to be kept in separate registers. Consequently, there are two types of PTCB, Public Sector PTCB and Mortgage PTCB. An independent auditor verifies the compliance of the issuer with the coverage requirements set out in the framework.

Loans secured by a first rank mortgage on residential or commercial property within the EU qualify as collateral. In addition, housing loans, which are guaranteed by a credit institution or through an adequate insurance contract also qualify as mortgage collateral. Residential mortgages count as collateral up to an LTV of 80%, while commercial mortgages count up to 60%. Valuation of the underlying properties must be carried out by an independent specialist before the mortgage loan is entered into the cover pool. The issuer has to verify the valuation every three years in the case of residential mortgages and annually for commercial mortgages. In the event of significant market changes, a revaluation has to be carried out more frequently. Revaluation can be linked to a mortgage index.

Public sector collateral can consist of loans and bonds issued or guaranteed by central administrations or regional and local authorities within the EU.

Substitution assets are limited to a maximum of 20% of the total cover pool. These assets can consist of deposits with the Bank of Portugal, cash or long-term deposits with credit institutions rated at least A- or other high quality liquid assets as defined by the Bank of Portugal. Derivatives used for hedging purposes can also be part of the cover pool. Claims of derivative counterparts rank pari passu with those of covered bondholders.

Matching requirements The Portuguese covered bond framework requires that the nominal value of outstanding Mortgage PTCB does not exceed 95% of the nominal value of the cover assets, resulting in a mandatory over-collateralisation of 5.3%. There is no over-collateralisation required for Public Sector PTCB. The average maturity of outstanding covered bonds cannot exceed that of the


cover assets, and interest payable on outstanding covered bonds must not exceed interest received from the cover assets. Furthermore, the issuer is obliged to hedge potential currency risk. Issuers are also required to provide an NPV matching which has to withstand a stress scenario (200bp yield curve shift).

Post-bankruptcy procedures In the event of the issuer’s insolvency, cover assets and outstanding covered bonds are segregated from the balance sheet. The Bank of Portugal has the power to appoint another credit institution which will take over the management of the separated cover pool and outstanding covered bonds. Although the covered bonds do not automatically accelerate in the event of the issuer’s bankruptcy, there is the possibility of a bondholder meeting to decide (with a two third’s majority) on the early redemption of the outstanding covered bonds in a post-bankruptcy scenario.

Risk weighting PTCB meet the requirements of Article 52(4) of the UCITS directive. In addition, PTCB meet the requirements of the CRD provided that non-guaranteed bank debt does not exceed 15% of the cover pool. As a result, PTCB qualify for a preferential risk weighting under CRD.

Market development January 2013 saw the first Portuguese covered bond issuance since March 2010 when the market came to a halt during the sovereign debt crisis. While no further benchmark covered bonds have been issued since January 2013, we expect supply to increase when the economic situation in Portugal stabilises.

Portuguese Covered Bonds – Rating Overview Issuer Public Covered Bonds Mortgage Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch S&P Moody’s Fitch BCPPL n.a. n.a. n.a. n.a. Ba1 BBB- B- B1 BB+

BESPL n.a. n.a. n.a. n.a. Baa3 n.a. BB- Ba3 n.a.

BPIPL n.a. n.a. n.a. A- Baa3 BBB+ BB- Ba3 BB+

CXGD n.a. Baa3 BBB- n.a. Baa3 BBB BB- Ba3 BB+

MONTPI n.a. n.a. n.a. n.a. Baa3 BBB n.a. Ba3 BB

SANTAN n.a. n.a. n.a. BB+ Baa3 BBB BB Ba1 BBB-



Total Outstanding Jumbo Covered Bonds Outstanding Jumbo CB By Issuer (Sep 13)

0

5

10

15

20

2006 2007 2008 2009 2010 2011 2012 Sep-13

Public Sector CB

Mortgage CB

€bn

0

1

2

3

4

5

6

BCPP

L

BESP

L

BPIP

L

CXGD

SANT

AN

Public Sector CB

Mortgage CB

€bn


Jumbo CB Gross Issuance Jumbo CB Maturity Profile (Sep 13)

0

1

2

3

4

5

6

7

2006 2007 2008 2009 2010 2011 2012 Sep-13

Public Sector CB

Mortgage CB

€bn

0

1

2

3

4

2014

2015

2016

2017

2018

2020

Public Sector CB

Mortgage CB

€bn



Spanish Cédulas Legal basis The issuance of Spanish Cédulas Hipotecarias (CH) is based on the Spanish Mortgage Market Law of 1981. The law for the issuance of Spanish public covered bonds (Cédulas Territoreales, [CT]) was passed in 2002. In 2007 the Spanish Mortgage Market Law of 1981 was amended, adding a number of improvements and clarifications to the existing framework for the issuance of CH. The changes included an increase of the legal minimum over collateralisation to 25%, the introduction of substitute collateral, as well as inclusion of derivatives as collateral. In 2012, Spanish lawmakers have introduced a third type of covered bond called Cédulas de Internacionalizacion (CI). These newly created Cédulas allow Spanish banks to use loans granted to finance export and international expansion of Spanish companies as collateral. At the time of writing further details about asset eligibility criteria for CI were yet to be provided by secondary regulation.

The issuers Every Spanish bank can issue Cédulas, i.e. there is no special bank principle. Main issuers are large Spanish commercial banks as well as savings banks of various sizes. As a specialty of the Cédulas market, there are also issuers of joint or pooled Cédulas, such as: AYTCED, CEDTDA, IMCEDI or PITCH. Within these structures, a number of banks issue smaller-sized Cédulas with the same coupon and payment details into a special fund. The fund then issues one large bond, which is backed by the portfolio of Cédulas. Cash flows from the underlying Cédulas are simply passed on to the holders of the joint Cédulas issue. The structure is enhanced by liquidity support (either cash buffer or liquidity line), and also provides for a potential maturity extension of up to three years (soft bullet).

Cover assets CH can be covered by residential and commercial mortgages within the EU with a maximum LTV of 80% (95% in the case of an additional guarantee or insurance) and 60%, respectively. CT are covered by loans to public sector entities within the EEA. The cover register has no earmarking-function. Instead, all mortgages and public sector debt (eligible and non-eligible) on the issuer’s balance sheet are automatically encumbered as collateral for any outstanding Cédulas. Thus, Cédulas holders have a preferential claim against all mortgage or public sector assets on the balance sheet of the issuer, i.e. also on those which do not meet the coverage criteria. Derivatives used as hedge contracts can be included in the cover pool, so derivative counterparts also have a preferential claim against the cover assets. Substitute collateral is limited to a maximum of 5%.

Matching requirements CH and CT have a mandatory minimum over-collateralisation of 25% and 42%, respectively. The calculation of the minimum over-collateralisation is based only on eligible assets. There are no further covered bond specific matching requirements.


Post-bankruptcy procedures In the event of the issuer’s bankruptcy, Cédulas cash flows arising from the collateral assets would be used to make payments to Cédulas holders as originally scheduled. There is no automatic acceleration of payments. The preferential claim of Cédulas holders ranks very high, and even comes ahead of tax claims. The bankruptcy administrators have the ability to liquidate assets or to borrow against the pool in order to create liquidity. There is no specifically appointed cover pool administrator for the Cédulas. Instead, the bankruptcy administrators that look after claims of unsecured creditors, are also in charge of claims from Cédulas holders. Unsettled claims from covered bondholders rank pari passu with the other unsecured creditors.

If an issuer that is part of a joint Cédulas transaction falls into bankruptcy, interest payments continue to be paid to the joint Cédulas holders out of the liquidity buffer. The liquidity buffer compensates for potential time delays that might occur during the liquidation of the underlying collateral portfolio. If interest payments under the Cédulas of the defaulted issuer are resumed, the liquidity buffer is replenished. Potential losses occurring from a shortfall of collateral of one of the participating banks are borne by the holders of the joint Cédulas on a pro-rata basis.

Risk weighting Spanish Cédulas meet the requirements of Article 52(4) of the UCITS directive, as well as the CRD requirements, and qualify for preferential treatment under CRD.

Market development Market growth stagnated with the outbreak of the financial crisis. While new issue activity rebounded in 2010 from lows seen in 2008 and 2009, the volume of maturing Cédulas started to increase as well. The significant consolidation process in the Spanish banking sector has reduced the number of active issuers. While there has been issuance from national champions as well as lower rated Spanish banks in 2013, issuance of joint Cédulas has not resumed since the outbreak of the crisis.


Spanish Cédulas – Rating Overview

Issuer Cédulas Territoreales Cédulas Hipotecarias Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch S&P Moody’s Fitch AYTCED n.a.1) n.a.1) n.a.1) n.a.1) n.a.1) n.a.1) n.a. n.a. n.a.

BBVASM n.a. A3 n.a. A- A3 n.a. BBB- Baa3 BBB+ BKIASM n.a. Ba1 n.a. BBB Ba1 n.a. BB- B1 BBB- BKTSM n.a. n.a. n.a. A A3 n.a. BB Ba1 n.a. CABKSM n.a. A3 n.a. AA- A3 n.a. BBB- Baa3 BBB CAIXAC n.a. Ba2 n.a. BBB Ba2 n.a. n.a. B3 n.a. CAJARU n.a. n.a. n.a. n.a. Ba2 BBB+ n.a. n.a. BB CAZAR n.a. n.a. n.a. A Baa1 n.a. BB Ba2 n.a. CEDGBP n.a.1) n.a.1) n.a.1) n.a.1) n.a.1) n.a.1) n.a. n.a. n.a. CEDTDA n.a.1) n.a.1) n.a.1) n.a.1) n.a.1) n.a.1) n.a. n.a. n.a. CRUNAV n.a. n.a. n.a. n.a. A3 n.a. n.a. Baa3 BBB IMCEDI n.a.1) n.a.1) n.a.1) n.a.1) n.a.1) n.a.1) n.a. n.a. n.a. KUTXAB n.a. n.a. n.a. AA- A3 n.a. BBB- Ba1 BBB NOVAGA n.a. n.a. n.a. n.a. Ba2 n.a. n.a. B3 n.a. PITCH n.a. n.a. n.a. A- A3 n.a. n.a. n.a. n.a. POPSM n.a. n.a. n.a. BBB+ Baa2 n.a. Ba3 BB- BB+ SABSM n.a. n.a. n.a. n.a. A3 n.a. BB Ba1 BB+ SANTAN n.a. A3 n.a. n.a. A3 A BBB Baa2 BBB+ SANTCF n.a. n.a. n.a. n.a. A3 n.a. BBB- Baa2 BBB+ UCAJLN n.a. n.a. n.a. n.a. Baa2 n.a. n.a. Ba3 BBB-

Source - S&P, Moody’s, Fitch 1) rating depends on specific bond issue

Total Outstanding Jumbo Cédulas Outstanding Jumbo Cédulas By Issuer (Sep 13)

0

50

100

150

200

250

300

1999 2001 2003 2005 2007 2009 2011 Sep-13

Cedulas Ter.

Cedulas Hip.

€bn

05

10152025303540

AYTC

ED

BBVA

SM

BKIA

SM

BKTS

M

CABK

SM

CAIX

AC

CAJA

RU

CAZA

R

CEDG

BP

CEDT

DA

CRUN

AV

IMCE

DI

KUTX

AB

NOVA

GA

PITC

H

POPS

M

SABS

M

SANT

AN

SANT

CF

UCAJ

LN

Cedulas Ter.

Cedulas Hip.

€bn


Jumbo Cédulas Gross Issuance Jumbo Cédulas Maturity Profile (Sep 13)

0

10

20

30

40

50

60

70

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

Cedulas Ter.

Cedulas Hip.

€bn

05

101520253035404550

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2025

2026

2027

2031

2036

Cedulas Ter.

Cedulas Hip.

€bn



Swedish Säkerställda Obligationer Legal basis The law for the issuance of Swedish Covered Bonds (Säkerställda Obligationer) came into effect on 1 July 2004 and was supplemented by an additional regulation from the supervisory authority (Finansinspektionen, the Swedish FSA) in September of the same year. In 2010, the legal framework was amended to improve access to liquidity in a post-bankruptcy scenario.

The issuers Swedish Covered Bonds (SCB) can be issued by every Swedish bank, provided the bank has received a special licence from the Swedish FSA. Thus, there is no special bank principle in Sweden. However, several issuers of covered bonds are specialised mortgage lenders which are owned by larger banks or banking groups. Issuers are under the specific supervision of the Swedish FSA. If the issuer is in material breach of any of its obligations under the covered bond act, the Swedish FSA can revoke its license to issue covered bonds. The license can also be revoked if the issuer has not issued any covered bonds within one year from the date that it received the license.

Cover assets SCB can be covered by mortgage loans and public sector debt. Both types of assets are held within the same pool. Consequently, there is no distinction between Public SCB and Mortgage SCB. All cover assets have to be entered into a special register. The register also contains derivative agreements, which have been used for hedging purposes.

Mortgage loans secured on residential, agricultural, office and commercial property can be used as collateral. In addition, site-leasehold rights designated for residential, office or business purposes and tenant-owner rights can be used as collateral. The share of commercial mortgages within the cover pool is limited to a maximum of 10%. The geographical scope of eligible mortgage assets is limited to the EEA. Eligible residential mortgages only count up to a LTV ratio in of 75%. The maximum LTV level for agricultural and commercial mortgages is 70% and 60%, respectively. The valuation of the underlying property is linked to the market value and has to be carried out by an experienced appraiser. Banks have to review the valuation “where the market conditions at the locality or the region have seriously declined”.

Public sector collateral consists of loans from or guaranteed by the following entities:

The Swedish State, a Swedish municipality or a comparable public body; A foreign state or central bank where the claim is in the foreign state’s

currency and is refinanced in that currency; The European Communities or any of the foreign states or central banks

as prescribed by the Swedish government; Foreign municipalities or comparable public bodies which possess the

authority to collect taxes as prescribed by the Swedish Government.


A maximum of 20% of the cover pool can consist of substitute collateral. In special circumstances, the Swedish FSA can permit a maximum of 30% for a limited period of time. Substitute collateral can consist of 0% risk-weighted assets such as cash as well as bonds issued by the Swedish government, Swedish municipalities or a comparable public body. The Swedish FSA might also permit the use of other assets such as obligations from certain financial institutions with a risk weighting of 20% as substitute collateral.

The Swedish FSA appoints and remunerates an independent inspector for each issuing institution. The inspector’s main task is to monitor that the cover register is maintained according to the provisions of the covered bond act, in particular that only assets which meet the eligibility criteria are entered into the register.

Matching requirements At all times, the nominal value of the cover pool must be higher than the nominal value of the claims arising from the outstanding covered bonds. In addition, the Swedish framework prescribes that the present value of the cover assets exceed the present value of the liabilities with respect to the covered bonds. The present value matching has to withstand a simulated parallel shift of the yield curve (upwards and downwards) by 100bp. Currency risk, which can occur because of mismatches between cover assets and outstanding covered bonds, is limited by the fact that present value matching has to withstand a simulated 10% change of the ratio between the currency of the covered bonds and the currency of the cover assets.

Post-bankruptcy proceedings Upon the issuer’s insolvency, all assets contained in the cover pool, together with the derivative agreements listed in the cover register, are segregated from the bank’s balance sheet. Covered bondholders and derivative counterparts continue to receive interest and capital payments as scheduled. Within the Swedish framework there is no special administrator appointed for the management of the segregated cover pool. Instead, the pool will be administered by the same bankruptcy administrator who is responsible for the liquidation of the non-collateral assets. With the amendment of the legal framework in 2010, the bankruptcy administrator was empowered to raise liquidity through loans or repo transactions in order to maintain the matching in a post-bankruptcy scenario. In addition the administrator has the ability to sell assets from the cover pool in order to generate liquidity for the payment of covered bondholders.

Risk weighting SCB meet the requirements of Article 52(4) of the UCITS directive. In addition, SCB meet the requirements of the CRD provided that non-guaranteed bank debt does not exceed 15% of the cover pool and thus qualify for a preferential risk weighting under CRD.


Market development The issuance activity within the Swedish covered bond market is focussed mainly on the domestic SEK market as well the EUR benchmark market and the USD benchmark market There are currently seven issuing entity active in the market. Supply in Swedish covered bonds, especially in euro, has been rather low in 2012 and 2013 so far as the issuers were focussing more on the domestic SEK market. We expect issuance activity in euros to continue to be moderate within the foreseeable future.

Swedish Covered Bonds – Rating Overview Issuer Swedish Covered Bonds Unsecured Debt (Parent)

S&P Moody’s Fitch S&P Moody’s Fitch LANSBK AAA Aaa n.a. A A3 n.a.

LANHYP AAA n.a. n.a. A A3 A+

NDASS AAA Aaa n.a. AA- Aa3 AA-

SBAB AAA Aaa n.a. A A2 n.a.

SEB n.a. Aaa n.a. A+ A1 A+

SHBASS n.a. Aaa n.a. AA- Aa3 AA-

SWEDA AAA Aaa n.a. A+ A1 n.a.


Total Outstanding Swedish CB Outstanding Swedish CB By Issuer (Sep 13)

0

5

10

15

20

25

30

35

2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0123456789

10

LANS

BK

NDAS

S

SCBC

C

SEB

SHBA

SS

SPNT

AB

SVSK

HB

€bn


Jumbo Swedish CB Gross Issuance Jumbo Swedish CB Maturity Profile (Sep 13)

0

2

4

6

8

10

12

14

2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0123456789

2014

2015

2016

2017

2018

2020

2021

€bn



Swiss Covered Bonds Legal basis Although Switzerland has a dedicated legal framework for the issuance of covered bonds (Swiss Pfandbriefe) since 1930, issuance in international benchmark format only started in 2009. Since the Swiss legal framework only allows two specialised institutions to issue Pfandbriefe, the other Swiss banks that want to issue covered bonds are relying purely on contractual agreements for their issuance. In this chapter we will concentrate on Swiss Covered Bonds, i.e. covered bonds that are issued on the basis of contractual agreements.

The issuers In the structures used so far in Switzerland the covered bonds are issued by the originating bank. The bonds are full recourse obligations of the issuing bank and, in addition, benefit from the covered bond guarantee issued by a vehicle to which the cover assets have been assigned. Issuers of Swiss Covered Bonds do not require a special license.

Cover assets Eligibility criteria for Swiss Covered Bonds are set out in the relevant programme documentation of each issuer. At the time of writing, both programmes only allowed residential mortgage loans as collateral, where the underlying property is located in Switzerland and the loan is denominated in CHF. The aggregate loan size must not be in excess of CHF5mn. A monthly Asset Coverage Test (ACT) only gives credit to the mortgage loan 70% (UBS AG) or 80% (Credit Suisse AG) of the value of the property. Cash, AAA-rated government securities, AAA-rated RMBS with a remaining maturity of less than one year and Swiss Pfandbriefe qualify as substitution assets. The volume of substitution assets must not exceed 15% of the cover pool.

Matching requirements A monthly ACT provides a certain level of over-collateralisation, which is dynamic and can change depending on the quality of the cover pool. The minimum over-collateralisation stands at 11% while it is capped at a maximum of 54%. A monthly interest coverage test ensures that interest provided by the cover pool is sufficient to pay interest due on the outstanding covered bonds. Currency risk and interest rate risk is hedged by the guarantor through swap agreements. So far, only Swiss Covered Bonds with hard bullet maturities have been issued in the benchmark market.

Post-bankruptcy procedures Following an issuer event of default, the guarantor will ultimately assume payments to the covered bondholders based on the cash flows generated from the cover pool. Substitution of assets would stop and the cover pool would become static. The monthly ACT is replaced by an Amortisation Test (AT) which determines whether there are still sufficient assets in the pool to repay all outstanding covered bonds. If the AT is breached, payments of the covered bonds accelerate. The purpose of the AT is to limit subordination of holders of covered bonds with longer maturities. Covered bondholders


continue to have a claim against the issuer, which ranks pari passu with other unsecured creditors of that issuer.

Risk weighting Swiss Covered Bonds do not meet the requirements of Article 52(4) of the UCITS directive, and therefore do not qualify for preferential treatment under CRD.

Market development The first Swiss Covered Bond was issued in September 2009 by UBS AG. Credit Suisse AG joined the market in November 2010. The fact that many smaller regional banks have indirect access (via Pfandbriefzentrale der schweizerischen Kantonalbanken and Pfandbriefbank schweizerischer Hypothekarinstitute) to the Swiss Pfandbrief market can be seen as the main reason why the number of issuers in the Swiss Covered Bond market has not increased. At the time of writing the total amount of outstanding covered bonds amounted to more than €18bn equivalent, most of which had been issued in the € benchmark sector. However, several benchmark covered bonds have also been issued in USD.

Swiss Covered Bonds – Rating Overview Issuer Swiss Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch CS n.a. Aaa AAA A A1 A

UBS n.a. Aaa AAA A A2 A


Jumbo Swiss CB Gross Issuance Jumbo Swiss CB Maturity Profile (Sep 13)

0.00.51.01.52.02.53.03.54.04.5

2009 2010 2011 2012 Sep-13

€bn

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2014

2015

2016

2017

2018

2019

2022

€bn



UK Covered Bonds Legal basis On 6 March 2008, the Regulated Covered Bond Regulations 2008 came into effect. The regulations are complemented by the Regulated Covered Bonds Specialist Sourcebook from the FSA (now FCA). Before the implementation of the legal framework, UK Covered Bonds were solely issued on the basis of contractual agreements. The main aim of the framework is to allow the issuance of Regulated Covered Bonds, which meet the requirements of what was then Art. 22(4) UCITS (now Art. 52(4) UCITS). So far, eleven issuers (ABBEY, BACR, CLYDES, COOPWH, COVBS, HSBC, LEED, LLOYDS, NWIDE, RBS and YBS) have registered their programmes with the FCA. A list of registered covered bond programmes can be found on the FCA’s website. Since the framework follows a principles-based approach and contains only a few detailed rules, the specific terms of the covered bonds continue to be covered by contracts within the covered bond programmes. The method of asset segregation remains the same under the framework. The originator of the mortgages sells a pool of mortgages to an entity which is incorporated as a limited liability partnership (LLP). The LLP is consolidated within the issuer, but does not fall into the bankruptcy estate in the event of the issuer’s insolvency. The LLP issues a guarantee in favour of the holders of a senior unsecured bond (the covered bond) issued by the originating bank. Thus, holders of a UK Covered Bond also have an unsecured claim against the issuing bank. The transfer of mortgages to the LLP is conducted on the basis of an equitable assignment. This means that the LLP is the economic owner of the mortgages, but the transfer will only be completed on the occurrence of certain trigger events. Such trigger events include the default of the issuer and a continuous breach of the Asset Coverage Test (ACT).

The Regulated Covered Bond framework was amended in January 2013 introducing, among other things, the possibility for issuers to designate single asset type and mixed asset type programmes as well as requiring more extensive cover pool transparency.

The issuers The FCA maintains a register for regulated covered bond issuers and regulated covered bonds. Issuers have to apply to the FCA to include their covered bond programmes in the register. Once the programme has been registered, the issuer can draw under the programme without the need of further applications. Material changes to the registered covered bond programmes need the approval of the FCA. Issuers of UK Covered Bonds do not need to be specialised institutions.

Cover assets Regulated covered bonds can be secured by any asset specified by paragraph 68 of Annex VI of the Banking Consolidation Directive apart from exposures to credit institutions rated below AA- and securitisations. Geographically, eligible mortgages are limited to EEA countries as well as Switzerland, USA, Canada, Japan, Australia and New Zealand. The geographical range of public sector debt includes all EU countries and those non-EU countries which are rated AA- or better. Single asset class covered


bonds can only be secured by public sector debt, residential mortgage loans or commercial mortgage loans. A mixing of the three asset types within one pool is not possible. Substitution assets are limited to a maximum of 15%. Since January 2013, an independent cover pool monitor needs to be appointed for each regulated covered bond programme. The cover pool monitor ensures through regular inspections that the issuer and the pool is compliant with covered bond regulation. The cover pool monitor reports to the FCA.

Matching requirements The covered bond framework requires that the cover pool is capable of securing claims related to the covered bonds, as well as cost required for the maintenance and administration of the cover pool in the event of the issuer’s default. Regulated covered bonds must have a nominal over-collateralisation of at least 8%. There are no other specific matching requirements; however, the FCA will consider credit risk, asset concentration risk, market risk and counterparty risk when assessing the issuer’s compliance with the general coverage requirement.

Existing covered bond programmes show different repayment structures. Most issuers use soft bullet repayment within their programmes, although some programmes have the option to issue hard bullet or soft bullet covered bonds. Hard bullet structures demand full repayment at the specified maturity in order to avoid a default of the covered bonds. The hard bullet repayment is used in conjunction with a pre-maturity test.

Post-bankruptcy procedures Following an issuer event of default, the equitable assignment of mortgages to the LLP will be completed and the LLP will take over payments of capital and interest to the covered bondholders. In such a scenario there would be no further ACT, thus no substitution of assets. Cash flows arising from the pool would be passed on to the covered bondholders as originally scheduled, as long as the pool is solvent. Solvency of the pool is determined by a monthly Amortisation Test (AT). The principle of the AT is similar to that of the ACT, but with a less strict valuation basis. For example, there is no longer a hair cut or deduction of mortgage loans in arrears and LTV limits are raised to 100%. If the AT is breached, the assets held by the LLP will be liquidated and the covered bonds accelerated. Unpaid claims of covered bondholders rank pari passu with other unsecured creditors.

Risk weighting Regulated Covered Bonds meet the requirements of Article 52(4) of the UCITS directive and qualify for preferential treatment under CRD.

Market development Issuance in the UK Covered Bond market dropped significantly in 2012. At the time of writing, no benchmark UK Covered Bond has been issued in 2013. The main reason behind the very low issuance activity lies in the funding for lending programme initiated by the Bank of England in July 2012. Within this programme UK banks can use, among other assets, portfolios of mortgages, RMBS and covered bonds as collateral for lending operations with the central bank. In April 2013, the funding for lending programme was


extended until January 2015. It is unlikely that issuance of UK Covered Bonds will increase notably while the funding for lending programme is running in its current form.

UK Covered Bonds – Rating Overview Issuer UK Covered Bonds Unsecured Debt

S&P Moody’s Fitch S&P Moody’s Fitch ABBEY AAA Aaa AAA A A2 A

BACR AAA Aaa AAA A A2 A

CLYDES n.a. Aaa AAA BBB+ Baa2 A

COOPWH n.a. Baa3 A- n.a. Caa1 BB-

COVBS n.a. Aaa AAA n.a. A3 A

HSBC AAA Aaa AAA AA- Aa3 AA-

LEED n.a. Aaa AAA n.a. A3 A-

LLOYDS n.a. Aaa AAA A A2 A

LLOYDS1) AAA Aaa AAA A A2 A

NWIDE AAA Aaa AAA A A2 A

RBS n.a. Aaa AAA A A3 A

YBS n.a. Aa2 AA+ A- (S) Baa2 BBB+

Source - S&P, Moody’s, Fitch 1) BOS Covered Bond Programme

Total Outstanding Jumbo UKCB Outstanding Jumbo UKCB By Issuer (Sep 13)

0102030405060708090

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

02468

1012141618

ABBE

Y

BACR

BRAD

BI

COVB

S

HBOS

LLOY

DS

NRBS

NWID

E

RBS

YBS

€bn


Jumbo UKCB Gross Issuance Jumbo UKCB Maturity Profile (Sep 13)

0

5

10

15

20

25

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sep-13

€bn

0

2

4

6

8

10

12

14

16

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

€bn



US Covered Bonds Legal basis So far, US Covered Bonds have only been issued based on contractual agreements. Two banks (Bank of America (BAC) and Washington Mutual (now JPM)) have set up covered bond programmes. While there are still covered bonds outstanding that have been issued under these programmes, no new issuance has occurred since 2007.

In March 2010, the United States Covered Bond Act of 2010 was introduced into the House of Representatives by Scott Garrett. The aim of the Bill was to create a statutory framework for the issuance of covered bonds in the US. In June 2011, an amended version of this Bill (the The US Covered Bond Act of 2011) passed the Financial Services Committee of US House of Representatives. However, the Bill was never voted on by the full House of Representatives. The Bill was introduced in the Senate but no hearings were held on it. At the time of writing, the Bill has not yet been reintroduced in the new congress.

The issuers So far, US Covered Bonds have not been issued directly by the bank that originates the mortgage loans, but by a special purpose vehicle (WM Covered Bond Programme in the case of JPM and BA Covered Bond Issuer in the case of BAC). In both cases, the issuer is a statutory trust organised under the laws of Delaware, and thus not a regulated financial institution. It is not owned by the originating bank and there is no direct or indirect support from the bank. The issuer’s activities consist of the acquisition of Mortgage Bonds from the bank and the issuance of covered bonds. For each covered bond that is issued, the bank issues a mortgage bond and sells it to the special purpose vehicle. These mortgage bonds will be denominated in US$, and will carry a floating rate coupon. After being swapped into fixed rate € cash flows, the cash flows arising from the mortgage bond will be passed on to the covered bondholders. The recourse of the covered bondholders is limited to the cash flows arising from the mortgage bonds which, in turn, represent full recourse against the bank.

Cover assets The mortgage bonds used as collateral for existing transactions are secured by a dynamic pool of mortgage loans held by the originating bank. A monthly Asset Coverage Test (ACT) ensures that there is always sufficient mortgage collateral for the outstanding mortgage bonds. Within the ACT, mortgage loans only count as collateral up to a LTV ratio of 75%. The ACT also provides for a dynamic minimum over-collateralisation. Valuation of the mortgages is linked to the OFHEO House Price Index. If the ACT is breached and not passed on the next test date, this would trigger a mortgage bond issuer event of default. As a result, no further covered bonds could be issued under the programme and the covered bond issuer would be entitled to enforce its secured claims under the mortgage bonds.

The covered bond programme specifies certain eligibility criteria for the mortgages that can be used. These eligibility criteria are relatively broad, with the main restriction being that the inclusion of the mortgage loans


should not lead to a mortgage bond default or a negative rating effect for the covered bonds. Mortgage loans used as collateral must not have an outstanding volume greater than $3mn (JPM) or $5mn (BAC). Eligibility criteria can only be changed with the approval of the rating agencies.

In addition to mortgage loans, a maximum of 10% of the collateral can consist of substitution assets. These assets include exposures to 0% risk-weighted public sector entities and central banks, as well as exposures to 10% risk-weighted institutions. Exposures to 20% risk-weighted institutions and AAA-rated RMBS tranches can also be used, but only if their share does not exceed 10% of the outstanding covered bonds.

Matching requirements Interest rate and currency mismatches between the US$-denominated, floating-rate mortgage bonds and the €-denominated fixed-rate covered bonds are hedged via a covered bond swap. Potential interest rate and prepayment risk between the mortgage loans and the mortgage bonds is borne by the bank.

Post-bankruptcy procedures In the event of the bank’s default, the covered bond issuer is entitled to enforce the security granted under the mortgage bonds. The proceeds arising from the realisation of the mortgage collateral would be deposited in a GIC account. Interest payments arising from the GIC account will then be passed on to the covered bond swap provider who continues to make fixed-rate € payments to the covered bond issuer. The covered bonds do not automatically accelerate. Both covered bond programmes provide for a soft bullet repayment, i.e. there is an optional maturity extension of 60 days (first two issues of JPM) or 120 days (all other issues of JPM and BAC) in the event of insufficient liquidity to repay the covered bonds.

In the event of the bank’s insolvency, the Federal Deposit Insurance Corporation (FDIC) has the power to repudiate contracts the bank has entered into. If this affects the mortgage bonds, compensatory damages would be paid to the covered bond issuer for the benefit of the covered bondholders. These damages would reflect the par value of the mortgage bonds, plus accrued interest. In addition, the FDIC has the power to order a stay period of up to 90 days during which creditors would not have access to the collateral or receive any damages. During this period, the covered bond swap provider would still have to make interest payments to the covered bond issuer even if he does not receive any payments from the bank or the GIC account. This stay period was shortened to 10 days for covered bonds that meet the requirements of the FDIC policy statement.

Risk weighting US Covered Bonds do not meet the requirements of Article 52(4) of the UCITS directive. Consequently, they do not qualify for preferential treatment under CRD either.


Market development Since a near term introduction of a legislative framework for the issuance of covered bonds in the US is unlikely, we do not expect any issuance from US banks in the foreseeable future. The challenging task of reducing the size of, and reliance on government sponsored entities could provide a constructive environment for the development of a covered bond market. As previous developments have shown, however, the successful implementation of a legislative framework will not happen without support from lawmakers, regulators and banks.

US Covered Bonds – Rating Overview Issuer US Covered Bonds Unsecured Debt (Mortgage Bond

Issuer) S&P Moody’s Fitch S&P Moody’s Fitch

BAC A+ A1 AA- A A3 A

JPM AA- n.a. A+ A Aa3 A+


Outstanding US CB By Issuer (Sep 13) Jumbo US CB Maturity Profile (Sep 13)

0

1

2

3

4

5

BAC

WM

€bn

0.0

0.5

1.0

1.5

2.0

2.520

14

2016

2017

€bn



Appendix Australian Covered Bonds Austrian Fund. Anleihen Austrian Pfandbriefe Belgian Covered Bonds Canadian Covered Bond

Special Bank Principle No No Yes No No

Eligible collateral Mortgages and public sector debt

Mortgages and public sector debt

Mortgages and public sector debt

Mortgages, public sector debt and MBS

Mortgages

LTV Commercial Mgt 60% n.a. 60% 60% n.a.

LTV Residential Mgt 80% n.a. 60% 80% 80%

Derivatives as collateral Yes Yes Yes Yes Yes

Substitute Collateral 15% 15% 15% 15% 10%

Mandatory Over-Collateral Yes Optional Yes Yes Yes

Separate public & mortgage collateral No No Yes Yes n.a.

Limit on outstanding CB Yes No No Yes Yes*

52(4) UCITS compliant No Yes Yes Yes No

Source – BNP Paribas * OSFI limit of max 4% of total assets Cypriot Covered Bonds Danish SDO Dutch Covered Bonds. Finnish Covered Bonds French Obligations Foncières

Special Bank Principle No No No No Yes

Eligible collateral Mortgages, public sector debt

and maritime loans Mortgages and public sector

debt Mortgages Mortgages and public sector

debt Mortgages, public sector debt

and MBS

LTV Commercial Mgt 60% 60% n.a. 60% 60%

LTV Residential Mgt 75% 80% 80% 70% 80%


Substitute Collateral 15% 15% 10% 20% 15%

Mandatory Over-Collateral Yes No Yes Yes Yes

Separate public & mortgage collateral Yes No

n.a. No No

Limit on outstanding CB Yes** No No No No

52(4) UCITS compliant Yes Yes Yes*** Yes Yes

Source – BNP Paribas ** Max 25% of a bank’s asset can be used as collateral ***if registered


French Obl. Fin. de l’Habitat French CRH German Pfandbriefe Greek Covered Bonds Hungarian Covered Bonds

Special Bank Principle Yes No No No Yes

Eligible collateral Residential Mortgages and MBS

Mortgages and MBS Mgt, publ. sector debt, ship mgt and aircraft fin

Mortgages, public sector debt and ship mortgages

Mortgages

LTV Commercial Mgt n.a. n.a. 60% 60% 60%


Derivatives as collateral Yes**** No Yes Yes Yes

Substitute Collateral 15% n.a. 10-20% 15% 20%

Mandatory Over-Collateral Yes Yes Yes Yes No

Separate public & mortgage collateral n.a. n.a.

Yes Yes n.a.

Limit on outstanding CB No No No Yes No

52(4) UCITS compliant Yes Yes Yes Yes Yes

Source – BNP Paribas **** Subject to trigger event Irish ACS Italian Obbligazioni Garantite Korean Covered Bonds Luxembourg Lettres de Gage New Zealand Covered Bonds

Special Bank Principle Yes No No Yes No

Eligible collateral Mortgages, public sector debt, ABS/MBS

Mortgages, public sector debt and ABS/MBS

Mortgages Mortgages, public sector debt, movable assets, ABS/MBS

Mortgages

LTV Commercial Mgt 60% 60% n.a. 60% n.a.



Substitute Collateral 15% 15% n.a. 20% 20%

Mandatory Over-Collateral Yes No Yes Yes Yes Separate public & mortgage collateral

Yes No n.a.

Yes n.a.

Limit on outstanding CB No Yes No No n.a.

52(4) UCITS compliant Yes Yes No Yes No



Norwegian Covered Bond Portuguese Covered Bonds Spanish Cédulas Swedish Säkerställda Obligationer

Swiss Covered Bonds

Special Bank Principle Yes No No No No

Eligible collateral Mortgages and public sector

debt Mortgages and public sector



debt Mortgages

LTV Commercial Mgt 60% 60% 60% 60% n.a.

LTV Residential Mgt 75% 80% 95% 75% 70% - 80%


Substitute Collateral 20% 20% 5% 20-30% 15%

Mandatory Over-Collateral No Yes (Mortgage) Yes No Yes

Separate public & mortgage collateral

No Yes Yes No n.a.

Limit on outstanding CB No No No No No

52(4) UCITS compliant Yes Yes Yes Yes No


UK Covered Bonds US Covered Bonds

Special Bank Principle No No

Eligible collateral Mortgages, ship mgt., publ. sector debt and MBS

Mortgages

LTV Commercial Mgt 60% n.a.

LTV Residential Mgt 80% 75%

Derivatives as collateral Yes Yes

Substitute Collateral 15% 10%

Mandatory Over-Collateral Yes Yes Separate public & mortgage collateral No n.a.

Limit on outstanding CB Yes***** No

52(4) UCITS compliant Yes No

Source – BNP Paribas ***** Issue specific approval from FSA required


Contacts Robert McAdie, Global Head of Fixed Income Strategy and Credit Research

+44 20 7595 8885 [email protected]

Olivia Frieser, Global Head of Credit Research and Sector Specialists +44 20 7595 8591 [email protected]

European Credit Research Fundamental Research Luba Fakhrutdinova, Junior Credit Analyst Banks +44 20 7595 8082 [email protected]

Heiko Langer, Senior Credit Analyst Covered Bonds +44 20 7595 8569 [email protected]

Norbert Ling, Credit Analyst Retail, Metals & Mining & Building Products +44 20 7595 8853 [email protected]

Hunter Martin, CFA, Credit Analyst TMT +44 20 7595 8491 [email protected]

Geoffroy de Pellegars, Junior Credit Analyst Banks +44 20 7595 8082 [email protected]

Timothy Rea, Credit Analyst Autos, Aero & Def, Pharma +44 20 7595 8317 [email protected]

James Sparrow, Senior Credit Analyst Utilities +44 20 7595 1269 [email protected]

Rafael Villarreal, Senior Credit Analyst Insurance +44 20 7595 8918 [email protected]

Credit Strategy Matthew Leeming, Head of Quantitative & European Credit Strategy +44 20 7595 1230 [email protected]

Mahesh Bhimalingam, Senior Credit Strategist Macro & Relative Value Credit Strategy +44 20 7595 8439 [email protected]

Pierre-Yves Bretonniere, Senior Credit Strategist Relative Value & Quantitative Credit Strategy +44 20 7595 8973 [email protected]

Joanna Chan, Junior Credit Strategist Relative Value & Quantitative Credit Strategy +44 20 7595 8185 [email protected]

Klaus Plattner, Graduate Macro & Relative Value Credit Strategy +44 20 7595 8428 [email protected]

Greg Venizelos, Senior Credit Strategist Macro & Relative Value Credit Strategy +44 20 7595 8296 [email protected]

Sector Specialists Jean-Yves Guibert, Head of European High Yield Sector Specialists - HY TMT +44 20 7595 8308 [email protected]

Florent Egonneau, Junior Sector Specialist High Yield +44 20 7595 4910 [email protected]

Andrea Gredy, Junior Sector Specialist High Yield +44 20 7595 1287 [email protected]

Anthony Langlois, Sector Specialist High Yield +44 20 7595 3329 anthony.langlois @uk.bnpparibas.com

Julien Raffelsbauer, Senior Sector Specialist HY Travel, Leisure, Transportation and Shipping


Helen Rodriguez, Senior Sector Specialist HY Consumer, Food & Beverage, Retail and Gaming


Paola Lamedica, Senior Sector Specialist Option & Structured Product +44 20 7595 8081 [email protected]

Production Barbara Hickling, Editor +44 20 7595 8599 [email protected]

Amanda Railson, Deputy Editor +44 20 7595 8260 [email protected]

Charlotte Hodge, Research Assistant +44 20 7595 8338 [email protected]

mailto:[email protected]








Research Disclaimers

RESEARCH DISCLAIMERS: Recommendation System: Type Terminology Horizon Credit Trend (1) Positive/ Stable/ Negative 6 months Investment Recommendation (2) Buy/ Add/ Hold/ Reduce/ Sell (*) Up to 6 months (1) Credit Trend is based on underlying Credit fundamentals, business environment and industry trends; (2) Investment Recommendations are as follows: (*) BUY – Maximise exposure based on improving financial profile and/or significant under-valuation. ADD – Overweight exposure within industry sector/index, based on improving financial profile, and/or defensive characteristics and/or cheap valuation. HOLD – Maintain position based on stable credit fundamentals and/or average expected return characteristics within peer group. REDUCE – Underweight exposure within industry sector/index based on weakening financial profile, increased volatility and/or rich valuation. SELL – Sell exposure/Maximise protection largely based on deteriorating credit fundamentals, negative headline/event risks and/or significant over-

valuation.

IMPORTANT DISCLOSURES Company Disclosure(s) AAB 4 AARB 4 ABBEY 4 ACACB 4,5 ACASCF 4,5 ACHMEA 4 AIB 4,5 AKTIA (MB) 4 AKTIA (PLC) 4 ANZ 4 ANZNZ 4,5 ASBBNK 4,5 AXASA

4,5 A BNP Paribas executive or employee holds responsibilities in the executive board of AXA.

AYTCED 4 BAC 4,5 BACA 4,5 BACR 4,5 BACRED 4 BANCAR 4 BAWAG 4 BBVASM 4 BCPPL 4 BESPL 4 BHH 4 BKIASM 4 BKIR 4 BKTSM 4 BMO 4 BNS 4 BOCYCY 4 BPCECB 4 BPCOV 4 BPEIM 4 BPIM 4,5 BPIPL 4 BYLAN 4 BZLNZ 4 CABKSM 4,5 CAFFIL 4,5 CAIXAC 4 CAJARU 4 CAZAR 4 CBAAU 4 CCBGBB 4 CCDJ 4,5 CDEE 4 CEDGBP 4 CEDTDA 4 CFF 4


CIFEUR 4 CITNAT 4,5 CLYDES 4 CM 4 CMARK 4 CMARK 4 CMCICB 4 CMZB 4,5 COOPWH 4 COREAL 4 COVBS 4 CRDEM 4 CRH 4 CRUNAV 4 CS 4,5 CXGD 4 DANBNK 4 DB 4,5 DEKA 4 DEPFA 4 DEXGRP 4 DEXGRP 4,5 DGHYP 4 DHY 4 DKRED 4 DNBNO 4,5 DPB 4,5 DUSHYP 4 EBSBLD 4 EEPK 4,5 EIKBOL 4 ERSTAA 4 ERSTBK 4,5 ETEGA 4 FHBHU 4 GE 4 HBOS 4 HESLAN 4 HSBC 4,5 HSBC 4,5 HSHN 4,5 HVB 4 HYNOE 4,5 HYPFRA 4 HYPFRA 4 IMCEDI 4 INGDIB 4 INTNED 4,5 ISPIM 4,5 JPM 4,5 KA 4,5 KBC 4,5 KHFC 4,5 KIWI 4 KUTXAB 4 LANHYP 4 LANSBK 4 LBBER 4 LBBW 4 LBPSFH 4 LEED 4 LLOYDS 4 MONTE 4 MONTPI 4 MUNHYP 4,5 NAB 4 NACN 4,5 NDASS 4 NDASS 4


NDASS 4 NDB 4,5 NDB 4 NIBCAP 4 NOVAGA 4 NWIDE 4 OTP 4,5 PBBGR 4 PBINTL 4,5 PITCH 4 PMIIM 4 POHBK 4 POPSM 4,5 RBS 4,5 RFLBNI 4,5 RFLBST 4,5 RY 4,5 SABSM 4 SAMBNK 4 SANTAN 4 SANTAN 4 SANTCF 4 SBAB 4,5 SEB 4 SEBAG 4 SHBASS 4 SNSSNS 4 SOCSCF 4,5 SOCSFH 4,5 SPABOL 4,5 STBNO 4 SUNAU 4 SVEGNO 4,5 SWEDA 4 TD 4 UBIIM 4 UBS 4,5 UCAJLN 4 UCGIM 4,5 UCJB 4,5 WESTIB 4 WLBANK 4 WSTP 4,5 WSTP 4,5 YBS 4 (1) Shareholdings exceeding 5% of the total issued share capital in the relevant issuer are held by BNPP or an affiliated company; (2) Shareholdings exceeding 5% of the total issued share capital of BNPP or an affiliated company are held by the relevant issuer; (3) Other financial interests held by BNPP or an affiliated company in relation to the relevant issuer are significant in relation to the research recommendation; (4) BNPP or any affiliated company is a market maker or liquidity provider in the securities of the relevant issuer or in related derivatives; (5) BNPP or any affiliated company has been lead manager or co-lead manager over the previous 12 months of a publicly disclosed offer of securities of the relevant issuer or in related derivatives; (6) BNPP or an affiliated company is party to any other agreement with the relevant issuer relating to the provision of investment banking services, (7) BNPP or an affiliated company is party to an agreement with the relevant issuer relating to the production of the research recommendation. The information and opinions contained in this report have been obtained from, or are based on, public sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate, complete or up to date and it should not be relied upon as such. This report does not constitute a prospectus or other offering document or an offer or solicitation to buy or sell any securities or other investment. Information and opinions contained in the report are published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for the exercise of judgement by any recipient, are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference to past performance should not be taken as an indication of future performance. To the fullest extent permitted by law, no BNP Paribas group company accepts any liability whatsoever (including in negligence) for any direct or consequential loss arising from any use of or reliance on material contained in this report. All estimates and opinions included in this report are made as of the date of this report. Unless otherwise indicated in this report there is no intention to update this report. BNP Paribas SA and its affiliates (collectively “BNP Paribas”) may make a market in, or may, as principal or agent, buy or sell securities of the issuers mentioned in this report or derivatives thereon. Prices, yields and other similar information included in this report are included for information purposes. Numerous factors will affect market pricing and there is no certainty that transactions could be executed at these prices BNP Paribas may have a financial interest in the issuers mentioned in this report, including a long or short position in their securities and/or options, futures or other derivative instruments based thereon, or vice versa. BNP Paribas, including its officers and employees may serve or have served as an officer, director or in an advisory capacity for any issuer mentioned in this report. BNP Paribas may, from time to time, solicit, perform or have performed investment banking, underwriting or other services (including acting as adviser, manager, underwriter or lender) within the last 12 months for any issuer referred to in this report. BNP Paribas may be a party to an agreement with the issuer relating to the production of this report. BNP Paribas may, to the extent permitted by law, have acted upon or used the information contained herein, or the research or analysis on which it was based, before its


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