Brazilian Banks Eyes Covered Bond Issuance
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The Brazilian covered bonds will have a huge demand in the market. We should understand the characteristics of covered bonds and why a lot of economies are focusing to issue the covered bonds in the present world economic scenario.
Covered Bonds[1] share common features like mortgage-backed securities but there are certain differences such as these covered bonds remain in the balance sheet of the issuer and it also offer buyer additional protection against risk. These bonds are secured from both investors and issuer’s point of view. This feature of covered bonds makes them unique and desirable to issue by different governments across Europe and other countries.
The Brazilian Government had introduced Letra Imobiliaria Garantida (LIG) at the end of 2014 whereby a green signal was given for the issuance of Covered Bonds. Brazil is experiencing interest rate hike which lead to the reduction in the deposits in the low-cost savings accounts. Primarily, these savings accounts were the main source of funding for mortgages. These covered bonds can become an alternative source of housing finance. The final rules and regulations will be framed by the government by the end of 2016.
The history of covered bonds is about more than 250 years old. Covered bonds are issued by many economies and it had a record of no default. S&P Global Ratings[2] projects that the Brazilian economy will shrink by 3.6% during this year. Accordingly the rating agency has lowered its rating from BB+ to BB and gives a negative outlook with respect to the economy as a whole. In addition as of April 2016, total year-to-date withdrawals from Brazilian savings accounts have reached more than R$32 billion. This roughly is around 5% of the outstanding balance for savings deposits held by the banks. As a result of this there was an urgent need to find less volatile funding sources that can better match long-term housing loans.
S&P Global Ratings is now publishing a series of articles answering the frequently asked questions on the topic of Brazilian banks issuing covered bonds.
What are the general eligibility criteria?
The key eligibility criteria are as follows:-
· Limits for loan-to-value (LTV) ratios for each asset class (notably residential and commercial mortgages);
· The maximum loan payment term;
· Limitations for the cover pool in connection with the issuer's assets; and
· Reserve liquidity for subsequent amortizations.
The above noted are some of the general eligibility criteria of the issuance of covered bonds. But, the actual eligibility is determined by the regulators of different countries. There is specific regulatory framework in many European countries such as Austria, Belgium, Denmark, France, Germany, Italy, Sweden, Australia and Singapore. In some markets, universal banks need to issue covered bonds whereas in some markets only mortgage banks and SPVs are eligible to issue covered bonds. In New Zealand covered bonds issue is specified on a transactional basis. The legal framework assessment, the sovereign credit capacity assessment and the systematic importance of the issuance of covered bonds are the most important conditions in determining the rating of covered bonds in an economy.
What are overcapitalization requirements?
Overcapitalization is defined as a percentage difference in covered pool assets size relative to the number of bonds issued. OC requirements are needed to cover refinancing costs and mitigate the risks in case of the detoriation in the assets quality overtime. In Spain the minimum OC is 25% for mortgage programs, France is >=5%, Belgium is 5% and in New Zealand it is specific to the particular issue.
Is it necessary that a cover pool should contain only one class of underlying assets?
The European Banking Authority recommends to have only one assets class of underlying assets in case of cover pools containing a primary assets other than residential or commercial mortgages. In case mixed real estate pools also there should be followed a particular ratio determined by the regulatory framework.
What is assets segregation with respect to covered bonds issuance?
This is one of the important features of covered bonds. Here the assets in the cover pool are “ring-fenced” and set aside to exclusively benefit the bondholders. In this way the issuer’s failure or insolvency will not affect the covered bonds maturity. Thus covered bonds are not in the list of defaults for more than 250 years.
What percentage of the bank’s assets is used to be included as a part of cover pool?
Different countries have imposed different limits of the allocation of bank’s assets in the cover pool. In New Zealand the assets in covered bonds cannot exceed 10%, Belgium- 8%, Canada-4%, Singapore-4% and in other nations there is no limit as to the bank’s assets in mortgage pools. But certainly they can put the upper cap limits on certain assets that comprise the pools.
Would covered bonds bring positive growth in Brazil?
Covered bonds are a successful history in many European nations as well as North America, Canada and US have seen successful issuance of covered bonds in past. Unlike Mortgage backed securities (MBS), covered bonds have a dynamic cover pools. These are maintained to ensure performance of covered bonds. These bonds have a record of no default in the history of 250+ years. Since the outlook of Brazilian economy is negative as stated by S&P Global rating agency it would be interesting to see how this new move of government will to improve the financial crisis situation in the state.
Reported by – Trupti Upadhyay
Date:-01st June, 2016