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06 June 2014
Richard Kemmish

As I’m new to this parish I thought it might be helpful to list the premises that I consider to be axiomatic. This is partly to stir up debate (comments are always very welcome), partly so that you know where I am coming from in the other posts. So, a few of my core beliefs are:

Covered bonds work. They are exceptionally good at protecting investors from the deterioration of asset pools in even the most extreme stress scenarios. To illustrate, take a look at the cover pools backing Irish mortgage covered bonds and compare and contrast with everything you read about the Irish mortgage market.

Regulation and supervision designed to protect the interests of covered bonds holders is essential to their success and is frequently overlooked by investors but it is not the same as an explicit government guarantee. There are currently huge differences in the extent (and quality) of supervision across Europe.  If there is a failure of regulation, there is an onus on the government to protect investors from the consequences. If there is a failure of assets and/or structure, there is not.

Covered bonds should be restricted to assets that have a ‘public policy’ nature, where it is legitimate for politicians and regulators to facilitate the funding of the asset class.  It should not be used for commercial arbitrage of the capital markets. But the definition of public policy assets is not set in stone and will change as the needs of society change.

Unsecured bank debt is far more likely to default after the Bank Resolution Directive is passed than it is now. And the Loss Given Default will be close to, or exactly 100% for unsecured creditors. The credit differential between unsecured and secured debt (including securitisations) will grow and is currently vastly underestimated. 

Governments can default on their debt without causing the default of high quality private sector debt. This is particularly the case within a multi-national currency bloc but not necessarily limited to those cases. In my defence I held this view before the non-default of National Bank of Greece’s covered bonds.

In times of crisis bank treasurers invariably do whatever they have to do to keep their covered bond markets at the best possible rating and to ensure the best possible market access. The credit protection you have now is less than you will have when you need it. 

Rating Agencies are exceptionally good at analysing individual risks within a covered bond. They are not so good at deciding which is the relevant risk that you as an investor should focus on. That is your job. They are good builders, bad architects. 

Home ownership is vital to a functioning democracy. People with mortgages don’t start riots.

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