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One Year On

10 August 2016
Richard Kemmish

This time last year the covered bond community were packing their speedos and booking their flights to Barcelona. Mercifully this year we will be in more sober, business minded Duesseldorf and can focus better on the state of our market.
It does feel like an appropriate time though to reflect on the year, in particular through the lens of the opening remarks. Last year, in the Euromoney welcoming speech John Baskott asked what threats there were to the long, unblemished track record of covered bond’s credit? He postulated three threats.

Firstly, covered bonds have survived or even avoided significant threats due to the largesse of governments. That can no longer be relied upon. As popular sentiment towards banks remains at rock bottom so does the political support for a bank bail-out at tax payer expense. Toughened up state aid rules make it more difficult for a state to support the bank, even if they wanted to and this is only partially mitigated for covered bonds by their exemption from the replacement for state aid: bail-in.   
For me this problem divides into two. There is the risk of a bank explicitly failing to support a bank and the risk of consequential damage, for example due to different policy priorities.

The risk of a state deciding not to bail out a bank, or being unable to due to state aid rules appears to have diminished. In the first test case since Barcelona the Italian government was not exactly reticent to support its banks, they have worked hard to be allowed to do precisely that under EU law. Admittedly there the prevalence of retail depositors has made tax-payer support more politically palatable but even so a precedent has been established and the rule that there must be a minimum level of investor participation in losses before state aid is available, has diminished.    

Consequential damage to banks as a result of other priorities, in particular consumer protection rules has become a greater risk. Over the last year one country has introduced a datio in solutum rule (the consumer’s liability under the mortgage loan is capped at the value of the property mortgaged. In other words, you can just hand in the keys and walk away). There are mitigants there and so far the main effect seems to have been to have been to reduce the availability of mortgages for retail consumers rather than actually impair credit worthiness but a precedent has been set.

The compulsory redenomination of foreign currency mortgages at an off market rate is a similar threat. Governments have sought to protect consumers rather than damage banks, but the effect is the same.

The release of the film ‘The Big Short’ – although it is about America, securitisations and the past -hasn’t exactly helped popular sentiment towards bailing out bonds backed by mortgages.

The unpopularity of banks was just one of the threats to the track record of covered bonds. The other two threats I will discuss next time.

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