Hans-Joachim (Achim) Dübel: Spanish Covered Bonds


My friend Achim Duebel asked me to post this on Zero Hedge.  When we met for breakfast last week with Chris Mayer he reminded us that the over-collateralization rates for Spanish covered bonds goes into the stratosphere -- 200-300% -- a grim indication of loss given default. And the Spanish CBs don't just include residential mortgages, but also development loans that are now moribund.  Now you know why everyone in Europe has been desperately trying to ignore Spain for the past 18 months.  -- Chris  

Spanish covered bonds

By Hans-Joachim (Achim) Duebel

The FT reported last week: "Spain’s government will on Thursday announce the appointment of Blackrock and Oliver Wyman as independent valuers of the real estate loans that lie at the heart of the country’s banking crisis."


As Blackrock and Oliver Wyman get started, the public sponsors of that - surely expensive - due diligence exercise might want to consider moving a step further.

The deficient structure of the Spanish covered bond legislation (Cedulas Hipotecarias) has been co-responsible for increasing anxiety among foreign investors and has directly contributed to shutting out banks from the market.

Under the current legislation, using de-facto the U.S. FHLB funding model where entire mortgage portfolios are pledged even for small claims, investors are promised access to seemingly lavishly scaled excess collateral. However, the lack of structure that the law provides turns this promise hollow and threatens high LGD if issuers should not be rescued.

Two points for change are most salient:

-           Despite occasional language suggesting the contrary the law does not provide for a dedicated cover to protect investor interest. Such a dedication can only be established in a system based on a regular due diligence process (e.g. full cover reviews in Germany every 3 years) and under the supervision of an independent trustee who is in possession of asset substitution rights on behalf of investors. These characteristics, standard templates in other European laws, are absent in the Spanish law. Having an ‘eligible asset’ definition policed by  a general bank regulator (under conflict of interest between bond and depositor interest) is not a credible approach.

The RE loan review under way could be used to create such dedicated cover pools to back the outstanding bonds; where assets are deficient, they should be substituted by cash.

Given where the RE market crisis stands, a deficiency analysis would probably have to take into account current LTV rather than origination LTV. Only Denmark so far has designed a system directly dealing with current LTV shortfall in residential housing. Safeguards here still should be considered in the Spanish case to put a floor under bond values.

-           A large nominal overcollateralization level, if backed by proven assets, will prompt the deposit insurer to play hardball during an insolvency in order to withhold as much assets for satisfying depositor claims as possible. The FHLB OC has been the nightmare of Sheila Bair in recent years, following the IndyMac insolvency where FDIC had to cede USD 24 billion in collateral to the FHLB for USD 8 billion in loans.

All the more concerning is that the Spanish Cedula legislation, apparently due to the above wide collateral definition, does not operate under pre-insolvency segregation mechanisms that are the standard elsewhere in Europe and that would allow a separate insolvency administrator to play against the deposit insurer.

Other points surely would be worth adding, but are probably not Spain-specific (e.g. more regular collateral reporting). It is in both in the interest of Spain and Europe to avoid contagion from a failing covered bond law for what has become the backbone of European bank refinancing during the crisis. It is also in the interest of both to reestablish a market-based funding mechanism that can attract foreign investors back into the market, or keep them from leaving. Putting the covered bond on its feet with priority – as parallel proposals for Eurozone deposit insurance system - could finally reduce pressure for de-facto unsecured funding from the central bank.



Hans-Joachim (Achim) Dübel


Esmarchstr. 15

D-10407 Berlin




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