According to a Wall Street Journal article, investors in the covered bond market have also discovered the need to perform due diligence on the underlying assets. This is a huge change in the covered bond market which previously did not focus on the underlying collateral.
The covered bond that highlighted this conversion to doing due diligence on the underlying collateral was a covered bond issued by Banco Santander that was backed by loans to regional governments in Spain.
Investors balked at buying a €1 billion ($1.46 billion) bond offering by Banco Santander SA that was backed by debt of Spanish local governments, according to people familiar with the sale.
... The sale flopped just as debate about a Greek debt default was heating up and shortly after concerns flared about whether Spanish cities and regions have considerably more debt on their books than they have publicly acknowledged.
Santander's covered bond was backed by a pool of loans that the bank had made to regional and local governments across Spain. Santander offered to pay a relatively high 1.95 percentage points over midswaps, a benchmark lending rate, to entice investors to buy the bonds, which had the top triple-A rating from Moody's Investors Service.
Apparently investors have learned that a triple-A rating does not mean that they should not do their due diligence and look at the underlying collateral.
Santander and the deal's three managers could find buyers for about only half the bonds. It is considered disappointing if a bond deal has more than 5% to 10% that remains unsold, according to analysts and people familiar with the covered-bond market.
... The managing banks each ended up swallowing roughly €100 million of the debt, these people said. Some of the debt also was placed with Santander subsidiaries, including its asset-management arm, according to people close to the deal.
... Several people close to the deal described it as a disaster. According to one person, some of the banks wanted to pull the transaction when buyers balked and they realized the extent of the hit they would have to take. They ultimately agreed to pony up the funds to complete the transaction.
... But the deal's troubles represent a strike against a common financing device for European banks. Covered bonds are securities backed by a separate pool of loans. The bonds traditionally have been backed by pools of residential mortgages, but sometimes use other asset classes, including local-government debt and credit-card receivables, as collateral.
They are considered relatively less risky for investors because they are secured by loans that remain on the bank's balance sheet. If the bank defaults on the bond, investors get the underlying collateral, in this case, the debt of Spanish governments.
The collateral for the Santander bonds were loans the bank had made to regional and local governments in Catalonia, Madrid, Valencia, Andalucia, Basque country and the Canary Islands, according to a person familiar with the matter.
While the underlying loans remain on Santander's balance sheet, Britain's HSBC, Germany's Commerzbank and France's Société Générale gained exposure to the Spanish regions when they bought the bonds.
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