Saturday, July 21, 2012

Desperate for more ECB funding and running out of collateral, Spain is creating a new type of covered bonds

Spanish banks are running out of collateral that can be pledged at the ECB. The ECB no longer permits banks' own bonds guaranteed by their government (beyond what's already been pledged) to be used as collateral (see the document in this post).

What about using more covered bonds? Unfortunately with unemployment pushing 25% and housing declining quickly, demand for mortgages has dried up.

Changes in demand for loans to households (seasonally adjusted, source: Bank of Spain)

That means mortgage-backed covered bonds (Cedulas) can no longer be issued. These bonds were quite popular in the Eurozone during the bubble years, but are now mostly sitting at the ECB as collateral.

In a desperate attempt to create more covered bonds in order to extract additional lending from the ECB, the Spanish government is about to authorize a new type of securitization structure:
Reuters: - Spanish banks are hoping that the new structure - Cedulas de Internacionalizacion (CI) - will extend this funding lifeline by allowing collateral, previously excluded, to be used.

Under the terms of the new law, export finance credit from high quality financial institutions or guaranteed public sector entities can be used to back a new issue.

This would have the added benefit of lowering issuers' funding costs because covered bonds benefit from lower haircut valuations compared with securitisation, Moody's said.

The ECB accepts self-issued covered bonds as collateral, but not self-issued senior unsecured debt, it added.
Spanish banks are already borrowing €337bn from the ECB (in practice the banks are borrowing from the Bank of Spain who is funding all that lending via TARGET2 loans from the Eurosystem). With these new bonds in place the central bank lending will increase further. Over time the nation's whole economy will in effect be funded by the central bank and any private credit that can be packaged into covered bonds will be pledged as collateral.

Spanish banks' borrowing from the ECB
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