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12 | ifr special report | June 2009 GOVERNMENT GUARANTEES

Benchmark GGB issuance per country 4% 3%

1% 29%



Sweden Spain

8% 13% 3% Source: Barclays Capital

market. But covered bonds have the advantage of the flexibility to extend out to longer maturities, which has some appeal to the real money investor base and to those investors looking to add some exposure to mortgage-market related credit risk. However, the relatively low levels of public issuance of covered bonds makes it difficult to generalise. "The jumbo covered bond market has always been a five-year plus market, so no great change here," said Nick Morgan, managing director, head of financial institutions Europe & Middle East, RBC Capital Markets. "The GGB market simply replaced the senior unsecured market, which was always concentrated in two to five-year maturities to match the average life of most bank assets." According to a FIG DCM banker, more

senior, unsecured issuance is likely to be in maturities of up to five years as the government-guaranteed schemes start to wind down. On the other hand, the

covered bonds market will see issuance ranging from three-year to 12 year maturities.

"The big question in this market is, as not everybody has access to everything, how will various issuers fulfil their different funding needs," he queried. According to RBC's Morgan, "demand for duration is clearly there if the product [covered bond] is appropriately priced, which means a spread to senior unsecured debt. The last six months have been a sobering time for bank issuers, who are finally prepared to issue at levels that investors are prepared to buy at - largely because it is the cheapest alternative to paying for the guarantee and they have collateral available after 6-9 months of redemptions."

Supply picks up

As the GGB issuance market winds down, participants expect increased issuance of covered bonds in the next 12 months, as

Benchmark of gross supply by collateral type Public


100 80 60 40 20 0

Source: Barclays Capital

Nov 08


Jan 09

Feb Mar Apr May Mortgage 8% 8% 2% 1%

Netherlands Portugal

Ireland Germany France Denmark Austria Australia

markets stabilise. In the more traditional covered bond markets such as France, Germany, Spain, Denmark and Norway, recovery is now apparent. Bankers expect other markets to follow in due course. The ECB announcement is also likely to result in an increased in supply. However, uptake under the proposed ECB scheme will be dependent on the applicable eligibility criteria.

"Covered bonds ought to do well in the coming 12 months as risk appetite returns and banks seek to re-establish credit curves," said RBC's Morgan. "If GGBs are the ultimate in credit-enhanced senior bank debt, then covered bonds are the next step up the risk curve and can play an important part in the transition to orderly non-guaranteed bank debt markets."

In its EU banks’ funding structures and policies report in May, the ECB said government-guaranteed funding has been both too little and too much for the market: too little because it cannot cover all EU banks’ funding needs over the medium term; but too much because markets can only be deemed to have reopened when private investor confidence has returned in some form. "The crisis has made it clear that liquidity has a cost, which should be adequately priced by financial institutions, both externally (funding liquidity: how easy the bank funds its position, and market liquidity: the ability to sell assets with immediacy at fair value) and internally (between business units of the same financial group)," the ECB said. "Banks are keen to move away from issuing GGBs, just as soon as is practicable,” concluded Morgan. “Cost is clearly the key consideration, but there are other more political motivations too. "In the medium term (next six months), GGBs will inevitably co-exist with senior un- guaranteed issues - secured and unsecured - and I think the three can complement each other well. However, as we move into 2010, it's clear that the bigger, better banks will have successfully migrated away from needing the guarantee, leaving just the smaller and more troubled banks issuing GGBs. Covered bonds - with or without the ECB's help - should be able to flourish in this environment".

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