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2 | ifr special report | June 2009 Contents

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3 Restoring confidence With the crisis came a power shift. Investors, once the price-takers, now call the shots in covered bonds. A change in the required new issue premiums has been supplemented by a shift in the placement of deals. But has there been a fundamental shift in the way investors approach this product, or have they just had their hands strengthened by circumstances?

5 Back from the brink The covered bond market had been a serious casualty of increased investor risk aversion in the wake of the banking crisis until a new buyer of assets was announced in early May: the European Central Bank. At a stroke it reversed the widening of covered bond spreads that had characterised most of the previous two years, reinvigorating the new issue market.

7 Central banks to the rescue Central banks have always accepted covered bonds as a form of collateral when lending to banks. Now, as the market struggles to recover from the credit crisis, a number of central bank initiatives are either explicitly or implicitly helping to re-establish covered bond trading.

9 End of an erAAA A new threat to the covered bond recovery has emerged in the form of the rating agencies. New rating proposals from S&P pose a risk that up to 60% of covered bonds could lose their Triple A status, while Fitch might downgrade up to 5% of public sector and 10% of mortgage covered bonds.

11 Happy co-existence The meaningful re-opening of the covered bond market in May is the next step in the healing process of the crisis-ravaged markets. The short-term fix of government-guaranteed senior bonds will have to be complemented by the long-term funding mix of covered bonds and senior unguaranteed issuances to rebuild a normal, functioning market, especially when some of the GGB issuance windows are to close by this year end.

13 All eyes on Asia Having been introduced as long ago as 1890 in Germany and actively issued in 22 European countries, it seems extraordinary that Asia’s first covered bond was issued only in May. Educating investors about a new product was always going to prove a challenge but Kookmin's deal took the continent by storm, heralding what is likely to be a boom in covered bond issuance from Asia.

15 Pfandbriefe in the aftermath Like all covered bonds, the German Pfandbrief market has faced tough competition from a relatively new kid on the block: state guaranteed bank bonds. This, coupled with continued aversion to bank risk in general, prompted a serious decline in jumbo covered bond issuance. But dig a little deeper and figures show that this jurisdiction has actually maintained a stable source of refinancing for its banks.

17 Back on track? After a hiatus during the credit crash, the momentum towards creating a covered bond market in the US has picked up again. Potential issuers, investors and dealers are discussing the future of the asset class, but several questions, related to structure, liquidity and default, still remain.

18 Bonds uninterrupted Nordic covered bond markets enjoy the distinction of being the only ones that remained open throughout the financial downturn. During this time they have been forced to rely on support from domestic investors, but there are signs that those from abroad are starting to show increased interest – excellent news for the region’s issuers.

19 The ultimate validation Until now, Germany's biggest bank has raised most of its debt financing via unsecured bank bonds. As a national champion, its decision to issue Pfandbriefe – Germany's largest and highly coveted bond market – was a welcome boost for the asset class. But why has it taken Germany’s biggest bank so long to reach this point?

20 Back into the fold BNP Paribas caused a stir in 2006 when it was perceived to cock a snook at the French authorities by issuing its covered bond outside the Obligation Fonciere framework. This year its offering came within the framework but the bank insists it will do what is necessary to diversify its funding sources and its offering for clients.

Front cover photo credit: Ognen Teofilovski/Reuters

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