Tuesday, 25 June 2019

Painful progress

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After breakthroughs in Singapore and South Korea, the rest of Asia is well behind with the introduction of covered bonds. The pace of progress, however, is likely to remain slow.

After making significant inroads last year, Asia’s nascent covered bond market is going nowhere fast. The optimism and excitement at the growth potential for this market in Asia at the start of 2015 has been replaced with a more realistic expectation that any meaningful expansion of covered bonds outside of South Korea and Singapore will take years.

Covered bonds have been popular for years in places like Germany, Denmark and Spain, as well as Australia and New Zealand, because they offer banks a resilient source of funding at tight spreads. Investors get a safer asset and are given more direct access to collateral, usually mortgage loans, in the case of defaults, meaning that the bonds carry low risk weightings.

In Asia, however, bankers see a variety of obstacles to the wider use of the format.

Three covered bonds were printed in Asia in 2015. It was a year when Singapore made its highly anticipated debut and Korean issuers sold statutory covered bonds for the first time. These were DBS Bank’s August US$1bn three-year at mid-swaps plus 37bp, Kookmin’s October US$500m five-year at mid-swaps plus 90bp and Korea Housing’s November US$500m five-year at US Treasuries plus 90bp.

“There may be some disconnect between market interest, issuer interest and the actual opportunity set for covered bonds in the region. Covered bonds are not a product banks can simply choose to issue if they want to do so.”

Bankers described the deals as successful, though books were less than two times oversubscribed. They pointed out that orders came from more geographically diverse investors than usual for Asian bank bonds. DBS and Kookmin achieved Triple A ratings for their notes, allowing them to attract some foreign investors, who only invested in top-rated securities.

However, bankers do not foresee much increase in covered-bond issuance beyond those markets this year, saying that the market is still in its infancy and future issuers and investors will want to see how deals perform before making any decisions.

The market is also limited by the fact that only a handful of lenders are permitted to do these deals. Banks require a fundamental legislative and regulatory framework that covers technical issues and establishes rules that recognise holders of covered bonds ahead of depositors.

“There is absolutely a high level of interest in covered bonds, but it’s just not a technical possibility at present in many markets,” said Brian Weintraub, head of financial institutions capital markets Asia at Deutsche Bank. “We are optimistic this will change over time, but it is early days across the broader market.”

As an example, the Monetary Authority of Singapore first set rules for covered bonds in 2013 and it was not until two years later, and after extensive debate and feedback over topics like how much of a bank’s total assets could be used as collateral, that the market was able to come to fruition.

There are also technological and infrastructure challenges within the banks themselves. For one, setting up a covered bond programme requires capabilities like a sophisticated mortgage loan system, which enables banks to track and allocate loans, and provide their historical data. Bankers estimate that setting up such a system would take at least six months in the best-case scenario.

“There may be some disconnect between market interest, issuer interest and the actual opportunity set for covered bonds in the region,” Weintraub said. “Covered bonds are not a product banks can simply choose to issue if they want to do so. For example, they cannot just leverage another bank’s documentation, especially if that bank is in another country within the region.

“Specific covered bond legislation needs to be passed in the jurisdiction in question, issuers require a range of technology and risk management systems to be deployed, and regulatory sign-offs are required – much of this does not yet exist in many countries across the region.”

Nevertheless, bankers are keeping a close eye on the market to see where it may go next. A number of them mentioned Hong Kong as a potential candidate and suggested that the Hong Kong Monetary Authority was looking into it. However, an HKMA official said he was not aware of any discussions. Among other countries mentioned are Taiwan, Malaysia, China and India.

Yet, each of these suggestions comes with caveats related to legislative challenges and market infrastructure, in addition to fundamental questions over whether or not these jurisdictions even need these instruments.

“Covered bonds only really make sense to banks that have significant US dollar funding needs within the APAC region, and there aren’t many regular FIG US dollar issuers.” said Cristina Chang, managing director, head of securitised products for Asia-Pacific at Citigroup.

“There are, maybe, only a handful in South-East Asia that issue from time to time. So, there isn’t a huge need. It would make sense for Korean banks with US dollar needs, so you’ll probably see more of them consider issuance given the successful Kookmin precedent.”

Kookmin has since followed its deal with another in January, a five-year US$500m bond that braved volatile conditions to price slightly wider at mid-swaps plus 95bp. Unlike its earlier deal, Kookmin saw more interest from Asian investors and banks, but the size of the investor book was identical at US$800m. Bankers on the deal were pleased with the result, but doubted that it would have much impact as far as encouraging more issuers to come to the market.

United Overseas Bank is planning to follow peer DBS to the covered bond market with a euro-denominated issue. However, even DBS found that the market could be challenging. Late last year, it sounded investors for a potential sterling deal, but nothing materialised.

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