Barclays AAA Handbook.6.2010

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RESEARCH June 2010

THE AAA HANDBOOK 2010 REBUILDING TRUST

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ON THE LAST PAGE

Barclays Capital | AAA Handbook 2010

FOREWORD

Rebuilding trust Larry Kantor +1 (212) 412 1458 [email protected]

As we put together our eighth edition of The AAA Handbook, the market environment has deteriorated from just a few months ago. Increases in spreads and volatility, as well as a decline in liquidity, have left investors concerned that perhaps we have not seen the last of the crisis environment of 2008. In a sense, the recent environment has increased the attractiveness of the assets covered in this book. While sovereign debt concerns are greater than ever, all of the supranationals, agencies, sub-sovereigns, government guaranteed and covered bonds have continued to pay interest and principal on schedule. In addition, the rally in core European government bonds has increased the yield advantage of these instruments. One major change from 2008 is that the market is differentiating among the bonds issued by the various countries to a much greater extent, rendering the analysis of these instruments more important than ever. We see this book as a guide to facilitate a dialogue between you, our clients, and the analysts who put it together. As always, we hope that we are able to provide you with information and analysis that will lead to better investment decisions.

Larry Kantor Head of Research Barclays Capital

10 June 2010

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Barclays Capital | AAA Handbook 2010

TABLE OF CONTENTS INTRODUCTION

4

Strategy CENTRAL BANK COLLATERAL SCHEMES

9

SECONDARY MARKET CONDITIONS

14

AAA RATED BONDS AND BENCHMARK INDICES

17

BARCLAYS CAPITAL LIVE

26

INTERACTIVE AAA HANDBOOK

30

RELATIVE VALUE INTERACTIVE

33

RISK WEIGHTINGS AND LIQUIDITY RISK REGULATIONS

38

COVERED BOND RATING METHODOLOGIES

52

IAS AND THE APPEAL OF REGISTERED BONDS

73

EURO AREA HOUSING MARKET

76

SPANISH HOUSING MARKET

83

UK HOUSING MARKET

88

US HOUSING MARKETS

92

Market overviews SUPRAS AND EUROPEAN AGENCIES

10 June 2010

96

UNITED STATES: GOVERNMENT-GUARANTEED BONDS

114

GOVERNMENT-GUARANTEED DEBT INSTRUMENTS

119

UNITED STATES: AGENCIES

130

JAPANESE PUBLIC SECTOR

140

AUSTRALIAN PUBLIC AGENCIES

142

SPANISH AUTONOMOUS COMMUNITIES

144

GERMAN LÄNDER

155

CANADIAN MARKET

169

DANISH MARKET

179

PFANDBRIEF MARKET

187

SPANISH MARKET

197

FRENCH MARKET

208

GREEK MARKET

222

IRISH MARKET

232

ITALIAN MARKET

239 2

Barclays Capital | AAA Handbook 2010

LUXEMBOURG MARKET

248

DUTCH MARKET

254

NORWEGIAN MARKET

262

HUNGARIAN MARKET

270

AUSTRIAN MARKET

276

PORTUGUESE MARKET

281

SWISS MARKET

288

FINNISH MARKET

294

SWEDISH MARKET

301

UK MARKET

309

US MARKET

318

Issuer profiles SUPRAS AND EUROPEAN AGENCIES PROFILES

331

OTHER SUPRAS AND AGENCIES

378

US AGENCIES PROFILES

409

JAPANESE PUBLIC SECTOR PROFILES

425

AUSTRALIAN ISSUER PROFILES

437

GERMAN LÄNDER PROFILES

449

PFANDBRIEF ISSUER PROFILES

469

SPANISH COVERED BOND PROFILES

519

FRENCH COVERED BOND PROFILES

557

IRISH COVERED BOND PROFILES

579

UK COVERED BOND PROFILES

589

SWEDISH COVERED BOND PROFILES

601

PORTUGUESE ISSUER PROFILES

615

ITALIAN ISSUER PROFILES

629

OTHER COVERED BOND PROFILES

645

APPENDIX

685

Note: Unless otherwise stated, the sources for all table and charts in the profile section are company reports and Barclays Capital.

10 June 2010

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Barclays Capital | AAA Handbook 2010

INTRODUCTION

Rebuilding trust Fritz Engelhard +49 69 7161 1725 [email protected]

Twelve months ago we published The AAA Handbook 2009: Finding a new balance. Since then, the environment for investors in supranationals, agencies, sub-sovereigns and covered bonds has generally improved. However, in recent months, it has become clear that some of the support measures established in 2008-09 have created new challenges. These are growing fiscal burdens in many countries, a more negative perception of sovereign default risk, rising supply of government debt and higher macroeconomic uncertainties, in particular with regard to inflationary expectations. The focus of all stakeholders is very much on rebuilding trust in the interplay between markets, regulation and supervision. In the introduction to this year’s edition of The AAA Handbook – our eighth – we discuss what differentiates the current market environment from the situation in H2 08 and highlight some specifics of AAA products. We also explain why the publication is still called “The AAA Handbook”, despite some negative rating migration and the impaired credibility of rating agencies. This Handbook consists of three sections: Strategy, Market Sector Overviews and individual Issuer Profiles. This year, we have included two sections on sovereign debt developments and the impact the substantial support packages is likely to have on the fiscal position of some countries and the broader economy. We comment on the development of secondary market liquidity and highlight the changes in covered bond rating methodologies and proposed changes to liquidity risk regulations. As usual, we also include our housing market forecasts. We have added and updated the sector overviews to account for the ever-changing and increasing covered bond universe. We describe legislation that has been amended, explain the respective frameworks and highlight strengths and weaknesses. Finally, we have enhanced the profiles section, including the new AAA debt issuers. We hope that The AAA Handbook 2010 will prove a useful tool in your investment decisions. If you have any questions please feel free to contact us – our details are on the back page.

Déjà-vu feelings – but this time is different Memories are still fresh from 2008-09

Concerns about USD funding of European banks

10 June 2010

Pressure on equity and credit spread markets, high volatility in government debt markets, reduced secondary market liquidity and signs of stress in money markets, combined with central bank interventions, created a challenging market environment in Q2 10. This was a kind of ‘déjà-vu’ experience for many investors, who still had fresh memories from their experiences in Q4 08 and Q1 09. In particular, the recent rise in USD Libor fixing, which was not mirrored by a similar move in Euribor, has caused concerns about a renewed funding crunch. This seems to partly reflect a re-assessment of counterparty credit risk in light of sovereign concerns. Combined with a persistent fall in outstanding USD commercial paper, which decreased from $2.2trn in 2007 to $1.1trn currently, this has caused concerns about the ability of European banks to fund themselves in the US market. While the EUR-USD 1y basis swap moved below 50bp again, it seems unlikely that considerable demand for USD funding is emerging, or likely to emerge. In particular, the ECB could provide liquidity through longer-term (1M-3M) USD auctions if conditions deteriorate.

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Barclays Capital | AAA Handbook 2010

Figure 1: USD Libor fixings increase

Figure 2: Moves in EUR–USD basis

3.5

0

3.0

-10

2.5

-20

2.0 -30

1.5 -40

1.0

-50

0.5 0.0 Jan-09

Apr-09

Jul-09

Oct-09

EUR Euribor 3M

Jan-10

-60 Jan-09

Apr-10

Source: Barclays Capital

Moderate spread widening more driven by financials than corporates

Focus on sovereign debt markets

Source: Barclays Capital

Some other measures of financial stress, such as credit indices and FRA-OIS also indicate increasing pressure. 1y Spot FRA–OIS in EUR and USD widened by 17bp and 36bp, respectively, between early April and end-May, leading to a conversion of both measures. Within the same period, the iTraxx 5y Europe widened from 80bp to 125bp. However, as can be seen in Figure 3, both measures are still far from the historically wide levels seen in 2008-09. Furthermore, the credit spread differential between financials and non-financials has reached a new peak, which partly reflects a higher sensitivity of financials to volatility in sovereign debt markets, but also indicates that concerns about the real economy are contained. From a AAA investor’s point of view, the main difference to the situation 15 months ago is the overwhelming impact of the development in (mainly European) sovereign debt markets, on the relative value across various AAA segments. This has had two important implications with regard to cross-sector allocation. First, stress in European sovereign debt markets has a more pronounced impact on the allocation between covered bonds and SSA markets. Second, other factors that used to influence swap spreads, such as supply/demand dynamics and issuer-specific risk factors have moved to the background.

Figure 3: One-year spot FRA-OIS and 5y iTraxx Europe are far from distressed levels of 2008-09 200 180 160

275

140 120 100 80 60

200

40 20 0 Jul-08 Jan-09 Jul-09 EUR 1yr Spot FRA - OIS iTraxx 5yr Europe (RS) Source: Barclays Capital

10 June 2010

Jul-09 Jan-10 EUR-USD 1yr basis

USD LIBOR 3M (R)

Figure 4: Credit spreads of financials at their widest versus non-financials 100

250 225 175 150 125 100 75 50 Jan-10 USD 1yr Spot FRA - OIS

50 0 -50 -100 -150 Jul-08

Jan-09

Jul-09

Jan-10

iTraxx 5yr Europe: Financials - Non Financials Source: Barclays Capital

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Barclays Capital | AAA Handbook 2010

Figure 5: Distribution of outstanding SSA debt by origin of the issuer (based on €iBoxx), May 2010

Portugal 2.3%

Other 16.2% Germany 33.4%

Austria 5.3%

Figure 6: Distribution of outstanding covered bond debt by origin of the issuer (based on €iBoxx), May 2010 Italy 2.0%

Sweden The 2.8% Netherlands 3.2% Ireland

Other 7.1%

Spain 30.7%

3.2%

The Netherlands 7.4%

UK 7.6%

Spain 7.6% Supra 15.0% Source: Markit, Barclays Capital

High weight of European core countries in the SSA market

On aggregate, SSA markets outperformed covered bond markets between mid April and mid May

Narrow correlation between government bonds and agency debt from the same country

10 June 2010

France 15.1%

Germany 19.7%

France 21.5%

Source: Markit, Barclays Capital

When managing exposure to sovereign risk across SSA and covered bond products, it is essential to take into account that the weight of core countries is much higher in SSA markets compared with covered bond markets. For example, European core countries and supra nationals currently make up 76% of the total outstanding SSA debt included in the €iBoxx Index. At the same time, with a 31% market share, Spanish issuers are the largest contributors in the European covered bond arena, with issuers from Ireland, Portugal, Italy and Greece combined making up another 8%. The relatively strong weight of Spain in covered bond markets is reflected in the underperformance of the respective aggregate covered bond index versus the SSA Index. As Figure 7 shows, on aggregate the swap-spread differential between covered bonds and SSA markets widened from mid April to mid May. Thus, one form of expressing a view on the development of European peripheral markets is to adapt the relative weight of these two sectors, basically establishing an Overweight in SSA markets versus covered bonds, in case one expects a further swap spread widening in European peripherals and an Underweight in peripherals versus covered bonds in case one expects a swap spread tightening. The dominant influence of developments in sovereign markets on the relative value within the AAA sector is reflected in the narrow correlation between government bond spreads and agency spreads of issuers from the same country. Figure 8 highlights that spread moves in 4y Spanish government bonds reflected in similar swap spread moves of bonds issued by ICO, the Spanish government-sponsored agency. However, and this is particularly true for covered bonds, we also could observe that spread contraction in AAA products regularly lagged the respective spread tightening in sovereign markets by several days.

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Barclays Capital | AAA Handbook 2010

Figure 7: Swap spread differential between covered bonds and SSA widens 160

Figure 8: Swap spread correlation of 4y government bonds and 4y agency bonds of the same country

€ ASW 4Y Agency Swap Spread

140 120 100 80 60 40 20 0 Jul-09

Oct-09

Jan-10

Apr-10

180 160 140 120 100 80 60 40 20 0 -20 -40 -100

Signs of resilience

0

50

100

150

200

4Y Sovereign Swap Spread

iBoxx Euro Covered 5-7 iBoxx Euro Sub-Sovereigns 5-7 Source: Markit, Barclays Capital

-50

Spain

Germany

France

The Netherlands

Source: Markit, Barclays Capital

Despite the substantial headwinds, there are a number of factors that are supportive for the AAA segment. First, the rally in yields and in particular in core European government bonds has made spread products more attractive again. As pricing action was very fast, many investors have missed the rally. In order to cope with target total return requirements without compromising on underlying default and loss risk, many investors focus strongly on the AAA segment when making new investments. Second, so far the kind of distressed selling pressure observed 15 months ago has not been prevalent. While investors were biased to check bids for all those sectors where the spill-over from the respective sovereign market was particularly pronounced, bid/ask spreads still remained below the levels reached in 2008-09. Third, we also note that the market differentiates much more strongly compared with the situation15 months ago. The large SSA, GGB and covered bond segments from European core countries as well as from UK and Scandinavian countries remained well bid throughout the phase of increased sovereign spread volatility.

Thinking beyond the rating letter Yes, we still call this the “The AAA Handbook”

Most ratings remained close to AAA and all products continued to make scheduled payments

10 June 2010

Over the past two years, we have frequently been asked whether we would consider changing the name of our AAA Handbook publication. Many debt instruments have lost their triple-A ratings and in the process, the credibility of rating agencies has suffered strongly. However, we have kept the title in the past two editions and we also keep it for this year for one very practical reason: most people still understand what we mean when saying the book covers the “AAA sector”. This is simply much shorter than “supranationals, agencies, sub-sovereigns government-guaranteed and covered bonds”. Second, although the sector has also experienced some downgrades and increased rating volatility, the respective rating actions were not only much more limited compared with other debt instruments, such as some structured credit products for example, but also rating agency default and recovery statistics underline that rating agencies were mostly on track with regard to their assessment of default and loss evaluations of more traditional debt instruments, including high investment grade securities. The debt products we covered in the 2009 edition of this book continued to pay interest and principal on schedule and most of those suffering downgrades were staying close to the AAA level.

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Barclays Capital | AAA Handbook 2010

A rates product differs from a credit product in the way investors look at it

Drawbacks of using ratings as strict investment criteria

Beyond the rating letter – the benefits of a qualitative approach to ratings

Third, irrespective of their actual rating, “AAA products” are different from traditional credit instruments. Most investors in AAA debt generally focus strongly on actively managing the exposure of their portfolios to changes in interest rates or the shape of the yield curve rather than fundamental default and loss risk. They buy and sell securities not just because they are bullish or bearish on certain credits, but mainly because they wish to express a view on interest rates and/or moves of the swap curve versus the government bond curve. Thus, compared with typical credit investors, they make stronger demands on secondary market liquidity. Their investment decisions are also driven by the specific regulatory treatment of these instruments in terms of risk-weighting and central bank repo eligibility 1. Finally, market participants increasingly refrain from applying strict rating criteria. While it appears tempting to implement strict rules because of the simplicity and clarity of such an approach, there are a number of caveats. First, the definition of ratings varies across the major agencies. Strict rules are not suited to take this aspect into account. Second, hard rating limits put asset managers under pressure to sell securities when the respective limit is breached because of a downgrade. As the market environment is generally difficult in such instances, the respective unwind could be harmful for the performance of the affected portfolio. Third, the market processes information faster than the rating agencies. Default rates and rating trends generally reach a turning point about six-to-nine months after credit spreads reach a cyclical peak. Thus, investors and regulators are at risk of being consistently behind the curve when applying strict rating criteria. Owing to these drawbacks, we recommend avoiding the use of ratings as strict investment criteria as much as possible. Avoiding ratings as strict investment criteria does not imply that one should completely ignore them. Quite the contrary is true. Generally, ratings are the result of a detailed analytical process. Rating agencies put a lot of effort into developing specific rating methodologies. Furthermore, they reacted to the financial market turmoil by adjusting their general methods, changing their assumptions and disclosing more information on their rating approaches. Following these discussions, monitoring the development of risk factors, tracking the assumptions regarding payment interruptions and recoveries, could all be beneficial in strengthening the understanding of AAA products. One interesting common characteristic of the products covered in the book is that rating agencies developed specific rating approaches for these products. They differ from the general corporate debt rating methodologies, as supranationals, agencies, sub-sovereigns government-guaranteed and covered bonds generally feature below-average default risk and above-average recovery prospects, irrespective of the actual rating level. This is why we keep the “AAA Handbook” title and might even continue to do so even if the rating agencies drop rating letters.

1

In this context it is worth noting that in 2007, the ECB published a working paper titled, ‘What hides behind sovereign ratings?’ It concludes that across rating agencies and over various periods the respective ratings have “a good overall prediction power”.

10 June 2010

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Barclays Capital | AAA Handbook 2010

CENTRAL BANK COLLATERAL SCHEMES

Broadening the scope Fritz Engelhard +49 69 7161 1725 [email protected] Huw Worthington +44 (0) 20 7773 1307 [email protected]

The eligibility of the debt instruments covered in this handbook as collateral for central bank liquidity facilities has been an important factor in bank sector demand for the asset class over the years. One of the features of central bank responses to the credit crisis has been a widening in the range of facilities through which central banks have provided funds against collateral to market participants. There are significant variations in the range of collateral accepted in the different facilities provided by the ECB, the Fed and the Bank of England. Below we provide a summary.

Collateral at the ECB Collateral is placed with the Eurosystem to secure borrowing from it and to back the payments system

A wide range of EUR debt is eligible

Shift to a single list at the start of 2007

Banks deposit collateral with the Eurosystem (ie, the ECB and member central banks) as security for borrowing from the ECB and as security for intra-day credit provided in the process of the operation of the real-time payments system (TARGET). The ECB defines the criteria for determining the eligibility of assets as collateral and publishes updated lists of eligible assets daily. The same list applies to all collateral transactions within the Eurosystem. The ECB accepts a wide range of EUR-denominated assets as collateral, ranging from government bonds to asset-backed securities (ABS) and credit claims. For ABS, only true sale securitisations can be included, and bonds must be from the most senior tranche available. From 1 March 2010, the credit requirements for ABS were amended such that ABS issued after 1 March 2009 also had to have an initial rating of AAA/Aaa with at least two rating agencies. From 1 March 2011, this would be extended to all ABS in issue irrespective of issuance date. Over the lifetime of the ABS, however, the previously existing single-A minimum rating threshold would have to be retained for it to remain eligible. CDOs of ABS are not eligible as collateral. At the beginning of 2007, the ECB moved from a two-tier collateral system (in which some assets were limited to use as collateral in specific countries) to a single list, which now defines the assets eligible as collateral throughout the Eurosystem. The ECB announced further changes to its collateral policy in 2008, with the changes taking effect from 1 February 2009. The main changes, implemented were the following:

10 June 2010

„

A change in the categories of collateral, with ABS shifted to a new Category 5, and traditional unsecured bank bonds being shifted to a new Category 4 (Figure 9 and Figure 10).

„

An increase of 5% in the haircut charged on unsecured bank bonds (the new Category 4) across the board.

„

A uniform haircut for ABS securities in Category 5, of 12% (instead of the previous sliding scale, and the effective haircut for most ABS that was at 2%). In addition, for all ABS that are priced ‘theoretically’ (basically, for which there is no secondary market), there is an extra surcharge of 5% (effectively 4.4%). Traditional (and jumbo) covered bonds are not included in this.

„

The definition of ‘close links’ is being extended, so as to exclude some bonds, and there are also some increased requirements related to ratings. 9

Barclays Capital | AAA Handbook 2010

Figure 9: New categories of eligible marketable collateral Category 1

Category 2

Category 3

Category 4

Category 5

Central government

Local/regional government

Traditional covered bonds

Credit institutions

ABS

Central banks

Jumbo covered bonds

Corporate/other

Supras/agencies Source: ECB

Eligible assets include marketable and non-marketable assets

The single list is composed mainly of marketable assets, which are grouped into four categories, reflecting varying levels of liquidity. However, with the initiation of the single list at the start of 2007, non-marketable assets (mainly credit claims or bank loans) were included in the list across the whole euro area for the first time. In addition, with the move to a single list, the range of issuers has been expanded to include, for example, EURdenominated debt issued by entities established in G-10 countries outside the EEA. Marketable assets are subject to haircuts. For floating rate assets, the haircut for 0-1y fixed-rate debt in the corresponding liquidity category is applied. Therefore, for European ABS, most of which is in floating rate form, this is normally the relevant measure.

Figure 10: Haircut schedule for fixed coupon marketable assets (%) Residual maturity (yrs)

Category 1

Category 2

Category 3

Category 4

Category 5*

0-1

0.5

1

1.5

6.5

12

1-3

1.5

2.5

3

8

12

3-5

2.5

3.5

4.5

9.5

12

5-7

3

4.5

5.5

10.5

12

7-10

4

5.5

6.5

11.5

12

>10

5.5

7.5

9

14

12

Note: Assets in category 5 that are given a theoretical value are subject to an additional valuation markdown of 5% Source: ECB

Non-marketable assets are subject to much higher haircuts than marketable assets, Figure 11.

Figure 11: Haircut schedule for fixed coupon non-marketable assets (%) Residual maturity (yrs)

Fixed interest payment and valuation based upon theoretical price assigned by NCB*

Fixed interest payment and valuation according to the outstanding amount assigned by NCB

0-1

7

9

1-3

9

15

3-5

11

20

5-7

12

24

7-10

13

29

>10

17

41

Note: *NCB = National Central Bank. Source: ECB

There was c.EUR13.1trn of eligible collateral in 2009

10 June 2010

The ECB estimates that in 2009, total eligible collateral averaged EUR13.1trn, of which, on average, EUR2.034trn was deposited as collateral in the Eurosystem. Of this, EUR709bn, on average, was used as collateral for borrowing from the ECB via open market operations (OMOs).

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Barclays Capital | AAA Handbook 2010

Figure 12: Breakdown of assets put forward as collateral by asset type 2,500 2,000 1,500 1,000 500 0 2004 Government Corporate Other

2005

2006 Avg

2007 Avg

Credit Institutions - uncovered ABS

2008 Avg

2009 Avg

Credit Institutions - Covered Non -marketable assets

Note: The Government category includes debt issued by central and regional governments. Source: ECB, Barclays Capital

Fall in usage of government bonds and rise in ABS, bank bonds and credit claims

According to the ECB Annual Report, central government bonds increased as a percentage of total collateral held in the Eurosystem, from 10% to 11% between 2008 and 2009 (comparing year average data). The share of ABS went down from 28% in 2008, to 23% in 2009, due to reductions in market values and haircut increases, while the overall actual amount remained stable. The fall in ABS saw uncovered bank bonds increase their share to become the largest single class in 2009 at c.28%, thus exceeding the amount of ABS. Although it takes longer to establish eligibility for credit claims than for marketable assets and despite the higher haircuts to which they are subject, the amount of non-marketable assets used increased from 4% in 2006, to 14% on average in 2009. The new asset classes, some of which are temporarily eligible, accounted for 3.8% on average. In addition to the claims above, the ECB in October 2008 temporarily extended the range of eligible assets to include the following listed below. Initially the assets were to be eligible until end 2009, however this was subsequently extended and they will remain eligible until the end of 2010 currently. „

Marketable debt instruments denominated in other currencies than the euro, namely the US dollar, the British pound and the Japanese yen, and issued in the euro area. These instruments are subject to a uniform haircut add-on of 8%.

„

Debt instruments issued by credit institutions, which are traded on the accepted nonregulated markets that are mentioned on the ECB website; this measure implies inter alia that certificates of deposits (CDs) are also eligible when traded on one of these accepted non-regulated markets. All debt instruments issued by credit institutions, which are traded on the accepted non-regulated markets, are subject to a 5% haircut add-on.

„

Subordinated debt instruments when they are protected by an acceptable guarantee as specified in section 6.3.2 of the General Documentation on Eurosystem monetary policy instruments and procedures. These instruments are subject to a haircut add-on of 10%, with a further 5% valuation markdown in case of theoretical valuation.

Furthermore, the ECB announced a lowering of the credit threshold for marketable and nonmarketable assets from A- to BBB-, with the exception of ABS, and imposed a haircut add-on of 5% on all assets rated BBB-. The measures were originally intended to remain in force until end-2009, again however this was extended until first end-2010 and then in April 2010 it was 10 June 2010

11

Barclays Capital | AAA Handbook 2010

announced that they would be allowed permanently. As previously, these lower-rated assets are subject to an increased haircut of 5%; however, the ECB also said that in July 2010 it would replace the uniform haircut add-on with a graduated haircut schedule, which will be at least as high as the haircut currently applied, based upon the following parameters. „

Maturity, liquidity category and the credit quality of the asset. The lowest haircuts will apply to the most liquid assets with the shortest maturities, while the highest haircuts will apply to the least liquid assets with the longest maturities.

Notably no changes were to be made to the current haircut schedule foreseen for central government debt instruments and possible debt instruments issued by central banks that are rated in the above-mentioned range. This carve-out for government debt was supplemented by a subsequent decision in early May 2010 that until further notice the minimum credit rating threshold for marketable debt instruments issued or guaranteed by the Greek government would be suspended. The new haircuts will not imply an undue decrease in the collateral available to counterparties.

Collateral at the Fed Prior to the onset of the banking sector liquidity crisis in H2 07, the Fed made three facilities available in which it accepted specified types of USD-denominated collateral, against the provision of funds or securities, namely: „

OMOs with primary dealers

„

Discount window lending to banks

„

Securities lending through the system open market account (SOMA)

With financial markets returning to more normal activity, the liquidity and credit programmes introduced in 2008 have all expired with the exception of a small part of the Term Asset-Backed Facility (TALF). The TALF supports the issuance of ABS collateralised debt by a wide variety of loans by providing non-recourse (three-year) funding to any eligible borrower owning eligible collateral. At the moment with bank reserves exceeding $1trn, and its exit strategy still several months off, the Federal Reserve is doing no open market operations and use of the discount window has ebbed to under $10bn. Securities lending through the SOMA also has been light – mainly because the amount of specials activity in the repo market has been compressed by the low level of repo rates.

Collateral at the Bank of England Range of different collateral lists

Traditionally, the Bank of England (BoE) has provided funds against collateral via:

eligible for different facilities „

OMOs – both short-term (normally one week) repos conducted weekly at the Bank’s official rate, and longer-term repos (with maturities from three to 12 months), conducted monthly at variable rates.

„

Standing facilities, through which the BoE lends to eligible UK banks and building societies overnight at a penal rate.

For both OMOs and standing facilities, the BoE normally accepts as collateral:

10 June 2010

„

UK government securities and bills in GBP and other currencies

„

BoE foreign currency debt securities 12

Barclays Capital | AAA Handbook 2010 „

Certain GBP and EUR securities issued by EEA central governments, central banks and international institutions.

At various stages since the start of the crisis, the BoE has provided additional longer-term funding against a wider range of collateral. However, the most notable of these came in late April 2008, when the BoE announced a Special Liquidity Scheme (SLS), affecting institutions eligible to use its standing facilities. Under this scheme, the BoE provides Treasury bills for certain assets sitting on bank balance sheets that cannot be securitised in the wholesale funding market. The key features of the facility are as follows.

Acceptable collateral „

AAA UK and EEA covered bonds

„

AAA tranches of UK and EEA RMBS

„

AAA tranches of UK, US and EEA credit card ABS

„

G10 sovereign debt rated Aa3 or higher

„

G10 explicitly guaranteed Agency AAAs

„

Conventional US GSE AAA debt

Currency The facility is not limited to GBP-denominated securities, but can also be used for EUR, USD, AUD, CAD SEK, CHF and JPY (the last for Japanese government bonds only). However, foreign currency securities will be liable to an additional haircut.

Constraints on RMBS For RMBS, the facility is primarily intended to provide liquidity for securities backed by collateral held on bank balance sheets at end-2007, and not to provide a source of funding new business. For RMBS master trusts that include assets originated after December 2007, their securities will be eligible on a declining scale over time, ie, 100% of the amount outstanding at 31 December 2007 is eligible in Year 1, 66% in Year 2, and 33% in Year 3.

Term and size The SLS was introduced in April 2008, and was designed to finance part of the overhang of illiquid assets on banks’ balance sheets by exchanging them temporarily for more easily tradable assets. Securities formed from loans existing before 31 December 2007 had been eligible for use in the SLS. The drawdown period for the SLS closed on 30 January 2009. Use of the Scheme has been considerable, totalling £186bn of Treasury Bills against £287bn of collateral. Although the drawdown window to access the SLS has closed, the Scheme will remain in place for three years, thereby providing participating institutions with continuing liquidity support and certainty. In March 2010, the Bank of England published a consultation document that sought views on two specific issues: First, on extending the list of eligible collateral acceptable at its Discount Window Facility so as to include various classes of loan portfolios; and second, on an initiative to require greater transparency with respect to the covered bonds and ABS that it acquires via its market operations.

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Barclays Capital | AAA Handbook 2010

SECONDARY MARKET CONDITIONS

Happiness makes up in height for what it lacks in length 2 Fritz Engelhard +49 69 7161 1725 [email protected]

Significant improvement of market conditions in H2 09

Pronounced tightening of bid/ask spreads in some covered bond instruments

The significant improvement of secondary market liquidity for €-denominated AAA instruments, which could be observed in the course of H2, were challenged by the persistent deterioration of trading conditions in sovereign markets in the first few months of 2010. While the renewed worsening of secondary market liquidity was a kind of ‘déjà-vu’ experience for many investors, we would argue that the current situation differs from that the market experienced 15 months ago, as there are a number of factors which suggest that an acceptable level of secondary market liquidity could be sustained. Between Q2 09 and Q4 09, secondary market liquidity in €-denominated AAA instruments improved markedly. This was the result of a whole bundle of supporting factors. First, issuance activity in SSA and GGB space decreased substantially in the course of H2 09, which helped ease concerns regarding a permanent repricing of the sector through primary market transactions. Second, the European Central Bank’s covered bond purchase programme led to a swing from one-sided selling to one-sided buying in covered bond markets. Third, the bond market rally, which saw the 5y swap rate decrease by 50bp between early June and early October, has created an incentive to some investors for taking profit. This in turn led to more two-way flow in AAA markets, thereby further improving secondary market liquidity. The narrowing of bid/ask spreads in €-denominated benchmark AAA instruments was well reflected in covered bond markets, where swap spreads have been subject to a marked tightening since the ECB announced the implementation of the CBPP. Average bid/offer spreads persistently fell from rather wide levels of up to 75bp in Q1 09, to their lowest figure of down to 5-10bp in mid April 2010, thereby reducing significantly the liquidity gap between various market segments (Figure 13).

Figure 13: Bid/offer spreads on secondary covered bond market 80

bp

75

60

50

50

40

25

20 20

35 35

30 15

10

10

30 20 20

10

5

20

25

20

20 15

7

7

12

20 15 7

12

10

15

0 Pfandbrief early 2009

Multi-Cédulas mid 2009

Cédulas early 2010

Obl Fonc

Fr Common

Mid April 2010

UK Covered Mid May 2010

Source: Barclays Capital

2

10 June 2010

Robert Frost (American Poet)

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Barclays Capital | AAA Handbook 2010

Pronounced tightening of bid/ask spreads in some covered bond instruments

Déjà-vu feelings but this time is different

Investors shift focus on exposure to sovereign risk and the management of country risk limits

Already in February and more pronounced from mid April onwards, increasing tensions in sovereign debt markets had significant spill-over effects in AAA markets. The pattern was rather simple. Agencies, sub-sovereigns, government guaranteed bonds and covered bonds issued out of European peripheral countries saw their swap spreads widen basically in line with swap spreads of the respective government bonds. The worsening of market conditions also reflected in bid/ask spreads, which widened back to mid 2009 levels in Cédulas for example, but in jumbo Pfandbriefe widened back towards 10bp again. Interestingly, in the early phase of the sovereign debt-related swap spread widening, some AAA instruments, including covered bonds, eventually traded tighter compared to the respective government bonds of the same country. The renewed worsening of secondary market liquidity was a kind of ‘déjà-vu’ experience for many investors, who still had fresh memories from their experiences in Q4 08 and Q1 09. However, in our view, the current situation differs from the situation the market experienced in the pronounced liquidity squeeze of Q4 08/Q1 09. First, pressure is not coming out of traditional credit spread markets and stress in interbank lending markets but rather from the other end of the fixed income spectrum (Figure 14). Second, the rally at the long-end of the yield curve leaves many fixed income investors with outright gains on their investments (Figure 15). Third, so far there has been no distressed selling behaviour in AAA markets characterised by price-insensitive inventory clearing operations. Fourth, screen prices have generally become more reliable, as market makers are less inclined to keep bid/ask spreads artificially tight, but are more ready to express potential buying and selling levels through the quotes shown on the screens The above differences to the stressed situation in Q4 08/Q1 09, have some important implications for trading patterns and investor behaviour. As most investors in AAA products mainly use their exposure to SSA, GGB and covered bond markets to enhance return beyond their core mandates in sovereign markets, they were forced to shift their attention strongly towards managing their exposure to sovereign debt markets. Furthermore, even investors with pure non-sovereign mandates were obliged to focus on the development in sovereign debt markets, as the situation in the respective sovereign market generally overshadowed other traditional relative value factors, such as issuer-specific risk, demand/supply trends and, for covered bonds, the quality of collateral assets. If anything, most investors became stricter in limiting their exposure to those sovereigns that have been identified as more vulnerable. However, on the positive side, we could also observe that in those periods where trading conditions in the affected sovereign debt markets improved, with a certain delay, this also had positive spill-over effects for the AAA products trading environment.

Figure 14: Swap spread widening in Spanish agency and covered bonds largely a result of pressure on SPBGs € OAS 180 160 140 120 100 80 60 40 20 0 -20 Jan-09

Apr-09

Jul-09

ICO 3.500% Jan 14 SPGB 4.250% Jan 14 Source: Barclays Capital

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Oct-09

Jan-10

Apr-10

SANTAN 3.500% Feb 14

Figure 15: Strong outright performance of long-dated covered bonds makes unwinds less painful 115 113 111 109 107 105 103 101 99 97 95 Jan 09

Apr 09

Jul 09

Oct 09

Jan 10

Apr 10

iBoxx Euro Covered 1-3 Total Return Index iBoxx Euro Covered 7-10 Total Return Index Source: Barclays Capital

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Barclays Capital | AAA Handbook 2010

Bond market rally fosters twoway flow

So far no signs of distressed selling

More realistic screen prices for jumbo covered bonds

Environment remains challenging

10 June 2010

Another aspect that differentiates the current situation from the one 15 months ago is the strong performance at the long end of the yield curve. As pricing action was very fast, many investors have simply missed the rally. In order to cope with target total return requirements without compromising on underlying default and loss risk, many investors focus strongly on the AAA segment when making new investments. Furthermore, the bond market rally reduces potential losses that outright investors may need to incur when unwinding some of their exposures to markets with above-average spread volatility. Both factors contribute to two-way flow and help improve secondary market liquidity. Between mid April and mid May, secondary market turnover in AAA markets was characterised by investors checking bids for all those sectors where the spill-over from the respective sovereign market was particularly pronounced. However, there was not the same kind of distressed selling pressure as it could be observed 15 months earlier. This is also reflected by the fact that bid/ask spreads still remained below the levels reached in early 2009, while swap spreads in some cases hit fresh highs. Given that central banks reacted quickly by signalling that they are prepared to accommodate rising demand for liquidity, for the moment there are no signs that history will repeat itself on this front. Furthermore, the large SSA, GGB and covered bond segments from European core countries as well as from UK and Scandinavian countries remained rather well bid throughout the phase of increased sovereign spread volatility. A fourth element, which differentiates the current situation from the one 15 months ago, is the more realistic approach to show prices on screens. In particular in the jumbo covered bond sector, historically market makers were generally inclined to show artificial screen prices, which gave misleading information on executable price levels and rather hampered price discovery. Many investors adapted their approach and switched from price taker into price maker mode. By communicating the prices they were prepared to accept, they kept informed about market opportunities and they could also gauge the development of liquidity over time. However, in the course of 2009 already, market makers have adapted their approach, showing screen prices which better reflect executable levels. Thus, it has become easier for investors to evaluate market conditions, although the overall market depth was limited through the fact that the respective amounts have been cut down and the number of active market makers decreased. While the above elements may help sustain an acceptable level of secondary market liquidity, we warn that liquidity conditions are unsteady. Renewed market volatility, in combination with the negative experience of many investors of being limited to fulfil their mandates in managing risk positions, makes them not only risk-averse but also sensitive to changes in market conditions.

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Barclays Capital | AAA Handbook 2010

AAA RATED BONDS AND BENCHMARK INDICES

The Barclays Capital Euro Aggregate Bond Index Leef H Dierks +49 (0) 69 7161 1781 [email protected]

The Euro-Aggregate Index tracks fixed-rate, investment-grade euro-denominated securities. Inclusion is based on the currency of the issue, and not the domicile of the issuer. The principal sectors in the index – Treasury, Corporate, Government-Related and Securitised Securities – are part of the Pan-European Aggregate and the Global Aggregate indices. The Euro-Aggregate Index was launched on 1 July 1998.

Figure 16: Barclays Capital Euro Aggregate Bond Index weighting of selected sub-sectors, 2010 Baa 8%

Securitised 12%

A 11%

Corporate 18% Aaa 54%

Treasury 55% Aa 27%

Govt.Related 15%

Source: Barclays Capital

Figure 17: Barclays Capital Euro Aggregate Bond Index – country weightings, 2010 Greek 3% Belgian 4%

Austrian Portuguese 2% 3%

Other 3% German 22%

Dutch 5% Spanish 11% French 19% Non-EMU 13%

Italian 15%

Source: Barclays Capital

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Barclays Capital | AAA Handbook 2010

Pricing and related issues Sources and frequency

All bonds are priced daily by Barclays Capital traders, third-party vendors or, as in the case of traditional Pfandbriefe, by an interpolated yield curve.

Timing

Pricing is at 4:15pm London time. If European markets are open, but the UK is closed, then pricing will remain constant until the close of the next UK business day. If the last business day of the month is a public holiday in the major European markets, then prices from the previous business day are used.

Bid or offer side

Outstanding issues are priced on the bid side, with the exception of Euro Treasury bonds, which use mid dollar prices. New issues enter the index on the offer side.

Settlement assumptions Verification

T+1 settlement basis Multi-contributor verification: The primary price for each security is analysed and compared to other third-party pricing sources through both statistical routines and scrutiny by research staff. Significant discrepancies are investigated and corrected as necessary. On occasion, index users may also challenge price levels, which are subsequently reviewed by the pricing team. Prices are then updated as needed using input from the trading desk.

Rules for inclusion Amount outstanding Quality

Maturity

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€300mn minimum par amount outstanding. Must be rated investment grade (Baa3/BBB-/BBB- or above) using the middle rating of Moody’s, S&P and Fitch, respectively. „

When all three agencies rate an issue, a median or “two out of three” rating is used to determine index eligibility by dropping the highest and the lowest rating.

„

When a rating from only two agencies is available, the lowest (“most conservative”) of the two is used.

„

When a rating from only one agency is available, that rating is used to determine index eligibility.

„

Unrated Pfandbriefe are assigned ratings that are one full rating category above the issuer’s unsecured debt. This is consistent with Moody’s methodology and reflects the underlying collateral.

Maturity „

At least one year until final maturity, regardless of optionality. For securities with a coupon that converts from fixed to floating, at least one year until the conversion date.

„

Perpetual securities are included in the index provided they are callable or their coupons switch from a fixed to variable rate. These are included until one year before their first call date, providing they meet all other index criteria.

Seniority of debt

Senior and subordinated issues are included. Undated securities are included provided their coupons switch from fixed to variable rate.

Coupon

Fixed-rate, step-up coupons and coupons that change according to a pre-determined schedule are also included. Capital securities with coupons that convert from fixed to floatingrate are index-eligible given that they are currently fixed-rate; the maturity date then equals the conversion date. Fixed-rate perpetual capital securities that remain fixed-rate following their first call date and which provide no incentives to call the bonds are excluded. 18

Barclays Capital | AAA Handbook 2010

Currency Market of issue Security Types

Euro. Publicly issued in the eurobond and eurozone domestic markets. Included: „

Fixed-rate bullet, puttable and callable

„

Soft bullets

„

Fixed-rate and fixed-to-floating capital securities

Excluded: „

Bonds with equity-type features (eg, warrants, convertibility to equity)

„

Private placements, including Schuldscheine

„

Floating-rate issues

„

Inflation-linked bonds

„

German Schuldscheine and Genussscheine

Rebalancing rules Frequency

The composition of the Returns Universe is rebalanced monthly at month’s end and represents the set of bonds on which index returns are calculated. The Statistics Universe changes daily to reflect issues dropping out and entering the index, but is not used for return calculation. On the last business day of the month, the composition of the latest Statistics Universe becomes the Returns Universe for the following month.

Index changes

During the month, indicative changes to securities (maturity, credit rating change, sector reclassification, amount outstanding) are reflected in both the Statistics and Returns universe of the index on a daily basis. These changes may cause bonds to enter or fall out of the Statistics Universe of the index on a daily basis, but will affect the composition of the Returns Universe only at month-end when the index is rebalanced.

Re-investment of cash flows

Interest and principal payments earned by the Returns Universe are held in the index without a reinvestment return until month-end when it is removed from the index.

New issues

Qualifying securities issued, but not necessarily settled; on or before the month-end rebalancing date qualify for inclusion in the following month’s Returns Universe.

Development of AAA segment Debt issued by supras, sub-sovereigns, agencies, and within the scope of governmentguaranteed or covered bond programmes is represented in the ‘Government Related’ and ‘Securitised’ sub-indices. As of mid-May 2010, these two sectors made up €1.86trn or 27% of the total volume outstanding. The ‘Government Related’ Sub-Index (€1,045bn) consists of ‘Agencies’ (€557bn), ‘Local Authorities’ (€284bn), ‘Sovereigns’ (€69bn), and ‘Supranationals’ (€133bn). The ‘Securitised’ Sub-Index (€817bn) is mostly made up of Mortgage (€574bn) and Public Sector (€189bn) covered bonds. Figure 18 and Figure 19 show the composition of the AAA segment, ie, the development of the total amount outstanding, and the respective swap spread developments.

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Barclays Capital | AAA Handbook 2010

Figure 18: Barclays Capital Euro Aggregate Bond Index – weightings of AAA subsectors, 2010

Public Sector Covered 10%

Agencies 31%

Mortgage Covered 32%

Supranational Sovereigns 7% 4%

Local Authorities 16%

Source: Barclays Capital

Figure 19: Barclays Capital Euro Aggregate Bond Index AAA sector – amount outstanding and spread development €bn 1200

OAS 250

1000

200

800

150

600

100

400 50

200 0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Dec-09 Government-Related Public Sector Covered

Mortgage Covered

0 Jan-07 Jul-07 Jan-08 Jul-08 Government-Related Public Sector Covered

Jan-09 Jul-09 Dec-09 Mortgage Covered

Source: Barclays Capital

The iBoxx € Index The iBoxx € Index family represents the investment grade fixed-income market for euro and euro area currency-denominated bonds 3. The iBoxx € Benchmark Index comprises an overall index and four major index sub-groups. These are sovereigns, corporates, collateralised (covered and other securitised bonds) and sub-sovereigns (agencies, supranationals and government-guaranteed organisations), which fulfil the respective maturity, rating and sector index requirements. The Sovereign Index group is made up of eurodenominated sovereign debt from euro area governments. It includes an overall index and maturity indices. At the time of writing, an iBoxx € Index is published for Germany, France, Italy (each with overall and maturity indices), Austria, Belgium, Finland, Greece, Ireland, Luxembourg, the Netherlands, Portugal, Slovakia and Spain (each with overall indices). 3

Note that bonds denominated in a non euro currency are included in the iBoxx indices with their amounts outstanding being redenominated into euro.

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Barclays Capital | AAA Handbook 2010

The iBoxx € Non-Sovereigns Index comprises all those bonds that do not qualify for inclusion in the iBoxx € Sovereigns Index. These bonds are further classified into the Sub-sovereign, Collateralised and Corporates sub-groups. In the following, we limit ourselves to the SubSovereigns and Collateralised indices. The respective structure is outlined below (Figure 20).

Figure 20: New iBoxx € Overall Benchmark Index iBoxx € Overall Benchmark Index iBoxx € Non-Sovereigns Index iBoxx € Sub-sovereigns Rating and Maturity indices iBoxx € Supranationals

iBoxx € Collateralised Rating and Maturity indices iBoxx € Covered

iBoxx € Corporates Rating and Maturity indices iBoxx € Financials

iBoxx € Agencies

iBoxx € Germany Covered

Financials Rating Indices

iBoxx € Public Banks

iBoxx € Spain Covered

Financials Sub Indices

iBoxx € Regions

iBoxx € France Covered

iBoxx € Other Sovereigns

iBoxx € Ireland Covered

iBoxx € Other Sub-sovereigns

iBoxx € UK Covered iBoxx € Other Covered iBoxx € Austria Covered

iBoxx € Non-Financials Non-Financials Rating Indices iBoxx € Corporates Market Sector Corporates Market Sector Indices

iBoxx € Netherlands Covered iBoxx € Norway Covered iBoxx € Portugal Covered iBoxx € Sweden Covered iBoxx € US Covered iBoxx € Italy (new) iBoxx € Securitised iBoxx € Other Collateralised iBoxx € Sovereigns Index Source: Indexco, Barclays Capital

Addition of further sub-indices

In 2008, the iBoxx Covered Index was enhanced by six new country sub-indices. Among these were Austria, The Netherlands, Norway, Portugal, Sweden and the US. Furthermore, the sub-index ‘Spain Covered’ was split into ‘Spain Covered 1-3’, ‘Spain Covered 3-5’, ‘Spain Covered 5-7’, ‘Spain Covered 7-10’ and ‘Spain Covered 10+’. In addition, the section ‘Covered 1-10’ was created. Also, where appropriate, individual country indices were subdivided to better reflect the legal status of the covered bonds issued. For the time being, this holds true for French Obligations Foncières and French Common Law Covered Bonds. Since January 2009, however, this separation is also applicable to the “Spain Covered” section, which was divided into iBoxx € Spain Covered Single Cédulas and iBoxx € Spain Covered Pooled Cédulas. Also, in 2008, an ‘iBoxx € Other Pfandbriefe’ category was introduced, which at the time of writing included covered bonds collateralised by ship mortgages. Following the inaugural launch of an Italian OBG in 2008, Italy was extracted from the ‘Other Covered’ bracket in 2009 and established as a proper sub-index. Following Italy’s departure, the ‘Other Covered’ Index include Canada, Finland, Luxemburg and Hungary, at the time of writing. In order for covered bonds issued out of a single country to be grouped into an individual index, a minimum total issue of €6bn from at least two issuers is required.

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Barclays Capital | AAA Handbook 2010

Pricing provided by 10 financial institutions

Prices for the bonds included in the indices are provided by 10 major financial institutions, among them Barclays Capital. Deutsche Börse calculates and disseminates the indices. The frequency of calculation and dissemination is once per minute between 9.00am and 5.15pm CET. End-of-day closing values are calculated and disseminated for all indices after 5:15pm CET. Operationally, the iBoxx € indices have a base date of 31 December 1998.

iBoxx € Index rules Only fixed-coupon and zerocoupon bonds and step-ups are eligible for inclusion in the index

The selection criteria for the inclusion of bonds in the iBoxx € indices are the bond type, the rating, the time to maturity, and the outstanding amount. Generally, only fixed-rate bonds whose cash flow can be determined in advance, such as fixed-coupon, zero-coupon or stepup bonds, are eligible for the indices. Soft-bullet bonds are considered only for the iBoxx €collateralised indices. Callable bonds are only eligible if they are subordinated debt, including fixed-to-floaters. Sinking funds, amortising bonds, other callable, undated bonds, floating rate bonds, fixed-to-floater bonds, collateralised debt obligations (CDOs) and bonds collateralised by CDOs, German Kommunalanleihen and retail bonds are specifically excluded from the indices. Originally, UK covered bonds belonged to the collateralised category, but they were transferred to the covered category in 2005, where they now have their own sub-category (UK Covered) (Figure 20). Figure 21 outlines the bond types that are currently included in the iBoxx € Covered Index.

Figure 21: Covered bonds qualifying for the iBoxx € Covered Index Name

Country of origin

Fundierte Bankschuldverschreibungen

Austria

Jumbo Pfandbrief

Germany

Obligations Foncières

France

Cédulas Hipotecarias

Spain

Cédulas Territoriales

Spain

Lettre de Gage

Luxemburg

Asset Covered Security

Ireland

UK Covered Bonds

UK

Obrigacaoes Hipotecarias

Portugal

Säkerställda Obligationer

Sweden

Særligt Dækkede Realkreditobligationer

Denmark

Dutch Covered Bonds

Netherlands

Obbligazioni Bancarie Garantite

Italy

Jelzaloglevel

Hungary

Obligasjonslån med portefoljepant

Norway

Joukkovelkakirja

Finland

Canadian Covered Bonds

Canada

US Covered Bonds

US

Note that as at April 2010, Greek covered bonds were not included in the Markit iBoxx EUR Covered indices. Source: iBoxx, Barclays Capital

Investment grade rating required for inclusion in iBoxx € Index

10 June 2010

All bonds in the iBoxx € Index family must be rated investment grade by at least one of Standard & Poor’s, Moody’s or Fitch. In case a bond is rated by several agencies, the average rating rounded to the nearest integer will be attached to the bond. The rating determines whether the bond is eligible for the iBoxx € indices and to which rating index it belongs. The minimum rating to qualify a bond as investment grade is BBB- for Fitch or S&P and Baa3 22

Barclays Capital | AAA Handbook 2010

from Moody’s. Ratings are consolidated (eg, BBB+, BBB and BBB- are consolidated to BBB; A+, A and A- are consolidated to A and so on) 4. Note that bonds in the iBoxx € Eurozone Index do not need to be rated; however, a rating requirement for the individual countries included in this index has been introduced. In order for their bonds to be eligible for the indices, all countries which are part of the iBoxx € Eurozone indices require a long-term local currency sovereign debt rating of investment grade. The respective index rating is determined by the average rating of Fitch Ratings, Moody’s Investors Service and Standard & Poor’s Rating Services. Minimum amount outstanding required for inclusion in iBoxx € Index

All bonds must have a minimum remaining term to maturity (TTM) of at least one year on the respective rebalancing date. Also, as outlined in Figure 22, the bonds require a specific minimum amount outstanding to be eligible for the indices.

Figure 22: Minimum amount outstanding for inclusion in iBoxx Index Bond

Outstanding amount

Sovereigns

€2bn

Sub-sovereigns

€1bn

Covered

€1bn

Collateralised

€500mn (€1bn) (except covered bonds)

Corporates

€500mn (€1bn for bonds issued in legacy currencies)

Source: iBoxx, Barclays Capital

Figure 23 outlines the development of the historical weightings of different AAA groups within the iBoxx € Index. The combined weight of the sectors outlined below (Agencies, Regions, Covered Bonds, Supranationals and Other Sub-Sovereigns) amounted to c.20.8% as at end-April 2010, decreasing around 0.8pp from 21.6% as at end-April 2009. The sudden decline in the weight of the AAA bonds in mid-2004 was attributed to a reduction in the weightings of agencies. This comes as iBoxx reclassified several institutions, among them German Landesbanks, Electricité de France, Infrastrutture SpA, and others.

Figure 23: Historical weights of agencies, regions, covered bonds, supranationals and other sub-sovereigns (%) 25 20 15 10 5 0 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Agencies Supranationals

Other sub-sovereigns Covered

Regions Total

Source: iBoxx, Barclays Capital

4

Ford and GM were taken out of the index in the first half of 2005, which resulted in a sudden increase in credit spreads and a sudden decrease afterwards due to survivorship bias.

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Barclays Capital | AAA Handbook 2010

Asymmetric swap spread widening from September 2008

The historical ASM development for these sub-indices is outlined in Figure 24. On a general note, we observe that between 2000 and 2007, the sectors analysed performed relatively well. Owing to the turmoil in the global money and capital markets, which became more evident in August 2007, the asset swap margin (ASM) of covered bonds started widening in a relatively stronger manner compared with other sub groups. Following the collapse of Lehman Brothers in mid-September 2008, however, spreads started widening significantly. In this context, we observe a strongly asymmetrical development of the widening momentum. Following the pronounced widening momentum observed in early 2009, swapspreads started to contract again after the ECB announced its €60bn covered bond purchase programme. Still, the once relatively homogeneous market had already started drifting apart in early 2008. Following a recovery phase of swap-spreads in late 2009, they came under renewed pressure in early 2010, as concerns regarding the fiscal position of some Mediterranean rim European Monetary Union member countries started mounting (Figure 24).

Figure 24: Historical ASM for covered bonds, agencies, regions, supranationals and other sub-sovereigns (bp) 200 150 100 50 0 -50 Jan-06 Agencies

Jan-07

Jan-08

Other sub-sovereigns

Jan-09 Regions

Supranationals

Jan-10 Covered

Source: iBoxx, Barclays Capital

Figure 25 outlines the relative weights of the selected sub-covered bond sectors within the iBoxx € Index. As can be seen, the ongoing modest supply of German jumbo Pfandbriefe has caused the weight of the respective sub-index to plummet to 2.3% as at end-April 2010, from 9.5% as at end-2001. Despite being fairly more modest, a comparable development can be observed in the case of Spanish Cédulas, whose relative weight has steadily declined since early 2008. Their current weight within the index amounts to 3.2% as at end-April 2010 and thus is the highest. The proportion of French issuers remained stable at a level of around 2.5% as at end-April 2010.

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Barclays Capital | AAA Handbook 2010

Figure 25: iBoxx weighting of selected sub-covered bond sectors (%) 2

10 8 6

1 4 2 0 Jan-00

Dec-01

Dec-03

France

Dec-05 Germany

Jan-08

Jan-10 Spain

0 Jan-00

Dec-01 Ireland

Dec-03

Dec-05 UK

Jan-08

Jan-10 Others

Source: iBoxx, Barclays Capital

Generally, as at end-April 2010, covered bonds had a weight of approximately 11.0% in the iBoxx Index, down about 1pp to 11.0%, from 12.0% as at end-April 2009. This, in our view, is largely due to the fact that covered bond issuance stalled between mid-2008 and mid2009, whereas the issuance of other debt instruments sharply increased. Still, the situation might be poised for a change as issuance has strongly recovered: totalling €66bn in Q1 10, from €12bn in Q1 09.

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Barclays Capital | AAA Handbook 2010

BARCLAYS CAPITAL LIVE

One portal for all research publications & analytics Stuart Urquhart +44 (0) 20 7773 8410 [email protected]

Barclays Capital is committed to developing relevant and innovative solutions for the longterm success of our clients. That is why we have developed Barclays Capital Live, our research website offering online access to world class research, indices, analytical tools, reporting and electronic trading via BARX. We look forward to working in partnership with you to ensure that Barclays Capital Live is customised and developed to meet your long-term needs.

Introduction Barclays Capital Live is accessible via https://live.barcap.com. Key features include:

10 June 2010

„

Award-winning global research

„

Full spectrum of benchmark and strategy indices

„

Comprehensive cross-asset class data

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Access to award-winning electronic trading services, BARX

26

Barclays Capital | AAA Handbook 2010

Frequently asked questions Overview What is Barclays Capital Live?

What does Barclays Capital

Barclays Capital Live is a web-based portal that combines the best of Barclays Capital’s analytical tools, research and indices, as well as trading, risk management and reporting systems, into a single site for our clients. Barclays Capital Live offers:

Live offer? „

Award-winning research, analytical tools and prime brokerage services

„

Barclays Capital indices

„

Comprehensive market data

„

Access to award-winning electronic trading services: BARX

„

Research, data and analytical tools, including: −

Interactive AAA Handbook, Curve, Relative Value Interactive (RVI)

−

Market Matrix, Options Analytics,

−

FX Flows, FX Optimiser, Oasis and VarApp,

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„

Access to BARX electronic trading applications

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Enhanced navigation for more efficient access to content

For more information on the portal’s offering please contact the Barclays Capital Live helpdesk at [email protected]. Does Barclays Capital Live offer

Yes, electronic trading is offered via BARX, subject to acceptance of the BARX Terms.

electronic trading?

Accessing Barclays Capital Live To log into Barclays Capital Live, please visit live.barcap.com and enter your login name and password. To request access to Barclays Capital Live, or if you have misplaced your username and/or password, please contact your Barclays Capital Sales Representative. He or she will contact the Barclays Capital Live Sales Group who will provide you with your own login information. If you wish to have access to additional functionality or product classes that you are not permissioned for, please contact your Barclays Capital Sales Representative.

Training and contacts Barclays Capital Live product managers are available to assist with training. Please contact your Barclays Capital Sales Representative who will coordinate a convenient day and time. Please see the contact list on the back cover of this brochure if you have any further questions about Barclays Capital Live.

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Barclays Capital | AAA Handbook 2010

Global research Barclays Capital Live gives you easy access to award-winning research across commodities, credit, economics, emerging markets, equities, foreign exchange, inflation, interest rates, municipals and securitisation.

Key features include: „

Easily accessible summaries of recent research for every asset class

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Indices Barclays Capital is a leading provider of fixed income benchmarks, customised indices and innovative strategy indices. You now have access to the most comprehensive fixed income and strategy-based index family on a single platform.

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The Barclays Capital Indices platform offers market leading benchmarks and alpha generating index products to meet the diverse needs of global investors including: „

Portfolio benchmarking and performance measurement

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Barclays Capital | AAA Handbook 2010

Cross-asset class data Barclays Capital Live’s market monitors, charting and statistical applications deliver a rich set of proprietary data to keep you abreast of the markets and support your investment and risk management decisions. In addition, Barclays Capital Live also makes available to you Relative Value Interactive (RVI), combining interactive pricing reports, curve builders, time series analysis and regression functionality to help users identify value, explore trades and test relationships.

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„

Efficient data downloading

„

Batch reports that enable you to schedule and receive your charts and data via email

Sophisticated analytical tools Barclays Capital Live’s cutting edge quantitative models and analytical tools will enable you to enhance your security, market and portfolio analysis. The platform provides access to exclusive content previously distributed through the Barclays Capital Research site. This includes:

Key features include: „

Basis tools multiple security analysis

„

Capital structure analysis

„

Single security analysis

„

CDX/ABX/CMBX analysis

„

Interactive AAA Handbook

„

Convertible bond market intelligence

„

Curve, Market Matrix

„

Equity trading and impact cost analysis

„

Inflation-Linked Analytics

„

MBS/ABS/CMBS surveillance

„

FX Flows, FX Optimiser, Oasis

„

Options and volatility analysis

„

Rates relative value analysis

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Barclays Capital | AAA Handbook 2010

INTERACTIVE AAA HANDBOOK

The AAA book at your fingertips Stuart Urquhart +44 (0) 20 7773 8410 [email protected]

The interactive AAA handbook offers direct access to individual issuer profiles supported by the latest market valuations and credit term structures to help identify relative value opportunities and explore trade themes. The seven previous hard copy editions of the AAA handbook have been powerful tools that helped investment decisions in what proved to be challenging and turbulent market conditions. To keep pace with the constantly evolving environment, we now provide current market analysis in the form of bond pricing reports and issuer curves. The interactive AAA Handbook is the one place where clients can access all of Barclays Capital’s covered bond content and analytical tools. Key features include:

10 June 2010

„

Issuer-specific credit term structures from our ‘Curve’ analysis

„

Current market valuations via Pricing Reports

„

Individual issuer profiles

„

Strategy and market overviews

„

Archived AAA publications

30

Barclays Capital | AAA Handbook 2010

Our curve analytical platform explores value between the instruments from a specific issuer and their own fitted curve. It also compares the credit term structure of associated issuers and across various markets. Historical curves are available to highlight the evolution of trading opportunities. Key features include: „

Charting an issuer’s bonds against fitted curves to identify relative value opportunities

„

Comparison of all issuers contained within the AAA book

„

Flexibility to remove bonds from an issuer’s curve to create custom curves

„

Examine the evolution of value by comparing historical curves

„

Bond-specific historical performance can be analysed in our time series viewer

„

Trade themes and curve analysis can be communicated through easy web links

„

‘Curve’ also provides access to a vast array of Sovereign and Credit data

Historical iIssuer-specific credit term structures

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Barclays Capital | AAA Handbook 2010

The pricing reports provide current market analysis, for all issuers, through a range of yield and spread-to-benchmark measures along with the historical performance of each instrument to identify rich/cheap performance and thus generate trade ideas. Key features include: „

A vast array of yield, rolldown, carry and spread to benchmark analysis

„

Heat maps based on standard deviation movements to identify value

„

Ability to examine the historical performance of any measure

„

Customisable layouts allow users to design reports to their own requirements

„

Benchmark curves include Government (AAA) and Swaps for liquidity

„

Comparison of all issuers contained within the AAA book

Current market analysis delivered via Pricing Reports

The interactive AAA handbook can be found among the analytical tools in the interest rate section of Barclays Capital Live (BCL): https://live.barcap.com To navigate within BCL: Interest Rates > Analytic Tools > Interactive AAA Handbook or type Keyword: AAAhandbook into the search browser.

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Barclays Capital | AAA Handbook 2010

RELATIVE VALUE INTERACTIVE

One platform, clear concise research Relative Value Interactive (RVI) offers direct access to the performance history of all asset classes contained within this AAA Handbook, and much more.

Stuart Urquhart +44 (0) 20 7773 8410 [email protected]

The key to accurate analysis is good quality data. RVI is sourced directly from Barclays Capital’s trading platforms, ensuring clean trade-focused analysis. The analytics behind the vast majority of Barclays Capital’s published research comes from our internal analytics. RVI clearly identifies how various financial sectors have performed

RVI drives research publications

with respect to each other. Double clicking desired data 1 sends the history of each structure into the time series window accompanied by the credit term structure 2 to identify how the relationships have developed.

Figure 26: Research publications driven by RVI

1

2

Source: Barclays Capital’s RVI

Research themes can be presented through RVI, and tailored views give the analysis a new dimension. Whether exploring raw data or complex trade structures, users have the ability to switch easily between trades, asset themes and supporting arguments. RVI is available externally; clients can customise Barclays Capital’s research to their own requirements.

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Barclays Capital | AAA Handbook 2010

Market focused

RVI’s predominant theme is to offer market-focused insights into the performance of individual asset classes and to put this into a global context. 3 RVI offers a comprehensive range of instrument-specific analyses covering over 15,000 nominal and inflation-linked bonds, with extensive emerging market coverage; spot and forward swaps in 30 currencies; foreign exchange and volatility and skew data for the major currencies.

Customise RVI – you have control

Match mandate or replicate portfolio

Research’s traditional rich/cheap bond reports are now interactive; heat maps quickly identify areas of value within each asset class, and a range of both absolute and relative attributes highlight value. Simply click on any column heading to rank data and reveal the value within chosen asset class. Alternatively use RVI’s advanced filter to search for value based on mandated criteria, or tailor RVI’s analysis to match portfolio holdings. Thus, RVI will only highlight user-specific trade ideas. 4

Figure 27: Personalise RVI

4

3

4

3

5

Source: Barclays Capital’s RVI

Once specific instruments have been identified, their history can be sent to the time series viewer for further investigation. 5

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Barclays Capital | AAA Handbook 2010

The time series viewer allows users to identify and retrieve market data easily, either directly from universally recognised codes or RVI’s report structure. Simple algebraic manipulation allows construction of switch trades, asset swaps and curve structures. RVI recognises there is core of regularly analysed structures, so users can take advantage of the pre-canned curve reports, 6 which also identify how various maturities have performed with respect to each other. Curve steepness and arcs are analysed in detail to identify value. Results can be transferred directly to Excel or Word.

Figure 28: Historical analysis at your fingertips

6

6

Source: Barclays Capital’s RVI

Entire reports, filters, client portfolios and trade ideas are fully transferable; users can save and share favourites. RVI provides a common language with which to communicate trade ideas. Research provides a range of market-orientated themes and trade templates. Identify value across markets

RVI offers the ability to visualise the credit term structure of each issuer/sector. Individual bonds are plotted against a fitted curve to clearly identify specific issues that trade rich or cheap to their peers. 7 Curves can be built from any of the measures available in RVI’s extensive bond reports.

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Barclays Capital | AAA Handbook 2010

Create bespoke, generic analysis

RVI’s filter function can be used to focus on asset allocation themes. In Figure 29, issuers are combined to generate generic Pfandbriefe (blue) and Cédulas (grey) curves, clearly identifying that AAA Pfandbriefe trade richer, on the whole, than their AAA Cédulas counterparts, more importantly it shows that the fitted curves fluctuate between a relatively low 70bp for 3y and 8y maturities to spreads of up to 120bp 8 for issues with 5y maturities.

Figure 29: RVI’s Bond Curve Viewer

9

8

Source: Barclays Capital’s RVI

Compare over time

Users can take advantage of the report’s historical calendar 9 to compare curves from the same issuer over time to see how the credit term structure has evolved. Likewise, the curves of various issuers can be analysed together to identify cross-asset relative value opportunities. Once the user has identified bonds of interest, they can double click the relevant point to send the issue’s history to the time series window, where they can investigate trade ideas and take advantage of the full range of RVI’s analytical/regression features.

Comprehensive model testing

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Regression analysis is provided to explore historical relationships, investigate causality and highlight correlation between time series. RVI provides a vast array of raw and derived instrument-specific metrics, which can be used to test the accuracy of trading models and to identify trade signals. 36

Barclays Capital | AAA Handbook 2010

Our flexible regression toolkit offers the ability to plot trend lines, select regression methodology, override intercepts and reveal value. Analysis can be cloned to match dates of previous events, 10 to highlight historical relationships, forecast fair value levels 11 and generate what-if scenarios. Multi-factor regression solves for various explanatory variables, perfect for generating regression-weighted barbells and highlighting a trade’s directionality. Fitted analysis can be exported to the time series viewer, to explore if the model stands the test of time.

Figure 30: RVI’s regression toolkit

10

11 12

Source: Barclays Capital’s RVI

The regression viewer’s tabs offer clarity, 12 the second plots residuals over time to demonstrate the model’s robustness and highlight cyclical trends, whilst the third provides statistical analysis including coefficients, fit, residuals and fair value levels. Intuitive Research

RVI is designed to make Research accessible, intuitive and easy to use, by providing current market overviews and instrument-specific performance. Widely used by Research, Sales and Traders, RVI is an integral part of BARX, offering access to Barclays Capital’s Research through our trading platforms. RVI can be accessed via the Analytical Tools section of the Barclays Capital Live website.

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Barclays Capital | AAA Handbook 2010

RISK WEIGHTINGS AND LIQUIDITY RISK REGULATIONS

Funding market challenges from proposed regulation Fritz Engelhard +49 (0) 6971611725 [email protected]

This chapter provides an overview of recent proposals regarding the treatment of covered bonds, agencies, supra-nationals and sub-sovereigns under the Basel Committee’s recent initiative relating to liquidity risk. These were mirrored by the European Commission’s proposal regarding further changes to its capital requirements directive (CRD). In our view, the respective proposals could have significant implications for the business model of many covered bond banks and, if implemented without major changes, will provide significant challenges and perhaps even threaten the existence of funding markets, which not only continued to function throughout the recent financial markets crisis but have also been in place for more than a century. As we have done previously, we also describe the calculation of risk weighting for AAA products under the CRD.

SSA and covered bonds within the proposed liquidity risk framework Basel and Brussels address liquidity risk

The Basel committee suggests the introduction of two new liquidity risk standards

Definition of the liquidity coverage ratio (LCR)

In December 2009 the Basel Committee on Banking Supervision published a paper titled “International framework for liquidity risk measurement, standards and monitoring” 5. This document, which is also known as “Basel III”, addresses the adequacy of liquidity risk management rules of the banking industry. On 26 February 2010, the European Commission launched a public consultation, regarding further possible changes to the CRD, also known as “CRD IV” 6. Amongst others 7, CRD IV suggests the introduction of new liquidity standards, basically building on the respective Basel III proposal. The European Commission explicitly highlights that it “strongly supports the work” of the Basel Committee in this area and envisages publishing a legislative proposal in H2 2010. Both, the Basel Committee and the European Commission suggest the introduction of two new regulatory standards for liquidity risk, the liquidity coverage ratio (LCR) and the Net Stable Funding Ratio (NSFR). The LCR is designed to “promote the short-term resiliency of the liquidity risk profile of institutions by ensuring that they have sufficient high quality liquid resources to survive an acute stress scenario lasting for one month”. The NSFR is designed to “promote resiliency over longer-term time horizons by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing structural basis”. Supra, sub-sovereign, agency (SSA) and covered bonds play a role in both, the LCR and the NSFR. Within the calculation of the LCR, the consultative document suggests that SSA covered bonds could be part of the enumerator, as they may both qualify for the “stock of high quality liquid assets”. Furthermore, in the denominator of the LCR, the net cash outflows over a 30day period, the consultative paper makes exceptions for “secured funding run-off”, as it allows for those funding operations secured by government debt and marketable securities by certain public sector entities to be deducted from net outflows, as it is assumed that these could be rolled-over.

5

http://www.bis.org/publ/bcbs165.htm http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm 7 Besides liquidity standards, CRD IV also addresses a number of other topics, such as the definition of capital, the leverage ratio, counterparty credit risk, countercyclical measures, the role of systemically important financial institutions and a single rule book in banking. 6

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Barclays Capital | AAA Handbook 2010

Definition of Liquidity Coverage Ratio (LCR): Stock of high quality liquid assets ≥ 100% Net cash outflows over a 30 - day time period

The definition of “high quality liquid assets” comprises, amongst others 8, marketable securities issued or guaranteed by sovereigns, central banks, non-central government public sector entities (PSEs), the Bank for International Settlements, the International Monetary Fund, the European Commission, or multi-lateral development banks as long as they are assigned a 0% risk-weight under the Basel II standardised approach, “deep” repo-markets exist for the respective securities and they have not been issued by financial institutions. Covered bonds 9, could also qualify for such liquidity buffer investments. However, unlike sovereign or SSA exposures, haircuts are applied and covered bonds are subject to rating requirements (20% for covered bonds rated at least AA and 40% for covered bond rated at least A-). Furthermore, additional secondary market liquidity requirements were stipulated for covered bonds and they are actually treated similar to corporate bonds fulfilling analogical criteria. 10

n

Definition of the net stable funding ratio (NSFR)

Within the calculation of the NSFR, in the enumerator, covered bonds should qualify for the “available amount of stable funding”. To the extent they are regarded as “secured … borrowings and liabilities . . . with effective maturities of one year or greater” they are fully acknowledged (ASF Factor = 100%). Any other covered bonds, in particular those with a term to maturity of less than one year, would not be acknowledged. On the other side, when calculating the required stable funding, the denominator, SSA and covered bonds are subject to an RSF factor, which should reflect how easy they could be “monetised through sale or use as collateral in secured borrowing”. The consultative document suggests assigning an RSF factor of 5% for SSA bonds and 20% to covered bonds with an effective maturity of more than one year. Definition Net Stable Funding Ratio (NSFR):

Available amount of stable funding > 100% Required amount of stable funding Inconsistent treatment of covered bonds within the LCR

In our mind, the way covered bonds are represented in the definition of the LCR and the NSFR is inconsistent. When it comes to the LCR, we note that covered bond funding would not qualify for the exceptions made in the calculation for the "secured funding run-off". Assuming that refinancing via covered bonds would be impossible, whilst at the same time covered bonds qualify for the "stock of high quality liquid assets" is a contradiction, as the later implies that there is a bid for covered bonds even in times of stress. Although the definition of covered bond which can be held under the LCR definition excludes those issued by the respective bank itself, we note that even at the height of the recent financial market crisis, in Q4 08 and Q1 09, there was ongoing covered bond issuance activity in particular through privately placed covered bonds, whilst other unsecured funding sources dried up.

8

Cash, central bank reserves, government bonds. Without explicitly referring to it, the “Basel III” paper copied the definition of covered bonds as stipulated under the EU’s UCITS 22(4) directive. 10 In this respect it is worth noting that the €730bn market of benchmark covered bonds is not only much bigger and more liquid than the €80bn market for AAA/AA rated corporate bonds, but that such treatment contradicts the initial rationale of the European Commission for introducing article 22(4) into UCITS. The EU COM (86) 315 explanatory memorandum with respect to the amendment of Directive 85/611 from 4 June 1986 states that UCITS 22(4) is designed to treat covered bonds “as equivalent to bonds issued or guaranteed by the State”. 9

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Barclays Capital | AAA Handbook 2010

There are no rules for unwinding liquidity buffer investments under certain conditions

Further potentially substantial funding needs through collateralising asset swap hedges

Inconsistent treatment of covered bonds within NSFR

Furthermore, under the proposed regime, banks need to maintain the LCR at all times and no rules were stipulated, under which conditions banks would eventually be able to make use of liquidity buffer investments. Not allowing banks to sell liquidity buffer investments under certain circumstances is inconsistent with the idea of maintaining a liquidity buffer, as this means that (a) the respective investments are basically not available for sale and thus inherently illiquid and (b) banks are forced to maintain additional liquidity holdings on top of their liquidity buffer investments in order to be able to factually raise liquidity when they are under stress. As highlighted above, under the proposed rules, banks might be forced to maintain rather important holdings of (basically) government bonds and AAA instruments. Besides the negative impact this might have on net interest margins and the internal capital generation capacity of banks, we note that credit institutions would typically hedge the respective securities holdings against market risk in order to avoid any losses when eventually raising liquidity against them. This would typically be done through entering into asset swap agreements. As can be experienced in the current environment, times of increased systemic stress are generally accompanied by a significant decrease of interest rates. Thus, the gap between the current coupon payments the asset swap counterparties receive and the correspondent swap yield would increase. Consequently, the requirements for the respective banks to collateralise their asset swap off-balance sheet positions will also increase. Depending on the size and the seasoning of the underlying bond portfolio, this could lead to a further substantial increase of funding needs. When it comes to the NSFR, we note that covered bonds with a term to maturity of less than one year would not fall under the definition of "available stable funding sources". At the same time, when it comes to the definition of "required stable funding uses", under certain circumstances, covered bonds qualify for an RSF (Required Stable Funding) factor of 20%, which implies that covered bond holdings could be monetised. Thus, again, as within the definition of the LCR, disregarding completely the ability of banks to refinance via covered bonds is not only in contrast to empirical evidence but also inconsistent with the assumption that covered bonds, albeit those not issued by the bank itself, could be sold in the secondary market.

Market implications The implementation of the new liquidity standards may have a significant impact on AAA markets. In particular, the preferential treatment of the SSA sector versus covered bonds could push the spread differential between SSA bonds and covered bonds from issuers of the same country persistently above the historical mean. More importantly, in those markets were specialised covered bond banks act as issuers of the covered bonds, the nonrecognition of securities with less than one year to maturity in the NSFR will make it extremely difficult to pursue their business. This is particularly important for those banks which use a matched funding strategy, such as the Danish mortgage banks. Thus, ironically, these markets, which not only continued to function throughout the recent financial markets crisis, but which have also have been in place for more than a century, are likely to shrink dramatically and potentially even disappear should the respective rules be implemented as proposed. The banking markets that make widespread use of covered bonds will generally suffer more

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From a systemic perspective, the markets where the domestic banking industry is a prolific user of the covered bond product (namely, Denmark, France, Germany, Ireland, Sweden, Spain) in general are likely to suffer more than those where the use of covered bonds is either non-existent or at a nascent stage (i.e. Belgium, Italy, and Portugal). In addition, on an 40

Barclays Capital | AAA Handbook 2010

individual level, covered bond issuance activity from those banking groups that make rather strong use of covered bond funding will generally suffer more than those who rely more on other sources of funding including deposits. For example the use of covered bond issuance might suffer more strongly with KA, BBCE, CCCI, DCL, AARB, EURHYP, LBBER, LBBW, ACHMEA, most Spanish savings banks, most Swedish banks, and NWIDE, YBS in the UK. On the other hand, covered bond issuance should hardly suffer with BAWAG, ERSTBK, BNP, CASA, CM, SOCGEN, DB, DPB, HSHN, all Italian banks, most Dutch banks, all Portugese banks, BKTSM, CAVALE, SANTAN and NORDEA. When gauging the impact on individual banking groups, we also point out that a differentiated view is needed, particularly when it comes to covered bond institutions with a strong focus on public sector lending. Most of these institutions, mainly German Pfandbriefbanks, are actively downsizing their portfolios and thus their need to roll maturing covered bonds is somewhat limited. Given that the implementation of these rules is planned for 2012 and that over the next one and half years the volume of outstanding public sector Pfandbriefe will very likely decrease by another €150bn from €470bn currently, the importance of this issue should not be overestimated. In Figure 31 below we provide an overview of the amount of outstanding covered bonds of individual banks at YE 09 and relate this to their respective debt funding and balance sheet size.

Figure 31: The weight of covered bonds within the funding profile of European banks, YE 09 Covered bonds (€bn)

Debt funding (€bn)

Total assets (€bn)

Covered bonds in % of debt funding

Covered bonds in % of total assets

BAWAG

2.2

9.3

41.2

23.7

5.3

ERSTBK

6.5

35.8

201.7

18.3

3.2

KA

7.3

13.3

18.3

54.9

39.9

BNP

19.5

239.2

2057.7

8.2

0.9

BPCE (incl. CFF)

Country

Issuer

Austria

France

Germany

Ireland

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115.4

219.4

1028.8

52.6

11.2

CASA

4.8

217.9

1557.3

2.2

0.3

CCCI*

18.8

31.4

40.0

59.9

47.0

CM

14.2

94.8

420.5

14.9

3.4

DCL

102.8

190.9

360.3

53.8

28.5

SOCGEN

6.2

315.0

1023.7

2.0

0.6

AARB

10.2

23.5

39.6

43.3

25.7

BYLAN

37.5

105.4

338.8

35.6

11.1

DB

1.0

131.8

1500.7

0.8

0.1

DPB

6.0

22.2

226.6

26.9

2.6

EURHYP

109.3

134.8

256.1

81.1

42.7

HESLAN

19.5

49.9

148.9

39.0

13.1

HSHN

13.0

62.0

174.5

21.0

7.5

LBBER

42.8

56.6

143.8

75.6

29.7

LBBW

63.4

110.7

411.7

57.2

15.4

NDB

23.4

85.1

238.7

27.5

9.8

WESTLB

10.9

36.2

242.3

30.2

4.5

AIB

10.8

35.2

174.3

30.5

6.2

BKIR

9.0

49.2

181.1

18.4

5.0

EBSBLD*

1.5

3.9

21.4

38.5

7.0

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Barclays Capital | AAA Handbook 2010

Covered bonds (€bn)

Debt funding (€bn)

Total assets (€bn)

Covered bonds in % of debt funding

Covered bonds in % of total assets

BANCAR

1.0

10.0

36.3

10.0

2.8

BPIM

1.0

25.2

125.7

4.0

0.8

ISPIM

2.0

185.2

624.8

1.1

0.3

PMIIM

2.0

12.0

44.3

16.7

4.5

UBIIM

2.0

44.3

122.3

4.5

1.6

UCGIM

6.0

214.8

928.8

2.8

0.6

ABNANV

9.0

110.2

469.3

8.2

1.9

ACHMEA

4.2

12.2

16.0

34.5

26.3

INTNED

11.8

130.0

1163.6

9.1

1.0

SNSSNS

2.0

34.9

128.9

5.7

1.6

BCPPL

4.5

20.0

95.6

22.6

4.7

BESPL

3.6

35.7

82.2

10.2

4.4

BPIPL

2.0

9.7

47.5

20.5

4.2

CXGD

6.1

25.2

121.0

24.2

5.0

MONTPI

1.0

5.3

17.2

18.9

5.8

SANTAN

2.0

11.9

48.4

16.8

4.1

BANEST

16.1

32.6

122.3

49.3

13.1

BANSAB

13.1

24.9

82.8

52.7

15.8

BBVASM

34.7

117.8

535.1

29.5

6.5

BILBIZ

3.8

3.9

29.8

99.2

12.9

BKTSM

2.0

19.1

54.5

10.5

3.7

CAGALI

9.0

11.2

46.3

80.0

19.4

CAIXAB

26.8

52.7

271.9

50.7

9.8

CAIXAC

8.4

20.9

63.7

40.4

13.3

CAJAME

12.9

16.1

75.5

80.1

17.1

CAJAMM

24.1

56.3

191.9

42.8

12.6

CAVALE

8.4

35.0

111.5

24.1

7.6

PASTOR

4.0

8.0

32.3

50.1

12.4

POPSM

10.7

32.2

129.3

33.3

8.3

SANTAN

27.8

243.3

1,110.5

11.4

2.5

UNICAJ

1.6

5.0

34.2

31.4

4.6

Country

Issuer

Italy

Netherlands

Portugal

Spain

Sweden

LANSBK

55.0

61.1

157.0

90.0

35.0

(SEK bn)

NBHSS

257.0

1310.9

4,831.8

19.6

5.3

SCBCC

140.0

166.6

198.1

84.0

70.6

SEB

160.5

492.4

2,308.2

32.6

7.0

SHBASS

358.3

1,025.1

2,122.8

35.0

16.9

SPNTAB

341.4

741.2

1,794.7

46.1

19.0

UK

ABBEY

9.6

52.1

288.2

18.4

3.3

(£bn)

HSBC

15.6

177.4

2,364.5

8.8

0.7

LLOYDS

40.7

268.2

1,027.3

15.2

4.0

NWIDE

23.8

39.0

191.4

61.1

12.4

YBS

3.0

5.8

22.7

51.7

13.2

Note: YE 08 Source: Company reports

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Barclays Capital | AAA Handbook 2010

The CRD and risk weighting of covered bonds CRD refers to UCITS 22(4) and in addition stipulates a series of eligibility criteria for cover assets

In June 2006, the European Commission published the CRD in its Official Journal. It became effective on 1 January 200811. The special treatment of covered bonds is an important feature of the CRD as it goes beyond the Basel II framework. With regards to covered bonds, the CRD text (Annex VI, PART 1, paragraph 68-70) refers to the criteria of Article 22 (4) of the EU Directive 85/611 (Directive on Undertakings of Collective Investment in Transferable Securities or UCITS). UCITS 22(4) gives a legal definition of a covered bond along the following lines: „

The covered bond must be issued by an EU credit institution.

„

The credit institution must be subject to special public supervision by virtue of legal provisions protecting the holders of the bonds.

„

The investment of issuing proceeds may be effected in eligible assets only; the eligibility criteria are set by law.

„

Bondholders’ claims on the issuer must be fully secured by eligible assets until maturity.

„

Bondholders must have a preferential claim on a subset of the issuer’s assets in case of issuer default.

Beyond these more formal rules, a series of eligibility criteria for cover assets were stipulated. According to these criteria, the asset pool of a covered bond may include: „

Exposures to or guaranteed by central governments, central banks, public sector entities, regional governments and local authorities in the EU.

„

Exposures to or guaranteed by non-EU central governments, non-EU central banks, multilateral development banks, international organisations with a minimum rating of AA- and exposures to or guaranteed by non-EU public sector entities, non-EU regional governments and non-EU local authorities with a minimum rating of AA- and up to 20% of the nominal amount of outstanding covered bonds with a minimum rating of A-.

„

Substitute assets from institutions with a minimum rating of AA-; the total exposure of this kind shall not exceed 15% of the nominal amount of outstanding covered bonds; exposures caused by transmission and management of payments of the obligors of, or liquidation proceeds in respect of, loans secured by real estate to the holders of covered bonds shall not be comprised by the 15% limit; exposures to institutions in the EU with a maturity not exceeding 100 days shall not be comprised by the AA- rating requirement, but those institutions must as a minimum qualify for an A- rating.

„

Loans secured by residential real estate or shares in Finnish residential housing companies up to an LTV of 80% or by senior RMBS notes issued by securitisation entities governed by the laws of a Member State, provided that at least 90% of the assets of such securitisation entities are composed of mortgages up to an LTV of 80% and the notes are rated at least AA- and do not exceed 20% of the nominal amount of the outstanding issue.

„

Loans secured by commercial real estate or shares in Finnish housing companies up to an LTV of 60% or by senior CMBS notes issued by securitisation entities governed by the laws of a Member State provided that at least 90% of the assets of such securitisation entities are composed of mortgages up to an LTV of 60% and the notes are at least rated AA- and do not exceed 20% of the nominal amount of the outstanding issue; national regulators may allow also for the inclusion of loans with an LTV of up to 70% in

11

Regarding the specific timetable fort he implementation of the CRD you may have a look at the respective chapter of the 2007 edition of the AAA Handbook.

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case a minimum 10% over-collateralisation is established and such overcollateralisation is protected in case the respective issuer is subject to insolvency procedures; in addition, ship mortgage loans with an LTV of up to 60% are allowed. Until 31 December 2010, the 20% limit for RMBS/CMBS notes as specified in (d) and (e) does not apply, provided that those securitisation notes are rated AAA. Before the end of this period, the derogation shall be reviewed and consequent to such review the EC may, as appropriate, extend this period. The covered bond industry, as represented by the European Covered Bond Council (ECBC), suggests converting the exception for RMBS/CMBS notes into a general rule, provided that the securitised residential or commercial real estate exposures were originated by a member of the same consolidated group. However, given that the respective exceptions will expire automatically and thus existing rules need to be explicitly amended before year end, at this stage it is not clear whether these exemptions will be put into law in a timely fashion. Standardised and internal ratings-based options

As with other categories of risk exposures, the assessment of risk weightings is conducted within the context of either a revised standardised approach (RSA) or an internal ratings-based approach (IRBA). The latter comes in both foundation and advanced forms. Application to individual banks depends on the level of sophistication of their risk management systems. Compared with the debate about the definition of the term covered bond, the application of the general CRD/Basel II framework for corporate exposures to covered bonds was much less in the limelight. Thus, from the beginning, a rather strong link between the credit profile of an issuer’s senior unsecured debt and the covered bond risk weighting was made in the RSA, as well as in the IRBA. In this respect, the CRD contrasts with most central bank regulations for repo business with covered bonds. For example, in the eurozone, Denmark, Norway, Sweden and Switzerland, banks issuing covered bonds are allowed to use their own covered bonds as collateral for repo transactions with the central bank, as the respective authorities concentrate on the generally low likelihood of payment interruptions in case of the bank's insolvency, and thus focus more strongly on the default probability of underlying assets.

The revised standardised approach for covered bonds The RSA links covered bond risk weights to those of the issuers’ senior debt

Under the revised standardised approach (RSA), covered bonds are assigned a risk weight on the basis of the one attributed to senior unsecured exposures to the credit institution which issues them. For banks with a senior weighting of 50%, the covered bond weighting has been reduced to 20%. In contrast, banks with a senior, unsecured risk weight of 150% will have a covered bond weight of 100%. The correspondence between senior and covered bond risk weights is as follows:

Figure 32: Risk weightings for senior debt and covered bonds %

%

%

%

Senior Unsecured risk weight

20

50

100

150

Covered bond risk weight

10

20

50

100

Source: European Commission.

Two options for assigning bank senior risk weightings: sovereign-linked; and bank credit-based

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The derivation of risk weightings for covered bonds is complicated by the fact that the Basel Committee has set up two ways of linking bank credit ratings to bank risk weightings, which link the bank’s risk weighting to the credit rating of the home country sovereign or to that of the bank itself. This approach has also been followed in the EC directive. On this basis, the correspondence of covered bond risk weightings to issuing bank credit ratings under the two calculation methods is shown in Figure 33 and Figure 34 below. 44

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Figure 33: Risk weights under Option 1 (%) Credit rating of sovereign

AAA to AA-

A+ to A-

BBB+ to BBB-

BB+ to B-

Below B-

Unrated

Sovereign risk weight

0

Bank senior unsecured risk weight

20

20

50

100

150

100

50

100

100

150

Covered bond risk weight

10

100

20

50

50

100

50

AAA to AA-

A+ to A-

BBB+ to BBB-

BB+ to B-

Below B-

Unrated

Senior unsecured risk weight

20

50

50

100

150

50

Covered bond risk weight

10

20

20

50

100

20

Source: Basel Committee, European Commission, Barclays Capital

Figure 34: Risk weights under Option 2 (%) Credit rating of bank

Source: Basel Committee, European Commission, Barclays Capital

For banks operating under Option 1, most EU covered bonds qualify for a 10% weight

Option 2 leads to 20% covered bond weightings for sub AA- issuers

So, for example, under Option 1, if a bank is based in a country with a sovereign rating of AA- or better, its senior debt will be assigned a risk weighting of 20% and its covered bonds a weighting of 10%. For investing banks whose regulator applies Option 1, all banks within the EU, except for Greece and Malta, would attract a 20% risk weighting on senior unsecured debt because their sovereign ratings are all at least AA-/Aa3 (except for Greece and Malta, which are single-A). Hence, under this option, most EU covered bond issues would be assigned a risk weighting of 10%. In contrast, Option 2 introduces more differentiation in risk weightings as the determining factor is the credit rating of the individual issuing bank. For banks that have a credit rating of less than AA-, this leads to a senior unsecured risk weighting of 50% and a covered bond weighting of 20%. The choice between Options 1 and 2 is at the discretion of national regulators. Figure 35 gives an overview on how EU countries decided on the respective options.

The internal ratings-based approach (IRBA) for covered bonds The IRBA specifies functions for deriving risk weights from inputs on risk components

Under the IRBA, banks that have been so authorised by their regulators can determine their capital requirements on the basis of internally generated estimates of the risk of loss on their assets. These estimates require inputs relating to the one-year probability of default (PD), the loss-given default (LGD), the exposure at default (EAD) and the effective maturity (M), which are combined to give capital requirements and risk weightings using functions specified by the Basel Committee and the EC (which in most cases are broadly comparable). Variations on the standard functions are provided to apply to different groups of assets, such as retail exposures and securitisations. Two levels of IRBA have been established, namely the foundation and advanced levels. Those banks qualifying only for the foundation IRBA are allowed to provide their own estimates only of PD; the other risk components are provided by the regulator. Banks qualifying for the advanced approach are allowed to provide their own estimates of all the risk components, subject to any constraints that may be specified by the regulator.

EC specifies constraints on key risk components for covered bonds

The Basel framework for IRBA calculations makes no separate reference to covered bonds. However, the CRD provides a specific framework for calculating internal ratings-based risk weights for covered bonds (non-EC based banks applying the Basel framework to covered bonds would have to treat them as senior bank debt.) The EC legislation specifies constraints on risk components as follows: PD (which relates to issuer rather than issue default risk) must be at least 0.03%.

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LGD should be assigned a value of 12.5% and, exceptionally until 31 December 2010, 11.25% in case all exposure to public sector entities and all substitute assets have a minimum rating of double-A minus, securitisation notes make up only up to 10% of the total nominal amount of outstanding covered bonds, no ship mortgages are included in the cover pool OR the respective covered bonds are rated triple-A. The covered bond industry, as represented by the European Covered Bond Council (ECBC) suggests converting the exception for the application of an LGD of 11.25% into a general rule, as empirical data suggest rather high recovery values for mortgage loans12. For banks applying the advanced version, a lower LGD is possible. Historical data for residential mortgage assets underline that LGD levels are basically below 10%. M, the effective maturity of the bond, is limited to a range of one to five years. For the foundation approach, regulators may specify an effective maturity of 2.5 years for all bonds. All banks using the advanced approach would have to apply this maturity range. Figure 35: National discretions regarding Options 1/2 in the RSA and the calculation of M in the IRBA across EU countries Country

Within the RSA, exposures to institutions are assigned according to Option 1 (central government risk weight based method)?*

Explicit maturity adjustment required under IRBA?**

Austria

Yes

No

Belgium

No

Yes

Bulgaria

No

No

Cyprus

Yes

Yes

Czech Republic

No

No

Germany

Yes

No

Denmark

Yes

No

Estonia

Yes

No

Greece

No

Yes

Spain

Yes

No

Finland

Yes

No

France

Yes

No

Hungary

Yes

No

Ireland

No

Yes

Italy

Yes

No

Lithuania

No

No

Luxembourg

Yes

Yes

Latvia

Yes

Yes

Malta

No

Yes

Netherlands

No

Yes

Poland

No

No

Portugal

Yes

No

Romania

No

No

Sweden

Yes

No

Slovenia

No

No

Slovakia

No

No

United Kingdom

No

Yes

Note: * Within the scope of CRD Article 80 paragraph 3 and Annex VI Part 1 Paragraph 6.3; ** According to CRD Annex VII Part 2 Paragraph 12. Source: Committee of European Banking Supervisors (CEBS), Barclays Capital 12

Given that the respective exceptions will expire automatically and thus existing rules need to be explicitly amended before year end, at this stage it is not clear whether these exemptions will be put into law in a timely fashion.

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As the majority of covered bonds are rated AAA or comply with the criteria for the application of an 11.25% LGD level, our illustrations of risk weightings are based on an 11.25% LGD. Also, we illustrate figures for the range of possible effective maturities, as well as the central 2.5 yr case. The room for discretion on the part of individual banks is limited, given the constraints on the specification of LGD and M. For PD, the default probability input, one-year default probabilities published by the rating agencies provide at least a starting point.

Figure 36: Rating agency cumulative one-year default rates (%) S&P (1981-2009)

Moody's (1983-2009)

Fitch (1991-2009)

AAA/Aaa

0.00

0.00

0.00

AA/Aa

0.02

0.02

0.08

A/A

0.08

0.06

0.13

BBB/Baa

0.26

0.20

0.58

BB/Ba

0.97

1.21

1.49

Source: S&P, Moody’s, Fitch

Room for debate on default probabilities

Bank risk models probably apply higher default probabilities

These figures reflect default history for corporates globally, so there may be reservations about their applicability to European banks. The different periods used in the agencies’ surveys complicate comparisons, but the divergences in their figures highlight that this is not a precise science. Standard risk management caution would counsel using the highest figure in each of these comparisons. In any event, the implication is of a very sharp rise in default probabilities for BBB and BB issuers. Default probabilities produced by risk models used by individual banks may also show some variation from these figures. Our impression is that bank risk models generally operate on the basis of slightly higher default probabilities than the rating agencies’ historical studies suggest and that banks apply more differentiation than is provided by the rating agencies’ broad alphabetic bands. Figure 37 provides an illustrative matrix of risk weightings based on plugging a range of different default probabilities and the average life figures in the EC functions.

Figure 37: Risk-weighted asset ratios (%) for different default probabilities and average lives (LGD = 11.25% in all cases) Probability of default (%) Bond Life (yrs)

0.03%

0.05%

0.10%

0.20%

0.25%

0.35%

1

2.01%

2.97%

4.95%

7.96%

9.19%

11.29%

2

3.22%

4.46%

6.89%

10.41%

11.80%

14.14%

2.5

3.83%

5.21%

7.86%

11.63%

13.11%

15.57%

3

4.43%

5.95%

8.83%

12.86%

14.42%

17.00%

4

5.65%

7.44%

10.77%

15.31%

17.03%

19.86%

5

6.86%

8.93%

12.71%

17.76%

19.65%

22.71%

Note: As five years is the maximum bond life that can be input, the bottom row of the table also provides the risk weighting to be applied to all longer maturities. Source: Barclays Capital

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Low risk weightings for issuers with AA credit ratings… … especially for shorter maturities

For M = 2.5, risk weightings will be less than 10% for A- rated issuers and better

The 0.03% floor for PD is likely to be applied by most risk models, at least down to banks rated at the bottom of the AA range. For covered bonds issued by banks in this top category, the risk weighting will range from 2.0% to 6.9% depending on maturity. This represents a significant capital saving relative to the risk weightings under the RSA. It also highlights that in the IRBA, the risk weighting is significantly affected by the remaining life of the bond, which is not the case in the RSA. Banks applying the IRBA have a significant incentive in terms of capital utilisation to invest in shorter maturities. The general point here is that different banks may use differing assumptions about default probabilities, and Figure 37 provides a matrix from which readers can derive or interpolate risk weightings based on their own assumptions. The matrix also highlights the importance of the assumption regarding the effective maturity requirement specified by individual regulators. In the event that all bonds are given a value of 2.5 for M, all covered bonds from issuers with senior ratings of A- or better would have a risk weighting of less than 10%. If regulators apply the range of one to five years for M, the 10% threshold moves up to A flat to A+ issuers for longer-dated covered bonds.

Treatment of sub-sovereigns, public sector companies and supranationals Key MDBs some PSEs have benefited from the introduction of the Basel II/CRD framework

For this sector, the key change provided by the Basel II/CRD framework is that, under the standard approach (RSA), the risk weighting of leading multilateral development banks (MDBs) has been reduced from 20% to zero. In addition, for AAA/AA public sector entities that used to be 100% weighted, there has been a reduction to 20%. As a general principle, risk weightings for MDBs are linked to credit ratings in the same way as for commercial banks (applying the Option 2 approach). However, the leading MDBs are subject to an exception, under which they are given a 0% risk weighting, providing that they satisfy a list of criteria (relating to ratings, ownership, capital structure and asset quality) specified by the Basel Committee. The Basel Committee specifically listed the following institutions as fulfilling these criteria: 0% applied to this standard list of MDBs World Bank Group comprising the International Bank for Reconstruction and Development (IBRD) and the International Finance Corporation (IFC), the Asian Development Bank (ADB), the African Development Bank (AfDB), the European Bank for Reconstruction and Development (EBRD), the Inter-American Development Bank (IADB), the European Investment Bank (EIB), the European Investment Fund (EIF), the Nordic Investment Bank (NIB), the Caribbean Development Bank (CDB), the Islamic Development Bank (IDB), and the Council of Europe Development Bank (CEDB).

Similar message from CRD

The CRD text follows the same approach and produces a virtually identical list of institutions that qualify for zero risk weighting. Exceptions are that the CRD list does not include the IDB. Also, unpaid capital in the EIF is assigned a 20% risk weight, while it was explicitly mentioned that a 0% risk weight should be assigned to exposures to the European Community, the International Monetary Fund and the Bank for International Settlements. Note, however, that Eurofima is not included in these lists, although it is a supranational entity. Under Basel I, it suffered a 100% risk weighting, but under Basel II/CRD, its weighting fell to 20% because of its AAA credit rating. Since publication of the Basel II/CRD documents, both the EC and Basel Committee have accepted the new entity IFFIm as being equivalent to an MDB. They have therefore assigned a zero risk weighting to its debt issues.

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Public sector entities and regional governments open to range of approaches, ultimately linked to the extent of revenueraising powers and/ or guarantees

For non-central government public sector entities (PSEs), which include sub-national governments and public sector companies, Basel III also sets them within a general framework of treatment in the same way as commercial banks. Unlike MDBs, however, there is the possibility of applying either of the two options that are applied to banks. According to Option 1, the respective public sector entities (PSEs) should be assigned a risk weight one category less favourable than that assigned to the sovereign and according to Option 2 the risk weighting for claims against the PSE should be tied to the entity’s own rating. In addition, however, national regulators are allowed the discretion to apply the same risk weighting for the claims against a PSE as for the sovereign in whose country the PSE is established. This area of the Basel framework leaves scope for national discretion, but the Basel guidance highlights revenue-raising powers or the existence of specific guarantees as two main bases for allocation of risk weightings to PSEs. The final paper gives an example, in which it distinguishes between different PSEs by reference to revenue-raising capacity, as follows: “Regional governments and local authorities – These could qualify for the same treatment as claims on their sovereign or central government if these governments and local authorities have specific revenue raising powers and have specific institutional arrangements, the effect of which is to reduce their risks of default. Administrative bodies responsible to central governments, regional governments or to local authorities and other non-commercial undertakings owned by the governments or local authorities may not warrant the same treatment as claims on their sovereign if the entities do not have revenue raising powers or other arrangements as described above. If strict lending rules apply to these entities and a declaration of bankruptcy is not possible because of their special public status, it may be appropriate to treat these claims in the same manner as claims on banks. Commercial undertakings owned by central governments, regional governments or by local authorities may be treated as normal commercial enterprises. If these entities function as a corporate in competitive markets even though the state, a regional authority or a local authority is the major shareholder of these entities, supervisors should decide to consider them as corporates and therefore attach to them the applicable risk weights.”

CRD presentation differs from Basel II, but the results are in line

The CRD provides separate treatments for regional and local governments (RLGs); and public sector entities, specifically including only administrative bodies and non-commercial undertakings. Public sector commercial undertakings are by implication treated with corporates. However, although the presentation differs superficially from the Basel II, the results are the same. In summary: Eurozone RLGs are weighted either in line with central government (0%) or as institutions (20%), at the discretion of respective national regulators. The German Länder retain a zero risk weighting, underpinned by their strong revenue-raising powers. Given the trend towards increasing delegation of expenditure responsibilities and revenue-raising powers to lower levels of government, there may be increasing scope for applying zero risk weightings to a wider range of regional and local governments in the medium term. Administrative and non-commercial PSEs can also be treated either as central government (if the regulator takes the view that there is no difference in risk between a PSE and its respective government), or as an institution. For AAA/AA countries, this means that risk weightings are either 0% or 20%. For most cases there is no change from Basel I. One significant exception is Rentenbank, which has been assigned a 0% weighting, instead of the previous 20%, by the German regulator.

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Commercial PSEs are weighted as corporates on the basis of their credit ratings, unless they are backed by a government guarantee (eg, Network Rail), in which case they also are given a government risk weighting. For non-guaranteed AAA/AA- entities, the transition to Basel II/CRD has brought risk weightings down from 100% to 20%, given that they are determined by credit rating bands. Key beneficiaries from this change are la Poste and SNCF. (Similarly, the risk weighting for GPPS also fell from 100% to 20%, because of a similar treatment for AAA securitisations.) Differences in exposure classes under IRBA

Exposures treated as central government are not subject to 0.03% PD floor, but are subject to higher LGD values than covered bonds

The IRB approach requires exposures to be allocated to a smaller number of issuer categories than are available under the RSA. In the latter, RLGs, administrative bodies and noncommercial PSEs, MDBs, and international organisations are treated as separate exposure classes from central governments/central banks, institutions, and corporates. In the IRBA, all these quasi-sovereign entities and MDBs have to be assigned to central government, institutions or corporates. However, the CRD requires that MDBs, RLGs and PSEs that are treated as central governments under the RSA, are also treated as such under the IRBA. Under the IRBA, the key benefit from being classed as a central government exposure is that the 0.03% minimum value for PD applied to all other exposure classes does not apply. For AAA governments, the one-year PD is effectively zero (cf Figure 36). In principle, this could lead to zero risk weightings under IRBA for many of the public sector issuers that are zero weighted under RSA. However, the CRD also insists on a principle of conservatism in applying the IRBA and our impression is that bank risk management functions typically apply non-zero PDs to most sovereign exposures. In these cases, risk weightings for public sector exposures suffer by comparison with those for covered bonds from the fact that the proposed LGD for senior debt (other than covered bonds) should be set at 45%, compared with 11.25% for covered bonds. Questions remain about the application of IRBA to low default portfolios. However, the effect of applying IRBA to public sector debt issues is limited because a substantial proportion of banking sector holdings of these securities are held in trading books (which use RSA-type weights to calculate specific risk) rather than banking books, and also by the use of exemptions, through which IRB banks are able to apply the RSA to part of their portfolios.

Implementation and national discretions Implementation of CRD and consultation on national discretions

The final agreement on CRD was the starting signal for regulators and lawmakers in EU countries to implement the new capital adequacy regime in national regulations. The Committee of European Banking Supervisors (CEBS) provides an overview on the use of options and national discretions used by individual countries when introducing the CRD 13. Following CRD implementation within the EU, the focus has been on consistency across EU countries. This is important in order to optimise regulatory efficiency and maximise clarity for the financial services industry, which frequently operates in several jurisdictions. On this background, the EU Commission asked CEBS for technical advice on options and national discretions in the CRD 14 on 27 April 2007. Following discussions with industry experts, on 22 May 2008, CEBS published a consultation paper 15 which was setting out its preliminary views. CEBS suggests to keep as a national discretion approximately one fifth of the 152 provisions covered in its analysis. On 17 October 2008, CEBS published its response and

13

http://www.c-ebs.org/sd/Options.htm http://www.c-ebs.org/documents/CFA10onnationaldiscretions16052007.pdf 15 http://www.c-ebs.org/press/documents/CP18_ond.pdf 14

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final advice 16 in which CEBS suggested to keep as a national discretion 28% of the 152 provisions covered in its analysis. No proposals regarding national discretions on covered bond regulations

Proposals regarding national discretions on exposures to public sector entities

With respect to covered bond, the final paper did not contain any specific proposals. Thus the discretion provided in CRD Annex VI Part 1 point 68 (e) regarding the recognition of commercial mortgage cover pools with a higher LTV level of 70% was kept in place. Similarly, the discretion regarding Annex VII Part 2 point 8 (2nd subparagraph) with regards to the transitional provision regarding the assignment of an 11.25% LGD to covered bonds in case certain conditions are met were maintained. With respect to public sector entities the final CEBS paper suggests to keep unchanged national discretions regarding the more permissive treatment of exposures to public sector entities stipulated in CRD Annex VI, Part 1, Point 14 and under Point 16 also proposed to add a binding mutual recognition clause, which obliges EU member states to either set criteria for the recognition of public sector entities as institutions or publish a list of public sector entities treated as institutions. A similar suggestion was made with regards to CRD Annex VI, Part 1, Point 15, which allows the treatment of public sector entities as exposures to the central government of the respective jurisdiction. When it comes to the more permissive treatment of exposures to public sector entities of third countries as it is stipulated in CRD Annex VI, Part 1, Point 17, CEBS suggests to deal with this through a non-binding joint assessment process to be carried out by all supervisors that wish to participate.

Refinements and amendments to the CRD In the course of 2008, the European Commission ran a number of public consultations for a refinement of the CRD. This has been mainly in three areas: (1) large exposures, hybrid capital instruments supervisory arrangements, the waivers for cooperative banks organized in networks and adjustments to certain technical provisions, (2) an adjusted proposal for securitizations and other risk transfer products and (3) trading book requirements for “incremental risk”. Whilst within the consultation phase none of the initial proposals related to covered bonds or public sector entities, the final paper proposed a reduction of the 100% exemption for covered bonds for large exposures to 75% and a restriction for the issuance of covered bonds to 50% of a credit institutions assets. In the meantime, however, these proposals were withdrawn. The “CRD IV” proposal does not contain any additional rules or refinements regarding the risk weighting of SSA or covered bonds. However, the European Commission explicitly stated that it would not extend the exceptions made for covered bonds with regards to the application of a lower LGD of 11.25% and the inclusion of more than 20% of MBS in the cover pool.

16

http://www.c-ebs.org/getdoc/5830b511-ce4b-4705-86ed-c1b835438f7f/CEBS-technical-advice-to-theEuropean-Commission.aspx

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COVERED BOND RATING METHODOLOGIES

A mixed blessing Fritz Engelhard +49 69 7161 1725 [email protected]

In this chapter we first discuss the role of covered bond ratings from an investor’s point of view and provide an overview on the reaction of rating agencies to the financial market crisis. We then describe the general approaches of Moody’s, S&P and Fitch to covered bonds, including recent adjustments to the respective methodologies.

The role of covered bond ratings from an investor’s perspective Despite being basically irrelevant for relative value, covered bond ratings attract a lot of attention

So why is the industry focusing so much on covered bond ratings?

From an investor’s point of view, ratings give poor advice on the valuation of covered bonds. The dispersion of covered bond spreads across the term structure is significant. For example, in the 5y jumbo covered bond segment, swap spreads currently range from +5bp for triple-A rated German Pfandbriefe to +220bp for triple-A rated Portuguese covered bonds and MultiCédulas. Despite being basically irrelevant for relative value,, covered bond ratings still attract a lot of attention. Last year, this was highlighted by the strong emphasis the industry has put on the final release of the new S&P rating methodology for covered bonds The fact that covered bond ratings are unsuitable for grasping the relative value of covered bonds is in stark contrast to the attention they attract from market participants and regulators. This needs further explanation. There are a number of areas in which covered bond ratings play a distinct role. First, many investors use them as qualitative guidance for gauging the underlying credit risk of covered bonds. Rating agencies have access to material non-public information (ie, loan-by-loan data on collateral pools) and have also specialised in modelling default risk and recovery values. Second, some investors apply covered bond ratings as strictly binding investment criteria, most notably when the respective portfolio managers are benchmarked against a fixed income index. In particular, in terms of rating-based sub-indices, the triple-A and the double-A threshold play an important role when applied to covered bond portfolios. Third, a number of rules and regulations refer to covered bond ratings. Generally, regulators tend to refer to ratings because there are difficulties in defining credit quality within a fixed set of rules and because they can build on a standard that has developed over many years. The European Central Bank’s (ECB) repo collateral scheme and its covered bond purchase programme refer to ratings. In addition, the Capital Requirements Directive (CRD) stipulates covered bond ratings as a threshold to qualify for a “Loss Given Default” (LGD) of 11.25% in case certain cover pool eligibility criteria are not met. Furthermore, under the Dutch covered bond regime, covered bonds need to be at least rated AA- to qualify for registration. Finally, covered bonds ratings frequently play an important role in the securities portfolios of banks (including the cover pools of covered bonds). Regularly, the average quality of such portfolios is measured against publicly assigned ratings and banks may come under pressure to either sell the respective securities or re-calibrate their portfolios when faced with negative rating migration.

Trust and reliance on ratings is stronger compared with traditional “credit” investors

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On a more general level, we would also argue that trust and reliance on ratings is more important in the covered bond (‘rates’) sector than the traditional corporate/financial debt (‘credit’) sector. This is because most covered bond investors generally focus strongly on actively managing the exposure of their portfolios to changes in interest rates or the shape of the yield curve rather than fundamental default risk. Regularly, these investors do not build up many resources for running a detailed credit analysis, as the purpose of the covered bond is to isolate them as much as possible from credit risk. 52

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Another important aspect with regard to the use of covered bond ratings is that the sensitivity of investors to rating migration is not uniform. When trying to rank investor type according to their sensitivity to covered bond ratings, we would put central bank investors and credit institutions as most sensitive. Frequently we receive most enquiries on covered bond ratings from these investors. We also observe that both are rather eager to position for potential negative rating actions, which reflects that for them ratings are in many cases an important and strict investment criteria. Asset managers from the funds industry, in particular those who manage special funds, are generally much less sensitive to covered bond ratings. In our experience, they are usually more flexible in amending their investment criteria and they may also have longer grace periods for unwinding exposures, which do no longer fulfil the respective ratings threshold. In our view, insurance companies and pension funds are the least sensitive to rating migration. Their investment horizons are long term; thus, they tend to have a more fundamental view on issuers, cover pools and legal frameworks. This also allows them to position tactically and exploit market opportunities in times of distress. In Figure 38 we summarise how we would rank the various investor types according to their sensitivity to covered bond ratings. Figure 38: Rating sensitivity scale Credit Institutions

Central Banks

Asset Mangers (Retail Funds)

Asset Mangers (Special Funds)

Insurance / Pension Funds

Sensitivity to Ratings High

Low

Source: Barclays Capital

Drawbacks of using ratings as strict investment criteria

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For many investors and rule makers, applying strict rating criteria appears tempting because of the simplicity and clarity of such an approach. However, there are a number of caveats when implementing such strict rules. First, the definition of ratings varies across the major agencies (Figure 39). Strict rules are not suited to take this aspect into account. Second, hard rating limits put asset managers under pressure to sell securities when the respective limit is breached because of a downgrade. As the market environment is generally difficult in such instances, the respective unwind could be harmful for the performance of the affected portfolio. Third, this credit cycle again proved that the market processes information faster than the rating agencies. Default rates and rating trends generally reach a turning point about six to nine months after credit spreads reach a cyclical peak. Thus, investors and regulators are at risk of being consistently behind the curve when applying strict rating criteria. Due to these drawbacks, we recommend avoiding the use of covered bond ratings as strict investment criteria as much as possible.

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Figure 39: Rating definitions Fitch “Fitch Ratings' credit ratings provide an opinion on the relative ability of an entity to meet financial commitments, such as interest, preferred dividends, repayment of principal, insurance claims or counterparty obligations.” Moody’s “Moody's long-term obligation ratings are opinions of the relative credit risk of fixed-income obligations with an original maturity of one year or more. They address the possibility that a financial obligation will not be honoured as promised. Such ratings reflect both the likelihood of default and any financial loss suffered in the event of default.” Standard & Poor’s “Standard & Poor’s credit ratings are designed primarily to provide rankings among issuers and obligations of overall creditworthiness; the ratings are not measures of absolute default probability. Creditworthiness encompasses likelihood of default, and also includes (i) payment priority, (ii) recovery, and (iii) credit stability.” Source: Fitch, Moody’s, S&P

The benefits of a qualitative approach to covered bond ratings

Avoiding covered bond ratings as strict investment criteria does not imply that one should completely ignore ratings. Quite the contrary is true. Covered bond ratings are the result of a complex and detailed analytical process that involves the analysis of financial institutions, the quality of asset portfolios, legal frameworks and contractual commitments. Over the past 15 years, rating agencies have put a lot of effort into developing specific covered bond rating methodologies. Furthermore, they reacted to the financial market turmoil by adjusting their general methods, changing their assumptions and disclosing more information on their rating approaches. Tracking these discussions, monitoring the development of collateral scores, following the assumptions regarding payment interruptions (including the exposure of covered bonds to liquidity risk) and looking at the rating agencies assessment of counterparty risk could all be very beneficial in strengthening the understanding of individual products.

Figure 40: The response of the rating agencies to the financial market crisis General methodology „

Overhauling the basic approach to rating covered bonds (S&P)

„

Amending approach to liquidity risk (Fitch)

„

Amending counterparty risk criteria (Fitch, S&P)

Assumptions „

Tightening assumptions regarding the secondary market liquidity of cover assets

„

Tightening counterparty risk assumptions

„

Adjusting stress scenarios for defaults and losses on cover pool assets

Disclosure „

Clarifying rating process

„

Disclosing refinancing assumptions

„

Disclosing assumptions regarding payment interruptions

„

Publishing collateral quality scores

Source: Barclays Capital

10 June 2010

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Figure 41: Overview of rating agency methodology changes, refinements and disclosures, 2008-10 Rating Agency

Category*

Date

Topic

S&P

GM

26-Feb-08

S&P publishes its new derivative counterparty framework for covered bonds.

Fitch

GM

02-Jun-08

Fitch publishes an exposure draft on its criteria for swaps in covered bonds.

Moody’s

D

17-Sep-08

Moody’s discloses more information about its assessment of the protection provided by a swap against interest and/or currency risk in covered bonds.

Fitch

GM/A

17-Oct-08

Fitch announces plans to revise liquidity assumptions for covered bonds.

S&P

GM/A

22-Oct-08

S&P updates derivative counterparty criteria and removes the eligibility of A-2 counterparties in AAA-rated transactions.

S&P

GM

04-Feb-09

S&P publishes a request for comment on a proposal to overhaul its covered bond rating methodology.

Fitch

GM/A

11-Mar-09

Fitch publishes an exposure draft on the assessment of liquidity risks in covered bonds.

Fitch

GM

30-Mar-09

Fitch publishes its exposure draft on counterparty risk in structured finance transactions. The proposed amendments in Fitch’s approach will also be relevant for covered bonds.

S&P

GM/A

01-Apr-09

S&P announces an update of its methodology for assessing counterparty risk in AAA-rated transactions.

Moody’s

A

08-Apr-09

Moody’s announces an increase of the spreads it uses to model refinancing risk for European covered bonds. Fitch discusses the impact of contractual clauses in covered bonds on its ratings.

Fitch

D

04-Jun-09

Moody’s

A

12-Jun-09

Moody’s concludes review of refinancing assumptions.

Fitch

GM/A

07-Jul-09

Fitch publishes its final update on liquidity risk assumptions and revises alternative management scores.

Moody’s

D

19-Aug-09

Moody’s publishes report on its approach to rating financial entities specialised in issuing covered bonds. Moody’s publishes report on its approach to rating Spanish Multi-Issuer covered bonds.

Moody’s

D

14-Sep-09

Fitch

A

07-Oct-09

Fitch reviews assumptions for covered bonds secured by commercial mortgage loans.

Fitch

GM/A

22-Oct-09

Fitch releases an amended approach to counterparty risk in structured finance transactions

Moody’s

A

23-Nov-09

Moody's revises approach to set-off risk for Dutch covered bond programmes.

S&P

GM

16-Dec-09

S&P presents its new covered bond rating methodology and puts 98 covered bond programmes on ‘watch negative’.

Moody’s

D

04-Mar-10

Moody’s presents an in-depth description on its current methodology for covered bond ratings.

Moody’s

A

13-Apr

Moody’s updates on non EEA assets in German and Austrian covered bond transactions.

Moody’s

D

13-Apr

Moody’s publishes its first monitoring overview on EMEA covered bonds.

S&P

D

19-Apr-10

S&P updates on the roll-out of its new covered bond rating methodology, highlighting that it resolved 56 of the 98 credit watch statuses on covered bond programmes, and in 51 of these 56 cases, the respective ratings were affirmed.

Fitch

A

05-May-10

Fitch revises methodology on covered bonds secured by commercial mortgages.

Note: * GM = General Methodology, A = Assumptions; D = Disclosure. Source: Rating Agencies, Barclays Capital

On the back of the heated debate on ratings in general, and the repeated amendments of covered bond rating approaches and assumptions in particular, we recommend investors and regulators to take a step back and eventually reconsider their approach in making use of ratings. As highlighted above, we believe that a purely quantitative approach with strict rating criteria appears inappropriate. However, the increasing disclosure of rating agencies regarding their approaches to the asset class and to individual programmes may form a good basis for defining investment criteria. On the other hand, it remains important to keep track of all the other criteria, such as the general financial market environment, investor preferences and supply trends to grasp the relative value of individual products. Throwing out the baby with the bathwater

10 June 2010

From a macro-economic point of view, we also warn that a strict application of rating criteria could have harmful effects on the covered bond product. Over the past two years most covered bond issuers have shown strong commitment to adjusting their programmes to the increasing requirements of rating agencies. They showed this commitment to achieve their two main objectives: 1) minimise the link between the covered bond rating and the issuer rating; and 2) employ the respective collateral in the most efficient way. Driven by investor guidelines and regulations, most issuers focused strongly on the outcome of the 55

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rating process, the covered bond rating, and generally made efforts to achieve and/or keep a triple-A rating. The flipside of this process is that the economics of using covered bonds have strongly deteriorated. In addition, issuers with a lower senior unsecured rating, which generally benefit the most from making use of secured funding via covered bonds, increasingly struggle to access the market. Again, focusing more on the qualitative aspects of the rating and surveillance process could help reduce the stigma of not being rated tripleA and thus improve the ability of issuers to make an efficient use of covered bond funding, which has proven to be a stabilising factor for the liquidity position of banks. In the following three sections we describe the general approaches of Moody’s, S&P and Fitch to covered bonds. We also include recent refinements. The respective descriptions are based on the rating agencies’ publications of their covered bond approaches, as well as on reports discussing individual aspects of the relevant methodologies.

Moody’s Current rating approach published in June 2005

Prior to 2005, Moody’s differentiated between a fundamental and a structured finance approach

Focus on expected loss

10 June 2010

Moody’s current rating methodology dates back to June 2005. Its approach aims to determine covered bond ratings on a quantitative basis with the inclusion of a detailed analysis of the cover pool. Following the announcement of its methodology in 2005, Moody’s started to apply the revised approach to all existing covered bond ratings. As part of this, the rating agency carried out a detailed review of the legal environments affecting covered bonds. Against this background, it developed a legal checklist designed to clarify all areas of the respective jurisdiction that may affect an expected loss or timeliness of payment for a covered bond. Historically, Moody’s has differentiated between a fundamental approach and a structured finance approach. The fundamental approach was applied when three criteria were met: 1) cover assets remain consolidated on the originator’s balance sheet; 2) bondholders have full recourse claim against the issuer, but no direct and separate claim against any specific asset subset within the cover pools; 3) there are no incremental, contractual provisions adopted by the issuer beyond the scope of legal requirements geared towards achieving a specific rating level. Given that most covered bonds fulfilled these criteria, Moody’s generally applied the fundamental approach. Only when covered bonds benefited from additional structural enhancements or were issued within a jurisdiction in which no specific covered bond law was established did Moody’s follow a structured finance approach. Within the fundamental approach, Moody’s followed a notching policy based on a catalogue of covered bond-specific features, such as the quality of the cover portfolio, the availability of over-collateralisation, provisions against cash-flow mismatches, segregation of cover assets, protection against liquidity, non-substitution and operational risks, as well as the probability of systemic support. This analysis resulted in the definition of a maximum upward notching against the senior unsecured rating. Within the structured approach, Moody’s focused on the strength of the assets and protection against cash flow interruption. Particular emphasis was placed on the enforceability of over-collateralisation and its effect on the expected loss of a covered bond. Since 2005, Moody’s focuses on the expected losses for covered bond investors and employs a joint default approach, which means the final rating reflects the credit profile of the issuer and the quality of the cover pool. As a first step, the probability of default for each month during the life of the bond is calculated based on the senior unsecured rating of the issuer. Secondly, the expected loss is estimated, taking into account the net present value cover of outstanding covered bonds and any other outstanding claim against the issuer. Three factors enter the calculation of net present value cover: 1) the credit quality of the collateral; 2) the refinancing risk

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for bridging liquidity gaps; and 3) exposure to interest rate risk. To calculate the expected loss for covered bond investors, the default probability is multiplied by the expected loss. Use of idealised default probability data

Moody’s takes the probability of issuer default from its idealised probability of default data, which contain default probabilities across different rating categories over a horizon of up to ten years. According to these data, default probabilities are low between AAA and A1 rated debtors and up to a five-year horizon, but start to increase substantially from A2 onwards and for debt with a maturity of greater than five years.

Figure 42: Default probabilities increase substantially for issuer ratings below A1 7% 6% 5% 4% 3% 2% 1% 0% 1

2

3 Aaa A2

4 Aa1 A3

5

6 Aa2 Baa1

7

8 Aa3 Baa2

9

10 A1 Baa3

Source: Moody’s, Barclays Capital

Structured finance approach used to assess pool quality

Assessing the quality of the cover pool is the first step in estimating the potential loss in the event of issuer default. As with its structured finance approach, Moody’s analyses the portfolio on a loan-by-loan basis. Alternatively, for each asset class, Moody’s has defined a catalogue of data requirements in cases where data can only be supplied on a stratified basis. Obviously, the less detailed the information provided, the more severe the potential penalties for assessing the portfolio quality. As cover pools are generally dynamic, Moody’s monitors the quality of cover assets on a quarterly basis. The quality of the cover pool is measured by the so-called collateral score, which basically represents the required amount of risk-free credit enhancement to protect a triple-A rating purely against a deterioration of the credit quality of cover pool assets. Thus, the respective score does not include potential support from the sponsor bank, potential haircuts due to forced monetisation of the cover pool assets or exposure to market risk. The lower the collateral score, the better the quality of the cover pool. Collateral scores need careful interpretation, as they are subject to a number of risk factors.

Figure 43: Collateral scores – statistical overview Parameter

Value

No. of programmes with published collateral scores 164 (120 mortgage/43 public sector / 1 mixed) Average collateral score

11.4%

Average collateral score (mortgage)

12.7%

Average collateral score (public sector)

7.7%

Minimum collateral score

1.80%

Maximum collateral score

66.9%

Source: Moody’s, Barclays Capital

10 June 2010

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Haircuts applied to the published collateral scores

Correlation assumptions depend on type of cover assets

Collateral scores to be published for a growing number of covered bond programmes

Collateral scores may cap the maximum achievable covered bond rating, in particular when the sponsor bank rating is low and the pool consists of mortgages

Diversification of cover assets has a rather strong impact

Collateral scores for Cédulas are generally distorted to the upside, as they also reflect the quality of non-eligible assets

It is important to note that Moody’s applies a haircut to the collateral score as long as a covered bond programme is supported by an investment grade-rated sponsor bank. This is mainly because the respective sponsor banks generally support the quality of the cover pool. In addition, depending on the structure of the respective covered bond programme, Moody’s typically assumes a probability of less than 10% for a scenario in which an issuer default would immediately be followed by a credit-stress scenario on the cover pool. Haircuts applied to the collateral score of the respective programmes are based on assumptions regarding the default correlation between the sponsor bank and the cover pool. Generally, a relatively low minimum default correlation is assumed for public sector cover pools, and a “standard” minimum default correlation is assumed for mortgage cover pools. Under certain conditions, haircuts of 33%, 45% and 50% are applied to public sector cover pools and a haircut of 33% is applied to mortgage covered bonds. Moody’s publishes collateral scores where sufficient information on the cover pool is provided and with the issuer’s approval. With regard to newly rated programmes, collateral scores are generally published within the respective pre-sale reports. We understand that so far issuers have not rejected the publication of the collateral score and are generally rather eager to see the collateral scores being published. A full list of the assigned collateral scores is available in the appendix of this book. The collateral scores for individual programmes help to assess the sensitivity of achievable covered bond ratings to changes in the sponsor bank’s senior unsecured rating. The lower the collateral score (ie, the higher the rating assessment of the cover pool), the less sensitive is the achievable covered bond target rating to the level of the sponsor bank’s senior unsecured rating. Owing to the very low collateral scores of many cover pools, the cover bond rating of these programmes seems to be more restricted by the timeliness of payment considerations than by concerns about cover asset quality. However, particularly when a relatively high collateral score on a mortgage-secured programme is combined with a rather low issuer rating, the maximum achievable covered bond rating is capped by cover pool quality. So far, Moody’s has published the collateral score for 164 covered bond programmes. The average collateral score across all programmes is 11.4%, with a minimum of 1.8% and a maximum of 66.9%. When comparing collateral scores across different programmes, a number of special factors need to be taken into account. In particular, small and/or highly concentrated cover pools, characterised by a number of large obligors and/or assets with high default correlation, suffer from rather high collateral scores. This is demonstrated by the fact that the collateral score for Cédulas Territoriales, issued by smaller-sized Spanish savings banks that generally focus purely on local public sector business, is rather high, while the collateral score of Cédulas Territoriales issued by BBVA and Banco Santander, which have a more diversified public sector portfolio, is rather low (6.3% and 5.0%, respectively). Another example that demonstrates the limited comparability of collateral scores refers to Cédulas programmes. Collateral scores for Spanish Cédulas reflect the total portfolio of securing assets and not just the portfolio of eligible assets. However, asset quality of the eligible portfolio is generally above average; thus, the published collateral scores are somewhat distorted to the upside. On 13 April 2010, Moody’s published a report titled “Moody’s EMEA Covered Bond Monitoring Overview: Q3 2009”. The paper gives an overview on some key risk measures Moody’s assigns to covered bond programmes in the course of its rating process. Among others, it included an overview on average collateral scores of mortgage collateral scores

10 June 2010

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per country. The respective figures highlight that Moody’s assigned a below-average mortgage pool quality rating to programmes from Spain, Ireland and Denmark and a particularly high average mortgage pool quality rating to programmes from Finland, The Netherlands, Norway and Portugal. Diversification of cover assets has a rather strong impact

Dual impact of collateral quality

Assessment of refinancing risk

In our view, a look at collateral scores across covered bond categories could be particularly rewarding for investors who take a more fundamental view on covered bonds despite the above limitations. In particular, the collateral scores of most mortgage-secured programmes are as low as the collateral scores of those public sector programmes backed by diversified pools. We observe that an increasing number of investors are starting to focus on pool quality to differentiate various programmes. Thus, we expect Moody’s’ collateral score to become an important criterion in assessing relative value across different covered bonds. The quality of the cover pool has a dual effect on the assessment of the expected loss calculation within the Moody’s rating approach. First, it determines the amount that has to be written off. As explained above, Moody’s assumes a stronger depreciation in cases where the issuer’s credit profile is more narrowly correlated with the quality of cover assets. Secondly, the quality of the cover pool determines the amount of collateral that can be refinanced at different rating levels. Within the stress scenario, liquidity gaps may need to be bridged by using alternative ways of funding. To assess refinancing risk, Moody’s focuses on three aspects: „

The refinancing margin to finance cover assets after adjustment for write-offs following issuer default.

„

The portion of cover bonds that rely on refinancing in order to be repaid prior to their legal final maturity.

„

The expected average life of cover assets at the time of refinance. The calculation of stressed refinancing margins is mainly based on historically observed margins for different quality pools across the respective asset categories, the time needed to complete the refinancing and the length of time between the issue date of the covered bond and the refinancing date. To estimate refinancing needs, Moody’s analyses the amortisation profile of cover assets and outstanding covered bonds, as well as available over-collateralisation. Generally, exposure to refinancing risk will be lower:

Figure 44: Average collateral score by country – mortgage cover pools 30% 24%

25% 20%

15%

14%

15%

12%

10%

12%

7%

7%

3%

5%

5%

7% 4%

7%

4%

UK

It a ly et he rl a nd s N or w ay Po rt ug al Sp ai n Sw ed en N

Fr an ce G er m an y G re ec e I re la nd

D

en m

ar

k Fi nl an d

0%

Collateral -Score

Average

Source: Moody’s

10 June 2010

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Changed refinancing assumptions in Q1 08

−

The longer the collection period for the covered bond programme

−

The higher the principal payment rate on cover assets

−

The greater the amount of over-collateralisation

Decreasing secondary market liquidity in markets in which cover pool assets could be monetised prompted Moody’s to review and update its refinancing stress assumptions in Q1 08. A respective report was published on 29 February 2008. The review process resulted in rising credit enhancement requirements for a number of programmes. The names of the respective programmes were not disclosed. Moody’s confirmed that the affected issuers all agreed to add the required credit enhancement to their covered bond programmes to maintain current rating levels.

Analysis of interest risk

Finally, Moody’s methodology addresses interest rate risk by assessing the potential mismatches for the time period between the issuer default and the legal final maturity of the covered bond, as well as between the latter and the legal final maturity of the cover pool. The evaluation of mismatches is based on the analysis of the cover pool, hedge arrangements and imposed hedging rules. The potential loss to investors is then calculated by running stress scenarios based on historical data.

Link between covered bond

To provide clear guidance on the criteria that have to be fulfilled to reach a particular target rating, Moody’s clarifies the relationship between the issuer rating and the recovery requirement by stipulating the following formula:

target rating and issuer rating through minimum recovery requirement

Issuer expected loss * (1 – recovery on assets) = Aaa expected loss This means that the recovery requirement depends on the ratio between the expected loss of the target rating and the expected loss of the issuer rating. For example, on a 10y horizon, an A3-rated issuer (expected loss: 0.9900%) with an Aaa target rating (expected loss: 0.0055%) would be confronted with a minimum recovery requirement of 99.4%.

Weak cover pool features reflected in narrower link to issuer rating

In cases of high-quality collateral, a certain amount of over-collateralisation and minimal interest rate risk, a maximum rating difference between covered bonds and issuer ratings of six notches can generally be achieved. In cases of comparatively low-quality collateral, no over-collateralisation and substantial interest rate risk, a maximum rating difference of three notches can usually be achieved. Thus, unsurprisingly, weak cover pool characteristics are reflected in a closer link between the covered bond rating and the issuer rating.

Figure 45: Recovery requirements quite strong for issuer ratings below A1 Required Recovery 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Aaa Aaa

Aa1

Aa1 Aa2

Aa3

Aa2 A1

A2

A3

Aa3 Baa1

Baa2

Baa3

Source: Moody’s, Barclays Capital

10 June 2010

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Increased covered bond rating volatility in certain areas

More transparency regarding the impact of timely payment concerns on covered bond ratings

Application of the so-called Timely Payment Indicator

Rating ceilings applied irrespective of the outcome of the expected loss analysis

Investors should be particularly aware that there are areas in which the rating volatility for covered bonds could exceed the rating volatility of the senior ratings of the respective sponsor bank. This is the case, for example, when senior unsecured ratings move below certain thresholds, as Moody’s then no longer recognises any voluntary overcollateralisation, only the amount of additional collateral that is regarded as legally binding. This is at least the case when the senior unsecured rating moves into sub-investment grade territory, but in some cases also at an earlier stage. Another factor contributing to increased rating volatility is the assessment of timely payment. In the Moody’s approach, issuers rated below A1 may only achieve an Aaa covered bond rating if the covered bonds are expected to be paid on a timely basis following issuer default. In a report entitled Timely Payment in Covered Bonds following Sponsor Bank default on 13 March, Moody’s disclosed the sensitivity of its covered bond rating ceilings to changes of the sponsor bank’s senior ratings across individual covered bond programmes. Still, the assessment of timely payment could be quite volatile. In the case of the Icelandic covered bond programme of Kaupthing, for example, Moody’s reduced its timely payment assessment from the second-best class (‘high’) to the worst (‘very improbable’). Within Moody’s covered bond approach, the assessment of the timely payment of interest and principal in the event of a sponsor bank default is an important factor that links the covered bond ratings to the senior rating. Moody’s applies a so-called Timely Payment Indicator (TPI) to individual programmes. The TPI ranges from “very high” or close to 100% probability of timely payment to “very improbable” or close to 0% probability of timely payment. Moody’s also explained that it could assess a covered bond programme as “delinked”, although this is currently not the case with any programme. The TPI is split into six categories. Figure 46 and Figure 47 highlight the maximum ratings that can be achieved on the basis of a given timeliness of payment category and a given senior rating level. The TPI matrix defines ceilings for covered bond ratings, which are applied irrespective of the results of the expected loss assessment. For example, a covered bond programme with a TPI of “Probable-High” and that is sponsored by a bank with a Baa1 senior rating would not qualify for an Aaa rating even if the expected loss analysis suggested that an Aaa rating would be appropriate.

Figure 46: Covered bond rating ceilings across Timely Payment Indicator (TPI) categories Sponsor bank senior rating A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1

Very improbable

Improbable

Probable

Probable - High

High

Very high

Aaa Aa1 Aa2 Aa3 A1 A3 Baa3 Baa3 Baa3 Ba3

Aaa Aa1 Aa2 Aa3 A1 A2 Baa2 Baa2 Baa2 Ba2

Aaa Aaa Aaa Aa1 Aa2 A1 Baa1 Baa1 Baa1 Ba1

Aaa Aaa Aaa Aa1 Aa2 Aa3 A3 A3 A3 Baa3

Aaa Aaa Aaa Aaa Aa1 Aa2 A2 A2 A2 Baa2

Aaa Aaa Aaa Aaa Aaa Aa1 A1 A1 A1 Baa1

Source: Moody’s

10 June 2010

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Figure 47: Covered bond rating ceilings across TPI categories Aaa Aa1 Aa2 Aa3 Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3

A1

A2

A3

Baa1 Baa2 Baa3 Ba1 Ba2

Ba3

B1

B2

B3

Very Improbable Improbable Probable Probable - High High Very High

Source: Moody’s, Barclays Capital

Of the five factors influencing the TPI, the analysis of the legal and contractual arrangements is particularly detailed

Swap arrangements negatively affect TPI

Nature of assets and liabilities is taken into account

Additional factors are considered

TPIs assigned to individual programmes

10 June 2010

According to Moody’s, the assessment of the TPI is based on five different factors: 1) the strength of the respective legislation and/or contractual agreements; 2) the nature of hedging arrangements; 3) the type of assets; 4) the nature of liabilities; and 5) a series of “Other Factors”. With regards to the strength of legislation and/or contracts, Moody’s focuses on general provisions concerning the commingling of cash flows, the quality of coverage tests, periodic matching of cash flows, as well as protection against short-term liquidity shortfalls. In addition, the capacity of a programme to cope with refinancing risk to operate principal payments is considered. Furthermore, the ability of an administrator to arrange timely payment is taken into account. In order to give a rough guidance about how legal and contractual arrangements influence the TPI in individual countries, Moody’s has published a table listing the strengths and weaknesses across various jurisdictions. With regards to hedging arrangements, Moody’s generally regards swap arrangements as negative from a timely payment perspective. Moody’s argues that the respective swap contracts typically imply exposure to the sponsor bank and also may hinder the monetisation of assets and/or repurchase of liabilities. In Moody’s view, this can only be mitigated by specific structural arrangements such as extended grace periods. With regards to the third factor influencing the TPI, the type of assets, Moody’s assesses the depth and liquidity of those markets in which the respective cover assets can be sold and/or alternative funding can be raised against them. In terms of the type of covered bonds, Moody’s regards non-bullet bonds as less exposed to refinancing risk as bonds that feature pass-through structures. There are also a number of “Other Factors” influencing the TPI. Among these factors are informal timely payment arrangements, such as the coverage of liquidity gaps through an appropriate matching of redemptions and/or the maintenance of suitably liquid assets. Also, a low correlation between the probability of default of the sponsor bank and the cover pool would be regarded as positive. In addition, Moody’s argues that large amounts of overcollateralisation may allow covered bond ratings to exceed TPI constraints. Lastly, in cases where the sponsor bank rating would be sub-investment grade, Moody’s would regard the time to the next principal payment, as well as the cash position of the sponsor bank, as important factors influencing the TPI. Figure 48 gives a summary of the respective TPI assessments by product class. Currently, the majority of programmes secured by mortgages are assessed to have a TPI that is in the “Probable” to “Probable-High” range, and the majority of programmes secured by publicsector assets are assessed to have a TPI that is in the “Probable-High” to “High” range. 62

Barclays Capital | AAA Handbook 2010

Figure 48: Country overview of TPI assessments Country

Public sector

Mortgage

Austria Denmark Finland France - legislative France – common law Germany4 Germany (structured) Hungary Iceland Ireland Italy Latvia Netherlands Norway Poland Portugal Spain Sweden Switzerland United Kingdom United States

High -1 -1 Probable-High -1 High -1 -1 -1 Probable-High Probable-High (CDEP) -1 -1 -1 Very improbable High Probable-High -1 -1 -1 -1

Probable Very High2 Probable Probable-High3 Probable Probable-High5 Probable Improbable Very improbable Probable-High/Probable6 Probable -7 Probable Hgh8 Very improbable Probable-High Probable Probable Probable (UBS) Probable9 Improbable

Notes: 1There is either no such product category rated by Moody’s, or none of the respective issuers is publicly rated by Moody’s; 2except Danske Bank Global Covered Bond Programme, which is “Probable”; 2except GE SCF, which is “Probable”; 4The TPI for Ship Pfandbriefe is “Probable”; 5except Deutsche Bank, which is “Probable”; 6AIB,BKIR,EBS /ANGIRI; 7covered bonds in Latvia are currently rated one notch above the senior unsecured rating of the sponsor bank; 8except DNB Nor, which is “Probable” and SpareBank 1 Boligkredit, which is “Probable High”; 9the TPI for the HBOS Treasury Services programme backed by social housing loans is “Probable-High” and a number of covered bond programmes with additional safeguards and pass-through language may achieve better TPI scores (up to “Very High”). Source: Moody’s, Barclays Capital

Only in special cases should the provision of additional collateral influence the TPI

Maturity extension and use of hedges may have a rather strong influence on the TPI

In certain areas, the rating volatility of covered bonds may exceed rating volatility of senior bank ratings

10 June 2010

From a systematic point of view, Moody’s acknowledges that the provision of large amounts of over-collateralisation may allow covered bond ratings to exceed TPI constraints. While we understand that such a rule is currently not applied in any programme, in our view, this should be allowed in special cases where, for example, limited liquidity of cover assets is the main factor restricting the TPI. In particular, concerns regarding the legal and contractual agreements could hardly be compensated just by providing more collateral. We also note that Moody’s regards maturity extension features as a rather efficient tool to overcome timely payment concerns. At the same time, the inclusion of hedge contracts can have a rather negative effect on the rating ceiling. This seems to be reflected, for example, in the fact that the Irish public sector Asset Covered Securities (ACS) has been assigned the same TPI (“Probable-High”) as some of the mortgage ACS, which generally benefit from maturity extension features. Regarding the TPI matrix, we find it important to highlight that a downgrade of a bank’s senior rating from Baa2 to Baa3 could have a materially different effect on covered bond ratings when moving from a TPI of “Probable” to “Probable-High”. If “Probable” was assigned, such a single-notch downgrade of the senior rating would lower the covered bond rating ceiling two notches (from Aa2 to A1), while in the case of “Probable-High” being assigned, the downgrade would be limited to a one-notch downgrade (from Aa2 to Aa3). Other examples where rating volatility of covered bonds may exceed rating volatility of senior bank ratings include sponsor institutions possibly losing their investment grade senior rating, as well as the senior rating dropping from Ba3 to B1. In both cases, covered bond ratings would be lowered three notches across all TPI categories. 63

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Standard & Poor’s Historically, S&P’s covered bond ratings were de-linked from the issuer rating

Demand for self-commitments in 2003

Launch of Covered Bond Monitor in 2006

New methodology published in December 2009

Five-step approach

10 June 2010

When it first started to rate German Pfandbriefe in the mid-1990s, S&P used a structured finance approach. A key characteristic of S&P’s initial approach was not only the strong focus on the quality of underlying assets and the adequacy of cash flows, but also the readiness of the rating agency to replace the lack of legal supervision with its own surveillance. Consequently, there used to be ample room to apply credit enhancements, particularly through the maintenance of excess (quality) assets, to gain a AAA rating. S&P ratings were generally not linked to the senior unsecured rating of the issuer and, as such, the vast majority of covered bond issuers were rated AAA. In an attempt to add an additional layer of control beyond its internal surveillance, in 2003 S&P started to emphasise the need of issuers to be particularly transparent about liquidity risk and the commitment to over-collateralisation. Therefore, S&P expected issuers to communicate publicly the liquidity profile and the minimum level of over-collateralisation that investors could expect to be maintained over time. In this respect, it is also worth noting that S&P applied an additional penalty should an issuer not make such a public statement. In February 2006, S&P launched the Covered Bond Monitor, a tool for issuers to model covered bond asset quality and cash flow adequacy. While S&P has maintained its basic approach, it has refined the rating process and underlined the fact that it will place more emphasis on the corporate review of the issuer. When introducing the cover pool monitor, S&P also highlighted that, in addition to its quantitative analysis, qualitative aspects, such as the strength of the legal framework and the issuer’s commitment to the covered bond product, will play an important role in the credit committee’s decision-making process. On 12 May 2010, S&P released a web-based version of the covered bond monitor. Following its announcement on 4 February 2009, in which S&P outlined plans to substantially amend its existing covered bonds rating methodology, the rating agency finally presented its new methodology on 16 December 2009. Within the scope of the new methodology, S&P links the covered bond rating to the rating of the issuer provided S&P believes the respective covered bond programme has asset-liability mismatches that are not addressed structurally. The new methodology for determining a covered bond rating is based on the assessment of a number of factors including asset risk, cash flow risk, legal risk, operational and administrative risk and counterparty risk. The revision of the S&P approach was focussed on asset and cash flow risk as the most relevant determinants. More precisely, within the scope of the revised methodology, S&P developed a five-step process to evaluate the maximum potential rating uplifts for a covered bond programme. This process is based on the combined assessment of a potential asset-liability mismatch exposure and the covered bond programme’s categorisation. Furthermore, determinants include the issuer’s rating, AALM exposure, jurisdiction, range of refinancing options, available credit enhancement and target price at which assets can be liquidated in a stress scenario (Figure 49).

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Figure 49: Assessing asset-liability mismatch risk in covered bonds Five Key Areas of Standard & Poor ‘s Covered Bond Ratings Analysis Asset Risk

Cash Flow Risk

Legal Risk

Operational and Administrative Risk

Counterparty Risk

See relevant criteria

Step 1: ALMM Classification

=

Zero Low Moderate High

Step 2: Program Categorization

=

Category 1 Category 2 Category 3

=

3 5 4 3

Step 4: Cash Flow and Market Value Analysis

=

Determine target credit enhancement to achieve maximum potential ratings uplift

Step 5: The Covered Bond Rating

=

Compare target credit enhancement with available credit enhancement

Max Potential Ratings Uplift (Notches )

Step 3: The Maximum Potential Covered Bond Rating

Category 2 Unrestricted 7 6 6 5 5 4 1

ALMM risk Zero Low Moderate High

Source: Standard & Poor’s

ALMM classification

In the first step, S&P assesses the riskiness of a programme’s asset-liability mismatch by calculating the maximum cumulative asset-liability mismatch (ALMM) as a percentage of outstanding liabilities. This is then classified as low, moderate or high risk, thereby determining the maximum potential rating uplift a covered bond programme may have from the issuer’s rating. When determining the asset-liability mismatch, S&P applies a cash flow based approach, taking into account prepayments on mortgage portfolios, considering liabilityspecific features (ie, maturity extension, pre-maturity tests) and treating near-term exposure as more significant than mismatches occurring in the medium or long term. The latter is achieved by introducing a so-called scaling factor, through which S&P weighs net stressed cash flows occurring in up to one year at 100%; those occurring in the following years are 5pp lower weight for each year, until those occurring in 10 years and later are weighted at 50%.

Figure 50: Asset-liability mismatch classifications and maximum potential uplift ranges ALMM risk

ALMM percentage

Max. potential number of notches uplift

Zero

N/A

Unrestricted

Low

0 ≤ 15

5 to 7

Moderate

15 ≤ 30

4 to 6

High

> 30

3 to 5

Source: S&P

10 June 2010

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Programme categorisation

In the second step, S&P categorises covered bond programmes according to their ability to obtain third-party liquidity or monetise assets to fund potential asset-liability mismatches after an issuer fails. S&P segments the programmes into three categories depending on the covered bond programme’s jurisdiction and the issuer’s ability to access external financing or monetise the collateral pool. The potential rating uplifts for categories one, two, and three are seven, six, and five rating notches, respectively. Note that within this measure, S&P strongly differentiates between the systemic importance of covered bonds for a market, thereby concluding how likely the covered bond programme is to access funding and how governments and regulators could likely support financial stability. Despite this rather formal approach, we understand that S&P is prepared to consider that for some public sector cover pool assets the strength of funding sources must not necessarily be a function of the systemic importance of the covered bond product or whether the respective covered bond market could be qualified as “well-established”, but rather a function of the breadth and depth of the market for the underlying cover assets.

Figure 51: Covered bond programme categories Characteristic

Range of funding options

Strength of funding sources

Jurisdictions

Maximum potential rating uplift.

Covered Bond Category Category 1

Category 2

A programme has the flexibility to raise funds through asset sales and borrowing from either banks or the central bank. There are no restrictions on when or how funds can be raised. The covered bond market has, in S&P’s opinion, a long and well-established history. In S&P’s view, systemic importance of the product is high. S&P considers if there is a broad range of banks that are able to lend and evaluates if there would be adequate demand among a broad range of investors for the assets backing the programme. Denmark, France (Obligations Foncières), Germany (Pfandbrief), Spain (stand-alone Cédulas)

A programme is able to raise funds either through asset sales or borrowing from either banks or the central bank. There are no restrictions on when or how funds can be raised. The covered bond market has, in S&P’s opinion, a limited history. In S&P’s view, systemic importance is not as strong as Category 1. S&P considers if there is a broad range of banks that are able to lend and evaluates if there would be an adequate demand among a broad range of investors for the assets backing the programme. Canada, Finland, France (common law covered bonds), Ireland, Italy, Luxembourg, The Netherlands, Norway, Portugal, Sweden, U.K. 4 to 6

5 to 7

Category 3 A programme's access to funding is restricted so the sale of assets is forced.

The covered bond product is newly established in that jurisdiction. In S&P’s view, systemic importance is low. S&P considers if banks are unable to lend to programmes and evaluates if there is uncertain demand among a broad range of investors for the assets backing the programme. Greece, US

3 to 5

Source: S&P

Determination of maximum potential ratings uplift

In the third step, based on a combination of the asset-liability exposure and an issuer’s ability to cover the latter, S&P determines the maximum potential rating on a covered bond programme. In principle, the classification of the asset-liability mismatch and the categorisation of each programme are combined (Figure 51).

Figure 52: Maximum potential ratings uplift from issuer’s rating* Asset-liability mismatch risk

Category 1

2

3

Zero

Unrestricted

Unrestricted

Unrestricted

Low

7

6

5

Moderate

6

5

4

High

5

4

3

Note: *By number of notches. Source: Standard & Poor’s

10 June 2010

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Cash flow and market value analysis

Assignment of covered bond rating

Assignment of outlooks

In the fourth step, S&P analyses the cash flows to determine the periodic asset-liability mismatches of a covered bond programme before applying a stress test to the cover pool. If a programme is able to liquidate sufficient assets to meet mismatches while leaving collateral to service the remaining debt, the maximum potential rating can be achieved. In order to determine the stressed net present value of projected cash flows, S&P determines target asset spreads over the relevant funding rate (ie, Euribor). These target asset spreads are generally based on the widest historical spreads for securitizations or similar assetbased financing instruments. For mortgage collateral pools, target assets spreads range from 425bp for prime residential mortgage loans to 1000bp for commercial mortgage loans. For public sector collateral pools, target assets spreads range from 100bp for AAArated sovereign exposures to 300bp for A/BBB-rated sovereign exposures. In the fifth and final step, S&P assigns the rating to the covered bond programme by assessing whether a programme’s available credit enhancement is equal to the stress test’s target for the maximum potential rating determined in step three. In case the available credit enhancement covers all credit risks related to the default of the cover pool assets, S&P assigns a first notch of uplift. For any further uplift, the remaining credit enhancement should be able to cover the market value risk arising from the asset-liability mismatch. To determine the credit enhancement for each additional notch of uplift, S&P divides the credit enhancement differential by the number of additional notches. In the case of the available credit enhancement being below the stress test’s target volume, the covered bond programme’s rating will be lower than the potential maximum rating. S&P also applies outlooks to covered bond ratings. Whilst the outlook on covered bonds ratings is closely aligned to that on the issuer, it is also a function of S&P’s assessment of the issuer’s future business plans (acquisition of assets and funding operations), the expected performance of the collateral, as well as the expected asset-liability structure. Thus, in theory, a rating-positive (-negative) business plan could lead to a positive (negative) outlook on the covered bond rating, although the senior rating of the respective bank is on outlook negative (positive).

Fitch Fitch’s rating methodology has been refined since it started rating covered bonds in 1998

A three-stage process

10 June 2010

Fitch’s approach to covered bonds dates back to 1998, when the agency presented a rating methodology for German Pfandbriefe. At that time, Fitch clarified that not only is the quality of cover assets vital to the credit status of Pfandbriefe, but so is the credit profile of the issuing bank. Since the late 1990s, Fitch has published a series of methodology publications for other covered bond markets. A major step in refining and explaining its general approach to covered bonds has been the introduction of the “discontinuity factor” (Dfactor) in 2006. In June 2009, Fitch presented its final update on liquidity risk assumptions and also revised alternative management scores. The implementation of the proposed changes resulted in a deterioration of D-factors for most covered bond programmes; as a consequence, it has become difficult for mortgage-covered bonds to reach a triple-A rating on a probability of default basis, in case the issuer is rated below AA-. Furthermore, the new recovery assumptions have led to an increase of OC requirements for maintaining a given rating uplift, as Fitch applies the respective fire-sale discounts on the full remaining pool at the time of default of the covered bond. Fitch’s rating process for covered bonds contains three major steps. As a first step, Fitch determines the maximum achievable covered bond rating on a probability of default basis. This is done by combining an issuer’s default rating with the so-called “discontinuity factor”. The second step consists of stress-testing over-collateralisation to set the covered bond rating on probability of default basis. This is done by comparing stressed cash flows 67

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from cover assets with payments due on covered bonds in a wind-down scenario. As a third and final step, Fitch assigns a recovery uplift to reflect stressed recoveries from cover assets in case of a covered bond default.

Determination of the D-Factor Gradual approach to reflect exposure to an issuer’s credit profile

Discontinuity factor is based on four input categories

Within Fitch’s approach, the weight that an issuer’s credit profile plays in the assessment of a covered bond programme is a function of the risk of payment interruptions. An increased risk for payment interruptions is reflected in a greater weight of the issuer rating when assessing a covered bond programme. To measure the risk of payment interruptions across various covered bond systems and cover pool-specific characteristics, a D-factor is calculated. This factor ranges from 0-100%, where 0% is applied for perfect continuity of payments and 100% is applied when an issuer default automatically triggers a default of covered bonds. The calculation of the discontinuity factor is based on a scoring model that stipulates four main input factors for measuring the risk of payment interruptions: 1. The extent of asset segregation, with a 45% weight; 2. The specification of an alternative management of cover assets, with a 15% weight; 3. The assessment of liquidity gaps, with a 35% weight; and 4. The oversight of covered bonds, with a 5% weight.

The focus is on system-specific factors

Three-step approach for the scoring of the liquidity gap component

10 June 2010

Within the scoring model, system-specific drivers play a dominant role. They are included in all four categories. The importance of a proper segregation of cover assets, which, in Fitch’s model, is driven purely by system-specific drivers, reflects the 45% weight the agency gives to this item. When analysing the extent of asset segregation, Fitch mainly focuses on the protection of the claims of covered bond investors against any claims of other creditors that may arise in the course of bankruptcy proceedings. This also includes the protection of overcollateralisation and derivative contracts. The second most important item in the calculation of the D-factor is the analysis of liquidity gaps, which is weighted 35%. When looking at liquidity risk, Fitch evaluates means for overcoming potential liquidity problems through passthrough amortisation agreements, liquidation of cover assets, pre-maturity tests or through accumulation or extension periods. The third element in the calculation of the D-factor refers to the specification of an alternative manager of cover assets. Within this category, Fitch emphasises the timely appointment of a back-up cover pool manager and the ability of this back-up manager to raise money against cover assets. Finally, when looking at the oversight of covered bond programmes, Fitch examines the reporting and auditing standards, as well as the importance of covered bond funding within a country’s banking system. Within the calculation of the D-factor, the scoring of the liquidity gap component is based on a three-step approach. First, Fitch allocates the respective cover assets to seven different liquidity classes, which reflect the time needed to liquidate the respective assets. These may range from class 1 (up to one week) to class 7 (more than 12 months). Fitch also indicated in which liquidity classes it would see different types of public sector and mortgage assets. On the public sector side, the main criteria refer to the respective sovereign country, the type of debtor (sovereign, region, province, municipality, other public sector entity) and the type of instrument (bonds, promissory note, loan, other). With respect to mortgage assets, Fitch suggests differentiating across countries, with “established residential mortgage markets in Western Europe and Canada” falling into liquidity class 5 (6-9 months), but Germany and the US falling into class 4 (3-6 months) because of the higher likelihood of asset pool transfers in the case of Germany and the depth of the RMBS market in the case of the US. Other mortgage 68

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asset types (ie, specialist residential, commercial) are assessed on a case-by-case basis. In step two, the respective liquidity risk mitigants are assessed. The following instruments are recognised in order of decreasing comfort: pass-through mechanisms, maturity extension, pre-maturity test, public liquidity guidelines, and internal liquidity guidelines. Finally, Fitch checks the extent to which the provided liquidity instruments would be sufficient to cope with the uncertainty of monetising assets in a given timeframe. Assigning jurisdiction-specific components within the alternative management score

Overriding rules

Within the calculation of the D-factor, the alternative management score is based on two types of sub-components: jurisdiction-specific components and issuer-specific components. To gauge the former, Fitch analyses legislative, regulatory or contractual provisions for replacing an insolvent institution in its capacity as manager of the covered bonds and servicer of the cover assets. Within its scoring, Fitch penalises programmes that involve a special purpose vehicle (SPV), as it is concerned that the “underlying provisions may give rise to delay”. However, in case contractual provisions detail the steps to be taken in the transition process, and the party responsible for taking decisions would be willing and able to do this without facing obstacles such as obtaining bondholder consent or finding a new partner, Fitch would give credit for such features. Fitch classifies the systemic alternative management score of covered bond programmes across the following three categories (in decreasing order): „

Legislative frameworks in which the regulator has an active say in the management of the cover assets and covered bonds (Ireland, Luxembourg, Germany).

„

Integrated frameworks with a regulator involved in the appointment of a dedicated alternative manager, frameworks in which the cover pool is isolated in a special purpose financial institution, contractual programmes involving a SPV with efficient provision for the replacement of the manager (Denmark, Norway (when the issuer could not fall into insolvency estate of the parent), Portugal, France, and The Netherlands).

„

Legislative frameworks with no dedicated covered bonds administrator, legislative frameworks involving a SPV or contractual programmes with the potential for a slower transition (Spain, Norway – when the issuer could fall into insolvency estate of the parent – Italy, Greece, Canada, UK and the US).

There are also three rules that override the result of the scoring model. The D-factor will be set at 100% when: 1) the asset segregation score does not reach a sufficiently high level; 2) the cover pool administration is deemed inadequate; or 3) an acceleration with an automatic freeze of all cash flows is imposed during an issuer insolvency.

Step 1 The discontinuity factor and the issuer default rating determine the maximum achievable covered bond rating on a PD basis

10 June 2010

After having determined the D-factor, Fitch calculates the highest achievable covered bond rating based purely on probability of default (PD) considerations by multiplying the five-year cumulative PD related to the issuer default rating (IDR) with the discontinuity factor. Then it selects the rating category associated with the adjusted PD level. For example, a single-A rated bank with a discontinuity factor of 40% for its covered bond programme would be exposed to a maximum AA rating on a PD basis for the covered bonds. The relationship between the IDR and the maximum covered bond rating achievable on a PD basis across different levels for the discontinuity factor is shown in Figure 53.

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Figure 53: Maximum covered bond rating achievable on a PD basis Issuer IDR

5y PD (%)

Discontinuity factor (%) 100

75

50

40

30

20

14

10

5

0

AAA

0.03

AAA

AAA

AAA

AAA

AAA

AAA

AAA

AAA

AAA

AAA

AA+

0.094

AA+

AA+

AAA

AAA

AAA

AAA

AAA

AAA

AAA

AAA

AA

0.203

AA

AA

AA+

AA+

AAA

AAA

AAA

AAA

AAA

AAA

AA-

0.255

AA-

AA

AA+

AA+

AA+

AAA

AAA

AAA

AAA

AAA

A+

0.501

A+

AA-

AA-

AA

AA

AA+

AA+

AAA

AAA

AAA

A

0.561

A

A+

AA-

AA

AA

AA+

AA+

AAA

AAA

AAA

A-

0.787

A-

A

A+

AA-

AA-

AA

AA+

AA+

AAA

AAA

BBB+

1.016

BBB+

A-

A+

A+

AA-

AA

AA

AA+

AAA

AAA

BBB

1.582

BBB

BBB+

A-

A

A+

AA-

AA-

AA

AA+

AAA AAA

BBB-

3.361

BBB-

BBB-

BBB

BBB

BBB+

A

A+

AA-

AA

BB+

5.355

BB+

BBB-

BBB-

BBB

BBB

BBB+

A-

A

AA-

AAA

BB

7.477

BB

BB+

BBB-

BBB-

BBB

BBB

BBB+

A-

AA-

AAA

BB-

11.007

BB-

BB

BB+

BB+

BBB-

BBB

BBB

BBB+

A

AAA

B+

15.37

B+

BB-

BB

BB+

BB+

BBB-

BBB

BBB

A-

AAA

B

19.616

B

B+

BB-

BB

BB+

BBB-

BBB-

BBB

BBB+

AAA

B-

25.53

B-

B

BB-

BB-

BB

BB+

BBB-

BBB-

BBB+

AAA

Source: Fitch

Step 2 The final PD of the covered bonds is determined through an iterative stress testing of over-collateralisation

Various types of overcollateralisation commitments recognised

Comparison of cash flows post-issuer default

10 June 2010

To determine the final PD of the covered bonds, Fitch positions the covered bond rating on a PD basis between the issuer default rating and the maximum achievable rating on a PD basis. It runs a cash-flow model under different rating scenarios, starting at the top of the range – ie, with the maximum achievable covered bond rating on a PD basis. In case overcollateralisation is insufficient to avoid a default of the covered bonds, the analysis is reiterated at lower rating levels, with the IDR building a floor for the covered bond rating on a PD basis. If the PD threshold for the maximum achievable rating is passed, the PD of the covered bond is set at the respective level. When running the cash-flow models, Fitch either recognises contractual, committed or publicly-stated minimum over-collateralisation levels, or applies the lowest overcollateralisation level in the preceding 12 months if the issuer’s short-term rating is at least F2 and, in the case this is not feasible, the minimum mandatory over-collateralisation level. This approach helps avoid rating volatility in the background of the observed swings in over-collateralisation levels. However, Fitch clarified that a sudden drop in overcollateralisation may result in a reduction of the covered bond rating on a PD basis, which may trigger a downgrade of the respective covered bonds. When running its stress tests, Fitch assumes several timings of the issuer default. Fitch’s model then compares the cash flows from the cover pool with the payments due on the covered bonds following an issuer default. Thus it is assumed that the assets are under the care of an alternative manager, no new assets enter the cover pool and further issuance of covered bonds is suspended. The simulation incorporates stressed assumptions about the credit risk of cover assets and about asset-liability mismatches in terms of maturity, interest rate and currency. Where available, Fitch applies the same assumptions and stresses as in structured finance transactions, which are backed by the same type of assets. In addition, the assumed cost of an alternative manager is factored in. 70

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Assessing stressed sales proceeds

To capture depressed sales prices, Fitch takes into account the increased importance of access to central bank liquidity instruments. In this respect, the ability of an alternative manager to act as counterparty for central bank repo transactions, as well as the eligibility of cover assets as security for such transactions and the respective haircuts, are assessed individually. Fitch also models fire-sale discounts. Importantly, the respective principles will also apply to assess stressed recoveries in a scenario in which the covered bonds would be in default. According to Fitch, such discounts would be 3-10% for public sector assets and 10-20% for mortgage assets. The criteria for applying haircuts to various asset types resemble the criteria for allocating assets types to the different liquidity classes. On the public sector side, the main criteria refer to the respective sovereign country, the type of debtor and the type of instrument. Stressed margins may vary between Euribor +50bp and Euribor +250bp. With respect to mortgage assets, Fitch suggests differentiating across countries, LTV ratios, property types and loan features. Stressed margins may vary between Euribor +120bp and Euribor +400bp.

Step 3 Adjustments for recoveries lead to final covered bond ratings

It is fair to assume that a twonotch upgrade is applied in most programmes

More transparency through the publication of key rating factors

While the discontinuity factor plays a key role in Fitch’s rating approach, the rating agency has also outlined a clear approach to the role of recoveries within its rating process. After the calculation of the covered bond rating based on a PD basis, a final adjustment is made to take into account recovery prospects. Where the recovery prospects are outstanding – which is assumed when recovery rates are estimated to be above 90% – covered bonds will be rated two notches above the covered rating level, which was determined on a PD basis. In cases where the issuer has a sub-investment grade rating, a three-notch upgrade is applied. In Figure 54 we show Fitch’s approach to recovery rates and notching. Given the secured nature of covered bond debt instruments, it is fair to assume that covered bonds would regularly achieve an RR1 recovery rating. This is highlighted by the fact that Fitch listed German Pfandbriefe and Spanish Cédulas Hipotecarias in the RR1 category when introducing recovery ratings in February 2005. Thus, we believe that achieving an AA covered bond rating on a PD basis is for most programmes the threshold for finally getting an AAA covered bond rating. Mainly in cases where over-collateralisation levels are insufficient, it is understood that a recovery rating of RR2 would be applied, which means the threshold for reaching an AAA covered bond rating would increase to AA+ when the covered bond rating is arrived at on a PD basis. Fitch publishes the D-factor for the respective covered bonds of its rating universe as well as the covered bond rating on a PD basis. Since March 2008, all assigned D-factors are made available over the newly-introduced covered bond section of its ‘SMART’ (Surveillance, Metrics, Analytics, Research Tools) platform. The tool also offers information on the Figure 54: Fitch’s recovery ratings Maximum notching Recovery rating

Recovery prospects

Recovery bands given default (%)

Investment grade

Non-investment grade

RR1 RR2

Outstanding

91-100

2

3

Superior

71-90

1

RR3

2

Good

51-70

1

1

RR4

Average

RR5

Below average

RR6

Poor

31-50

-

-

Nov-30

-1

-1

0-10

0.5

0.6666667

Source: Fitch

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composition of cover assets, major risk factors, over-collateralisation levels and performance statistics across all covered bond programmes rated by Fitch. Interesting difference of average d-factors across product categories

Public sector-backed covered bond programmes are generally assigned a lower D-factor

In particular, the publication of D-factors helps assess the sensitivity of the respective product to a potential downgrade of an issuer’s IDR. A full list of the assigned D-factors is available in the appendix of this publication. In addition, the comparison of D-factors across product categories yields interesting results. The cross-country comparison shows that the average D-factor for mortgage covered bonds is the lowest in Ireland, Portugal and the UK. These are also the only countries in which the average D-factor is equal to or below 15%. US covered bonds and Spanish Cédulas are ranked lowest, with average D-factors of 69.8% and 41.3%, respectively. When calculating the average D-factor by collateral type, the analysis reveals that the average d-factor of covered bond programmes backed by public sector assets is 10.0% – much lower than the average d-factor for those programmes secured by mortgages, which is 20.9%.

Figure 55: D-factors across collateral types (min/max/avg in %)* as of mid-May 2010 Mortgage

Public sector

Canada

18.1 / 18.1 / 18.1

21.2 / 21.2 / 21.2

Germany

13.7 / 25.2 / 18.9

4.7 / 11.9 / 7.3

Denmark

15.0 / 16.6 / 15.8

Spain

40.8 / 41.9 / 41.3

France

9.4 / 37.9 / 19.7

11.8 / 16.6 / 13.9

United Kingdom**

6.5 / 18.5 / 11.8

11.2 / 11.2 / 11.2

Greece

20.1 / 39.3 / 32.6

Ireland

11.6 / 19.6 / 14.8

Italy

13.7 / 17.6 / 16.2

Luxembourg Netherlands

9.5 / 9.5 / 9.5 13.8 / 13.8 / 13.8

12.7 / 16.7 / 15.3

Norway

15.3 / 18.9 / 16.9

Portugal

14.9 / 15.3 / 15.0

Switzerland (UBS)

21.9 / 21.9 / 21.9

US

39.6 / 100 / 69.8

Summary

6.5 / 100 / 20.9

32.0 /

4.7 / 32.0 / 10.0

Notes:*Some countries are missing because Fitch either has not assigned covered bond ratings and/or it has not yet assigned a D-factor; excluding the former Chelsea BS programme. Source: Fitch, Barclays Capital

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IAS AND THE APPEAL OF REGISTERED BONDS

Braced against the storm Fritz Engelhard +49 69 7161 1725 [email protected]

The financial market disruptions exposed many investors to charges on their securities portfolios and/or the disclosure of substantial non-realised losses. This has created an increasing incentive for many publicly-traded investors in AAA debt reporting under IAS 39.9 rules to re-allocate their fixed-income holdings from benchmark bonds to registered bonds. This is because the respective debt products can be booked under the loans and receivables account. Mainly German insurance companies and pension funds make use of this feature, as it allows them to benefit from the pick-up which is offered by AAA products, without exposing them to high performance volatility.

Benchmark offerings compete increasingly with non-liquid instruments Non-liquid fixed-income instruments – no longer a purely German affair

Four main categories of financial assets defined in IAS 39.9

The particular appeal of the ‘loans and receivables’ category

Initially the use of registered bonds was mainly driven by the application of international accounting standards (IAS), as they allow investing in debt products that are recognised as loans and receivables in the financial assets framework of IAS 39.9. As the capital market environment became more stressful over the past three years, the incentives to use these non-liquid fixed income instruments grew substantially. The covered bonds of those issuers at the forefront of this development, namely Austria, France, Germany, Ireland and Luxembourg, as well as some Scandinavian issuers, were generally less exposed to spread volatility compared to their peers, as they were in a position to smoothly replace their funding through benchmark securities with registered bonds. According to regulation 1606/2002 of the European Parliament and of the council of 19 July 2002, since 2005, publicly-traded companies are required to apply a single set of highquality international accounting standards for the preparation of their consolidated financial statements. The regulation explicitly refers to the international accounting standards set by the International Accounting Standards Board (IASB), a private group of international accounting experts. A key part of the framework is the definition of different categories of financial assets. IAS39.9 defines four major categories of financial assets. These are: 1) financial assets at fair value through profit or loss; 2) available for sale; 3) loans and receivables; and 4) held to maturity. Figure 56 describes the decision process for the designation of different financial assets to these four categories 17. There is an important difference between ‘loans and receivables’, ‘held to maturity’ and the remaining two categories. The former allow disclosure of the respective assets at amortised costs 18, while assets in the “fair value through profit or loss” category must be disclosed at fair value with an effect on the profit and loss statement. Assets in the “available for sale” category must be disclosed at fair value without an effect on the profit and loss statement. This means that if the fair value of assets that are designated to the ‘loans and receivables‘ or ‘held to maturity’ categories move above amortised costs, the company creates unrealised gains and if it moves below amortised costs, it creates unrealised profits. By increasing the share of assets that can be designated to these two categories, companies that report under IAS are able to reduce the volatility of their income statements and more easily smooth out fluctuations in their capitalisation. It is also worth noting that the appeal of the ‘loans and receivables’ category is stronger than the ‘held to maturity category’, as

17

For further reading please refer to the IASB homepage: http://www.iasb.org According to IAS39.9, amortised cost is the amount at which the financial asset is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation and minus any reduction for impairment or uncollectability.

18

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Figure 56: Categorisation of financial assets according to IAS 39.9 Financial Instrument

Near-term sale? OR derivative? OR designated as at “fair value through profit or loss"? Yes

No

Fixed or determinable payments? No

Yes

Quoted in an active market? No

Yes

Designated as “available for sale"? Yes

No

No

Fixed maturity? AND positive intention and ability to hold to maturity AND not designated as “available for sale"? Yes

Financial Asset s at Fair Value Through Profit or Loss

Available for Sale

Loans and Receivables

Held to Maturity

Source: IAS 39.9, Barclays Capital

the former leaves the investor with more flexibility in terms of having the ability to sell the asset prior to maturity. Promissory notes and registered bonds fall into the loans and receivables category

Strong incentives for investors and issuers to make more use of registered bonds

In Germany, there are two non-liquid instruments, Schuldscheindarlehen (promissory notes) and Namensschuldverschreibungen (registered bonds), which fall in the loans and receivables category under IAS 39. In other countries, namely Austria, Denmark, France, Ireland, Luxembourg, Norway, Sweden and the UK, issuers also make use of these products. An important criterion is that these assets are not listed on an exchange in order to ensure that there is no active market under the definition of IAS 39 19. The documentation of these products is straightforward. It basically contains the names of the two parties, the principal amount, the interest rate, the coupon payment dates, the maturity date, call and/or assignment terms and the governing law. This rather simple documentation is possible as these types of instruments are embedded in a rigorous legal framework. A pre-condition to selling these products to investors is the formation of an appropriate infrastructure. Documentation has to be handled, pricing requests for plain vanilla products have to be answered within a relatively short period of time (about 15 minutes) and the issuer should eventually also be prepared to handle repurchase requests for these instruments. In addition, the respective debt instruments are transferable. The issuer will be informed about a transfer of the respective loan certificate in order to ensure timely payments of cash flows. With the breakout of the financial markets crisis in mid-2007, regular issuers of AAA debt with important funding needs had a strong incentive to develop or enhance their activities with respect to their issuance in registered format. This is mainly because investors reduce potential pressure on reported mark-to-market losses, but also, from an issuer’s point of view, registered bonds and Schuldscheindarlehen have specific advantages: they can gain swift market access owing to limited documentation requirements while remaining very flexible in terms of market timing and the fixing of terms and conditions. In addition, issuers can raise funds with a high degree of discretion in an efficient manner owing to generally lower documentation costs and products that are more closely tailored to individual investor’s needs. 19

IAS39 AG71 describes what is understood under an active market. It says that a financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis.

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Increasing appetite for registered AAA debt is reflected in the Pfandbrief market

Gross fee income of €171bn in 2009, suggests ongoing strong demand for registered bonds from German insurance companies

The increasing need for registered AAA debt reflects well in the Pfandbrief market. Until Q3 02, the market share of registered Pfandbriefe was stable at slightly above 25%, but since Q4 02, it is has grown consistently and currently stands at 38.3%. This reflects not only the preparation for IAS 39.9, but also the fact that in particular, many insurance companies preferred to focus on this format, as investments in registered debt were an efficient tool for stabilising income statements in an environment that has been characterised by volatile interest rate developments and widening credit spreads. The particular appetite of German insurance companies and pension funds for promissory notes and registered bonds could make a strong contribution to an issuer’s funding profile. According to the association of German insurance companies (GDV), the industries’ gross fee income amounted to €171.3bn in 2009. Life insurers, which as of YE 08 made up €686bn, or 59.2% of the total €1,160bn of investments, had total investments of €706.3bn at 30 September 2009. At this date, fixed income made up €614bn or 87% of the total. While government bonds made up only €19.1bn, or 2.7% of total investments, listed covered bonds made up €180.8bn, or 25.6%, and another €106.1bn, or 15.0%, consisted of loans to credit institutions.

Figure 57: Market share of registered Pfandbriefe is growing consistently 40% 38% 36% 34% 32% 30% 28% 26% 24% 2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Market share of registered Pfandbriefe Source: Bundesbank, Barclays Capital

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EURO AREA HOUSING MARKET

Contrasting trends Julian Callow +44 (0) 20 7773 1369 [email protected]

Overall, euro area house prices look likely to continue to correct downwards, largely on account of a further significant correction that is likely in the Irish and Spanish markets, and amid a very weak outlook for household spending power. The contrasting trends in economic and financial conditions across the euro area have become ever more apparent in divergent house price trends, which increasingly are demonstrating a correction in markets where there has been an excess in valuation and housing supply. Whereas the markets in Austria, Finland, France and Germany have been showing some recovery (albeit tentative for France and Germany), other markets have generally been exhibiting weakness, consistent with very weak data for household personal disposable income and rising unemployment. The markets in Ireland and Spain have shown the most dramatic weakening, commensurate with the excess housing supply that the local booms had delivered 20. In the case of these markets, the ratio of construction investment to GDP had reached exceptionally high levels a few years previously, reaching 18% for Spain and 22% for Ireland in late 2006. It is these markets that have suffered the largest price declines, with Irish existing home prices in Q4 09 at just 63% of their peak level (in Q3 06), and consequently back to levels prevailing in early 2003, and Spanish house prices in Q1 10 at 89% of their peak level (in Q1 08), and consequently back at Q4 05 levels. In contrast, no other countries experienced such high ratios at the peak (for example, the high for this ratio hit 14% for France, 11% for Italy, 13% for Greece, and 12% for Portugal and the UK). In turn, the relative lack of excess housing supply can help to explain why these housing markets have been comparatively much less badly affected by the financial crisis. That said, the house price correction during 2008-09 was apparent in nearly all countries, with only Austria and Germany not affected.

Figure 58: House price changes and 2010 projection % change Y/Y 2004

Austria Belgium Finland -2.7

12.0

France

German y Greece

Ireland

Italy

NL

Portuga l

Spain

Euro area

UK

5.2

15.2

-0.8

2.3

11.6

10.4

3.6

3.9

17.4

8.8

11.2

2005

5.9

16.7

6.3

15.2

0.0

10.9

11.8

8.1

3.9

2.9

13.9

9.1

6.5

2006

4.0

11.1

6.4

12.0

0.6

12.4

13.4

6.7

4.6

0.3

10.4

7.7

4.6

2007

4.1

9.2

5.5

6.7

0.8

5.1

1.0

5.5

4.2

0.5

5.8

4.9

11.1

2008

1.3

5.3

0.6

1.2

0.8

1.7

-8.8

3.1

2.9

-4.3

0.7

1.4

-1.1

2009

3.6

-0.5

-0.3

-7.2

1.3

-3.4

-21.7

-3.1

-3.3

-1.6

-7.4

-4.2

-8.2

2010 F

4.2

-0.6

9.8

1.7

0.3

-2.4

-14.8

-5.0

-1.2

1.0

-5.0

-1.4

5.9

Typical price*

182

195

147

200

173

126

238

181

262

99

166

180

207

Note: *Q1 10 estimate, in thousands of euros (except UK: in thousands of pounds). Source: Haver Analytics and other national sources mentioned in this note, Barclays Capital

20

According to Instituto de Práctica Empresarial (IPE), a business school that specialises in property, there are now around 1,050,000 unsold new-build homes on the market in Spain with around 40% of these units in Andalucia and the Valencian Community

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Figure 59: Typical dwelling prices, euro, ‘000 400 forecast

euro k

350 300 250

NL

300

200

FR Germany

150

350

250

UK

200

Ireland

euro k

forecast

400

Belgium

Austria

150 Italy

100

100

Spain

Portugal

50

50

0

0 84

88

92

96

00

04

Finland

08

Greece 84

88

92

96

00

04

08

Source: Barclays Capital using national data sources

Figure 60: EC consumer survey – intention to purchase a home in next 12 months (diffusion balance, %) -60

Euro area France

-65

-60

Germany Italy

-65

Portugal

Ireland

Greece

UK

Spain

-70

-70

-75

-75

-80 -80

-85

-85

-90

-90

-95 -100 1990

94

98

02

06

2010

-95 1990

94

98

02

06

2010

Source: European Commission, Thomson Datastream, Barclays Capital

Ireland

Spain

Italy

France

Portugal

Greece

22

E12 US UK Japan

17

16

forecast

21

forecast

Figure 61: Construction investment ratio to GDP (%)

Germany

12

11

6

7 80

84

88

92

96

2000

04

08

80

84

88

92

96

2000

04

08

Source: Haver Analytics, Barclays Capital

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Figure 62: Historical ratios of typical dwelling prices versus per capita personal disposable income 30

25

25

Japan (Tokyo and Osaka conurbations)

20 20

UK

15

France 10

15

Ireland

10

US

5

0 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

euro area Spain

5 0 1975

1985

1995

2005

Source: Barclays Capital using national data sources

Overall, in a fundamental sense, house price valuations depend upon a combination of the ratio of house prices to income levels, the level of interest rates, and the level of supply in relation to demand. In this note, we focus primarily on the first two factors, and in particular on the level of typical existing house prices (using a database which we have developed) in relation to per capita personal disposable income (we use per capita PDI since this is a measure which is relatively easily attainable across countries on a quarterly basis, so enabling comparisons and timely calculations). That said, the ratio of house prices to income levels is not constant. While such series may appear to be mean reverting in the long run (see charts above), there can be significant discrepancies over long periods. Moreover, presumably reflecting differences in population densities, land use and taxation, there can be substantial differences in such ratios at a country level (for example, in Japan and Britain the ratio appears to be particularly high). In the current environment, the highly accommodative policy of the European central bank has meant that mortgage rates are at extremely low levels in the euro area. That said, this may well not capture the extent of bank caution in advancing new mortgages, particularly to new borrowers. As well, per capital nominal personal disposable income has begun to fall in the case of Greece, Ireland, Portugal and Spain, and is unlikely to show much if any expansion in these countries in the next few years on account of the dramatic fiscal tightening that they will experience, accompanied by wage adjustment. In the country-level charts which follow for the euro area, we show developments in house prices (using representative series for existing home prices), per capita personal disposable income and interest rates. For most countries, the ratios of house prices to income have been correcting, but still appear to be high from a historical perspective. This indicates further downside risks, despite very low interest rates. However, for Austria and Germany the reverse has been true – since the mid 1990s for Germany (and early 1990s for Austria) the ratio of house prices to income levels has been in a strong downward trend. Further, the ratio has declined significantly for Portugal, suggesting that the Portuguese market, despite a prospect of very major fiscal consolidation ahead, may not be overvalued.

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Figure 63: Austria – house prices

30

13 12

25 20 15

1.0

house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS

0.9 forecast

14

House price growth, % y/y

0.8

Per capita personal disposable income, % y/y

11

Typical mortgage rate, %

10

0.6

9

0.5

8

0.4

7

0.3

6

0.2

5

0.1

10 5 0 -5 -10

4

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Haver Analytics, Eurostat, OeNB, Barclays Capital

0.7

0.0 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

Figure 64: Belgium – house prices House price growth, % y/y Per capita disposable income, % y/y Typical mortgage rate, %

20 15

12 11

1.0 house price/per capita PDI ratio, LHS

0.9

New borrower hypothetical interest costs*, RHS

0.7

0.8

9

10

8

5

forecast

10

7

0.1

4

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Statbel, BNB, Haver Analytics, Barclays Capital

0.4

0.2

5

-5

0.5

0.3

6

0

0.6

0.0 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

Figure 65: Finland – house prices

50

House price growth, % y/y

14

Per capita personal disposable income, % y/y

13

Typical mortgage rate, %

40

12

1.0 house price/per capita PDI ratio, LHS

11

30

10

20

0.9 forecast

60

New borrower hypothetical interest costs*, RHS

0.8 0.7 0.6

9

0.5

10

8

0.4

0

7

0.3

-10

6

0.2

-20

5

0.1

-30

4

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Haver Analytics, Barclays Capital

10 June 2010

0.0 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

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Figure 66: France – house prices 12

15

11

10

10

5

9

0

8

-5

7

1.0 forecast

20

house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS

0.9 0.8 0.7 0.6 0.5 0.4 0.3

House price growth, % y/y -10

0.2 6

Per capita personal PDI, % y/y Typical mortgage rate, %

-15

0.1 0.0

5

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: INSEE, Thomson Datastream, Haver Analytics, Barclays Capital

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

Figure 67: Germany – house prices House price growth, % y/y

14

Per capita personal disposable income, % y/y

12

Typical mortgage rate, %

14

New borrower hypothetical interest costs*, RHS

13

10

1.0

house price/per capita PDI ratio, LHS

0.9 forecast

16

12

0.8 0.7 0.6

8 6

0.5

11

4

0.4 10

2 0

0.3 0.2

9

-2

0.1

-4

8

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Bulwien, Thomson Datastream, Barclays Capital

0.0 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

Figure 68: Greece – house prices 25

House price growth, % y/y Per capita PDI (est from 08), % y/y

20

Typical mortgage rate, %

8

house price/per capita PDI ratio, LHS

7

New borrower hypothetical interest costs*, RHS

1.0 0.9

15

0.8 0.7 0.6 forecast

10 6

5 0

0.5 0.4 0.3

5

0.2

-5

0.1

-10

0.0

4

97

99

01

03

05

07

09

Source: Central Bank of Greece, Haver Analytics, Barclays Capital

10 June 2010

11

97

99

01

03

05

07

09

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

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Figure 69: Ireland – house prices 40

1.5 18

30

house price/per capita PDI ratio, LHS

1.3

16 14

10

1.1 New borrower hypothetical interest costs*, RHS

12

0

10

-10 House price growth, % y/y -20

Per capita PDI (est. from 08) , % y/y Typical mortgage rate, %

-30

0.7 0.5

8

0.3

6

0.1

4

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Dept of Environment, Thomson Datastream, Barclays Capital

0.9 forecast

20

-0.1 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

Figure 70: Italy – house prices 12

30

House price growth, % y/y

25

Per capita PDI, % y/y

20

Typical mortgage rate, %

11 10

1.5

house price/per capita PDI ratio, LHS

1.3

New borrower hypothetical interest costs*, RHS

1.1 forecast

35

15

9

10

8

5

7

0.5

6

0.3

5

0.1

0 -5 -10

4

-15

0.7

-0.1 84 86 88 90 92 94 96 98 00 02 04 06 08 10

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Nomisma, Thomson Datastream, Barclays Capital

0.9

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

Figure 71: Netherlands – house prices 16

25

15

20

1.0

house price/per capita PDI ratio, LHS

0.9 0.8

14

12

10

11

5

10

0

9

-5 -10

House price growth, % y/y

8

Per capita PDI, % y/y

7

Typical mortgage rate, %

6

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Haver Analytics, Barclays Capital

10 June 2010

0.7

New borrower hypothetical interest costs*, RHS

0.6 0.5 0.4 forecast

13

15

0.3 0.2 0.1 0.0

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Note: *House price/per capital PDI ratio times 0.5x mortgage rate on new lending

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Figure 72: Portugal – house prices House price growth, % y/y

14

20

Per capita PDI , % y/y

13

16

Typical mortgage rate, %

house price/per capita PDI ratio, LHS

1.4

New borrower hypothetical interest costs*, RHS

12

12

forecast

24

1.0 0.8

11

8

1.2

0.6

4

10 0.4

0 9

-4

0.2 0.0

8

-8 88

90

92

94

96

98

00

02

04

06

08

88

10

Source: INE, Haver Analytics, Barclays Capital

90

92

94

96

98

00

02

04

06

08

10

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

Figure 73: Spain – house prices

House price growth, % Y/Y Per capita PDI, % y/y Typical mortgage rate, %

30

11 10

1.0

house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS

forecast

12

40

0.9 0.8 0.7

20

9

0.6

10

8

0.5

7

0.4

0

0.3

6 -10

0.2

5

-20

0.1 0.0

4 84 86 88 90 92 94 96 98 00 02 04 06 08 10

84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Haver Analytics, Barclays Capital

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

Figure 74: Euro area – house prices

13

Typical mortgage rate, %

11

11

house price/per capita PDI ratio, LHS

1.0

10

new borrower hypothetical interest costs*, RHS

0.8

9 7

9

5 3

0.9 0.7 forecast

House price growth, % y/y Per capita PDI, % y/y

15

8

0.6 0.5 0.4

1

0.3

-1

7

0.2

-3

0.1

-5

6 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Source: Thomson Datastream, Haver Analytics, Barclays Capital

10 June 2010

0.0 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending

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SPANISH HOUSING MARKET

Overview Leef H Dierks +49 (0) 69 7161 1781 [email protected]

Official data imply declining house prices in Spain

After a phase of unprecedented growth in the period between 1998 and 2004, with official figures indicating a record of 18.5% y/y in Q4 03, Spanish house price growth has since continuously declined. Between Q4 04 and Q1 09, house prices as reported by the Spanish Ministry of Housing (Ministerio de Vivienda), which usually refer to valuations, have steadily fallen and actually contracted since Q4 08 for the first time since the country’s economic recession in 1993. Since Q2 09, however, the decline appears to have lost momentum with the pace gradually moderating. In Q1 10, the latest date for which data were available, house prices fell 4.7% y/y, up from a 6.3% y/y decline in Q4 09 and a 7.1% y/y fall in Q3 09 (Figure 75). In contrast to previous quarters, however, the discrepancy between the official house price series and monthly data provided by private sources such as Fotocasa or Expocasa has steadily declined and bears a relatively high level of congruence as of late. Whereas the house price series of Fotocasa indicate a 5.6% y/y decline in house prices in March 2010, the latest date for which data were available, the Expocasa series point towards a 5.0% y/y drop in house prices in May 2010. With its indication of a 4.7% y/y decline, the official series is only slightly geared to the upside, which, in our view, increases its explanatory content after previously being systematically geared to the upside (Figure 75). Considering recent macroeconomic developments, unsurprisingly, regional house price developments have developed asymmetrically over the course of the past few quarters. As a rule of thumb, economically stronger regions and/or regions which experienced strong house price growth until 2004 are currently those experiencing a more pronounced contraction in house prices. In 2008, among the regions most affected were the Balearic Islands, where prices contracted by a high 14.4% y/y (from 9.6% y/y growth in 2007) according to data complied by Expocasa. In Comunidad Valenciana, house prices fell 9.2% y/y in 2008 (-1.4% y/y in 2007), followed by Catalonia (-8.7% y/y in 2008, from -2.5% in 2007), and Madrid (-8.0% y/y in 2008, from -2.4% y/ yin 2007). In 2009, on average, house price declines were less pronounced, falling 7.4% y/y in Madrid, 6.7% y/y in Comunidad Valenciana and 6.6% y/y in Catalonia. On the Balearic Islands, house prices remained nearly stable, contracting by a moderate 1.2% y/y. The most recent Q1 10 data further support the findings of a regionally

Figure 75: Spanish housing prices a) Annual house price inflation (%)

b) Annual house price inflation (%)

20

20 15

15

10 10

5 5

0

0

-5 -10

-5 -10 Jun-98

Jun-01

Jun-04

Jun-07

Jun-10

-15 2005 2006 Fotocasa

2007 2008 2009 Expocasa Official

2010 Idealista

Source: INE, MVIV, Expocasa, Fotocasa, Idealista, Barclays Capital

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biased development. On the Balearic Islands, house prices fell by an average of 6.3% y/y, followed by 3.3% in Catalonia. In Comunidad Valenciana and Madrid, house prices fell by 1.8% y/y and 1.7% y/y, respectively (Figure 76). Figure 76: Regional house price developments (y/y variation in %) 2007

2008

2009

2010

Andalusia

2.9

-6.0

-5.6

-2.3

Aragon

-2.3

-8.3

-6.4

-1.7

Asturias

-0.4

-5.8

-4.4

-0.1

Cantabria

2.1

-2.9

-5.2

0.2

Castilla and Leon

2.8

-7.0

-7.0

-2.0

Castilla-La Mancha

0.8

-11.0

-9.2

-2.1

Catalonia

-2.5

-8.7

-6.6

-3.3

Valencia

-1.4

-9.2

-6.7

-1.8

Extremadura

-0.6

-8.3

-8.3

-0.7

Galicia

0.7

1.6

-5.2

-2.0

Balearic Islands

-1.0

-14.3

-1.2

-6.3

Canary Islands

3.8

-5.1

-2.6

-2.8

La Rioja

-11.1

-2.4

-1.4

-3.1

Madrid

-2.4

-8.0

-7.4

-1.7

Murcia

-0.2

-9.2

-6.1

1.8

Navarra

-4.0

-9.0

-6.1

-1.9

Basque Country

-0.4

-7.8

-2.8

-2.0

Source: Expocasa, Barclays Capital

Large stock of unsold property

Taking into consideration a stock of 688,000 unsold dwellings as reported by the Ministerio de Vivienda for year-end 2009 (with estimates on behalf of the G-12 property developers association pointing towards the markedly higher figure of 1,000,000) and the currently challenging economic environment with an unemployment rate of more than 20%, we do not expect Spanish house prices to markedly recover in the near term. Despite the growth rate in the stock of unsold dwellings falling to 12% y/y in 2009 from 40% in the years before, we highlight that the better part of this stock remains on the balance sheet of property developers, which, facing mounting pressures regarding the full and timely repayment of loans as of late, have started transferring assets to Spanish commercial and savings banks. By now, most financial institutions in Spain have set up subsidiaries whose sole business purpose is to sell (residential) property. We thus believe that over the course of 2010, Spanish house prices are poised to further decline, albeit at a slightly more moderate pace than in the years before.

Ongoing decline in the

Owing to the economic deceleration that saw both unemployment and the consumers’ savings rate rising sharply over the course of the past year, the Spanish construction sector has remained under pressure, with the number of new dwellings built contracting by 60% y/y for the second consecutive year. Whereas in 2007, the number of newly built dwellings still amounted to 650,427 units, figures plummeted to 264,795 units in 2008 and further to 111,140 units in 2009, the lowest number in more than 20 years. Only three years before, in 2006, the number of new dwellings built hit a record of 794,000 units, ie, more than the combined figure of dwellings built in Germany, France and Italy in the same period (Figure 77). In light of the aforementioned stock of unsold dwellings and economic situation in Spain, we do not expect this development to markedly change in 2010. In contrast, with 6,331 and 7,575 units, respectively, the number of new dwellings started in January and February 2010 is significantly lower than in the same period in 2009 (9,861 units in January and 10,253 units in

number of dwellings built

10 June 2010

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Barclays Capital | AAA Handbook 2010

February) which, in our view, is a reliable indicator of a further moderating construction activity in 2010. The count of dwellings built is likely to further decline in 2010 (Figure 77). The number of property transactions, in contrast, appears to have gradually recovered as of late. Although still falling at a pace of 18% y/y to 462,747 units in 2009, from 564,464 units in 2008, already down12.4% y/y from 836,871 units in 2007, the development in Q4 09 reflected a (temporary) recovery as sales climbed to the highest number in the past six quarters (Figure 78). What is more, spurred by an 18.7% y/y (+7.2% m/m) increase to 41,033 units in the number of (new and used) urban dwellings sold, the overall number of property transactions strongly picked up in February 2010. In May 2010, overall housing transactions increased at a pace of 9% y/y. Applicable interest rates on mortgage loans at historical lows

The current recovery in the volume of property transactions is (partly) attributable to the benign interest rate environment. Average rates applicable to mortgage loans, of which 98% are pegged to the 12-month Euribor, remained at historical lows. At the time of writing, 12month Euribor stood at 1.24%, ie, even below the 1.6% observed in June 2009 – and markedly lower than the 5.4% recorded in June 2008 (Figure 78). As the principal mortgage rate in Spain usually is re-set once a year, this development has meanwhile left its mark on the average applicable mortgage rate. In March 2010, the latest date for which data were available, the average interest rate applicable to a mortgage loan stood at 2.5% in the case of commercial and 3.0% in the case of savings banks. In June 2009, the respective rates still stood at 3.0% in the case of commercial and 3.5% in the case of savings banks 21. Despite this strong decline in the applicable mortgage rates and the related drop in the Households’ Theoretical Affordability Index, as published by Banco de España (BdE), which dropped to 34.5% in Q1 10 from 43.3% in Q1 09 and thus to its lowest level since Q4 03 22, this development has so far not caused mortgage lending to recover. According to Banco de España data, mortgage lending increased at a pace of 0.8% y/y in February 2010, the latest date for which data were available. This is in line with the pace observed over the course of the past 12 months, which indicates that in principle, new mortgage lending in Spain came to a standstill in spring 2009. Adding to this development, in our view, is the fact the over the

Figure 77: Construction activity in Spain a) Dwellings built in Spain (in ‘000 units)

b) Dwellings started (in ‘000 units)

800

100

80

600

60

400 40

200

20

0 1992 1994 1996 1998 2000 2002 2004 2006 2008

0 Jun-92

Jun-96

Jun-00

Jun-04

Jun-08

Source: INE, Barclays Capital

21 22

10 June 2010

Source: AHE, June 2010. Source: Banco de España (BdE); March 2010.

85

Barclays Capital | AAA Handbook 2010

course of the past few quarters both commercial and savings banks have become increasingly hesitant with regards to mortgage lending. Three years ago, during its peak in spring 2006, mortgage lending had increased at a pace of more than 35% y/y (Figure 79). Notwithstanding the historically unprecedented interest rate environment, we do not expect mortgage lending to markedly recover in the months ahead, mostly because of the country’s challenging economic situation. Following a 3.6% y/y GDP decline in 2009, the unemployment rate in Spain stood at 20.05% at end-March 2010, with few indicators pointing towards a marked near-term improvement. As the development on the Spanish labour market is likely to continue to overshadow the demand for new (and used) housing and thus for mortgage lending, we do not expect numbers to significantly improve over the course of 2010. The recently adopted austerity measures which are set to cut the budget deficit to 9.3% of GDP in 2010 and to 6.0% of GDP in 2010, are likely to lead to more muted activity, particularly as civil servants will face a 5% salary cut in 2010 and a freeze of their pay until end-2011.

Figure 78: Property market indicators a) Number of transactions (in ‘000)

b) 12-month Euribor (%)

300

6

250

5

200

4

150

3

100

2

50

1

0 Q1 04

Q1 05

Q1 06

Q1 07

Q1 08

Q1 09

0 Jun-05

Jun-06

Jun-07

Jun-08

Jun-09

Jun-10

Source: Ministerio de Vivienda, Barclays Capital

Figure 79: Affordability a) Household’s Theoretical Affordability Indicator

b) Variation in monthly mortgage lending (in % y/y)

60

40

50 30

40 30

20

20 10

10 0 Jun-98

Jun-00 Jun-02 Jun-04 excluding deductions

Jun-06 Jun-08 Jun-10 including deductions

0 Mar-99

Mar-01

Mar-03

Mar-05

Mar-07

Mar-09

Source: Banco de España, Barclays Capital

10 June 2010

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Barclays Capital | AAA Handbook 2010

Steady increase in NPL ratios

In line with the economic downturn and the surge in the country’s unemployment rate, the ratio of NPLs has sharply increased over the past two years. Whereas in June 2008, the NPL ratio as reported by Banco de España stood at a modest 1.7%, it subsequently increased to 4.6% in June 2009 and to 5.4% in February 2010. Yet, compared to 2008, the (monthly) increases in NPL appear to have gradually declined. Still, in light of the current economic situation, we expect the NPL ratio to further increase, thereby forcing banks to increase risk provisions in anticipation of higher write-offs (Figure 80). Despite being usually understood to be low-risk, mortgage lending could not decouple itself from the overall deterioration of the banks’ assets. Starting in late 2007, the ratio of nonperforming mortgage loans started to experience a pronounced increase, with the overall NPL ratio climbing to 5.3% in Q1 10 from 4.6% in Q2 09 and 1.7% in Q2 08. Yet whereas previously, the increase in non-performing mortgage loans was strongly driven by Spanish savings banks, which, on average, reported a 100bp higher NPL ratio than the country’s commercial banks, this development seems to have stalled in Q4 09, when the ratio of non-performing mortgage loans as reported by Spanish commercial banks (5.6%) stood in line with that of the country’s savings banks (5.6%) (Figure 80). Generally, savings banks appear to be more strongly affected by nonperforming mortgage loans as they did not reduce their mortgage lending activity as early as commercial banks and thus face weaker vintages with regards to the underlying (already elevated) house prices. Also, on average, the savings banks exposure towards property developers is higher than in the case of commercial banks. In January 2010, the latest date for which data is available, the situation had gradually shifted again, with commercial banks reporting a slightly lower NPL ratio (5.2%) than the savings banks (5.3%).

Conclusion

As a result of the high stock of unsold dwellings and the economic situation that has deteriorated compared with previous years, we do not expect the Spanish housing market to markedly recover in the near term. Despite a historically low interest environment, the country’s very high unemployment rate is likely to cause the non-performing (mortgage) loan ratio to further increase in the months ahead, thereby casting doubts over the performance of the collateral pool of Spanish covered bonds. Whereas we do not expect the legally binding over-collateralisation ratios to be breached, investors should prepare themselves to further headline news, particularly with regard to the country’s savings banks, which are on the brink of an extensive consolidation process. Furthermore, despite gradually abating at the time of writing, distortions related to the swap-spread performance of Spanish sovereign debt could continue to overshadow the market. Thus, despite the currently elevated swap-spread levels of many Spanish covered bonds, we advise investors to stay alert and to thoroughly analyse an issuer’s and an issue’s credit quality.

Figure 80: Development of non-performing loan ratios a) Non-performing loans (%)

b) Non-performing mortgage loans (%)

10

6%

8 4%

6 2%

4

2 0% Jun-05

0 70

75

80

85

90

95

00

05

10

Jun-06 total

Jun-07

Jun-08

commercial banks

Jun-09

Jun-10

savings banks

Source: Banco de España, AHE, Barclays Capital

10 June 2010

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Barclays Capital | AAA Handbook 2010

UK HOUSING MARKET

The mortgageless recovery Simon Hayes +44 (0) 20 7773 4637 [email protected] UK house prices have recovered strongly over the past year

House prices continue to rise in spite of weak mortgage lending. Low interest rates and a smaller-than-expected rise in unemployment have kept mortgage arrears and possessions low. The outlook is positive but subdued by pre-crisis standards. UK house prices have recovered strongly over the past year. According to the Nationwide Index, prices were up 10.6% y/y in April, leaving them 10% below their pre-crisis peak (Figure 81). The recovery has been broadly-based geographically, with every region/country seeing y/y increases except for Northern Ireland – although London (15.7% y/y) and the south east (13% y/y) have been the notable outperformers. Market activity has not been buoyant, however. The number of residential property transactions in the 12 months to March was 45% down on that seen in 2007, for example. Anecdotally, rising prices have been driven by a low level of properties put up for sale rather than by particularly strong demand. However, the RICS survey does not wholly support this view, suggesting instead that there was a pronounced turnaround in new buyer enquiries last year and that the improvement in new instructions to sell, although slow to kick in, has not been particularly weak (Figure 82). If we use these two series to construct a measure of the change in net demand it tends to lag house price inflation by around nine months (Figure 83). The recent moderation in house price inflation would be consistent with the market moving closer to equilibrium during the remainder of the year.

This has been despite weak mortgage lending

The rise in house prices has occurred in spite of weak mortgage flows. Net mortgage lending for house purchase was £12.2bn in the year to March, barely 10% of the level seen in 2007 (Figure 84). UK banks are continuing to provide mortgage credit, but this is being offset significantly by ongoing retrenchment by building societies and other lenders (primarily foreign banks). The market has instead been supported by cash buyers: as we have observed before (see Households’ enduring desire for housing, 25 November 2009), although households’ purchases of housing assets has weakened, it has not weakened by as much as would have been expected given the fall in mortgage lending. The channelling of savings into housing is one of the consequences of loose monetary policy.

Figure 81: Average UK house price £'000 200 180

Nominal

160

Real

Figure 82: RICS survey balances Balance, 6mma 60

New buyer enquiries New instructions to sell

40

140 20

120 100

0

80 -20

60 40

-40

20 0

-60 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Source: Haver Analytics, Barclays Capital

10 June 2010

01

02

03

04

05

06

07

08

09

10

Source: Haver Analytics, Barclays Capital

88

Barclays Capital | AAA Handbook 2010

The other notable feature of the housing market has been the fact that mortgage arrears and possessions have been much lower than might have been expected. To illustrate this point, Figure 85 shows how, in a simple linear regression (estimated up to 2007), changes in house prices, mortgage payments and unemployment account for changes in mortgage possessions. The large negative residuals in 2008 and 2009 indicate that the upward pressure on possessions coming from falling house prices and rising unemployment would have pointed to much higher possessions than were actually observed. This is so even taking into account the large drop in mortgage payments in 2009, which was helpful in cushioning the market from the effects of the recession.

Mortgage arrears and possessions have been much lower than expected

Given our forecasts for house prices, interest rates and unemployment, our simple model predicts possessions to fall by around 4% in 2010. However, it is worth noting that data for Q1 10 show a 16.5% fall relative to the quarterly average in 2009, so another undershoot relative to the model may be in train. Even so, there are, in our view, reasons to be cautious about the possessions outlook. There seems to be a good deal of forbearance propping up the UK economy at present. Firms’ cash flow is being assisted by government schemes to defer tax payments. Unemployment Figure 83: House prices and net demand

Figure 84: Net mortgage lending

Net new demand, lagged 9 months (lhs) House prices, 6-month change (rhs)

Balance 60 40

% 20

12

Other

15

10

UK banks

10

20

£bn

5

Total

8 6 4

0 0 -20

-5

-40 -60 01

02

03

04

05

06

07

08

09

2 0

-10

-2

-15

-4

10

99

00

01

02

03

04

05

06

07

08

09

Source: Haver Analytics, Barclays Capital

Source: Haver Analytics, Barclays Capital

Figure 85: Mortgage possessions

Figure 86: Ratio of house prices to household income

% y/y 200

Constant

House prices

Ratio

Mortgage payments

Unemployment

5.5

150

Residual

Actual

Model forecast

5.0

100

4.5

50

4.0

10

Actual Average Trend assuming income elasticity of 1.1

3.5

0

3.0 -50

2.5 -100 89

91

93

95

97

99

Source: Haver Analytics, Barclays Capital

10 June 2010

01

03

05

07

09

2.0 55 59 63 67 71 75 79 83 87 91 95 99 03 07 Source: Haver Analytics, Barclays Capital

89

Barclays Capital | AAA Handbook 2010

is being held down by labour hoarding. Possessions are reportedly being dampened by forbearance by lenders. If the economy puts in a steady recovery, as we expect, this forbearance will be seen to have been helpful in cushioning the economy against the worst effects of the recession. However, were another crisis to ensue it is possible that the UK could see a surge in company insolvencies and a rise in unemployment, and arrears and possessions could rise once more. How do the recent price increases leave housing valuations? Many commentators focus on the ratio of house prices to some measure of household income. On our preferred version of this statistic – the ratio of house prices to disposable income per household – the market appears significantly overvalued still. The ratio stood at 4.4 in Q4 09, some way above its historical average of 3.1 (Figure 86). The house price to income ratio remains high …

… but taking mortgage rates and housing supply into account housing looks undervalued

The use of the historical average as a valuation benchmark is questionable, however, as the series is not obviously mean-reverting. If instead we use the historical relationship between house prices and income – which produces an income elasticity of 1.1 as opposed to the 1.0 implicit in the assumption of a constant price-income ratio – the degree of over-valuation appears lower but still substantial (Figure 86). Again, however, we would question the worth of such a simple, even simplistic, benchmark. In particular, this measure takes no account of factors such as impediments to the supply of new housing, which is particularly acute in the UK given strict planning laws, and changes in the user cost of housing such as mortgage rates. Housing supply is likely to be a particular problem. Prior to the credit crisis the government’s housing advisory body said the UK would need to build around 240,000 new houses a year in order to stabilise affordability. Such a pace of construction had not been seen since the late 1980s (Figure 87). Moreover, house building has slumped recently, and in the four quarters to Q3 09 only 155,000 houses were completed.. The supply problem is therefore getting worse, not better, and we believe this is likely to provide a significant support to prices over the medium term. If we construct a simple long-run housing valuation model incorporating these factors, UK house prices appear to have undershot their equilibrium (Figure 88) and are around 10% below the model’s predicted value. Our overall assessment is that house prices will continue to rise over the course of the next year, but at a moderate pace – more moderate than seen over the past year. On the

Figure 87: Housing completions, four-quarter rolling sum

Figure 88: UK house prices

thousands

£'000

250

200

240

180

Actual

230

160

Long-run model equilibrium

220

140

210 200

120 100

190

80

180

60

170

40

160

20

150

0 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09

Source: Haver Analytics, Barclays Capital

10 June 2010

75

78

81 84

87

90

93

96

99 02

05

08

Source: Haver Analytics, Barclays Capital

90

Barclays Capital | AAA Handbook 2010

supportive side, in addition to weak housing supply mortgage rates have been stable for the past year, and we expect the policy rate to stay at its current level for the rest of 2010. The outlook for mortgage lending remains subdued, however: the Bank of England’s credit conditions survey indicates that mortgage availability has stabilised but is not expected to show any material improvement in the near term (Figure 89). The outlook for real post-tax household income over the next 12 months is weak in the context of high unemployment, relatively high inflation and higher taxes. We therefore expect house price inflation to moderate from around 10% at present to around 4% at the end of the year (Figure 90). However, as the economic recovery becomes more firmly established we expect household confidence to improve which, together with a continuing shortage of supply, should put further upward pressure on prices. We see the annual rate of house price inflation back up to around 9% by the end of 2011.

Figure 90: House price inflation

Figure 89: Availability of mortgage credit, BoE credit conditions survey

% y/y

20

30

10

Forecast

25

0

20

-10

15

-20

10

-30

5

-40

Reported

-50

Expected

0 -5 -10

Source: Bank of England, Barclays Capital

10 June 2010

Jun-10

Mar-10

Dec-09

Sep-09

Jun-09

Mar-09

Dec-08

Sep-08

Jun-08

Mar-08

-60

-15 -20 01

03

05

07

09

11

Source: Haver Analytics, Barclays Capital

91

Barclays Capital | AAA Handbook 2010

US HOUSING MARKETS

Recovering in fits and starts Peter Newland +1 212 526 3153 [email protected] Theresa Chen +1 212 526 7195 [email protected]

The housing market is no longer a drag on the US economy

Housing market activity has turned higher, boosted significantly by the homebuyer tax credit. Negative payback is likely when this expires but the recovery in sales and starts, albeit from a low base, should remain intact. Foreclosures continue to pose a hurdle.

Overview Having fallen precipitously during 2006-08 and stabilised during 2009, there has been a clear improvement in housing demand this year, as the broader economic recovery has gained traction and housing affordability has improved (average prices have been brought into line with household income, Figure 91, and mortgage rates have fallen). However, there has also been an “artificial” boost to demand from government policies, notably the homebuyer tax credit and Fed MBS purchase program. Looking through these temporary boosts we judge that the housing market is in the early stages of recovery and expect an upward trend in sales and starts, albeit from very low bases. However, this is unlikely to translate into significant price gains in the near term at the national level, with downward pressure from foreclosed properties entering the market offsetting upward pressure from improving demand, employment and income growth. Within our broader view of the economic outlook we look for residential construction to add positively to GDP growth over the course of this year and next, having been a drag for the previous four years. In our judgement the downside risks to this view are limited given how low activity has fallen and, in light of this, even another further leg down would only have a limited impact on top-line GDP growth. House price growth is likely to remain subdued for some time; one impact being that housing wealth will remain depressed (although this should become less negative as house prices stabilise). However, income growth and stock market wealth are more important drivers of consumer spending decisions and hence the broader economic recovery.

A closer look at the numbers Sales have risen, boosted by the homebuyer tax credit

Sales, particularly of existing homes, have risen strongly this year, although there has been a clear boost from the homebuyer tax credit. This initially ran to November 2009 (for signed contracts) and had the impact of pulling demand forward, boosting sales in the months prior

Figure 91: Home prices relative to income

Figure 92: Existing and new home sales Mn, saar

index 1987 = 100 325

7.5

Forecast Existing home sales New home sales

7.0

275

1600 1400 1200

6.5 225

1000

6.0

800

175

5.5

125

5.0

75

4.5 87

89 91

93

95

Case-Shiller HPA

97 99

01

03

05 07

09

Median family income

Note: Barclays forecast for 1Q09; Source: Case-Shiller, BEA, Barclays Capital

10 June 2010

600 400 200 0

4.0 99 00 01 02 03 04 05 06 07 08 09 10 11 Source: Census Bureau, Barclays Capital

92

Barclays Capital | AAA Handbook 2010

to the expiration and depressing them thereafter. The tax credit was later extended to April 2010 for signed contracts (June for closed deals) and appears to have had a similar impact again – sales jumped sharply higher in March and April, but we expect this to be partly reversed in coming months (Figure 92). An additional, but smaller, boost has come from the Fed’s MBS purchase program, which has helped keep mortgage rates close to historical lows. Rates look unlikely to move sharply higher in the near term (with the Fed likely to maintain a loose policy stance) and while access to mortgage credit remains limited, there are signs (from the Fed’s Senior Loan Officers Survey, for example) that credit conditions are no longer tightening, particularly for prime borrowers. Building permits and homebuilder sentiment have improved too

Rising sales should lead to a pick-up in construction

More timely indicators have improved too. Building permits have edged higher and pending home sales increased through Q1, consistent with a sustained rise in home sales over the summer. Mortgage purchase applications continue to be volatile. A recent pick-up in the NAHB Housing Index suggest that builders have grown in optimism – the Headline Index has recently reached levels last seen in 2007. However, the series still remains low compared to its history. Looking ahead, once the volatility around the homebuyer tax credit has played out, we expect home sales to be on a moderate upward trend. This should translate into further gains in housing starts too. As builders have reduced inventories to such low levels, even a small gain in new home sales should spur an increase in construction. Starts reached 672,000 in April, from the record low of 488,000 in January 2009. However, this remains well below the peak of 2.27mn recorded in January 2006 and what we judge to be the “neutral” rate of housing starts (based on demographic factors) of around 1.5mn. This implies that homebuilders are ‘under-building’, which is appropriate as they offset the ‘over building’ between 1996-2006 (Figure 93) and continue to face competition from foreclosed properties coming back on to the market.

Foreclosure pipeline remains a hurdle Foreclosures continue to represent a headwind…

In our summary last year, Housing to bottom in stages (AAA Handbook, June 2009), we expected that overall housing inventories would remain bloated due to rising foreclosures, and that this process would constrain new construction and put downward pressure on home prices through the second half of this year. To a large degree this view has been confirmed by the data. If anything, the pressure was a bit less severe than we anticipated due in large part to foreclosure moratoriums, loan modification programs and policies like the homebuyer tax credit.

Figure 93: Housing starts – Actual versus natural rate

Figure 94: Foreclosures pipeline

mn, saar

Thousands of mortgages

2.2 2.0

4,500

f/c Seriously delinquent or foreclosure

4,000

1.8 1.6

Real Estate Owned (REO)

3,500 f/c

1.4 1.2 1.0

3,000 2,500 2,000

0.8 0.6

1,500

0.4 0.2

500

1,000

80

85

90

95

Natural rate of starts Source: NAR, Census Bureau, Barclays Capital

10 June 2010

00

05

10

Actual starts

0 05

06

07

08

09

10

11

12

Source: Barclays Capital

93

Barclays Capital | AAA Handbook 2010

That said, the foreclosure pipeline is likely to be a continued headwind in the coming year as about 4.2mn mortgages are either seriously delinquent (90+ days) or in some stage of foreclosure (Figure 94). While foreclosures started have likely peaked (Figure 95), real estate-owned (REO) inventories will remain significant as the various programs put in place to provide a boost to the housing market and forestall foreclosures fade (REO is the last stage of the foreclosure process when banks take ownership of the home). The speed at which foreclosed properties enter the market as re-sales is key to gauging the risk to the housing recovery. If foreclosures flood the market rapidly, it could drag down home prices further and slow housing starts. Working against this is our projection for continued growth in income and employment, which should continue to provide a boost to housing demand. In addition, further delaying of foreclosures from the Treasury’s expansion of the Home Affordable Modification Program is likely to reduce some downside pressure on home prices, albeit at the expense of prolonging the adjustment.

… and are likely to limit price gains this year and next

A look at regional trends At the time of our last AAA Handbook we divided states into the following buckets based on home price movements through the first quarter of 2009:

Regional variations are stark

„

“Severe bubble-to-bust”: States with at least 20% y/y appreciation during the boom and 20% y/y deprecation through Q1 09. Four states fit this description at the time: Nevada, California, Arizona and Florida.

„

“Muted bubble-to-bust”: 14 states with a less dramatic boom and bust swing.

„

“Bust but no bubble”: Included the most distressed states, which experienced a sharp drop in home prices without a bubble. This bucket included Michigan, Ohio, Georgia and Minnesota.

„

“Mild depreciation”: The majority of the states fell into this category. There was no boom, but economic weakness and tighter credit depressed prices.

„

“Home price appreciation”: Texas, South Dakota, North Dakota and Wyoming were four states that largely escaped the housing downturn at the time of our last housing report.

Figure 95: Foreclosures started with forecasts millions of homes

Figure 96: Home price movements

Forecasts

% change y/y through Q1 2010 2

3.5 3.0

0

2.5

-2

2.0 1.5

-4

1.0

-6

0.5

-8 0.0 92

94

96

98

00

02

04

06

Source: Mortgage Bankers Association, Barclays Capital

10 June 2010

08

10

12

Severe Muted Bust but no Mild Home price bubble-to- bubble-tobubble depreciation appreciation bust bust Note: based on FHFA purchase-only home prices. Source: Barclays Capital

94

Barclays Capital | AAA Handbook 2010

The trends in home price movements at that time largely remained in place through the first quarter of 2010 (Figure 96). Severe bubble-to-bust states declined further by 7%, while those in the muted bubble-to-bust, bust but no bubble, and mild depreciation buckets experienced average declines between 2% and 4.4%. Finally, those states in the home price appreciation category continued to see slight gains in home prices. Therefore, although the national home price indices are basically flat on a y/y basis (Figure 97), those states with the most severe case of boom-bust behaviour continue to experience price weakness and the various regional markets remain in different stages of repair. Some states still have a large degree of excess supply …

… which is more broadly associated with economic conditions

To get an idea of whether these regional trends will remain in place, we examine a proxy of housing over-supply based on home-owner vacancy rates. We do this for both the US and individual states. The US vacancy rate has continued to edge down for five consecutive quarters and as of Q1 10 now stands at 2.6%. 23 Based on an estimate of the US housing stock, this translates to an oversupply of about 630,000 homes on the market, down from about 700,000 a year earlier. Yet the level of oversupply nationwide still sits well above its historical average of 1.7%. State by state results, as expected, exhibit a wide variance. Figure 98 summarizes these results in a histogram. At one end of the spectrum, are Nevada, Florida, and Michigan, three states where excess homes make up 2-3% of the housing stock. Ohio, Georgia, and Arizona are next with vacancy rates between 1.5% and 1.9%. Each of these six states fall into the first or third home price bucket, meaning prices are still falling. These states are also states with high levels of unemployment and foreclosures, which means higher numbers of transactions and downward pressure on prices. At the other end of the spectrum are those states with low over-supply (ie, undersupply) and low rates of unemployment.

Bottom line Adjustment will take time, but housing activity should continue to improve

The housing market continues to face a long period of adjustment, as foreclosures work through the system, damping starts and prices. However, demand has picked up on the back of government support and improving fundamentals. We expect the upward trend to persist.

Figure 97: National home prices

Figure 98: Histogram of states by housing supply # of states 30

latest % y/y

% change from respective peak

Radar Logic RPX (Mar)

-0.3

-32.5

25 20

Case-Shiller 20-city (Mar)

2.4

-32

National Assoc. of Realtors (Apr)

4.0

-29

Zillow.com (Q1)

-3.8

-23.3

15

0.5

-31

10

-2.3

-13.4 5

4. OH 5. GA 6. AZ 7. SC 8. CO 9. MN 10. RI

48. 49. 50. 51.

WY WV ND NM

1. NV 2. FL 3. MI

0 2% - 3% 1% - 2% 0% - 1% 2029

2019

2018

2017

MLIs

2020-2029

Agencies

2016

2015

2014

2013

2012

2011

2010

0

20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 2 20 0 10 09 yt M ay

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

250

0 to 3

3.01 to 5

5.01 to 7

7.01 to 10

Over

Source: Dealogic DCM Analytics, Barclays Capital

Effects of credit crisis on agency financial performance Financial performance benefitted from improved funding conditions and valuation profits

10 June 2010

The severe widening in credit and ABS spreads since summer 2007 has adversely affected the liquidity portfolios that some supras and agencies maintain to prevent their underlying lending business from being interrupted by primary market difficulties. Typically, these portfolios have been invested in highly-rated securities and, prior to 2007 and 2008, were generally seen as a positive credit factor. However, in so far as the investment range has included bank bonds and ABS, the sharp widening in spreads and loss in trading liquidity in these instruments, combined with IFRS mark-to-market requirements, has resulted in adverse valuation effects 103

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that have depressed net income in 2007 and 2008. This effect reversed in 2009 and most agencies were able to book valuation gains on their portfolios. Combined with improved funding conditions, SSAs have in general been able to improve their financial performance. We expect results to continuously be affected by mark-to-market valuations of investment and liquidity portfolios. Loan-loss provisions have been relatively capped compared to commercial banks, mirroring conservative and stringent risk measures of SSAs.

Market structure – defining the sector In our previous discussion of supply trends and our normal monitoring of debt supply from the sector, we use data from the dealogic DCM Analytics database for issues by all the issuers listed in Figure 113 and Figure 114 at the end of this section, which provide an at-aglance comparison of the variety of purposes and sectors involved, along with their ownership, types of support and risk weighting. Broadly speaking, in defining our coverage of the supranational and European agency sectors, we aim to include non-government public sector issuers of straight bonds that represent the next step along the credit curve from core eurozone government bonds. The definition of the supranational sector is relatively straightforward, being largely composed of MLIs, with a generally well-recognised composition mostly determined by the lists of entities treated as MLIs/development banks by financial regulators. One exception is Eurofima, which is set up as a supranational body and widely viewed in debt markets as such; however, it is not included in the regulators’ MLI list primarily because its ownership is not directly by governments but by their respective railway companies, albeit with government backing. As a result, it is treated less favourably in terms of risk weightings (20%, as opposed to zero for other MLIs). In contrast, the definition of the European agency sector is less clear cut. Varying types of public mission and types/degrees of public ownership/support can lead to public sector entities being variously described as agencies, public banks, sub-sovereign issuers, etc. We use ‘European agency’ as an inclusive term for various types of public sector entities

In the AAA Handbook and in our ongoing approach to the sector, we use ‘European agency’ as an inclusive and comprehensive term and treat it as shorthand for a range of different public sector entities that are of interest to investors in high quality debt instruments. In determining the appropriateness of including any individual entity, we concentrate on: „

„

10 June 2010

The relationship to the government or wider public sector, which is normally characterised by various combinations of: −

public ownership

−

explicit or implicit debt guarantees

−

other forms of support for the whole entity or for asset quality and other aspects of its business

−

public sector mission or policy role

The focus of its debt issuance. Within the agency sector, we focus on straight, unsecured debt issuers, excluding entities for which the main interest may be in covered bond issues, such as Landesbanks, which are covered separately in this book. We generally have not included GGBs because issuance is temporary; we discuss the respective instruments in a separate chapter. However, due to its specific setup, we have included the French SFEF vehicle. In addition, we do include debt issued by securitisation vehicles if the securitisation 104

Barclays Capital | AAA Handbook 2010

is of public sector receivables and the bond issues are bullet transactions of benchmark size (ie, GPPS and CDEP/ISPA). From the list of issuers in Figure 114, we can also see the range of different types of entity within the European agency sector. They may be subdivided as follows (some issuers may appear under more than one heading): „

„

„

Financial agencies: −

Public sector promotional/development banks – eg, KfW, Rentenbank, LBank, NRW Bank, BNG, Nedwbk, ICO

−

Entities geared specifically to refinancing government or other public sector debt – eg, CADES, ERAP, GPPS

−

Entities that are channels for infrastructure funding – eg, CDEP/ISPA, CNA

−

Export finance agencies – eg, SEK, Eksportfinans, OKB

−

Local authority lenders – eg, Kommunalbanken, Eksportfinans

−

Other special purpose financial entities – eg, SFEF

Non-financial entities: −

Rail sector entities – eg, RFF, SNCF, UKRAIL, LCR Finance

−

Others – la Poste, RTVE

Structured/securitised transactions – eg, CDEP/ISPA, GPPS

Focus on more liquid issues – iBoxx coverage The iBoxx indices provide a tool for monitoring performance of the more liquid benchmark issues in the three key currency sectors: EUR, USD and GBP. Here we discuss the mapping of our coverage of the MLI and European agency sectors on to the iBoxx indices for these currencies.

Figure 109: Supranational issuance in iBoxx bond indices, mid-May 2009 Euro iBoxx (€mn)

Dollar iBoxx ($mn)

GBP iBoxx (£mn)

EIB IBRD IADB COE ASIA AFDB IFC EBRD IFFIM NIB CAF EUROF

EIB IBRD NIB EBRD COE IADB EUROF IFFIM

Supranationals EIB EEC NIB

48,000 7,700 1,000

35,750 8,600 8,500 5,100 4,000 3,000 2,500 1,500 1,000 1,000 540 500

37,298 1,826 1,393 1,031 1,000 574 515 250

Supranationals

56,700

71,990

43,886

Total supras, agencies, public banks and other sub-sovs

291,450

188,119

93,615

Source: iBoxx indices, Barclays Capital

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EIB is by far the largest supranational issuer in the euro, sterling and dollar markets

The table above underlines the dominance of EIB within the supranational sector, particularly within euros. Within dollars and, to a lesser extent, sterling, there is a greater degree of diversification available to investors, although in all three cases EIB is by far the largest individual issuer.

Figure 110: European agency issue volumes in iBoxx bond indices, mid-May 2009 Euro iBoxx (€bn)

Dollar iBoxx ($bn)

GBP iBoxx (£bn)

European agencies KFW

55,000

KFW

25,500

KFW

SFEFR

31,000

FFCB

13,979

ICO

24,213 2,550

CADES

22,500

JFCORP

8,250

RENTEN

1,600

NRWBK

11,500

BNG

8,250

KNFP

660

ICO

11,350

CADES

7,000

NRWBK

500

RENTEN

4,750

RENTEN

6,950

LBANK

350

CNA

4,700

SFEFR

6,000

KBN

300

UNEDIC

4,000

OKB

6,000

CADES

200

FOBR

3,000

NEDWBK

5,550

AGFRNC

200

LBANK

2,500

KBN

5,000

SEK

100

HSHFF

1,500

ICO

4,750

SEK

1,250

LBANK

3,500

OBND

1,000

KOMINS

3,000

KOMMUN

1,000

AGFRNC

2,250

KNFP

1,000

EXPT

2,000

EXPT

1,000

SEK

1,000

CDCEPS

1,000

European agencies totals

157,050

109,979

30,673

Other sub-sovereigns RESFER

12,300

UKRAIL

4,250

UKRAIL

5,875

ASFING

6,300

ASFING

1,250

RESFER

3,039

DBB*

2,600

BTUN*

650

LCRFIN

2,750

SNCF

2,600

SNCVP*

525

FRPTT

1,000

SNCF

500

TRANLN*

400

FRPTT Other sub-sovereigns totals

24,800

6,150

200 13,289

Public banks

Public banks totals

BNG

14,200

BNG

3,955

NEDWBK

6,700

NEDWBK

1,012

NDB

6,500

OKB

450

OKB

5,000

HESLAN

200

BYLAN

4,000

LBBER

150

WESTLB

4,000

DEKA

2,500

HSHN

2,500

LBBER

2,500

HAA

2,000

HESLAN

2,000

BYLABO

1,000 52,900

-

5,767

Note:* We do not cover these issuers. ** GPPS was originally treated as an agency by iBoxx, but was subsequently reclassified to the Securitised Index. (Grey shaded issuers are included in our coverage of covered bonds) Source: iBoxx indices, Barclays Capital

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Figure 110 illustrates that, for European entities, the iBoxx indices allocate the names that we normally regard as ‘agency-type’ issuers across several categories – European agencies, other sub-sovereigns and public banks (and within the iBoxx family of indices, there are variations in the allocation of names between the sub-sectors). The public banks index also includes several issuers that we analyse as Pfandbriefe issuers elsewhere in this book, but which also have straight debt outstanding. For the issuance covered in the various iBoxx indices listed in Figure 111, almost all names (responsible for over 96% of the outstanding amounts) are covered either under our European agency section or within Pfandbriefe. Multi-currency funding

Figure 109 and Figure 110 also illustrate the multi-currency funding orientation of the supranationals and European agencies. For most entities in this sector, EUR, USD and GBP are the main issuing currencies. Although, as illustrated in Figure 107, they also tap a widening range of other currency debt markets (which often provide more competitive funding costs); the Big Three currency sectors account for c.80% of gross supply and debt outstanding. For the issues that are included in the iBoxx indices, the EUR sector is the largest, accounting for over half of the total outstanding, while USD and GBP account for 33% and 15%, respectively (expressed in common currency).

Figure 111: Supranationals and European agencies – iBoxx indices in local and common currency terms (including public banks and other sub-sovereigns) Outstanding amounts (local currency units bn)

EUR equivalents (EURbn)

500

400

450

350

400

300

350 300

250

250

200

200

150

150

100

100

50

50

0

0

EUR

Euro iBoxx (€ bn) Dollar iBoxx ($ bn) GBP iBoxx (£ bn) May 06

May 07

May 08

May 09

May 10

Local currency (% changes)

USD

May 06

May 07

GBP

May 08

May 10

EUR equivalents (% changes)

40

50

30

40

20

30

10

20

0

10

-10

0

-20

-10

-30

-20

-40

-30

-50

-40

-60

-50 Euro iBoxx (€ bn) Dollar iBoxx ($ bn) GBP iBoxx (£ bn) % chg 09/08

% chg 10/09

EUR

USD % chg 08/07

GBP

Total

% chg 09/08

Note: For EUR equivalent charts, USD and GBP values are converted to EUR at exchange rates in May each year. Source: iBoxx indices, Barclays Capital

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Figure 112 compares the sector breakdowns within the three currency sectors. Supranationals are much more important within the USD and GBP indices (where they account for 44-46% of the totals) than is the case for euros (only 25%).

Figure 112: Breakdown of Supranational and European agency issuance in iBoxx bond indices, late May 2009 (% of total) Euro iBoxx

Supranationals 25% Public Banks 18%

Other SubSovereigns 9%

Dollar iBoxx

GBP iBoxx

Supranationals 44%

Supranationals 46%

European Agencies 54%

European Agencies 33%

European Agencies 59% Other SubSovereigns 3%

Public Banks 6%

Other SubSovereigns 14%

Source: iBoxx indices, Barclays Capital

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Figure 113: Multi-lateral lending institutions (MLIs) – key comparisons

Full name Multilaterals ADB Asian (ASIA) Development Bank

AfDB

African Development Bank

CEB (COE)

Council of Europe Development Bank

EBRD

European Bank for Reconstruction and Development European Investment Bank

EIB

Eurofima (EUROF)

European Company for the Financing of Railroad Rolling Stock

EU / EEC

European Union

IADB

Inter-American Development Bank

IBRD

International Bank for Reconstruction and Development International Finance Corporation

IFC

Purpose

Sector and type of lending/investment

Risk weightings Basel II RSA*

Ownership

Support

67 governments, 48 within and 19 outside the region. US and Japan are the leading shareholders, each with 15.6%. 77 governments, 53 regional and 24 non-regional members.

More than 50% of callable capital is AAA/AA.

0%

28% of callable capital is AAA.

0%

About two-thirds of the loan portfolio is advanced through other financial institutions, which take on the credit risk. The remainder is to governments and public sector institutions. Loans to and share investments in public and private sector entities and projects. Funding of the private sector is generally not covered by third-party guarantees. Loans and guarantees to public and private sector borrowers within the EU and countries with EU ties. Very strong asset quality is supported by third-party guarantees for the bulk of loans. Loans to state railway companies, secured against rolling stock and backed by government guarantees – therefore, assets are effectively sovereign risk.

40 governments across Western and Eastern Europe that are Council of Europe members. 60 countries, the EU and the EIB

Over 90% of callable capital is investment grade.

0%

89% of callable capital is investment grade; 57% by EU members and institutions.

0%

EU member governments

77% of capital is AAA/AA.

0%

Railway companies in 26 European countries

20%

Sovereign loans to EU member states

27 member states of the European Union 26 Latin American and Caribbean governments, US, Canada and 19 non-regional governments.

Shareholder obligations are guaranteed by respective governments, which also guarantee repayment of loans. About 90% of callable capital is backed by AAA/AA governments. Guarantee by 27 member states via EU budget 61% of callable capital is investment grade.

0%

Reduction of poverty in Asia and the Pacific region.

Loans are mostly to public sector borrowers in the Asia-Pacific region, but increasing focus on nonsovereign operations.

Promoting economic development, social progress and poverty reduction in African member countries. Loans for disaster relief and social improvement in Western and Eastern Europe. Funding the development of market economies in Central and Eastern Europe and the FSU. Loans to support EU development, especially infrastructure and SMEs. Funding the renewal and modernisation of those European railway companies that are shareholders through loans secured against rolling stock. Balance-of-paymentssupport and macrofinancial assistance Key regional development bank for Latin America and the Caribbean – loans to sovereigns and sovereign-guaranteed entities. Loans to support development and reduce poverty in middle-income developing countries. Supports private enterprise in emerging markets through loans and equity finance.

Loans (and limited equity investments) to public and private sector borrowers in African member countries.

Loans are mainly to sovereigns or are sovereign-guaranteed. Private sector risk is limited to a maximum of 10% of the portfolio.

0%

Loans to governments, agencies and private enterprises, but the latter are all government-guaranteed, so IBRD's credit risk is all sovereign risk.

Worldwide range of governments – 185 in all.

Almost 80% of callable capital is investment grade.

0%

Loan/equity funding of private enterprise is split about 80%/20%. Wide geographic spread.

Worldwide range of 179 governments

0%

Private company limited by guarantee and a UK registered charity The five Nordic countries and three Baltic countries

Virtually all subscribed capital is paid in to correspond to the relatively high risks attached to its private enterprise focus. Almost 80% is provided by investment-grade sovereigns. Supported by legally binding grant obligations from the governments of the UK, France, Italy, Spain, Norway, Sweden and South Africa. 96% of callable capital is AAA.

IIFIm

International Finance Facility for Immunisation

Provides funding for vaccination programmes in developing countries

All funds are transferred to finance vaccination programmes operated by the Global Alliance for Vaccines and Immunisation (GAVI).

NIB

Nordic Investment Bank

Provides long-term finance for investment projects that benefit the Nordic region.

Loans to public and private sector entities in the Nordic region, the Baltic countries and emerging markets, the latter largely backed by member government guarantees.

0%

0%

Note: * RSA = Revised Standardised Approach. Source: Barclays Capital

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Figure 114: European agencies/quasi-sovereigns – key comparisons

Full name

Type

Purpose

Agence Française de Développement

French EPIC

France’s development bank

BOE

Bank of England

UK central bank

BNG

Bank Nederlandse Gemeenten

CADES

Sector and type of lending/investment

Risk weightings Basel II RSA*

Ownership

Support

Long-term development funding in areas of French interest, mostly Africa, and French overseas departments and territories.

100% French state

Solvency and liquidity support as a French EP.

20%

Central banking

Issues debt to fund its own reserves of foreign exchange, which are held to support the implementation of its monetary policy objectives. These reserves are separate from the UK’s national foreign currency reserves.

100% UK government

Government ownership

0%

Dutch public sector bank

Act as a bank of, and for, Dutch local authorities and other public sector institutions.

Loans to Dutch munis and other public sector entities, notably housing associations and mortgage funds. Asset quality is underwritten by the municipal legal framework and by various public sector guarantee funds.

50% Dutch State – 50% other Dutch public entities

Public policy role and asset quality support but no direct debt guarantee from the state.

20%

Caisse d'Amortissement de la Dette Sociale

French EPA

Created to refinance and amortise French social security debt.

Unusual balance sheet structure dominated by the net balance sheet liability: €72.9bn at end-2007.

100% French state

Solvency and liquidity support as a French EP. Dedicated tax revenue.

0%

CDC (CDCEPS)

Caisse des Dépôts

French EP

Financial institution fulfilling a range of public missions

Managing funds entrusted to it from various sources, eg, tax-exempt savings accounts, legal deposits and public retirement funds.

100% French state

Solvency and liquidity support as a French EP.

0%

CNA

Caisse Nationale des Autoroutes

French EPA

Sole function is to act as a non-profit making financing vehicle for public sector toll motorway operators.

Loans are solely to public sector toll road operators, most of which were privatised during 2005-06. Lending to private sector operators will be phased out by 2009, so CNA’s balance sheet will trend lower over time.

100% French state

Solvency and liquidity support as a French EP.

20%

Eksportfinans (EXPT)

Eksportfinans ASA

Norwegian specialised financial institution

Provision of competitive longterm funding and other financial services in the areas of export and municipal finance.

1) Long-term low margin loans to Norwegian municipalities; 2) Exportrelated loans on commercial and government-supported terms to Norwegian exporters and foreign buyers.

15% Norwegian state; 85% banks operating in Norway.

Public policy role in provision of export finance and close interaction with various areas of government, but no direct state guarantee.

20%

ERSTAA

Erste Abwicklungsanstal t

Special purpose agency

Allow for an orderly run-off of nonperforming or non strategic assets of WestLB AG

Asset purchase scheme / wind-up entity

48.2% State of NRW and 25% each regional savings banks associations of Westphalia and Rhineland, 1.8% two regional associations of Rhineland and Westphalia

Owners are obliged to compensate ERSTAA for any losses not covered by guarantees for certain debt and equity.

0%

FOBR

Fondo de Reestructuracion Ordenada Bancaria

Special fund, established for assisting the restrucuturing process of Spanish banks

Temporary capital injections into banks to assist in the restructuring and consolidation of the Spanish banking system

Support for Spanish banking sector

Of EUR 9bn capital, EUR6.75bn has been provided by government and EUR2.25bn by Deposit Guarantee Funds

Explicit and irrevocable guarantee from the Kingdom of Spain.

0%

Financials AFD (CCCE)

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Full name

Type

Purpose

GPPS

German Postal Pension Securitisation plc

Dublin –based securitisation vehicle

ICO

Instituto de Credito Oficial

State financial agency and development bank

Securitisation of receivables related to pensions payable to retired civil service employees of the Deutsche Bundespost and German postal successor companies. Promotion of economic and social development in Spain.

KFW

German development bank

KOMBNK (KBN)

Kommunalbanken AS

Specialist Norwegian local authority lender

Kommuninvest (KOMINS)

Kommuninvest I Sverige AB

Specialist Swedish local authority lender

KommuneKredit (KOMMUN)

KommuneKredit

Specialist Danish local authority lender

L-Bank (LBANK)

Landeskreditbank BadenWürttemberg Förderbank

State development bank

Municipality Finance (KUNTA)

Municipality Finance

Specialised financial institution

NRW.Bank(NR WBK)

NRW.Bank

State development bank

10 June 2010

Formed to finance reconstruction, now involved in supporting a range of public policies including lending to SMEs, housing, infrastructure and environmental projects; export and project finance; and assistance to developing markets. Sole role is to lend to the local government, which is a guaranteed sector in Norway Lending to member authorities and entities owned by them. Lending to Danish local governments and entities backed by local government guarantees. To support economic development in the State of BadenWürttemberg (BW), enhancing the state's attractions as a business location. To provide competitive funding to Finnish local authorities and related entities.

To support infrastructure and economic development in the state of NRW.

Sector and type of lending/investment

Risk weightings Basel II RSA*

Ownership

Support

Government and government-backed receivables.

Vehicle company

Receivables are paid by and/or guaranteed by the German government

20%

Provides medium and longtem funds, mostly to SMEs, in selected sectors, such as housing, infrastructure, telecoms, energy, environment and transport, and to Spanish regions. It also provides export finance and channels public funding to alleviate effects of crises and natural disasters. Loans to support SMEs, housing finance, infrastructure and environmental projects, export and project finance, and emerging markets – mainly provided through commercial banks. Much of the credit risk is transferred to intermediating banks or to public authorities.

100% owned by the Kingdom of Spain

Explicit, direct, irrevocable and unconditional debt guarantee by the Kingdom of Spain.

0%

80% German Federal Republic; 20% Länder.

Explicit federal debt guarantee and Anstaltslast solvency support.

0%

Local government

100% Norwegian government.

Maintenance obligation from Norwegian central government

20%

Local government

Kommuninvest Cooperative Society, a co-operative grouping of Swedish local authorities All the 98 Danish municipalities and 5 regions in the local government sector

Joint and several guarantees from local authority members

0%

Joint and several guarantees from local authority members

0%

100% owned by the State of BadenWurttemberg

Explicit guarantee by the State of BadenWurttemberg as well as support through Anstaltslast and Gewährträgerhaftung .

0%

59.3% by Finnish local governments and the Finnish local government association; 40.7% by the Local Government Pension Institute. 98.6% state of NRW; 0.7% each from the regional associations of Rhineland and Westphalia-Lippe

Explicit guarantee by the Municipal Guarantee Board (which in turn is owned and guaranteed by most Finnish municipalities). Anstaltslast and Gewährträgerhaftung support from its owners. Explicit debt guarantee from NRW. Also NRW guarantee of its holding in WestLB AG.

0%

Local government

Provides funding for five main areas of activity: housing projects; new business start-ups and SMEs; infrastructure projects; real estate investment in technology parks; social initiatives. Long-term loans to Finnish local governments, entities guaranteed by local governments and municipal entities involved in provision of social housing.

Provides funding to business start-ups and SMEs, public infrastructure projects, housing and urban development.

0%

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Sector and type of lending/investment

Full name

Type

Purpose

NWB (NEDWBK)

De Nederlandse Waterschaftsbank

Dutch public sector bank

Banker to Dutch water control boards, it was initially established to fund investment in sea defences.

OKB

Oesterreichische Kontrollbank AG

Austrian banking corporation

Primary function is provision of export finance.

Rentenbank (RENTEN)

Landwirtschaftlich e Rentenbank

German development bank

Public policy role to support financing the agricultural, rural and food sectors.

SEK

Swedish Export Credit

Export finance agency

SFEF

Société de Financement de l’Èconomie Française

French Special Financing Company

Provision of longterm export finance to Swedish industry and commerce. More broadly, provides long-term financial solutions for Swedish business. Support the French banking system

Unédic

Unédic

Association with a public service mission

Central organisation of the French unemployment benefit system.

Asfinag (ASFING)

Autobahnen und Schnellstrassen Finanzierungs AG

Governmentowned company

Construction and operation of Austria’s trunk road network

Transportation

ISPA (CDEP)

Infrastrutture SpA

Created as limited liability company under Italian law – now dissolved.

Financing of Italian high speed rail network

ISPA’s public debt issues have all been issued under the €25bn ISPA High Speed Railway Funding Notes Programme, and were issued to fund project loan tranches related to financing the Italian high speed rail project.

Loans to, or guaranteed by, the Dutch public sector. The main categories are loans to housing corporations and to munis, much of which is guaranteed by central or local government, so asset quality is supported by strong credit quality of these sectors. (Water boards now only take c.12% of loans.) 1) Administers export guarantees on behalf of Austrian government; 2) medium- and long-term refinancing for banks and foreign importers financing Austrian exports.

The bulk of funding for the agricultural and rural sectors is channelled through commercial banks, which take on the credit risk of the final exposure. Although concentrated in Germany, exposure is spread across the EU. Export-related loans on commercial and government-supported terms to Swedish exporters and foreign buyers. Also long-term loans related to project and infrastructure finance. Provides funding for the French banking industry in order to encourage lending to the French economy, with a focus on helping corporates, households and local authorities.

Risk weightings Basel II RSA*

Ownership

Support

81% Dutch waterboards; 17% Dutch state; 2% Dutch provinces.

Public policy role but no direct guarantee.

20%

Wholly owned by Austrian banks

Asset quality support provided by government guarantees of export loans. Unconditional guarantee by Republic of Austria for debt issued to finance export loans. Anstaltslast support but no direct guarantee.

0%

100% by the Kingdom of Sweden

No direct guarantee, but strong implicit support based on public policy role and government ownership.

20%

34% by the French government and 66% by 7 large French banks

Bond issues benefit from a guarantee of the French government

0%

Not an EPIC, but debt issues have been explicitly guaranteed by the French state.

0%

100% by the Republic of Austria

Explicit debt guarantee, as well as solvency and liquidity support from the Austria government

0%

Now has been merged into its former parent Cassa Depositi e Prestiti (CDEP)

Debt service from project revenues and state transfers, with further Italian government backing of any shortfall. Transaction rights constitute segregated assets and so continue to back the debt after ISPA’s merger into CDEP

0%

No shareholders: capital is akin to an endowment fund for agriculture

0%

Industrials

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Full name

Type

Purpose

LCR (LCRFIN)

LCR Finance plc

Private Corporation, wholly owned finance subsidiary of London & Continental Railways plc (LCR)

Building the Channel Tunnel Rail Link (CTRL) between the tunnel and central London, and the operation of Eurostar in the UK.

Network Rail (UKRAIL)

Network Rail MTN Finance plc and Network Rail Infrastructure Finance plc

Issuing entities for Network Rail Infrastructure Ltd

La Poste (FRPTT)

La Poste

RATP (RATPFP)

REFER

Sector and type of lending/investment

Risk weightings Basel II RSA*

Ownership

Support

Railway construction and operation.

Ove Arup, Bechtel, Halcrow, National Express, UBS, London Electricity and SNCF.

Bonds are explicitly guaranteed by the UK government.

0%

Network Rail Infrastructure Ltd owns and operates the UK’s railway infrastructure.

Operation of rail infrastructure.

Network Rail is owned by: 1) rail industry members; 2) public interest members; 3) reps of regional and local govt; 4) a Special Member, who may be elected by the Secretary of State for Transport.

Financial indemnity from the UK government.

0%

French public entity (Exploitant Autonome de Droit Public)

Provision of French postal services.

Mail, parcels, logistics and financial services.

100% French state

Solvency and liquidity support as a French EP.

20%

Regie Autonome des Transports Parisiens

French EPIC

Created to develop, maintain and operate public transport in the Greater Paris area.

Ownership and operation of metro, tramway and bus lines in the Greater Paris area; operation of urban express (RER) services jointly with SNCF.

100% French state

Majority ownership of French Republic.

20%

Rede Ferroviária Nacional, EP.

Portuguese public entity

Owns, maintains and develops the Portuguese rail infrastructure.

Rail infrastructure.

100% Portuguese state

Support as a public entity – cannot go bankrupt. Some issues are explicitly state-guaranteed.

Guarantee d debt: 0% Nonguarantee d debt:: 50%

RFF (RESFER)

Reseau Ferre de France

French EPIC

Owns French railway infrastructure.

Network and maintenance of rail infrastructure is contracted out to SNCF.

100% French state.

Support as a French EP – dependent on state subsidy.

20%

RTVE

Ente Publico RTVE, En Liquidacion

Spanish public entity (ente publico)

Residual entity amortising debt incurred by the former RTVE.

Provision of national TV and radio services.

100% Spanish state.

No direct guarantee, but closeness of support is reflected in 0% risk weighting. Funding of debt amortisation is included in the Spanish government’s general budget.

0%

SNCF

Société Nationale de Chemins de Fer Francais

French EPIC

French railway operator.

Operates French railway services and manages the railway infrastructure on behalf of RFF.

100% French state

Solvency and liquidity support as a French EP.

20%

Notes: 1) The Bloomberg ticker is provided in brackets if it differs from the normal short name; 2) * RSA = Revised Standardised Approach. Source: Barclays Capital

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UNITED STATES: GOVERNMENT-GUARANTEED BONDS

Temporary Liquidity Guarantee Program Rajiv Setia +1 212 412 5507 [email protected] James Ma +1 212 526 6566 [email protected]

Generally considered a success, the TLGP closed to primary issuance on October 31, 2009 after cumulative long-term issuance of $300bn since its initiation in November 2008 (Figure 115). Practically all of the issued long-term debt remains outstanding today, and the guarantee remains in force for these issues. Thus, as a service to secondary market investors, we reprint the relevant portions of our previous primer on the program terms below. In terms of market positioning, we note that TLGP paper generally remains a less liquid market than agency bellwethers even as the Fed has been active in the latter. As such, the liquidity premium charged by investors has caused TLGP names to trade at least 5-7bp behind agencies on a Libor basis. While this is a considerable improvement from the 5070bp margin in the program’s infancy (Figure 116), we observe that TLGP paper has a lower risk weight (0% versus 20%) and an explicit government guarantee. A sister program to the TLGP, the NCUA also introduced the TCCULGP to grant a similar government guarantee to debt issued by corporate credit unions. This program expires June 30, 2010, and there have been four issues ($5.5bn) made under it. Similar to the FDIC’s program, the TCCULGP guarantees timely payment of interest and principal to bondholders, backed by the full faith and credit of the US government. Also like the TLGP debt, this paper is rated AAA/Aaa and bears the same index classification as TLGP paper in the Barclays Capital family of indices.

Basic terms of the program Which entities are eligible to participate in TLGP? TLGP is open to all FDIC-insured US banks as well as bank holding companies

All FDIC-insured depository institutions (IDI), which includes US branches of foreign banks. Also, any US bank or S&L holding company is eligible as long as it has at least one subsidiary that is an IDI. In addition, at its discretion, the FDIC can designate affiliates of IDIs (eg, GE Capital Corporation) as eligible for participation in the program.

Figure 116: History of TLGP spreads to Libor

Figure 115: Cumulative TLGP issuance history 100

$ bn

$ bn

90 80 70 60

350

100

300

80

250

60

200

40

150

20

100

0

ASW, bp

50 40 30 20 10 0 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Issuance (LHS) Source: Barclays Capital

10 June 2010

Sep-09

50

-20

0

-40 Nov-08

Apr-09

Cumulative (RHS)

Sep-09 2y

2.5y

Feb-10 3y

Source: Barclays Capital

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As the program has wound to a close, it is no surprise that the most frequent issuers of TLGP paper have generally been those with the largest funding needs and most name recognition (Figure 117). Since the structure of the TLGP retains the name of the issuing entity (in contrast to the French SFEFR model), the program is relatively more economical from a funding cost standpoint for issuer names that are better-known, despite the strength of the FDIC’s guarantee being uniform across all debt issued.

Figure 117: Largest TLGP issuers C

GE

BAC

JPM

MS

GS

29 others

64.6

60.0

44.5

40.5

23.8

21.7

54.5

Source: Barclays Capital

Which types of obligations are eligible to be guaranteed? Senior unsecured debt with more than one month to maturity is eligible for the guarantee

Some mandatory convertible debt is also eligible, but none has been issued yet

The FDIC will guarantee senior unsecured debt with a maturity of more than 30 days (including commercial paper and Fed funds). Coupons may be fixed, floating, or zero. The debt may be denominated in a foreign currency (Figure 118). It explicitly excludes secured debt, structured notes, and debt with embedded options (callables, convertibles, etc), with the lone exception of mandatory convertible debt (MCD) meeting the following criteria: „

MCD conversion date must be on or before the maximum allowable terminal maturity; the bond itself is only guaranteed through the conversion date.

„

MCD issuance is exempted from issuers’ individual caps.

„

The FDIC must give prior written approval for any MCD issuance.

The FDIC stated that its intent with the MCD program was “to give eligible entities additional flexibility to obtain funding from investors with longer-term investment horizons” and to “reduce the concentration of FDIC-guaranteed debt maturing in mid-2012.” 24

How long does the program last? The debt guarantee extended until 31 December 2012 for issuers who participated in the extended window – ie, who opted to issue through 31 October 2009 (‘participants’). Issuers who were not participants were limited to final maturities through 30 June 2012. Predictably, this limitation affected the maturity distribution of outstanding TLGP debt (Figure 119). In either case, any TLGP debt that matures on or before the corresponding termination date is fully guaranteed, but any TLGP debt with a longer maturity will only be guaranteed through the termination date. All debt issued under the program has maturities before the relevant termination date, however.

What is the fee schedule? Fees vary by maturity and whether the issuer is a depository institution or a bank holding company

The FDIC charges a guarantee fee on a sliding scale, which also varies if the issuer is a participant in the extended window (as defined above). The annual rate is a flat 50bp for debt with a maturity of 31-180 days and 75bp for debt with a maturity of 181-364 days. For debt with 365 days or longer to maturity, the base fee is 100bp. There is an additional set of surcharges for long-term debt, which vary by date of issuance and whether the issuing name is a depository institution or a bank holding company.

24

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FDIC Interim Rule, 27 February 2009.

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Figure 118: TLGP outstandings are mainly in USD EUR 2.1%

GBP 1.3%

HKD 0.2%

JPY 0.1%

Figure 119: TLGP maturity distribution 70

$ bn

60 50 40 30 20 10

USD 96.4% Source: Barclays Capital

0 Dec-09

Jun-10 Dec-10

Jun-11 Dec-11 Fixed

Jun-12 Dec-12

Floating

Source: Barclays Capital

Can participating institutions sell non-guaranteed debt as well? By default, banks cannot pick and choose; all senior unsecured debt was guaranteed at the program’s outset. However, issuing institutions could have retained the option to sell nonguaranteed debt if they paid a relatively high one-time fee. As capital markets have returned to health, many large issuers have come to market in non-guaranteed space as a show of strength and, of course, have continued to do so after the program’s end.

Has FDIC considered extending the terminal maturities beyond 2012? In October 2009, the FDIC approved an emergency extension of the TLGP debt guarantee program through April 30, 2010. Note that the previous set of program terms still ended on October 31, and any banks who want to issue beyond that date were required to reapply (none did). Under the emergency extension, issuers were obligated to demonstrate an inability to issue non-guaranteed paper, and would be assessed a 300bp guarantee fee; the maximum maturity remained at December 31, 2012 during the extension period. Ultimately, the punitive nature of the new guarantee fee precluded any actual issuance.

Top queries from investors What are these bonds’ credit ratings? TLGP bonds are rated AAA

All three rating agencies have rated TLGP debt maturing on or before December 31, 2012 with the same rating as US government debt (ie, AAA/ A-1+).

What is the risk weighting for TLGP debt? FDIC, OTS and OCC had originally set the risk weighting at 20%, but then clandestinely lowered it to 0% in November 2009 after the program’s end, citing “the legislative history of the US government’s full faith and credit backing of the FDIC.” The risk-weighting for analogous debt guaranteed under various European programs is 0%. Notably, the FDIC decision minimises the risk of further “unintended consequences” in the agency debt market, where debt is 20% risk-weighted, as no new issuance can be added to the market.

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How does the guarantee differ from the GSEs’ “effective” guarantee, and how will the FDIC go about getting the money to pay claims? FDIC guarantee is “full faith and credit” of the US government

The FDIC has stated that the guarantee (of timely payment of principal and interest) carries the full faith and credit of the US government. This probably reflects the FDIC Act, which states that non-deposit obligations of the FDIC are explicitly guaranteed. In contrast, FNM/FRE carry an “effective” guarantee, under which the Treasury has pledged to keep GAAP net assets positive by making injections of preferred equity with no limits through 2012 and up to $200bn per institution thereafter if needed. The FDIC’s Deposit Insurance Fund (DIF) will not be used to pay claims, as the TLGP is designed to operate on the proceeds of the guarantee fees. If the fees are not enough, the FDIC will levy a special assessment on all IDI to pay for any shortfall. Notably, one stated objective of the latest round of TLGP fee hikes was to replenish the DIF with the remaining accumulated fee income after paying any claims on TLGP. Some investors have questioned whether the FDIC is sufficiently funded to withstand a large bank failure. Others have raised the possibility that $400bn may not suffice in supporting the housing GSEs after 2012 if housing does not improve. In our view, both asset classes should be viewed as fully government guaranteed; authorities worldwide are going to be unwilling to let any large leveraged global financial institution fail.

Will the FDIC honour the timely payment schedule of principal and interest? FDIC will honour timely payment of interest and principal through the terminal maturity

Yes, the FDIC explicitly guarantees timely payment of interest and principal through December 31, 2012 (ie, no acceleration). For TLGP debt maturing after that date, it indicates that it could accelerate (as an issuer missing payments would already be in default).

How will investors know if a particular bond is guaranteed? All TLGP debt must state that the bond is explicitly FDIC (using the “full faith and credit” terminology) guaranteed on the prospectus. If an issuer retains the option to issue nonguaranteed debt, it must say that it is not guaranteed on the prospectus.

Figure 120: Components of the US Aggregate Index, $bn Gov-Guaranteed (FDIC debt, AID, KfW, etc) $228 2%

Securitised $5,029 43%

Agency $1,240 11% Treasury and other Gov-related $4,587 34%

Corporate $2,424 18%

Gov-Owned (FNM, FRE, TVA, etc) $768 7% Gov-Sponsored (FHLB, FFCB, etc) $286 2%

Note: As of 30 April 2010. Source: Barclays Capital

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Market structure and implications Where is FDIC debt classified in the Barclays Index? FDIC debt is classified in the US Aggregate within the “Agency: Government Guaranteed” subsector. In contrast, existing GSE debt will fall within the “Government Sponsored” or “Government-Owned” sub-sectors (Figure 120).

Who is the marginal buyer of TLGP debt? In practice, TLGP debt is traded similar to agency paper and attracts a similar investor base

TLGP bonds are traded off the agency desks of primary dealers. The product has appeal to a broad range of traditional rate investors looking for a high yielding Treasury surrogate. Traditional agency investors have been a natural fit for FDIC debt, and since the TLGP market’s early stages, both asset classes have not only converged, but also tightened substantially with the advent of QE. We believe the prototypical credit investor may not be willing to buy TLGP paper given lower yields/spreads, even as issuance from FDIC-insured entities has typically accounted for a very high proportion of overall IG corporate issuance. As a result, demand for nonFDIC corporate paper seems to have surpassed supply, leading to outperformance.

Where will TLGP debt trade in relation to GSE paper? Fundamentals should lead to little difference between TLGP, agency debt

From a fundamental standpoint, the differences between agencies and TLGP debt are subtle. As mentioned earlier, TLGP paper trades 5-7bp behind agencies (Figure 121), most likely due to liquidity premium as the float of the average TLGP deal is smaller than even those agencies that have been heavily purchased by the Fed. However, on the other hand, from a fundamental standpoint TLGP paper has two advantages: a full faith and credit guarantee and a 0% risk weighting. Thus, in some sense the spread differential will be driven by demand dynamics. We believe the tension in the investor base will remain between spread- and liquidity-sensitive money managers (not all of whom may have approval to buy TLGP paper in their government/agency portfolios), and bank portfolios that assign more importance to yield and risk weight. Only recently has the tiering in spreads between larger issuers with a global footprint – and ability to issue large deal sizes – and less well-known entities reduced; some of this reflects different degrees of approval for investor mandates. In contrast, this difference is quite stark for non-US-government-guaranteed USD bonds, as the basis for this paper seems to reflect more than sovereign credit risk implies (Figure 122).

MM Libor Spread (bp)

Figure 121: Asset swap levels of TLGP paper versus agencies

Figure 122: TLGP versus sovereign CDS, GGBs

0

60

-5

50

ASW, bp

40

-10

INTNED 2.625 2/12

30

-15

20 -20

SWEDA 2.8 2/12

10

-25

0

-30

-10

-35

-20 0

1 FNMA

Source: Barclays Capital

10 June 2010

FHLMC

2 FHLB

3 FFCB

4

BACR 2.7 3/12

MQGAU 2.6 1/12

SFEFR 2.125 1/12

C 2.0 3/12 0

10

TLGP

20

30

40

50

60

2y Sovereign CDS Source: Barclays Capital

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GOVERNMENT-GUARANTEED DEBT INSTRUMENTS

The safety jacket for the financial system loses air Michaela Seimen +44 (0) 20 3134 0134 [email protected]

After more than 1.5 years helping to rebuild confidence in financial institutions and support private funding for them, the newly and temporarily established instrument of Government Guaranteed Bonds (GGBs) seems to have edged closer to the end of its shelf life. Despite the EU Commission’s indication that an extension of guarantee programmes could be possible if respective fees and structures are adjusted, we believe that GGB issue volumes will not grow again but rather gradually phase out.

A brief look at the origins of GGBs and how this market developed GGBs created as new asset class in October 2008 wih aim of limited life span

To counteract the de-facto closure of the term-funding markets in the aftermath of the Lehman Brothers collapse in mid-September 2008, virtually all European economies started to establish government guarantee and support schemes for the financial sector. In late October 2008, after several countries decided to provide support to ailing lenders, spurred by the developments surrounding German Hypo Real Estate (HYPORE), French Dexia (DEXIA) and some of the major Irish banks, an inaugural GGB was issued. In less than a year, this previously unknown asset class experienced unprecedented growth across the US, the UK, and Europe. Within the comparatively short period between late October 2008 and early June 2009, benchmark-sized GGBs with an aggregated amount of €340bn were issued, with nearly €240bn issued in H1 09 alone. However, despite this unprecedented growth in issuance, since the ECB’s announcement on 7 May 2009 that it would acquire “Euro-denominated covered bonds issued in the euro area” the issuance of GGBs came to a temporary halt 25 and with eventually only limited further benchmark GGBs being issued until today. The ECB announcement proved to be part of the right instruments to help re-establish confidence in financial markets. As a result financial market conditions improved considerably from June 2009, with the issuance of covered or senior unsecured bonds becoming more attractive compared with the issuance of GGBs.

Government Guarentee programmes vary from country to country

To assess GGBs, formally, a distinction needs to be made with regard to the scope of the guarantee, ie, the volumes covered. For example, the first government guarantee framework established in Ireland provided a guarantee for all new and outstanding debt. However, this was altered in late 2009 with a new guarantee framework, adopting the general European structure of guarantee schemes, with governments only guaranteeing new debt, for which the issuer purposely requested a guarantee. This enables banks to issue simultaneously guaranteed and non-guaranteed debt. Furthermore we distinguish how governments support the issuance of GGBs. In the case of France, for example, the central government established a single entity designed to tap the market, the so-called Société de Financement de l’Economie Française – SFEF. All GGB issuance is conducted exclusively through this entity. This approach is in sharp contrast to most other European sovereigns, which decided to let issuers tap the market on an individual basis. In our view, and this is also supported through the markedly tighter swap spread levels, the first approach is somewhat preferable. Investors have to deal with only a single issuer who is committed to issuing benchmark deals and they do not have to establish credit lines for a

25

10 June 2010

Source: ECB Monthly Bulletin, May 2009.

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multitude of potential issuers. Retrospectively, we believe that a joint approach as in the case of France would on several occasions have been preferable for some of the countries that left the banks to their own devices with regards to the issuance of GGBs. As a result this would have added more transparency and ultimately better liquidity. GGBs are primarily issued in USD and EUR

In terms of GGB supply, the dominating currencies are USD and EUR. Whereas the GGB market was in the beginning driven by strong issuance activity of USD-denominated debt, EUR-denominated issuance started dominating the market from February 2009 onwards, on average accounting for two-thirds of all supply. GBP-denominated issuance has always lagged (Figure 123).

Figure 123: Benchmark GGB issuance – all countries; EUR, USD & GBP 90

80.4

€bn

75

Figure 124: GGB issuance currency allocation, since Oct 08

64.1 56.9

60 43.0 45

35.0

30

16.3 8.3 2.1

15 7.5

EUR 42%

USD 44%

32.4

8.1 1.8

5.0 7.15.1 0.3

0 Oct- Dec- Feb- Apr- Jun- Aug- Oct- Dec- Feb- Apr08 08 09 09 09 09 09 09 10 10 EUR

GBP

Source: Barclays Capital

USD

Other 8%

GBP 6%

Source: Bloomberg, Barclays Capital

With issuance volumes of up to €80bn in selected months, room for the issuance of other eventually comparable products was scarce. In other words, the issuance of GGBs effectively triggered a pronounced crowding-out effect which, among others, left its mark on the benchmark covered bond market where issuance volumes fell to a multi-year low, accordingly. With gross global benchmark GGB supply since October 2008 of more than EUR370bn, only about EUR17bn have been issued in 2010, which has been due to the ongoing improvement in financial market conditions and opening up of other funding channels. Originally issuance windows of most government-guarantee schemes were set to close in December 2009; however, most of the programmes extended issuance windows into 2010. Issues under MTN programmes conceal real size of GDP market

It should be noted that issuers were to a large extent using MTN programmes for issuing GGBs. Therefore the actual funding levels via GGBs were much higher than the benchmark issuance numbers suggest. According to Bloomberg data, the overall GGB market reached an approximate size of EUR920bn as of today, with activities well into 2010 (Figure 125). As to the regional distribution of issued benchmark size GGBs, we observe that with more than a quarter (28%) of all supply the US dominates the market, followed by France (19%), due to its single issuer, Société de Financement de l’Economie Française (SFEF), UK (12%) and Spain (10%). Generally, and notwithstanding the concentration on the few larger players, the GGB market appears to be relatively fragmented in terms of supply, with several European countries accounting for between 7% and 1% of all supply (Figure 127).

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Figure 125: Issuance of GGB in all countries, all currencies, incl. FRN & non-benchmark 140

€bn 112 114

120

111

100 79

80

65

60

74 59

51

50

40

32

20

27

35 22

11

8

16

11 16

12 0

0

Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 EUR

GBP

Other

USD

Source: Bloomberg, Barclays Capital

Redemptions crowd in 2012

Given the concentration of issuing activities in regard to GGBs, we believe that problems could well arise with regards to the maturity structure of the issued guaranteed bonds. Despite most programmes foreseeing a maximum term to maturity (TTM) of 60 months, issuers more strongly favoured the three-year maturity bracket, ie, mostly issuing GGBs that mature in 2012. This has led to a €347bn redemption hump in 2012, which in principle should cause issuers to increasingly rely on other maturities (Figure 128). For at least two reasons, though, this is not quite as straightforward as one might assume. First, from an investor’s perspective, bank treasuries, which are among the largest buyers of GGBs, clearly favour shorter-dated maturities and would thus probably have preferred a GGB with a 3y maturity over a GGB with a 5y maturity. Second, from an issuer’s perspective, issuing within the 3y sector is preferable to issuing within the 5y sector as a result of the spread differences between 3y and 5y swap rates in major funding currencies combined with additional costs in regard to longer payments of guarantee fees.

Figure 127: Benchmark GGB issuance per country, since Oct 08

Figure 126: Top 10 issuers of GGBs (all currencies) €bn 120

106

100

US 28%

83

AUS 4%

AUT DK 3% 1% FR 19%

80 56

60

47 38

38

40

35

32

29

22

20

Source: Bloomberg, Barclays Capital

10 June 2010

WSTP

JPM

BAC

GE

DEXGRP

LLOYDS

C

RBS

SFEFR

HYPORE

0

NOR 0.1% UK 12% SWE 3%

GER 7% IRE 5% ESP 10%

PT NED 1% 7%

Source: Barclays Capital

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Figure 128: Overall GGB redemptions per country (€ bn) 400

Figure 129: Benchmark GGB redemptions (€ bn) 200

€bn 347

€bn 164

350 160

300 250 200

115

120

206 163

80

150 101 100 50

48

40

31

40

40

12

16

6

1

0

0 2009 AU

2010 DE

2011

2012

FR

2013

GB

2014 Other

2015

2009

2010

US

Source: Bloomberg, Barclays Capital

2011

EUR

2012 GBP

2013

2014

2015

USD

Source: Barclays Capital

The overall improving situation on the market in line with the redemption hump, in our view, reduced issuers’ appetite to further (exclusively) rely on the issuance of GGBs. This trend was further driven by the ongoing swap spread tightening of alternative instruments such as covered bonds or senior debt, for example (see Figure 130). As a result of this development in Q2 09, several markets that previously were effectively shut, re-opened again and thereby gradually undermined the previous dominance of GGB issues. Figure 130: Swap spread developments 350 300 250 200 150 100 50 0 -50 -100 Jan-08

May-08

Sep-08

Jan-09

Soverigns

May-09 Covered

Sep-09

Jan-10

May-10

Financial Senior

Source: iBoxx, Barclays Capital

Basic terms of the programmes Design of guarantee schemes strongly differs across Europe

10 June 2010

Notwithstanding the common aim of the government guarantee schemes, ie, to provide financial sector entities with access to term funding, the programmes’ individual designs strongly differ across Europe and the UK. Among the more similar features, however, are the issuance windows and the maximum term to maturity of new issues (Figure 131). Please note that the EC is currently discussing potentially extending guarantee programmes, which might result in prolonged issuance windows in some countries.

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Figure 131: GGB issuance windows PT NZ AT SE DK NL ES*** IE** AU FR GB* DE US Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Closing date / final issuance date

Jan-15

Jan-16

Jan-17

Final maturity

Note: *Following closure of the drawdown window on 28 February 2010, Eligible Institutions are able to refinance debt already guaranteed under the scheme, but they cannot issue new debt. **The Scheme, in line with all schemes approved under state aid rules, is subject to ongoing six monthly approvals by the European Commission. ***Establishment of FROB. Source: Barclays Capital

When aggregating the originally granted government guarantees (including the UK), we arrive at a total of approximately €2,900bn. Yet, this figure was of a rather hypothetical nature. As mentioned earlier, up until now approximately €920bn of GGBs has been issued, ie, little less than a third of the overall sum provided. Already in 2009, for example, selected entities, especially US-based issuers, have started to repay the guarantee funds used. Refining the analysis to country-specific figures illustrates that on average, little more than 20% of the total funds provided within the scope of government guarantee schemes have been used by the respective financial entities (see Figure 133). Despite large GGB issues, only smaller amounts of total guarantees have been used

With regard to other characteristics, the different government guarantee schemes are far less homogeneous, particularly as pertains to details such as the respective capital injections or the fee charged by the guarantor (ie, the government), for example (see Figure 135).

Figure 132: Guarantee schemes versus amounts granted

Figure 133: Guarantee schemes versus amounts granted 100%

€ bn 1000

75%

750

50%

500

25%

250

0

0% US

IRE GER FR NED ESP SWE UK AUT PT AUS*

issued until end May 2010

total volume granted

Note: *For AUT no maximum guarantee programme amount disclosed. Source: Barclays Capital

10 June 2010

US

IRE GER FR NED ESP SWE UK AUT PT

issued until end May 2010

total volume granted

Source: Barclays Capital

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Frequently asked questions What risk weighting applies to government guaranteed bonds? Within the EU, the risk weighting of government guaranteed debt is regulated by the Capital Requirements Directive (CRD). CRD Annex VII Part 4 2.2.4 stipulates the minimum requirements for assessing the effect of guarantees within the Internal Ratings Based (IRB) approach. According to these regulations, eligible guarantees must be, in particular, “noncancellable on the part of the guarantor, in force until the obligation is satisfied in full… and legally enforceable against the guarantor”. In addition, generally, the respective guarantees should not be subject to any conditions. The CRD text says that “guarantees prescribing conditions under which the guarantor may not be obliged to perform (conditional guarantees) may be recognised subject to the approval of competent authorities”. 0% risk weighting

We have analysed some of the legal documents regarding the guarantee schemes in France, Germany, Ireland, Portugal, Spain and the UK and conclude that the respective guarantees, which protect investors within the newly created government-guaranteed bond schemes, fulfil these criteria 26.. Some investors may argue that the guarantees are effectively subject to conditions and can potentially be revoked, as the respective issuers need to fulfil specific conditions in order to make use of the guarantee schemes. However, as outlined above, this is only relevant with respect to the relationship between the guarantor and the issuing entity. For example, if the issuing entity violates a criteria that is part of its agreement with the guarantor, the guarantor may restrict further drawing capacity on the respective guarantee. But any such non-fulfilment of the relevant conditions has no influence on the guarantee, which is given unconditionally and irrevocably to the bondholders, who are the direct beneficiaries of the guarantee. Thus, objections regarding the potential cancellation of the respective guarantees are not valid, in our view. Consequently, we argue that bonds guaranteed by governments where the respective debt benefits from a 0% risk weighting, should also have a risk weighting of zero. Figure 134 outlines the concept of a generic government guarantee scheme.

Figure 134: Generic government-guarantee scheme Guarantee (unconditional & irrevocable) Potential recovery proceeds Guaranteed Bond

Consideration Guarantor

Bond Holders Holders

Issuer Fulfilment of eligibility & business criteria

Bond Proceeds

Source: Barclays Capital

FDIC-guaranteed debt

US authorities have decided that insured depository institutions should apply a 20% risk weighting for FDIC-guaranteed debt, as a lower risk weighting for such debt “would be inconsistent with the need… to maintain strong capital bases” 27. This also suggests that US banks may need to apply a 20% risk weighting for bonds guaranteed by European 26

In Ireland the guarantee may be revoked, as a whole or in part, subject to certain criteria. However, the regulation also clarifies that following such revocation, the liabilities covered by the guarantee at the date of expiry “shall continue to be covered by the guarantee to their maturity date or 29 September 2010”. 27 For further details please refer to the FDIC (page 14).

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governments. From a European bank investor’s perspective, we argue that the wording of the guarantee within the US Temporary Liquidity Guarantee Program (TLGP) suggests that the requirements of the CRD are fulfilled. In particular, we note that article 370.3 says that “upon the uncured failure of a participating entity to make a timely payment of principal or interest as required under an FDIC-guaranteed debt instrument, the FDIC will pay unpaid principal and/or interest”. Again, the conditions under which the respective guarantees can be used refer to the relationship between the issuing entity and the FDIC, but not to the direct legal link between the guarantor and the holder of guaranteed debt. Thus, we argue that European banks should be in a position to apply a 0% risk weighting when holding FDIC-guaranteed bonds.

What effect would non-payment of non-guaranteed senior claims by the issuer have on GGBs? Early redemption in the event that guarantees are drawn looks unlikely

Another legal question arises about the scenario where a bank making use of the guarantee mechanism fails to make a payment on non-guaranteed senior claims. The guaranteed notes rank pari passu with all of the other unsecured and unsubordinated obligations of the relevant issuers 28. Thus, a failure to pay on non-guaranteed senior claims could lead to investors seeing their guaranteed bonds being redeemed before the scheduled maturity date, in the event that the guarantors pay the respective compensation when being drawn on the guarantee. The respective documentation of guaranteed debt instruments generally provides no clear guidance on this topic. We noted, however, that some guarantee notifications state that the respective guarantor guarantees notes according to the Terms and Conditions of these notes (eg, SOFFIN guarantee). Given that the documentation for each benchmark issue of different issuers may vary, investors need to refer to the respective bond documentation to get more clarity about the inherent and defined default scenarios and further handling. Under certain conditions, a guarantor might therefore be obliged to accelerate the bond repayment. However, in our view, an early redemption of the respective guaranteed notes is rather unlikely in most cases. First, from an economic point of view, the respective guarantors will prefer to make payments as scheduled in order to gain time and use the potential recovery proceeds for making such guarantee payments. Second, from an operational point of view, generally, the continuation of scheduled payments is much easier to manage compared with a final indemnity payment, particularly when taking into account that the covered guarantee period is limited to a well defined and rather short horizon. Consequently, we would assume that in the case of a non-payment of an issuer’s senior debt, the holders of guaranteed debt would receive their payments as scheduled. The similar status of guaranteed notes and non-guaranteed notes (including covered bonds) in terms of seniority also implies that the non-guaranteed notes implicitly benefit from the same ranking. As explained above, a non-payment of similarly ranking nonguaranteed debt would also be a ‘damage event’ with respect to the senior debt issued under the government guarantee scheme. As the guarantee schemes are designed to avoid a wind-down scenario, resulting in a subsequent fire-sale of bank assets, we argue that government authorities would rather give further support to the respective entities than allow a payment shortfall on similarly ranking non-guaranteed debt to trigger a scenario they are trying to avoid. As a result, investors in non-guaranteed debt, such as covered bonds, which fall under the respective guarantee period, may prefer to focus on the status 28

There is no such link in those cases where the issuing entity of the guaranteed debt is a government-sponsored special purpose entity, such as the French Société de Financement de l’Economie Francaise (SFEF) for example.

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of the respective guarantee schemes than the financial status of the issuing entity and the quality of cover pools. Importantly, within the EU, the respective guarantee schemes need to be approved by the European Commission 29.

Conclusion Given the recent improvement in the global financial markets and the assumption that due to the changed market environment, we believe that the GGB market is nearing its end. Without doubt, over the course of Q4 08 and H1 09, the issuance of GGBs was necessary to cover the immediate funding needs and liquidity gaps of several market participants. At the same time, the issuance of GGB, which for several months was the only source of term funding, enabled these players to gain some time in order to assess their balance sheet structures and to perform the necessary adjustments. This, however, has meanwhile markedly changed. We therefore believe that in the weeks and months ahead, primary market activity related to GGBs will phase out. Some reservations remain, however. According to our observations, in 2009 the re-opening of primary markets for alternatives such as covered bonds or senior unsecured debt was limited in the beginning to larger countries – and thus issuers. Thus, among the first entities to issue covered bonds after a pronounced dry spell were large German, French and Spanish issuers. Basically the same pattern can be observed in the case of senior unsecured debt, where French and UK issuers were first to tap the market again. Only later did issuers from smaller countries follow, among them Dutch, Swedish and Greek players, which issued either covered bonds or senior unsecured debt. Such a differentiation could, however, be revived should market conditions worsen again, resulting in further extensions of guarantee programmes in certain countries. Nevertheless, given the strict terms of the guarantees and applied fee structures, for most banks GGBs are a rather costly funding source and likely to become even more so. Future issues might therefore be rather concentrated on short-term funding and private placements.

29

The respective state aid cases can be found at http: ec.europa.eu/comm/competition/state_aid/what_is_new/news.html.

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Figure 135: Characteristics of government-guarantee schemes Country

Guarantees

Guarantee format

Austria

€80bn

Two types of guarantees: 1) the government guarantees Austria Clearingbank that is lending to banks on a collateralised basis to credit institutions and insurance companies; 2) the government guarantees directly or indirectly credit institutions liabilities.

Belgium

€240bn in total (€90bn for Dexia, rest is unallocated, ie, in May 2009, KBC got guarantees on €5.5bn of CDOs and €14.4bn of MBIA debt)

Two types of guarantees: 1) a guarantee by the government to the NBB extending collateralised loans to banks in need; 2) "new interbank and institutional deposits and financing, as well as new bond issuance intended for institutional investors" by a number of Dexia entities (joint with France and Luxembourg), to be extended to any 'systemic bank' if/when needed. New debt issued by banks.

Denmark

Unlimited

Finland

€50bn, with limits per bank

France

€320bn (of which €55bn for Dexia)

SFEF (French Financing Corporation) issues debt on behalf of banks (exceptionally, France can also guarantee bank debt directly).

Germany

€480bn for the SoFFin fund (of which €172.5bn was drawn as of April 2010).

"debt and liabilities issued... by companies of the financial sector" from 20 October 2008 onwards (excluding Pfandbrief)

Greece

€15bn

New medium-term notes issued by banks.

Ireland

>€420bn

2008 Scheme: All deposits (retail, commercial, institutional and interbank), asset covered securities, senior unsecured debt and dated subordinated debt (Lower Tier 2) for 11 institutions. ‘Eligible Liabilities Guarantee (ELG) Scheme 2009: Since 9 December 2009, new debt issued by banks.

Italy

No specific maximum amounts.

Two types of guarantees: 1) the Italian government guarantees BoI repo advances to banks ("against bonds held by banks or issued by banks after Oct13"); and 2) guarantee debt issued by Italian banks.

Netherlands

€200bn

Senior unsecured debt instrument (CDs, CP or bullet MTN) in euro, GBP or USD.

Portugal

€20bn

New issuance of CP, CD and senior unsecured bonds and notes to refinance maturing liabilities

Spain

€100bn until end-2008, undefined for 2009 (but expectation of at least €100bn).

New debt issued by banks.

Sweden

SEK1500bn

Below one year: 50bp for unsecured debt and 25bp for covered bonds. Above one year: same +CDS (Jan 07-Aug 08)

Switzerland

"The amount guaranteed for this purpose would depend on the specific needs of the Banking system." Asset Protection Scheme. Bank to hold first loss", after which HMT takes 90% of loss on outstanding principal amount of the asset outstanding. RBS applied for £325bn for £19.5bn; Lloyds £260bn at a cost of £15.6bn.

"... the Federal Council is prepared to guarantee new short- and medium-term interbank liabilities and the money market transactions of Swiss banks. The aim of such a measure would be to facilitate the refinancing of the banks." New issuance of CP, CD and senior unsecured bonds and notes, to refinance debt or loans, in euro, £ or US dollars. Range of currencies (AUD, JPY, CAD, and CHF) was expanded on 15 December 2008.

UK

Source: Local sources, Barclays Capital

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Figure 136: Characteristics of government-guarantee schemes Country

Asset purchase /exchange

Capital injections

Austria Belgium

Austria Clearingbank loans are collateralised. -

Denmark

-

Finland France

Loans of SFEF are collateralised with non-ECB eligible collateral

Germany

-

Greece

€8bn of exchange against state bonds (¤2bn done in 2008) €5bn preferred shares. Capital injection a condition The NAMA (www.nama.ie)

€15bn (of equity capital, this amount can be exceeded to the extent that the €85bnguarantee has not been used) €4.7bn in Fortis, €1bn in Dexia, €500mn in Ethias (all equity); €3.5bn of preferred to KBC (+€2bn+€1.5bn from the Flemish government) First package did not include capital injection, but a second package (announced on 19 January 2009) does, for a total of DKK100bn of hybrid core capital Provisionally, €4bn in 'private equity' €40bn, of which €1bn of equity for Dexia, twice €10.5bn of Tier 1 capital for six other banks (end-2008 and 22 January 2009). Managed by the SPPE (State Shareholding Corporation). Additional €5bn to Caisse d'Epargne on 17 March 2009. €80bn (€70bn +€10bn top-up) for both asset purchase and capital injections. Purchases: max €5bn per financial group; injections: max €10bn per group. As of 9 April 2009, a total of €19bn of capital injections was committed. In 2009, the government decided to establish a 'bad bank' framework. The German government also prepared a specific measure to allow German Landesbanks to spin-off non-strategic assets €5bn preferred shares. Capital injection a condition for participation in the plan

Ireland Italy

Netherlands

Portugal Spain

Sweden Switzerland UK

€40bn (exchange of non-ECB eligible collateral for new T-bills, with a maturity of 6 months, renewable until June 2010). Back-up facility for $35bn of Alt-A mortgages from ING (risk is 80% on the state, against a fee) announced on 26 January 2009. FAAF:€¤30bn of non ECB eligible AA/AAA collateral (with a max volume of €50bn), favouring assets backed by loans granted after Oct 08. A combination of outright purchases and repos (www.fondoaaf.es). The scheme has been stopped at just below €20bn currently. USD54bn of illiquid UBS assets (European and US) BoE SLS: £185bn of T-Bills swapped for £287bn of assets– facility closed 30 January 2009. New Asset Purchase Facility (APF) for BOE to purchase up to £50bn corporate paper, CP/CD, etc, as part of QE policy (initial amount funded by bill allowed to run off).

An initial €10bn (typically against preferred stock with an 8% dividend and 25% voting rights) was planned; new capital injections took place in 2009. Initially, no banks applied. But in Feb-March 09, a total of €9.55bn was injected following the publication of the Tremonti bonds law. €20bn (of which €10bn used by ING in quasi Tier securities, €3bn for Aegon) + €17bn Fortis equity

€4bn of preferential share for 5 years (3 November 2008) FROB (www.frob.es)

Up to SEK50bn in exchange for preferred shares or hybrid capital (announced 3 February 2009) CHF6bn of convertible debt (UBS) Equity capital (common and preferred shares; injection into RBS and Lloyds /HBOS).

Source: Local sources, Barclays Capital

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Figure 137: Characteristics of government-guarantee schemes Country

Guarantee fees

Financing

Austria

50bp for instruments less than 1y, median CDS (January 2007-Aug 08) +50bp for others. 55bp fee for the loans from Austria Clearing bank.

Regular bonds to be raised by the Austrian DMO.

Belgium

50bp for instruments less than 1y, median CDS (Jan 07-Aug 08)+50bp for others.

Regular bonds and bills.

Denmark

Borne mostly by The Private Contingency Association (banks), which will contribute up to DKK35bn (above that: the Kingdom of Denmark is responsible, but there is no detail of any potential charge back on the guarantees). Cost of hybrid capital to be between 9% and 11.25%.

The winding up company will finance itself by raising loans.

Finland

50bp for unsecured debt and 25bp for covered bonds+ issuer specific cost (based on rating).

To be administered by the State Treasury

France

Cost of SFEF issuance +CDS (Jan 07-Aug 08)+20bp.

New debt issued by vehicle (first issue in week of 10 Nov)

Germany

50bp for instruments less than 1y, median CDS (Jan 07-Aug 08) +50bp for others; 10bp commitment fee.

Regular bills and bonds.

Greece

Preferred shares bear a 10% dividend; Guarantee: between 25 and 50bp for less than one year, and CDS + a spread for over one year.

Regular bills and bonds.

Ireland

€1bn total over two years, but the exact mechanism is at the discretion of the Minister of Finance.

Regular bonds.

Italy

50bp for less than a year, CDS based above one year (but no more details).

Regular T-bills and bonds, as well as new CST (instruments of 6-months, deliverable into the ECB).

Netherlands

50bp for instruments less than 1y, median CDS (Jan 07-Aug 08) +50bp for others.

Regular bonds and bills.

Portugal

50bp for instruments less than 1y, median CDS (Jan 07-Aug 08) +50bp for others.

Regular bonds and bills.

Spain

50bp for instruments less than 1y, median CDS (Jan 07-Aug 08) +50bp for others. Slightly different charges apply when no CDS exists.

Regular bonds and bills.

Sweden

Below one year: 50bp for unsecured debt and 25bp for covered bonds. Above one year: same +CDS (January 2007 until 20 August 2008).

Regular bonds and bills.

Switzerland

Convertible coupon of 12.5% for UBS.

Budget resources for the capital injection. Loan in USD from Fed for illiquid assets (later to be refinanced in the market).

UK

12mth median CDS 5y +50bp. Reference period shifted to Jul 07-Jul 08 on 15 Dec, 2008 (a lowering of between 15bp and 30bp), applicable retrospectively.

Regular gilts and T-bills.

Source: Local sources, Barclays Capital

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UNITED STATES: AGENCIES

The long and winding road Rajiv Setia

„

Resolving the debate on the government-sponsored enterprises (GSEs) is likely to take several years as Congress hammers out the future of US housing finance, preserving the status quo in the meantime.

„

By raising the portfolio and debt caps at Fannie Mae/Freddie Mac, and removing the limit on equity infusions through 2012, the Treasury has taken immediate nationalization off the table. From a fundamental standpoint at the Federal Home Loan Banks (FHLB), we believe it has worked through a slim majority of losses on non-agency mortgage-backed securities (MBS) and retains a substantial capital base.

„

Despite higher cap limits, FNM/FRE portfolio growth should remain muted in 2010 as both GSEs work through delinquency buyouts. FHLB advance activity has plummeted, and we expect this pattern to continue potentially into 2011.

+1 212 412 5507 [email protected] James Ma +1 212 412 2563 [email protected]

Debate on housing finance reform advances glacially We expect the administration to maintain the status quo at FNM/FRE for several years

Questions about the fate of Fannie Mae (FNM) and Freddie Mac (FRE) broadly center on two different timetables. As we have detailed in prior publications, we believe that the status quo will hold for several years: „

Despite lacking an explicit guarantee and likely posting quarterly losses for the next few years, FNM/FRE still have a smoothly functioning guarantee business. In the near term, there simply is no viable alternative to the GSEs for housing finance in our view.

„

While conservatorship technically implies that FNM/FRE are being healed slowly and run for profit, it is clear that Congress will use FNM/FRE for public policy purposes in the near term, even if such a decision is not economic. In fact, Representative Barney Frank recently stated that the entities already “have become kind of public utilities.” 30

Longer term, regardless of what the administration outlines, it is Congress that must decide the extent of government involvement in housing policy and what role, if any, the GSEs or their successors play in fulfilling their vision. We expect the debate to be long and protracted and would not be surprised to see it stretch out over many years.

The Administration’s stance: A dream deferred President Obama’s FY 11 budget made only the briefest mention of the future of the GSEs, and did not materially change the treatment of FNM/FRE from FY 10. Regarding the GSEs’ future forms, the Office of Management and Budget (OMB) stated only that “The Administration continues to monitor the situation of the GSEs closely and will continue to provide updates on considerations for longer term reform of Fannie Mae and Freddie Mac as appropriate.” 31 Shortly after the first Congressional hearing on the future of the GSEs, Assistant Treasury Secretary Barr detailed the administration’s four main goals for housing finance reform in comments to the Mortgage Bankers’ Association:

30 31

10 June 2010

Interview on CNBC, 5 January 2010 p.352, Credit and Insurance, Analytical Perspectives, Budget of the US Government for FY 2011

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Barclays Capital | AAA Handbook 2010 „

Availability of mortgage credit “to a wide range of borrowers, including those with low and moderate incomes, to support the purchase of homes they can afford.”

„

“Affordable housing options, both ownership and rental, for low- and moderateincome households.”

„

“Access to mortgage products that are easily understood, such as the 30-year fixed-rate mortgage and conventional variable mortgages with straightforward terms and pricing.”

„

A housing finance system that distributes “credit and interest rate risk that results from mortgage lending” in a way “that minimizes risk to the broader financial and economic system and does not generate excess volatility or contribute to financial instability.”

Finally, Assistant Secretary Barr noted that the claim “that Fannie and Freddie’s collapse was caused by the government’s imposition of affordable housing goals … simply is not supported by the facts” and that the GSEs’ downfall was ultimately caused by a combination of relaxed standards and weak regulation. In our view, these remarks are consistent with Treasury Secretary Geithner’s previous public comments, which have emphasized retaining positive elements of the GSEs and including a role for the government. We believe that the administration is interested in preserving a GSE structure, particularly as regards housing affordability, but realizes that reducing systemic risk has become a political necessity as well.

Administration releases public questions on the future of housing finance Finally, the administration has released the promised set of questions open for public comment, which is the culmination of previously hinted-at administration plans since 2009: „

The first question asks which policy goals should be prioritized, including sustainable homeownership and housing affordability.

„

The second and third questions are related: the former asks what degree of government involvement is optimal, including the existence of GSEs and/or explicit guarantees, while the latter asks if the government approach should differ across market segments.

„

The fourth question seeks suggestions on how to improve the existing system, including Figure 139: Agency activity picks up the slack from PLS

Figure 138: Sources of US mortgage credit

Other, 581, ABS pools, 5%

GSEs, 439, 4%

70%

Conventional

60%

1525, 14%

50% 40%

Other bank funds, 2396, 22%

GSE pools, 5214, 49%

30%

Subprime/ AltA/HEL

GNMA

20% Jumbo

FHLB advances, 631, 6%

Total = $10,786bn

Source: Barclays Capital, 4Q09 Federal Reserve Flow of Funds report

10 June 2010

10% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Barclays Capital

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the role of the GSEs; the seventh questions asks whether lessons from overseas housing markets can be applied to the US. „

Finally, the fifth and sixth questions ask how the housing finance should support sound market practices and protect the consumer.

In our view, the fact that public comments are being solicited in the absence of an interim proposal (unlike the process with programs conceived rapidly, like the TLGP) indicates that the process of housing finance reform is still in an embryonic stage, and if GSE restructuring is truly the eventual outcome, it will not be for a considerable period. Furthermore, questions 2-3 indicated that the administration believes a government role in housing finance should be preserved, consistent with Secretary Geithner’s recent rhetoric. Taken together with Assistant Secretary Barr’s remarks, the administration’s stance seems to reflect the reality that there is no easy replacement for the existing guarantee business at FNM/FRE, particularly in terms of nationwide standardization and market share (Figure 138). The simple fact remains that the GSEs help finance about $6trn of the existing $11trn stock of mortgage debt outstanding. With banks under pressure to deleverage, it is wishful thinking to assume that the private sector can fill the financing gap that would be created if government involvement in the housing sector were switched off all at once. Meanwhile, the economics of private-label securitization still remain unattractive relative to GSE financing as the government continues to crowd out the private sector (Figure 139). In all, we continue to expect no near-term GSE restructuring, and the nearest timeline for serious proposals to be considered is 2011, in our view. Furthermore, the timeline for actual changes to the current mortgage system may well be drawn out over the rest of the decade.

Shedding light on the Preferred Stock Purchase Agreements We summarize the status quo of the Treasury’s support for FNM and FRE, namely the changes to the PSPAs made in late December 2009: 32 „

Limit on equity injections temporarily suspended: The maximum amount that can be drawn by either GSE increases from $200bn to the greater of that amount or $200bn “plus

Figure 140: PSPA cushions largely preserved through 2012 210 180

Figure 141: Changes to portfolio caps 900

Cumulative draws, $bn

Retained portfolio, $bn

850

150

800

120 750 90 700

Capacity

60

650 Dec-07

30

Jun-08 Dec-08

Jun-09 Dec-09

Jun-10 Dec-10

0 3Q08

4Q08

1Q09 FNM

2Q09

3Q09

FRE

Portfolio FNM Old Limit FNM New Limit Both

1Q10

Maximum

Source: Barclays Capital

Portfolio FRE Old Limit FRE

Source: Barclays Capital

32

10 June 2010

4Q09

Treasury changes Preferred Stock Purchase Agreements, 25 December 2009.

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the cumulative total of Deficiency Amounts determined for calendar quarters in calendar years 2010, 2011, and 2012, less any Surplus amount determined as of December 31, 2012.”33 Structuring the caps in this fashion is clever, as it largely preserves the size of the existing capital cushion post-2012 (Figure 140). As such, FNM’s cushion has been preserved at $125bn, and FRE’s at $148bn, given cumulative draws through Q4 09. In our view, the higher backstops are very welcome, but only likely to be drawn on if housing suffers another dramatic decline. Our base case forecast remains that cumulative draws for FRE and FNM will ultimately total $90bn and $140bn, respectively. „

Portfolio caps redefined: The Treasury also changed how it defined the portfolio caps to allow FNM/FRE more flexibility. Previously, they were required to shrink by 10% per annum based on YE 09 assets; now, shrinkage is based on the YE 09 limit of $900bn. So, the portfolio cap is $810bn as of YE10, $729bn as of YE 11, and so on. Based on the current portfolio sizes of roughly $750bn each, not only do the GSEs not need to shrink in 2010, they can grow (Figure 141). While we do not anticipate large-scale growth, we expect delinquency buy-outs to keep the portfolio from shrinking. As a result, we have revised our term debt issuance forecast for 2010 to $70bn (largely due to a term-out of liabilities by all three major GSEs).

„

Definitions of “mortgage assets” and “indebtedness” refined: As the GSEs have prospectively applied FAS 166/7 and consolidated the guarantee businesses, the Treasury has explicitly stated that it will ignore the effect of these changes in calculating the caps and draws. It will evaluate assets and liabilities “without giving effect to any change that may be made hereafter in respect of Statement of Financial Accounting Standards No. 140, 166, or 167, or any similar accounting standard.” 34

„

Periodic Commitment Fee postponed: Recall that FNM/FRE were set to begin paying a fee to Treasury for their use of the PSPAs in 2010. With the amendments, the Treasury has pushed back the start date to March 31, 2011.

By allowing the GSEs to make unlimited draws in 2010-12, the Treasury has removed the primary element of doubt in the strength of its support for FNM/FRE. As a practical matter, we expect the bulk of legacy losses at the GSEs to be provisioned for by 2012. Thus, losses post-2012 are fairly unlikely unless housing suffers a double-dip. Current origination by the GSEs is likely to be very profitable and should increasingly serve as an offset to legacy expenses. Furthermore, post-YE 12, the GSEs will still have roughly $100bn+ of capacity left to support debtholders. The key takeaway is that at least for the next three years, FNM/FRE credit and Treasury credit are analogous. Furthermore, these changes indicate that immediate nationalization for FNM/FRE is not in the cards.

FNM/FRE return to losses in Q1 10 earnings releases FNM reported an $11.5bn net loss for the three months ended March 31, 2010, before paying preferred dividends of $1.5bn to Treasury. This is the second straight improvement in quarterly results, but FNM was still unable to avoid requesting another $8.4bn in equity from the Treasury. Freddie Mac reported a net loss of $6.7bn in the quarter, excluding the $1.3bn preferred dividend. FRE also returned to making draws from the Treasury, requesting another $10.6bn.

33 34

10 June 2010

Second Amendment to Amended and Restated Senior Preferred Stock Purchase Agreement, Financialstability.gov. Ibid.

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Revenues and credit expenses both lower Credit loss provisions were the primary contributors to the posted losses at both FNM and FRE, totaling $11.9bn and $5.4bn in Q1 10, respectively. While FRE saw some improvement from previous quarters, FNM did not and attributed this to increased loan modifications, as well as a general deterioration of its credit book. While FNM still expects a national decline in home price appreciation (HPA) and more foreclosures in 2010, “if current trends continue, our credit-related expenses could be lower in 2010 than in 2009,” when they totaled $73.5bn. Cumulative provisions are now roughly $120bn at FNM and $55bn at FRE (Figure 142), or about 70% and 60% of our lifetime estimate of guarantee losses, respectively. Notably, both GSEs have begun to see a deceleration of the serious delinquency rate (Figure 143), and loss severities have moderated slightly, to 35-39%. Both GSEs expect defaults and severities to remain at elevated levels; we agree with this assessment. Reported severities of 35-40% in recent quarters at FNM have been realized on dispositions of around $40bn; the eventual pipeline that must be cleared will be closer to $400bn, and the severity on this remaining stock should be much higher.

A look at net interest income Net interest income was $2.8bn at FNM and $4.1bn at FRE in Q1 10, down from Q4 09. However, these two figures are not directly comparable because of accounting changes. Net interest income now includes amounts previously included as guarantee fee income, as well as expenses on non-performing loans. As buyouts continue to ramp up, non-performing assets (NPA) will become an ever-larger portion of the retained portfolio that will still need to be funded. Furthermore, of late, FNM has been less nimble in liquidating its REO inventory (Figure 144). Both of these patterns should serve to depress net interest margins (NIMs). At FNM, reported non-performing loans were $223bn as of Q1 10; this amount includes 60d+ delinquent loans on the guarantee book, as well as the retained portfolio. We estimate that cumulative NPAs are closer to $280bn, given REO acquisitions and resolutions that have circumvented the foreclosure process (short sales and deeds in lieu). This is tracking ahead of our lifetime estimate of $340-400bn NPA; a similar measure for FRE is about $140bn, versus our estimate of $180-200bn.

MTM and other items were mixed Mark-to-market (MTM) derivatives losses were substantial at both GSEs, totaling $2.8bn at Figure 142: Cumulative loss provisions versus charge-offs 120

Figure 143: Serious delinquencies decelerate 6%

Cumulative, $bn

100

5%

80

4%

60

Single-family serious delinquency rate, %

3%

40

2%

20 1%

0 2005 2006 2007 2008 1Q09 2Q09 3Q09 4Q09 1Q10 FNM Provisions

FNM Charge-offs

FRE Provisions

FRE Charge-offs

Source: Barclays Capital

10 June 2010

0% Jan-06

Dec-06 FNM

Nov-07

Oct-08

Sep-09

FRE (new format 3/09)

Source: Barclays Capital

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FNM and $4.7bn at FRE in Q1 10, despite the relatively small rally in rates. The losses were due to pay-fixed swap and payer swaption positions, a pattern similar to 3Q09, when 5y swap rates also rallied about 30bp. Other-than-temporary impairments (OTTI) was minimal at both GSEs, below $500mn at each.

Draws from Treasury continue Although FNM posted a $13.1bn quarterly loss (after dividends), it requested just $8.4bn in equity from the Treasury. In contrast to FRE, which adjusted net assets lower because of the accounting change and requested $10.6bn, FNM actually increased net assets by $3.3bn on January 1. On top of this were mark-ups of securities taken during Q1 10: fair values of the $70bn in subprime, alt-A, and CMBS in the portfolio increased by about 2 cents on the dollar, while the roughly $60bn in agency MBS held in available for sale (AFS) were marked up by about 1pt. Cumulative draws from Treasury will total $84bn at FNM and $61bn at FRE after the Q1 10 results are included (Figure 145). In its forward-looking statements, both GSEs expect draws on the Treasury to continue, and we see little in these results that would cause us to alter our expectation that cumulative draws are likely to total about $140bn at FNM and $90bn at FRE. Notably, FNM does “not expect to earn profits in excess of our annual dividend obligation to the Treasury for the indefinite future” and admits that “there is significant uncertainty as to our long-term financial stability” as a result. Although we agree with the assessment that dividend payments to the Treasury will outstrip earnings, we reiterate our view that the unlimited PSPA capacity through 2012 will suffice to stabilize FNM and FRE.

FHLB Q1 10 results: advances shrink, net interest income steady The Federal Home Loan Bank System recently reported its Q1 10 consolidated results, posting a $325mn profit. Although this compares somewhat less favourably with the $550mn gain in Q4 09, a wider swath of the System Banks (ie, all but one) was profitable. Advance demand is still declining, by $59bn in the quarter, as banks pay down sources of wholesale funding (Figure 146). At the same time, net interest income remained fairly robust at $1.2bn in Q1 10, from $1.3bn in Q4 09, despite the shrinking balance sheet. This is a positive for retained earnings and, by extension, capital.

Figure 145: Draws on Treasury resume at FRE, FNM

Figure 144: Non-performing assets at FNM 70

000 properties

$ bn

250

35

Capital infusion, $bn

Capital infusion, $bn

30

60 200 50

90 75

25

60

20 150

40 30

100 20

45 15 30

10

15

5 50

10 1Q09

2Q09

REO Added Source: Barclays Capital

10 June 2010

3Q09

4Q09

REO Disposed

1Q10 NPA (RHS)

0

0 3Q08

4Q08 1Q09 2Q09 FNM (LHS) Cum FNM (RHS)

3Q09 4Q09 1Q10 FRE (LHS) Cum FRE (RHS)

Source: Barclays Capital

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Non-agency MBS and further impairments The FHLB’s non-agency MBS continue to pay down (the Q1 10 balance was $56bn), and both credit- and non-credit OTTI reduced further, to roughly $200mn each. This was about half the amount taken in Q4 09 and demonstrates a continued improvement since H1 09. However, total non-credit OTTI taken on non-agency MBS is a still-considerable $8.3bn, which would outstrip Systemwide retained earnings of $6.0bn (Figure 147). Overall, by taking $2.7bn of credit-related OTTI since Q1 09, we believe that the FHLB has worked through roughly half of the $5-6bn in lifetime losses it will experience on its nonagency MBS holdings, which its capital cushion can easily absorb.

Capital situation improves further Notably, the FHLB System continued to grow its regulatory and risk-based capital cushions in Q1 10, despite a slight reduction in its capital balance. The regulatory capital surplus increased to $20.4bn, while the risk-based capital surplus swelled to $36.5bn. FHLB Seattle’s risk-based surplus remained steady at roughly $500mn, a welcome sign of health after previously negative headlines. Together with the positives in income and OTTI, the FHLB System appears relatively healthy from a capital standpoint.

Clearing the air on term supply As we have detailed in previous publications, 35 we do not expect the $200bn in announced delinquency buyouts by FNM and FRE to lead to a commensurate surge in term debt issuance needs. This is due to a multitude of factors (Figure 148): „

FNM/FRE already own some of the MBS supported by the affected pools (a).

Figure 146: Advances and debt outstanding reduce further $ bn 1,100

$ bn 1,400

1,000

1,300

900

1,200

800

1,100

Figure 147: AOCI versus retained earnings % of total assets 2.0% 1.6% 1.2% 0.8%

Advances (LHS)

Debt Outstanding (RHS)

Source: Barclays Capital

Retained Earnings

Total

Seattle

Topeka

San Fran

Dallas

Negative AOCI

*Note: Atlanta as of Q4 09, rest as of Q1 10. Source: Barclays Capital

35

10 June 2010

Dec-09

Des Moines

Mar-09

Indianapolis

Jun-08

Chicago

Sep-07

Cincinnati

Dec-06

Atlanta

800

500

Pittsburgh

900

600

0.0% -0.4% New York

1,000

`

Boston

700

0.4%

“Godot has arrived”, and “Changes in GSE delinquency buyout policy,” Market Strategy Americas, 11 February 2010.

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Figure 149: Fannie Mae portfolio versus issuance, Q1 10

Figure 148: Working through FNM/FRE funding needs $ bn

FNM

FRE

FNM, $bn

Stated amount of 120d+ delinquencies, YE’09

127

72

- Amount in own MBS on balance sheet (a)

-15

-15

Debt

- Amount sold forward (b)

-62

NA

DN

Near-term funding needs (a subtotal)

50

57

Bullet

+ Pipeline thru YE10, net of self-owned pools (c)

110

60

Callable Total

- Estimated runoff thru YE10 (d)

-80

-80

Estimated 2010 funding needs for buyouts(e)

80

37

Portfolio

Jan

Feb

Mar

Apr

Total

-22

7

23

9

16

-7

-6

9

1

-4

8

2

2

1

13

-21

2

33

11

25

3

8

38

49

YTD net issuance, short-term debt

16

-1

Loans

YTD net issuance, long-term debt

9

13

MBS

-41

-17

1

-57

12

Total

-37

-9

39

-8

Total YTD net issuance (f)

25

Source: Barclays Capital

Source: Barclays Capital „

FNM can deliver roughly $62bn in MBS via forward sales contracts that were already locked in as of YE 09 (b). If the GSE does indeed exercise this option, it would have the added benefit of clearing cap room in the retained portfolio relative to the $810bn limit that is binding at YE 10.

„

Both GSEs have a healthy pipeline of loans that will need to be bought out in 2010 under the new guidelines – we estimate $110bn for FNM and $60bn for FRE. However, much of this delinquent loan pipeline can be funded from portfolio pay-downs over the course of the year (d). At the current rate, a runoff of about $80bn implies FNM will have only $30bn more in buyouts to fund, while FRE (with lower overall delinquency rates and a smaller portfolio) would recoup $20bn if it does not reinvest pay-downs (c and d).

„

Both GSEs have funded through April at roughly the pace we would expect for the balance of 2010 (f).

Issuance in the time of buyouts Notably, both FNM and FRE have increased loan balances in their retained portfolios by $50bn each through Q1 10 and generally reduced their holdings of MBS (agency and nonagency) by the same amount (Figure 149 and Figure 150). Not surprisingly, the need to finance buyouts with debt funding has been muted as a result. In contrast, FHLB has shrunk sharply YTD, as demand for advances continues to decline. Also year-to-date, there have been stark contrasts in the funding mix between FNM and FRE. To wit, FNM has mainly issued discount notes and callables, likely in order to retain maximum flexibility in the size of total debt outstanding. In contrast, FRE has concentrated on issuing term bullet debt, primarily floaters. FHLB has contrasted with both FNM and FRE in that it has sharply reduced long-term bullet funding (Figure 151).

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Figure 150: Freddie Mac portfolio versus issuance, 1Q10 FRE, $bn

Figure 151: YTD net issuance has been mixed YTD net issuance, $bn

Jan

Feb

Mar

Apr

Total

DN

3

9

-3

-11

-1

Bullet

11

0

5

3

19

Callable

4

-1

-3

-6

-6

Total

18

8

0

-14

12

Loans

0

-3

51

48

MBS

-11

-9

-30

-50

Total

-12

-11

21

-2

Debt

Discount notes

FNM

FRE

FHLB

Total

16

-1

-7

8

Bullet

-4

19

-68

-53

Callable

13

-6

15

22

Total

25

12

-60

-23

Portfolio

Source: Barclays Capital

Source: Barclays Capital

Debt funding and spread implications We have written at length about rollover risk at FHLB, as debt maturing in 10yrs

Source: Danmarks Nationalbank, Statistics Denmark, Barclays Capital

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Recovery still lacks sustainable momentum

Modest increase in mortgage lending

Market controlled by five mortgage institutions

As the volumes of monthly net mortgage lending still are declining, however, we remain cautious as to whether the stabilisation in house price growth already signals a broad-based recovery (Figure 199). Adding to this uncertainty is macroeconomic data, which point towards an ongoing rise in unemployment figures and the potential risk of increasing interest rates once Danmarks Nationalbank swings into a hiking cycle. The concerns are also supported by more recent data, which show that the number of property transactions in Denmark remain on relatively low levels – despite a light recovery in Q2 09, the latest date for which data were available. In Q2 09, the number of property transactions increased to 18,552 units from 14,189 units in Q1 09. Still, in Q2 08, the respective figure amounted to 26,491 units (Figure 202). According to data from the Association of Danish Mortgage Banks, this upward trend continued in Q3 09, when turnover in single-family houses was down c.13% y/y, whereas the number of transactions in owner-occupied flats had increased by nearly 15% y/y 61. Nonetheless, the time that flats which have been put up for sale remain on the market is high, despite a stabilisation at just under eight months for both house and owner-occupied flats. Demand thus seems to be the crucial factor for a sustainable recovery of the Danish housing market. As at end-January 2010, the latest date for which data were available, total domestic lending (excluding loans to MFIs by Danish mortgage institutions amounted to DKK2,285bn, up 4.9% y/y from DKK2,178bn a year before 62. Approximately 60% of the loans granted were raised on owner-occupied flats and second homes, which together account for circa 75% of the total loan volume. Whereas roughly 55% of all mortgage loans granted are subject to a fixed interest rate, floating rate products, which have become increasingly less popular as of late, account for the remaining 45%. The Danish mortgage market is controlled by five players. All of these entities are specialpurpose banks whose assets exclusively consist of mortgage loans and reserves and which need to be funded through the issuance of mortgage bonds and equity. At least 60% of the reserves have to be invested in alternative instruments of higher quality and liquidity than mortgage bonds. As in the years before, the market is dominated by Nykredit Realkredit whose market share increased to 55.9% of net new lending in 2009, from 40.7% in 2008 63. The institution’s gross new residential lending amounted to DKK164bn in 2009, up from DKK112bn in 2008, thereby corresponding to a market share of Danish residential mortgage lending of 48.9%, ie, slightly up from 47.4% in 2008 64. The second-largest lender, Realkredit Danmark, which is the Danske Bank Group's mortgage finance specialist, benefited from a market share (including repo loans) of 28.2% as at year-end 2009, slightly down from 30.5% a year before 65. Market shares of domestic rivals such as Nordea Kredit, which slightly increased to 12.9% in Q4 09 from 12.6% in Q4 08, BRFkredit, which fell to 8.5% in 2009, from 9.3% in 2008, or DLR Kredit, which stood largely stable at 5.7% in 2009, from 5.8% in 2008, were at markedly lower levels (Figure 204).

61

Source: Danmarks Nationalbank, Monetary Review, Q4 2009. Source: Statistics Denmark. 63 Following the acquisition of Totalkredit in 2003, Nykredit Realkredit became the largest Danish mortgage lender. 64 Source: Nykredit, Annual Report 2009. 65 Source: Danske Bank, Annual Report 2009. 62

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Figure 204: Danish mortgage lenders Name

Market share*

Rating

Lending activities

Nykredit Realkredit

55.9%

Aaa**

After the acquisition of Totalkredit, a Danish mortgage bank, Nykredit became the largest mortgage bank in Denmark, being active in all lending activities

Realkredit Danmark

28.2%

Aaa

Realkredit Danmark specialises in mortgage lending secured by residential, commercial, agricultural or industrial properties. The entity, which dates back to 1851, is part of the Danske Bank Group.

Nordea Kredit

12.9%

Aaa

All property categories except for some types of publicly-subsidised building projects. Nordea Kredit, which was formed in 1993, is part of the Nordea Group.

BRFkredit

8.5%

Aa1***

DLR Kredit

5.7%

Aa1

BRFkredit offers mortgage loans against a mortgage on owner-occupied homes, commercial properties, and subsidised housing. In the corporate lending segment, BRFkredit focuses on loans for office and business properties and for private rental and cooperative housing. Loans for owneroccupied homes accounted for 44% of all lending as at year-end 2009. BRFkredit dates back to 1797. DLR Kredit focuses on mortgage loans for the financing of commercial properties (agricultural properties and urban trade properties – private rental housing, co-operative housing, office and business premises, manufacturing and manual industries and social housing).

Note: * Company information, **Aa1 for older series, ***Aa2 for older series. Source: Company information, Barclays Capital

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Denmark (Realkreditobligationer)

Name of debt instrument(s)

Realkreditobligationer

Legislation

Law enshrined in 1850, modified in 1970, 1989, 2001, and 2003

Special banking principle

Yes. new mortgage institutions

Restrictions on business activities

All types of mortgage lending as well as some ancillary activities

Asset allocation

Cover assets remain on the balance sheet and can be allocated to a specific series, which serves as coverage for outstanding bonds, either mutually or on a stand-alone basis

Inclusion of hedge positions

Hedge positions cannot be included in the asset pool, but the so-called balance sheet principle provides a protection against mismatching

Substitute collateral

Up to 2% substitute collateral may be used temporarily

Restrictions on inclusion of commercial mortgage loans in the cover pool

No

Geographical scope for public assets

Not applicable

Geographical scope for mortgage assets

No legal limitations, but the issuer’s strategy is focused on domestic business

LTV barrier residential

80% (60% for secondary residences; 84% for subsidised housing facilities with a public sector guarantee for 65-84%)

LTV barrier commercial

60% for industrial and commercial real estate; 70% for agricultural mortgage loans and 40% for other types of real estate, including greenfield land

Basis for valuation = mortgage lending value

No. The "amount that a professional purchaser is assumed to be prepared to pay".

Valuation check

Annual examination

Special supervision

Yes. Finanstilsynet – the Danish banking regulator

Protection against mismatching

We believe the protection against mismatching is rather strict. The so-called ‘special balance principle’ strongly restricts market and liquidity risk. Also, borrowers must compensate bondholders for early asset repayment.

Protection against credit risk

–

Protection against operative risk

No. Neither a back-up servicer nor a cover pool administrator is stipulated

Mandatory over-collateralisation

No

Voluntary over-collateralisation is protected

Yes

Bankruptcy remoteness of the issuer

No, but the assets within the cover pool are exempt from bankruptcy proceedings

Outstanding covered bonds to regulatory capital

–

In the event of insolvency first claim is on:

All mortgages

External support mechanisms

In the event of insufficient pool assets proceeds to cover their claim, mortgage bond investors rank ahead of senior debt holders. In addition, shareholders may extend some other form of support (eg, guaranteeing the ‘top slice’ of the mortgage loans)

UCITS Art. 22 par. 4 compliant?

No

CRD Annex VI, Part 1, §65 compliant?

No. As no preferential treatment as defined by CRD

Source: Barclays Capital

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Denmark (Særligt Dækkede Realkreditobligationer, Særligt Dækkede Obligationer)

Name of debt instrument(s)

Særligt Dækkede Realkreditobligationer (SDRO), Særligt Dækkede Obligationer (SDO)

Legislation

Law enshrined in 1850, modified in 1970, 1989, 2001, 2003, and 2006/07

Special banking principle

SDRO: mortgage banks. SDO: universal and mortgage banks as well as ship financing institutions after being licensed by Finanstilsynet – the Danish banking regulator

Restrictions on business activities

SDRO: All types of mortgage lending as well as some ancillary activities. SDO: no

Asset allocation

Universal banks are required to register assets that serve as collateral for covered bonds in a separate cover pool. In the case of mortgage banks, cover assets remain on the balance sheet and have to be allocated to a specific series.

Inclusion of hedge positions

Hedge positions cannot be included in the asset pool, but the so-called balance sheet principle provides a protection against mismatching

Substitute collateral

Up to 2% substitute collateral may be used temporarily

Restrictions on inclusion of commercial mortgage loans in the cover pool

No

Geographical scope for public assets

Not applicable

Geographical scope for mortgage assets

No legal limitations, but the issuer’s strategy is focused on domestic business

LTV barrier residential

80% for residential mortgages with maximum maturity of 30 years and maximum interest-only period of 10 years; 70% (75% from 2009) for residential mortgage loans with longer maturity and/or interest only periods; 60% for secondary residences; 84% for subsidised housing facilities with a public sector guarantee for 65-84%)

LTV barrier commercial

60% for industrial and commercial real estate (may be raised to 70% under certain conditions); 70% for agricultural mortgage loans and 40% for other types of real estate, including undeveloped land

Basis for valuation = mortgage lending value

Market value

Valuation check

Annual examination

Special supervision

Yes. Finanstilsynet – the Danish banking regulator

Protection against mismatching

We believe the protection against mismatching is very strict. The so-called ‘general balance principle’ restricts market and liquidity risk

Protection against credit risk

–

Protection against operative risk

No. Neither a back-up servicer nor a cover pool administrator is stipulated

Mandatory over-collateralisation

No

Voluntary over-collateralisation is protected

Yes

Bankruptcy remoteness of the issuer

No, but the assets within the cover pool are exempt from bankruptcy proceedings

Outstanding covered bonds to regulatory capital

–

In the event of insolvency first claim is on:

All mortgages

External support mechanisms

In the event of insufficient pool assets proceeds to cover their claim, mortgage bond investors rank ahead of senior debt holders. In addition, shareholders may extend some other form of support (eg, guaranteeing the ‘top slice’ of the mortgage loans)

UCITS Art. 22 par. 4 compliant?

Yes

CRD Annex VI, Part 1, §65 compliant?

Yes

Source: Barclays Capital

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PFANDBRIEF MARKET

Jumbo market structure and spread development Fritz Engelhard +49 69 7161 1725 [email protected]

Spill-over from the financial market crisis

Issuance of jumbo Pfandbriefe began in June 1995. Initially, the market grew exponentially and in 2003, a peak of €413bn of outstanding jumbo Pfandbriefe was reached. However, since mid-2004, volumes have decreased persistently. In mid-May 2010, the total volume of outstanding jumbo Pfandbriefe stood at €208bn. At that time, the market consisted of 25 issuers, with a total of 144 issues. The current average size of jumbo Pfandbriefe is €1.5bn. From mid-2007 onwards, swap spreads of jumbo Pfandbriefe started to widen. On the back of low secondary market turnover, the widening trend was relatively constrained until Q3 08. The events surrounding Hypo Real Estate Group in early October led to a significant swap widening and swap spreads reached a peak around mid swaps +100bp in Q1 09. Over the past 12 months the significant tightening move has led swap spreads back down to 20bp. While average spreads between mortgage and public sector Pfandbriefe diverged and widened from 1bp in mid-2007 to a peak of 10bp in September 2008, the trend reversed and in Q1 09 mortgage Pfandbriefe were quoted on average about 5bp tighter. Currently, the spread differential between both types of Pfandbriefe is negligible.

Figure 205: Development of outstanding volume and avg size €bn

€bn

450 400 350 300 250 200 150 100 50 0

3.6

Figure 206: Market share, May 2010 MUNHYP 4%

3.0

BYLAN 5%

2.4 1.8

DGHYP 6%

1.2

HVB 7%

0.6 0.0 95

97

99

01

03

05

07

WLBANK 4% DEXGRP 4% BHH 5%

LBBW 8%

09

Jumbo Mortgage Pfandbriefe Jumbo Public Pfandbriefe Average size of Jumbo Pfandbriefe (RS)

Figure 207: Spread development

Other 20%

EURHYP 23% HYPORE 14%

Figure 208: Credit term structure of major issuers, May 2010 Barcap OAS

120

140

100

120

80

100

60

80

40

60

20

40

0

20

-20 99

00

01 02 03 04 05 06 07 08 09 iBoxx Euro Oeffentliche Pfandbriefe ASM iBoxx Euro Hypothekenpfandbriefe ASM

10

0 2009 EURHYP

2012

2014 BHH

2017 HYPORE

2020 HVB

Source: Barclays Capital

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Background Four types of Pfandbriefe

Pfandbriefe can be traced back to the 1800s

Mortgage Banking Act became effective in 1900

Pfandbrief Law and Ship Banking Act became effective in 1927 and 1933, respectively

Internationalisation of the Pfandbrief leads to a refinement of the legal framework

Introduction of the German Pfandbrief Act in 2005

10 June 2010

Pfandbriefe bonds are German debt instruments backed by either public sector loans (Öffentliche Pfandbriefe = Public Sector Pfandbriefe), claims secured by mortgages on real estate (Hypothekenpfandbriefe = Mortgage Pfandbriefe), ship mortgages (Schiffspfandbriefe = Ship Mortgage Pfandbriefe) or aircraft mortgages (Flugzeugpfandbriefe = Aircraft Mortgage Pfandbriefe). Issuance is based on the German Pfandbrief Act, which came into force on 19 July 2005. As of February 2010, there was a total of €705bn of outstanding Pfandbriefe across all four categories, although the vast majority, €472bn, or 67%, consisted of public sector Pfandbriefe. The first Pfandbriefe bonds were issued in 1769 in areas such as Silesia, where Frederick II sought to relieve poverty after the devastating 1756-63 Prussian War. The bonds were backed by landlords’ property. By 1770, “Landschaften” were established as public law associations of landowners who, in turn, refinanced these through “Hypothekenpfandbriefe” bearer bonds. A revival of the collateralised idea took place in the mid-19th century, with the majority of Pfandbriefe bonds issued by public law credit institutions. Soon after this, the direct claims of a bondholder to the mortgaged property were abandoned in favour of the “asset pool” concept. In 1900, the Mortgage Banking Act (MBA) came into effect. It was the first explicit legal framework for the issuance of Pfandbriefe and it contained a number of important features, such as the protection of cover assets against an insolvency of the issuing bank, the stipulation of eligibility criteria and a special regulatory oversight. Under the MBA, the business activities of Pfandbrief banks were limited to mortgage and public sector lending and the banks were allowed to issue both public sector and mortgage Pfandbriefe. Only socalled “mixed mortgage banks” had the privilege to follow other business activities as well. In 1927, the Pfandbrief Law (PL) for public sector banks became effective. It gave public sector credit institutions the right to issue public sector and mortgage Pfandbriefe. Compared with the MBA, the provisions of the PL were somewhat less stringent. This was particularly apparent with respect to the lack of supervisory control, the absence of a 60% LTV limit and the lack of strict rules for the application of mortgage lending value principles. The Ship Banking Act (SBA) became effective in 1933. Ship mortgage banks were limited to ship mortgage and public sector lending, and the banks were allowed to issue both public sector and ship mortgage Pfandbriefe. There has been remarkably little change in the different frameworks for Pfandbrief banks. However, with the introduction of the euro and the general opening up of international capital markets in the 1990s, Pfandbrief banks reacted by introducing the jumbo model in 1995. The broadening of the investor base helped Pfandbrief banks to grow their businesses. At the same time, the safety mechanism of the Pfandbrief framework came under scrutiny. This resulted in a series of amendments, which related mainly to the protection of the claims of Pfandbrief investors in an insolvency scenario and stricter rules for asset liability matching. In 2005, the German Pfandbrief legislation was harmonised and the German Pfandbrief Act was introduced. This was driven mainly by two factors. First, the quality of Pfandbriefe had been threatened by the withdrawal of the state guarantees from German Landesbanks and savings banks issued under the PL, due to the legislation’s weak provisions. The second important factor in the creation of the Pfandbrief Act was the problem of maintaining a different level playing field for mortgage and public sector lending business between pure mortgage banks, mixed mortgage banks, public sector banks and commercial banks 188

Barclays Capital | AAA Handbook 2010

without Pfandbrief privileges. There was no compelling reason to expose the various types of credit institutions to different business restrictions for entering and doing mortgage and public sector business. Pfandbrief Act triggers a series of strategic decisions

Fallout from financial market crisis

The introduction of the Pfandbrief Act sparked a series of interesting strategic decisions from several issuers. The most obvious of these developments was the integration of specialised mortgage banks into the operations of their parent companies. Elsewhere, WestLB AG announced that it would resume public sector Pfandbrief issuance out of Germany and also Deutsche Kreditbank AG, a member of Bayern LB Group, started issuing public sector Pfandbriefe. More recently, Deutsche Postbank (in 2007), Deutsche Apotheker and Ärtztebank (in 2008) and Deutsche Bank (2009), all received Pfandbriefbank licences, but with a focus on mortgage Pfandbrief business. The failure of Hypo Real Estate Group in Q3 08 highlighted the limitations of running aggressive liquidity and credit spread risk positions within public sector covered bond programmes. Figure 209 highlights that the non-realised losses of the securities holdings of some German Pfandbriefbanks exceeded the reported equity at YE 09.

Figure 209: 2009 balance sheet data of German Pfandbriefbanks Reported nonrealised net losses (€mn)

Tot. Securities holdings (€mn)

Aareal Bank AG

298

14,136

39,569

2,077

14%

53%

Bayerische Hypo- und Vereisbank AG

934

92,022

309,076

23,638

4%

24%

Name

Tot. assets (€mn)

Reported nonSecurities realised net classified as fixed Tot. equity losses in % of assets in % of tot. (€mn) tot. equity securities

Berlin Hannoversche Hypothekenbank AG

82

12,776

41,291

789

10%

44%

Deutsche Hypothekenbank Hannover AG

161

12,303

34,050

655

25%

95%

2,461

40,921

272,944

2,491

99%

92%

472

18,343

47,291

331

143%

76%

Deutsche Pfandbriefbank AG Dexia Kommunalbank AG DG Hyp AG Düsseldorfer Hypothekenbank AG Eurohypo AG

1,280

26,046

68,075

1,426

90%

100%

382

13,425

24,170

307

124%

98%

1,858

60,750

216,312

5,654

33%

71%

Muenchener Hypothekenbank eG

175

6,831

35,733

763

23%

94%

WL-Bank AG

362

14,603

43,380

330

110%

89%

Source: 2009 Annual Reports according to German GAAP, Barclays Capital

While in Q4 08/Q1 09 the exposure of Pfandriefbanks to financials was the main factor that led to an increase of non-realised losses, recent spread volatility in sovereign debt markets leads to new concerns. According to the latest available data from the German association of Pfandbriefbanks (vdp), as of 31 December 2009, German Pfandbriefbanks had a combined €87.5bn of exposures to Italy (€37.6bn), Spain (€25.1bn), Greece (€14.1bn), Portugal (€7.6bn), and Ireland (€3.0bn). These exposures are held inside as well as outside the cover pools of the respective public sector Pfandbriefe and may consist not only of government bonds, but also of exposures to sub-sovereigns. As a breakdown of these data by company is generally not available, we have taken a closer look at the data for the public sector cover pools of selected Pfandbriefbanks. (Figure 210).

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Figure 210: Public sector cover pool exposures of selected German Pfandbriefbanks to Italy, Spain, Greece, Portugal and Ireland (in €mn)

Ticker

Total cover pool

IT

SP

GR

PT

IR

GR, PT, IR, SP, IT in % of GR, PT, IR, SP, Reporting total cover IT in % of total date pool equity

AARB

3,179

0

55

25

184

89

31 Dec 09

11%

17%

BHH

12,874

228

250

0

137

0

31 Dec 09

5%

78%

BYLAN

49,368

27

0

0

424

105

31 Dec 09

1%

3%

DHH

16,648

65

30

20

670

1,319 31 Dec 09

13%

321%

DEXGRP

36,336

637

334

30

750

1,909 31 Dec 09

10%

1105%

DGHYP

33,468

880

900

50

4,883 1,853 31 Dec 09

DUSHYP

10,466

152

230

13

EURHYP

66,825

35

131

0

26%

601%

30 Sep 09

13%

429%

2,179 1,285 31 Dec 09

5%

64%

639

50

285

HVB

9,762

136

0

0

HYPORE

59,024

3,718

1,980

0

LBW

72,706

823

0

0

271

832

31 Dec 09

3%

17%

MUNHYP

11,664

68

95

23

164

120

31 Dec 09

4%

61%

WESTLB

11,032

100

170

35

351

0

31 Dec 09

6%

16%

WLBANK

25,804

362

967

589

31 Dec 09

8%

608%

Total

419,155 7,231

-

10%

57%

155

0

4,330

196

31 Dec 09

2%

1%

2,496 7,194 31 Dec 09

0

26%

618%

14,165 15,580

Source: Company data, Barclays Capital

Downturn in public sector Pfandbrief business accelerates

Most public sector Pfandbrief portfolios are basically in a wind-down mode. As a result, the downturn in public sector Pfandbrief business accelerated in the course of 2008. Bundesbank data indicate that the y/y change of listed public sector Pfandbriefe decreased from around -4.5% in mid-2007, to a new historical low of -22.5% in September 2009. In February 2010, the total volume stood at €284bn, down €422bn, or 59.8%, from its peak in August 2000.

Figure 211: Listed Pfandbriefe – outstanding volume €bn 900

Figure 212: Listed Pfandbriefe – y/y change y/y change 40%

800

30%

700

20%

600 500

10%

400

0%

300

-10%

200

-20%

100 0

-30% 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 Mortgage Pfandbriefe

Source: Bundesbank, Barclays Capital

10 June 2010

Public Sector Pfandbriefe

60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 Mortgage Pfandbriefe

Public Sector Pfandbriefe

Source: Bundesbank, Barclays Capital

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Incentives of funding commercial mortgage portfolios with Pfandbrief issuance

Proposals to amend the Pfandbrief Act

In contrast to the public sector Pfandbrief business, issuance of mortgage Pfandbrief business improved over the past two years. This has been partly the result of the ongoing freeze in securitisation markets and the challenging funding conditions in non-secured debt markets. In addition, pressure on Pfandbrief spreads has been particularly low, due to the traditionally strong faith in the product, the broad domestic investor base, the issuers’ ability to place bonds in registered format and the persistent decrease of outstanding public sector Pfandbriefe. Consequently, from an issuer’s point of view, the relative economics of using the Pfandbrief market for funding commercial real estate portfolios have been rather good. This is reflected by the fact that many Pfandbriefbanks, which focus on commercial mortgage lending, since mid 2007 concentrated on making this business eligible for Pfandbrief funding. However, rating agencies are in an ongoing process of adjusting their valuation models and an increase of haircuts on cover assets could potentially be significant on commercial real estate portfolios. Such amendments may have a negative impact on the economics of using commercial mortgage collateral. Finally, the fact that new Pfandbrief programmes with a focus on residential mortgages have been launched highlights the fact that funding has also become more attractive in this space, albeit competition from funding via deposits remains severe. On 24 March 2010, the German government presented amendments to the Pfandbrief Act to the German parliament. The draft bill has the objective of adapting to market developments and maintaining the Pfandbrief’s attractiveness for issuers and investors. Importantly, the proposed amendments contain rules that are designed to clarify the status of the Pfandbriefbank in a stress scenario. The new rules stipulate that the non-insolvent part of the Pfandbriefbank should be able to continue to operate under the existing legal entity and banking licence. The special administrator would be enabled to continue all banking operations, which help ensure the proper management of the Pfandbrief business. These rules were designed to facilitate the liquidity management of the Pfandbriefbank in a stressed environment. In particular, they may allow a Pfandbriefbank to have continued access to central bank liquidity facilities. Furthermore, a number of other amendments have been made in order to clarify liabilities of the Pfandbrief trustee and set minimum standards for the reporting dates with regards to the information that needs to be published under transparency rules. From an investor’s point of view, the new regulations, in particular the rules addressing the legal status of the Pfandbriefbank may help improve the liquidity position of a Pfandbriefbank in a stress scenario and thus could be a positive for the quality of the Pfandbrief. Furthermore, to the extent that rating agencies give credit to these new rules, they may also help further reduce rating volatility.

Reduced spread volatility in jumbo Pfandbriefe

10 June 2010

Within the European covered bond sector, jumbo Pfandbriefe were the first sector were swap spreads decreased close to those levels observed prior to the acceleration of the financial market crisis in Q4 08. Figure 213 below indicates that spread volatility has been less pronounced in the jumbo Pfandbrief market compared to other jumbo covered bonds and for the moment, Pfandbriefe did not suffer at all from renewed volatility in sovereign bond markets of European peripheral countries.

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Figure 213: iBoxx Covered and iBoxx Germany Covered 200 180 160 140 120 100 80 60 40 20 0 -20 1999

2000

2001

2002

2003

2004

iBoxx Euro Covered 5-7 ASM

2005

2006

2007

2008

2009

2010

iBoxx Euro Germany Covered 5-7 ASM

Source: Barclays Capital

Strengths

Weaknesses

The key strengths of the Pfandbrief framework are: „

Cover assets are separated from the balance sheet through registration. In the case of issuer insolvency, cover assets are not subject to insolvency proceedings.

„

Cash flow adequacy is secured through the stipulation of net present value cover, which also has to be tested against stress scenarios. In addition, through specific rules, liquidity over at least 180 days following the take over of the Pfandbrief business by the Cover Pool Administrator is ensured through specific regulations.

„

Rigorous surveillance as well as detailed rules regarding transparency. In addition, there is strong institutional support for the Pfandbrief product.

The relative weaknesses of the Pfandbrief framework are outlined below: „

Pfandbrief’s quality depends, in many cases, on the maintenance of voluntary overcollateralisation, which can be subject to change, particularly in a stress scenario.

„

Through the mortgage-lending value approach, there is typically a delay before property price developments are reflected in the valuations of mortgage cover assets. This can become problematic if there is a pronounced downturn in the property market.

Overview Under the Pfandbrief Act, the ability to issue Pfandbriefe is subject to the fulfilment of operational, regulatory and asset-quality requirements

10 June 2010

The issuance of Pfandbriefe is subject to the fulfilment of specific requirements. These requirements refer to regulatory approval, the operational set-up and the quality of cover assets. The regulatory prerequisites consist of the requirement that issuers must possess a general banking licence and that BaFin, the German banking regulator, assigns a specific Pfandbrief licence separately for each type of Pfandbrief. According to article 2(1) of the Pfandbrief Act, the Pfandbrief issuance is permitted in the following scenarios. „

When the bank has a minimum core capital of €25mn.

„

If it has permission to carry out lending business.

„

When it has appropriate risk management rules and instruments for running and controlling the cover business and the Pfandbrief issuance in place.

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BaFin is empowered to assign and to withdraw the Pfandbrief licence Operational requirements also include transparency rules

„

If the company’s business plan and organisational set-up reflect the commitment to do Pfandbrief business on a regular basis.

„

If it maintains adequate operational structures and resources for the respective types of cover business.

According to article 2 (2) of the Pfandbrief Act, BaFin is empowered to withdraw the licence if the pre-requisites listed above are no longer fulfilled or if no Pfandbrief has been issued for two years and none can be expected to be issued within six months. Article 2(1) reveals that, beyond the formal requirements for issuing Pfandbriefe, the legal framework also stipulates a series of operational requirements. These mainly include rules about risk management capacities, professional expertise and the overall operational set-up. In addition, Article 28 stipulates specific reporting standards, which oblige Pfandbrief issuers to publish data on collateral quality and market risk indicators on a regular basis. The transparency rules stipulate the reporting of the following data on a quarterly basis. „

The nominal and the present value of cover assets and outstanding Pfandbriefe, as well as the calculated net present value.

„

Term to maturity and fixed interest periods of assets and liabilities broken down into annual brackets for the next five years, as well as from five to 10 years and over 10 years.

„

The share of derivates in the cover pool.

„

The stratification of cover assets across loan size brackets geographical origin and loan type.

„

The volume of payments that are 90 days in arrears across different regions.

Article 28 of the Pfandbrief Act also stipulates the reporting of collateral information on an annual basis. According to these rules, the annual report has to contain information about the number of foreclosures and forced administrations, the number of properties which were taken over to avoid losses, the volume of in-arrears for which no provisions were made and the total amount of repaid mortgages. Non-guaranteed debt of public sector credit institutions is not eligible for public sector Pfandbriefe

There are additional safety measures that refer to the asset quality of the underlying portfolio. In particular, non-guaranteed debt issued by public sector credit institutions is not eligible for the cover pool of a public sector Pfandbrief. With respect to mortgage Pfandbriefe, the application of mortgage lending value principles is stipulated. An additional feature of the Pfandbrief Act is the stipulation of a specific control of the Pfandbrief business and, in particular, of the evaluation of cover assets by the German banking regulator, at least every two years.

Qualifying collateral Public sector cover assets

Mortgage cover assets

10 June 2010

Public sector loans that are refinanced through Pfandbriefe may only be granted to public authorities within the European Union (EU), the European Economic Area (EEA), Canada, Japan, Switzerland and the US, where the risk weighting of the public authority is 20% or less. However, as mentioned above, business with non-EU countries, in which the preferential claim of the Pfandbrief holder is not recognised, is limited to 10% of all EU business, and business where the preferential claim is recognised. In addition, public sector exposures to member states outside the EEA are restricted to assets of credit quality step 1 (with a minimum AA- rating). In the case of mortgage Pfandbriefe, only mortgage loans (or a portion thereof) with a loanto-value ratio not exceeding 60% qualify for inclusion in the asset pool. In addition, the respective mortgages have to be evaluated according to mortgage lending value principles. 193

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The geographical scope of eligible mortgage business contains the following areas: EEA countries Switzerland, the US, Canada and Japan. Mortgage loans to non-EU countries, in which the preferential claim of the Pfandbrief holder is not recognised, are only allowed up to an amount of 10% of the sum of total EU mortgage loans and mortgage loans in countries with a preferential claim. In case of ship mortgages, this limit is raised to 20%. In addition, the Pfandbrief Act stipulates that Pfandbrief banks, which want to enter new business areas, such as the Japanese property lending market, have to prove that they have operated in this business successfully on a non-cover basis for two years before they may get approval for making it eligible for Pfandbrief cover. Substitute cover assets

The Pfandbrief Act also allows for the inclusion of substitute assets. Up to 10% of the nominal volume of Pfandbriefe outstanding may consist of money claims against the European Central Bank or central banks in the European Union, or against “adequate” (“geeignete”) credit institutions. In the case of mortgage Pfandbriefe, the part of those 10% not being exhausted by these asset types and then up to 20% may consist of cover assets eligible for public sector Pfandbriefe (Article 19 (3) Pfandbrief Act). In addition, substitute exposures, including claims against financial institutions, are restricted to assets of credit quality step 1 (with a minimum AA- rating) in case they are against issuers outside the EEA.

Derivatives allowed

Long positions in derivatives – such as swaps and options – are eligible to be used as collateral for Pfandbriefe issued under the Pfanbrief Act, on condition that they do not exceed 12% of the NPV of the collateral pool. They have to be marked to market on a daily basis.

up to 12%

Regulatory oversight of assets Compliance monitored by BaFin, which also appoints a trustee who supervises and controls cover pool assets

BaFin regularly audits compliance to Pfandbrief Act

Compliance with the Pfandbrief Act is monitored by BaFin. The registration of assets is supervised and controlled by a trustee who is appointed by the BaFin after consultation with the mortgage bank. In addition, the trustee monitors the compliance with other provisions of the Pfandbrief Act. Together with the Pfandbrief bank, the trustee has joint custody of the assets included in the cover pools and of any documents evidencing such assets. The trustee may release such assets to the Pfandbrief bank only under circumstances expressly provided for by statute. Moreover, the Pfandbrief bank may remove any assets from the pool only with the permission of the trustee. Any issuance of Pfandbriefe may take place only upon prior certification by the trustee that the Pfandbriefe to be issued meet all statutory requirements. In addition to the monitoring conducted by the trustee, BaFin should conduct audits at least every two years, which focus particularly on assets that were newly added to the pools. BaFin also supervises compliance of Pfandbrief banks within the provisions of the Pfandbrief Act, including approval of valuation guidelines for mortgaged property, approval of the principal characteristics of the provisions of the loans, the resolution of disputes between the bank and the trustee, and the enforcement of the limitations on the issuance of Pfandbriefe.

Asset/liability risk management Net present value cover stipulated

10 June 2010

The nominal value of the cover assets must permanently be higher than the total value of the Pfandbriefe and the interest income must at least be the same. This is stipulated in § 4(1) Pfandbrief Act. Moreover, § 4(2) Pfandbrief Act requires that Pfandbriefe are covered on a net present value basis and also stipulates a 2% over-collateralisation. This 2% applies equally to mortgage and public sector Pfandbriefe pools and is designed so that maintenance and one-off costs could be paid for in case the issuer becomes insolvent. Details with respect to the net present cover are regulated in secondary legislation. In July 2005, the Bafin issued the ‘Present Value Rules for Pfandbrief Banks’ (“Barwertverordnung für Pfandbriefbanken”), which stipulated that at no point in time over the next six months 194

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without any new injections should there be a cover ratio below 100% between the collateral assets (incl. derivatives) and the Pfandbriefe bonds used to finance the collateral loans. Specific liquidity management requirements

Furthermore, Pfandbriefbanks are obliged to ensure that over the next 180 days, payments which are due on the Pfandbriefe are always covered by sufficient liquidity on the asset side. For this matter, Pfandbriefbanks need to calculate the cumulative sum of the daily net liquidity position for the next 180 days. The largest negative sum (liquidity shortfall) over the 180 day period needs to be fully covered with ECB eligible substitute assets.

Bankruptcy remoteness and payment in case of insolvency Pfandbriefe creditors enjoy preferential claim in case of insolvency

Pfandbriefe not subject to acceleration in case of insolvency

Banking regulator may request the appointment of a Cover Pool Administrator

10 June 2010

In the event of a Pfandbrief bank's insolvency – something that has never occurred – the provisions of Pfandbrief Act stipulate that the claims of holders of Pfandbriefe will be satisfied out of the asset pools (accordingly, the assets therein are "ring-fenced"), thereby taking priority over all other creditors in bankruptcy. In the event of the opening of insolvency proceedings with respect to a mortgage bank, the outstanding Pfandbriefe, unlike the other debt obligations of the mortgage bank, will not be accelerated. The cover pools will be treated as separate assets and will not be part of insolvency proceedings. Only if a pool becomes insolvent will a separate insolvency proceeding be opened. To the extent that the assets in the cover pools are then not enough to meet the liabilities, the Pfandbriefe investors rank pari passu with other creditors for the issuers remaining assets. In an insolvency scenario, an additional person, called the Cover Pool Administrator (CPA), would be appointed by the local court upon the authorisation of the Bafin. The CPA is entitled to arrange bridge financing but is not able to issue new Pfandbriefe. However, Article 30(2) contains wording that would allow the CPA to represent the Pfandbriefbank vis-à-vis third parties. This helps improve the ability to raise liquidity in a stress scenario. The CPA would also be able to transfer the collateral pool, or parts of the collateral pool to a sound Pfandbrief bank. The liquidator will also not have access to any of the over-collateralisation unless the liquidator can expressly prove that the collateral is obviously not needed for the Pfandbriefe holders. This also holds true with respect to the interest from collateral assets.

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Pfandbrief Act

Name of debt instrument(s)

Hypothekenpfandbriefe, Öffentliche Pfandbriefe, Schiffspfandbriefe, Flugzeugpfandbriefe.

Legislation

German Pfandbrief Act effective since 19 July 2005.

Special banking principle

No, the use of each of the respective Pfandbrief types is subject to a licence.

Restrictions on business activities

Not applicable.

Asset allocation

Cover assets remain on the balance sheet, but are maintained in a separate cover registers.

Inclusion of Hedge Positions

Hedge positions can be included in the cover register, but the volume is limited to 12% of the pool's value at that time.

Substitute collateral

Up to 10%.

Restrictions on inclusion of commercial mortgage loans in the cover pool

No.

Geographical scope for public assets

Central governments and sub-sovereigns with a maximum 20% risk weighting in EEA countries, Switzerland, the US, Canada and Japan; public loans to non-EU countries in which the preferential claim of the Pfandbrief holder is not recognised are only allowed to an amount of 10% of the sum of total public loans with EU countries and countries with a preferential claim.

Geographical scope for mortgage assets

EEA countries Switzerland, the US, Canada and Japan. Mortgage loans to non-EU countries, in which the preferential claim of the Pfandbrief holder is not recognised, are only allowed to an amount of 10% of the sum of total EU mortgage loans and mortgage loans in countries with a preferential claim.

LTV barrier residential

60%.

LTV barrier commercial

60%.

Basis for valuation = mortgage lending value

Yes; "durch sorgfältige Ermittlung festgestellter Verkaufswert" (prudently assessed market value).

Valuation check

Regular (every two years) examination of the cover register stipulated by law.

Special supervision

Yes; Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), the German banking regulator and an independent trustee.

Protection against mismatching

Coverage by nominal value and by net-present value required by law. Specific coverage of liquidity risk over a 180-day period.

Protection against credit risk

The issuer may replace non-performing loans. Further protection may stem from voluntary overcollateralisation.

Protection against operative risk

The regulator is able to request the court appoint up to two cover pool administrator, in addition, there are detailed rules for the transfer of assets and liabilities.

Mandatory minimum overcollateralisation

102%.

Voluntary over-collateralisation is protected

Yes.

Bankruptcy remoteness of the issuer

No, but assets within the cover register are exempt from bankruptcy proceedings.

Outstanding covered bonds to regulatory capital

—

In the event of insolvency first claim is on

All assets earmarked for the respective asset pool. In addition, investors may benefit from positive market values of derivatives.

External support mechanisms

In the event of insufficient proceeds from the pool assets to cover their claim, Pfandbriefe investors rank pari passu with senior debt holders. In addition, shareholder(s) may extend some other form of support.

UCITS Art. 22 par. 4 compliant?

Yes.

CRD Annex VI, Part 1, §65 compliant?

Yes.

Source: Barclays Capital

10 June 2010

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SPANISH MARKET

Overview Spurred by the marked recovery in primary covered bond market activity in mid-2009, Spanish benchmark supply doubled to €17.3bn in 2009, from €8.8bn in 2008. Part of this development was due to the fact that as several smaller savings banks (cajas de ahorro) could access the market at relatively lower funding levels, they opted for an independent issuance of plain vanilla covered bonds instead of participating in pooled issues as before. In 2010, year-to-date issuance stood at €12bn at the time of writing. As a result of the recovery – which, however, has come to an abrupt halt of late because of spill-over effects arising from a pronounced volatility phase of government bonds’ swap spreads – the Spanish benchmark covered bond marked could defend its position as the world’s largest covered bond market in terms of volume. At the time of writing, the aggregate amount outstanding of mortgage and public sector backed Spanish benchmark covered bonds amounted to €263.5bn from 151 deals by 22 different issuers (Figure 214). In mid-May 2009, the market volume still stood at €251bn from 139 benchmark deals. The overall amount outstanding of the historically dominant jumbo Pfandbrief market, in comparison, further declined and stood at €215.6bn from 146 deals at the time of writing, down from €247bn from 159 issues in mid-May 2009.

Leef H Dierks +49 (0) 69 7161 1781 [email protected]

Despite doubling from 2008 when issuance, overshadowed by the global financial crisis, had plummeted to €8.8bn and thus its lowest levels since 2001, the recovery to an issuance of €17.3bn in 2009 is still markedly lower than the average annual volumes in between 2003 and 2007, which oscillated between €32bn and €65bn. In 2010, we estimate issuance to increase to €25bn versus redemption payments of €23bn at the same time. In light of the high correlation between Spanish government and covered bonds and the recent weeks’ rollercoaster ride with regards to swap spread development, however, we expect issuance to remain subdued in the remainder of 2010. Overall, new issuance was strongly geared towards mortgage-backed covered bonds, which dominated 2009 supply. Following the sharp increase in debt issuance on behalf of Spanish Autonomous Communities, which, for some investors, provided a well suited alternative, it was not until March 2010 that the issuance of public sector backed covered-bond was revived. Figure 214: Outstanding Spanish covered bonds a) Outstanding Spanish covered bonds

b) Issuers’ market share, as at June 2010

300

2.0

1.5 200 1.0 100 0.5

0 Jan-00

Jan-02

Jan-04

Jan-06

Jan-08

0.0 Jan-10

Jumbo Covered Bonds outstanding (€ bn) (LS) Average size (€ bn) (RS)

POPSM 4% BANSAB 3%

Others 10%

IMCEDI 5% BANEST 6% CEDTDA 8% CAJAMM 9%

AYTCED 18%

BBVASM 15%

SANTAN 11%

CAIXAB 11%

Source: Barclays Capital

10 June 2010

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Swap spreads: Back to where we stood a year ago

Overall, neither the pick-up in issuance nor the steadily increasing redemption payments have had a material impact on the market shares of Spanish covered bond issuers. As in the years before, the five largest players accounted for a combined 64% of the outstanding volume. Multi-Cédulas issuer AYTCED, Europe’s third-largest issuer with €48.2bn of covered bonds outstanding at the time of writing, accounted for 18% of all volume outstanding, up from 17% in mid-May 2009, followed by BBVASM (15%, up from 14% in mid-May 2009), CAIXAB 11% (down from 12% in mid-May 2009), CAJAMM (unchanged at 9%), and SANTAN (11%, up from 10% in mid-May 2009) (Figure 214). In other words, the (opportunistic) covered bond issuance on behalf of several smaller savings banks that joined the market in 2009, among them BILBIZ, UNICAJ and CAZAR, has so far failed to leave its mark on the market which, as before, remains dominated by the five major players previously outlined. Following the ECB’s May 2009 announcement that it would acquire €60bn of “€denominated covered bonds issued in the euro area” in the period between July 2009 and June 2010, swap spreads of covered bonds started markedly tightening. Owing to their relatively high sensitivity, Spanish covered bonds were among the papers that strongly benefitted from this development. By early October 2009, the iBoxx Euro Spain Covered Index had fallen to 90bp, from 200bp in early May 2009, and thus stood at the same levels as in September 2008. Given mounting concerns regarding the fiscal position of some Mediterranean rim sovereigns, however, by November 2009 the situation started to change again. Following the sharp and abrupt widening of Spanish government bonds swapspreads in Q1 10, the swap spreads of respective covered bonds came under renewed pressure and sharply widened (Figure 215). In particular, longer-dated Spanish covered bonds were affected and traded at their historically widest levels (mid-swaps plus 225bp) in the days before the EU announced its €750bn rescue package.

High correlation with spread development of sovereign debt

Taking into consideration the marked swap-spread contraction of bonds issued by Mediterranean rim sovereigns in the aftermath of the EU’s announcement (Figure 216), swap spreads of Spanish covered bonds are likely to recover in the short term but, in our view, are unlikely to return to “pre-crisis” levels for the foreseeable future, particularly as the situation in the Spanish housing market so far has shown little signs of a broad-based recovery. In addition, the economic situation in Spain with an unemployment rate of 20%,

Figure 215: Swap spread development on the Spanish covered bond markeT a) Swap spread development

b) iBoxx Euro Spain Covered

250

250

200

200

150

150

100

100 50 0 May-04 May-05 May-06 May-07 May-08 May-09 May-10 iBoxx Euro Spain Covered (Swap spread in bp)

50 Oct-08

Feb-09

Jun-09

Oct-09

Feb-10

Jun-10

Spain Covered

1 to 3 years

3 to 5 years

5 to 7 years

7 to 10 years

>10 years

Source: Barclays Capital

10 June 2010

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the steady increase in non-performing loans (NPLs), and the impact of the government’s recently announced austerity measures, as well as the consolidation of the country’s savings banks sector are adding to investors’ perception of a phase of elevated uncertainty. Market is steadily drifting apart

In light of the developments portrayed above, the once relative homogeneity of the Spanish covered bond market has dissipated. Whereas the swap-spread difference between plain vanilla and pooled covered bonds amounted to little more than 20bp in early 2008, it has since increased and amounted to 70bp at the time of writing. Pooled covered bonds, ie, the so-called Multi-Cédulas, have been particularly sensitive to the recent market distortions; a development which, in our view, is due to the fact that as many as 26 different savings banks can participate in selected Multi-Cédulas issues. These often are smaller-sized entities with a strong regional focus. Also, these lenders, among them many we expect to be affected by the consolidation process, often are geared towards (residential) mortgage lending and on several occasions feature sizeable exposures towards property developers. As of late, this strategic alignment has been reflected in steadily rising ratios of NPLs. Thus, irrespective of Multi-Cédulas per se being less exposed to potential risks regarding the geographical concentration of the collateral pool (as a result of the diversification across different non-benchmark covered bond issuers) and the additional protection provided by a liquidity facility, which helps bridge any possible delays in payments related to an issuer event of default, investors have remained distant. Plain vanilla covered bonds issued by larger commercial banks trade at markedly tighter levels (130bp) than those of savings banks (165bp), for example. What is more, plain vanilla covered bonds from larger savings banks, with established (liquid) benchmark curves have on average, over the past few years, traded at significantly tighter levels than covered bonds issued by smaller savings banks which previously limited themselves to an issuance within the scope of pooled covered bonds. Also, the swap-spread difference between Spanish government debt and plain vanilla single-name covered bonds issued by major commercial banks has markedly contracted. On several occasions over the past year, investors could switch out of covered bonds and into sovereign debt with literally no give-up (Figure 217).

a) Swap spread development

b) Correlation analysis, May 2008-May 2010

250

Bonos swap spreads (bp)

Figure 216: Correlation between Spanish sovereign debt and covered bonds

200 150 100 50

y = 71.085Ln(x) - 302.31

200

2

R = 0.6321 150 100 50 0

0 -50 May-08

-50

Nov-08

May-09

iBoxx Euro Spain Covered Source: Barclays Capital

10 June 2010

Nov-09

May-10

50

100

150

200

250

Covered bond swap spreads (bp)

iBoxx Euro Spain (Note: light blue mark = 14 May 2010)

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Figure 217: Market environment a) Swap spread development (in bp)

b) Credit term structure

250

ASW (bp) 250

200 150 200

100 50 150

0 -50 Jan-08

TTM (yrs)

Jul-08

Jan-09

SANTAN 3.500% Feb 14 CAJAMM 5.000% Oct 14

Jul-09

Jan-10

AYTCED 4.000% Apr 14 SPGB 4.750% Jul 14

100 0

5 SANTAN

10 AYTCED

15

20 CAJAMM

Source: Barclays Capital

Impact on covered bonds

The above developments have meanwhile left their mark on Spanish covered bonds which, as outlined above, have been subject to an asymmetrical swap-spread development. With concerns regarding the fiscal position of several Mediterranean rim countries overshadowing the swap spread development of the respective sovereign bonds, covered bonds generally trade on a wider note. Still, the once homogeneous Spanish market has steadily drifted apart over the course of the past few years, affecting Multi-Cédulas in particular, where as many as 26 different savings banks, among them many smaller and regionally active entities, have pooled their (non-benchmark) covered bond issuance. Following the steady increase in the NPL ratio to 5.3% at the time of writing, we believe that the smaller savings banks could come under further pressure, particularly as they generally are less diversified, but more exposed to residential mortgage lending and often have a relatively high exposure to real-estate developers. Property developers, of which many have by now filed for bankruptcy, are among the most affected entities, as their business models rely on intact demand for new dwellings and relatively cheap refunding methods. Despite these conditions being fulfilled until mid-2006, the situation deteriorated afterwards and has affected virtually all Spanish property developers. Following the development observed over the course of the past year, we thus expect the respective coverage and collateralisation ratios to further decline.

Support mechanisms protect

In light of the above, we highlight that despite this increasingly challenging situation, Spanish savings banks benefit from the support mechanism of the CECA. This body not only provides technological and advisory services that are of particular relevance for smaller savings banks, but it also has its own banking licence and is able to provide liquidity and arrange support for distressed savings banks. Furthermore, savings banks benefit from the Spanish Fondo de Garantía de Depósitos – FDG (the Spanish depositor guarantee fund). As no Spanish savings bank has ever defaulted on its obligations since the inception of the sector in 1837, the FDG has accumulated sufficient reserves, which it is authorised to use to rescue or manage the liquidation of a troubled savings bank.

Spanish savings banks

As of late, merger activity among Spanish savings banks (‘cajas’) has started to gain considerable momentum. On 22 May, news emerged that the regulator Banco de España (BdE) had seized control of CajaSur after merger talks with domestic peer Unicaja had failed. As in the case of Caja Castilla La Mancha (CCM), which was seized in March 2008, Banco de España assigned the so-called Orderly Bank Restructuring Fund – Fondo de Reestructuración 10 June 2010

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Ordenada Bancaria (FROB) – as provisional administrator. For the time being, Banco de España, ie, the regulator, and thus not the cajas, seem to be the driving force behind the mergers. This perception could likely be fuelled over the course of the summer if Banco de España believes the consolidation efforts of the cajas are insufficient. With the availability of new loans granted within the scope of the FROB expiring by 30 June, Banco de España has ratcheted up its rhetoric of late, and, in the case of CajaSur, acted decisively. The pressure on the cajas has increased further with Banco de España hinting that it would not seek to extend the 30 June deadline for its banks to apply for aid from the FROB.

Figure 218: The changing landscape of the Spanish savings banks sector Under FROB administration

New Caja Catalana New Unnim

Merging

Merging

Likely merging

Likely merging

Caja Castilla La Mancha

Caixa Catalunya

Caixa Sabadell

CAM

Caja Duero

Caja Murcia

Caja Madrid

CajaSur

Caixa Manresa

Caixa Terrassa

Cajastur

Caja Espana

Caja Granada

Caja Canarias

Caixa Tarragona

Caixa Manlleu

Caja Santander y Cantabria

Sa Nostra

Caixa Laietana

Caja Extremadura

Caixa Penedés

Caja de Avila Caja Segovia Caja Rioja

FROB involvement €1.250bn

€500mn

€1.600bn

€562mn

Source: Company statements, press reports, Barclays Capital

Historical background Two different types of covered bonds

Spanish legislation distinguishes between two different types of covered bonds. Whereas CH are covered bonds backed by Spanish mortgage loans, Cédulas Territoriales (CT) are covered bonds backed by loans granted to the public sector. Yet, Cédulas can also be issued in quasi-structured finance forms, the so-called Multi-Cédulas, backed by smaller regional (savings) banks, which pool resources to issue large liquid jumbos. So far, Multi-Cédulas have been issued by AYTCED, CEDTDA, IMCEDI, and PITCH. Given the pass-through format of any such Multi-Cédulas, investors are not only protected by the same legislative framework as for stand-alone Cédulas Hipotecarias or Territoriales, but they potentially benefit from the diversification offered from the pool of banks participating in these transactions, as well as the provided liquidity back-up. The structure of CH issues is regulated by the 1981 Ley del Mercado Hipotecario and the Mortgage Market Act (MMA), which was amended in 1991 and in 2003. Given that historically, the Spanish mortgage market has largely been based on variable interest rates, which accounted for 98% of all mortgage lending as at end-May 2010, most mortgages have also been financed via floating retail deposits. The CH bonds that existed before 1999 were mostly small domestic issues with limited liquidity. In 1999, the Spanish government made several legal changes, such as exempting EU institutions from the withholding tax on listed bonds and eliminating the need for CH issuers to place “insurance” deposits at the Bank of Spain for each CH issue. In February 2005, the exemption from withholding tax was broadened to include any global investor that is not incorporated in a country regarded as a tax haven. The widened exemption from withholding tax refers to all bonds issued after 7 July 2003 by a credit institution, and thus includes pooled Cédulas that are listed on an exchange and are not purchased by a Spanish investor or investors from tax havens. To help investors benefit from tax exemptions, the credit entity needs to disclose the identity

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and country of residence of the respective bondholders. It also needs to disclose the amount of income paid in each period and identify the respective notes. On 23 April 2008, the exemption from withholding tax was extended to beneficial owners resident in a country or territory considered by Spanish legislation to be a tax haven. These are now eligible for exemption from withholding tax on interest paid from all public debt securities and those private debt securities that are subject to Laws 19/2003, 23/2005 and 36/2007. 66 Little effort in claiming exemption from withholding tax

Strengths

There generally is little effort required in claiming exemption from Spanish withholding tax. More precisely, a form needs to be filled out once, confirming the name of the beneficiary of the interest payments. Only in the case of a change of details, eg, a change of name, does a form with the new information have to be updated and resubmitted. Moreover, a certificate of residence, which should come from local tax authorities, needs to be submitted to the respective clearing houses – Euroclear and Clearstream – on an annual basis. If these two documents are on hand at the clearing house, interest payments on any Spanish covered bond are automatically exempt from the withholding tax at source. Thus, there is generally no need either to report any changes in the volume of holdings or to fill out a form for each bond. In the case of more than one beneficial owner, an additional form must be completed each time a payment is expected. However, as this process is generally automated by the clearing institutions, investors will receive a notification and are asked to reconfirm the respective amounts and the list of beneficial owners two to three days prior to a coupon payment. Overall, we regard the operational effort in receiving a tax exemption on Spanish covered bonds as little different to the procedures for other covered bonds. Among the particular strengths of the Spanish Cédulas framework, in our view, are: CH benefit from a mandatory over-collateralisation, which states that they can only be issued up to 80% of the total registered mortgage book, thus implying an over-collateralisation level of 125%. In case of CTs, this amounts to 143%. In the case of an issuer’s insolvency, however, the entire pool of (non-securitised) mortgage loans supports the CH.

Weaknesses

„

The pool of eligible assets needs to be registered in a separate register and thus is operationally segregated from other assets on an issuer’s balance sheet. This facilitates the execution of the legally embedded explicit duty of the insolvency administrator to ensure an uninterrupted servicing of Cédulas.

„

As the amended regime has introduced the possibility of making use of substitute collateral, investors may benefit from protection against liquidity risk. In addition, when it comes to the issue of Multi-Cédulas, the liquidity enhancement, mostly provided by larger banks, as well as maturity extension language, serve as additional liquidity buffers for the holders of Multi-Cédulas.

Among the relative weaknesses of the Spanish Cédulas framework, in our view, are: „

Both CH and CT are backed by the individual issuer’s total pool of mortgage and public sector loans, respectively. This creates a concern for unsecured investors and depositors with respect to subordination, which could lead to a situation where the respective claims of Cédulas holders are legally challenged.

„

The above is further magnified by the fact that the administration of the cover pool and the issuer’s insolvency would be executed by a single party, which could potentially impede the immediate availability of cash flows in the case of issuer insolvency,

66

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Source: Clearstream, 23 April 2008.

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although the amended legislation now explicitly obliges the insolvency administrator to sustain interest and amortisation payments related to Cédulas throughout the insolvency procedure. „

There is a lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. However, this can be mitigated by detailed and regular reporting on cover pool characteristics and risk management indicators on a voluntary basis.

Collateral for Cédulas Hipotecarias Eligible assets

CH are mortgage certificates, collateralised by first-lien mortgage loans. Eligible assets include residential and commercial mortgage loans registered in Spain and other member states of the European Union. Spanish banking regulations stipulate that the loan-to-value ratio (LTV) for residential mortgage loans must not exceed 80%; ie, the total volume of CH is limited to 80% of the registered loans. In the case of commercial real estate loans, the LTV ratio must not exceed 60% 67. If the level of over-collateralisation drops below the mandatory level then the same amount of ‘underfund’ has to be deposited in cash with the Banco de España. The issuer then has up to three months to restore the overcollateralisation through adding new eligible loans, buying CH from the market, or by redeeming a sufficient level of outstanding CH to re-establish a minimum mandatory level of over-collateralisation. Meanwhile, the bank would have to cover any deficit through depositing cash or government bonds with the Banco de España within 10 days 68.

Introduction of cover pool register

As a result of legal changes that became effective in December 2007, a special register comprising the mortgage loans, public debt and substitute cover assets used to back the CH and CT was introduced. As in other European legislations, such as Germany and Ireland, the register will have to be maintained by the issuers (Article 13). Furthermore, as another consequence of the new legislation, the substitute collateral for CH can account for up to 5% of the total outstanding cover pool (Article 16). 69 Substitute assets can be:

Inclusion of real estate guarantees from EU member states

„

Fixed-rate assets (securities) issued by the Spanish government, the Instituto de Crédito Oficial (ICO), or other member states of the EU.,

„

Fixed-rate assets (securities) quoted on a regulated or an official secondary market with a credit rating comparable to that of the Kingdom of Spain and provided that these securities are not issued by the covered bond issuer or related entities, and that these securities are not backed by any mortgage loans conceded by related entities (ie, including CH, AAA-rated ABS or RMBS)

„

Other assets of low-risk and high-liquidity that will be determined on a regular basis (Article 17).

Furthermore, also owing to the legal changes, the geographical limits for mortgages pooled in the asset cover pool (previously only Spain) were extended to real estate guarantees from other European Union member states. However, the method by which the mortgage lending value of the non-domestic real estate will be assessed has not yet been determined (Article

67

These LTV barriers, however, were revised within the scope of legal changes which became effective in late 2007: the LTV ratio of mortgage loans not granted for the purpose of constructing, renovating, or acquiring residential real estate was lowered from 70% previously to 60% now. The LTV ratio of mortgage loans granted for the construction, renovation, or purchase of residential real estate remained contained at 80%. Besides, loans with an LTV ratio above 80% but below 95% will also be eligible as a cover asset in case an additional bank guarantee or credit loan insurance is provided (Article 5). 68 At the time of writing this was of subordinated relevance as Spanish issuers were over-funded by an average of c.130% to 140%. This, however, is sharply down from the 250% observed until 2007. 69 The capital requirements directive (CRD), in contrast, allows for a 15% limit for substitute cover.

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5). Even though we do not expect any significant changes in the compositions of the respective cover pools in the medium term, the amendment paves the way for an improvement in the geographical diversification in the long term. Public-sector loans and bonds do not yet constitute substitute eligible assets

In contrast to other European legislations, public sector loans and bonds do not constitute eligible substitute assets for CH yet. Similarly, Bonos Hipotecarios, which are mortgage bonds that require individual registration, or mortgage loans that are registered as collateral for Participationes Hipotecarias, do not qualify as eligible assets.

Collateral for Cédulas Territoriales Eligible assets

CT were first issued in April 2003 and are currently regulated by Article 13 of the Ley de Medidas de Reforma del Sistema Financiero, the Financial System Reform Law (FSRL). Eligible assets include loans to states, autonomous communities, local authorities and public sector companies within the EU and EEA (European Economic Area). The range of eligible loans to the public sector is not limited by a rating or a risk weighting, yet, there is no scope to lend outside the EEA. The law pertaining to CT was further strengthened in July 2003 with a new Spanish Insolvency Law, which became effective in September 2004. This law classifies CT holders as special privileged creditors, giving them the same seniority as CH holders over and above those of unsecured creditors. CT are not backed by an explicitly defined collateral pool or a special purpose vehicle, but in fact have seniority on the proceeds of the entire EEA public loan portfolio.

Minimum mandatory over-

Holders of CT potentially benefit from a minimum mandatory over-collateralisation level of 143%; ie, the total volume of CT is limited to 70% of registered loans, giving an exceptionally high level of security in comparison with other public sector covered bond markets. The amount of CT a bank can issue is limited by Spanish law and is tied to the volume of available eligible assets. This pool of eligible assets is dynamic, reflecting redemptions and newly originated public sector loans. Given the possibility of issuance of additional CT, the level of over-collateralisation may vary over time. If this 70% limit were breached, the issuer would need to restore the minimum level of over-collateralisation within three months through adding new eligible loans, buying CT from the market, or by redeeming a sufficient level of outstanding CT to re-establish a minimum mandatory level of over-collateralisation. Meanwhile, the bank would have to cover any deficit through depositing cash or government bonds with the Banco de España within 10 days.

collateralisation of 143%

Regulatory oversight of assets Regulatory oversight by Banco de España

Oversight is enacted by Banco de España. In the case of Multi-Cédulas issued by AYTCED, CEDTDA, IMCEDI, or PITCH, where a pool of smaller mortgage banks pool together (in fixed percentages) to issue jumbo Cédulas by means of a Spanish special purpose vehicle (Fondo de Titulizacion de Activos – FTA) and the appointment of a trustee (Sociedad Gestora), there is an additional layer of control. The trustee is supervised by the Comisión Nacional del Mercado de Valores (CNMV), the Spanish Commission of Securities, and is authorised to act on behalf of the holders of the Cédulas bonds. The trustee’s job is to manage the cash flows even though it does not guarantee the cash flows from the FTA.

Asset/liability risk management Few prepayments

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mortgagors taking out floating-rate mortgages must be offered interest rate caps by the mortgage bank; however, the mortgagors’ awareness of this facility and their take-up has so far been nearly non-existent 70. Law 41/2007 71, which was adopted on 7 December 2007 and makes amendments to Law 2/1981 regarding the Mortgage Market Regulation, stipulates a significant reduction of legal costs 72. Also, the maturity of mortgage loans granted after 7 December 2007 can be extended without the need to cancel and reconstitute the respective loan. Overall, we do not expect these changes to the Spanish mortgage law – such as the extension of the repayment period in selected cases, for example – to have an effect on CH. Additional cash pool in case of Multi-Cédulas

In the case of Multi-Cédulas, there is an additional cash pool to back the Cédulas. The participating banks’ exact contributions into this cash pool are determined by the rating agencies, which determine the amount required to attain the required AAA rating. The size of the pool is generally set to meet a sudden fall in the coupon from a certain percentage of the collateral over a two-year period. The cash is deposited with an ‘arms-length’ institution (eg, a state-owned Instituto de Credito Oficial (ICO) to ensure punctual payment for the Cédulas. Alternatively, a back-up liquidity line has been set up. This institution in turn pays a guaranteed minimum rate of interest on the cash back to the participating banks.

Bankruptcy remoteness and payment in the event of insolvency Cédulas senior to all creditors

CT and CH rank senior to all other creditors. The introduction of new legislation in 2003 meant that this also holds true for Spanish tax authorities and employees’ claims. Should loans fail to cover the Cédulas’ claims in the event of a liquidation, Cédulas would have a senior unsecured claim on all other remaining assets, ranking pari passu with other senior unsecured creditors. CT and CH are an issuer’s direct liabilities (ie, they do not require the use of a special-purpose vehicle) with the underlying cover assets being segregated from other assets on the issuer’s balance sheet. As the cover pool register principle was not introduced until late 2007 however, the timeliness of repayment could previously have been affected. In order to avoid any such delays in payments, the legal basis for an uninterrupted servicing of interest and principal had already been created through the insolvency regime, which became effective in September 2004. Despite the privileged position of Cédulas holders, their claims would immediately be repaid. This is stated in article 146 of the Ley Concursal, the Insolvency Act, which stipulates the "in advance maturity” (vencimiento anticipado) of the respective credits once the liquidation process has started. Nevertheless, articles 14(2) MMA (Mortgage Market Act; Ley del Mercado Hipotecario) and 13(7) FSRL (Financial System Reform Law; Ley de Medidas de Reforma del Sistema Financiero) state that the claims of Cédulas holders should be treated equally as claims against the insolvency estate on the basis of article 84(2.7) Ley Concursal. This means that their claims are subject to article 154(2) and article 59(1) Ley Concursal, which stipulate uninterrupted servicing of interest and principal.

New framework as legal basis for uninterrupted repayment of Cédulas in case of issuer insolvency

Article 154(2) states that "los créditos contra la masa, cualquiera que sea su naturaleza, habrán de satisfacerse a sus respectivos vencimientos, cualquiera que sea el estado del concurso" (credits against the insolvency estate have to be serviced at their respective maturities, irrespective of their origin and irrespective of the state of insolvency). The

70

As at end-May 2010, 98% of all Spanish mortgage loans granted were subject to a variable interest rate. This ratio is largely unchanged from the years before. 71 Source: Boletin Oficial del Estado, 8 December 2007. 72 Average legal costs for the modification of the conditions of a €120,000 mortgage, for example, now are €67 instead of €351 previously.

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limitations of article 56 Ley Concursal, which implies an acceleration of the claims of creditors with a special privilege after a period of 12 months, should be irrelevant for Cédulas holders, as they can refer to articles 14(2) MMA and 13(7) FSRL. Implementation of insolvency law

In co-operation with the Spanish Ministry of Justice (Ministerio de Justicia), selected elements of the Spanish insolvency law (Ley Concursal) were also implemented into the new law. The respective amendments lead to an improved segregation of the collateral pool in the case of insolvency of the issuer (Article 14). The law states that Cédulas holders have a preferential claim over all other creditors with regard to the total amount of mortgage loans serving as collateral for the Cédulas and other substitute assets. Besides, in the case of an insolvency of the issuer, Cédulas holders benefit from a special privilege outlined in section 1, number 1 of Article 90 of the Ley Concursal. Notwithstanding section 2, number 7 of Article 84 of the Ley Concursal, it is stated that interest and amortisation payments related to Cédulas have to be sustained throughout the insolvency procedure. If these payments do not occur, the insolvency administrator has to ensure the respective payments by selling substitute assets. Should these prove insufficient, the insolvency administrator has to conduct other financial operations in order to guarantee the respective payments to the Cédulas holders.

Structured Cédulas bondholders

In the case of Multi-Cédulas, bondholders have direct recourse to the FTA, which in turn has recourse to the individual banks’ portfolios. An independent third party acts as a paying agent. This independent paying agent also manages the cash pool, which acts as a buffer against payment delays if one of the individual banks goes bankrupt. If one of the participating banks cannot maintain over-collateralisation of 125% in the case of CH, there may be an early redemption. In this event, proportional interest and amortisation payments would be made. Multi-Cédulas programmes stipulate that redemptions should also include accrued interest. Should any remaining claims be made on the structured Cédulas transaction, the legal maturity of the FTA would be extended by a further three years until all liabilities are met.

have direct recourse to the FTA

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Spain

Name of debt instrument(s)

Cédulas Hipotecarias (CH), Cédulas Territoriales (CT).

Legislation

Law enshrined on 25 March 1981 (CH) and 22 November 2002 (CT). Amendments on 22 November 2007.

Special banking principle

No; any Spanish bank with eligible assets.

Restrictions on business activities

Not applicable.

Asset allocation

Cover assets remain on the balance sheet, but are maintained in separate coverpool registers.

Inclusion of hedge positions

Hedge positions can be included in the cover register.

Substitute collateral

Up to 5%.

Restrictions on inclusion of commercial mortgage loans in the cover pool

No.

Geographical scope for public assets

Any country is allowed, but only public loans from EEA countries (including sub-sovereigns and publicsector companies) are eligible for collateral.

Geographical scope for mortgage assets

Properties located in the EU.

LTV barrier residential

80%.

LTV barrier commercial

60%.

Basis for valuation = mortgage lending value

No; "valor de tasación" ("estimated value" = market value).

Valuation check

The examination of property valuations is part of the specific surveillance.

Special supervision

Yes; Banco de Espana (Spanish Central Bank).

Protection against mismatching

Coverage by nominal value.

Protection against credit risk

–

Protection against operative risk

No back-up servicer or cover pool administrator is stipulated. Investors may derive comfort from the fact that there are a broad number of Cédulas issuers.

Mandatory overcollateralisation

125% (CH) / 143% (CT).

Voluntary over-collateralisation is protected

Yes.

Bankruptcy remoteness of the issuer

No; only Multi Cédulas provide independence from parents through a reserve fund or a liquidity line and by issuer diversification.

Outstanding covered bonds to regulatory capital

–

In the event of insolvency 1st claim is on

All mortgages (CH)/public loans and credits (CT) are in favour of the issuer (since September 2004, claims of CT investors rank at a similar level of seniority as those of CH investors).

External support mechanisms

In the event of insufficient proceeds from the pool assets to cover their claim, Cédulas investors rank pari passu with senior debt holders.

UCITS Art. 22 par. 4 compliant?

Yes.

CRD Annex VI, Part 1, §65 compliant?

Yes.

Source: Barclays Capital

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FRENCH MARKET

Jumbo market structure and spread development Fritz Engelhard +49 69 7161 1725 [email protected]

Spill-over from the financial market crisis

Since its inception in 1999, the French jumbo market has expanded persistently. As at mid May 2010, the total volume of outstanding €-denominated jumbo French covered bonds was €187bn. The jumbo market consisted of five issuers of Obligations Foncières (OFs), BNPSCF, CFF, CIFEUR, DEXMA, GESCF and SG, and six issuers of French common law covered bonds (FCLCBs), ACAFP, BNPPCB, BPCOV, CDEE, CMCICB and HSBC 73. Furthermore, Caisse de Refinancement Hypothecaire (CRH) has 13 benchmark French covered bonds, with a total volume of €40bn outstanding. Thus, including CRH, currently, there are 100 jumbo French covered bonds outstanding with an average size of €1.9bn. From mid-2007 onwards, swap spreads started to widen. Until Q3 08, the trend was somewhat limited in the OF market, more pronounced for CRH bonds and substantial for FCLCBs. The spread differential between 5y OFs and 5y FCLCBs diverged, widening from an initial 2bp to a peak at 20bp in July 2008. The further escalation of the crisis in H2 08 led to substantial further widening in OF spreads. In Q1 09, the 5y FCLCBs was quoted about 35bp tighter compared with 5y OFs. In the course of 2009 however, the spread differential contracted again and since YE 09 is close to zero again.

Figure 220: Market share, May 2010

Figure 219: Outstanding volume and average size € bn

€ bn

200

3.0 2.5

150

GESCF 1% DEXMA 18%

HSBC ACACB SOCSCF BNPPCB BNPSCF 1% 4% 8% 3% 1% BPCOV 2% CDEE 1%

2.0 1.5

100

1.0

CFF 26%

50 0.5 0.0

0 99 00

01 02

03 04 05

06 07 08

CRH 21%

09 10 CMCICB 5%

Jumbo French Common Law Covered Bonds Jumbo Obligations Foncières & CRH Average size of Jumbo Covered Bonds (RHS) Source: Barclays Capital

CIFEUR 9%

Source: Barclays Capital

73

Note that since 1 July 2008 onwards, the iBoxx € France Covered Index has been further split into an iBoxx € France Covered Legal (incl. CRH) and an iBoxx € France Covered Structured component.

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Figure 222: Sector credit term structures

Figure 221: Spread development 160

Barcap OAS

140

80 70 60

120 100

50 40 30 20 10

80 60 40 20 0 -20 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 iBoxx Euro France Covered ASM 5Y France (OF) 5Y France (SCF) Source: Barclays Capital

0 -10 -20 2009

2012

2014 OF

2017 FCLCB

2020

2023

2025

CRH

Source: Barclays Capital

Background French Mortgage Bank Act 1999 ensured prior claims of mortgage bondholders in the event of insolvency

Implementation of CRD into French law triggers amendments to the OF framework

CRH more strongly resembles other statutory covered bond products

Legislation on the mortgage markets in France dates back to 1852, although until recently, it was cumbersome. Furthermore, the French Bankruptcy Act of 1985 failed to recognise the senior claims of mortgage bondholders, making their issuance rather unattractive. Given this background, most secured debt issuance prior to 1999 was executed through MBS or ABS-type vehicles or the CRH. The introduction of the French Mortgage Bank Act in 1999 finally paved the way for a jumbo covered bond approach. The resulting Sociétés de Crédit Foncières (SCFs), which are allowed to issue Obligations Foncières (OFs), are exempt from the 1985 Bankruptcy Act. As in other European countries, the implementation of CRD into French law triggered changes to the regulations for SCFs. This was basically made through Ordonnance 2007571 from 19 April 2007 and Decree 2007-745 from 9 May 2007. The respective changes in the legislative and regulatory parts of the French Banking Act primarily were made to ensure compliance of OFs with CRD rules. In particular, the limit for substitution assets was lowered to 15% from 20%. In addition, several amendments were made to modernise the legal framework and make it more flexible to respond to the changing needs of the French industry. Importantly, in Article R515-6 of the Banking Code, the limit on the inclusion of guaranteed housing loans was raised to 35% from 20%. On 31 October 2006, the French banking regulator (Commission Bancaire) attributed a 10% risk weighting to the debt of CRH. This reflected an amendment to the French Banking Act, which clarified the privileged access of debt investors to its assets. 74 The decisions regarding CRH helped the respective debt product to more strongly resemble other traditional covered bond products, which are equally based on a statutory regime. Issuance through the jumbo model generally is handicapped by CRH’s lack of operational flexibility. Yet, since early 2008 efforts have been made to introduce a smoother approach when it comes to new offerings. A more detailed explanation of CRH can be found in the ‘Profiles’ section of this book, and at the end of this chapter there is an overview in table form.

74

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The amendment was made through law Nr. 2006-872 from 16 July 2006.

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Development of common law covered bond products

Introduction of legal framework for Obligations à l’Habitat and ability to retain own covered bonds

Separate discussion of OFs and common law covered bonds

In November 2006, BNP Paribas presented the first French common law covered bond programme. Basically, the bank chose this route because it could use its collateral more efficiently than with the established legal framework for OFs. In the course of the past two years, other major French banking groups followed this example and set up FCLCB programmes: Groupe Crédit Mutuel, which set up the CM-CIC Covered Bonds programme; Groupe Banques Populaires, which launched the Banques Populaires Covered Bonds programme; Caisse Nationale des Caisses d’Épargne et de Prévoyance, which set up the GCE Covered Bonds programme; Crédit Agricole, which set up the Crédit Agricole Covered Bonds programme; Caisse Interfédérale de Crédit Mutuel (CICM), which set up the Crédit Mutuel Arkea covered bond programme and HSBC France, which set up the HSBC Covered Bonds (France) programme. On 16 December 2009, the French government presented a number of new banking regulations 75, which also included the introduction of a legal framework for Sociétés de Financement de l’Habitat (SFHs), which will have the right to issue Obligations à l’Habitat (OHs). For these entities there will be no limit on the inclusion of guaranteed loans in their cover pools. We would expect the majority of those banks who so far issue French common law covered bonds to either convert their existing funding entities into SFHs, or create a new SFH. Furthermore, the draft law includes rules that would enable SCFs and SFHs to retain own-bonds for short periods in order to use these as collateral for central bank repo transactions. This would help facilitate liquidity management in a stress scenario. The technical part of this section of the AAA Handbook is split into two. In the first part, we describe the OF framework. In the second part we describe French common law covered bonds. At the end of the section, there are separate summary tables for both instruments and also a summary table for CRH covered bonds.

Part 1: Obligations Foncières OF issuers with quite different approaches to the covered bond business

OFs are backed by a dynamic pool of public sector assets, mortgage assets or a combination of both. To issue OFs, the respective SCFs must apply to become a specialised credit institution. As described below, Dexia Municipal Agency (DEXMA) and BNP Paribas Public Sector SCF focus on the issuance of OFs with pure public sector collateral, Compagnie de Financement Foncier (CFF) and Société Générale SCF combine public sector and mortgage assets within their OF businesses. CIF Euromortgage (CIFEUR) as well as GE SCF (GESCF) concentrate purely on funding mortgage assets through OFs. „

BNP Paribas Public Sector SCF is a wholly owned subsidiary of BNP Paribas. Its main purpose is to help finance BNP Paribas’ €17bn public sector loan portfolio through OF issuance.

„

Compagnie de Financement Foncier (CFF) is a wholly-owned subsidiary of Credit Foncier de France, which, in turn, is a member of the Caisses d’Epargne Group, with Caisse Nationale des Caisses d’Épargne et de Prévoyance (CNCE) holding 75% of CFF. CFF’s main purpose is to acquire public sector assets, mortgage loans and RMBS tranches that were originated through the group’s network, and refinance these assets predominantly through OF issuance.

„

CIF Euromortgage (CIFEUR) is a wholly-owned subsidiary of Caisse Central du Credit Immobilier de France (3CIF). Its main purpose is to acquire French RMBS tranches with loans that were originated through the group’s network and mix these with RMBS

75

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http://www.assemblee-nationale.fr/13/dossiers/regulation_bancaire.asp

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tranches that are backed by mortgage assets from other countries of the European Economic Area (EEA). The respective cover assets are then refinanced predominantly through OF issuance.

Strengths

„

Dexia Municipal Agency (DEXMA) is owned by Dexia Credit Local. The main purpose of DEXMA is to acquire public sector assets that were originated through its parent and refinance these assets predominantly through OF issuance.

„

GE SCF (GESCF) is 99.9% owned by GE Money Bank. The sole purpose of GESCCF is to acquire mortgages and home loans that were originated through its parent and refinance these assets predominantly through OF issuance.

„

Société Générale SCF (SGSCF) is owned by Société Générale. The sole purpose of SGSCF is to provide funding for its parent. This is reflected by the fact that the proceeds of the issuance of OFs are made available by the issuer to Société Générale through secured loans that rank pari passu and without priority among themselves. The respective payment obligations of Société Générale will be secured by a portfolio of collateral assets, which may contain exposures to public sector entities, property loans or RMBS notes.

A detailed analysis of all three issuers is provided in the profiles section of this book. The particular strengths of the French OF framework include:

Weaknesses

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„

Strict segregation of all cover assets from the balance sheet of the originating entity.

„

The limitation of liquidity and market risk, as well as the commitment to a minimum level of over-collateralisation, all can be regulated on a contractual basis and, thus, be tailored to the individual profiles of the respective issuers.

„

In the case of the cover pool containing a mix of public sector and mortgage assets, investors may benefit from enhanced diversification, as the default probability of both asset types is generally not strongly correlated, and recovery prospects are usually rather different.

The particular weaknesses of the French OF framework include: „

Lack of strict asset/liability matching requirements and restrictions with regards to liquidity risk and any mandatory over-collateralisation. However, in France, this is mitigated by liquidity and market risk being generally limited rather strictly on a contractual basis, and any additional risks can be offset by voluntary overcollateralisation, which is protected in an insolvency scenario and regularly subject to rating agency surveillance.

„

Potential support from the industry is regarded as weaker compared with some other frameworks, as OF issuers specialized legal entities with no staff, but service level agreements in place. This is mitigated by an increasing volume of domestic mortgage and public sector business being funded through OFs, which, as such, favours structural support.

„

Lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. This is mitigated by the fact that, to date, all OF issuers have reported cover pool characteristics on a regular basis.

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Collateral for Obligations Foncières No separation of public sector assets from mortgage assets in cover pools

Substitution assets allowed, but subject to a maximum 15%

There is no segregation of public sector lending from mortgage lending within the SCF. The law restricts the assets that are eligible for inclusion as collateral for Obligation Foncières to: „

Loans to public sector entities (central, local and regional) within the EU, EEA, French overseas territories, Switzerland, Canada, Japan and the US.

„

Normal non-guaranteed mortgages up to a maximum LTV of 60% and residential mortgages to individual mortgagors up to a maximum LTV of 80%.

„

Guaranteed loans, which are exclusively used for the financing of real estate property. As with traditional mortgages, the LTV barrier is set at 60% for all types of property financing loans and at 80% for residential housing loans for individual borrowers. The guarantor has to be a credit institution or an insurance company with a minimum capital of €12mn and should not be consolidated to the same corporate group as the SCF. Housing loans that have a ‘Fonds de Garantie à L’Accesion Sociale’ – a French state guarantee – may have an LTV of up to 100%. Guaranteed loans should not exceed 35% of all assets within the SCF.

„

Units of residential mortgage-backed securities must have 90% or more of their assets in the eligible assets listed above. In addition, the respective securities can only make up 20% of the nominal amount of outstanding OFs in case they are not rated triple A. Otherwise, they can make up to 100% of the nominal amount of outstanding OFs. R515-4 of the Banking Act, which stipulates regulatory requirements for the inclusion of securitisation notes, explicitly states that eligibility rules will be re-examined before 31 December 2010.

A special supervisor (Controleur Specifique) must assess the market value of the properties financed using evaluation principles laid down in legislation (L.515-30 and Réglement n 9910). Commercial property values have to be assessed once a year if the purchase price (or the last estimated price) is above €450,000, and every three years if the price (or the last estimated price) is below €450,000, or in case of housing loans. Substitute collateral is permissible in the form of eligible assets, according to Annex VI, Part 1 point 68(c) of the EU Capital Requirements Directive. The limit on substitute collateral within the SCF is 15%.

Regulatory oversight of assets Independent trustee appointed by Commission Bancaire, responsible for monitoring SCF activities

The Controleur Specifique is responsible for monitoring the SCF’s activities. He must have accountancy qualifications and be nominated by the Commission Bancaire. He determines the eligibility of collateral with reference to legislation, the required over-collateralisation at all times, and is obliged to notify the Commission Bancaire in the case of a shortfall of collateral or a general deterioration in terms of ability to pay coupons.

Asset/liability risk management French legislation limits SCF activities – individual contractual clauses assure a positive net present value

10 June 2010

To minimise risks to holders of Obligation Foncières, French law limits the activities in which SCFs can participate and prohibits them from holding equity stakes, providing traditional banking facilities or from undertaking derivative transactions, unless for hedging purposes. Bondholders enjoy the benefit of over-collateralisation, which is subject to contractual agreements. In addition, the law stipulates that while there is no legal limit on the mismatching of assets versus liabilities, at all times the SCF must prove it can repay all its liabilities with no delays. All three SCFs adopted individual contractual clauses designed to ensure a positive net present value throughout specific stress scenarios. This means that, in practice, there is little regulatory capital at risk. The loan collateral can only be financed through the issuance of OFs or unsecured borrowing.

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Bankruptcy remoteness and payment in the case of insolvency SCFs are protected by law from bankruptcy proceedings that affect their parent companies. The same legislation stipulates that all proceeds generated by a specialised mortgage credit institution must be used to pay, with priority, interest and principal to holders of Obligation Foncières. Given that SCFs can borrow funds on an unsecured basis, the law stipulates that they can also be declared bankrupt. In this instance, however, all unsecured creditors, including the fiscal authorities and employees, are subordinate to the priority claims of OF holders and have no claims on any of the assets of the SCF, until the holders of the Obligation Foncières have been paid in full. The implication of this provision is that unsecured creditors have no interest in attempting to stop SCFs from paying amounts due to OF holders.

OF holders have prior claims against all assets of the SCF

Part 2: French common law covered bonds As mentioned above, BNP Paribas introduced the first French common law covered bond programme in November 2006. Its main aim was to make more efficient use of the bank’s collateral than with the established legal framework for Obligations Foncières. BNP Paribas has more than 50% of its housing loan business and about two-thirds of its current originations secured by guarantees. As such, one major obstacle that it was particularly keen to overcome was the 20% cap on guaranteed housing loans, which was increased to 35% only in May 2007. With BNP Paribas’ position reflecting overall trends within the French banking industry, unsurprisingly, six more issuers launched similar programmes since 2006. French common law covered bonds make full use of the implementation of the EU Collateral Directive 76 in the French Banking Act. Among other things, the respective rules protect the enforcement of financial collateral arrangements between credit institutions.

Application of structured finance techniques

French common law covered bonds are issued through a multi-stage structure. A dedicated covered bond funding entity is the issuer and is a regulated French credit institution with limited purpose. The covered bonds are limited recourse obligations of the issuer. The proceeds from the sale of the covered bonds are used to finance advances to the respective sponsoring banks (BNP Paribas, BFCM, BFBP, CNCE, CASA, CICM, HSBC France) 77. The covered bonds are secured by a pledge of the issuer’s assets, and the advances are, in turn, secured by a pledge over cover assets, which remain either on the sponsoring bank’s balance sheet and/or on the balance sheets of the respective subsidiaries, affiliates and

Multi-stage structure

Figure 223: BNP Paribas covered bond structure

Collateral Security

Cover Pool

Cover Pool

Affiliates / Subsidiaries

Affiliates / Subsidiaries

Interest & Principal

Audit Firm

Cover Pool

Issuer Issuer Security Security Agent Agent

Interest & Principal

Collateral Security

Hedging Counterparties

Borrower Facility

Covered Bonds SA (Issuer) Pledge of Issuer’s Interest & Assets Principal

Interest & Principal

Borrower Facility

XXX (Borrower) (Borrower)) Collateral Security

Figure 224: Other common law covered bond structure

Covered Bond Proceeds

Hedging Counterparties (Hedge entered upon breach of rating trigger)

Borrower Facility Facility* Audit Firm

XXX (Borrower) Interest & Principal

Borrower Facility

Covered Bonds SA (Issuer)

Issuer Issuer Security Security Agent Agent

Pledge of Issuer’s Interest & Assets Principal

Covered Bond Investors

Covered Bond Proceeds

Hedging Counterparties Hedging Counterparties (Hedge entered upon breach of rating trigger)

Covered Bond Investors

Note: In case of the BFBP programme, the advances are made directly to the individual group member banks. Source: Transaction documents, Barclays Capital

76 77

10 June 2010

Directive 2002/47 In case of the BFBP programme the advances are made directly to the individual group member banks.

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group member banks. Upon a borrower enforcement notice or in case of default of the sponsoring bank and/or the participating group member banks, the respective cover assets, including underlying securities, will be transferred to the covered bond issuer. Covered bonds rank pari passu

Strengths

Weaknesses

The covered bonds are limited recourse obligations of the issuer backed by related secured advances. Under the terms of a borrower facility agreement, the issuers grant advances to the sponsoring bank. The terms and conditions of these advances are designed to match those of the covered bonds. The covered bonds are either fungible with an existing series or constitute a new series with different terms. All covered bonds issued under the respective programme rank pari passu with each other and share equally in the security. Subject to certain rating triggers, swaps with suitable counterparties will have to be entered to ensure that exposure to market risk, which may occur upon an enforcement of the collateral, is properly hedged. The particular strengths of French common law covered bond programmes are: „

Cover assets are separated from the balance sheet at the inception of the programme/issuance through the transfer of receivables to the dedicated covered bond funding entity.

„

Cash flow adequacy is secured through the asset-coverage test and the contractual obligation to neutralise any exposure to interest rate and currency risk.

„

Investors are well protected against liquidity risk because there is a clear escalation process in case of a credit profile deterioration of participating parties.

The relative weaknesses of French covered bond programmes are: „

Compared with traditional covered bond products, the programme contains a rather complex set of structural features.

„

So far, the record of French banking regulators with regards to the surveillance of French common law covered bonds is rather limited.

„

Within the French common law covered bond programme, regularly a substantial percentage of the cover pool assets are secured by a guarantee provided by specialist insurance companies, which partly also belong to the same financial services group as the respective sponsor bank. Thus, the cover pool is exposed to additional default risk. However, this is mitigated by the fact that upon a downgrade of the sponsor bank below a certain trigger level (generally A-), the respective programmes foresee that the sponsor bank will pay and maintain the registration cost of the mortgages or similar legal privileges securing the payment of the home loans granted by the counterparties belonging to the group.

Qualifying collateral Initial focus on French housing loans

10 June 2010

The collateral securing the advances, which from an economic point of view is the ultimate collateral of the covered bonds, initially consisted of French housing loans, which are secured either by a mortgage or a guarantee from a third party. Being a structured programme, geographical restrictions to date have been self imposed. All common law covered bond programmes have an 80% LTV limit. When calculating the appropriate loan balance within the asset-coverage test, higher LTV loans (up to 100%) are included in the pool, but loan amounts exceeding the respective cap are not taken into account when calculating the appropriate loan balance within the asset-coverage test (see explanation below). Loans in arrears are not eligible. A maximum single-loan amount is set at €1mn in all existing common law covered bond programmes. The properties are valued using the 214

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French mortgage market accepted practice. The property values are indexed to the French INSEE 78 house price index or PERVAL 79 house price index on a quarterly basis. Price decreases are fully reflected in the revaluation, while in the case of price increases, a 20% haircut is applied. Substitution assets can be included in the cover pool. Their aggregate value can make up as much as 20% of cover assets and may consist of exposures that are subject to relatively high quality criteria. They consist of short-term (80% (in % of tot.)

68

68

69

66

64

69

38.1

33.8

39.9

34.0

25.6

37.0

Buy to let (in % of tot.)

15.9

13.6

7.6

4.3

10.9

15.6

Owner occupied (in % of tot.)

79.5

83.8

89.9

93.5

86.5

75.9

Vacation/second home (in % of tot.)

4.6

2.6

2.5

2.2

2.3

8.5

Source: Programme reports, Barclays Capital

10 June 2010

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France – Obligations Foncières

Name of debt instrument(s)

Obligations Foncières.

Legislation

Law enacted on 25 June 1999, amended in Q2 01, Q2 02 and Q2 07

Special banking principle

Yes; mortgage credit institutions: Sociétés de Crédit Foncier (SCF).

Restrictions on business activities

Only public sector, residential and commercial mortgages, guaranteed loans, units of eligible ABS issues and bonds, issued or guaranteed by public entities.

Asset allocation

Eligible assets are transferred to the SCF, which, in turn, are fully consolidated within the parent company’s balance sheet. The same SCF may acquire both public sector and mortgage loans.

Inclusion of hedge positions

Hedge positions can be included in the cover register.

Substitute collateral

Up to 15%.

Restrictions on inclusion of commercial mortgage loans in the cover pool

No.

Geographical scope for public assets

Central governments and sub-sovereigns in EEA countries, Switzerland, the US, Canada and Japan.

Geographical scope for mortgage assets

EEA countries, Switzerland, the US, Canada and Japan.

LTV barrier residential

Up to 60% of the value of the financed asset is eligible for the loan. This amount may be increased to 80% if the entire loan portfolio consists of loans to individuals and is intended to finance home purchases. It may be raised to 100% for loans guaranteed by the FGAS (Fonds de Garantie de l'Accession Sociale à la propriété).

LTV barrier commercial

60%.

Basis for valuation = mortgage lending value

Yes; ‘valeur hypothécaire’ (market value = upper limit).

Valuation check

Annual examination.

Special supervision

Yes; Commission Bancaire (French banking regulator) and a special supervisor.

Protection against mismatching

Not compulsory, though the law requires the special supervisor to inform both the SCF’s management and the Commission Bancaire if an SCF mismatching risk appears too high. OFs issued from all three issuers benefit from additional protection through contractual features.

Protection against credit risk

Not compulsory, but common law covered bonds may include contractual rules that stipulate that overcollateralisation adjusts to cover pool characteristics.

Protection against operative risk

Not compulsory, but could be included through contractual rules.

Mandatory minimum overcollateralisation

No.

Voluntary over-collateralisation is protected

Yes.

Bankruptcy remoteness of the issuer

No, but status of the issuer as a separate legal entity provides bankruptcy remoteness from the parent.

Outstanding covered bonds to regulatory capital

—

In the event of insolvency first claim is on…

… all assets of the SCF. In addition, investors may have a claim on derivative counterparties.

External support mechanisms

No formal recourse to assets outside the SCF, but we expect the Commission Bancaire to exert some pressure over the shareholder(s) to support the SCF.

Compliance with UCITS 22(4)

Yes.

Compliance with CRD

Yes.

Source: Barclays Capital

10 June 2010

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France – Caisse de Refinancement de l’Habitat (CRH)

Name of debt instrument(s)

CRH Covered Bond.

Legislation

Law enacted on 11 June 1985, amended in Q2 01, Q2 02 and Q2 07

Special banking principle

Yes; specialised credit institution: Établissement de crédit agréé en qualité de société financière.

Restrictions on business activities

Only mortgage notes (billets de mobilisation).

Asset allocation

CRH debt obligations are collateralised by a portfolio of mortgage notes issued by the stakeholders of CRH. The mortgage notes in turn are backed by portfolios of home loans, which are secured by mortgages or guarantees.

Inclusion of hedge positions

No.

Substitute collateral

Not needed in the normal course of business, due to narrow matching of assets and liabilities. Still, according to CRH’s statutes, its shareholders have to make liquidity advances to CRH of up to 5% of the respective outstanding mortgage notes and capital contributions in relation to their use of the CRH scheme.

Restrictions on inclusion of commercial mortgage loans in the cover pool

Not eligible – single loan amount capped at €1mn

Geographical scope for public assets

-

Geographical scope for mortgage assets

France

LTV barrier residential

Up to 60% of the value of the financed asset is eligible for the loan. This amount may be increased to 80% if the entire loan portfolio consists of loans to individuals and is intended to finance home purchases. The limit may be raised to 90%, if the amount of the collateralised loans exceeds that of the bonds by at least 25%. It may be raised to 100% for loans guaranteed by the FGAS (Fonds de Garantie de l'Accession Sociale à la propriété).

LTV barrier commercial

-

Basis for valuation = mortgage lending value

Yes; ‘valeur hypothécaire’ (market value = upper limit).

Valuation check

Monthly coverage calculation.

Special supervision

Yes; Commission Bancaire (French banking regulator); in addition, CRH regularly audits the portfolio pledged by borrowing banks.

Protection against mismatching

Cash flows from mortgage notes are generally matched with payments on CRH bonds.

Protection against credit risk

Through high mandatory over-collateralisation.

Protection against operative risk

CRH has neither the capacity to manage home loans nor is it prepared to actively manage interest rate risk. Thus, investors would be exposed to operational, liquidity and market risk. However, this is mitigated by the fact that CRH would very likely seek to assign the loan portfolio to a third party and buy back outstanding CRH bonds with the respective proceeds.

Mandatory minimum overcollateralisation

125%.

Voluntary over-collateralisation is protected

Yes.

Bankruptcy remoteness of the issuer

No, but status of the issuer as a separate legal entity provides bankruptcy remoteness from the mortgage note issuers.

Outstanding covered bonds to regulatory capital

—

In the event of insolvency first claim is on …

… all assets of CRH.

External support mechanisms

We would regard it as very likely that CRH may benefit from additional solvency commitments as well as operational support in case of need.

Compliance with UCITS 22(4)

Yes.

Compliance with CRD

Yes.

Source: Barclays Capital

10 June 2010

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France – Common Law Covered bonds

Name of debt instrument(s)

French Common Law Covered bond

Legislation

Private legal structure based on French banking and contract law.

Special banking principle

Yes; the issuer is a special purpose credit institution.

Restrictions on business activities

Not applicable.

Asset allocation

Covered bonds are issued by a dedicated covered bond funding entity, which grants advances to the sponsor bank. The respective advances are secured by cover assets, which are on the balance sheet of the sponsor bank. Upon a borrower enforcement notice or in case of default of the sponsoring bank, the respective cover assets, including underlying securities, will be transferred to the dedicated covered bond funding entity.

Inclusion of hedge positions

Hedge positions are part of the structural enhancements intended to protect bondholders.

Substitute collateral

Up to 10%.

Restrictions on inclusion of certain types of mortgage loans in the cover pool

Subject to contractual prescriptions. Only performing French residential housing loans, which are secured either through a mortgage or through a guarantee agreement.

Geographical scope for public assets

Subject to contractual prescriptions.

Geographical scope for mortgage assets

Subject to contractual prescriptions.

LTV barrier residential

Subject to contractual prescriptions; generally 80%.

LTV barrier commercial

Subject to contractual prescriptions; irrelevant until now.

Basis for valuation = mortgage lending value

No. Basis = market value.

Valuation check

Indexed to house price index. Price decreases are fully reflected in the revaluation, while in the case of price increases, a haircut (20%) is applied.

Special supervision

Yes; the French banking regulator (Commission Bancaire) and an independent asset monitor.

Protection against mismatching

There are contractual provisions that stipulate that exposure to interest rate and currency risk has to be neutralised. In addition, downgrade triggers for swap counterparties, the asset-coverage test, the amortisation test and the pre-maturity test are designed to ensure cash flow adequacy.

Protection against credit risk

Yes; defined by asset-coverage test.

Protection against operative risk

Yes; stipulated through contractual rules.

Mandatory minimum overcollateralisation

Yes, with regards to the borrower advances; subject to the asset percentage applied in the assetcoverage test.

Voluntary over-collateralisation is protected

Yes.

Bankruptcy remoteness of the issuer

Yes, all assets are owned by the covered bond funding entity; covered bondholders benefit from the automatic segregation of assets upon a borrower enforcement notice or an insolvency of the sponsor bank.

Outstanding covered bonds to regulatory capital

—

In the event of insolvency first claim is on …

… all the payments received from the covered bond funding entity's assets. Investors continue to receive scheduled payments, as if the sponsor bank had not defaulted.

External support mechanisms

Bondholders’ rights exclusively refer to segregated assets; there is no recourse to the sponsor bank.

Compliance with UCITS 22(4)

tbd

Compliance with CRD

tbd

Source: Barclays Capital

10 June 2010

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GREEK MARKET

Overview Leef H Dierks +49 (0) 69 7161 1781 [email protected]

With only one benchmark covered bond outstanding at the time of writing, the Greek covered bond market is among Europe’s smallest, with a total volume of €1.5bn. The first (and hitherto only) Greek benchmark covered bond was publicly issued on the primary market in September 2009. Yet, despite the rather modest primary market appearance of Greek covered bonds so far, we emphasise that since summer 2008, Greek covered bond issuers have increasingly relied upon the issuance of covered bonds designed for liquidity operations of the European Central Bank (ECB). From July 2008 to May 2010, six benchmark deals totalling €6.5bn were issued, taking the aggregate volume of Greek covered bonds to €8bn at the time of writing (Figure 227).

Figure 227: Outstanding Greek covered bonds Instrument

Coupon

ISIN

Size (€ bn)

Launch date

Spread at launch at 28 May 2010 Mid-swaps (bp)

Public issuance

ETEGA Oct 2016

3.875%

XS0438753294

1.50

30 Sep 2009

+90

+450

Likely retained issuance

EGNATI Nov 2010

ECB +110bp

XS0400240262

1.00

17 Nov 2008

NA

ETEGA Dec 2014

ECB +70bp

XS0402183940

1.00

27 Nov 2008

NA

ETEGA Dec 2013

ECB +65bp

XS0398841782

1.00

28 Nov 2008

NA

ALPCB Jul 2011

1mth EURIBOR +35bp

XS0378006604

1.00

16 Jul 2008

NA

ALPCB Jul 2013

1mth EURIBOR +45bp

XS0378340847

1.00

16 Jul 2008

ECB +190bp

XS0496641761

1.50

17 Mar 2010

ETEGA Aug 2018

NA +190

NA

Source: Barclays Capital

At the time of writing, almost all major Greek banks were active on the covered bond market. As the amounts issued so far are markedly lower than the respective programme sizes, gross issuance might well increase in the medium to long term (Figure 228). Overshadowed by the current macroeconomic situation, however, we do not expect Greek covered bonds to be publicly issued on the primary market in the near future because the new issuance premium would likely need to be in excess of the swap spread levels of Greek government bonds, making the refinancing through covered bonds relatively unattractive. Instead, unless the overall situation improves significantly and swap spreads contract markedly again, we expect potential Greek covered bond issues to rely on the issuance of covered bonds that are tailor-made for the ECB.

Figure 228: Greek covered bond programmes Issuer

Ticker

Programme size

Amount issued

Collateral pool

OC

National Bank of Greece*

ETEGA

€10.0bn

€3.5bn

€5.1bn

147%

Marfin Egnatia Bank**

EGNATI

€3.0bn

€1.0bn

€1.3bn

132%

Alpha Bank

ALPCB

€8.0bn

€2.0bn

Note: * As at end-February 2010; ** As at end-January 2010. Source: Company information, Barclays Capital

Greek legislation allows for issuance in two ways 10 June 2010

The issuance of Greek covered bonds is governed by primary and secondary legislation. The principal laws that cover the issuance of covered bonds in Greece are Article 91 of Law 222

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3601/2007, which came into effect on 1 August 2007, and Governor’s Act No. 2598/2.11.2007 issued by the Bank of Greece (BoG) in November 2007 under the authority conferred on it by the primary covered bond law. In contrast to other covered bond frameworks, the Greek legislation allows for the issuance of covered bonds in two different ways: a so-called direct issuance in which cover assets remain ring-fenced on the issuer’s balance sheet; and an indirect issuance in which cover assets are transferred to a special purpose vehicle (SPV), which then acts as the issuer of covered bonds.

Figure 229: Generic Greek (indirect) covered bond transaction structure Repayment of Intercompany Loan Intercompany Loan Interest Rate Swap Provider(s)

Covered Bond plc (Issuer)

Purchase Price

Bank (Seller and Guarantor)

Sale of Mortgage Loans and Related Securities Covered Bond Proceeds

Covered Bond Swap Provider(s)

Covered Bonds

Covered Bond Holders/Trustee

Covered Bond Guarantee

Source: Barclays Capital

Indirect issuance through SPV

Within the scope of the indirect issuance (Figure 229), cover assets are transferred to a SPV, which then acts as the issuer of covered bonds. The debt issued by the SPV is guaranteed by a credit institution as if it were the principal obligor. Technically, within the scope of the indirect issuance, the bank sells the cover assets to the issuer (SPV). The purchase is funded through a subordinated inter-company loan, which will be redeemed with proceeds from the sale of covered bonds. The inter-company loan will furthermore fund a reserve account that is set up on establishment of the covered bond programmes to cover interest payments due on the liability side and senior expenses for one month. The indirect issuance structure is formally allowed under §10 of the Primary Greek Covered Bond Law, which allows the issue of covered bonds by a Greek credit institution directly or by a SPV with its registered office either in Greece or in a member state of the European Economic Area (EEA). The SPV needs to be solely consolidated with the relevant sponsor bank. Greek provisions on solo consolidation enable the Bank of Greece to allow sponsor banks to take into account subsidiaries with material obligations existing vis-à-vis the credit institution when determining their capital adequacy on an unconsolidated basis. In economic terms, we believe that for Greek entities, the indirect issuance of covered bonds is more relevant because it enables investors to circumvent the Greek withholding tax that applies in the case of a direct issuance. Also, the indirect approach is the standard method of Greek banks when issuing senior debt.

Issuance through SPVs incorporated under UK law

10 June 2010

Within the scope of the Greek indirect covered bond programmes established so far, the covered bond issuers are SPVs incorporated under UK law. The SPV will issue the covered bonds as direct, unconditional and subordinated obligations. At the same time, the sponsor bank (ie, the guarantor) grants an unconditional, first-demand guarantee on the covered bond, which is drafted under UK law. According to the rating agencies, this choice will be 223

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recognised and applied by the Greek courts, and the guarantee ensures the dual recourse against the cover assets and a financial institution, thereby constituting an essential feature of covered bond issuance. Covered bond holders benefit from preferential claim

True sale structure

The Greek covered bond legislation in combination with the Greek securitisation law provides for a true sale of the assets to the issuer (ie, the SPV). The legal effect of the true sale is to segregate the assets over which the covered bond investors will have special creditor privilege in the event of an issuer’s winding down or dissolution. The special creditor privilege foresees that no other creditor of the covered bond issuer will be able to claim any rights over the collateral pool until all amounts due to the covered bond investors have been fully repaid. In this context, the inter-company loan to the SPV from the issuing bank is also subordinated.

Legal requirements

In order to issue covered bonds pursuant to the Greek covered bond legislation, institutions must have a regulatory capital of at least €500mn and a capital adequacy ratio of at least 9% at the time of issuance. Furthermore, in the case of total assets comprising the collateral pool exceeding 20% of the available assets of the institution (as issuer or guarantor), the Bank of Greece may impose further capital requirements. When determining whether to impose additional capital requirements, the Bank of Greece will take several factors into consideration, among them the possibility of any significant deterioration of the average quality of the available assets for the institution following the issuance of covered bonds. Available assets in this context refer to the issuer’s or guarantor’s assets on an individual basis, thereby excluding any receivables transferred to a SPV under Article 10 of the Greek Securitisation Law, assets that are the underlying instruments of reverse repos and assets charged in favour of third parties.

Strengths

Weaknesses

10 June 2010

According to §10 of the primary Greek covered bond legislation in combination with Article 10, §18 of the Greek securitisation law, if insolvency proceedings are commenced against a sponsor bank or SPV that has previously issued covered bonds, the holders of those covered bonds and the secured creditors will have a preferential claim on the cover assets located in Greece as a result of a statutory pledge. According to Article 451 of the Greek Civil Code and §8 and §10 of the primary Greek covered bond legislation, the statutory pledge created in favour of the trustee, for the benefit of, among others, the covered bond investors, enjoys priority over all other rights, including potential rights arising from set-offs.

In our view, among the strengths of the Greek covered bond programmes are: „

In case of an indirect issuance, cover assets are separated from the balance sheet of the guarantor at inception of the programme through a true sale to the covered bond issuer.

„

Cash flow adequacy is secured through a nominal value test, a net present value (NPV) test and an interest cover test. Furthermore, any exposure to interest rate and currency risks has to be neutralised.

„

Investors are protected against liquidity risk because there is a clear escalation process in the case of a deterioration of the credit profile of participating parties.

Among the weaknesses of the Greek covered bond programmes, in our opinion, are: „

Compared with other covered bond legislations, the issuers’ choice between a direct or indirect covered bond issuance adds to a lower level of standardisation.

„

As the issuer of indirectly issued Greek covered bonds is an SPV and thus not a regulated financial institution, indirectly issued Greek covered bonds do not comply with the definition of covered bonds as applied in Article 22 (4) of the Undertakings for 224

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Collective Investment in Transferable Securities Directive (UCITS), or the European Capital Requirements Directive (CRD). This does not apply for directly issued Greek covered bonds, however. „

In the issuer’s event of default, there is a potential risk that depositors with the sponsor bank will try to offset losses suffered on their deposits against amounts they owe to the bank under their residential mortgage loan. In our view, this is mitigated by the fact that exercising set-off rights can only occur after all covered bonds (and privileged creditors) have been repaid in full.

Qualifying collateral for Greek covered bonds Collateral of covered bond programmes consists of residential mortgage loans

According to the Greek covered bond legislation, the eligible assets for the collateral pool backing covered bonds issued include loans secured by mortgages on residential and commercial property (provided that the security over such real estate is governed by Greek law), loans secured by ship mortgages, loans granted to or guaranteed by certain governmental bodies, government-issued securities and other highly rated securities, among others (§ 8(b), Section B, Bank of Greece Act No. 2588/20.8.2007). Within the scope of the existing Greek covered bond programmes, however, the collateral consists of residential mortgages located in Greece. Substitution assets can be included in the cover pool up to an aggregate value of 15% of the cover assets. Among these are euro-gilt edged securities, high-quality deposits and debt obligations, as well as high-quality government securities with a maturity of up to one year and RMBS securities satisfying certain minimum rating criteria with maturities of up to one year. There is no restriction with regard to the proportion of residential or commercial mortgages or other eligible assets in the collateral pool. In order to include assets governed by foreign law in the collateral pool, a legal opinion needs to be submitted to the Bank of Greece confirming that the security created over these assets is valid, binding and enforceable under the provisions of the applicable foreign law. To be eligible for inclusion in the collateral pool of Greek covered bonds, mortgage loans need to comply with a maximum loan-to-value (LTV) ratio of 80% in the case of residential and 60% in the case of commercial loans. Loans with higher LTV ratios can also be included in the collateral pool, but those parts of the loan with an LTV higher than 80% cannot be taken into consideration when testing for compliance with the mandatory tests. Generally, loans being in arrears are not eligible and need to be replaced.

Three mandatory tests

10 June 2010

The Greek covered bond legislation prescribes a total of three mandatory tests to determine the relationship between the collateral provided and the covered bonds issued. „

Nominal value test: The covered bond issuer and the respective guarantor have to ensure that on each calculation date the nominal value of the covered bonds outstanding does not exceed 95% of the nominal value of the collateral pool. In order to assess compliance with this nominal value test, the assets comprising the collateral pool shall be evaluated at their nominal value plus accrued interest.

„

NPV test: The covered bond issuer and the respective guarantor have to ensure that on each calculation date, the NPV of the collateral assets (including swaps) is at least equal to the NPV of the covered bonds outstanding. The Bank of Greece (BoG) furthermore requires compliance with this test under a stress-test scenario, comprising a 200bp parallel shift of the interest yield curve.

„

Interest cover test: The covered bond issuer and the respective guarantor have to ensure that on each calculation date, the amount of interest payments expected on the cover 225

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assets needs to be at least equal to the interest payable on the covered bonds issued 12 months from the calculation date. Breach of asset coverage test triggers issuer’s event of default

The breach of any one of these three mandatory tests triggers the guarantor’s event of default. In consequence, the issuer will have to perform an asset coverage test, which is met if the aggregate loan amount is at least equal to the principal outstanding of the covered bonds. The breach of the asset covered test triggers an issuer’s event of default and leads to an acceleration of the covered bonds issued.

Potential offset risk

In accordance with the Greek covered bond legislation, the statutory pledge created in favour of the trustee (Figure 229) has priority to all other rights, including those arising from a potential offset when loans are held by the covered bond issuer. Yet, in the issuer’s event of default, we believe there is a potential risk that depositors with the sponsor bank try to offset losses suffered on their deposits against amounts they owe to the bank under their residential mortgage loan. Evidently, this creates a potential risk for covered bond holders regardless of the contractual elements of the deposits and loans. However, in our view, exercising offset rights can only occur after all covered bonds (and privileged creditors) have been repaid in full, as this would otherwise contradict the statutory pledge created in favour of the covered bond investors over the cover pool, as outlined in the Greek covered bond legislation.

Breach of amortisation test

Following a guarantor event of default and the service of a guarantor acceleration notice (but prior to service of an issuer acceleration notice) and as long as covered bonds remain outstanding, the issuer has to ensure that on each calculation date the aggregate loan amount determined by the amortisation test is at least equal to the aggregate principal amount outstanding of the covered bonds. The amortisation test will be carried out by the servicer on each calculation date following the guarantor event of default and service of a guarantor acceleration notice. A breach of the amortisation test constitutes an issuer’s event of default, upon which the trustee can accelerate the obligations of the issuer and the guarantor under the covered bonds and require all amounts (within the scope of the covered bonds and the covered bond guarantee) to become immediately due and payable. Following the acceleration, the trustee can enforce the security over the charged property (including the loans and their related security) after having been indemnified and/or secured to its satisfaction.

triggers issuer’s event of default

Regulatory oversight of assets and asset/liability risk management The hitherto established Greek covered bond programmes feature contractual provisions that stipulate interest rate exposure has to be neutralised. In addition, downgrade triggers for swap counterparties, maturity extension rules and the amortisation test all ensure cash flow adequacy. Soft-bullet maturity

The Greek covered bond programmes feature a soft-bullet maturity. Following the serving of a notice to pay, the guarantor may not have sufficient proceeds for a timely repayment of the covered bonds that mature soon after such an event. In this case, the legal final maturity will be extended by 12 months to allow for a realisation of cover assets.

Additional safeguards

The current Greek covered bond programmes include a number of further safeguards. In particular, there are minimum rating requirements for third parties supporting the transaction, including the currency and interest rate swap counterparties, as well as the cash manager. Under the terms of the covered bond swaps, in the event that the relevant rating of the swap provider or any guarantor of the swap provider’s obligations is downgraded below a rating previously specified in the swap agreement, the swap provider

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will be required to take certain remedial measures, among them the provision of collateral for its obligations under the swap, arranging for its obligations under the swap to be transferred to an entity with the ratings required, or any other action agreed upon with the relevant rating agencies. In addition, if the net exposure of the covered bond issuer against the swap provider under the relevant swap exceeds the threshold specified in the relevant swap agreement, the swap provider may be required to provide collateral for its obligations. A failure to take such steps will, subject to certain conditions, allow the covered bond issuer to terminate the swap. Furthermore, as an additional safeguard, independent audits of the asset coverage test calculations are undertaken on each quarterly calculation date. Reserve fund

The reserve fund is set up to cover up to one month of interest due on the covered bonds issued as well as senior expenses. The respective amount will be retained in a so-called reserve fund GIC account. If subsequently there is an issuer event of default, the contents of the reserve fund will form part of available revenue receipts to be used by the guarantor to meet its obligations under the covered bond guarantee.

Bankruptcy remoteness and payment in case of insolvency Bankruptcy proceedings against sponsor bank do not result in acceleration of covered bonds

§10 of the secondary Greek covered bond legislation stipulates that the initiation of bankruptcy proceedings against the sponsor bank does not necessarily have to result in the acceleration of the covered bonds issued. Accordingly, the insolvency or other event of default of the guarantor will result in the guarantee given on the covered bonds accelerating against the guarantor, but will not result in an acceleration of the covered bonds issued. The issuer event of default, however, will result in the acceleration of the covered bonds issued. Upon the latter, all amounts due on the covered bonds issued – and thus (provided it had not accelerated previously) the guarantee pledged on the covered bonds – will accelerate and become due and payable immediately. Covered bond investors will in that case not continue to receive payments as outlined in the original terms of the covered bond programmes. According to the covered bond programmes established so far, issuer events of default occur: „

If default is made on behalf of the covered bond issuer for a period of at least seven days in the payment of any amounts due under the covered bonds;

„

Through failure by the issuer to pay any interest or principal due on the covered bonds of any series for more than 30 days;

„

Through failure by the issuer on any other obligation under the covered bonds for more than 30 days;

„

Through bankruptcy or appointment of a liquidator taking control of the issuer or its assets;

„

By failure to rectify any breach of the asset coverage test.

In summary, the indirect issuance of Greek covered bonds bears some resemblance to the structure of UK covered bonds, with the covered bond issuers in fact being SPVs incorporated under English law. This setup is required to circumvent the otherwise applicable Greek withholding tax.

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The Greek housing and mortgage market House prices started falling in Q3 08

As most other European countries, Greece was also subject to a market deceleration in house price growth over the past two years. This is particularly obvious in the case of the larger Athens area where prices for residential property fell 5.4% y/y in Q3 09, the latest date for which data were available. Weakening house prices started gaining momentum in late 2008 when the house price index started contracting after four years of positive price growth. Similar developments can be observed in other urban areas in which the decline in house prices started slightly later and was not as pronounced as in the case of Athens. In Q3 09, the latest date for which data were available, house prices in the urban areas of Greece had fallen 0.7% y/y – ie, more modestly than in Q1 09 (-2.5% y/y) and Q2 09 (-1.9% y/y), respectively (Figure 230). In light of the current economic difficulties in Greece, we do not expect house price growth to recover markedly in the near term. For historical reasons, Greece has one of the highest home-ownership ratios in the EU, amounting to approximately 84% as of year-end 2007. This is clearly above the euro area average of roughly 60%. Still, reflecting the aftermath of the regulation of the Greek mortgage market, per capita mortgage debt stood at a modest €5,100 – less than half of the EU-27 average of €11,600 as at year-end 2006, the latest date for which data were available. In terms of residential debt-to-GDP ratio, the respective level stood at a moderate 29.3% (ie, clearly below the EU-27 average of 49.0%) 82.

Pace of residential mortgage lending declining

The decline in Greek house prices will likely not be offset by the pronounced fall in mortgage rates. Whereas the average applicable interest rate for floating rate mortgage loans, which accounted for roughly 80% of all new mortgage lending volumes at the time of writing, stood at 5.5% in September 2008, it had fallen to 3.1% by January 2010, the latest date for which data were available (Figure 231). Despite mortgage financing thus being historically cheap, we do not expect Greek house prices to benefit markedly from this development, as demand will likely remain muted because of the country’s macroeconomic situation. In line with this development and overshadowed by the ongoing economic deceleration, aggregate Greek mortgage lending increased at a modest 3.7% y/y from December 2008 to December 2009, the latest date for which data were available (Figure 235). As the Greek mortgage market is heavily geared towards mortgage loans with a rate fixation of less than one year or floating, we furthermore expect a high proportion of this growth to be attributed to mortgage borrowers rolling their debt. Note that since early 2009, roughly 80% of all newly granted mortgage loans had a floating interest rate or a rate fixed for a period of up to one year, strongly up from c.30% observed in 2007 and 2008. The weight of other instruments, among them longer dated, fixed rate mortgage loans, fell markedly (Figure 234). Following a decade of strong growth in residential mortgage lending from 1996 to 2006, the pace of lending showed the first signs of slowing in 2007. As a result of the 1994 deregulation of the Greek mortgage market, interest rates, which had previously been administratively set, increasingly became subject to competition among the banks. Furthermore, in the run-up to Greece’s membership in the European Monetary Union (EMU), interest rates generally came under pressure, thereby exerting additional downward pressures on interest rates in mortgage loans. The consequent fall in interest rates, both in nominal and real terms, with a floating interest rate or a rate fixed for a period of up to one year falling to 4.4% as at year-end 2006 from 20% as at year-end 1993, clearly fuelled demand for mortgage loans. According to data provided by the Bank of Greece, housing

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Source: European Mortgage Federation.

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loans (excluding securitised loans) amounted to €80.6bn as at year-end 2009, the latest date for which data were available. As at year-end 2003, the Greek residential mortgage market had a size of only €26.5bn (Figure 232). Deregulation of mortgage market in 1994

Prior to 1994, only specialised credit institutions such as the Deposits and Loans Fund, the National Mortgage Bank of Greece, the National Housing Bank of Greece, the Postal Savings Bank and Aspis Bank were permitted to engage in mortgage lending in Greece. In 1994, commercial banks were then allowed to enter the relatively modestly developed market. As a result of the previous regulation, Greek households were rather credit constrained, with housing purchases often made in cash obtained through savings or intra-family transfers, or through financing provided by property developers. However, with property developers financing themselves through bank loans, this corresponded to indirect bank lending to those acquiring residential property. Still, the previous credit constraints of Greek households led to significant pent-up demand for mortgage loans, which, following the 1994 deregulation, was increasingly met by commercial banks 83. Furthermore, as a result of the deregulation process, mortgage loans for residential properties became an increasingly important constituent of bank portfolios, with the share of mortgage loans in total bank loans doubling from 14% as at year-end 1995, to 29% as at year-end 2005.

83

Source: The interaction between mortgage financing and housing prices in Greece. Sophocles N. Brissimis and Thomas Vlassopoulos, Bank of Greece Working Paper Nr. 58, March 2007.

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Figure 230: Annual house price variation (% y/y)

Figure 231: Interest rate for housing loans (%)

20

8

15

6

10 5

4

0 -5

2 Sep-02

-10 Dec-01

Dec-03

Dec-05

Dec-07

Urban areas

Dec-09

Mar-04

Sep-05

Mar-07

Floating or < 1yr fixation >5 and 1 and 10 yr fixation

Source: Bank of Greece, Haver Analytics, Barclays Capital

Source: Bank of Greece, Barclays Capital

Figure 232: Residential mortgage lending in Greece (€bn)

Figure 233: Volume of new residential mortgage lending (nsa) 3

90

€ bn

80 2

70 60

1

50 40

0 Jan-04

30 20 Oct-03

Oct-04

Oct-05 Oct-06

Oct-07

Oct-08

Jul-05

Jan-07

Floating or 5 and 1 and 10 yr fixation

Source: Bank of Greece, Haver Analytics, Barclays Capital

Source: Bank of Greece, Barclays Capital

Figure 234: Type of new mortgage loans granted (%)

Figure 235: Mortgage lending (annual variation, %) 40

100%

80%

30

60%

20 40%

10

20% Floating or 5 and 1 and 10 yr fixation Jan-08

Jan-10

0 Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Source: Bank of Greece, Haver Analytics, Barclays Capital

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Greece

Name of debt instrument(s)

Greek Covered Bonds

Legislation

Greek covered bond law and a secondary regulation

Special banking principle

No; any Greek Bank

Restrictions on business activities

Not applicable

Asset allocation

In the case of the so far established Greek covered bond programmes based upon the indirect issuance scheme, cover assets are segregated through a transfer to a separate entity (SPV).

Inclusion of Hedge Positions

Hedge positions are part of the structural enhancements intended to protect bondholders.

Substitute collateral

Up to 15% in the currently established covered bond programmes.

Restrictions on inclusion of commercial mortgage loans in the cover pool

In the currently established covered bond programmes, the collateral consists of prime residential loans secured by first-lien mortgages.

Geographical scope for public assets

Not applicable.

Geographical scope for mortgage assets

Republic of Greece. (The Greek Covered Bond Law provides that in order for any assets governed by foreign law to be included in the Cover Pool, a legal opinion must be submitted to the Bank of Greece confirming that the security created over such foreign assets is valid, binding and enforceable under the provisions of the applicable foreign law.)

LTV barrier residential

80%

LTV barrier commercial

Not applicable

Basis for valuation = mortgage lending value

No. Basis = market value

Valuation check

Subject to bank-internal procedures

Special supervision

Bank of Greece and an independent trustee

Protection against mismatching

Within the Greek covered bond programmes established so far, there are contractual provisions that stipulate that exposure to interest rate and currency risk has to be neutralised. In addition, downgrade triggers for swap counterparties, maturity extension rules and the amortisation test all ensure cash-flow adequacy.

Protection against credit risk

Yes; defined by asset coverage test

Protection against operative risk

Yes; stipulated through contractual rules

Mandatory over-collateralisation

Yes; subject to the asset percentage applied in the asset coverage test.

Voluntary over-collateralisation is protected

Yes.

Bankruptcy remoteness of the issuer

No, but within the scope of an indirect covered bond issuance, all assets are ring-fenced within a specially separated entity

Outstanding covered bonds to regulatory capital

-

In the event of insolvency first claim is on…

… all the payments received from the special entity's assets. These payments are collected in a GIC account. Investors continue to receive scheduled payments, as if the issuer had not defaulted.

External support mechanisms

In the event of insufficient pool assets proceeds to cover their claim, investors rank pari passu with senior debt holders. There is a simultaneous unsecured dual claim against the guarantor and secured against the portfolio held by the specially separated entity.

Compliance with UCITS 22(4)

Yes. (In the case of a direct issuance.)

Compliance with CRD

Yes. (In the case of a direct issuance.)

Source: Barclays Capital.

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IRISH MARKET

Jumbo market structure and spread development Issuance of jumbo Asset Covered Securities (ACS) started in 2003. Shortly after inception, the market grew strongly, then stabilised at €35bn and then decreased slightly below €30bn. As of mid-May 2010, the total volume of outstanding jumbo ACS was €25bn. The market consisted of five issuers with a total 13 issues. DEPFA ACS is the largest, with a market share of 57%, followed by Bank of Ireland Mortgage Bank (22%) and Allied Irish Mortgage Bank (11%). The average size of jumbo ACS is currently €1.9bn.

Fritz Engelhard +49 69 7161 1725 [email protected]

Over a long period, spreads tightened consistently and reached historical lows in early 2007, but they have been under pressure since mid-2007. Initially spread widening was more pronounced in mortgage ACS because of a general supply overhang of mortgage-secured debt instruments, combined with a more negative market perception. However, the break out of the crisis surrounding Depfa Bank plc pushed the spreads of its public sector ACS above those for mortgage ACS. The significant overall spread tightening in Q2 09 was followed by a phase of spread stability, until spreads started to re-widen in Q2 10.

Strong swings between public sector and mortgage ACS since mid-2007

Figure 236: Development of outstanding volume and avg size € bn 40

Figure 237: Market share, May 2010

€ bn 4.0

35

3.5

30

3.0

25

2.5

20

2.0

15

1.5

10

1.0

5

0.5

0 2003

EBSBLD 4%

2005

2006

2007

2008

2009

AIB 11%

BKIR 22%

0.0 2004

WESTLB 6%

DEPFA 57%

2010

Jumbo Asset Covered Securities Averge size of Jumbo Asset Covered Securities (RS) Source: Barclays Capital

Source: Barclays Capital

Figure 238: Spread development

Figure 239: Credit term structure of major issuers

600

Barcap OAS

500

250

400

200

300

150

200 100

100

0

50

-100 03

04

05

06

07

08

Euro Irish Covered ASM 5Y Irish Mortgage ACS 5Y Irish Public ACS (Depfa) Source: Barclays Capital

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09

10

0 2008

2011

2013 DEPFA

2016 BKIR

2019

2021

AIB

Source: Barclays Capital

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Covered bond legislation enacted in 2001

Existing issuers focus on either the mortgage or the public sector business

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In 1995, when German mortgage banks began to issue jumbo Pfandbriefe, the financial authorities were considering establishing a covered bond framework in Ireland. With the introduction of the euro in 1999, the initiative gained momentum. The Irish mortgage lending industry was keen on developing a more efficient and competitive instrument to fund the rapidly expanding mortgage business. In addition, the project was regarded by financial authorities as important for strengthening the Irish capital market’s position versus its European peers. The initiative proved successful and, on 18 December 2001, the Asset Covered Securities Bill was enacted. Shortly after, the first designated credit institutions (DCIs) were established. Pursuant to the Irish Law, cover assets have to be transferred to a DCI, but can also be originated by it. The DCI is obliged to keep public sector and/or mortgage loans in separate cover registers. These segregated assets then serve as cover for Asset Covered Securities (ACS), which are either backed by public sector assets, residential mortgage assets or, since the introduction of new legislation in April 2007, commercial mortgage assets. To issue ACS, the respective DCIs must apply to become a designated mortgage credit institution, a designated public sector credit institution or both. As described below, DEPFA ACS BANK and WestLB Covered Bond Bank focus on the issuance of public sector ACS, while Allied Irish Mortgage Bank, Anglo Irish Mortgage Bank, Bank of Ireland Mortgage Bank and EBS Mortgage Finance concentrate on issuing mortgage ACS: „

Allied Irish Mortgage Bank is part of Allied Irish Bank’s (AIB) mortgage business and is 100%-owned by AIB. Its main purpose is to acquire mortgage loans originated by AIB and refinance them predominantly through the issuance of mortgage ACS.

„

Anglo Irish Mortgage Bank is a wholly-owned subsidiary of Anglo Irish Bank (ANGIRI). Its main purpose is to acquire commercial mortgage portfolios originated by its parent and refinance them predominantly through the issuance of mortgage ACS. It is the first issuer of commercial mortgage ACS.

„

Bank of Ireland Mortgage Bank is part of Bank of Ireland’s Retail Financial Services Ireland Mortgage business and is 100% owned by Bank of Ireland. Its main purpose is to acquire mortgage loans originated by Bank of Ireland and refinance these loans predominantly through the issuance of mortgage ACS.

„

DEPFA ACS BANK is 100%-owned by DEPFA Bank plc. Its main purpose is to carry out the wholesale funding activities for DEPFA Bank plc’s public sector business, largely through the issuance of public sector ACS. In 2007, DEPFA Bank plc became part of Hypo Real Estate Group, assuming responsibility for the group’s public sector finance business. Following the group’s nationalisation in 2009, DEPFA Bank plc is subject to the group’s restructuring.

„

EBS Mortgage Finance is part of EBS Building Society’s (EBSBLD) mortgage business and is 100% owned by EBSBLD. Its main purpose is to acquire residential mortgage loans originated by EBSBLD and refinance them predominantly through the issuance of mortgage ACS.

„

WestLB Covered Bond Bank plc is a wholly-owned subsidiary of WestLB AG. Initially, WestLB Covered Bond Bank plc enjoyed a key strategic role within the WestLB AG group in refinancing public sector operations, mainly through the issuance of public sector ACS. On 22 July 2005, WestLB AG announced it would resume Pfandbrief issuance out of Germany, scale back the activities of WestLB Covered Bond Bank plc and consider strategic options for its Irish funding arm. In May 2010, 100% of the ownership of WestLB Covered Bond Bank was transferred to Erste Abwicklungsanstalt (EAA), the work-out entity of WestLB supported by the state of North-Rhine Westphalia. In the course of the transfer, EAA 233

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irrevocably and unconditionally became the principal obligor of WestLB Covered Bond Bank plc’s obligations. At the time of writing, West LB Covered Bond Bank plc had only one jumbo public sector ACS outstanding, the €1.5bn 4.0% WESTLB March 2014. Amendment passed in April 2007

Recent developments

Strengths

On 9 April 2007, an amendment of the Asset Covered Securities Act was passed, and on 31 August 2007, secondary legislation was signed. The bill was put in place in response to the developing nature of the business and to anticipate the effect of new EU provisions. Some of the key amendments include the introduction of mandatory minimum over-collateralisation (residential: 3%; commercial: 10%), the use of commercial mortgages as 100% backing for ACS, a reduction in the limit for the inclusion of substitution assets to 15% from 20%, the use of securitised mortgage loans as backing for the bonds, and the addition of New Zealand and Australia to the list of category ‘A’ countries. Within the past 12 months, due to the challenging conditions in jumbo covered bond markets, opportunities to tap the jumbo market have been very limited and only two new benchmark deals were launched. At the same time, the focus has shifted more towards private placements. Strict segregation of all cover assets from the balance sheet of the originating entity. Particularly firm matching requirements, which stipulate: that the duration of the assets must not be less than that of the securities; that over a rolling 12 months, interest receivable on the assets is not less than interest payable on the ACS; and that the currency of the assets matches that of the ACS after hedging. The ability of the Irish National Management Treasury Agency (NTMA) to execute management functions in case an ACS issuer runs into an insolvency scenario, as well as the real-time monitoring through the cover asset monitor.

Weaknesses

Lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. This is mitigated by the fact that, to date, all ACS issuers have reported cover pool characteristics and risk management indicators on a regular basis. Potential support from the industry is regarded as weaker compared with some other frameworks, as there are only a few ACS issuers, and some of them have a non-Irish background. This is mitigated by the fact that reliance on potential support generally makes issuers reluctant to strive for a valid business model and gives investors an excuse for having a sloppy attitude with respect to surveillance. In addition, the importance of the financial services industry to the Irish economy and the increasing volume of domestic mortgage business, which is funded through ACS, are strong arguments in favour of strict surveillance and structural support.

Qualifying collateral for ACS LTV of 75% for residential mortgages

EEA with restrictions, and some OECD countries with a 10% limit

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Assets eligible for inclusion in the cover asset pool are mortgage credit assets, cover asset hedge contracts and substitution assets. Only mortgages with loan-to-value (LTV) ratios not exceeding 75% for residential properties and 60% for commercial real estate are eligible for inclusion in the cover asset pool (mortgages with an LTV greater than the maximum may also be included, but the amount by which the principal amount of the assets exceeds the LTV has to be disregarded). Mortgage credit assets and substitution assets located in EEA countries can be included in the asset pool without restrictions, as well as exposure to “A” countries (eg, Australia, Canada, Japan, New Zealand, Switzerland and the US). Mortgage loans to “B” countries (eg, OECD countries that 234

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have not rescheduled their external debt in the preceding five years) cannot be included in the cover asset pool. Commercial properties can be included in the asset pool of a mortgage covered security, provided that they account for less than 10% of the prudent market value of the mortgage credits in the asset pool. Geographical restrictions for commercial mortgage covered securities are similar to those for residential mortgage covered securities. Substitution assets (essentially deposits with eligible financial institutions, as well as assets approved by the IFSRA) cannot exceed 15% of the prudent market value of the asset pool. Inclusion of MBS is subject to a list of criteria and only up to 20%

Rather broad geographical scope for the asset pool of public sector ACS

Derivatives within the pool

Use of credit transaction assets

Following the amendment in April 2007, both types of mortgage covered securities may also include securitised mortgage credit assets. This is subject to a list of criteria. For example, the securitisation entity, which is the issuer of the securitised mortgage credit assets, has to be established under and subject to the laws of an EEA country; at least 90% of the assets held by the securitisation entity have to comprise of one or more mortgage credits, which, if held by a designated mortgage credit institution, would qualify as mortgage credit assets; and the securitised mortgage credit assets must constitute senior claims of the securitisation entity. In addition, the inclusion of MBS should not exceed a certain percentage of the cover asset pool. This percentage may be specified by the IFSRA by regulatory notice. The percentage has been set at 20%, to be in line with the CRD regime. For public loan-backed ACS issuers (eg, DEPFA ACS), assets that are eligible for inclusion in the cover asset pool are public credit assets (these include financial obligations to public sector entities as defined by the CRD), cover asset hedge contracts and substitution assets. Public credit assets and substitution assets located in EEA countries are eligible for inclusion in the asset pool with no limitations, as well as exposure to “A” countries. Exposure to “B” countries is subject to the upper limit of 10% of the prudent market value of all the public credit assets and substitution assets held, but lending to these countries cannot be included in the asset pool cover. Substitution assets cannot exceed 15% of the prudent market value of the asset pool. Pursuant to the Asset Covered Securities Act, designated credit institutions must keep a register for the assets (including substitution assets) included in the asset cover pool. Details of the asset hedge contracts entered into also have to be kept in the register. Institutions that are designated mortgage credit institutions, designated commercial mortgage institutions and public credit institutions are required to keep separate registers for their mortgage, commercial mortgage and public credit covered securities businesses. The registration is supervised by a cover asset monitor – effectively, a trustee appointed by the institution, subject to approval from the IFSRA. To ensure adequate levels of liquidity without diverting too many resources away from the designated credit institution’s core activity of providing mortgages or public sector loans, the Asset Covered Securities Act allows designated credit institutions to hold 10% of their assets in the form of credit transaction assets (eg, deposits with eligible financial institutions, financial assets and other transactions designated as a credit transaction by the Minister of Finance).

Regulatory oversight of assets Trustee concept

10 June 2010

To ensure that the pools provide adequate coverage for covered securities outstanding, inclusion (or removal) of assets in (from) the relevant asset pool is possible only after approval by the cover-asset monitor (ie, a trustee), whose role is to monitor ongoing compliance with existing legislation/regulations for the benefit of preferred bondholders. Importantly, the cover asset pools are managed dynamically, with eligible assets used to replace assets that no longer qualify for inclusion in the pool.

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Asset/liability risk management The aggregate principal amount of the outstanding ACS issued by a designated credit institution must be covered by assets that qualify for use as cover under the provisions of the Asset Covered Securities Act, (cover asset hedges are included in the calculations). To ensure this “matching” principle and to minimise the adverse effects that unexpected market movements may have on P&L and the balance sheet, the Asset Covered Securities Act, specifies that: Limitations on yield curve risk,

„

The duration of the asset cover pool has to be equal to or greater than that of the covered securities issued. To limit the potential mismatch, a regulatory notice, which became effective on 13 August 2002, clarified that the weighted-average duration of the public cover asset pool must not be more than three years greater than the weightedaverage duration of the public ACS issued.

„

The prudential market value of the asset pool has to be greater than that of the covered securities issued.

„

The interest generated in any given 12-month period by the asset pool has to be greater than the interest payable on the covered securities issued.

„

The currency of denomination of the assets in the pool has to be the same as the covered securities issued.

„

The issuing entity has to manage its interest rate position to ensure that a 1% shift and twist in the yield curve does not exceed, in net present value terms, 10% of own funds.

interest cover and FX risk, as well as a stress test

Mandatory over-collateralisation on a net present value basis

The ACS Act also stipulates a 3% mandatory over-collateralisation for mortgage and public sector ACS, and a 10% mandatory over-collateralisation for commercial mortgage ACS on a net present value basis. It is also worth noting that the level of mandatory overcollateralisation does not affect any higher existing contractual minimum overcollateralisation levels. If asset covered securities provisions, including the matching requirements mentioned above, are breached, the institution will not be able to issue any further ACS until the violation(s) is (are) rectified.

Bankruptcy remoteness and payment in case of insolvency No acceleration as long as cover pool’s integrity is not breached

In the worst-case scenario, ACS investors rank pari passu among themselves

10 June 2010

In the event of a designated credit institution becoming insolvent, potentially insolvent, having difficulties that threaten the position of creditors or having its licence revoked, the IFSRA may request that the National Treasury Management Agency (NTMA) appoint a new manager to assume control of the asset cover pools and manage them in the commercial interest of the holders of asset covered securities issued by the institution and persons with whom the institution has entered into cover asset hedge contracts. If the NTMA is unsuccessful in finding a qualified manager for this role, the IFSRA may appoint the NTMA to manage the asset covered securities activities of a designated or formerly designated credit institution. Given this, it is important to note that the NTMA is prepared to perform back office functions. In case of insolvency of a designated credit institution (or its parent), the asset cover pools and associated cover asset hedges are excluded from the estate of the insolvent institution, and neither outstanding ACS nor cover asset hedge contracts are accelerated as long as the cover asset pool continues to perform. Managers and cover-asset monitors (defined in the current legislation as super-preferred creditors) rank ahead of any preferred creditor. Preferred creditors (ie, holders of ACS and persons with whom the institution has entered 236

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into cover asset hedge contracts), in turn, rank pari passu among themselves, and have preferential claims with respect to the covered asset pools. The two pools of assets will be treated as separate pools, meaning that holders of mortgage covered securities have preferential claim only over the mortgage cover asset pool, and holders of public credit covered securities have preferential claim only over the public cover asset pool. If the claims of a preferred creditor are not fully satisfied from the proceeds from the disposal of covered assets, these creditors become unsecured creditors for the unsatisfied portion of their claims and rank equally not only among themselves but also with other unsecured creditors of the designated ACS issuer.

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Ireland

Name of debt instrument(s)

Mortgage, commercial mortgage and public Asset Covered Securities (ACS).

Legislation

Asset Covered Securities Act from 18 December 2001, amended 9 April 2007.

Special banking principle

Yes; Designated Credit Institution (DCI) mortgage, commercial mortgage and/or public.

Restrictions on business activities

Mainly public sector, residential and commercial mortgage lending in OECD countries and some “secondary” activities.

Asset allocation

Eligible assets are transferred to the DCI. The DCI could acquire public sector, mortgage and commercial mortgage loans, but is obliged to maintain separate cover registers for each asset class.

Inclusion of hedge positions

Hedge positions can be included in the asset pool and have to be documented in the “cover asset hedge contract register”.

Substitute collateral

Up to 15%.

Restrictions on inclusion of commercial mortgage loans in the cover pool

Yes, with respect to Mortgage ACS, commercial mortgage loans should not exceed 10% of the total cover assets. Commercial Mortgage ACS may consist purely of commercial mortgage assets.

Geographical scope for public assets

Central governments and sub-sovereigns in EEA countries, the US, Australia, Canada, Japan, New Zealand and Switzerland are allowed. Loans to other OECD countries are permitted, but are not eligible for cover. The total amount of these public sector loans should not exceed 10% of total assets. In addition, exposures to AAA-rated multilateral development banks and international organisations are allowed.

Geographical scope for mortgage assets

Every EEA country, the US, Australia, Canada, Japan, New Zealand and Switzerland are allowed.

LTV barrier residential

75%; loans above the legal LTV limit must be refinanced on an unsecured basis, and the average LTV for all mortgages should not exceed 80%.

LTV barrier commercial

Maximum 60%; loans above the legal LTV limit are permitted to be refinanced on an unsecured basis, and the average LTV for all mortgages must not exceed 80%.

Basis for valuation = mortgage lending value

Yes; “prudent market value” (market value = upper limit).

Valuation check

The examination of property valuations is part of the specific surveillance.

Special supervision

Yes; Central Bank and Financial Services Authority of Ireland and a special supervisor (“cover asset monitor”).

Protection against mismatching

Coverage by nominal value and by net present value required by law. The law also stipulates that the duration of public sector assets must be at least as high, but not in excess of three years, of the public sector ACS. Exchange rate risk is prohibited, and in addition, the total amount of interest receivable in any given 12-month period on the collateral assets must exceed the total amount of interest payable on such bonds in the same period.

Protection against credit risk

The issuer may replace non-performing loans.

Protection against operative risk

No back-up servicer is stipulated. In the case of issuer insolvency, the National Treasury Management Agency (NTMA) can appoint a cover pool administrator or fulfil this role itself.

Mandatory minimum overcollateralisation

103% for mortgage and public sector ACS; 110% for Commercial Mortgage ACS. Any minimum overcollateralisation held on a contractual basis may exceed these levels and should be controlled by the cover asset monitor.

Voluntary over-collateralisation is protected

Yes.

Bankruptcy remoteness of the issuer

No, but status of the issuer as a separate legal entity provides bankruptcy remoteness from the parent company.

Outstanding covered bonds to regulatory capital

—

In the event of insolvency, first claim is on…

… all assets earmarked for the respective asset pools. In addition, investors may benefit from positive market values of derivatives.

External support mechanisms

No formal recourse to assets outside the DCI, but the regulator is expected to exert some pressure over the shareholder(s) to support the DCI.

UCITS Art. 22 par. 4 compliant?

Yes.

CRD Annex VI, Part 1, §65 compliant?

Yes.

Source: Barclays Capital

10 June 2010

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ITALIAN MARKET

Overview Leef H Dierks +49 (0) 69 7161 1781 [email protected]

With an aggregate amount outstanding of €11bn from nine deals issued between the inception of the market in July 2008 and the time of writing, the issuance of Italian benchmark covered bonds has so far not lived up to expectations and still ranks among the smaller ones in Europe, despite the country’s €282bn mortgage market. With funding conditions having become increasingly more benign as of late in the light of the ongoing normalisation on the global financial markets, and covered bonds ranking among the cheapest refinancing instruments for most European banks, we expect issuance to increase in the months ahead. Ceteris paribus, gross full-year supply, which we believe will be exclusively attributed to the issuance of so-called obbligazione bancarie garantite (OBG), could then amount to €10bn in 2010 – ie, markedly up from the €6bn issued in 2009 (Figure 240). Technically, the Italian covered bond market allows for the issuance of two different products, which themselves are backed by two different legal frameworks: the aforementioned OBG and covered bonds issued by Cassa Depositi e Prestiti (CDEP). The latter benefits from an exclusive regulation – Article 5/18 of Law No. 296 dated 30 September 2003 – which stipulates that CDEP may secure its assets, rights and obligations to the repayment of the amounts owed to holders of notes issued by it and other lenders. In November 2004, CDEP announced the launch of a €20bn covered bond program, issuing its first benchmark covered bond in March 2005. At the time of writing, CDEP had three benchmark transactions in the aggregate amount of €6bn outstanding. In light of the negligible supply activity in recent years (CDEP issued its last benchmark covered bond in September 2006), we believe issuance to gradually phase out in the years ahead.

Two different legal frameworks

The issuance of OBG is governed by amendments to the so-called Legge 130 that were approved by the Italian parliament in May 2005. Article 7 was enhanced by specific rules

Figure 240: Outstanding Italian jumbo covered bonds Instrument

ISIN

Size (€bn)

Launch date

Spread at launch

CDEP

at 28 May 2010

Mid swaps (bp)

CDEP 3.250% Jul 10

IT0003829105

1.00

17 Mar 2005

+1

+2

CDEP 3.750% Jan 12

IT0004103492

2.00

1 Sep 2006

+1

+55

CDEP 3.000% Jan 13

IT0003933717

3.00

13 Oct 2005

+3

+71

5.500% PMIIM Jul 11

IT0004391626

1.00

Jul 2008

+50

+58

4.250% UCGIM Jul 16

IT0004511959

2.00

Jun 2009

+103

+85

OBG

3.625% UBIIM Sep 16

IT0004533896

1.00

Sep 2009

+60

+85

3.500% PMIIM Oct 16

IT0004540289

1.00

Oct 2009

+50

+86

4.375% UCGIM Jan 22

IT0004547409

1.00

Oct 2009

+60

+70

4.000% UBIIM Dec 19

IT0004558794

1.00

Mar 2009

+67

+89

3.625% BANCAR Nov 16

IT0004548464

1.00

Oct 2009

+60

+105

3.625% BPIM Mar 17

IT0004587363

1.00

Feb 2010

+80

+95

3.250% ISPIM Apr 17

IT0004603434

2.00

Apr 2010

+50

+67

Total

€11.00bn

Source: Barclays Capital

10 June 2010

239

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that allow Italian banks to use mortgage and public sector loans (including securitisation notes backed by this type of assets) that have been segregated from other assets on their balance sheet as securing assets for OBG.

Obbligazioni bancarie garantite Structure strongly resembles design of UK covered bonds

The issuance of Italian OBG is governed by Article 7 of Legge 130, which permits a special purpose company (SPV) to issue a guarantee backed by the assets that the SPV has bought from the originating bank. As outlined in Figure 241, OBGs issued on the basis of Legge 130 strongly resemble the design of UK covered bonds.

Figure 241: Structure of obbligazioni bancarie garantite Mortgage Loans and Related Securities Banca XYZ (Seller)

Banca XYZ Interest rate swap provider

Banca XYZ Covered Bond SPV Banca

Consideration

Loan repayment

Intercompany loan Banca XYZ Issuer

Covered Bond Proceeds

Covered Bond swap provider

Covered Bond Guarantee and Deed of Charge Covered Bonds

Covered Bond Holders Bond Trustees Security Trustee Swap Providers Source: Barclays Capital

Direct recourse to bank as issuer of the bonds

Technically, OBGs are issued by a bank (issuer) with a SPV purchasing the coverage assets from a bank (seller), which presumably – but not necessarily – is the issuing bank. To finance the acquisition, the SPV will enter into an advance loan agreement – again, potentially, but not necessarily – with the issuing bank. The coverage assets allow the SPV to provide a guarantee in favour of the holders of the covered bonds. Article 7 of Legge 130 also envisages the possibility of segregating assets within the issuing bank to guarantee payments on the covered bonds. However, so far, Italian authorities have not promulgated the secondary legislation required to make use of this second option. Within the structure outlined in Figure 241, holders of OBG will have direct recourse to the bank as the issuer of the bonds, while at the same time they are protected by a pool of mortgages. The latter has been segregated and will be managed exclusively for their benefit in the event of difficulties. We understand the following points to be important features when analysing OBG. „

10 June 2010

Covered bonds are issued as direct, unsecured and unconditional obligations that will rank pari passu among themselves and with all other present and future unsecured and unsubordinated obligations of the respective issuer.

240

Barclays Capital | AAA Handbook 2010 „

Proceeds raised through the issuance of covered bonds are on-lent through an intercompany loan to the covered bond SPV. The latter is legally independent from the issuer, but consolidated in its accounts. The SPV uses these proceeds, together with a capital contribution from the issuer, to purchase portfolios of residential mortgage loans from the seller. Additionally, substitution assets can be acquired. The inter-company loan fully mirrors the covered bond.

Qualifying collateral for Italian OBG Investors benefit from two types of guarantees

Assets eligible for cover pool

Characteristics of the guarantee

10 June 2010

Article 7-bis of Legge 130 explicitly defines the type of assets that can be purchased by the SPV and that are eligible to act as collateral for the issuance of covered bonds. Specifically, these are monetary claims arising from mortgage loans, monetary claims against public sector entities (or those guaranteed by public sector entities) and/or asset-backed securities (ABS) that are backed by a collateral portfolio comprising the previous two types of claims. Covered bond holders technically thus benefit from two types of guarantees: a general one provided by the bank’s assets and a specific one provided by cover assets. By law, the repayment of the advance loan is subordinated to payments to the covered bondholders, the hedging counterparties and the other service providers/costs in the context of the transaction. With regard to the eligibility of mortgage assets, loan-to-value (LTV) ratios are limited to 80% for residential property and 60% for commercial property located in the European Economic Area (EEA) and Switzerland. According to the Basel II Revised Standardised Approach (RSA), the definition of public sector lending also includes assets from the EEA and Switzerland, with a risk weighting (RW) of not more than 20% and up to 10% of cover assets outside the EEA and Switzerland, provided that such exposures qualify under the RSA for a risk weighting of 0% for central governments and 20% for public sector entities, regional governments or local authorities. The decree furthermore foresees the use of senior tranches of securitisation transactions such as ABS and/or RMBS, provided that at least 95% of the collateral portfolio complies with eligibility criteria for mortgage and/or public sector lending, and the risk weighting is no more than 20% under the Basel II RSA. In addition, substitute assets of up to 15% of cover assets are allowed. They should consist of exposures to banks with a double-A rating from the EEA and Switzerland, or from a central government with a 0% risk weighting under the Basel II RSA. The Italian covered bond regulation stipulates that the guarantee provided by the SPV to OBG holders has to fulfil the following requirements: the guarantee needs to be irrevocable, unconditional, immediately available, and independent from the issuing bank’s obligations on the covered bond. Upon bankruptcy of the issuing bank, the guarantee will be callable by the holders of OBG. There will be no cross-acceleration with the bank’s debt to fulfil the rating agencies’ de-linking requirement. The guarantee will be limited to cover pool assets to ensure the bankruptcy remoteness of the SPV. The OBG holders will have the right to file a claim against the issuing bank for a full repayment. In this case, the holder will be represented exclusively through the SPV. Moreover, in the case of a liquidation of the issuing bank, the SPV will be entirely responsible for executing payments to the OBG holder and other counterparties and will represent the holders of the respective OBG in any proceedings against the issuing bank. Any amount obtained as a result of the liquidation procedure will become part of the cover pool and can therefore be used to satisfy the rights of the OBG holders.

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Regulatory oversight Banca d’ltalia in charge of special surveillance

Limits for capital ratios

Within the OBG framework, Banca d’Italia, the Italian central bank, assumes specific regulatory functions. It controls whether an issuing bank fulfils certain prerequisites, in particular with respect to regulatory capital. In addition, it will monitor the compliance of OBG with the regulations. On 15 May 2007, Banca d’Italia enacted its supervisory regulation (istruzioni di vigilanza) on OBG. According to this regulation, OBG issuers must have a minimum consolidated regulatory capital of €500mn, a minimum regulatory capital ratio of 9.0% and a minimum Tier 1 ratio of 6%. In addition to this policy, limits for allocating assets to covered bonds were stipulated and are listed in Figure 242.

Figure 242: Barriers for the allocation of assets (%) Total capital ratio

Tier 1 ratio

Cover assets/eligible assets

≥11.0

≥7.0

No limit

≥10.0 and 75%

26.3%

23.7%

37

51

WA seasoning (months) 30d in arrears

1.21%

3.10%

FICO 2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

14.2

2.6 2003

30 25 20 15 10 5 0

7.3

5.7 5.7

CADES 3.625% Apr 15 CADES 4.250% Apr 20

Public debt issuance ($bn)

13.6 7.0 7.0

Dec-09 Mar-10

Currency distribution, May 2010

0.3

2010

Sep-09

CADES 4.500% Sep 13 CADES 4.125% Apr 17

0

AUD/CAD/ NZD 1.9%

Debt instrument structure (€bn) Inflation Linked Bonds 13 3% Private placements 17.1% CP (Euro & US) 15.6%

10 June 2010

Jun-09

2006

0

40

2005

0 17,000

5

Bonds 50.5%

12

2010 yt May

71,283 73,652 72,092 82,676 96,954 72,713 75,598 74,203 84,286 97,106

10.0 7.7

5.8

10

2009

12.6

Public debt maturity structure, May 2010 ($bn)

10

8

2008

75,791 77,241 76,665 86,312 98,777

Note: CADES’ annual statements are prepared in accordance with accounting regulations applicable to financial institutions and French GAAP, adjusted to take account of the particular nature of the fund. Debt maturity and currency structure charts are based on dealogic DCM Analytics data

10.3

6

60

Off balance sheet commitments Obligations taken over by 0 0 CADES during year Outstanding commitment to 8,390 2,690 make payments to the State and social security funds

15

4

OAS swap spread evolution

2004

Balance sheet summary Total assets Debt transferred to Cades during year Gross liabilities of which Debt securities outstanding Net balance sheet liability

2006

60 50 40 30 20 10 0 Bonds

Private Inflation Linked placements Bonds Dec-08 Dec-09

MTNs

CP (Euro & US)

337

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Council of Europe Development Bank (COE) Description

Michaela Seimen Ratings table

% $ Index

% £ Index

Total assets

0.14

0.087

€22.7bn

The Council of Europe Development Bank (CEB) is a multi-lateral development bank formed by the Council of Europe, initially for the purpose of channelling funds to ease refugee problems, but now with a broader social orientation, encompassing both funding for disaster relief and longer-term projects for social improvement. With total assets at year-end 2009 of €22.7bn, CEB is one of the smaller and more slowly growing multi-lateral lending institutions (MLIs). Improved credit controls and a re-orientation of the loan portfolio over the past few years have improved asset quality.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1 +

F1+

Stable

Stable

Stable

Outlook

Risk weighting Basel II RSA: 0%

Key features of the credit „

Purpose: The Council of Europe (COE) established the CEB in 1956 as its sole financially autonomous institution. The Council was created in 1949 with the aim of strengthening democracy, human rights and the rule of law throughout its member states. The CEB’s functions have evolved to include funding disaster relief and a wider range of social projects that are linked to three main focus areas: namely social integration, environmental management and support for human capital. The COE’s 201014 Development Plan is governed by the prospect of a fragile economic recovery on a global scale, a significant increase in unemployment and a greater vulnerability of the emerging countries in central and south-eastern Europe. The plan foresees an increased mobilisation of the institutions resources, encompassing increased lending and strengthened collaboration with the EU and donor countries to optimise project implementation conditions.

„

Financials: Debt leverage and gearing – In past years CEB developed a new prudential framework, which aligns the bank’s risk framework with the principles of Basel II by shifting to more risk-based measures. It is mainly organised around three ratios: a risk-weighted capital adequacy ratio (maximum 100%); a risk asset coverage ratio (limiting the ratio of below investment-grade exposure to available own funds and AAA/AA callable capital to 66%); and a liquidity ratio (such that the cash position should be at least 50% of net treasury needs over the following three years). At year-end 2009, the capital adequacy ratio was 20.3% (20.4% in 2008), the risk asset coverage ratio was 40.5% (33.1%), and the liquidity ratio stood at 102.2% (103.7%). Financial performance – despite erosion in net margins on loans in 2008 and 2009, net income rose by €11.2mn, or 11.7% to €107mn in 2009, compared with €95.8mn in 2008. This was mainly due to favourable interest differential in refinancing conditions.

„

Ownership and capital structure: Ownership is spread across over 40 governments in western and eastern Europe. The most recent members are Serbia and Ireland (2004), Georgia (January 2007) and Montenegro (November 2007). The top five shareholders account for c.68% of the total capital subscription, and investment-grade countries provide more than 90% of callable capital, with the majority being provided by AAA sovereigns. The most recent general capital increase was in 2001.

„

„

Asset structure and quality: Over the past few years, CEB has diversified the geographical distribution of its loan portfolio, and in the process, has addressed earlier credit concerns. Loans outstanding slightly declined 1.7% in 2009 to €12.2bn. Between 2005 and 2009, the majority of loans were distributed as follows: Germany (in favour of target group countries) 15.3%, Portugal 11.3%, Poland 10.3%, Turkey 10.1%, Spain 7.5% and Lithuania 4.9%. Overall exposures are well diversified geographically. Increasing priority is being given to lending to a target group of 21 new EU members and transition countries of central and south-eastern Europe. Some 52% of the total amount approved during 2009 was to target group countries.

Funding: New borrowing decreased to €2.5bn in 2009 (€3.3bn in 2008), reflecting refinancing debt and to cover lending needs. In 2009, the CEB executed transactions in various currencies to diversify its funding and to broaden its investor base. In 2009, 31% of the funds raised by CEB were denominated in Australian dollars, 28% in GBP, 17% in CHF, 16% in Hong Kong dollars, 5% in US dollars and 3% in New Zealand dollars. This is in contrast to past years’ activities, when debt outstanding and new issuances were dominated by the dollar sector, which provided 66.5% (87% in 2007) of 2008 funding. CEB hedges all financing operations with swaps to eliminate both interest rate and foreign-exchange risks. After swaps, the total amount of funds borrowed was converted into euro. In 2008 and 2009, the average maturity of issues was five years. As of 31 December 2009, debt outstanding of CEB amounts to €16.5bn, up from €14.6bn as of year end 2008. The majority of redemptions of CEB’s debt are due until 2014, with c.€3.5bn maturing debt in 2011.

Strengths

Weaknesses

„

Asset quality is protected by preferred creditor status.

„

„

High-quality callable capital base.

„

Geographically diversified loan portfolio.

Highly leveraged relative to paid-in capital and reserves.

Key points for 2010 „

Continuing focus on loans to central and southeastern Europe.

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Public sector

Council of Europe Development Bank (COE)

Financial summary – YE Dec

Credit term structure

€ Balance sheet summary (€ bn)

2004 2005 2006 2007 2008 2009 % chg

Total assets

16.40 17.67 18.23 18.51 21.40 22.73

Net disbursed loans

10.84 11.71 12.10 12.11 12.60 12.33

30

4.0

20

7.79

-4.8

10

11.78 13.72 13.62 13.26 16.17 17.68

21.9

Subscribed capital

3.29

3.29

3.29

3.30

3.30

3.30

0.0

0

Paid-in capital and reserves

1.61

1.69

1.77

1.83

1.78

1.96

-2.2

-10

116.9 114.1 115.4 117.2 118.0 141.5

0.7

0

Income statement summary (€ mn) Operating expenses Net income

28.2

27.4

29.4

29.6

30.0

30.9

1.4

121.0

88.5

88.1

93.3

95.8 107.0

2.7

Profitability (%) Return on average assets

0.74

0.52

0.50

0.52

0.48

Return on capital

7.5

5.4

5.2

5.3

5.4

0.52 5.7

Cost/Income ratio

24.1

23.6

25.0

24.1

23.7

22.3

Net int rev/Op inc

100.0

98.4

98.2

95.4

93.1 101.9

Gearing, debt leverage & capital ratios (%) Disbursed loans/ Paid in capital & reserves

671.2 691.8 682.6 663.5 706.1 629.3

Disbursed loans/ Subscribed capital & reserves

238.7 253.6 257.6 254.5 267.1 251.9

Callable capital/Debt

21.3

21.5

22.1

18.1

16.6

9.8

9.6

9.7

9.9

8.3

8.6

8

100 80 60 40 20 0 -20 May-09

Aug-09 Nov-09 COE 5.500% Jun 12 COE 5.125% Apr 17

Feb-10 COE 4.500% Jun 14

4 3 2 1 0

2.3

2.0

2.6

2.8

3.3 2.4

2.1

1.4

Currency distribution, YE 09

4.4 3.4

4

3.3 2.4

3

EUR 1.5%

2.3

2 1

6

Public debt issuance ($bn)

Public debt maturity structure, May 2010 ($bn) 5

4

OAS swap spread evolution

2003

Paid-in res/Total assets

24.8

2

2010 yt May

Net interest income

2009

5.09

2008

5.35

2007

5.26

2006

5.04

2005

4.89

2004

Internbank & securities holdings Total borrowings

15.6

40

0.8

0.4

0.2 0.1

0.1

0.0

Capital structure, YE 09

10 June 2010

AUD/CAD/ NZD 10.6% Others 10.2%

Outstanding loan country distribution, YE 09 General Reserves 32.4%

Callable & unpaid 60.0%

>2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

0

USD 77.5%

Other Reserves & Retained Earnings Paid-in 0.1% 7.6%

Greece 3% Portugal 4% Turkey 6% Hungary 9% Finland 6% Poland Germany 6% 5%

Others 24% Spain 17% Italy 10% France 10% 339

Barclays Capital | AAA Handbook 2010

Eksportfinans (EXPT)

Michaela Seimen

Description

Ratings table

% $ Index

% £ Index

Total assets

0.072

NA

NOK225bn

The Eksportfinans Group (EXPT) provides long-term funding and other financial services in the areas of export and municipal finance. Ownership is spread across the Norwegian banking system and the Norwegian government (15%). EXPT is the sole specialised export lender in Norway. Effective March 2009, EXPT sold its subsidiary Kommunekreditt Norge AS, one of the main lenders to the Norwegian municipality sector. EXPT’s areas of activity are characterised by strong asset quality and narrow lending margins. EXPT is Norway’s leading international borrower.

Moody’s

S&P

Fitch

LT senior unsecured

Aa1

AA+

AA

ST

P-1

A-1 +

F1+

Negative

Stable

Stable

Outlook

Risk weighting Basel II RSA: 20%

Key features of the credit „

Purpose: EXPT was established in 1962 to provide long-term financing to Norwegian exporters. The institution is the sole specialised export lender in Norway, provides commercial export funding (on behalf of shareholder banks) and acts as an agent for government-supported finance. In 1999, it acquired local authority lender Kommunekreditt Norge AS, the secondlargest municipal lender in Norway. In 2009, Kommunekreditt Norge AS was sold to Kommunal Landspensjonskasse (KLP).

„

Asset structure and quality: EXPT has traditionally carried a high level of liquid assets as a hedge against interruptions to funding. As of year-end, liquidity placed in commercial paper and bonds amounted to NOK76.1bn, down from NOK108.1bn in 2008. The share invested in ABS with an average AAA rating has risen in recent years. As of year-end 2009, the ABS portfolio made up about 42% of the liquidity portfolio (covered by a Portfolio Hedge Agreement).

„

Ownership and capital structure: The Norwegian government has a 15% direct stake and a further indirect stake via DnB NOR Bank (40%). At the end of 2009, 26 Norwegian banks and foreign banks operating in Norway shared the other 45%. The largest shareholder is DnB NOR Bank ASA with 40%. There is no explicit guarantee of EXPT’s debt, but government participation, together with the company’s public policy role in providing export finance and close interaction with various areas of government, provides a strong expectation of government support. It is regulated as a specialised financial institution by Kredittilsynet (the Norwegian equivalent of the FSA).

„

„

Asset structure and quality: EXPT’s traditional export-related business areas were in lending for capital goods, ships built at Norwegian shipyards and more general export-related and international lending. During its ownership of Kommunekreditt, loan growth was concentrated in municipal lending. Kommunekreditt was sold in 2009, however, with a portfolio of NOK11bn of loans to Norwegian municipalities transferred to EXPT. EXPT expects to hold these loans to maturity. Over the past few years, export lending has grown, as demand has been boosted by strong growth in the shipping industry and the oil and gas sector, which has been driven by high oil prices. Asset quality of the loan book is inherently robust: All export-related lending is backed by guarantees provided by governments (of Norway and other OECD countries) and banks (currently mainly Norwegian). It has never suffered a loan loss on export finance.

Financial performance: The balance sheet decreased 24% in 2009 due to the sale of its subsidiary, reduction of its liquidity portfolio and foreign exchange rate effects. In the past, assets more than doubled. Net interest income increased strongly (+78%) due to effects related to beneficial borrowing conditions by EXPT in 2009. The Norwegian government agreed in 2008 to provide EXPT market-based funding on specified terms in 2009 and 2010. However, EXPT was able to raise sufficient funding volume in 2009 and has not utilised the agreement with the government. EXPT’s total capital ratio increased from 11.6% to 13.3% as of Q4 09. In 2008, shareholder banks agreed to provide NOK5bn credit protection against further unrealised losses in the liquidity portfolio under a so-called “Portfolio Hedge Agreement”.

„

Funding: EXPT is one of Norway’s largest international borrowers. In 2009, total borrowing amounted to NOK69.3bn, versus NOK93.7bn in 2008. It is active in MTN issuance across a range of currencies, particularly in structured MTNs, many of which are not captured in public databases, depressing the public volumes in our issuance chart. In 2009, a total of 1023 bonds were issued in nine currencies. EXPT normally issues one or two dollar benchmarks each year, in part to provide a benchmark for its MTN funding. In 2009, it issued three benchmark bonds: two bonds were issued in CHF with tenors of 7.5 and 9.5 years and a USD 5-year global benchmark issue targeted investors in the US, Europe, Middle East and Asia.

Strengths

Weaknesses

„

Strong asset quality and high levels of liquidity.

„

No explicit government debt or solvency guarantee.

„

Public policy role in the provision of export finance.

„

Narrow operating margins.

„

Government shareholding and stakes held by a wide range of banks, which underpin expectations that its export finance franchise will remain unchallenged.

„

Dependency on single business line of export lending.

„

Growth prospects: Can EXPT continue to sustain strong growth in its loan portfolios in the face of potential capital constraints in the event of further valuation pressure on the liquidity portfolio?

Key points for 2010 „

Performance of liquidity portfolio and implications for net income and credit ratings.

10 June 2010

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Barclays Capital | AAA Handbook 2010

Public sector

Eksportfinans (EXPT)

Financial summary – YE Dec NOK

Credit term structure

2006

2006 IFRS

2007

2008

2009 %chg

150

Balance sheet summary (NOK bn) 165.2

172.4

218.7

296.9

225.3 -24.1

Customer loans

90.3

79.0

98.8

112.8

66.7 -40.9

Security holdings

63.4

63.9

80.1

108.1

76.1 -29.6

2.4

3.0

2.7

7.2

5.4 -25.0

4.2

5.3

4.6

9.6

7.3 -23.4

157.3

160.6

206.3

259.0

197.6 -23.7

561.0 1,068.2

0

Income statement summary (NOK mn)

0.0

Net interest revenue

484.1

459.1

Operating income

511.0

394.3

-23.2 4,945.3 -2,313.6

NM

Operating expenses

177.7

177.2

186.7

187.3

-8.4

Pre tax income

333.3

217.1

-209.9 4,740.8 -2,500.9

NM

Net income

242.6

159.3

-148.8 3,435.6 -1,801.8

NM

204.5

1,470.0

Profitability (%) Return on assets

0.2

0.1

-0.1

1.3

-0.7

Return on equity

9.8

5.7

-5.2

69.6

-28.6 -21.3

5.9

3.4

-3.0

48.5

Cost/Income ratio

34.8

44.9

-804.7

4.1

-8.1

Net interest revenue/Op. income

94.7

116.4 -2418.1

21.6

-63.5

372.5 1967.5

137.3

Asset quality Non-accrual loans (NOKmn)

3.6

357.4

Non-accrual/total loans (%)

0.0

0.4

0.3

1.3

0.1

2356.8 1911.4 2741.5 1557.6

1784.9

OAS swap spread evolution 150 125 100 75 50 25 0 -25 May-09 Aug-09 Nov-09 EXPT 1.875% Apr 13 EXPT 5.500% Jun 17

2.7

3.3

2.2

3.7

3.7

12.2

12.2

9.6

11.6

13.3

2.6

3.0

2.1

3.2

3.3

6 5 4 3 2 1 0

Public debt maturity structure, May 2010 ($bn) 4

2.9

3

3.3 1.5

1.5

2

0.6

1

1.1

0.8

0.2 0.4

0.9

Sub debt 20.5%

Preferred cap secs 5.7%

10 June 2010

>2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

0

Capital structure, YE 09

2.9

3.6

2.8

3.0 1.5

Currency distribution, YE 09

2.7

2.5

Feb-10 EXPT 3.000% Nov 14

5.0

4.3 3.1

2003

Total capital/Total assets

5.0

2010 yt May

Total capital ratio

4.0

2009

Capital/Debt securities

3.0

Public debt issuance ($bn)

Gearing, debt leverage and capital adequacy Loans/Total capital

2.0

2008

Return on total capital

1.0

37.6

2007

Debt security funding

2006

Total capital

50

2005

Shareholders' equity

100

2004

Total assets

AUD/CAD/ NZD 12.3% EUR 15.9%

Others 14.1%

USD 38.0%

JPY 19.9%

Loan distribution, YE 09

Share capital 37.8%

Other equity 36.0%

Government supported Loans 31.8% Commercial Loans 68.2%

341

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Eurofima (EUROF)

Michaela Seimen

Description

Ratings table

% $ Index

% £ Index

Total assets

0.062

0.048

CHF35bn

Eurofima (The European Company for the Financing of Railroad Rolling Stock) is well defined by its long name. It was formed as a supranational organisation for this purpose in 1956. It is owned by the railway companies of 26 European countries and backed by sovereign guarantees on both its callable capital and its loans.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

NR

ST

P-1

A-1+

NR

Stable

Negative

NR

Outlook

Risk weighting Basel II RSA: 20%

Key features of the credit „

Purpose: Eurofima was established in 1956 as a supranational organisation under the terms of a convention signed in 1955, initially by 14 European governments (now 26), with the purpose of financing the acquisition of railway rolling stock and, more generally, supporting the development of rail transportation in Europe. Originally established for 50 years (to 2006), a subsequent agreement in 1984 extended its life a further 50 years to 2056.

„

Ownership and capital structure: It was set up as a joint-stock company, based in Basel and operating under its founding treaty and then under Swiss law. The shareholders are the national railways of the signatory countries. In 2007, the state railways of Portugal and Greece increased their participation in Eurofima’s share capital from 1% to 2% through a re-allocation of shares from the German, French and Italian railways, which are the three largest shareholders. Banking regulators treat Eurofima as a commercial public entity rather than a multilateral development bank. Under the Revised Standardised Approach of Basel II, which weights AAA to AA- corporates at 20%, Eurofima’s risk weighting reduces to this level, from 100%, which had applied under Basel I.

„

„

Debt leverage and gearing: At year-end 2009, total assets amounted to CHF37.4bn, slightly down 7.6% from 2008 levels. The ratio of subscribed capital and reserves to total loans, increased to 10.8% (10% in 2008); however, it is lower compared with other multi-lateral institutions. Nevertheless, the combination of guarantee support for Eurofima’s loans and the high-quality sovereign guarantees underpinning its callable capital are viewed by the rating agencies as sustaining its Aaa/AAA ratings. Until year-end 2009, Eurofima has never written off any loans or had to call on government guarantees.

„

Financial performance: New loan disbursements amounted to CHF1.8bn in 2009, down from CHF3.9bn in 2008. This was due to a continuing challenging economic environment, combined with five years of strong balance sheet growth, which resulted in more cautious lending activities. Net income rose a slight 4.8% to CHF50.8mn, mainly as a result of better net interest income due to favourable borrowing costs.

„

Funding: Total borrowing decreased to CHF2.3bn in 2009, from CHF4bn in 2008, and was made up of three currencies in total. For the first time since 2004, Eurofima re-entered the euro market with a new €500mn bond due in 2021. This issue was targeted at investors in its member states and to further broaden Eurofima’s investor base. After six benchmark bonds have been issued between 2004 and 2008 in the US$ market, there were no benchmark issues in 2009. US$ issues focused on the short to medium-term maturities, whereas Eurofima looked for duration in the euro and CHF markets.

Asset structure and quality: Its main activity is lending through equipment-financing contracts, which are secured against the purchased rolling stock and guaranteed by the respective national governments of the borrowing railway companies. Its asset quality is protected further through a combination of provisioning, a special guarantee reserve and a general reserve. As well as guaranteeing Eurofima’s loans to their respective railways, signatory governments provide a joint guarantee of the loans up to the value of their shareholdings. They also guarantee their national railways’ obligations as shareholders, specifically the joint obligation to provide callable capital.

Strengths

Weaknesses

„

„

High balance sheet leverage.

„

Risk-weighting treatment puts it at a disadvantage to other Multi-lateral Lending Institutions (MLIs).

Strong asset quality secured against rolling stock, backed by sovereign guarantees and further supported by a conservative provisioning policy.

Key points for 2010 „

No major developments expected. In light of the crises, Eurofima intends to strengthen its liquidity and equity base.

10 June 2010

342

Barclays Capital | AAA Handbook 2010

Public sector

Eurofima (EUROF)

Financial summary – YE Dec

Credit term structure

CHF 2005 2006 2007 2008 2009 % chg Balance sheet summary (CHF bn)

60

Total assets (net of unpaid capital) Disbursed loans

40

Cash and investments

31.4 32.3 33.3 38.4 35.3

-8.0

28.4 28.8 29.7 35.5 32.4

-8.6

2.1

Total borrowings

2.6

2.8

2.5

29.3 30.1 31.2 33.9 32.2

-4.9

10 0

2.6

2.6

2.6

2.6

0.0

Paid in capital + reserves

1.0

1.0

1.0

1.0

1.1

2.8

33.2 31.0 29.6 37.9 40.4

6.8

Income statement summary (CHF mn) 8.1

Net income

7.8

-1.9

47.2 45.4 44.5 45.4 50.8

8.3

8.1

7.9

11.9

Profitability (%) Return on average assets

0.16 0.14 0.14 0.13 0.14

Return on average equity

4.9

4.6

4.4

4.4

14.1 15.1 15.4 13.8 13.2

Net int rev/Op inc

57.6 56.7 56.1 66.1 69.1

0

2

OAS swap spread evolution 150 100

3.1

3.0 2.5 2.0 1.5 1.0 0.5 0.0

2.7

Public debt maturity structure, May 2010 ($bn)

2.7

1.8

Capital structure, YE 09

1.3

Currency distribution, YE 09

0.7

EUR 5% 0.5

AUD/CAD/ NZD 27.3% GBP 3%

USD 33%

>2029

2020-2029

2019

2018

0.9 1.2

2017

2016

2015

2014

2013

2012

2011

2010

1.0

1.4 1.4

2.2 0.4

3.2 1.9

2.5 1.7

2010 yt May

6.5

2.7

2009

6.1

3.1

2008

6.7

3.1

2007

6.9

3.1

2006

7.1

Paid in + res/Total assets

2005

Callable capital/Debt

CHF 27%

Others 2%

Loan distribution, YE 09 General Reserves 16.0% Other Reserves & Retained Earnings Paid-in 0.9% 16.6%

10 June 2010

Mar-10 EUROF 4.250% Feb 14

Public debt issuance ($bn)

958 1,133 1,027

2004

935

2003

931

Callable 66.5%

8

2,920 2,884 2,909 3,381 3,007

Loans/Subscribed cap. & res.

1.5 1.3 1.6

6

0 Jun-09 Sep-09 Dec-09 EUROF 5.125% Aug 12 EUROF 5.250% Apr 16

Gearing, debt leverage & capital ratios (%)

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

4

50

4.8

Cost/Income ratio

Loans/Paid in cap. & res.

20

7.6

2.6

Operating expenses

30

2.7

Subscribed capital

Net interest revenue

50

Switzerland 10.7% Belgium 13.9% Italy 13.9% France 16.9%

Spain 9.6% Austria 8.0% Germany 7.2% Portugal 4.4% Greece Others 4.3% 11.2%

343

Barclays Capital | AAA Handbook 2010

European Bank for Reconstruction & Development (EBRD) Description

Michaela Seimen

Ratings table

% $Index

% £ Index

Total assets

0.038

0.088

€33bn

The European Bank for Reconstruction and Development (EBRD) is the key regional development bank for the transition economies of Central and Eastern Europe (CEE) and the countries of the former Soviet Union. As new countries have progressed towards EU membership, the focus has increasingly been on those countries that are still outside the EU. This is inherently an area of higher credit risk, and EBRD’s credit quality is heavily dependent upon the strength of capital support and conservative financial policies.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

Outlook

Risk weighting Basel II RSA: 0%

Key features of the credit „

Purpose: The EBRD started operations in 1991. Its objective is to encourage the development of market economies in the CEE countries, as well as those of the former Soviet Union, stretching into central Asia.

„

Ownership and capital structure: The EBRD is owned by 61 countries, the EC and the EIB. Membership is not restricted to European nations – the US, Japan and Canada are among the leading shareholders. Borrowing members account for 12.8% of subscribed capital. The US is the largest individual shareholder with 10.1%. Members and institutions of the EU provide 57%, and investment grade shareholders provide almost 90%. Paid-in capital is 26% of the total, which is a relatively high proportion compared with other MLIs, but the percentage has declined over the past two years, reflecting growth in reserves and retained earnings.

„

Asset structure and quality: The bank operates in 30 countries, where it helps to finance public and private sector projects through loans, equity finance and the provision of guarantees. Financial institutions, infrastructure/energy projects as well as industry and commerce. Asset quality has been on an improving trend since a low point in 2000, and although impaired loans have increased sharply since 2007, they remain a relatively low proportion of total loans (2.3%) and are well covered by loan provisions. As the countries of CEE move into the EU, these countries have been de-emphasised in the EBRD’s portfolio. For example, in 2007, the Czech Republic became the first of the eight new EU members to “graduate” to an economic level at which the EBRD no longer makes new loans or investments in it.

„

Debt leverage and gearing: Given the relatively higher risk of EBRD’s assets, its financial policies are relatively conservative. It applies gearing ratios that limit outstanding loans, equities and guarantees to the total unimpaired subscribed capital, reserves and surpluses. Also, equity investments are limited to the paid-in capital, reserves and surpluses. Observed gearing and debt leverage ratios to capital (including and excluding callable capital) are therefore at the lower end of the MLI scale.

„

Financial performance: A declined net interest income combined with a continuing decline in valuations on equity investments for the second year in a row caused a net loss for the EBRD of -€746bn. Business volumes continued to expand strongly in 2009, with new commitments amounting to €7.9bn (in 311 projects), compared with €5.1bn (302 projects) in 2008. The balance sheet size decreased slightly by €518mn to €32.5bn. Outstanding loans increased c.19% over the year, while reserves and retained earnings, paid-in capital remained at stable levels.

„

Funding: EBRD focuses most of its funding efforts on MTN structures to minimise funding costs, rather than benchmark transactions. The currency mix of its outstanding debt is, therefore, particularly diverse.

Strengths

Weaknesses

„

Conservative financial policies.

„

Concentration in countries with low credit ratings.

„

Strong capital base.

„

„

Preferred creditor status.

Substantial amount of equity exposure, which is inherently high risk and subject to mark-to-market volatility.

„

Increased volatility in income, assets and capital as a result of the application of fair valuation techniques Will request for 50% capital increase be realisable?

Key points for 2010 „ „

Impact of global economic pressures on the economies of the transition region. Trends in asset quality – further scope for improvement?

10 June 2010

„

344

Barclays Capital | AAA Handbook 2010

Public sector

European Bank for Reconstruction & Development (EBRD)

Financial summary – YE Dec 2009 % chg -1.5 15.9 8.7 -11.6 7.6 0.0 -2.0 -12.7 -2.5 NM 50.3

2 1

6

60 40

Aug-09

Nov-09

Feb-10 EBRD 3.625% Jun 13

3.2 2.0

0.7

0.7 2009

1.5

2010 yt May

2.4 1.6

2008

2.0

2007

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

AUD/CAD/ NZD 16% JPY 14%

>2029

ZAR 7% Others 17% EUR 5%

GBP 2%

USD 39%

Loan distribution, YE 09 Reserves & Retained Earnings 24.2%

Paid-in 19.9%

10 June 2010

5

Public debt issuance ($bn)

0.6 2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

Callable 55.9%

4

EBRD 5.000% May 14 EBRD 2.750% Apr 15

0

Capital structure, YE 09

3

OAS swap spread evolution

-20 May-09

2.0

0.1 0.3 0.3 0.0

2

Currency distribution, YE 09

1.7 1.5

1.1

1.0

1

0

2.5 1.9

0

20

Public debt maturity structure, May 2010 ($bn) 3

14 12 10 8 6 4 2 0

2006

2008

2005

2007

2004

2006

Balance sheet summary (€ bn) Total assets 30.7 33.2 33.0 32.5 Net disbursed loans 8.0 8.9 10.7 12.4 Net share investments 5.1 6.6 4.4 4.8 Liquid assets 14.3 14.7 13.8 12.2 Total borrowings 16.8 17.7 18.4 19.8 Subscribed capital 19.8 19.8 19.8 19.8 Paid in capital and reserves 12.2 13.9 11.8 11.5 Income statement summary (€ mn) Net interest revenue 462 576 667 582 Operating expenses 225 251 243 237 Write-downs & provisions -53 201 -105 -535 Net income 2389 1884 -475 -714 Profitability (%) Return on average assets 8.1 5.9 -1.4 -2.2 Return on average equity 21.7 14.5 -3.7 -6.1 Cost/income ratio 8.4 13.0 -191.3 408.6 Net int rev/Op inc 17.3 29.8 -525.2 1003.4 Gearing, debt leverage & capital ratios (%) Loans & shares/Paid cap & res 107.0 111.7 128.6 149.3 Loans & shares/Total cap 48.7 54.4 57.3 65.9 Callable capital/debt 86.8 82.6 79.2 73.6 Paid in + res/Total assets 39.7 41.8 35.6 35.4 Asset quality (%) Non-accrual loans (€ mn) 19.0 37.0 127.0 305.0 Non-accrual/Total loans 0.2 0.4 1.2 2.3 Cum LLPs (€ mn) 341.0 124.0 227.0 719.0 Cum LLPs/Non-accrual loans 1,794.7 335.1 178.7 235.7

2003

€

Credit term structure

Poland 5.3% Russian Federation 30.5% Others 16.8%

RomaniaRegional Serbia 9.6% 4.7% 3.7%

Croatia 4.7% Kazakhstan 4.5%

Ukraine 13.4% Bulgaria Hungary 2.3%

4.6%

345

Barclays Capital | AAA Handbook 2010

European Investment Bank (EIB) Description

Michaela Seimen Ratings table

% € Index

% £ Index

Total assets

1.526

3.383

EUR352bn

The EIB is the world’s largest multi-lateral lending institution (MLI) in terms of total assets. Its key objective is to provide long-term finance to support EU development. Historically, the bulk of its loans have been within EU member states, with a key focus on financing infrastructure projects, particularly relating to the development of trans-European networks. In recent years, increasing emphasis has been given to lending to new and potential EU member countries and, within the EU, to providing support for small and medium-sized enterprises (SMEs).

Moody’s

S&P

Fitch AAA

LT Senior Unsecured

Aaa

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

Outlook

Risk weighting Basel II RSA: 0%

Key features of the credit „

Purpose: The EIB was established in 1958. Its particular focus has been on financing projects that promote regional development and social and economic cohesion, especially in Europe’s less prosperous regions, notably in recent years via funding of investment in trans-European communication networks (TENs) and implementing initiatives seeking to build a competitive and innovative economy. The current Corporate Operational Plan (COP), covering 2010-12, also reflects the EIB’s fast-track answer to the effect of the financial crisis on the real economy with increased and/or innovative lending to priority and/or particularly vulnerable sectors and regions, the development of new financial instruments. At the Economic and Financial Affairs Council (ECOFIN) meeting in early December 2008, an additional lending of at least €15bn per annum was envisaged for 2009 and 2010 as a “response to the present crisis in the banking industry”.

„

Ownership and capital structure: The EIB is owned by the members of the EU. The EIB Statute was amended to include the new EU members as owners, with effect from 1 May 2004. Following the increase in capital subscriptions, the four largest members account for a majority of subscribed capital. The credit quality of EIB’s owners remains higher than most MLIs: 62% of its capital is provided by countries with AAA sovereign foreign currency ratings; 77% by AAA/AA countries.

„

Asset structure and quality: As of year-end 2009, the EIB had a loan book of €406bn. The bank lends to public and private sector borrowers within the EU and to other countries with ties to the EU. Loan growth within the EU-15 is limited to 2% pa, to make room for more rapid growth in new members and accession and candidate countries. EIB loan quality is very high and gains substantial support from security related to underlying projects and in the form of thirdparty guarantees: between 2003 and 2009, about 90% of lending was provided to member states or guaranteed by member governments or their public institutions.

„

Debt leverage, gearing and financial performance: EIB is a highly leveraged entity among leading MLIs. The gearing policy limits loans outstanding (including undisbursed loans) and

guarantees to 250% of subscribed capital + reserves. Following a capital increase at the start of 2003, the next capital increase was planned for 2010. However, following the higher lending activity foreseen in the COP 2009-11, in April 2009 subscribed capital has been increased from €164bn to €232bn. This resulted in a capital adequacy ratio of about 30% as of year-end 2009. „

Financial performance: Although full results for year-end 2009 have not yet been published at the time of writing, initial indications from the bank are that loan approvals and disbursements accelerated strongly in 2009, continuing the trend from 2008. After total assets held steady at slightly above €300bn in 2006 and 2007, EIB’s total assets increased to €352bn as of year-end 2008. Income has increased strongly in recent years with profits of €1.9bn and €1.7bn as of year end 2009 and 2008, respectively.

„

Funding: In 2009, EIB raised €79.4bn (2008: €59.5bn) via 262 transactions (247 in 2008). EUR funding accounted for 54.4% of amounts raised. However, the EIB is a frequent non-USD issuer in the USD market and in 2009 raised USD27.9bn (25.9% of total funding). Also in 2009, the EIB issued its largest USD issue to date, a USD5bn three-year bond. Sterling funding accounted for 8.2% of total funds raised. Issuance of EIB in other currencies included 16 currencies. In the past EUR, USD and GBP have usually accounted for about 85-90% of funding. The choice of the funding currency is strongly influenced by market conditions. The EIB swaps some, but not all, of its non-EUR issues back to EUR. In 2009, the bank extended the maturity profile of its funding to 7.4 years, up from five years in 2008. In 2009, the Governing Council of the European Central Bank (ECB) decided that the EIB will be an eligible counterparty in the Eurosystem’s monetary policy operations. As of July 2009, the EIB has access to the Eurosystem’s open market operations and standing facilities under the same conditions as any other counterparty. The access to ECB liquidity allows the EIB to accommodate additional demand for its lending programme. For 2010 and 2011, it has indicated an expected funding range of €65-70bn.

Strengths

Weaknesses

„

„

Highly leveraged compared with other MLIs, especially relative to paid-in capital and reserves.

„

Some dilution of capital and asset quality resulting from support of new EU members, lowered ratings and SMEs.

„

Continued EIB contribution to EU cohesion objectives.

„ „

High-quality callable capital, provided entirely by EU member states. Key public policy role in implementing EU policy objectives. Asset quality is underpinned by stringent credit criteria and third-party guarantees, which ensure that the level of risk is much lower than suggested by raw leverage ratios.

Key points for 2010 „ „

A period of pronounced EIB balance sheet growth? Increasing focus on responding to the financial markets crisis.

10 June 2010

346

Barclays Capital | AAA Handbook 2010

Public sector

European Investment Bank (EIB)

Financial summary – YE Dec 2004 2005 2006 2007 2008 % ch

Balance sheet summary (€ bn)

100

Total assets

273.2 311.6 304.4 310.8 352.0

13.2

60

Disbursed loans

225.2 248.1 257.6 268.7 291.9

8.6

40

30.4 39.6 28.8 29.1 35.0

20.1

20

Total borrowings

226.0 261.6 253.1 260.5 290.5

11.5

0

Subscribed capital

163.7 163.7 163.7 164.8 164.8

0.0

-20

27.1 28.6 30.3 28.1 36.3

29.2

Income statement summary (€ mn) 1695 1676 1690 1863 2141 391

1044 1247 2260

80

843 6356 653.8

60

425

0.39 0.43 0.73 0.27 1.92

Return on average equity

3.8

Cost/income ratio

4.5

7.7

€OAS

0

2.9 19.8

22.4 19.0 15.3 28.3

Net int rev/Op inc

-20 May-09

6.1

105.0 103.5 66.2 136.5 30.7

Gearing, debt leverage & capital ratios (%) 831.2 868.3 850.4 957.1 804.6

Loans/Subscribed cap. & res.

123.4 134.8 138.7 145.5 151.4

Callable capital/debt

9.9

9.2 10.0

80 60 40 20 0

9.0 10.3

Liquidity (%) Liquid assets/Debt

13.4 15.1 11.4 11.2 12.0

Note: EIB’s accounts are drawn up in accordance with IFRS. Debt maturity and currency structure charts are based on dealogic DCM Analytics data, which may not include all MTN’s and private placements.

Public debt maturity structure, May 2010 (€bn)

>2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

Capital structure, YE 08

50.0

44.4

53.5

56.5

74.5 36.5

Others 5.9% AUD/CAD/ NZD 4.2% JPY 2.7%

GBP 15.7%

EUR 45.9%

USD 25.6%

Loan distribution, YE 08 Hungary Poland 2.6% 4.7%

General Reserves 8.55%

Paid-in 4.27%

10 June 2010

37.4

47.4

Currency distribution, YE 08

50 42.1 39.0 36.1 34.7 35.0 34.3 40 25.0 22.4 18.8 22.1 30 20 8.5 3.6 10 0

Callable (incl unpaid) 81.19%

Feb-10 EIB 1.625% Mar 13 EIB 5.125% May 17

Public debt issuance (€bn)

68.8 59.4 61.4 60.1 53.9

Paid in + res/total assets

Aug-09 Nov-09 EIB 1.125% Apr 12 EIB 2.750% Mar 15

2003

Loans/Paid in cap. & res.

30

40 20

Profitability (%) Return on average assets

25

OAS swap spread evolution

10.2

386

20

2010 yt May

Net income

308

15

2009

362

10

2008

Operating expenses

14.9

5

2007

Net interest revenue

0

2006

Paid in capital + reserves

2005

Liquid assets

€OAS

80

2004

€

Credit term structure

Other Reserves & Retained Earnings 5.99%

Others EU 17.8%

Greece 2.3% Portugal 3.8% United Kingdom France 8.0% 9.2%

Others nonEU 7.8% Germany 14.4% Spain 16.1% Italy 13.4% 347

Barclays Capital | AAA Handbook 2010

Instituto de Credito Oficial (ICO) Description

Michaela Seimen Ratings table

% € Index

% £ Index

Total assets

0.201

0.224

€53bn

Established in 1971, Instituto de Crédito Oficial (ICO) was originally responsible for the co-ordination and control of state-owned banks in Spain. In 1988, ICO became a state-owned enterprise and started tapping capital markets to raise resources. It also assumed the ownership of the capital of Spain’s state-owned banks. ICO has the legal nature of a credit institution and is classified as the Kingdom of Spain’s financial agency, with its own legal status, equity and cash assets. The Kingdom of Spain explicitly guarantees ICO’s debt.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AA

AA+

ST

P-1

A-1+

F1+

Stable

Negative

Stable

Outlook Note: As at 7 June 2010

Risk weighting 0% risk-weighted. Under the Basel II standard approach, the risk weighting of the Kingdom of Spain is applied to ICO.

Key features „

General: ICO is the Kingdom of Spain’s financial agency whose principal objective is to promote economic and social development by means of allocating medium- and long-term funds to selected domestic sectors such as housing construction, infrastructure, telecommunications, energy, environment and transport. Its legal status as a state-owned corporate entity rules out any privatisation. In light of ICO’s strategic importance as a provider of public services, we do not expect this to change any time soon.

„

Asset structure: In 2009, ICO granted loans with a total volume of €19.3, up from €16.2bn in 2008. Over 2009, ICO recorded a 14% y/y increase in its total assets to €60.4bn, largely as a result of increased lending, which was up in terms of direct loans (5.9%) and second-floor loans, mainly via the ICO-SME Facility (58.9%). Within the scope of its financing programmes, in 2009, ICO had arranged c.365,000 loans to the self-employed and enterprises and private individuals. ICO brokered 25% of loans granted in the Spanish financial system in 2009.

„

Ownership and support: ICO is wholly owned by the Spanish state and reports to the Ministry of Economy and Finance through the Secretariat of State for the Economy. The former is in charge of approving ICO’s annual budget. ICO’s borrowing limits are included in the government’s general budget, and the Council of Ministers appoints the chairperson of the Board. ICO is required to maintain the same level of regulatory capital as other credit institutions, with the exceptions stipulated in applicable regulations. At year-end 2009, regulatory capital stood at €3.1bn, or 5.2% of total assets. The 2009 National Budget Law included a capital increase of €140mn. The Spanish government provides a timely unlimited, explicit, direct, irrevocable and unconditional guarantee for ICO’s debt securities.

„

Funding: In order to refinance the loans granted whose volume grew strongly in recent years, ICO similarly increased its funding resources. The funding programme estimated for 2010 stands at €16-18bn compared with a funding volume of €17.4bn in 2009. ICO’s funding is diversified over 11 currencies, among them NOK, GBP, USD, AUD, NZD, BRL, JPY, CHF, EUR, SEK and TRY. 58% of funding is EUR denominated and 23.6% is in US$. ICO accesses the US investor base under 144-rule. In 2009, €14bn of funding was concentrated in medium- and long-term issues and €3.4bn in short-term deals. For 2010, ICO plans two to three benchmark transactions. As of April 2010, ICO had issued a total of about €3bn in three different currencies, among them USD, EUR and GBP. First issues comprised a 5-year euro benchmark bond and a 3-year US$ benchmark issue.

Strengths

Weaknesses

„

„

ICO’s rating depends on those of the sovereign, thus, the further rating migration of the Kingdom of Spain could trigger further downgrades. S&P downgraded its rating to AA from AA+ in April 2010 with a negative outlook on the rating.

„

As ICO is directly involved in several of the measures related to the economic stimulus packages adopted on behalf of the Kingdom of Spain, business volumes are likely to increase also over the course of 2010, in our view.

The Spanish government provides an explicit, direct, irrevocable and unconditional guarantee for debt securities issued by ICO. Furthermore, ICO benefits from its public ownership and given its strategic importance as a provider of public services, we do not expect this to change any time soon.

Key points for 2010 „

The ongoing economic deceleration led ICO to markedly increase its lending over 2008 and 2009. As it seems that the economic downturn in Spain has not yet bottomed, any further development of ICO’s overall funding needs should be monitored closely.

10 June 2010

348

Barclays Capital | AAA Handbook 2010

Financials and spreads

Instituto de Credito Oficial (ICO)

Financial summary – YE Dec €

Credit term structure 2005

2006

2007

2008

%ch

200

Total assets

26,691 32,298 39,883 52,970

23.5

150

Net loans (via banks and direct)

24,473 31,084 35,200 42,849

13.2

8,497 10,740 13,550 17,784

26.2

19,483 23,897 29,054 39,345

21.6

Balance sheet summary (€ mn)

Net direct loans Borrowing through securities Equity and reserves

1,295

1,407

2,226

2,736

100 50

58.2

0

Income statement summary (€ mn) Net interest revenues

90.4

196.2

207.4

295.2

5.7

Operating expenses Net operating income

33.2

36.4

121.6

229.4

234.0

57.2

159.8

85.9

65.7

-46.3

Write-offs and provisions

39.6

16.7

-83.0

Tax

13.5

52.3

25.8

45.0 -597.0 33.7

-50.7

Net income

51.1

106.1

79.2

88.4

-25.4

0

2

Return on assets

0.2

0.4

0.2

0.2

Return on equity & reserves

3.9

7.9

4.5

3.6

25.2

17.5

53.7

65.3

602.4

452.2

331.7

372.4

2.5

1.5

0.9

0.9

Provisions (€ mn)

650.7

475.2

343.2

539.7

Provisions/NPA (%)

108.0

105.1

103.5

144.9

2.6

1.5

1.0

1.2

Cost/Income ratio Non-performing assets (€ mn) % of total gross loans

Provisions/Gross loans (%)

200 150

0 Jun-09

18.9

22.1

15.8

15.7

Equity & reserves/Total assets (%

4.9

4.4

5.6

5.2

15

5

Public debt maturity structure, May 2010 (€bn)

13.2 6.1

4.3

3.8

2.3

0 2003

2004

2005

USD 33% 5.2 2.4 2.1 1.5 1.0 0.0 2.1 0.4 -

Capital structure, YE 08

>2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

0 EUR 43%

2006

2007

2008

2009

2010 yt May

GBP 8% AUD/CAD/NZD 8% Others 9%

Loan distribution, YE 08 Reserves (net of value adjustments) 21.8%

Paid-in capital 75.0%

8.3

12.7

10.1

Currency distribution, YE 08

10.4

3.2

Mar-10 ICO 3.500% Jan 14

Public debt issuance (€bn)

Note: ICO introduced IFRS reporting in its 2006 accounts and 2005 accounts were adjusted accordingly. The 2004 statements were prepared in accordance with the Bank of Spain’s Circular 4/2004, which replaced the earlier Circular 4/1991 as a transitional step towards IFRS.

10

Sep-09 Dec-09 ICO 4.375% May 12 ICO 4.375% May 19

10

Loans/Equity and reserves (times)

10 June 2010

10

50

Leverage and capital ratios (%)

5

8

OAS swap spread evolution

Asset quality

12.0

6

100

Profitability (%)

15

4

Income for the year 3.2%

Ordinary loans, 42%

Second-floor loans w/securitisation, 58%

Special and exceptional operations, 0.3%

349

Barclays Capital | AAA Handbook 2010

Inter-American Development Bank (IADB) Description

Michaela Seimen Ratings table

% $ Index

% £ Index

Total assets

0.234

0.052

$84bn

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

IADB is the key regional development bank, providing financing to Latin America and the Caribbean. It aims to promote environmentally sustainable growth, poverty reduction and social equity. Most loans are to sovereign borrowers or are sovereignguaranteed, although in 2006 the bank introduced a new initiative to encourage widening its client base. Despite the poor credit quality of the region over the years, IADB has maintained a very strong track record for asset quality. Moreover, capital cover ultimately continues to give bondholders very strong protection.

Risk weighting

Key features of the credit

Weaknesses

„

Purpose: The IADB was established in 1959 by the Organisation of American States to “help accelerate economic and social development in Latin America and the Caribbean”.

„

„

Ownership and capital structure: The IADB has 48 member countries: 26 Latin American and Caribbean members provide just over 50% of its callable capital (which accounts for c. 96% of total capital); the US 30%; Canada 4%; and 19 non-regional countries approximately 16%. In 2009, Canada offered to increase IADB’s callable capital by US$4bn on a temporary basis; accordingly, the authorised ordinary capital of the bank was increased to US$104.98bn. The paid-in capital stock of the bank remained unchanged. This subscription will continuously decrease after five years. Given the relatively low sovereign ratings in Latin America, IADB’s callable capital is of relatively lower quality, with 39% being provided by sub-investment grade or unrated sovereigns.

Debt leverage and gearing: In recognition of the risks attached to IADB’s Latin American lending focus, its financial policies are relatively conservative compared with other MLIs. Gearing limits constrain disbursed loans and guarantees to the sum of paid-in capital, general reserves and callable capital of non-borrowing members. Also, the total equity-to-loans ratio (TELR) was 34.2% at end-2009 (35.3% in 2008), below its medium-term target of 38%. Net borrowing is also limited to the callable capital of nonborrowing members. (In 2009, the ratio was 74.1% and in 2008 it was 69.3%.) Gearing and debt leverage ratios based on total capital are therefore at the lower end of the scale for MLIs.

„

Financial performance: A further increase in loan disbursements in 2009, together with reduced loan maturities, produced another increase in outstanding loans in 2009 and a continuation of balance sheet growth. Net operating income increased sharply after a loss in 2008. The income increase was mainly due to higher net interest income, resulting from an increase in net investment income in the bank’s trading investment portfolio.

„

Funding: The bank uses a combination of USD benchmark and MTN issues across a range of currencies, with a majority of its funding in USD. In 2009, IADB executed five benchmark global bond issues in US$ with two-, three-, five- and 10-year maturities for a combined US$9.5bn (US$11.1bn in 2008). In 2008 and 2009, all non-US$ borrowings are swapped into US$. Assets and .liabilities, after swaps, are held primarily in US$, but also in euro, JPY and CHF.

„

Asset structure and quality: The vast majority (c.95%) of loans are to sovereign borrowers or are sovereign-guaranteed. Loans to the private sector without government guarantee are limited to 10% of the loan portfolio (excluding emergency lending). The bank has three main loan categories: investment loans, policy-based loans and emergency loans. The first, related to individual projects, is the key priority and largest element. In 2006, the bank approved new guidelines to encourage lending to sub-national entities without a sovereign guarantee. (At end2009, 9% of loans and guarantees were non-guaranteed.) Given its regional focus, geographical concentration is inevitably very high. Nevertheless, preferred creditor status has been effective in maintaining debt service, even in times of stress. Nonaccruing loans had fallen sharply in recent years; however, they stepped up sharply at end-2008 as a result of a non-sovereign guaranteed loan being declared impaired at the end of the year. In 2009, loan losses decreased slightly. The Bank’s investment portfolio ($20.1bn at end-2009) consists amongst others of bank and ABS securities, which are more strongly exposed to credit spread risk.

Outlook

Basel II RSA: 0%

Strengths

Weaknesses

„

Conservative financial polices.

„

Strength of demand for IADB loans.

„

Preferred creditor status.

„

Innovations to widen IADB’s effect on the region.

„

Strong capital base, with borrowing well covered by investment grade callable capital.

„

Exchange rate moves affect asset-liability matching.

„

Trends in asset quality: further scope for improvement?

Key points for 2010 „

Latin American economic prospects and its inter-linkages with the US.

10 June 2010

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Barclays Capital | AAA Handbook 2010

Public sector

Inter-American Development Bank (IADB)

Financial summary – YE Dec

Credit term structure

$ 2005 2006 2007 Balance sheet summary ($ bn) Total assets 65.4 66.5 69.9 Disbursed loans 48.0 45.8 47.9 Cash and investments 13.8 16.1 16.4 Total borrowings 45.1 44.7 47.0 Subscribed capital 101.0 101.0 101.0 Paid in capital + reserves 18.7 19.8 20.4 Income statement summary ($ mn) Net interest revenue 1,038 984 756 Operating expenses 399 448 537 Write-downs & LLPs -14 -48 -13 Net inc bef Acc. Adjust 712 627 283 Net income 762 243 134 Profitability (%) Return on average assets 1.1 0.4 0.2 Return on average equity 4.1 1.3 0.7 Cost/Income ratio 36.4 43.6 66.5 Net int rev/Op inc 94.6 95.8 93.7 Gearing, debt leverage & capital ratios (%) Loans/Paid in cap & res 257.0 231.9 235.6 Loans/Subscribed cap & res 41.7 39.5 41.0 Callable capital/Debt 214.3 216.2 205.3 Paid in + res/Total assets 28.6 29.8 29.1 Asset quality (%) Non-accrual loans (€ mn) 196.0 66.0 2.0 Non-accrual/Total loans 0.4 0.1 0.0 Cum LLPs (€ mn) 175 90 70 Cum LLPs/Total loans 0.36 0.20 0.15

2008

2009

% chg

72.5 51.0 16.4 49.4 100.9 22.1

84.0 57.9 20.4 60.3 105.0 23.3

15.9 13.5 24.4 22.1 4.0 5.6

25 20 15 10 5 0 -5 -10 0

(436) 1,814 -516.1 508 624 22.8 93 -21 NM -972 1,294 -233.1 (22) 794 -3,709.1 0.0 -0.1 -136.9 117.5

1.0 3.5 32.9 95.6

231.5 43.1 195.6 30.5

248.7 46.8 166.9 27.8

288.0 0.6 169 0.33

2

Sep-09 Dec-09 IADB 4.375% Sep 12 IADB 3.875% Feb 20

Public debt issuance ($bn) 12 10 8 6 4 2 0

148 0.25

9.8 6.5 4.7

1.7 2.2

3.4

2004

2005

2006

3.1

2020-2029

2019

0.4 2018

2017

2016

2015

2014

2013

2012

2011

2010

3.3

3.7

4.5

2007

2.9

2008

2009

2010 yt May

Currency distribution, YE 09

0.4

Capital structure, YE 09

USD 57.3%

AUD/NZD/ CAD 21.2% GBP 4.4%

EUR Others 4.7% 7.9%

Loan distribution, YE 09 General Reserves 12.5%

Callable 81.2% Paid-in 3.5%

10 June 2010

Mar-10 IADB 4.250% Sep 15

JPY 4.6% 1.7 1.9

1.5

12

50

6.1 3.1

10

100

-50 Jun-09

>2029

6.2

8

0

Public debt maturity structure, May 2010 ($bn) 5.0

6

OAS swap spread evolution

2003

7 6 5 4 3 2 1 0

4

Other Reserves & Retained Earnings 2.9%

Guyana Haiti 10.4% Ecuador 3% 5.8% Uruguay Nicaragua 4.0% 13.3% Peru 6% Ecuador 10.1%

Others 13%

Dominican Other 8.3% Rep. 6.9% Brazil 4.5% Bolivia 9% 351

Barclays Capital | AAA Handbook 2010

International Bank for Reconstruction & Development (IBRD) Description

Michaela Seimen

Ratings table

% $ Index

% £ Index

Total assets

0.215

0.178

$275bn

IBRD is the major institution in the World Bank Group. Its key focus is funding projects geared to reducing poverty in middle-income developing countries. Its activities are global, although the loan book is concentrated in Asia, Latin America and central and eastern Europe. Despite high levels of country risk, its asset quality track record has been fairly sound. Overall, credit quality remains underpinned by its preferred creditor status, capital strength and conservative financial policies.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

Outlook

Risk weighting Basel II RSA: 0%

Key features of the credit „

Purpose: IBRD was established in 1945 to promote sustainable economic development and reduce poverty in developing countries. An increasing proportion of World Bank funding has been channelled through the group’s concessional financing arm, the IDA, while new loans by the IBRD (at market rates) have been relatively static. With gross disbursements running substantially below repayments, the total loan book has been contracting. IBRD has also promoted the Heavily Indebted Poor Countries (HIPC) Initiative.

„

Ownership and capital structure: The US is the largest shareholder (with 16.36% of callable capital), but ownership is spread across a wide range of governments, 186 in all. Member governments cover a broad range of sovereign ratings, but investment grade sovereigns provide almost 80% of the capital. In April 2010, a capital increase was announced after its last general increase in capital subscriptions in 1988. In recent years, capital growth has come from net income. At 30 June 2009, the authorised capital of IBRD was US$190.8bn. The announced capital increase has a total size of US$86bn and includes US$5bn in paid-in capital. In line with the capital increase a shift in voting power has been agreed, shifting voting power to developing countries.

„

Asset structure and quality: Loans are advanced to governments, agencies and private enterprises (guaranteed by their respective governments). IBRD’s credit risk is, therefore, all sovereign risk. Although the bank lends to inherently high-risk areas, IBRD is treated as a preferred creditor and has never written off any outstanding loans. Eventually all contractual principal and interest on its loans are collected; however, IBRD suffers losses resulting from the difference between the discounted present value of payments for interest and charges according to the related loan’s contractual terms and actual cash flow. In FY 09, non-accrual loans remained on a low level of about $0.5bn (c.0.5% of disbursed loans). Accumulated provisions for loan and guarantee losses increased from $1.4bn to $1.6bn as of end of June 2009.

„

Debt leverage and gearing: The bank’s articles limit net loans and guarantees to the sum of subscribed capital, reserves and surplus; this ratio is currently 48%. The related equity/loans ratio has been trending upwards in the past few years, but decreased during FY 09 to 34.53% from 37.62% in 2008. IBRD set a specified prudential minimum for liquid assets, with the minimum being equal to the highest consecutive six months of expected debt service obligations plus one-half of approved net loan disbursements as projected for the relevant fiscal year. The FY 10 level has been set at $20bn ($19bn in the previous year). At 30 June 2009, the aggregated size of IBRD’s liquid asset portfolio was US$36.8bn ($23bn in June 2008). During FY 09, new loans, guarantee commitments and facilities to member countries were US$32.9bn (US$13.5bn in FY 08). Lending to any individual country is limited by measures relating to the capital base. For FY 10, this limit has been set at US$16.5bn (an increase of US$1bn to FY 09). The largest exposure was to China, which had US$12.7bn of loans and guarantees outstanding at end-June 2009.

„

Financial performance: The bank is not a “profit-maximiser”, but needs to generate sufficient net income to grow the capital base. Financial statements are prepared according to US GAAP principles. Mark-to-market effects of derivative positions have increased volatility in reported net income in recent years. IBRD reported US$3.1bn of net income in June 2009, up from US$1.5bn in 2008. On a fair value basis, IBRD reported a net loss of US$225mn as of 30 June 2009 after a strong net profit of US$1.1bn in FY 08.

„

Funding: IBRD diversifies its funding via global offerings and private bond placements, designed to meet the needs of specific markets or types of investors. In FY 09, medium- and long-term debt (average maturity: 3.16 years) raised in financial markets amounted to US$44.3bn (US$19.1bn in 2008), via 374 transactions in 19 currencies (2008: 750 transactions). New funding is initially swapped to floating rate USD. Funding in FY 09 was increased to meet larger loan commitments due to the global financial crisis.

Strengths

Weaknesses

„

Wide range of membership enhances international political support.

„

„

The equity/loan ratio is high and a large proportion of callable capital is from high-grade countries and recent capital increase.

„

Long-standing track record of good risk management.

Loans are concentrated in low-rated countries. Nevertheless, the asset quality track record is good, and there has been some diversification away from key Latin American borrowers. The loans are protected by a preferred creditor status.

„

Conservative debt leverage and liquidity policies.

„

Focus on improving the effectiveness of international aid through supporting good governance

Key points for 2010 „

Global economic conditions – will IBRD’s emerging market borrowers be affected by the global credit crunch?

10 June 2010

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Public sector

International Bank for Reconstruction & Development (IBRD)

Financial summary – YE Dec

Credit term structure

$ 2006 Balance sheet summary ($ bn) Total assets 212.3 Net disbursed loans 100.2 Liquid assets 24.7 Total borrowings 95.8 Subscribed capital 189.7 Paid in capital and reserves 36.5 Income statement summary ($ mn) Net interest revenue 2,012 Operating expenses 1,055 Write-downs & LLPs -724 Underlying net income 1,740 Net income (after adjustments -2,389 for FAS 133 etc)

2007 2008 2009 % chg 207.9 233.6 275.4 95.4 97.3 103.7 22.0 22.7 36.8 87.8 87.7 110.0 189.8 189.8 189.9 39.9 41.4 39.7

17.9 6.6 61.7 25.5 0.1 -4.2

40 20 0 -20 0

2,240 1,065 -405 1,659 -140

2,632 1,728 -34.3 1,082 1,244 15.0 -684 284 -141.5 2,356 572 -75.7 1,491 3,114 108.9

5

10

0.7 3.7 36.9 89.9

150 100

Public debt issuance ($bn) 25 20 15 10 5 0

464 460 0.5 0.4 1,370 1,632 295.3 354.8 1.4 1.5

20.4

5.9

5.9

7.4

2003

2004

2005

JPY 18%

2.8

Capital structure, YE 09

>2029

2020-2029

2019

2018

8.4

2007

2008

7.1

2006

2009

2010 yt May

Currency distribution, YE 09

0.9 0.1 2017

2016

2015

2014

2013

2012

2011

2010

4.4

7.2 3.2

7.5 2.9 2.5 1.8

ZAR 4%

AUD/NZD/ CAD 15% EUR 5% Others 10%

USD 48%

Loan distribution, YE 09 General Reserves 11.8%

10 June 2010

30

-50 Jun-09 Sep-09 Dec-09 Mar-10 IBRD 2.000% Apr 12 IBRD 2.375% May 15 IBRD 3.625% May 13 IBRD 9.750% Jan 16 IBRD 7.625% Jan 23

239.2 266.4 45.1 48.5 203.3 162.1 17.7 14.4

6.6

Callable 81.8%

25

OAS swap spread evolution

9.6 6.1

20

0

1.2 7.7 54.1 75.2

Public debt maturity structure, May 2010 ($bn)

5.0

15

50

Profitability (%) Return on average assets -1.1 -0.1 Return on average equity -6.4 -0.4 Cost/Income ratio 47.0 42.7 Net int rev/Op inc 89.5 89.9 Gearing, debt leverage & capital ratios (%) Loans/Paid in cap & res 282.4 245.0 Loans/Subscribed cap & res 48.0 44.8 Callable capital/Debt 186.0 203.2 Paid in + res/Total assets 17.2 19.2 Asset quality (%) Non-accrual loans ($ mn) 1,038 1,070 Non-accrual/Total loans 1.0 1.1 Cum LLPs ($ mn) 2,296 1,932 Cum LLPs/Non-accrual loans 221.2 180.6 Cum LLPs/Total loans 2.2 2.0

12 10 8 6 4 2 0

60

Other Reserves & adjustments 2.3% Paid-in 5.3%

China Brazil 12.0% 9.9% Argentina 5.7% Others 26.3%

Colombia India Indonesia Mexico 5.4% 4.7% 8.1% 6.7% Peru 2.6%

Philippines 2.2% Poland 3.0% Romania Russian Federation 2.3% Turkey 8.3% 2.7% 353

Barclays Capital | AAA Handbook 2010

International Finance Corp (IFC) Description

Michaela Seimen Ratings table

%$ Index

% £ Index

Total assets

0.096

NA

€51.5bn

The IFC is the arm of the World Bank Group that focuses on supporting sustainable private enterprise in emerging markets through loan and equity finance without any direct government guarantees on its assets. Much smaller than its sister organisation, the IBRD, the high-risk nature of IFC’s business is reflected in a much weaker asset quality than most MLIs. However, IFC’s overall credit quality remains supported by a combination of high provisions, high levels of liquid assets, and conservative gearing and debt leverage.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

NR

ST

P-1

A-1+

NR

Stable

Stable

NR

Outlook

Risk weighting Basel II RSA: 0%

Key features of the credit „

Purpose: The IFC was established in 1956 to support economic growth in developing countries by promoting private enterprise through the provision of both loan and equity finance. The IFC is the largest and only global multi-lateral source of debt and equity financing for private enterprises in developing countries.

„

Ownership and capital structure: The IFC is a member of the World Bank Group. It is a separate legal entity, but membership is limited to member countries of the World Bank. Similar to the IBRD, it is noteworthy for its wide spread of ownership across 182 countries. Unlike other MLIs, IFC does not have callable capital – virtually all of its capital is paid-in or represents accumulated earnings and other reserves. 51% of its capital is held by G7 countries, 24% of which is concentrated with the US as largest shareholder, 6% with Japan and 21% by Germany, the UK, France, Canada and Italy.

„

Asset structure and quality: The IFC makes loans to and equity investments in private enterprises. Loans account for about 74% (2008: 70%) of IFC financing. The investment portfolio is widely diversified geographically. Among borrowing sectors, the finance and insurance sector represented 38% of the disbursed portfolio as of June 2009. The investment portfolio of loans, equities and debt securities has strongly increased over the past four years. Commitments and disbursements increased in FY 09, underpinning an increase in gross disbursed loans outstanding to USD16.8bn. Unlike most MLIs, IFC’s exposure is not covered by sovereign guarantees, although, historically, it has been accorded preferred creditor status by its members, so that transfer risk is effectively very low. Credit risk is inherently relatively high, but asset quality has improved sharply in the past four years, though it increased again as of June 2009 to 2.7% from 2.4% in 2008. Total reserves against losses increased in FY 09 to USD1.2bn, compared with USD848mn in FY 08. This is equivalent to 7.4% of the disbursed loan portfolio.

„

Debt leverage and gearing: To compensate for the higher risk profile of its asset portfolio, the IFC has conservative leverage and liquidity policies. The IFC aims to keep net liquidity of at least 65% of expected net cash requirements. On 30 June 2009, net liquidity was US$17.9bn (2008: US$14.6bn), representing 163% of liquid assets according to the guidelines. Liquid assets also include mortgage- and asset-backed securities.

„

Financial performance: The overall market environment has a significant influence on IFC’s financial performance. A strong upward trend in net income, after the FY 02 low (when emerging market financial pressures were at their worst), changed again in FY08, with heightened uncertainty replacing a rather stable environment of recent years. As an immediate result, income dropped in FY08 to US$500mn and in FY 09, IFC reported an overall net loss of US$151mn. IFC does not distribute dividends, so all net income in the past has boosted IFC’s own capital.

„

Funding: IFC executes a matched-funding policy, with virtually all of the funds for its lending activities being raised through the issuance of debt obligations in international capital markets. IFC’s funding structure is built on three pillars: 1) issue of liquid USD-denominated global benchmark bond; 2) access public and private bond markets; and 3) promote development of emerging capital markets by borrowing in local currencies. In FY 09, IFC borrowed US$8bn equivalent (FY 08: US$6.3bn) in seven different currencies (AUD, BRL, CAD, JPY, ZAR, TYR and USD). 76% of issues in FY 09 were in USD. Since 2000, IFC issued each year a 5-year USD global benchmark bond. All borrowings are swapped into variable-rate US$. (Approximately 70% of all IFC loans are denominated in USD) As of June 2009, IFC maintained US$25.7bn in outstanding debt in 16 currencies.

Strengths

Weaknesses

„

Conservative financial policies and aggressive provisioning policy.

„

Relatively high-risk investments.

„

Strong capital base and membership support.

„

„

High levels of liquidity on the balance sheet.

„

Substantial exposure to emerging market private sector entities, though its investment portfolio being well diversified on a sector basis.

Transfer risk is limited by preferred creditor status.

„

Continuing growth in the loan and equity portfolios

Key points for 2010 „ „

Size of the ABS portfolio and valuation effects. Effect of global financial crises on asset quality.

10 June 2010

354

Barclays Capital | AAA Handbook 2010

Public sector

International Finance Corp (IFC)

Financial summary – YE Dec

Credit term structure

$ 2006 2007 Balance sheet summary ($ bn) Total assets 38.5 40.6 Net disbursed loans 9.8 11.8 2.7 3.2 Net equity investments 23.3 21.7 Gross liquid assets 12.7 13.3 Net liquidity 15.0 15.9 Total borrowings 11.1 14.0 Paid in capital + reserves Income statement summary ($ mn) Net interest revenue 877 948 1107 2350 Other operating income 477 500 Operating expenses Write-downs & LLPs 15 -43 Net income 1263 2491 Profitability (%) Return on average assets 3.2 6.3 12.1 19.8 Return on average equity Cost/Income ratio 24.0 15.2 44.2 28.7 Net int rev/Op inc Gearing, debt leverage & capital ratios (%) Net loans & invest/Total cap 112.4 107.5 74.4 88.3 Total capital/Debt Paid in + res/Total assets 28.9 34.5 Asset quality ($ mn) Non-accrual loans 447 378 Accum LLPs 898 832 8.4 6.6 LLPs/gross disbursed loans (%)

2008 2009

%ch

10 5

49.5 14.1 7.3 22.6 14.6 20.3 18.3

51.5 14.9 5.3 25.1 17.9 25.7 16.1

4.1 5.7 -27.0 10.9 22.2 26.9 -11.7

945 1801 555 38 1612

893 111 629 438 -196

-6 -94 13 1053 -112

3.6 10.0 20.2 34.4

-0.4 -1.1 62.6 88.9

0 -5 -10 -15 0

117.5 125.8 90.1 62.7 36.9 31.3 369 457 848 1238 5.7 7.7

1

60 40 20 0 -20 -40 Jun-09

Sep-09 Dec-09 IFC 4.750% Apr 12 IFC 3.000% Apr 14

6 5 4 3 2 1 0

3.3 2.6

2.3

1.7

1.3

1.1

1.1

2004

2005

2006

2007

2008

2009

2010 yt May

EUR 0.03%

Capital structure, YE 09

>2029

0.7 2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

Mar-10 IFC 3.500% May 13 IFC 2.750% Apr 15

1.6 0.3 0.1 0.1 0.2

JPY 10.3% GBP 1.0%

USD 56.7%

Asset composition, YE 09 Other Reserves & Retained Earnings 85.3%

10 June 2010

6

5.6

Others 32.0%

2.8

1 0

Paid-in 14.7%

5

Currency distribution, YE 09

3.7 1.9 1.8 2.0 2.1

4

Public debt issuance ($bn) 23.8 46.0

Public debt maturity structure, May 2010 ($bn)

3 2

3

OAS swap spread evolution

2003

4

2

Sub-Sahara Other Africa 1.9% 8.0% North Africa & Middle East 9.4% Europe and Central Asia 27.0%

Latin America and Caribbean 28.2%

Asia 25.5%

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KFW Bankengruppe (KFW)

Michaela Seimen

Description

Ratings table

% € Index

% £ Index

Total assets

1.423

2.266

€400bn

KfW (Kreditanstalt für Wiederaufbau) was established in 1948 as a public law institution. It is the promotional bank of the Federal Republic of Germany, which owns 80% of the lender, while German states own the remaining 20%. KfW engages in lending to small and medium-sized enterprises (SME), entrepreneurship, environmental protection, housing, infrastructure, education finance, project and export finance, and development cooperation. Debt issued by KfW is explicitly guaranteed by the Federal Republic of Germany. With total assets of €400bn as at year-end 2009, slightly increased from €395bn in 2008, and more than 4,200 employees, KfW ranks among the 10 largest German banks.

LT senior unsecured ST Outlook

Moody’s

S&P

Fitch

Aaa P-1 Stable

AAA A-1+ Stable

AAA F1+ Stable

Risk weighting 0% risk weighted. According to §28 of the Solvency Regulation, funding raised by KfW will be treated equal to issues of the Federal Republic of Germany for risk-weighting purposes (0%).

Key features „

„

Explicit guarantee from the German state: The Federal Republic of Germany guarantees all existing and future obligations of KfW in respect of money borrowed, bonds issued and derivative transactions entered into by KfW, as well as third-party obligations that are expressly guaranteed by KfW. Further, following an understanding between the European Commission and the German Federal Ministry of Finance in 2002, the co-called Anstaltslast (maintenance obligation) and Gewährträgerhaftung (statutory guarantee) of the Federal Republic of Germany will continue to be available to KfW in respect of the promotional activities for which it is responsible. Whereas the maintenance obligation requires the public institution responsible for the lender’s creation to safeguard the bank’s economic basis and enable it to maintain operations and meet its obligations as they fall due, the statutory guarantee is an unlimited guarantee, in which the owner is responsible for all the entity’s liabilities. These forms of support render the explicit guarantee of secondary importance, except that it provides the basis for KfW’s debt to be zero risk-weighted. According to the 2002 EU Consensus, KfW will keep its unconditional and explicit guarantee, as well as the maintenance obligation and deficiency guarantee in the future.

„

Profitability: After KfW reported consolidated losses in 2007 and 2008, the institution returned to profitability in 2009, with a consolidated profit of €1.1bn as of year-end. The result was strongly driven by positive effects from the securities portfolio, as well as by higher risk provisions for lending business made in the worsening economic and financial market crisis. Highly favourable refinancing conditions also contributed to the improved performance of the lender.

„

Funding: KfW’s volume of business increased noticeably to €474.8bn and lending increased by 5% to €383.5bn. To refinance the increased business activities, KfW raised over the course of 2009, €74.7bn (2008: €75.3bn). About 47% of the funding volume has been raised via benchmark issues, split into €19bn and US$21bn issues respectively. As of December 2009 KfW had placed 412 transactions in 19 different currencies. Despite this wide diversification, the EUR remains the most important currency for KfW’s issues with a share of 44%, followed by USD with 35%, GBP with 7%, JPY with 4% and AUD 4%. For 2010 KfW has announced a planned funding volume of €70-75bn. KfW intends to issues more large-volume benchmark bonds in the core currencies EUR and USD and in all maturities. Furthermore, other public bonds in EUR and other currencies as well as private placements usually round off the entities funding mix. As of 21 April 2010, KfW had raised approximately €35bn (46.7%) of its intended funding volume for 2010. Still, in our view, the €75bn total funding needs envisaged for 2010 could be subject to an upward revision as continuing economic stimulus packages and emergency funding in Europe might well influence the bank’s funding target.

Structure: KfW is organised in six main component business areas: Promotional activities are concentrated in KfW Mittelstandsbank for SMEs and in KfW Privatkundenbank for housing, environment and education. KfW Kommunalbank focuses on financing for public clients. Development activities related to emerging markets are handled by KfW Entwicklungsbank/DEG. In 2004, KfW IPEX-Bank was established as a bank within the main bank to cover export and project finance. Treasury and funding, securitisation and other capital market-related activities are centralised in the bank’s Financial Markets business area.

Strengths

Weaknesses

„

„

From €6.2bn in 2007, KfW again reported a consolidated loss of €2.1bn in 2008, mostly due to developments surrounding IKB and Lehman Brothers, as well as Iceland. Consequently, the Tier 1 ratio fell from 9.4% in 2007, to 7.8% in 2008.

„

KfW’s involvement in the European emergency plan on behalf of the German government.

KfW benefits from being state owned and its explicit and unconditional guarantee, ie, the so-called Anstaltslast and Gewährträgerhaftung. Furthermore, KfW’s liabilities benefit from an explicit state guarantee, which underlines the bank’s distinct role in German public policy.

Key points for 2010 „ „

Monitor KfW’s profitability after the lender generated a second consecutive loss in 2008. Monitor any potentially higher-than-expected funding needs in 2010.

10 June 2010

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Financials and spreads

KFW Bankengruppe (KFW)

Financial summary – YE Dec €

Credit term structure

2006 2006* 2007* 2008* 2009* % Chg

Balance sheet summary (€ bn)

40 20

Total assets

359.6

334.4

354.0

394.8

400.1

1.3

Net Loans

289.0

282.5

298.3

320.3

334.0

4.3

0 -20

Share-holdings

19.5

2.9

2.7

1.7

1.4

-15.8

Debt securities

38.3

38.9

42.8

42.6

35.3

-17.1

-40

15.3

16.7

14.9

11.8

13.1

11.0

-60

Total borrowings

323.5

300.0

310.8

345.7

353.3

2.2

-80

of which debt securities

246.0

240.1

260.3

302.6

321.4

6.2

Capital (own funds)

0

5

10

15

Income statement summary (€ mn) Net interest revenue

1,568

1,754

1,755

2,006

2,654

32

Operating income

1,979

1,986

1,965

2,224

2,940

32

Operating expenses Pre-provision income

601

573

607

646

742

15

1,378

1,413

1,358

1,578

2,198

39

-162

7,521

4,324

1,014

Nn

1,565 -6,167 -2,657

1,127

-142

Net write-downs & LLPs

332

Net income

973

Profitability (%) Return on assets

0.28

0.46

-1.79

-0.71

Return on equity

6.7

10.3

-39.0

-19.9

0.28 9.0

Cost/Income ratio

30.4

28.9

30.9

29.0

25.2

Net int rev/Op inc

79.3

88.3

89.3

90.2

90.3

18.3

16.6

19.9

26.7

25.1

4.4

5.1

4.3

3.1

3.4

OAS swap spread evolution 75 50 25 0 -25 -50 -75 May-09

Aug-09 Nov-09 Feb-10 KFW 3.375% Jan 12 KFW 3.500% Jul 15 KFW 4.375% Jul 18 KFW 3.500% Jul 21

Leverage and capital ratios

Debt maturity structure, May 2010 (€bn) 75

35.7 29.6

24.8 25

41.7

47.5

30.4 12.4 13.3 10.5 10.6 8.2

Capital structure, May 2009

10 June 2010

>2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

0

Retained Earnings Fund for 36.0% General Banking Risks 0.4% Paid-in Capital 25.1%

67.6

67.2

2010 yt May

2009

2008

33.3

USD 30% 20.9

58.2

2007

36.0

43.2

Currency distribution, May 2009

48.2 53.5

50

80 60 40 20 0

2006

Note: KfW’s accounts are drawn up in accordance with the requirements of the German Commercial Code, the Ordinance regarding the Accounting System for Banks, and the Law Concerning KfW. *IFRS was introduced for consolidated accounts in 2007. Debt maturity and currency structures are based on dealogic DCM Analytics data.

2005

Debt maturity issuance (€bn)

2004

Total capital/Total assets (%)

2003

Loans/Total capital (times)

EUR 42%

GBP 15% JPY 3% AUD/CAD/ NZD 5% Others 5%

Loan distribution, May 2009

Other Reserves 38.5%

KfW Mittelstand sbank 20.3%

KfW Foerderbank 47.9%

KfW IPEXBank 24.9% KfW Entwicklung sbank 5.2% DEG 1.7%

357

Barclays Capital | AAA Handbook 2010

Kommunalbanken AS (KBN)

Michaela Seimen

Description

Ratings table

% $ Index

% £ Index

Total assets

0.076

0.027

NOK232bn

Kommunalbanken (KBN) is the leading funding agency for the local government sector in Norway. It is 100% owned by the Kingdom of Norway. KBN’s lending is restricted to Norwegian local government entities, and it benefits from strong central government support, control and supervision. KBN’s asset quality is extremely robust, reflecting the credit quality of the local government sector, and it has never suffered loan losses. Strong growth in its loans reflects not only market share gains, but also local authority demand, driven by increased public service commitments. This is likely to continue to be reflected in a trend growth in funding through international markets.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

NR

ST

P-1

A-1+

NR

Stable

Stable

NR

Outlook

Risk weighting Basel II RSA: 20%

Key features of the credit „

Purpose: Originally created as a government agency in 1926 and converted into its current form (as a limited company) in 1999, Kommunalbanken’s sole role is to provide low-cost funding to the local government and the local governmentguaranteed sector in Norway. As such, it is regarded as fulfilling an important public policy function. KBN has a market share of nearly 50% and is the largest lender to the Norwegian local government sector with more than 95% of Norway’s municipalities and counties having loans with KBN.

„

Ownership and capital structure: Effective 24 June 2009, the ownership structure of KBN changed, whereby the government took 100% ownership of KBN by acquiring the 20% share held by the National Local Government Pension Fund (KLP, a mutual pension and life assurance company for Norwegian local governments). KBN’s debt is not explicitly guaranteed, but the entity is supported by the central government in the form of a maintenance obligation, which affirms that the government is required to meet its financial obligations in a timely manner. The Ministry of Local Government and Regional Development appoints and controls all of KBN’s governing bodies, and it is supervised by the Norwegian Financial Supervisory Authority (Kredittillsynet).

„

Asset structure and quality: KBN lends over a wide range of maturities at very fine margins, but only to the local authority sector – ie, local governments, inter-government entities and entities guaranteed by local or central government. The Norwegian local government sector is very robust in credit terms. Composed of 19 counties and 430 municipalities, it provides about two-thirds of public services, representing about 20% of GDP. Norwegian local authorities are tightly supervised and controlled by central government. Under the Local Government Act, a local authority cannot go bankrupt and the authorities are backed by an implicit government guarantee, which underpins expectations of timely payment. KBN has never experienced loan losses.

„

Debt leverage and gearing: KBN has experienced strong growth in lending in recent years. In part, this reflects increased demand from local authorities to finance capital investment (the only purpose for which they are allowed to borrow), related to a widening range of responsibilities delegated to the authorities. Lending growth has also been driven by structural change in the local authority market, as direct competition from commercial banks has diminished, leaving KBN to compete primarily with Kommunekredit (the local authority subsidiary of KLP). As a result, KBN’s market share has been growing: its share of lending to the local government sector reached 46.7% in 2009, from 38.5% in 2007. There is now less scope to increase market share, but local authorities’ investment should support growth in their underlying demand for funds. Net income grew strongly from NOK390mn as of year-end 2008, to NOK1.399mn in 2009, due to strongly increased net interest, as well as net gains on repurchases of issued securities and valuation of financial instruments.

„

Capital adequacy: In recent years, capital increased through re-investment of the dividend and partly retained profits. In 2008, NOK500mn was injected via reinvestment of a previously declared dividend and share capital increases. The total capital ratio slightly decreased to 11.05% as of year-end 2009 compared to 11.6% at end-2008.

„

Funding: KBN pursues a diversified funding strategy. In 2009, more than 95% of funding was raised outside Norway, through 508 transactions, across 15 different currencies. KBN targets both institutional (via 15-25% benchmark issues, 30-40% private placements and 10-20% institutional niche markets) and retail investors (20-50%). Outside NOK, the principal currency components of the debt structure are JPY, USD, AUD, GBP and CHF. Issuance has increased from NOK67.9bn in 2008, to NOK116bn in 2009. Liquid benchmark transactions are becoming more important: Two US$1bn benchmark bonds have been issued in 2009, with 3y and 5y maturities. KBN envisages a continuing programme of two to three benchmark transactions per year. For 2010, total issues of US$15bn of long-term debt are planned.

Strengths

Weaknesses

„

Public sector ownership and maintenance obligation support from the central government.

„

Market share growth is approaching a limit, but with prospects of some continuous growth in local authority loan demand.

„

Robust credit quality of the Norwegian local government sector.

„

Risk weighting on loans to local authorities. The Norwegian banking regulator applies 20%.

Key points for 2010 „

Will growth in financing needs for investment by the municipal sector continue?

10 June 2010

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Barclays Capital | AAA Handbook 2010

Public sector

Kommunalbanken AS (KBN)

Financial summary – YE Dec

Credit term structure

NOK 2006 Balance sheet summary (NOK bn)

2007

2008

2009 % chg

Total assets

126.6

142.4

216.2

231.9

7.3

87.5

101.7

120.9

153.0

26.5

118.4

136.3

200.1

223.6

11.7

Capital (own funds)

1.1

1.3

2.2

3.6

61.5

Sub debt and Hybrid Tier 1

1.2

1.3

1.3

1.0

-24.1

5

Total reg capital

2.3

2.6

3.5

4.0

13.4

0

118.4

136.3

200.1

223.6

11.7

Loans Debt securities outstanding

Debt securities outstanding

Income statement summary (NOK mn) Net interest revenue

231.7

281.7

525.2 1053.0

100.5

Operating revenues

222.0

266.5

621.2 2037.0

227.9

Operating expenses

62.3

66.7

159.7

199.8

Pre-tax operating income Tax

78.4

25 20 15 10

0

542.8 1946.0

258.5

20

547.0

257.3

10

389.7 1399.0

259.0

56.3 143.5

153.1

Return on assets

0.1

0.1

0.2

0.6

Return on equity

10.4

11.0

17.7

39.3

Cost/Income ratio

28.1

25.0

12.6

4.5

Net int rev/Op rev

0.0

0.0

0.0

0.0

2

3

0 Jul-09 Oct-09 KOMBNK 5.125% May 12 KOMBNK 2.750% May 15

Profitability (%)

4

5

6

30

16.1

44.9

1

OAS swap spread evolution

91.0

114.8

Net income

30

Jan-10 Apr-10 KOMBNK 2.875% Oct 14 KOMBNK 2.000% Jan 13

Public debt issuance ($bn)

Capital adequacy (%) Tier 1 ratio Total capital ratio Total capital/Total assets

6.0

6.0

7.5

9.2

10.9

10.6

11.6

11.0

1.8

1.8

1.6

1.9

6 5 4 3 2 1 0

1.3

2003

Public debt maturity structure, May 2010 ($bn) 4.0

3.2 2.2 2.0

1.3

2005

2006

2007

2008

4.9

4.5

2009

2010 yt May

AUD/CAD/ EUR 1.2% NZD 16.9%

Others 8.4%

>2029

USD 43.2%

GBP 5.7% JPY 23.6%

Loan distribution, YE 09 Sub debt and Hybrid Tier 1 21.1%

Share capital 27.1% 10 June 2010

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

Retained profits, etc 51.9%

2.7

CHF 3.8%

0.2 0.5 0.1 0.2

Capital structure, YE 09

2004

2.4

3.8

Currency distribution, YE 09

3.3 3.3

1.8

2010

5 4 3 2 1 0

1.8

3.5

Sovereigns an central banks, 6% Securitisation 0.2% Financial institutions Multilateral 5%

Regional authorities 74%

development banks Public sector 7% entities, 8% 359

Barclays Capital | AAA Handbook 2010

Landeskreditbank Baden-Wuerttemberg Förderbank (LBANK) Description

Michaela Seimen

Ratings table

% € Index

% £ Index

Total assets

0.062

0.03

€60bn

Landeskreditbank Baden Württemberg Förderbank (LBANK) is the state development bank of the German State of Baden Württemberg. It is fully owned by the state and benefits from an explicit and unconditional guarantee (ie, the so-called Anstaltslast and Gewährträgerhaftung). According to the 2002 EU Consensus, LBANK will keep its unconditional and explicit guarantee, as well as guarantor and maintenance obligation in the future. Since its foundation in 1998, LBANK funds itself through the issuance of registered bonds and notes (Schuldscheine), as well as German domestic notes (Inhaberschuldverschreibungen) on a stand-alone basis. In 2001, this was extended by a debt issuance programme, followed by an Australian MTN programme in 2004. LBANK’s liabilities benefit from an explicit state guarantee.

LT senior unsecured ST Outlook

Moody’s

S&P

Fitch

Aaa Aaa Stable

AA+ AA+ Stable

AAA AAA Stable

Risk weighting 0% risk weighted. As a result of an explicit and irrevocable guarantee by the State of Baden-Württemberg, LBANK is 0%-risk-weighted. Under the Basel II standard approach, the risk weighting of the Federal Republic of Germany is applied to LBANK.

Key features „

„

Explicit guarantees from regional state: LBANK is wholly owned by the German State of Baden-Wuerttemberg, which has provided an explicit and unconditional guarantee for all debt issued by LBANK. Further, Baden-Wuerttemberg has provided the so-called Anstaltslast (maintenance obligation) and Gewährträgerhaftung (statutory guarantee). Whereas the maintenance obligation requires the public institution responsible for the lender’s creation (ie, Baden-Wuerttemberg) to safeguard the bank’s economic basis and enable it to maintain operations and meet its obligations as they fall due, the statutory guarantee is unlimited, as the owner is responsible for all the entity’s liabilities. These forms of support render the explicit guarantee of secondary importance, except that it provides the basis for LBANK debt to be zero risk-weighted. According to the 2002 EU Consensus, LBANK will keep its unconditional and explicit guarantee, as well as the maintenance obligation and deficiency guarantee in the future. Sound asset quality: In 2009, LBANK’s total assets decreased slightly by 2.6% to €59.7bn from €61.3bn in 2008, mainly based on decreased lending volume. Due to the global recession and businesses in Baden-Wuerttemberg being largely export focused, new financing volume to SMEs and business, the bank’s largest business segment, decreased by c.21% to €2.3bn in 2009, whereas the volume for loans related to the bank’s housing business slightly increased by 4.6% to €1.12bn. Due to lower tax income, local governments are currently somewhat financially constrained and business volume in this business segment therefore only slightly increased. As of year-end 2009, LBANK declared a portfolio of €2.4bn loans as problematic, which accounts for c.3.4% of the bank’s total loan portfolio, with part of these loans related to exposure in Saxony.

„

Strategic alignment: LBANK mainly focuses on three segments: economic development, housing and infrastructure within Baden-Wuerttemberg. LBANK furthermore operates as a conduit for the state’s development and social programmes and promotes the building of new homes and the modernisation of existing ones by housing companies and individuals. In an attempt to provide public funds for the above purposes, LBANK has launched several programmes for families who receive funds at attractive interest rates. Also, LBANK provides financial support to small- and medium-sized enterprises in BadenWuerttemberg. Owing to a reduction in the bank’s balance sheet, its business volume decreased by €1.66bn to €70.6bn as of yearend 2009.

„

Profitability: Driven by an increased interest rate income, LBANK’s most important source of income, the bank was able to slightly increase its profit in 2009 to €50.31mn, up from €21.71mn in 2008. In 2008, LBANK’s net profit slumped by 79% y/y from €102mn in 2007; however, profit maximisation is not a key objective for the bank. Due to the slow economic recovery, LBANK assigned €57mn to its fund for general bank risks, which currently stands at €304mn.

„

Funding: As in previous years, LBANK still heavily relied on interbank funding in 2009, which stood at €19.2bn, slightly down from €25.5bn in 2008. However, this decrease has been partly offset by increased Commercial Paper issues. As of yearend 2009, the bank’s €30bn Debt Issuance Programme and €5bn Commercial Paper Programmes have been utilised with €16bn and €4.1bn, respectively. LBANK does not plan to issue Pfandbriefe. The bank issued two US$ and one EUR benchmark bonds in 2009, albeit the focus for the bank lies in private placements in EUR. From €10.8bn in 2009, LBANK plans funding of €7-10bn in 2010.

Strengths

Weaknesses

„

„

LBANK continues to hold a sizable portfolio of residential property loans in the State of Saxony, which continues to drain on loan-loss provisions.

„

Performance of export-oriented business in BadenWuerttemberg and resulting impact on credit risk in the bank’s corporate portfolio.

LBANK benefits from being wholly owned by the State of BadenWürttemberg and its explicit and unconditional guarantee, which underlines the lender’s distinct role in public policy.

Key points for 2010 „

LBANK’s funding structure needs to be monitored.

„

Performance of ABS and CLN portfolio.

10 June 2010

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Barclays Capital | AAA Handbook 2010

Financials and spreads

Landeskreditbank Baden-Wuerttemberg Förderbank (LBANK)

Financial summary – YE Dec €

Credit term structure 2006 2007 2008 2009 % chg

60 50

Balance sheet summary (€ bn) Total assets

52.0 59.5 61.3 59.7

-2.6

40

Loans

40.9 43.2 41.7 41.1

of which mortgages

16.1 10.2

-1.4

30

9.5

9.0

-5.3

20

5.1

5.5

7.6

10

Debt security holdings

9.6 14.2 16.9 17.0

0.3

0

Capital (own funds)

1.9

2.1

4.2

46.0 52.7 56.3 54.5

-3.2

public sector loans

5.9

Total borrowings

5.5 1.9

2.0

0

2

4

6

8

OAS swap spread evolution

Income statement summary (€ mn) Net interest revenue

373

328

346

387

12.0

Operating income

443

395

398

442

11.0

Operating expenses

179

114

118

156

32.1

Pre-provision income

264

281

280

286

2.1

Write-downs & LLPs

42

1

148

124

na

139

152

21

50

135.9

Profitability (%) 1.1

2.5

Net int rev/Op inc

84.1 83.0 86.8 87.6

Public debt issuance (€bn) 8 5

Leverage and capital ratios Loans/Total capital (times)

3.7

3.3

3.2

3.1

3.5

3.8

3.5

Public debt maturity structure, May 2010 (€bn)

2.9

Currency distribution, May 2010 EUR 57%

8 4

6.2

0

Note: L-Bank accounts are drawn up in accordance with the German Commercial Code and the Regulation on the Accounting Principles applied to credit institutions. Debt maturity and currency structures are based on dealogic DCM Analytics data.

4.9

6.0

3

21.0 22.2 21.0 19.9

Total capital/Total assets (%)

5.4 4.0

2010 yt May

7.8

40.4 28.9 29.7 35.4

2009

7.2

Cost/Income ratio

Feb-10 LBANK 2.000% Oct 12

2008

0.1

Nov-09

2007

0.0

Aug-09

LBANK 4.125% Jul 11 LBANK 2.750% May 15

2006

0.3

0 May-09

2005

Return on avg equity

0.3

20

2004

Return on avg assets

40

2003

Net income

60

3.6 3.9 3.1

2.3

1.7 0.3

0.1 0.0 0.0 0.1 0.1

Others 9%

Capital structure, YE 09 Paid-in capital 12% Fund for general banking risks Unapprop 15% profit 2% 10 June 2010

>2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

0 USD 34%

Loan distribution, YE 09 Capital surplus 46% Retained profit and reserves 25%

Loans to banks 54% SME loans 21% Private customer loans 12%

Public sector loans 13%

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Landwirtschaftliche Rentenbank (RENTEN) Description

Michaela Seimen Ratings table

% € Index

% $ Index

Total assets

0.103

0.249

€78bn

Landwirtschaftliche Rentenbank (RENTEN), is a specialised development bank – ie, the central public refinancing agency for the German agricultural sector (including forestry and fishing), as well as for rural areas. It is headquartered in Frankfurt. RENTEN raises financial resources that are then on-lent to the domestic banking sector. The banks involved bear the credit risk and earn a spread for channelling the funds to the final beneficiaries. For its promotional activities, RENTEN does not receive funds from the German federal or regional governments (Bundesländer). The bank does not accept deposits, nor does it provide direct credit lines.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

Bonds

Aaa

AAA

AAA

Stable

Stable

Stable

Outlook

Note: As at 26 May 2010. The issuer credit ratings on RENTEN are based on the support of the government of the Federal Republic of Germany under the legal concept of the so-called Anstaltslast (maintenance obligation).

Risk weighting 0% According to §28 of the Solvency Regulation, funding raised by RENTEN will be treated equal to issues of the Federal Republic of Germany for risk weighting purposes (0%).

Key features of the credit „

„

Ownership structure: RENTEN was established by the Federal Republic of Germany as a public law institution through the socalled Rentenbank Law in 1949. Its roots, however, date back to Deutsche Rentenbank, which was founded in 1923 in an attempt to combat hyperinflationary problems. Being transformed into Deutsche Rentenbank-Kreditanstalt in 1925, the entity became the central refinancing institution for the German agricultural sector. Despite having built up RENTEN’s capital, neither the German agricultural sector nor any natural or legal entity, including the federal and Länder governments, holds any property rights over the entity. In the unlikely scenario of RENTEN being dissolved (which would require new legislation), its net assets after payment of all outstanding obligations could only be applied to support the agricultural sector as a whole. Nowadays, RENTEN’s capital comprises mostly accumulated reserves and issues of subordinated debt.

„

High asset quality: In 2009, RENTEN’s total assets fell to €75.8bn, from €87.9bn in 2008, as loans and advances to banks fell further to €46.4bn in 2009, from €61bn in 2007 and loans to customers decreased from €6.7bn to €1bn. RENTEN generally extends its loans via the borrowers’ principal banks, instead of directly via loans and advances to customers. As of year-end 2009, provisions for loan losses decreased from €58.2mn in 2008, to €40.4mn. RENTEN’s aggregated lending volume comprised €17.6bn in 2009.

„

Funding strategy: RENTEN is funded through borrowings or the issuance of securities on domestic and international capital markets. The bank has two funding programmes for its international funding activities – a €60bn EMTN programme and a €20bn ECP programme. As of year-end 2009, securitised liabilities amounted to €61.6bn, down from €68.9bn in 2008). The bank raised €10bn in 2009 (2008: €11.2bn); half of this volume was placed with domestic investors. For 2010, RENTEN advised of its medium and long-term funding plans of about €10bn. The bank intends to issue up to four EUR and USD benchmark bonds with maturities of up to 10 years, but focusing on maturities of five years and shorter. Benchmark issues typically account for 40% of RENTEN’s funding. Complementary, liquid issues in other currencies (non-core USD, Scandi currencies, GBP and JPY) and private placements are planned for 2010. As of 26 April 2010, RENTEN has raised about €5.4bn in medium and long-term funding. In the US, RENTEN is registered with the SEC under the Schedule B exemption for a “foreign government, or political subdivision thereof”.

Governmental support: Being the central public refinancing agency for the German agricultural sector, RENTEN benefits from the so-called Anstaltslast (ie, an “appropriate guarantee” from the Federal Republic of Germany in the meaning of the Consolidated EU Banking Directive) being obliged by law to capitalise Rentenbank adequately and ensure the bank’s ability to do business operations. Its liabilities, thus, are effectively backed by the full faith and credit of the Federal Republic of Germany. Note that unlike KFW, however, RENTEN does not benefit from a statutory federal guarantee. However, following the EC’s agreement in 2002 that the federal support for RENTEN is compatible with EU competition law, revisions to the Rentenbank Law reinforced its role as a federal development bank, and there is no prospect of a change in status.

Strengths

Weaknesses

„

„

Sound capitalisation: As at year-end 2009, RENTEN’s total capital stood at €3.1bn, up from €3bn in 2008, including subordinated liabilities of €1.1bn (2008: €1.1bn). Reserves and the fund for general banking risks stood at €2bn (2008: €1.9bn). At 15.3% (2008: 12.3%), RENTEN’s Tier 1 ratio stood well above the regulatory requirements.

Owing to its promotional policy mandate, RENTEN operates its special loans window at the expense of overall profitability. As a result of its non-profit mandate, RENTEN’s profitability has remained modest but stable over the course of the past years. Net profit stood at €11.3mn in 2009, from €10.8mn in 2008.

Key points for 2010 „

Further development of RENTEN’s refinancing costs.

10 June 2010

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Financials and spreads

Landwirtschaftliche Rentenbank (RENTEN)

Financial summary

Credit term structure

€

2007*

Balance sheet summary (€ bn) Total assets 88.7 Securities portfolio 26.0 Amounts due from banks 60.2 Amounts due from customers 1.3 Funding - bond issues 64.9 Other borrowing 14.8 Equity 2.0 Liable capital 2.8 Income statement summary (€ mn) Net interest income 199.8 Other operating income 2.5 Operating expenses 39.0 Net operating income 163.3 Provisions, FGBR, etc -112.3 Net income 51.0 Profitability (%) Return on assets 0.1 Return on own funds 2.5 Cost/Income ratio 19.3 Net int rev/Op inc 98.8 Leverage and capital ratios (%) Core capital ratio 10.4 Total capital ratio 16.7 Total capital/Total assets 3.2

2008*

2009*

% chg

90.1 27.5 52.8 6.5 66.6 14.8 2.1 2.9

77.8 27.9 45.8 0.6 60.3 9.4 2.2 3.0

-13.6 1.6 -13.2 -90.5 -9.5 -36.1 8.7 3.7

350.7 -47.0 42.4 261.3 202.9 464.2

381.0 -1.7 47.1 332.2 -409.1 -76.9

8.6 -96.4 11.1 27.1 NM -116.6

0.5 22.9 14.0 115.5

-0.1 -3.6 12.4 100.4

12.4 19.3 3.3

15.3 23.9 3.9

60

8

6.3 5.5

4

0

2

4

6

8

10

OAS swap spread evolution 75 50 25 0 -25 -50 May-09 Aug-09 Nov-09 Feb-10 RENTEN 3.875% Mar 12 RENTEN 3.250% Mar 14 RENTEN 4.375% Nov 17

15.1

12.3

14.5

14.1 10.6

8.7

7.8 5.2

4 0 2003

2004

2005

2006

2007

2008

2009

2010 yt May

USD 49% GBP 4%

4.1 3.3

Capital structure, YE 09

EUR 25%

>2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

-40

Currency distribution, May 2010

0.4 0.1 0.9 0.2

10 June 2010

-20

8

0

Other ret earnings, reval reserve and net profit 58%

0

12

9.2

4.6

20

16

Public debt maturity structure, May 2010 (€bn) 7.5 8.2

40

Public debt issuance (€bn)

Note: * Rentenbank implemented IFRS in 2007, and published comparative figures for 2006. Previous accounts are drawn up in accordance with the requirements of German banking regulations and the German Commercial Code. Debt maturity and currency structures are based on dealogic DCM Analytics data.

12

80

Others 6%

JPY 3% AUS/CAD/ NZD 13%

Asset composition, YE 09 Subscribed capital 6% Principal and g'tee reserves 34%

Loans and advances to banks 59.9%

Loans and advances to customers 0.8% Derivatives 3.7% Financial Investments 35.6%

363

Barclays Capital | AAA Handbook 2010

Nederlandse Waterschapsbank N.V. (NEDWBK) Description

Michaela Seimen

Ratings table

% € Index

% £ Index

Total assets

0.185

0.083

€52bn

De Nederlandse Waterschapsbank (NEDWBK) was founded in 1954 by the Dutch water boards (26 as of 2010) to provide them with funding for the substantial investments needed to attempt to better protect the country from potential floods. NEDWBK arranges short- and long-term loans for municipal authorities, provinces, public housing, healthcare, educational institutions and activities in the field of water and the environment. Since its founding, all shares in NEDWBK have been held by public authorities. With total assets of €52.4bn as at year-end 2009, up 8% y/y from €48.4bn in 2008, NEDWBK is one of the Netherlands’ largest banks in terms of assets. It refinances its activities on the international money and capital markets.

Moody’s

S&P

Fitch

LT Senior Unsecured

Aaa

AAA

NR

Bonds

Aaa

AAA

NR

Stable

Stable

NR

Outlook

Risk weighting Basel II RSA: 20%.

Key features „

Sound market position: As the principal banker to the Dutch water boards (waterschappen), NEDWBK benefits from its undisputed market leader position in this segment with a market share of c.90% in 2009. Further, with lending to the Dutch housing corporation sector, NEDWBK is among the largest providers of funding guaranteed by Waarborgfonds Sociale Woningbouw (WSW – a special, independent Social Housing Guarantee Fund secured via a backstop position of the central government and the municipalities), whose total guaranteed debt amounts to c.€72bn, of which c.€9bn needs to be refinanced on an annual basis.

„

High asset quality: NEDWBK’s loan book consists exclusively of loans granted to Dutch public sector entities, and/or loans guaranteed by public sector bodies. In 2009, NEDWBK’s longterm loan portfolio increased to €40.2bn (2008: €35.9bn), with lending to the water boards accounting for 10% of all lending, lending to Dutch housing corporations accounting for a strong 60% , up from 56% in 2008, municipal and provincial authorities accounting for 17% and Healthcare institutions for 9%. Owing to a very high asset quality, NEDWBK has so far never suffered a loan loss with – as a result of limited credit risk – no losses being expected. NEDWBK therefore has made no loan-loss provisions.

„

Potential governmental support: At the time of writing, all shares in NEDWBK (which, as at year-end 2009, had 33 employees) were held by Dutch public authorities. The water boards, which, in light of the Netherlands’ geographical location, play a crucial role in the country, are the dominant group of shareholders (81%). A further 17% is owned by the Dutch government and 2% by Dutch provinces. As the Dutch local governments are responsible for a large proportion of total government spending, NEDWBK, as one of the main funding sources, plays an important role in Dutch government finances. Rating agencies therefore believe that in the case of distress, the government would provide support to NEDWBK. Furthermore, there is widespread agreement that the Dutch government would not take any steps that would compromise the bank's ability to continue performing its role. In this context, we are not aware that the Dutch Ministry of Finance has indicated any plans to divest its participation in NEDWBK.

„

Funding: For its funding purposes, NEDWBK has established three different programmes: a €50bn debt issuance programme, a €15bn Euro-CP and CD programme and an AUD5bn Kauri Bond programme. In January 2009, NEDWBK’s ECP programme was increased to a maximum of €15bn from €10bn previously and NEDWBK further increased its reliance on the CP market by issuing a large proportion in short-term securities. NWB issued in 2009 over €25bn in CPs with terms averaging four months. In 2009, NEDWBK raised €7.6bn in long-term funding, up from €6.3bn in 2008. Long-term funding is focused in EUR (57%), USD(15%) and CHF (15%). NEDWBK also issues in JPY, GBP and HKD.

Strengths

Weaknesses

„

„

Profitability: After NEDWBK’s annual profit fell to €9mn in 2008, from €71mn in 2007, the bank reported an increased profit of €57mn in 2009, mostly owing to recovered market value results, which were driven by a fall in risk spreads. However, profit maximisation is in general not an objective for the bank.

„

Funding structure with high reliability on short-term funding.

Capital adequacy: As the majority of NEDWBK’s lending benefits from a 0% risk weighting, at 51.4% (2008: 56%), NEDWBK’s BIS solvency ratio is very high and markedly above the legal requirement of 8%.

Key points for 2010 „

Closely monitor the further development of NEDWBK profitability, particularly with regard to potentially further (un)realised losses in its fair value portfolio.

10 June 2010

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Financials and spreads

Nederlandse Waterschapsbank N.V. (NEDWBK)

Financial summary – YE Dec €

Credit term structure

2005 2006 2007 2008 2009 %chg

Balance sheet summary (€bn)

30 20

Total assets

33.2 35.2 38.8 48.4 52.4

8.3

Loans & advances

31.0 32.6 35.0 42.1 45.5

8.1

0

of which, Long term

26.3 28.8 32.0 35.9 40.2

11.8

-10

10

Liquid and Other assets

2.2

2.6

3.8

6.3

6.9

9.6

-20

Total capital

1.3

1.3

1.1

1.0

1.0

0.1

-30

28.2 30.1 33.2 41.5 46.2

11.5

Total borrowings

Income statement summary (€mn) Net interest revenue

126.0 125.0 114.0 128.0 92.0

-28.1

9.0 15.0 13.0 13.0 13.0

0.0

Operating expenses Pre-tax income

136.0 143.0 94.0 12.0 76.0 533.3

Net income

197.0 98.0 71.0

0

2

0.3

0.2

0.0

0.1

Return on equity

16.6

7.6

5.9

0.8

5.4

Cost/Income ratio

6.2

Net int rev/Op inc

50

-50 May-09 Aug-09 Nov-09 Feb-10 NEDWBK 3.750% Jan 12 NEDWBK 4.250% Nov 13 NEDWBK 3.375% Jan 16 NEDWBK 4.375% Jan 18

9.5 12.1 50.0 14.4

86.9 79.1 106.5 492.3 102.2

Gearing and debt leverage (%) LT Loans/Total capital

Public debt issuance (€bn)

2080 2199 2932 3432 3833

Capital/Debt securities

4.5

4.3

3.3

2.5

2.3

8

Capital adequacy (%)

6

Tier 1 / BIS Solvency Ratio

110.0 115.0 96.0 53.2 51.4

Total capital/Total assets

3.8

3.7

2.8

2.2

5.4

3.9 2.6

2.1

2

3.7 1.9 1.4 2.3 1.4

2.9

0.3 >2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

0

Capital structure, YE 09

4.8

0 2004

2005

2006

2007

2008

2009

2010 yt May

Currency distribution, May 2010

6.1 6.1

6

5.0

6.9

6.1

2 2003

Public debt maturity structure, May 2010 (€ bn)

6.4

5.7

3.2

4

2.0

Note: NWB switched to IFRS presentation of its accounts in 2005. Debt maturity and currency structures are based on dealogic DCM Analytics data.

2010

10

0 0.6

AUD/CAD/ NZD 5.0%

Others 1.0%

EUR 48.4%

CHF 10.4% JPY 6.9%

GBP 6.1%

USD 24.0%

Loan distribution, YE 09 Other 4.5%

Provinces 1% Dutch State 8% Water Boards 91%

10 June 2010

8

100

9.0 57.0 533.3

Return on assets

4

6

OAS swap spread evolution

Profitability (%)

8

4

Housing corporations 59.9%

Water boards 10.4% Municipal authorities 16.5%

Healthcare 8.6%

365

Barclays Capital | AAA Handbook 2010

Network Rail (UKRAIL)

Michaela Seimen

Description

Ratings table

% $ Index

% £ Index

Total assets

0.045

0.512

£38.1bn

Network Rail Ltd was created in 2002 to take over the functions of Railtrack Plc. Its main operating company, Network Rail Infrastructure Ltd, owns and operates the UK rail infrastructure. Following the passage of the Railways Act 2005, debt issued under its MTN and debt issuance programmes will be directly guaranteed by the UK government.

Moody’s

S&P

Fitch

LT Senior Unsecured

Aaa

AAA

ST

P-1

NR

Stable

Stable

Outlook

Risk weighting Basel II RSA: 0%

Key features of the credit „

Purpose: Network Rail Infrastructure Ltd is the main operating company of the Network rail Group. It owns and operates the UK’s railway infrastructure having taken responsibility for these in October 2002.

„

Ownership and status: Network Rail Infrastructure Ltd is 100% owned by the acquisition vehicle Network Rail Holdco Ltd, which in turn, is a wholly-owned subsidiary of Network Rail Ltd. The latter was established in March 2002 as a company limited by guarantee (CLG) ie, a private company without shareholders, run along commercial lines. It was created solely for the purpose of acquiring Railtrack Plc, following the latter’s placement into railway administration in October 2001. As a CLG, it aims to make surpluses from its operations but instead of paying dividends, profits will be invested in improvements in the infrastructure. The company is owned by members, rather than shareholders, which include representatives of regional and local government, rail industry members and public interest members and a special member who may be elected by the Secretary of State for Transport.

„

„

Financials: Network Rail’s financial year ends on 31 March. Since FY 07, Network rail has generated a profit as a result of higher track access charges and the ending of the deferral of revenue grants from the government, which had depressed revenues previously. As of FY 09, net profit decreased (deferred tax) to £609mn (2008: £1.2bn) owing to higher tax.

„

Funding: The Office of the Rail Regulator (ORR) in its draft determination of Control Period 4 (which began in April 2009) supported Network Rail’s intention made in its Strategic Business Plan in April 2008 to restrict the use of government guarantees to solely refinanced debt. Thus Network Rail has underlined its intention to shift to a programme of corporate borrowing (ie, without government guarantee) as a means of financing new investment. Network Rail is financed primarily as a result of revenues in the form of direct government grants and track access charges. Revenue requirements are set by the ORR on a five-yearly basis and the current regime runs from April 2009.

Debt programmes and support: Medium-term capital market funding was initially provided via a £10bn MTN programme in the name of Network Rail MTN Finance PLC. This was superseded in late 2004 by a £30bn Multi-currency Note Programme in the name of Network Rail Infrastructure Finance Plc. In addition, a £4bn Commercial Paper Programme has been put in place Both issuing vehicles are bankruptcy-remote vehicles and both programmes have received credit support from the SRA and the UK government. The Railways Act 2005 provided for support for Network Rail debt to be provided directly by the UK government through the office of the Secretary of State for Transport (a so called financial indemnity that expires in 2052 (maximum maturity date)).

Strengths

Weaknesses

„

„

UK government guarantee.

Dependent upon government support.

Key points for 2010 „

Acceptance and funding levels of corporate borrowing without government guarantee

10 June 2010

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Barclays Capital | AAA Handbook 2010

Public sector

Network Rail (UKRAIL)

Financial summary – YE Dec

Credit term structure H108 H1 09 % chg 10.0 12.1 62.9 6.2 0.0 3.0

32,466 31,062 34,154 34,596 34,011 38,132 5,077 2,606 4,245 15,264 17,428 18,508 20,341 9,590 9,591 7,162 6,899 7,106 5,960

2,984

3,117

4.5

2,301 3,283 -3,548 2,412 -849 1,189 2,524 -3,203 1,029 5,444

1,446 1,346 -1,764 1,220 -428 591 1,712 -1,910 1,400 3,716

1,654 1,280 -1,891 1,226 -471 45 1,638 -2,460 1,958 2,934

14.4 -4.9 7.2 0.5 10.0 -92.4 -4.3 28.8 39.9 -21.0

59.5% 59.9% 40.5% 4.2 x 2.8 x 67.2% 66.6% 5.5 x 13.9%

56.2% 59.9% 40.9% 4.2 x 2.9 x 67.6% 66.0% 5.2 x 8.6%

67.7% 59.5% 39.3% 3.9 x 2.6 x 68.4% 66.7% 5.7 x 7.7%

60 40 20 0 -20 -40 0

5

10

15

20

25

30

OAS swap spread evolution 50 30 10 -10 -30 May-09 Aug-09 Nov-09 UKRAIL 4.875% Mar 12

Feb-10 UKRAIL 4.625% Jul 20

UKRAIL 4.750% Nov 35

Public debt issuance ($bn)

Public debt maturity structure, May 2010 ($bn)

20 15 10 5 0

15.2

2009

4.5

1.4 2010 yt May

6.8

2008

4.0 2007

5.4

2006

6.1

2005

Note: Debt maturity and currency structure charts are based on dealogic DCM Analytics data

Currency distribution, May 2010 13.0 GBP 82.0%

>2029

2019

2020-2029

2018

2017

2016

2014

-

2013

-

2012

1.4 0.7 -

2011

1.3 2.1 2.0 1.5 -

2015

7.1

2010

14 12 10 8 6 4 2 0

80

2004

FY08

2003

£ mn FY06 FY07 Balance sheet summary Fixed assets 26,960 29,327 Total assets 28,098 30,604 Short term debt 4,186 2,862 Long term debt 14,207 15,725 Total debt 18,393 18,587 Shareholders funds 4,363 5,658 Income Statement Summary & cash flows Revenues 3,837 5,795 of which: Passenger franchise revenue 1,515 2,206 SRA revenue grants 1,983 3,227 Operatng costs -3,369 -3,517 Op Profit (ex exceptionals) 468 2,278 Net int & invest revenues -778 -902 Net income -253 1,035 Cash from operations 690 2,499 Net capex -2,917 -2,872 Net financing 2,230 535 Gross funding 9,090 10,435 Key ratios Gross Capex/Sales 80.5% 56.2% EBITDA margin 36.7% 57.5% EBIT margin 12.2% 39.3% EBITDA/Net int 1.8 x 3.7 x EBIT/Net int 0.6 x 2.5 x Total debt/Capital 74.6% 69.7% Net debt/Capital 74.6% 69.4% Net debt/EBITDA 13.0 x 5.5 x FFO/Net debt 4.1% 14.0%

Capital structure, YE 09

245

Called up share cap & share prem

10 June 2010

Others 5.0%

Revenue growth, YE 09 4,298

6,000 4,000 2,000 0 -2,000 -4,000

USD 13.0%

Reval reserv

1,140

1,558

Other reserves

Cum P&L

7,000 5,799 6,000 5,000 3,283 3,227 4,000 1,983 2,206 2,058 2,301 3,000 1,515 2,000 1,435 376 361 307 339 362 1,000 0 FY05 FY06 FY07 FY08 FY09* Passenger Franchise Revenue SRA revenue grants Other Revenues 367

Barclays Capital | AAA Handbook 2010

Nordic Investment Bank (NIB)

Michaela Seimen

Description

Ratings table

% $ Index

% £ Index

Total assets

0.060

0.120

€26bn

NIB is a multi-lateral lender created by Nordic governments to provide long-term financing for investment projects that benefit the region, especially by strengthening competitiveness and enhancing the environment. At the start of 2005, its membership was expanded to include the three Baltic countries of Estonia, Latvia and Lithuania. NIB is one of the smaller multi-lateral lending institutions (MLIs) and is fairly highly leveraged, but it has strong membership support from its highly-rated government owners, a relatively low level of country risk exposure, a very good record for asset quality and high levels of liquidity on its balance sheet.

Moody’s

S&P

Fitch

LT Senior Unsecured

Aaa

AAA

NR

ST

P-1

A-1+

NR

Stable

Stable

NR

Outlook

Risk weighting Basel II RSA: 0%

Key features of the credit „

Purpose: NIB was established in 1975 to provide medium- and long-term financing to support investment projects of benefit to the Nordic countries. This objective covers loans and guarantees extended within the Nordic region, as well as related projects in emerging markets. In 2006, the bank’s mission was revised to increase the focus on strengthening regional competitiveness and enhancing the environment.

„

Ownership and capital structure: In 2004, a new agreement extended membership to the Baltic countries (Estonia, Latvia and Lithuania) that was implemented in 2005. However, NIB’s ownership structure remains much more concentrated than other MLIs, with the five Nordic countries (Denmark, Finland, Iceland, Norway and Sweden) providing 96.6% of the capital base. The quality of its callable capital is very high, with 95.7% provided by AAA countries at end-2009, making it one of the strongest MLI in terms of capital quality. The inclusion of the Baltic members increased the bank’s authorised capital by €142mn, to €4,142mn.

„

Ratings: NIB lends to public and private sector entities. Manufacturing, energy and transport and communications are the principal borrowing sectors, and there is a particularly strong focus on supporting infrastructure and environmental projects. The bulk of NIB’s outstanding loans (85% at end-2009) is advanced within member countries, although new lending has been shifting towards non-members. Loans outside the member countries are made mainly via the Project Investment Loan (PIL) and Environmental Loan (MIL) facilities. A high proportion of PIL loans are protected by preferred creditor status and guarantees from NIB members. The asset quality track record has been strong, albeit in 2009 the bank categorised three loans totalling €24.1mn as non performing. As of year-end 2009, provisions increased to €101.3mn, up from €79.4mn in 2008.

Strengths

„

Debt leverage and gearing: The main constraint on leverage is a requirement that ordinary loans (within and outside the member countries) should be less than 2.5x the capital base (authorised capital plus accumulated general reserves). The ceiling for ordinary loans was EUR13.45bn at end-2009; separate limits apply to other lending. In particular, it has a EUR4bn limit on the PIL facility. In total, various measures of gearing and debt leverage rank NIB among the most highly leveraged of the MLIs, broadly similar to EIB. Liquidity levels are maintained at high levels: at end-2009, net liquidity amounted to EUR3.5bn (15% of total assets).

„

Financial performance: Lending remained strong in 2009, with loans agreed of €1.4bn, but did not reach the target of €2bn, due to decreased loan demand based on difficult financial market conditions. Total assets remained stable at €22.4bn (2008: €22.6bn). Profit improved in 2009 to €324mn, after a loss in 2008 of €282mn. The loss in 2008 was a result of negative valuation effects on the treasury and higher levels of provisions. These effects have been reversed and improved in 2009.

„

Funding: Capital market funding is spread across a wide range of currencies, although the dollar is the most important. It provided 34% (2008: 70%) of funding during 2009 and accounted for c.50% of outstanding debt at end-2009. Funding in euro accounted for 25% of new borrowings, but less then 10% of outstanding debt. After currency swaps, net exposure is mostly in euros, dollars and the Nordic currencies. In 2009, a total of €4.1bn was borrowed, via 71 transactions in 10 different currencies. Issuance included only one global USD benchmark transaction, compared with three in 2008. The bank focused in 2009 on an extension of maturities, which increased to 4.8 years in 2009, from 3.6 years in 2008. Total debt outstanding as of year-end was €18bn in 19 currencies. NIB targets funding of €4.1bn in 2010.

Weaknesses

„

Very high credit quality of member governments, providing strong confidence in callable capital.

„

Declining public sector guarantees for the loan book, but asset quality track record has been strong.

„

Relatively low levels of country risk compared with most MLIs.

„

Mark-to-market exposure to credit spreads on treasury portfolio.

„

High level of balance sheet liquidity.

„

Exposure to low-rated countries.

Key points for 2010 „

Further growth in loan book

10 June 2010

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Barclays Capital | AAA Handbook 2010

Public sector

Nordic Investment Bank (NIB)

Financial summary – YE Dec

Credit term structure

2006 2007 € Balance sheet summary (€bn) Total assets 18.0 20.0 Disbursed loans 11.5 12.3 Gross Liquid assets 3.8 4.5 Total borrowings 14.2 15.6 Subscribed capital 4.1 4.1 Paid in capital and reserves 2.0 2.0 Income statement summary (€mn) Net interest revenue 178.8 187.1 Operating expenses 32.1 32.0 Write-downs & LLPs 0.0 0.0 Net income 137.5 68.7 Profitability (%) Return on average assets 0.8 0.4 Return on average equity 6.9 3.4 Cost/Income ratio 18.9 31.8 Net int rev/Op inc 105.4 185.8 Gearing, debt leverage & capital ratios (%) Loans/Paid in cap & res 570.7 603.4 Loans/Subscribed cap & res 200.8 213.4 Callable capital/Debt 26.1 23.9 Paid in + res/Total assets 11.2 10.2 Asset quality (%) Non-accrual loans (€ mn) 0.0 0.0 Non-accrual/Total loans 0.0 0.0 Cum LLPs (€ mn) 0.4 0.3 Cum LLPs/Total loans 0.0 0.0

2008 2009 % chg 22.6 13.1 4.8 17.5 4.1 1.7

25.8 13.8 4.4 18.0 4.1 2.1

14.1 5.4 -8.8 2.6 0.0 18.5

212.0 219.0 3.3 34.9 35.7 2.3 79.2 42.5 nm -423.7 323.9 -176.4 -2.0 -22.5 -11.3 -68.5

15 10 5 0 -5 -10 0

1

2

3

4

OAS swap spread evolution 100 50

1.3 17.1 8.9 54.5

0 -50 May-09

755.1 671.2 239.5 238.4 21.2 20.7 7.6 7.9

Aug-09

Nov-09

Feb-10

NIB 3.625% Jun 13

NIB 2.375% Dec 11

Public debt issuance ($bn) 5

0.0 0.0 0.0 0.0 79.4 101.3 0.6 0.7

3.7

4 3

2.0

2

Note: Debt maturity and currency structure charts are based on dealogic DCM Analytics data

1.5

1.6

1.8

2004

2005

2006

3.9

3.5 1.5

1 0 2003

Public debt maturity structure, May 2010 ($bn) 4

3.0 3.3

1.4

1.1

0.6 0.4

1

1.4 EUR 6.4%

0.2 0.2 0.4

Capital structure, YE 09

>2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

0

2010 yt May

JPY 6.3%

AUD/CAD/ NZD 10.5%

USD 54.1% GBP 10.4%

Loan distribution, YE 09 Statutory reserve 12% Other reserves & retained earnings 17%

Callable 64% Paid-in 7%

10 June 2010

2009

Others 8.9%

2.0

2

2008

Currency distribution, YE 09

2.6

3

2007

Other 5.3%

Loans without formal security 72.3%

Loans to or guaranteed by government 13.3%

Loans to or guaranteed by local authorities in member countries 2.6% Loans guaranteed by banks 6.5%

369

Barclays Capital | AAA Handbook 2010

NRW.BANK (NRWBK)

Michaela Seimen

Description

Ratings table

% € Index

% $ Index

Total assets

0.225

0.005

€161bn

Until 2004, NRW.Bank (NRWBK), which now operates as the development bank of the German state of North Rhine-Westphalia, operated under the name Landesbank NRW. Its activities comprise supporting the state’s structural, economic and social policies, as well as the public tasks of the government institutions and agencies charged with implementing these policies. NRWBK benefits from an explicit and unconditional guarantee on behalf of North RhineWestphalia – ie, the so-called Anstaltslast and Gewährträgerhaftung. According to the 2002 EU Consensus, NRWBK will keep its unconditional and explicit guarantee, as well as guarantor and maintenance obligation.

Moody’s

S&P

Fitch

LT senior unsecured

Aa1

AA-

AAA

Pfandbriefe

NR

NR

AAA

Stable

Stable

Stable

Outlook Note: As at 7 June 2010

Risk weighting 0% risk-weighted. Under the Basel II standard approach, the risk weighting of the Federal Republic of Germany is applied to NRWBK.

Key features „

„

Explicit guarantee from regional state: With effect from 1 January 2010, North Rhine-Westphalia now holds c.98.6% (previously 64.7%) of NRW.BANK, and the Regional Associations of the Rhineland and Westphalia-Lippe each hold c.0.7% (previously 17.6%). The change in the owner structure follows a special law that was adopted in December 2009 and came into force on January 2010 to increase the development possibilities of NRW.Bank. North Rhine-Westphalia has provided the so-called Anstaltslast (maintenance obligation) and Gewährträgerhaftung (statutory guarantee) to NRWBK. Whereas the maintenance obligation requires the public institution responsible for the lender’s creation (ie, North RhineWestphalia) to safeguard the bank’s economic basis and enable it to maintain operations and meet its obligations as they fall due, the statutory guarantee is unlimited in that the owner is responsible for all the entity’s liabilities. These forms of support render the explicit guarantee of secondary importance, except that it provides the basis for NRWBK’s debt to be zero riskweighted. According to the 2002 EU Consensus, NRWBK will keep its unconditional and explicit guarantee, as well as the maintenance obligation and deficiency guarantee in the future. At end-April 2005, North Rhine-Westphalia provided an explicit guarantee of the book value of the bank’s holding in German Landesbank WestLB, thereby immunising the bank from valuation losses.

„

Asset quality: With total assets amounting to €161bn as at yearend 2009, NRWBK is Germany’s second-largest development bank after KfW (and the third-largest in Europe). Public sector and development business totalled c.€140bn as at year-end 2009 (ie, c.90% of NRWBK’s total assets). Whereas 62% was from the public finance sector, social housing accounted for a 13% stake, followed by lending to SMEs (7%) and individuals (7%). NRWBK cooperates closely with regional lending institutions, which carry the risk on most of their lending products. Still, NRWBK usually administers these loans until they are repaid. Due to the difficult economic environment new business volume in the Start-up and SME business declined sharply, down c.20%, with new commitments of €2.4bn. Also Municipal and Infrastructure Finance new business volume declined by c.22% to €2.7bn, due to a fall in volume, despite nearly unchanged numbers of commitments. New business for individuals was down by 1.4% compared to 2008 with a level of €1.7bn. However, business volumes for housing programmes increased. As at year-end 2009, 53% of NRWBK’s €160bn credit portfolio had a AAA rating, followed by 19% with AA and 14% with A. Social housing accounted for 13%, with the non-performing loans (NPL) ratio of 0.03% being markedly below the German average.

„

Funding: Over the course of 2009, NRWBK’s liabilities to banks decreased by €5bn to €48.6bn, mainly due to a decline in time deposits. Liabilities to customers slightly increased to €24.5bn and NRWBK’s certified liabilities increased by €5.6bn to €63.3bn. In 2009, placed debt was about €18bn, including €4bn funding brought forward. NRWBK has three funding programmes in place: a €15bn Global Commercial Paper Programme, a €50bn Debt Issuance Programme and an AUS3bn Kangaroo Programme. NRWBK’s annual funding strategy comprises about €12bn. The bank intends to further diversify its funding structure. Funding in 2009 was c.75% concentrated in EUR. USD issues comprised about 20% and other currencies (including 14 other currencies) represented about 5% in total funding.

Financial performance: Driven by a marked increase in its risk provisions and revaluations of adjustments, NRWBK’s net income fell to €32mn in 2008, from €126mn in 2007. Due to lower operating costs and lower risk provisions, net income improved in 2009 to €170.8mn. Yet, as in the case of other development banks, profit maximisation is not a key objective for the bank.

Strengths

Weaknesses

„

„

NRWBK benefits from its explicit and unconditional guarantee. Also, NRWBK’s liabilities benefit from an explicit state guarantee that underlines the lender’s distinct role in public policy.

Given its role as a development bank, NRWBK’s profitability remains low. Still, as in the case of other development banks, profit maximisation is not a key objective for NRWBK.

Key points for 2010 „

Further development of NRWBK’s risk provisions and revaluations of adjustments.

10 June 2010

370

Barclays Capital | AAA Handbook 2010

Financials and spreads

NRW.BANK (NRWBK)

Financial summary

Credit term structure

€ 2006 Balance sheet summary (€ bn) Total assets, of which 135.6 claims on banks 31.0 claims on customers 49.9 holdings of debt securities 48.7 equity holdings 2.4 Total borrowing, of which 111.3 debt securities 46.3 Equity 19.5 Total capital 20.0 Income statement summary (€ mn) Net interest revenue 340.5 Operating expenses 186.4 Pre-provision operating incomc 170.6 Risk provisions and writedowns -12.8 of which WestLB write-down 0.0 Net pre-tax incomce 135.8 Pre-tax income (excl WestLB) 135.8 Net income after tax 101.9 Profitability (%) Return on assets 0.1 Return on equity 0.5 Pre-provison op inc/assets 0.1 Pre-provison op inc/equity 0.9 Cost/Income ratio 52.2 Net int rev/Op. income 95.4 Leverage and capital ratios (%) Capital/Debt funding 17.9 Total capital/Total assets 14.7

2007

2008

2009

% chg

151.0 36.1 54.1 55.0 2.4 126.7 53.2 19.6 20.1

159.9 35.3 58.2 60.3 2.4 135.4 57.7 19.7 20.2

161.0 32.8 62.0 59.9 2.4 136.4 63.3 19.9 20.4

0.7 -7.0 6.5 -0.6 -1.0 0.8 9.7 1.3 1.2

317.7 201.5 176.2 3.9 0.0 171.6 171.6 133.6

500.2 226.1 343.8 272.4 0.0 71.4 71.4 32.8

490.5 182.6 403.7 204.7 0.0 199.0 199.0 171.1

-1.9 -19.3 17.4 NM NM NM 178.7 NM

0.1 0.7 0.1 0.9 53.3 84.1

0.0 0.2 0.2 1.7 39.7 87.8

0.1 0.9 0.3 2.0 31.1 83.7

0

2

4

75 50 25 0 -25 -50 Jun-09

Sep-09 Dec-09 NRW 3.625% Feb 12 NRW 4.375% Apr 22

20

4.1

5

15 15.8 13.3

14.9 12.6

15.0 12.7

10

6.0

9.3 5.9

0 2003 2004

2005 2006

2007 2008

2009 2010 yt May

USD 13.7%

6.3 3.0

2.0 1.6 0.6 1.2 0.4 1.2 >2029

2020-2029

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

12.9

9.8

Public debt currency structure, May 2010

Ownership structure, YE 09

10 June 2010

14.8

5

0

State of NRW 98%

10

Mar-10 NRW 3.500% Nov 15

16.4

12.0 7.4 7.6

8

Public debt issuance (€bn)

Public debt maturity structure, May 2010 (€bn) 15

6

OAS swap spread evolution

Note: NRW.Bank accounts are drawn up in accordance with the German Commercial Code and the regulation regarding Accounting for Banks and Financial Services Institutions. Debt maturity and currency structures are based on dealogic DCM Analytics data. The outstanding maturity and currency structure charts include debt incurred by the former Landesbank NRW, but the issuance chart includes only debt issued in the name of NRW.Bank.

10

30 20 10 0 -10 -20 -30 -40

EUR 80.0%

AUD/CAD/ NZD 2.0% Others 4.5%

Asset composition, YE 09 Rhineland regional association 1% WestphaliaLippe regional association 1%

EU government related 17% National government related 41%

Non-EU government related 4%

Treasury 9%

Loans to individuals 8% Housing business Loans to 13% corporates 8% 371

Barclays Capital | AAA Handbook 2010

Reseau Ferre de France (RESFER) Description

Michaela Seimen Ratings table

% € Index

% £ Index

Total assets

0.20

0.254

€46bn

Réseau Ferré de France (RFF) is a French public entity that owns the French rail infrastructure and has responsibility for its continuing development. Created in 1997, it is structurally loss making and financially dependent on state subsidies. RFF’s Aaa/AAA credit rating is entirely dependent on outside financial support and its legal status as a French EPIC, which ensures that the French state takes responsibility for its solvency and liquidity. As the infrastructure owner, privatisation is regarded as a non-starter and a non-issue in France.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

Outlook

Risk weighting Basel II RSA: 0%

Key features of the credit „

Purpose and business description: RFF was established as part of the 1997 reform of the French rail structure, acquiring ownership of the infrastructure (from the previously integrated rail operator, SNCF). Management of the network is contracted out to SNCF, leaving RFF responsible for policy matters and, specifically, for control over investment projects to extend the infrastructure. RFF continues to expand the high-speed rail network. The eastern HSL to Strasbourg opened to passenger traffic in June 2007. Plans for further expansion of the highspeed network include the South Europe Atlantic line from Tours to Bordeaux and the Rhine Rhone link. In 2009, investment spending increased to €3.4bn, from €3bn in 2008.

„

Ownership and support: RFF is wholly owned by the French state and is a public entity with industrial and commercial character (ie, an établissement public à caractère industriel et commercial – or EPIC), defined by its founding Law No 97-135. This status means that although its debt issues do not carry explicit government guarantees, the state is ultimately responsible for its solvency and for ensuring access to liquid funds. There is general agreement that there is no real prospect of privatisation for RFF, given its key public mission. Given that the rail reform that created RFF was designed to satisfy EC requirements for the separation of infrastructure ownership from operation, there is no EC pressure for a change of status; this was reaffirmed by the publication of a group of three EU directives on the railways in 2001. French government support is evidenced by RFF’s dependence on state subsidies, as outlined below.

„

Financial performance: RFF is financially dependent on French state support. The two key sources of operating income are infrastructure access fees (levied on SNCF) and infrastructure contributions from the state. A trend towards increased sourcing of revenues from access fees continued in 2009, however, state contributions increased again (by 40%) after reduced contributions in 2008. In past years, RFF has regularly made a large net loss, and the resultant substantial negative retained earnings have been balanced through a combination of capital grants and investment subsidies for debt reduction. In 2008, a change in the accounting approach for valuing assets increased assets substantially (by EUR11.3bn), with a corresponding increase in capital and reserves. This took the company back into positive equity at the end of 2008. Excluding the extraordinary income from asset revaluations, the 2008 pre-tax net result would have been -€930mn, from -€726mn in 2007. As of year-end 2009, RFF reported a profit of €418.3mn.

„

Funding: On RFF’s formation, the transfer of infrastructure assets from SNCF was mirrored by the creation of a liability to SNCF, under which RFF is responsible for servicing a substantial part of the debt still carried on SNCF’s balance sheet. As time passes, the structure of RFF’s debt is changing towards the bulk of its debt being issued in its own name. As would be expected for an infrastructure entity, the debt structure is relatively long term. Total debt remained stable in 2009. In 2009, RFF total debt issuance was c.EUR3bn (EUR3bn in 2008). So far in 2009, supply amounts to EUR150mn and GBP300mn. We understand that funding volume for RFF in 2010 will be around EUR1.3bn.

Strengths

Weaknesses

„

State support enshrined in EPIC status and demonstrated on a continual basis by state subsidies and capital injections.

„

Weak stand-alone financials – entirely dependent on state support.

„

No pressure for change of status, given its strong public policy role in France and the fact that it is seen as fitting EC models for infrastructure provision.

„

High and growing debt levels.

Key points for 2010 „

Continuing development of the high speed rail network.

10 June 2010

372

Barclays Capital | AAA Handbook 2010

Public sector

Reseau Ferre de France (RESFER)

Financial summary – YE Dec

Credit term structure

€ 2006 2007 2008 2009 % chg Balance sheet summary (€bn) Long term assets 24.8 26.6 37.8 40.1 42.5 Total assets 29.1 32.3 43.8 45.5 35.6 Borrowing 27.7 29.2 30.6 30.4 4.8 Retained earnings -21.9 -22.2 -23.0 -14.9 3.6 Total capital -2.5 -1.4 8.6 10.0 721.5 Income statement summary (€mn) Infrastructure fees 2304.4 2448.5 2675.8 2855.9 9.3 State infrastructure contr 979.0 828.1 658.2 2325.8 -20.5 Other operating income 1294.0 1398.5 1655.9 1824.9 18.4 Gross revenues 4577.4 4675.1 4989.9 7006.6 6.7 Network + asset -2676.2 -2835.2 -2924.8 -2954.1 3.2 management payments Net operating income (OI) Depreciation Operating result Net int + other fin costs Net income Key ratios (%) OI margin OI/Net interest* Net income/YE assets Net income/YE capital FFO/Capex Capex/Revenue FFO/Total debt Total debt/Total assets Total debt/OI (times) Total debt/Cap (times)

896.6 788.3 799.1 2683.0 -536.7 -639.9 -829.1 -983.3 226.9 -68.8 -213.7 1565.4 -481.9 -584.1 -813.7 -1171.7 -283.4 -795.8 8098.0 418.3 19.6 186.1 -1.0 11.3 -1.7 45.5 -0.1 95.3 30.9 -11.0

16.9 135.0 -2.5 57.8 -11.5 51.0 -0.9 90.5 37.1 -21.2

16.0 98.2 18.0 92.2 1.6 58.2 0.1 70.0 38.4 3.6

1.4 NM NM NM NM

50

30 20 10 0 0

5

10

15

30 20 10 0 Jan-10

Feb-10

Mar-10

Apr-10

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

3.0 1.9

2003

1.6

2004

1.9

2005

2.2

2.1

2006

1.6

856

418

-14,864 Initial cap endow.

Retained earnings

CHF 9.1%

EUR 67.7%

Others 1.9%

Breakdown of total debt (€bn) 14,682

8,909

Investment grants

30 25 20 15 10 5 0

16 14 14 12 16 11 10

21

20

18 8

7

23

5

25

4

28

2

28

2

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Transferred SNCF debt

10 June 2010

2010 yt May

GBP 17.7%

>2029

2020-2029

2019

Capital structure, YE 09 (French GAAP measure) 22,500 15,000 7,500 0 -7,500 -15,000 -22,500

2009

USD 3.7%

0.1 0.4 2018

1.1 2017

2016

0.2 2015

2014

2013

2012

2011

2010

0.7

2008

Public debt currency structure, May 2010

5.2 0.5

1.1

2007

8.3

1.7

May-10

RESFER 4.625% Mar 14 RESFER 4.375% Jun 22

Public debt issuance (€bn)

Public debt maturity structure, May 2010 (€bn)

0.3

25

40

RESFER 5.400% Feb 13 RESFER 4.450% Nov 17

38.3 229.0 0.9 4.2 69.1 45.5 7.2 66.9 11.3 3.0

20

OAS swap spread evolution

Note: RFF accounts are available in accordance with French GAAP and IFRS. Our table has continued to use French GAAAP owing to incomplete availability of IFRS information. Debt maturity and currency structure charts are based on dealogic DCM Analytics data

10 8 6 4 2 0

£OAS

40

RFF-issued debt 373

Barclays Capital | AAA Handbook 2010

Societe Nationale des Chemins de fer Français (SNCF) Description

Michaela Seimen

Ratings table

% € Index

% £ Index

Total assets

0.042

0.044

€47.2bn

SNCF is a French public entity that operates French railway services and manages the infrastructure on behalf of Réseau Ferré de France (RFF), the infrastructure owner. In addition, the SNCF Group is involved in wide range of freight, logistics and infrastructure services. Although there is no timescale for the opening of the domestic rail passenger market, SNCF is increasingly moving into a competitive arena in other areas (Domestic freight and international rail passenger traffic). SNCF’s credit standing is primarily dependent on its EPIC status. The social importance of SNCF’s public mission renders privatisation unlikely in the foreseeable future.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AA+

AAA

ST

P-1

A-1+

F1+

Stable

Negative

Stable

Outlook

Risk weighting Basel II RSA: 20%

Key features of the credit „

Purpose and business description: RFF was established as part of the 1997 reform of the French rail structure, acquiring ownership of the infrastructure (from the previously integrated rail operator, SNCF). Management of the network is contracted out to SNCF, leaving RFF responsible for policy matters and, specifically, for control over investment projects to extend the infrastructure. RFF continues to expand the high-speed rail network. The first phase of the eastern HSL to Strasbourg opened to passenger traffic in June 2007. Plans for further expansion of the high-speed network include the South Europe Atlantic line from Tours to Bordeaux (by 2015).

„

Ownership and support: RFF is wholly owned by the French state and is a public entity with industrial and commercial character (ie, an établissement public à caractère industriel et commercial – or EPIC), defined by its founding Law No 97-135. This status means that although its debt issues do not carry explicit government guarantees, the state is ultimately responsible for its solvency and for ensuring access to liquid funds. There is general agreement that there is no real prospect of privatisation for RFF, given its key public mission. As the rail reform that created RFF was designed to satisfy EC requirements for the separation of infrastructure ownership from operation. In May 2010 the EC asked the French government to change the status of SNCF from an industrial and commercial public undertaking into a public company (Plc). We understand that this request has also been raised with other railway service companies in Europe to restore healthy levels of competition in European railroad transport. However, French government support is evidenced by RFF’s dependence on state subsidies, as outlined below.

„

Purpose and business description: SNCF’s key role is the operation of French rail services and management of the French railway infrastructure on behalf of RFF. In 1997, the French government transferred the ownership of the infrastructure to the newly created RFF. SNCF was left with responsibility for operating services, and also for network maintenance and development on a sub-contracted basis. SNCF has also diversified into road (c.31% of business), sea (c.16%) and air (c.10%) transportation services. The key source of growth in recent years has been the high speed TGV services, boosted most recently by the opening of the new eastern TGV line to Strasbourg in June 2007. Increasing involvement by French regions in the organisation and financing of regional services (following the SRU Law) should underpin increasing investment in regional services. SNCF has ambitious longer-term targets for growth in freight traffic and expansion of its logistics entity has been a key source of revenue growth. Liberalisation in the domestic freight market was completed in line with EC requirements in March 2006. However, plans to eliminate freight losses by end-2006 have been missed, and the division remained loss-making in 2007 and 2008. In 2009, this business segment was strongly affected by the difficult economic situation.

„

Ownership and support: SNCF is wholly owned by the French state and is a public entity with industrial and commercial character (ie, an établissement public à caractère industriel et commercial – or EPIC). This status means that although its debt issues do not carry explicit government guarantees, the state is ultimately responsible for its solvency and for ensuring access to liquid funds. SNCF’s legal status was unaltered by the 1997 reform. Any future change would require new legislation. Although this cannot be ruled out indefinitely, the strong public policy role of the railways in France militates against a change in status. The current organisation seems to be fully compatible with EC requirements.

Strengths

Weaknesses

„

EPIC status, with no pressure in France for privatisation.

„

„

Political consensus on the importance of its public mission.

„

Rigidity of labour practices limits scope for rationalisation and improving profitability, but progress is being made with the move into more open markets.

Modern high-speed train network, which is driving the growing success in gaining market share for medium-distance travel.

„

Performance against targets for increasing investment and profitability. Continuing need for improvements in performance on the freight business.

Key points for 2010 „ „

Whether SNCF’s increasing move into competitive activities could lead to any EC challenge of its EPIC status. Impact of global economic situation on results.

10 June 2010

„

374

Barclays Capital | AAA Handbook 2010

Financials and spreads

Societe Nationale des Chemins de fer Français (SNCF)

Financial summary – YE Dec € mn

2006

Credit term structure 2006 2007 IFRS

2008

2009 % Chg

Balance sheet summary Total assets

5,142

5,172 3,426

0.17

2,393 1,944 -30.15

Assets net of RFF receivable

31,252 125,078 44,428 45,542 45,290

2.51

Total debt

14,948 24,659 22,007 23,245 22,878

5.63

Capital (Equity + Res)

8,123 -23,260 8,986

7,681 6,518 -14.52

Income statement summary

26 25 25 12.8

2,848

3,796 2,887

652

168 1,042

571

-980 -45.20

Operating income margin

13.0

17.3

12.2

13.8

14.4

40

Net income/End yr assets

1.8

0.1

2.2

1.2

-2.1

30

Net income/End yr capital

8.0

-0.7

11.6

7.4

-15.0

20

41.1

18.9

46.0

48.5

48.4

5.2

6.5

7.6

8.1

7.9

0.00

50

13.8

0.6

1.1

0.9

0.9

GBP 13%

USD 22%

CHF 13%

>2029

0.2

Capital structure, YE 09 (French GAAP measure)

EUR 48%

Others 5%

Revenue growth (€bn) Total revenues 30 25.2 24.9 22.2 22.5 22.1 22.4 23.1 23.6 25 20.1 18.4 19.8 20

2009

2008

2007

2006

2005

15 10 5 0 2000

Stockholders ' equity 89.0%

1999

Minority interests 0.8% Reserves for contingencies and losses 10.2%

1.2

2010 yt May

0.9

Public debt currency structure, May 2010

2020-2029

2019

2018

2017

2016

2015

2012

2014

2011

2013

1.0 0.5 0.6 0.3 0.1 0.2 0.1 0.1

Mar-10 SNCF 4.875% Jun 23 (L)

2.7

4.9

0.2

Dec-09

Public debt issuance (€bn) 3.0 2.5 2.0 1.5 1.0 0.5 0.0

Public debt maturity structure, May 2010 (€bn)

Sep-09

SNCF 4.625% Feb 24 (L)

2009

Note: SNCF implemented IFRS for the first time in 2007. Previous accounts were drawn up in accordance with French GAAP. Debt maturity and currency structure charts are based on dealogic DCM Analytics data

0 Jun-09

2008

302.6 351.0

2007

-106.0 244.9

2004

184.0

2003

Total debt/Capital

10

2004

Total debt/Operating income

£OAS

2003

Total debt/Total assets

2010

13.6

OAS swap spread evolution

2006

2,887 2,887

Key ratios

10 June 2010

13.4

2005

Net income (Group share)

0.7

13.2

2002

Operating income (OI)

6 5 4 3 2 1 0

13.0

21,875 21,965 23,691 20,886 20,105 -11.84

2001

Total revenues

£OAS

26 36,394 130,250 47,854 47,935 47,234

Receivable from RFF

27

375

Barclays Capital | AAA Handbook 2010

Swedish Export Credit (SEK)

Michaela Seimen

Description

Ratings table

% $ Index

% £ Index

Total assets

0.041

0.009

SEK372bn

Swedish Export Credit (SEK) is the key provider of long-term export finance in Sweden and is the only institution providing subsidised export credits on behalf of the Swedish government. More broadly, its business rationale can be described as the provision of long-term financial solutions for Swedish business, the public sector and financial institutions. As well as export finance, this includes participation in project and infrastructure finance.

LT Senior Unsecured ST Outlook

Moody’s

S&P

Fitch

Aa1

AA+

NR

P-1

A-1+

NR

Stable

Stable

NR

Risk weighting Basel II RSA: 20%

Key features of the credit „

Purpose: Swedish Export Credit (SEK) was established in 1962, primarily to provide long-term export finance on commercial terms to Swedish industry and commerce. It is the key provider of long-term export finance in Sweden and the only institution providing subsidised export credits on behalf of the Swedish government, through the S-System. Export credit remains the key focus of SEK’s business, although it is also involved in longterm loans related to project finance and investment, eg, in infrastructure and R&D projects. The overall rationale for SEK’s activities can more broadly be described as the provision of longterm financial solutions in the areas of export and infrastructure finance for Swedish entities, including not only corporates, but also public sector entities and financial institutions.

„

Ownership and status: The ownership structure has seen considerable change in recent years. From its establishment until 2000, SEK was 50%-owned by the Kingdom of Sweden and 50% by Swedish banks. From June 2000 until June 2003, ownership was split between the Kingdom of Sweden (65%) and ABB (35%). Since June 2003, it has been 100%-owned by the Kingdom of Sweden. The move to full government ownership reaffirmed SEK’s key public policy role and the closeness of its links to the government. For regulatory purposes, SEK is treated as a financial institution, licensed by the Swedish financial supervisory authority. Its debt is therefore 20% risk weighted.

„

Ratings: Moody’s and S&P rate SEK just one notch lower than Sweden, reflecting the strength of support implicit in government ownership, but also the absence of any explicit guarantee covering the debt, or the company’s solvency. Moody’s, for example, says that an upgrade to the sovereign level would only be triggered by a full explicit debt guarantee from the Kingdom of Sweden.

„

Financials: SEK has expanded strongly in recent years. In 2009, new lending increased by 89% to SEK122.5bn; 80% of lending has gone to the corporate sector. However, SEK’s balance sheet remained unchanged, despite an increase in the bank’s asset portfolio, which was offset by a decrease in the liquidity portfolio and derivatives positions. Net interest revenues rose substantially from SEK143.9mn in 2008, to SEK1.7bn, due to positive changes of fair value positions.

„

Asset quality and capital: Asset quality is protected by the widespread use of third-party guarantees, with a significant part of its loans being government backed. Provisions decreased from SEK557 in 2008, to SEK283mn as of year-end 2009. Provisions were mainly influenced by further write-downs related to an exposure to Glitnir and to loan losses and reversals in regard to Venantius (see below for details). The introduction of IFRS and transitional rules related to implementation of Basel II contributed to a sharp fall in capital adequacy ratios in 2007. However, these ratios improved substantially in 2008 and 2009, standing as of year-end 2009 at 18.7%. In December 2008, the Swedish government took the decision to contribute c.SEK3bn in additional equity to SEK, while allowing it to take over the shares in state-owned Venantius, contributing another SEK2.4bn and thus sharply increasing SEKs equity base. In addition, in December 2008, the Swedish Financial Supervisory Authority decided upon new regulations for calculating capital, with the effect that credit institutions can have a larger proportion of “other capital than equity” in their capital base.

„

Funding: SEK has a wide range of well-established borrowing programmes and borrows in a broad range of currencies, notably in JPY markets. A large portion of its funding is through small-tomedium-sized MTN transactions and private placements (which are not fully covered in the public issuance chart), but during past years, the institution has also become increasingly active in USD benchmark issuance. In 2009, total long-term funding reported in its annual report amounted to SEK112bn, compared to SEK86.2bn as of year-end 2008. SEK carried out 617 transactions in 2009. Japan is a key market for SEK and provided 29% of its funding in 2009 (2008: 44%) The European markets accounted for 29% (9% in 2008) of SEK’s total new borrowing, with one five-year euro public benchmark issuance. The US participated 24% in SEK’s 2009 borrowings (32% in 2008). SEK issued a five-year USD global benchmark in 2009, which was SEK’s first USD benchmark issuance since 2007. In 2009, a credit facility of up to SEK100bn and the opportunity to purchase estate guarantees on commercial terms for borrowing of up to SEK450bn was granted by the Swedish government to SEK. It did not use the SEK100bn credit facility provided in 2008 by the Swedish government.

Strengths

Weaknesses

„

100% ownership by the Kingdom of Sweden.

„

No explicit government debt or solvency guarantee.

„

Public policy role in the provision of export finance.

„

Strong asset quality.

„

Impact of global financial crises and general economic situation.

Key points for 2010 „

Continuing diversification from export finance

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Public sector

Swedish Export Credit (SEK)

Financial summary – YE Dec SEK

2006

Credit term structure 2006 (IFRS)

2007

2008

2009

%chg

245.2

297.3

370.0

371.6

0.4

Balance sheet summary (SEK bn) Total assets

150

229.2

Net Credits Liquidity portfolio

95.2

91.1

109.3

158.8

186.9

17.7

119.3

123.9

159.9

161.8

152.7

-5.6

4.1

4.3

4.5

10.4

13.5

29.4

Own funds Total capital Debt security funding

200

7.0

7.4

7.5

13.7

16.6

21.0

203.4

211.9

267.3

306.0

320.7

4.8

100 50 0 0

Income statement summary (SEK mn) Net interest revenue

797.8

793.0

833.1 1,543.1 1,994.3

29.2

Operating income

828.2

786.3

821.6 1,099.3 3,097.2

181.7

445.6

4

6

8

10

OAS swap spread evolution

Operating expenses

285.0

285.0

314.7

357.3

24.7

300

Pre tax income

543.2

501.3

506.9

185.0 2,368.6 1,180.3

200

Net income

385.6

355.5

353.0

143.7 1,727.3 1,102.0

Return on assets

0.18

0.16

0.13

0.04

0.47

Return on equity

9.8

8.9

8.1

1.9

14.5

Return on total capital

5.5

5.0

4.7

1.4

11.4

Cost/Income ratio

34.4

36.2

38.3

32.5

14.4

Net int rev/Op. income

96.3

100.9

101.4

140.4

64.4

Profitability (%)

2

100 0 -100 Jan-08

Apr-08

Jul-08

Oct-08

$ SEK 4.375% Dec 09 $ SEK 5.125% Mar 17

Jan-09

Apr-09

$ SEK 4.875% Sep 11

Gearing, debt leverage and capital adequacy (%) Loans/Total capital

Public debt issuance ($bn)

1364.1 1294.1 1585.6 1330.8 1232.5

Capital/Debt securities

3.4

3.5

2.8

4.5

5.2

Total reg. capital ratio

13.8

13.8

8.9

15.5

18.7

3.0

3.0

2.5

3.7

4.5

Total capital/Total assets

Note: Debt maturity and currency structure charts are based on dealogic DCM Analytics data

10 8 6 4 2 0

3.8

0.6

2.2

Capital structure, YE 09 Share capital 24.0% Subordinated debt 18.9% Profit for the year 10.4% 10 June 2010

>2029

2019

2018

0.3 0.5

1.2

2020-2029

1.5

2017

2016

2015

0.6 0.2 2014

2013

2012

2011

1.5 1.1

2004

2005

2006

Others 8.8%

5.2 2.4

2.8

2.5

2007

2008

2009

2010 yt May

Currency distribution, YE 09

3.5

2010

6 5 4 3 2 1 0

2.8

2.3

2003

Public debt maturity structure, May 2010 ($bn)

7.9

6.7

USD 41.2%

ZAR 7.2% AUD/CAD/ NZD 5.4% EUR 22.0%

JPY 15.4%

Credit composition, YE 09 Reserves 8.2% Retained profits 38.4%

States and regional governments 13.0% Securitizati on position 9.0% Financial institutions 30.0%

Corporates 48.0%

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OTHER SUPRAS AND AGENCIES While being less frequent borrowers in euros than most of the issuers for which we have prepared full profiles, the agencies and multi-lateral lending institutions included in this section are also of interest for AAA investors across various currency sectors. We have included charts illustrating issue flow from 2002 to May 2010 and the currency and maturity distribution of public debt for these entities at mid-May 2010. (The maturity structure charts include issues that matured in the first four and a half months of 2010.) In some cases, the charts are rather sparse, where, for instance, individual issuers have issued only occasionally, albeit in fairly large size or where the debt is virtually all in one currency. However, these charts do illustrate the variety of debt management approaches across the range of issuers. Furthermore, the individual issuers’ charts contribute to a wider overall picture of the sector, illustrating, for example, the episodic nature of issues that have been particularly associated with attempts to find new means of diverting funding away from government balance sheets. Some of these issuers also have smaller funding requirements than may be associated with the larger frequent borrowers that provide the core of the liquid, benchmark AAA market. Nevertheless, they can still add value to AAA portfolios. In some cases, this is through MTNs, which may be tailored to investors’ cash flow needs and also may provide incremental returns through varying degrees of structuring. In other cases, growth in issuers’ funding requirements is leading them into the benchmark markets, in which case they provide additional diversification opportunities within the liquid, tradeable AAA markets. Note: The charts for debt issuance and structure are derived from the dealogic DCM Analytics database. Particularly for issuers for which private placements account for an important part of their funding, the illustrated debt figures may fall short of the corresponding balance sheet data.

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African Development Bank (AFDB) Fritz Engelhard +49 69 7161 1725 [email protected] AFDB promotes African economic development

Focus on agriculture and rural development

Risk weighting – Basel II RSA: 0% The African Development Bank (AFDB) is the key regional multi-lateral development bank for Africa. It was established in 1964 and aims to promote economic development and social progress, thereby contributing to poverty reduction, in its African member countries. It has 77 shareholding countries, of which 53 are regional members and 24 are nonregional. The bank’s loan and equity finance is mostly related to specific projects. Funds are provided to public and private sector borrowers. In addition to project finance, it provides programme, sector and policy-based loans to support improvements to economic management and structure. Loan maturities are generally between 12 and 20 years and are provided on market-based terms, but with grace periods of up to five years. The bank’s key operational priorities include a focus on the infrastructure sector (especially water and power), promotion of regional integration and good governance, strengthening private sector development and competitiveness. During 2006, the bank introduced major organisational changes designed to enhance the pursuit of these objectives, notably through increased decentralisation, by opening a network of offices in its regional member countries. The very low levels of income on the continent are reflected in the fact that only 15 countries currently meet the income criteria to borrow from the bank’s main lending arm as at year-end 2008. The remaining 38 member countries have to access the bank’s concessional arm, the African Development Fund (ADF), which provides grants and concessionary loans with terms of up to 50 years. In April 2010, a committee of governors representing the African Development Bank shareholders endorsed a tripling of the Bank’s capital resources to nearly $100bn and recommended acceptance by the full membership with approval likely to take place at the AGM to be held in late May 2010. The bank is also involved in multi-lateral debt-relief schemes, notably the Heavily Indebted Poor Countries (HIPC) Initiative and the Multi-lateral Debt Relief Initiative (MRDI), which have contributed to a sharp reduction in aggregate African debt burdens in recent years (eg, the aggregate external debt/GDP ratio has fallen from 52.8% in 2002, to 20.4% in 2008).

Relatively high non-accruals

10 June 2010

At end-2008 (the last date for which data are available), total assets amounted to SDR12.57bn, a 4% increase from SDR12.08bn at end-2007. Net loans outstanding represented 45.5% of the balance sheet. Impaired loans are relatively high compared with other MLIs, although they fell sharply in 2008. At end-2008, impaired loans represented 4.7% of gross loans (from 12.7% in 2006) and were 37% covered by accumulated provisions for impairment. The bank also holds a portfolio of securities for liquidity purposes. Of SDR4.58bn at end-2008, c.SDR0.5bn was in ABS and SDR0.9bn was in corporate bonds and CP.

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Figure 315: AfDB public debt Issuance (USDbn)

Currency structure, May 2010

Maturity structure, May 2010 (USDbn)

6

3 AUD/ CAD/ NZD/ SGD Other 3% 11%

5 4 3 2

USD 65%

1

2

JPY 10%

2

ZAR 8%

1

CHF 3%

1

>2026

2024

2022

2020

2018

2016

2014

2012

2010

2007 2008 2009

2005 2006

2002 2003 2004

2001

2010

0

0

Source: Dealogic DCM Analytics, Barclays Capital

Agence Française de Developpement (AGFRNC) Fritz Engelhard +49 69 7161 1725 [email protected]

AfD is France’s development bank, providing long-term development funding in more than 60 countries, French overseas departments and territories

Risk weighting – Basel II RSA: 20% (0% for government-guaranteed issues). Agence Française de Développement (AfD) is France’s development bank. Its key function is to provide a channel for French official development assistance. It provides long-term development funding in more than 60 countries, French overseas departments and territories, although its business is concentrated in African countries. Lending has taken the form of long-term project finance, structural adjustment loans and subsidies, mainly to public sector borrowers. These are inevitably areas of high credit risk, but AfD’s direct exposure is reduced in so far as it operates on behalf of third parties and benefits from state loan guarantees. High levels of doubtful loans are reflected in generous provisions, but ultimately the credit rating reflects the strength of state support. AfD is wholly owned by the French state and is an autonomous public industrial and commercial institution, ie, an EPIC. Under French banking law, the institution is also defined as a specialised financial institution, having a permanent mission in the public interest to promote economic development in developing countries and in the French overseas departments and territories. It is therefore subject to the prudential requirements specified by French banking legislation. AfD has its origins in the Caisse Centrale de la France Libre (in effect the treasury and central bank of Free France), founded in 1941. Functional evolution over the years has been reflected in a succession of name changes, most recently to AfD in 1998, as part of a reform under which AfD became the leading public institution for funding French development aid. It also lends on behalf of third parties, principally the French state, and channels French contributions to the IMF Poverty Reduction and Growth Fund. Most of its funding is provided on a subsidised basis. As an EPIC, AfD is subject to French public law. It cannot be declared bankrupt and the French government is ultimately responsible for its solvency and liquidity. Given the nature of its public mission, there is no real prospect of a change in this legal status. The euro is AfD’s main issue currency, but it also has significant outstandings in GBP, JPY and CHF. All AfD debt used to carry an explicit guarantee from the French state. This is hardly ever the case now, but there are still some guaranteed issues outstanding.

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In 2009, AfD has seen a 38% increase in its financing volume, from €4.5bn in 2008, to €6.2bn in 2009. Total assets grew from €14.1bn at YE 08 to €15.1bn at YE 09. The growth in lending activity was mainly driven by lending to Sub Saharan Africa (€2.0bn), lending to the Mediterranean and Middle East (€1.51bn), and lending to Asia Pacific (€1.1bn). In terms of the type of lending, three-quarters of commitments break down between productive sectors (26.5%), infrastructure and urban development (25.5%) and the environment and natural resources (24.1%). Figure 316: AfD public debt, May 2010 Issuance (€bn)

Currency structure

Maturity structure (€bn)

3.0

2.5

2.5

2.0 Others 36.3%

1.5 1.1

1.5

0.3

0.7 0.1

0.5

0.4

0.5

0.5

0.7

1.0 EUR 57.2%

0.3

0.7 0.7

0.8

1.1 0.8

0.8

GBP 6.5%

0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029

2010 yt May

2009

2008

2007

2006

2005

2004

2003

0.0

0.0

2.0

1.0

1.8 2.0

2.5

Source: Dealogic DCM Analytics, Barclays Capital

ASFINAG (ASFING) Leef Dierks +49 (0) 69 7161 1781 [email protected]

Risk weighting – Basel II RSA: 0% Established in 1982, Autobahnen- und Schnellstrassen Finanzierungs AG (Ticker: ASFING) is responsible for the financing, construction, maintenance, and operation of the entire Austrian motorway and high-speed road network, which at the time of writing covered approximately 2,100km. ASFINAG also is in charge of road safety and traffic management, as well as collecting highway tolls. Debt issued by ASFINAG benefits from timely, unconditional, and irrevocable guarantee on behalf of the Republic of Austria. Note that the maximum amount of guaranteed debt that ASFINAG can issue annually is being decided upon by the Austrian Parliament. For the period from 2008 to 2014, a sum of €6.1bn has been earmarked for the construction or amplification of roads. Before ASFINAG established its €10bn EMTN programme in 2003 in order to raise funds directly in the market, a significant portion of its debt was provided by the Austrian government’s funding agency. The EMTN programme has the benefit of a full, explicit, direct, unconditional, and irrevocable guarantee from the government. This is extended annually (as part of the Austrian budget law) for a predetermined drawdown amount of €2.3bn in 2010. ASFINAG’s long-term financial debt increased to €10.2bn as at year-end 2008. Following moderate issuance of only €300mn in 2006, ASFINAG issued €1.3bn in 2007 and €1bn in 2008. In 2009, total issuance amounted to €1.8bn, ie, slightly less than the amount we expect to be issued in 2010 (€2.3bn).

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Figure 317: ASFINAG public debt, May 2010 Issuance (€bn)

Currency structure

Maturity structure (€bn)

2.5

2.0

1.0

1.0

1.3

1.5

1.0

1.3

1.2

1.5 1.0

1.5

CHF 2.4%

0.8

1.8 1.7

1.0

2.0 2.0

1.5

USD 20.8%

1.0

2010 yt May

2009

2008

2007

2006

2005

2004

2003

0.0

EUR 76.8%

-

0.5

0.3

0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029

0.5

Source: Dealogic DCM Analytics, Bloomberg, Barclays Capital

Bank of England (BOEN) Huw Worthington +44 (0) 20 7773 1307 [email protected] As the UK central bank it attracts a sovereign-level risk weighting

Risk weighting – Basel II RSA: 0% The Bank of England is the central bank of the UK. It is government-owned; specifically, its stock is held by the Treasury Solicitor on behalf of Her Majesty’s Treasury. The bank operates under a constitution that was most recently modified and redefined by the Bank of England Act of 1998. Although government-owned, its debt is not explicitly governmentguaranteed. However, the closeness of the linkages to the government is clear enough and, as with other central banks, its debt attracts a sovereign-level risk weighting for capital adequacy purposes. Under the Basel framework and the EC’s corresponding solvency ratio directive, this translates to a zero risk weighting. In 2000, the Bank of England Euro Note Programme replaced an earlier UK Government Euro Note Programme, in which notes were issued by the bank as agent for the UK Treasury. Under the earlier programme, obligations were, therefore, unambiguously UK government risk. In contrast, the Bank of England notes are not direct obligations of the UK government, but rather of the bank and have been issued to finance the bank’s own foreign exchange reserves, which it holds In support of its monetary policy objective.

Euro Note Programme has been replaced by a multi-currency debt issuance programme

10 June 2010

In December 2006, the bank announced that it was terminating the Euro Note Programme. However, it indicated that it would continue to finance its portfolio of foreign exchange reserves by issuing medium-term securities on an annual basis. The currency and maturity may vary from year to year. The first such issue, a USD2bn three-year issue, was launched in March 2007, followed by further USD2bn three-year issues in March 2008, 2009 and 2010. The charts in Figure 318 only cover debt issued under the new MTN programme.

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Figure 318: Bank of England foreign currency debt Issuance (USDbn)

Currency structure, May 2010

2.5

Maturity structure, May 2010 (USDbn) 1800 1600

2

1400 1200

1.5

1000 800

1

600

200 2020

2018

2016

0 2014

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0

400

2012

0.5

2010

USD 100%

Source: Dealogic DCM Analytics, Barclays Capital

Caisse des Dépôts (CDCEPS) Fritz Engelhard +49 69 7161 1725 [email protected]

CDC is a financial institution with French public entity status

Risk weighting – Basel II RSA: 0%. CDC is a French public entity originally established in 1816. It is a 100% state-owned financial institution with a range of public remits, as well as more commercial activities. Its key functions include: centralising and managing tax-exempt savings deposits (about €200bn); managing public retirement funds; providing various segregated banking services (eg, it has a legallyappointed monopoly on holding deposits of the legal profession and is banker to the French social security system); various investments connected to local and regional development; and operating a major long-term institutional investment fund. A common thread to these functions is its role in underwriting the security of funds entrusted to it from various sources.

Strong state support

CDC’s French sovereign-level credit ratings are based primarily on its public entity status, but it is also seen as having a very strong stand-alone position and conservative strategy. According to Articles L518-1 to L518-24 of the French Monetary and Financial Code, CDC is placed under the supervision and the guarantee of the French parliament. The strength of the linkages to the state is also reflected in its zero risk weighting. In H1 09, CDC reported a net profit of €728mn, following a net loss of €1.5bn in FY 08.

Access to international

While CDC benefits from a quite stable deposit base, at end-2006 it created a €6bn EMTN programme. As the issuance chart illustrates, its issuance programme has gathered some pace over the past four years. In 2010, CDC plans to issue €2-3bn of term funding.

capital markets

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Figure 319: CDC EMTN issuance, May 2010

1.0

2.0 1.2

0.6 1.0

1.0

0.1 2010 yt May

2009

2008

2007

2006

2005

2004

2003

0.0

0.2 EUR 41.1%

0.2

0.5

0.4 0.0

GBP 6.2% CHF 10.5%

0.5

0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029

1.5

0.4

0.8

0.0

2.5

1.1 1.1

1.2

Others 42.1%

2.5

0.5

3.0

Maturity structure (€bn) 1.1

Currency structure

0.7

Issuance (€bn)

Source: Dealogic DCM Analytics, Barclays Capital

Caisse Nationale des Autoroutes (CNA) Fritz Engelhard +49 69 7161 1725 [email protected]

Non-profit-making financing vehicle

Risk weighting – Basel II RSA: 20%. CNA is wholly owned by the French government. Formed in 1963, its sole function is to act as a non-profit-making financing vehicle for public sector entities – sociétés d’économie mixte concessionaires d’autoroutes (SEMCAs) – involved in the construction and operation of French toll motorways. Lending grew strongly in the mid-1990s to finance rapid growth in motorway construction. Its balance sheet is basically a match between loans to the SEMCAs and long-term borrowing, which is passed through on identical terms. Therefore, it acts as a straight conduit for funding. Most bond issues are for relatively long maturities of between 10 and 15 years.

EPA legal status

CNA has the legal status of an EPA (Établissement Public national à caractère administratif). The French Government is, therefore, ultimately responsible for maintaining its solvency and liquidity. As a non-commercial public entity, it attracts a 20% risk weighting for capital adequacy purposes.

Lends to French public sector

CNA has a clear public role, namely to act as a financing vehicle for French public sector motorway operators. The latter were well supported financially, given their central role in the development and operation of transport infrastructure. However, in 2005, the French government announced its intention to privatise the main SEMCAs and this was accomplished during 2005-06. Although two smaller operators remain state owned, the demand for CNA funding decreased to a much lower level, as the privatised entities lost access to new funding by end-2009. CNA’s outstanding debt will therefore trend lower over time.

motorway operators

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Figure 320: CNA public debt, May 2010 Issuance (€bn)

Maturity structure (€bn) 2.5

0.7

2.0

0.7

Currency structure

0.6 2.0

0.5 0.5

0.4

0.4

Others 0.0%

1.5

EUR 100.0% 0.1

0.5 0.0

2010 yt May

2008

2007

2006

2005

2004

2003

0.0

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029

-

0.1

2009

0.1 0.1

0.3

1.0

0.2

0.3

0.3

0.4 0.4 0.2 0.6

1.0

0.4

Source: Dealogic DCM Analytics, Barclays Capital

CNA’s public policy role and financial standing are unaffected by the trend contraction in its role and balance sheet. CNA’s établissement public status, with all that it implies in terms of ultimate state support, is, therefore, robust.

Erste Abwicklungsanstalt (ERSTAA) Fritz Engelhard +49 69 7161 1725 [email protected]

The first German wind-up agency

ERSTAA is regulated and supervised by FMSA and the German banking regulator

Owners are obliged to provide guarantees and capital

10 June 2010

Risk weighting – Basel II RSA: 0%. Erste Abwicklungsanstalt (ERSTAA) is a German special purpose agency which was created to allow for an orderly run-off of non-performing or non-strategic assets of WESTLB AG (WESTLB). Between December 2009 and April 2010, WESTLB transferred a total volume of €77bn of such assets, as well as about €26bn of liabilities, mainly grandfathered and secured debt, to ERSTAA. The transferred grandfathered debt continues to benefit from the maintenance guarantees of WestLB’s owners. Upon request of WESTLB, ERSTAA was established by the German Federal Financial Market Stabilisation Agency (Finanzmarktstabilisierungsanstalt or FMSA) in compliance with the provisions of section 8a of the Financial Market Stabilisation Fund Act. As ERSTAA is not considered to be a credit institution operating under the German banking act or under the EU Banking Directive, it is not subject to any regulatory capital requirements. Still, to the extent that it needs to act under its own name in order to fulfil its mission, the run-off of WESTLB’s legacy portfolio, it is allowed to conduct banking and financial services business in Germany. ERSTAA is regulated and supervised by FMSA and the German banking regulator. ERSTAA is owned by the state of North Rhine-Westphalia (48.2%), the two regional savings banks associations of Westphalia (25%) and Rhineland (25%), as well as the two regional associations of Rhineland and Westphalia. It received €3bn of capital from WestLB and a further €1bn in guarantees from its owners. The owners are obliged, on a pro rata basis, to compensate ERSTAA for any losses not covered by the guarantees and equity. The liability of the two savings banks associations is capped at €4.5bn. In order to strengthen its funding profile, ERSTAA receives funds from banks and also plans to issue debt in the capital markets.

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Risk weighting and rating linked to the state of North Rhine-Westphalia

Under German solvency rules, the debt issued by ERSTAA benefits from a 0% risk weighting. The German banking regulator links the risk-weighting to the risk weighting of debt issued by the state of North Rhine-Westphalia, assuming that the state of North RhineWestphalia would regard itself as being obliged to ensure that ERSTAA would be able to fully and timely fulfil all of its liabilities. The liabilities of ERSTAA are rated AA-, Aa1 and AAA by S&P, Moody’s and Fitch, and all three rating agencies have linked the debt rating of ERSTAA to the rating of the state of North Rhine-Westphalia (AA, Aa1, AAA).

European Union Michaela Seimen +44 (0) 20 3134 0134 [email protected]

Risk weighting – Basel II RSA: 0% The European Union is engaged in sovereign lending via so-called “balance-of-payments support” and in the form of macro-financial assistance. It is our understanding that the latter form of support is exceptional in nature and is mobilised on a case-by-case basis to help the beneficiary countries deal with serious, but generally short-term, balance of payments or budget difficulties. The European Union is empowered by the Treaty on the Functioning of the European Union (the Treaty) to adopt borrowing and guarantee programmes that mobilise the financial resources to fulfil its mandate. The mandate has so far been used for balance of payments support to member states that have not adopted the euro and in a smaller proportion for the macro-financial assistance programme to assist third countries. As of December 2009, the amount outstanding for the macro-financial assistance programme was EUR585mn. The balance of payments support programme was revived in 2008, and as of January 2010, Hungary, Latvia and Romania requested and received medium-term financial assistance totalling EUR10.7bn. For the balance of payments facility, the Commission can draw additional resources from the member states to honour its financial obligations in a timely manner. There are currently 27 states that are members of the European Union, with borrowings of the European Union being ultimately guaranteed by the 27 member states.

Technicalities of the EU support facility „

Under this facility, loans are granted only on a country’s specific request for support from the EU.

„

The Council of the European Union consists of representatives of the 27 member states decides by qualified majority1 about the support – the amount of the loan, instalments and the maximum overall maturity of the loan package.

„

This is followed by negotiations with the European Commission (EC) in regard to the details of the loan, including conditionality, in close coordination with the IMF. The EC decides on implementation (financial terms, timing, etc.).

The loans are financed exclusively with funds raised on the capital markets in euros only, and those funds are lent to beneficiary countries back-to-back, with the same coupon, 1

According to the definition by the European Union, a qualified majority (QM) is the number of votes required in the Council for a decision to be adopted when issues are being debated on the basis of Article 205(2) of the EC Treaty. Following the 2000 Inter Governmental Conference and the Nice Treaty, the number of votes allocated to each member state has been re-weighted, particularly for those states with larger populations, so that the legitimacy of the Council's decisions can be safeguarded in terms of their demographic representativeness. After 1 January 2007, following enlargement of the Union, the QM went up to 255 votes out of a total of 345, representing a majority of the member states. Moreover, a member state may request verification that the QM represents at least 62% of the total population of the Union. If this is not the case, the decision is not adopted. This equals roughly a two-thirds majority. Source: http://europa.eu

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maturity, etc., meaning each bond is specifically linked to an onward lending programme. It is not yet clear whether this would be the procedure for the extended programme as well. Given that the Commission and the beneficiary country have to agree on loan and funding parameters, EU bond issues are bound to the pace of these negotiations and can therefore not seek advantage of favourable market conditions. However, within these constraints, the EU intends to build a yield curve and enhance the liquidity of its issues wherever possible. In May 2009, the Council of the European Union amended the regulation for the establishment of a facility providing medium-term financial assistance for member states’ balance of payments2. Due to the scope and intensity of the international financial crisis, the demand for assistance in the member states outside the euro area was expected to increase. As such, the ceiling for outstanding amounts of loans to be granted to member states was raised from EUR25bn to EUR50bn. We expect this regulation to be adjusted by the additional support of EUR60bn in regard to Article 122.2 of the Treaty. In February 2010, the EU set a EUR20bn medium-term note programme in place, which we expect to be increased in the near term. As of today, 11 May 2010, the EU has six benchmark bonds outstanding with a total volume of EUR10.7bn.

Figure 321: Bond issues of the EU since December 2008 Bond

Amount

Issued

Beneficiary country

EEC 3.25 09/12/11

EUR2bn

Dec-08

Hungary

EEC 3.125 03/04/14

EUR1bn

Feb-09

Latvia

EEC 3.25 07/11/14

EUR2bn

Mar-09

Hungary

EEC 3.125 27/01/15

EUR1.5bn

Jun-09

Hungary

EEC 3.625 06/04/16

EUR2.7bn

Jul-09

Romania

EU 3.375 10/05/19

EUR1.5bn

Mar-10

Romania

Total

EUR10.7bn

Source: European Union, Barclays Capital

Procedures in a default scenario Should a beneficiary country default, the payments will be made from the budget of the European Union. EU member states are legally obliged to ensure that the budget always has sufficient funds to meet the EU’s obligations. For this purpose, the Commission may draw on all member states. The general budget of the European Union for the financial year 2010 amounts to EUR141.5bn in commitment appropriations (in payment appropriations, the budget 2010 is set at EUR122.9bn). According to the EU euro medium-term note programme, to date, the EU debt has been serviced through borrower repayments. The Commission has also sometimes made available limited cash resources for short periods to service the debt when repayments from borrowers were not received in time. Based on a statement on the webpage of the European Commission, we understand recipient countries accept to give the Commission “preferred creditor status”, which means that reimbursements of interest and principal to the EU take priority over funds owed to other creditors. However, at this point in time, we have not been able to further clarify this in the context of cooperation with the IMF.

2

10 June 2010

See Council Regulation (EC) No 431/2009 of 18 May 2009 amending Regulation (EC) No 332/2002.

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Fondo de Reestructuración Ordenada Bancaria (FROB) Michaela Seimen +44 (0) 20 3134 0134 [email protected]

Risk weighting – Basel II RSA, 0% Fondo de Reestructuración Ordenada Bancaria – the Fund for Ordered Bank Restructuring (FROB – Bloomberg ticker FOBR) – was established on 26 June 2009, in response to the recent financial crises.3 It is a legal entity, having been created by Royal Decree 9/2009. Its purpose is to assist in the restructuring and particularly consolidation of the Spanish banking system and to enhance the capital buffers of Spanish credit institutions. Beneficiaries of this support fund are credit institutions established in Spain. The support structure via FROB will be valid until 30 June 2010. However, given the relative slow process of the restructuring of the Spanish savings banks, we regard it as likely that this deadline will be extended. Spanish savings banks are among the financial institutions in Europe which are currently undergoing the most significant restructuring. Spanish savings banks grew strongly in the years leading up to the financial crisis and account for almost half of Spain’s overall lending. Owing to the importance of the sector for the Spanish economy, FROB’s main focus will be to support this sector. It is our understanding that it is the aim of the Bank of Spain to reduce the current number of 45 Spanish savings banks by about 1/3 via mergers into stronger institutions. The objectives and functions of FROB’s support are focused on temporary capital injections to stabilise banks and to assist via financial and management measures in the restructuring of the banking sector.

Support for the integration process of financial institutions FROB provides support in this respect by temporarily injecting capital into banks, which is carried out by the subscription of preferential shareholdings. Once an integration plan has been approved by the Bank of Spain, these shareholdings are convertible under market conditions. Entities having benefited from this support must undertake a repurchase of the respective preferential shareholdings within a period of five years. This period can be extended by a further two years. FROB may convert preference shares into ordinary shares and therefore shareholdings with voting rights or capital contributions (depending on the nature of entities involved). Both fundamentally and non-fundamentally sound credit institutions are eligible for support from FROB. Fundamentally sound institutions are defined by certain cumulative conditions, among others, the institution may not present any weakness that can affect its viability in the light of the evolution of financial markets. Capital injections by FROB for fundamentally sound institutions may not exceed 2% of Risk Weighted Assets. This threshold can be exceeded if the additional amount of the capital is linked to the costs of the integration between banks to achieve greater efficiency and for institutions which are considered to be non-fundamentally sound. In these cases, special behavioural restrictions must be adhered to by the respective institutions.

Support for the restructuring process of Spanish financial institutions The restructuring process is divided in three stages: The aim is to let the sector regulate itself as much as possible via initiatives driven by credit institutions themselves and, in the case of weakness institutions to try and find a private solution. 3 On 28 January 2010, the European Commission approved the suggested recapitalisation measures in favour of the banking sector in Spain in the form of support provided by FROB.

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In a second step, Spanish credit institutions can seek support of the relevant Deposit Guarantee Fund to ensure the respective entities viability, in case the Bank of Spain approves a presented action plan. Only as a third and final option, the Bank of Spain will appoint the FROB as the provisional administrator of a financial institution and a restructuring plan will be formulated, with the aim of a merger or the transfer (total or partial) of the entities business. FROB will provide support in the restructuring process via management and financial measures. Financial support measures include guarantees, loans with favourable conditions, subordinate financings, acquisition of asset, capital injections and others. Any credit institution benefiting from FROB support are bound to certain restrictions in regard to business growth, remuneration of senior management, dividend payments and any outstanding hybrid instruments.

Structure The Fund for Orderly Bank Restructuring is governed and managed by a Governing Committee, which is composed of five members by the Bank of Spain and one representative of each Deposit Guarantee Fund (the Bank Deposit Guarantee Fund, the Savings Bank Deposit Guarantee Fund and the Credit Cooperative Deposit Guarantee Fund). All of these eight members are appointed by the Minister for the Economy and Finance. FROB is subject to Parliamentary controls. A quarterly reporting of the Secretary of State for the Economy is scheduled for the Economy and Treasury of the Congress of Deputies on the aggregated credit evolution, the situation of the banking sector and evolution of the activities of FROB. The Chairman of the Governing Committee of FROB will report to the Committee for the Economy and Treasury of the Congress of Deputies, within 30 days after a transaction has been undertaken by the Fund. Furthermore, the Governing Committee is supposed to report on the management of the Fund to the Ministry of Economy and Finance on a four-monthly basis. The Ministry of Economy has a preliminary report and the right to a veto. FROB benefits from a government guarantee, the terms of which are explained in more detail in the following paragraph.

Funding and government support The FROB has been established based on a mixed funding model. The fund is capitalised with €9bn, of which €6.75bn have been charged to the General State Budget in 2009 and €2.25bn have been contributed from the Deposit Guarantee Funds. Individual contributions of each deposit fund are assigned according to the percentage of total deposits in credit institutions at the end of the fiscal year 2008. FROB may also fund itself on the securities markets by issuing fixed income securities, receive loans, apply to open credit facilities and undertake other borrowing transactions. However, external funding, regardless of the form of instruments, is limited to the sum of 10 times the funding available at any time. Currently, based on FROB’s capitalisation, this equals to a maximal amount of €90bn. Asset/liability management: Any unassigned moneys of the Fund have to be invested into public debt or into other high-quality, low-risk assets.

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Figure 322: Financial Structure of FROB

Liquid assets

Allocation

(current account, Public Debt)

(Government€6,750Mn) (FGD €2,250Mn)

Preference shares

Marketable bonds

(mainly)

(or other kind of outside financing)

€9,000Mn

Up to €90bn (leverage 10 x)

Source: FROB presentation from 27 October 2009, Barclays Capital

Under Article 114 of General Budget Law 47/2003 as of 26 November, the General State Administration is authorised to issue guarantees to secure the economic obligations enforceable against the FROB and derived from issues of financial instruments, agreements for loan and credit transactions and realisation of any other borrowing transactions made by FROB. The guarantees for FROB have been limited to a total of €27bn of principal plus the pertinent ordinary interests until 31 December 2009 and for subsequent financial periods, the maximum amounts for the issuance of guarantees will be as determined by the corresponding General State Budget Laws. In Art. 54 of Law 26/2009 as of 23 December 2009, on the State Budget for fiscal year 2010, €27bn have been set aside as endorsement to guarantee certain FROB obligations.

Only one benchmark issuance outstanding to date On 12 November 2009, FROB completed an inaugural €3bn five-year transaction. The fiveyear maturity aligns the funding with the terms for restructuring operations. According to a press release on 12 November 2009 by FROB, the geographic distribution was as follows: 30% Spain, 15% Germany, 12% France, 11% UK, 9% Switzerland, 9% Middle East & Asia, 5% Scandinavia and 9% Others. By investor type, fund managers provided the core of demand with 37%, followed by banks with 28%. Central banks and insurance companies took 11% of the bond issuance.

Rating and regulatory treatment The benchmark issue carries an explicit and irrevocable guarantee from the Kingdom of Spain. Owing to this guarantee, the rating of the bond is linked to the rating of the Spanish government, which is rated Aaa/AA/AAA by Moody’s/S&P/Fitch, respectively. The Bank of Spain confirmed that FROB debt is 0% risk weighted and satisfies the necessary requirements to be included as guarantee assets (“collateral”) in the monetary policy operations of the European Central Bank.

Support to Spanish credit entities As of the time of writing, FROB supplied financial support to four credit entities. 10 June 2010

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According to a notice by Banco de Espana dated 22 May 2010, CajaSur, which with total assets of €19bn as of year-end 2008 accounts for about 0.6% of the assets of the Spanish banking system, has been taken into administration, with FROB acting as interim administrator. FROB also announced it will underwrite the equity needed to allow CajaSur to reach a solvency ratio above the minimum required and to facilitate the entity with sufficient liquidity to honour all of its commitments. According to media reports, Cajasur will be recapitalised with more than €500mn.4 In March 2010, the FROB Governing Committee stated its intention to provide financial support to three integration processes among credit entities, based on the integration plans being approved by the Bank of Spain. In a press release by FROB on 25 March 2010, banks involved in these measures and financial aid agreed were given as follows: „

Caja Manlleu (total assets of €2.6bn as of year-end 2008), Caja Sabadell (€12.3bn as of year end 2008) and Caja Terrassa (€11.8bn as of year-end 2008) with a support amount of €380mn;

„

Caixa Catalunya (total assets of €63.6bn as of year end 2008), Caja Tarragona (€10.8bn as of year-end 2009) and Caja Manresa (€6.5bn as of year-end 2009) with a support amount of €1.25bn;

„

Caja Duero (total assets of €21.4bn as of year-end 2009) and Caja Espana (€25bn as of year-end 2008) with a support amount of €525mn.

With further mergers among Spanish savings banks planned, need for support by FROB likely to increase According to media reports5, Spanish savings bank Cajastur may seek up to €1.6bn in support from FROB. Cajastur plans to combine with Caja de Ahorros del Mediterraneo, Caja de Ahorros de Santander y Cantabria and Caja de Ahorros y Monte de Piedad de Extremadura to form the fifth-largest financial group in Spain with more than €135bn in assets.

German Postal Pensions Securitisation (GPPS) Leef Dierks +49 (0) 69 7161 1781 [email protected]

Securitisation of receivables related to German postal pensions

Risk weighting – Basel II RSA: 20% The German Postal Pensions Securitisation (GPPS) was created in 2005 as a securitisation vehicle. It was established in Dublin as a public company under the Irish Companies Acts 1963-2003. Following its founding, in June 2005, GPPS issued three tranches of debt with 2011, 2016 and 2021 maturities with an aggregate amount of €8bn. A year later, in June 2006, a second four-tranche transaction with maturities in 2010, 2017, 2022 and 2037 was issued in the aggregate amount of €7.5bn. Although separate issuing vehicles were used in the 2005 and 2006 transactions, the issuers have the same underlying form and purpose and are traded under the same ticker, thereby being treated as interchangeable in portfolio terms by financial markets. Note that all tranches issued over the course of 2005 and 2006 have been fixed-rate issues, with the exception of the 2037 issue, which is an FRN with a sinking fund that starts in January 2023. The proceeds of the issues were used to purchase receivables related to the payment of pensions that are due to retired civil servants who were previously employed by the Deutsche Bundespost or one of the postal successor companies (Deutsche Post AG, Deutsche Telekom AG, and Deutsche Postbank AG). Figure 323 and Figure 324 illustrate the transaction structure

4 5

10 June 2010

Please refer to FT.com on 24 May 2010 Please refer to Bloomberg on 25 May 2010

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in terms of contractual rights/statutory claims and cash flows, respectively. The seller of the receivables was BPS-PT (Bundes-Pensions-Service für Post und Telekommunikation), which is a registered association charged with handling pension payments to the aforementioned group of beneficiaries. Under the provisions of the Act on Postal Personnel Law, which was adopted as part of the Postal Affairs Reorganisation Act in 1994, BPS-PT collects payments according to an agreed schedule from the postal successor companies and the federal republic. From these payments, it makes pension payments as they come due. In addition to being one of the sources of regular payment flows, the Federal Republic of Germany was also required by the same legislation to make good any deficit between BPS-PT’s receipts and obligations and is also required to ensure that BPS-PT is at all times able to meet its obligations.

Figure 323: GPPS transaction structure – contractual rights and statutory claims Postal Successor Companies 1 Obligation to make contributions 4 Pledge

Federal Republic

3

BPS-PT (Seller)

Issuer 2

Funding claim pursuant to Bund Obligation

Sale of Purchased Receivables and Seller’s Guarantee

Claims under Notes

5

Noteholders Source: GPPS plc Offering Circular June 2005

Figure 324: Cash flows Postal Successor Companies

2

Payments under Purchased Receivables Note 1 Proceeds

Federal Republic

5 Payments under Bund Obligation

BPS-PT (Seller)

2 3 Payments under Seller’s Guarantee

Issuer

4 Debt Service

1 Note Proceeds

Noteholders Source: GPPS plc Offering Circular June 2005

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Following a review of securitisation operations undertaken by general governments, Eurostat in June 2007 decided that transactions of this type (where governments have committed to future payments and/or guarantees to the SPV) should be treated as government borrowing, thereby removing the benefit to German government debt ratios of this funding route. Therefore, we do not expect any further issuance from this vehicle.

Further debt issuance is unlikely in our view

Still, this leaves the Aaa/AAA/AAA rating of the existing issues unaffected as it is already predicated on the ultimate risk lying with the German government. As a securitisation, the risk weighting has fallen from 100% under Basel I to 20% under Basel II, RSA. (We also expect it to be treated as 20% under the Internal Ratings Based (IRB) approach, given that it would be treated as a non-granular securitisation.)

Figure 325: GPPS public debt, June 2010 Currency structure

Maturity structure (€bn)

10

7.5

3.0

8.0

3

1.5

1.5

1.0

2

2022

6

2021

2.0

8

3.5

4 EUR 100%

3.0

Issuance (€bn)

4 1

-

-

2037

2017 2018

2016

2008

2007

2006

2005

2004

2003

-

0

-

0 2002

2015

-

2012

-

2011

-

2010

-

2013 2014

-

2

Source: Bloomberg, Dealogic DCM Analytics, Barclays Capital

Infrastrutture SpA (CDEP) Huw Worthington

(Moody’s: Aa2/S&P A+/Fitch AA-)

+44 (0) 20 7773 1307 [email protected]

Risk weighting – Basel II RSA: 0% Infrastrutture SpA (ISPA) was established in 2002 as a limited liability company under Italian law and a wholly-owned subsidiary of Cassa Depositi e Prestiti (CDEP), with the function of funding major infrastructure projects in Italy. At that time, CDEP was a part of Italy’s public administration, but was converted in December 2003 into a limited liability company. It is now 70% owned by the state and continues to act as a specialist lender to public sector entities; in effect, it remains a financing arm of the Italian state.

ISPA’s debt issues related to financing Italy’s high speed rail project

10 June 2010

ISPA’s public debt issues were all issued during 2004-05 under the €25bn ISPA High Speed Railway Funding Notes Programme, to fund project loan tranches granted to Rete Ferroviria Italiana (RFI) Spa and Treno Alta Velocita (TAV Spa) related to financing the Italian project to construct a high speed rail network.

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Figure 326: ISPA public debt, May 2010 Maturity structure (€bn) 4.5

6.5 EUR 100.0%

6

4.0 3.5

5

3.0

4

2.5 2.0

-

2018

-

-

-

2013

2016

-

2012

2017

-

0.5 2011

1

2010

1.0

1.0

1.5 2

-

2.6

3

2015

7

Currency structure

3.9 4.2

Issuance (€bn)

2019-2028 >2028

ytd 2010

2009

2008

2007

2006

2005

2004

2003

2002

2014

0.0 0

Source: Dealogic DCM Analytics, Barclays Capital

Debt service is backed by the Italian state

Transaction rights are segregated assets

In 2005, Eurostat ruled that ISPA notes should be treated as government debt, leading to the merger of ISPA into its parent and adoption of the CDEP ticker

Terms of existing notes are unaltered but there will be no new supply in this form

10 June 2010

Debt service is provided through a combination of revenues from the project and state transfers from the Republic of Italy, which is also committed to making good any shortfall. The latter are not covered by a direct state guarantee but have been provided for under specific legislation (Article 75 of law No. 289 of 27 December 2002), a Ministerial Implementation Decree and a Credit Facility Agreement. This state support was the key to the sovereign level ratings applied by all three rating agencies, as well as the zero-risk weighting applied to the bonds. ISPA’s transaction rights under the loan tranches relating to each issue of notes constitute segregated assets (patrimonio separato) that are available only to meet the obligations of ISPA towards the respective note holders. According to the programme offering circular, “ISPA may only be liquidated by operation of law. In the event of the dissolution of ISPA and subsequent winding-up proceedings of any nature, the contracts relating to each pool of segregated assets shall continue in full force and effect. The entities responsible for the winding-up proceedings will provide for the debts owed by ISPA to the relevant ISPA creditors to be paid out of the specific segregated assets only, according to the maturity and other terms contained in the related pre-existing contracts”. In May 2005, a Eurostat ruling required that the ISPA notes be consolidated with Italian government debt. This decision was based on the interpretation that the structure of the transaction meant that the risk of repayment remained Italian government risk. Although this ruling did not altogether prevent further funding through this route, it clearly made it much less attractive, given the continuing search for ways of reducing Italian government indebtedness. From a government point of view, therefore, the raison d'être for a separate entity had effectively disappeared. Following this, the December 2005 Italian Budget Law enacted proposals to merge Infrastrutture Spa (ISPA) into its parent, CDEP, with effect from 1 January 2006; hence, ISPA has ceased to exist as a separate entity and the Bloomberg ticker for its debt issues has changed from ISPA to CDEP. In the 2005 Budget Law, articles 79-82, which confirmed the merger of ISPA into CDEP, also confirmed that the segregated asset provisions and the state contributions to debt service relating to the existing notes will continue unaltered after the merger. As a result, ISPA issues continue to attract sovereign-level credit ratings and risk weightings. (Downgrades of Italy’s sovereign credit ratings by S&P and Fitch in October 2006, to A+ and AA-, 394

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respectively, have therefore been reflected in CDEP’s senior, unsecured credit ratings.) However, with ISPA dissolved, new issuance to fund the remainder of the high speed rail project will need to come in some other form, while trading liquidity in the existing issues will be limited by the absence of new supply.

International Finance Facility for Immunisation (IFFIm) Huw Worthington +44 (0) 20 7773 1307 [email protected] IFFIm was created to mobilise capital market funding to support immunisation programmes in developing countries

Risk weighting – Basel II RSA: 0% IFFIm is an international development financing institution established in 2006 to provide a vehicle for mobilising funding with which to expand and accelerate global immunisation programmes in developing countries. It was created pursuant to the UN Millennium Development Goals agreed in 2000, and in particular the fourth goal – to reduce by twothirds the mortality rate of children under five by 2015. It was established in the UK as a private company limited by guarantee and is also registered as a UK charity. Financial management of IffIm has been outsourced to IBRD. Funds raised by IFFIm on international capital markets are used to finance vaccination programmes operated by the Global Alliance for Vaccines and Immunisation (GAVI). The intention is that, by accessing capital market funding, IFFIm enables the vaccination programme to be front-loaded. Bondholders will be repaid from the proceeds of grants committed by a group of governments led by the UK and France. Italy, Spain, Norway, Sweden and South Africa have also committed grants on a pre-determined schedule. All these grant obligations carry the full faith and credit of the respective governments. However, if recipient countries enter into protracted arrears to the IMF, donors’ obligations can be scaled down on a pre-determined basis. Limits on the gearing of debt issuance to donor commitments are intended to limit bondholders’ exposure to this risk. Although this structure has some characteristics of a government-backed securitisation, IFFIm has been classed as an international organisation by Eurostat for national accounting purposes and as equivalent to a multi-lateral development bank by the EC and the Basel Committee on Banking Supervision, which have therefore assigned a zero-risk weighting to its bond issues. According to its initial plans, IFFIm plans to raise up to $4bn in capital markets over a 10year period. Current donor commitments total $5.3bn spread over 20 years. So far, IFFIm has issued $1.7bn in bonds in a variety of currencies ranging from USD to ZAR.

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Figure 327: IFFIM public debt, May 2010 Issuance (USDbn)

Currency structure, May 2010

Maturity structure, May 2010 (USDbn)

0.9

0.9

0.8

0.8 AUD 5%

0.7 0.6

0.7 GBP 16%

0.5

0.6 0.5

USD 46%

0.4 0.3

NZD 4%

0.3 0.2

2023

2021

2019

0.0 2017

2010

2007 2008 2009

2005 2006

2002 2003 2004

2001

0.1 2015

ZAR 29%

0

2013

0.1

2011

0.2

0.4

Source: Dealogic DCM Analytics, Barclays Capital

KommuneKredit (KOMMUN) Huw Worthington +44 (0) 20 7773 1307 [email protected] Leading lender to the Danish local government sector Joint and several guarantees from members for KOMMUN debt

Sector reform involved consolidation of authorities

Kommunekredit’s legal framework has also been updated

10 June 2010

Risk weighting – Basel II RSA: 0% KommuneKredit is a specialised financial institution that is the leading lender to the Danish local authority sector, with a dominant market. It was originally established as a credit association under legislation passed in 1899 to provide loans to local governments and entities backed by local government guarantees. The members of the association are all the 98 Danish municipalities and five regions in the local government sector. The members are all jointly and severally liable for KommuneKredit’s liabilities. The Danish local government sector has robust credit quality, deriving from the close interaction with central government, an extensive equalisation system, low debt levels, limits on the purposes for which governments are allowed to borrow and a good track record for financial performance. Lending is only undertaken either to local governments or with the backing of a guarantee from local government. Notably, no local government in Denmark has ever defaulted: in cases of financial stress, they have been able to call on financial assistance from the Interior Ministry. In June 2005, legislation was passed to implement reform of the sector, including mergers to achieve a reduction in the number of authorities. The number of municipalities was reduced from 271 to 98, and the existing 14 counties were merged into five regions. Elections to the new bodies took place in November 2005, and the reform became fully effective as of 1 January 2007. In parallel with the local government reform, the legal framework for KommuneKredit has been updated with a new act that was adopted in April 2006. This leaves the key features of structure and support unchanged, but increases its minimum capital requirements, allows increased pre-funding (which will strengthen the liquidity position), and gives the Ministry of the Interior and Health increased authority to set financial guidelines.

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Figure 328: KommuneKredit public debt, May 2010 Issuance (EURbn)

Currency structure, May 2010

Maturity structure, May 2010 (EURbn) 1.6

1.8

1.2

1.4 1.2 € 31%

1.0

0.8

0.2 >2028

0.0 2026

NZD 3%

2024

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0.0

NOK 4%

2022

0.2

0.4

2020

ZAR 2%

0.6

2018

0.4

HKD 2% Other JPY 2% 12%

2016

0.6

2014

Swiss Franc 30%

0.8

1.0

2012

US Dollar 11%

1.4

AUD 3%

2010

1.6

Source: Dealogic DCM Analytics, Barclays Capital

At end-2009, KommuneKredit had total assets of DKK143.2bn, an increase of 11.2% on a year earlier. Outstanding lending increased 6% to DKK111.5bn at end-2009, while cash resources increased to DKK7.1bn. At year end 2009 total equity amounted to DKK4.4bn or 3.2% of liabilities against a legal requirement of minimum of 1%. About 26% of new funding totalling DKK57bn came from the Danish domestic market in 2009, about 61% from European markets, with 10% provided by other markets and Japan fell to 3% from 14% a year earlier. As a result of the financial crisis, other types of funding in the capital markets were used. In particular, short-term funding in the form of CP issuance has been important, with CP issuance of DKK21.2bn in 2009 versus DKK 13.1bn in 2008. In 2009, KommuneKredit envisages long-term funding of €3.5bn in total.

Kommuninvest I Sverige AB (KOMINS) Huw Worthington +44 (0) 20 7773 1307 [email protected] Lender to the Swedish local government sector

Risk weighting – Basel II RSA: 0% KOMINS lends to Swedish local authorities and entities owned by them. It is owned by Kommuninvest Co-operative Society, a co-operative grouping of local authorities. Established in 1986 as a combination of local authorities in one area of Sweden, it became a national organisation in 1993 and has grown rapidly in terms of coverage since then, with the growth in 2009 seeing the second highest membership increase ever. It now has 248 members (241 municipalities and seven county councils, out of the country’s total of 290 municipalities and 20 county councils), and the company has a goal of continuing growth in membership such that by 2015 all 310 local governments are hoped to become members. KOMINS takes the form of a not-for-profit joint stock company and is supervised by the Swedish Financial Supervisory Authority. Lending is limited to member authorities and entities owned by them, of which municipal housing corporations are the main borrowers. Its market share in the funding of its members was 51% at end 2009.

Joint and several guarantees from robust local government members

10 June 2010

All members also provide joint and several guarantees for KOMINS’ liabilities. As in other Nordic countries, the credit standing of the local government sector is robust. Local government in Sweden is responsible for c.74% of public consumption and c.25% of Swedish employment. Municipalities’ right to levy their own taxes is enshrined in the 397

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Swedish constitution, and locally-levied income taxes finance the bulk of local government expenditure. There is also a comprehensive equalisation system. Rapid growth in coverage, which has driven a rising market share

KOMINS’ total assets have grown rapidly as it has continued to increase its market share of local authority financing, mainly through growth in its membership base. With total assets of SEK183bn versus SEK142.7bn, of which loans accounted for SEK123bn (SEK105bn in 2008), there is still potential for market share growth, as additional members are added. Net income grew markedly to SEK66.5bn from SEK44.54bn, as pressure on net margins fell. KOMINS issues debt under a €15bn EMTN programme alongside domestic and euro CP programs and Japanese and German private placement markets. Debt is issued across a wide range of currencies. With the growth in its balance sheet and funding requirement, KOMINS has launched USD1bn benchmarks regularly in recent years, and with funding needs likely to continue increasing, benchmark transactions are likely to be at least a periodic feature of KOMINS’ funding programme. However, it has also been an active borrower historically via structured and non-structured MTNs across a range of currencies, although this has reduced in importance latterly due to increased investor demand for more traditional instruments.

Figure 329: KOMINS public debt Issuance (EURbn)

Currency structure, May 2010

4

Maturity structure, May 2010 (EURbn) 3.0

>2028

0.0 2026

CHF 14%

0.5

2024

2010

2008 2009

2006 2007

2004 2005

2002 2003

2001

0

NOK 1% ZAR SEK 8% 1%

2022

1

1.0

2020

1

1.5

2018

2

2016

USD 41%

2014

2

2.0

2012

3

2.5

€ 13% Other 0% JPY 14% NZD 2%

2010

AUD CAD 5% 1%

3

Source: Dealogic DCM Analytics, Barclays Capital

La Poste (FRPTT) Fritz Engelhard +49 69 7161 1725 [email protected] Originally, La Poste was formed as an independent, publiclyowned company EC pressure to end French government’s “unlimited guarantee” for La Poste

10 June 2010

Risk weighting – Basel II RSA: 20%. La Poste was established in 1991, following the law of July 1990, which split the former French Postal and Telecommunication Service (formerly a government department) into La Poste and France Telecom. Originally, La Poste was formed as an independent publicly-owned company (Exploitant Autonome de Droit Public), which means that it was 100% owned by the French government and its status was similar to that of an EPIC. However, already the 1990 law required La Poste to operate on a financially independent and profitable basis. In October 2006, the EC published a recommendation that the French government end the “unlimited guarantee” that it provides to La Poste as a public entity. The commission argued that this support gives La Poste an unfair advantage and distorts competition within the French postal market. In its view, it therefore acts counter to the liberalisation of EU postal 398

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markets being pursued by the commission. The EC release states that this action does not call into question La Poste's public entity status per se, although it remains unclear how a removal of the solvency guarantee can be reconciled with retention of La Poste’s public entity status. More broadly, the EC’s drive to liberalise postal markets has progressed further with the adoption by the EU parliament in January 2008 of the Third Postal Directive, which was then formally published in February. This directive sets a deadline of end-2010 for completion of the opening of postal markets to full competition. On 1 March 2010, the legal status of La Poste changed as it was transformed into a Société Anonyme (SA), a public limited company. The transformation was accompanied by a €2.7bn capital injection from the French government and Caisse des Dépôts et Consignations, the two owners of La Posta SA. The transformation law prescribes that the French Republic should keep a majority ownership in La Poste and it also assigns to La Poste the privilege of acting as the universal postal service provider for the next 15 years, with the obligation to maintain its network of 17,000 selling points. Between December 2005 and April 2010, its rating was downgraded from AA+ to A. S&P linked the downgrades to the group’s weak stand-alone credit profile and the reduction in mail volumes. S&P also revised the stand-alone credit profile on La Poste to a level consistent with BBB- from BBB. The stable outlook reflects S&P’s belief that timely provision of substantial additional capital should provide stability to La Poste's credit profile. S&P’s A rating does not apply to La Banque Postale, which is rated A+.

S&P downgrade to A

Fitch (the only other agency to rate La Poste) responded to the EC’s approval of the Banque Postale by assigning a AA+ rating to the bank, while maintaining its AAA rating with Stable Outlook for La Poste itself. However, the overriding emphasis on state support on which the stable outlook was predicated did not survive the EC recommendation to abolish the guarantee. This caused Fitch to revise its outlook to negative. In April 2008, the negative outlook was converted into a downgrade to AA for La Poste and AA- for La Banque Postale, reflecting Fitch’s view that the entity’s access to emergency liquidity advances had weakened as a result of the constraints involved in complying with EU rules on unfair competition.

Fitch downgrade to AA

Figure 330: La Poste public debt, May 2010 Maturity structure (€bn) 2.0

CHF 2.9%

0.7 0.8

1.0

0.2

-

EUR 96.3%

0.4 0.2 0.0

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029

2010 yt May

2009

1.4 1.2 0.8 0.6

0.5 0.5

2008

2007

2006

2005

2004

0.4

1.8 1.6

0.5 0.6 0.5 0.8

GBP 0.8%

0.8

1.8

2003

2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0

Currency structure

1.8

Issuance (€bn)

Source: Dealogic DCM Analytics, Barclays Capital

10 June 2010

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LCR Finance (LCRFIN) Risk weighting – Basel II RSA: 0%

Huw Worthington +44 (0) 20 7773 1307

LCR Finance plc is a wholly-owned finance subsidiary of London & Continental Railways Limited (LCR). LCR’s primary responsibilities has been the building of the Channel Tunnel Rail Link (now called High Speed 1 (HSD)) between the Channel Tunnel and central London, and the operation of Eurostar in the UK – the latter through its ownership of Eurostar (UK) Limited, the management of which is contracted out until 2010. LCR’s shareholders are Ove Arup, Bechtel, Halcrow, National Express, UBS, London Electricity and SNCF.

[email protected] Responsible for building Channel Tunnel Rail Link and operating Eurostar in the UK

Bond finance of the construction of the link was provided by: „

Straight bond issues totalling GBP3.75bn in the name of LCR Finance. These bond issues were backed by an unconditional and irrevocable guarantee of the due and punctual payment of all interest and principal payments related to the bonds from the UK government, specifically via the office of the Secretary of State for Transport. Although the shareholders of LCR are private sector companies involved in the construction of the high speed link, the government in effect controls any changes in ownership and restructuring, a fact that was underlined when the Office for National Statistics (ONS) decided to reclassify LCR (and hence its debt) to the public sector in early 2006. Specifically, the decision reclassified LCR from a private non-financial corporation to a public non-financial corporation. LCR bonds are therefore included within the definition of UK public sector debt (but not in general government indebtedness).

„

Two tranches of securitisations (in the name of CTRL Section 1 Finance plc). Nominal and index-linked tranches were used to securitise track access charges from Eurostar (guaranteed by the UK government) and domestic capacity charges provided by the UK government. Servicing of the bonds is therefore fully UK government risk. In 2005, the ONS reclassified the CTRL bonds as government borrowing because it was deemed to be a government-linked securitisation in which there had been no transfer of risk away from the government.

Following the successful completion of the HS1 rail link, the secretary of State for Transport has agreed to acquire CTRLF and LCRF and agreed to the novation of the relevant payment obligations in relation to the bonds referred to above. The straight bond issues remain unconditionally and irrevocably guaranteed by the UK government.

Figure 331: LCR Finance public debt Issuance (EURbn)

Currency structure, May 2010

1.8 1.7 GBP 100.0%

1.6

Maturity structure, May 2010 (EURbn) 1.7

1.8 1.6

1.4

1.4

1.2

1.2 1.0

1.0

0.8

0.8

0.6

0.6

-

-

-

-

2012

2013

2014

2015

2016

-

-

2019-2028 >2028

-

2017

-

2018

-

2011

0.2 0.2

2010

0.4

0.4

0.0 ytd 2010

2009

2008

2007

2006

2005

2004

2003

2002

0.0

Source: Dealogic DCM Analytics, Barclays Capital

10 June 2010

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Municipality Finance (KUNTA) Huw Worthington +44 (0) 20 7773 1307 [email protected] Specialised lender to Finnish municipalities and related entities

Risk weighting – Basel II RSA: 0% Municipality Finance (MF) is a specialised lender to Finnish municipalities and related entities, mainly related to investment projects and social housing, and is their leading credit provider. The current entity was created in 2001 through the merger of the former Municipality Finance and Municipal Housing Finance. In 2008, the company achieved continuing growth in loans (taking total assets to €14.56bn, an increase of 16%) and in net interest income (+71% to €50.5mn). The effect on net income was even more marked due to €8.1bn of provisions relating to exposures to Icelandic banks in 2008, meaning that net income rose from €2bn in 2008 to €24.87bn in 2009. Capital adequacy ratios under Basel II regulations saw the total capital ratio as at end-2009 rise sharply due to capital raising and higher retained earnings from 13.6% to 20.17%. MF is closely integrated with the municipality sector. First, it is owned by Finnish municipalities, either directly or through the shareholding of the Local Government Pensions Institution (LGPI). (In 2006, it conducted a share issue through which it increased the number of local authority shareholders by 48, bringing the total number of shareholders to 328, representing c.99% of the Finnish population.) Second, its debt issues are guaranteed by the Municipal Guarantee Board (which, in turn, is owned and guaranteed jointly by the municipalities). Third, MF lends only to municipalities that are members of the MGB and other entities that are linked to municipalities or involved in providing social housing. In 2004, the European Commission accepted the Finnish law under which the Municipal Guarantee Board grants guarantees to MF funding.

Credit ratings underpinned at sovereign level by credit strength of Finland’s muni sector

Zero risk weighting

10 June 2010

MF’s sovereign level credit ratings are therefore underpinned by the credit strengths of Finland’s municipality sector in three ways: asset quality; ownership; and the guarantee backing for MF’s debt issues. In Finland, municipalities have a strong, self-governing status. They have a broad range of expenditure responsibilities, extensive taxation rights, substantial financial autonomy and a long track record of sound finances. No municipality has defaulted in the past century. In the only case of significant financial distress (in the early 1990s), the central government demonstrated a willingness to provide support. MF is classified and supervised as a financial institution. However, because of the interrelationship with the local authority sector and, in particular, the Municipal Guarantee Board guarantee, MF’s bonds are zero-risk weighted in Finland. International funding is raised through its €15bn EMTN programme, a AUD1bn Kangaroo program and a €2bn Tbill programme.

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Figure 332: Municipality Finance public debt

CHF 22%

0.5 2009 2010

2006 2007 2008

2003 2004 2005

2001 2002

0.0

SEK 1%

ZAR 2%

1.2 1.0 0.8 0.6 0.4 0.2 0.0 2027

1.0

JPY 12% NZD 2% NOK 5%

1.4

2025

1.5

1.6

2023

2.0

1.8

2021

USD 34%

2.5

2.0

2019

3.0

Other 1% Euro 11% HKD 2%

2017

AUD GBP 7% 1%

2015

3.5

Maturity structure, May 2010 (EURbn)

2013

Currency structure, May 2010

2011

Issuance (EURbn)

Source: Dealogic DCM Analytics, Barclays Capital

Oesterreichische Kontrollbank (OeKB) Leef Dierks +49 (0) 69 7161 1781 [email protected]

Main activities: Administration of export guarantees and financing of exports

Risk weighting – Basel II RSA: 0% Established in 1946, Oesterreichische Kontrollbank (OKB) is Austria's main provider of financial and information services to the export industry and the capital market. The bank acts as an agent of the Republic of Austria, which unconditionally and irrevocably guarantees timely payment of OKB's debt obligations issued under the Export Financing Guarantees Act of 1981. Amendments to the act in 2003 removed the direct reference to OKB as the only financial institution charged with administering this business, thereby opening up the possibility of other entities potentially being handed this function in the future. In practice, however, we believe the probability of any significant changes are rather slim. The larger parts of OKB’s assets comprise medium- and long-term refinancing for banks and foreign importers financing Austrian exports. Generally, OKB’s refinancing is covered by the Republic of Austria’s guarantee of the underlying transaction. Given this level of cover, OKB has never suffered any loan losses.

Wholly owned by Austrian banks - but benefits from Republic of Austria guarantees

OKB is an Austrian banking corporation, created as a joint stock corporation under Austrian corporate law. Although all major shareholders currently are Austrian banks, there is no legal clause that would prevent non-banks from purchasing shares from one of the existing shareholders. Still, in practice, the shareholder structure has rarely been subject to changes. At the time of writing, the largest shareholders in OKB were Bank Austria Creditanstalt (24.8%), Unicredit (16.1%), and Erste Bank Group (12.9%). Taking into consideration OKB’s ownership structure, a substantial part of the bank’s export financing business is conducted directly with its shareholders. The Republic of Austria does not have any ownership participation in OKB. In addition to the protection provided to OKB’s assets by the republic’s export guarantees, however, the bank’s debt issued to finance its export loans is generally covered by an unconditional, full faith and credit guarantee by the Republic of Austria under the terms of the Export Financing Guarantees Act of 1981. As OKB pays a fee for the provision of this guarantee, it, in principle, could also issue non-guaranteed debt. In practice, however, this has generally not been the case, except for short-term debt on some occasions. Note that if the Austrian government

10 June 2010

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were to open the business to tender by other entities, it would have to give OKB a two-year notice of its intention. Even in the case of OKB losing its role, the guarantee granted would continue to apply to the outstanding debt. On the basis of the guarantee, OKB debt is rated at the same level as the Republic of Austria and also benefits from a risk weighting of 0%. OKB's multi-currency liability portfolio had a notional amount of €30bn at the time of writing. Approximately three-quarters of the portfolio consists of long-term financing. Whereas USD-denominated debt accounts for 43.8% of OKB’s total funding, followed by EUR-denominated issues which amounted to 26.1% and CHF-denominated issues whose proportion stood at 21.6%. Debt issued in GBP and other currencies accounted for an aggregated 8.8%. In 2009, a total of €3.3bn of new debt was issued. In 2010, long-term funding needs will amount to c.€4bn, which will be achieved through liquid benchmark issues in USD, EUR, JPY, CHF, and GBP, private placements, and structured MTNs.

Figure 333: OKB public debt, May 2010 Issuance (€bn)

Currency structure

GBP 4.9%

7 6

5.3

CHF 21.6%

5 Others 3.6%

3.5

8

5.3

6

7.9 7.9

4.8

9

Maturity structure (€bn)

4

2010 yt May

2009

2008

2007

2006

2005

2004

2003

0

USD 43.8%

2 1

0.9 0.8

0.9

1

EUR 26.1%

0.7 0.5

2

2.6 1.7 1.9

2.2 1.7 2.4

3

3

3.3

0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029

4

2.0

5

Source: Bloomberg, Dealogic DCM Analytics, Barclays Capital

Radio Television Española (RTVE) Leef Dierks +49 (0) 69 7161 1781 [email protected]

Debt fully repaid in April 2010

10 June 2010

Risk weighting – Basel II RSA: 0% Until the implementation of legal changes in 2006, Radio Television Espanola (RTVE) was a government-owned Spanish public entity with a public service role for the provision of national television and radio services. Financially, it depended on state subsidies and debt funding. Therefore, its credit quality was entirely determined by its linkages to, and support from, the state. This was reflected both in its sovereign level credit ratings and the fact that it is zero-risk weighted in Spain and various other European countries. In 2006, discussions regarding a reform of RTVE led to legislative changes. As a result of the new legislation, a new public entity, Corporacion RTVE, was created which then took over responsibility for RTVE’s commercial activities. Note, however, that the existing debt remained with the existing RTVE, which had entered a liquidation process under which it amortised the debt. Resources for the amortisation came from the Spanish government, with RTVE’s budget being included within the government’s general budget. As the last bond issued by RTVE matured in April 2010, we will no longer cover this issuer within the scope of the AAA Handbook. 403

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RATP – Regie Autonome des Transports Parisiens (RATPFP) Risk weighting – Basel II RSA: 20%.

Fritz Engelhard +49 69 7161 1725

RATP is the Greater Paris Transport Authority. It was created in 1948 to develop, maintain and operate public transportation in the Greater Paris area. Its principal activities are the ownership and operation of metro, tramway and bus lines in the Greater Paris area, as well as operating the urban express (RER) services jointly with SNCF. It has the legal status of an EPIC (a public entity with industrial and commercial character), established with a public service mission to operate and extend public transportation in the Greater Paris region. Consequently, it benefits from the range of state linkages and supports that are normal for EPICs. It cannot go bankrupt and is ultimately guaranteed by the French state, which is also committed to providing it with liquidity support if needed. Management is appointed by the state, which also supervises its budget and accounts. Specifically, it is supervised by the Syndicat des Transports d’Ile-de-France (STIF), which is the public authority for transport in the Greater Paris area. Although Parisian transport is RATP’s raison d’etre, it is also allowed to compete for projects outside the Ile-de-France region.

[email protected]

Established in 1948 to develop, maintain and operate public transport in Paris

RATP operates within the context of a three-year contractual agreement with STIF, which defines public transport policy, sets fare levels, etc, and a four-year business plan. The gap between the fares determined by STIF and the fares needed to cover costs is met by public subsidies. The business plan envisages significant investments in rolling stock and the existing network and stations. Together with the higher redemptions that came due last year, this has led to an increase in bond issuance in 2008. RATP’s key public service role, and the fact that it is so financially dependent on public subsidies means that its EPIC status is unlikely to be changed in the near future. Figure 334: RATP public debt, May 2010

CHF 32.1%

0.7

0.5

0.7 0.6

0.1

0.2

0.3

0.3

0.2

0.2

0.2

0.1

0.1 -

0.1

0.1 0.1

0.4

0.3

0.4

0.5

2010 yt May

2009

2008

2007

2006

2005

2004

2003

0.0

EUR 67.9%

0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029

0.3

0.6 0.4 0.4

0.8

0.6

0.7

0.9

0.9

Maturity structure (€bn) 0.6

Currency structure

1.0

0.3

Issuance (€bn)

Source: Dealogic DCM Analytics, Barclays Capital

Rede Ferroviária Nacional (REFER) Leef Dierks +49 (0) 69 7161 1781 [email protected]

10 June 2010

Risk weighting – Basel II: guaranteed issues: 0%; non-guaranteed issues: 50% Rede Ferroviária Nacional (REFER) is responsible for operating, maintaining and developing the Portuguese railway infrastructure. REFER was created in 1997 in order to conform to EU directives that required the separation of infrastructure from the operation of services. The latter remained primarily the responsibility of the previous integrated rail operator, Caminhos de Ferro Portugueses. 404

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Portuguese railway infrastructure operator

At the time of writing, REFER is a 100% state-owned company. It has the legal status of an Entidade Publica Empresarial, which means that it is not subject to corporate bankruptcy procedures. Also, its statutory capital must remain entirely and directly held by the Portuguese state. A privatisation of REFER would require a change of the entities legal status, which can only be decided upon in the Portuguese Parliament. Considering REFER’s role as an institution that undertakes activities in the public interest, however, we believe that, even in the long term, a privatisation is rather unlikely. As a result of the ongoing economic downturn in Portugal and the sovereign’s budgetary pressures which markedly increased as of late, REFER’s reliance on external borrowing in order to fund its persistent operating deficits and the better part of its substantial investment programme has shown a tendency to increase. Attributed to the continuing need to modernise the country’s railway network, we believe that debt issuance will likely further increase. For the time being, most of REFER’s outstanding debt (much of which is in the form of loans from the EIB) is backed either by government guarantees or by guarantees provided by MBIA. However, there are plans to determine the mix between guaranteed and non-guaranteed funding in the future, depending on the basis of relative funding costs. The entity intends, to an increasing extent, to reduce the proportion of debt issues benefiting from an explicit guarantee on behalf of the sovereign. For individual debt issues, the applicable credit ratings and risk weightings for REFER depend on whether issues benefit from an explicit state-guaranteed or not. Whereas guaranteed issues will benefit from Portugal’s sovereign rating of Aa2/A+/AA (all outlook negative) and a respective risk weighting of 0%, non-guaranteed issues, in contrast, are subject to REFER’s issuer rating of Aa2/A/NR (all outlook negative). In our view, however, the (modest) divergence in ratings reflects the rating agencies’ different approaches to rating government-related entities (GRE) rather than major differences in their evaluations of REFER’s fundamental characteristics. In terms of risk-weighting purposes, REFER is treated as a commercial public entity. Under Basel II, risk weightings for non-guaranteed debt under the standardised approach will be based on credit ratings. With regard to REFER, the split between the ratings assigned by Moody’s and S&P has an impact on the risk weighting of non-guaranteed debt. This is the case because the weaker rating will be taken as the basis for the risk weighting. S&P’s A rating therefore implies a 50% risk weighting for REFER’s non-guaranteed issues at the time of writing.

Figure 335: REFER debt, May 2010 Issuance (€bn)

Currency structure

Maturity structure (€bn)

1.5

1.0

0.5 0.5 0.5

EUR 100%

1.1

0.6

0.6

0.75

0.50

1.0

0.6

0.25

-

-

0.5

2010

2009

2008

2007

2006

2005

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2021 2024 2026

0.00 0.0

Source: Bloomberg, Dealogic DCM Analytics, Barclays Capital

10 June 2010

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Société de Financement de l'Economie Française (SFEF) Fritz Engelhard +49 69 7161 1725 [email protected]

France’s centralised issuer of government guaranteed debt

Risk weighting – Basel II RSA: 0%. SFEF has been established in October 2008 as a special financing company to support the French banking system. Its creation is based on the amended French monetary code. Between October 2008 and December 2009 a total financing volume of €265bn has been assigned. SFEF has been set up to encourage the banks participating in the scheme to finance the French economy, with a focus on helping corporates, households and local authorities. SFEF issues debt directly to the market. The respective obligations are guaranteed by the French state. The proceeds from SFEF debt-raising are used to provide funding to French credit institutions. To benefit from this liquidity, credit institutions must pledge assets as collateral. As SFEF debt benefits from an explicit guarantee by the French state, it takes on the sovereign zero-risk weighting and also benefits from triple-A ratings. SFEF has €50mn of capital, which is held by the French state (34%) and the French banking sector (66%), split equally between Banques Populaires, BNP Paribas, Caisse d’Epargne, Crédit Agricole, Crédit Mutuel, HSBC France and Société Générale (9.43% each). The State approved the SFEF’s executives and statutes and has a blocking minority. The Government Commissioner has a veto right in order to protect the French State’s financial interests. Furthermore, SFEF is subject to supervision by the Banking Commission. In order to access SFEF funding, participating banks needed to fulfil minimum regulatory capital requirements, pledge eligible assets, comply with a series of ethical guidelines and commit to granting new loans to the broader economy. Eligible collateral consist of French real estate loans, first-tier French mortgages or guaranteed home loans, loans to local authorities, loans to wellrated corporates, loans to French consumers and loans to credit export agencies. The quality of the collateral posted by the banks is supervised by a specific controller.

Figure 336: SFEF – structural overview French Republic

34%

Guarantee

Investors

Shareholder banks

Medium-term bonds issues

66%

SFEF

Loans

Banks

Loans

Broader Economy

Source: SFEF, Barclays Capital

Between November 2008 and September 2009, SFEF issued a total volume of €77bn, which was mainly EUR-denominated (€48bn), but also in USD-format ($39bn), and two floating rate notes in CHF (CHF 2bn) and £ (£750mn). About 90% was issued with a fixed coupon and the reminder as floater. According to information from individual annual reports, the largest participants taking advances from SFEF were Crédit Agricole (€21.6bn), BNPCE (€15.1bn), Société Générale (€13.6bn), BNP Paribas (€12.8bn) and Crédit Mutuel (€11.7bn). Crédit Agricole and BNP Paribas also reported the ratio between advances and pledged assets, which stood at 1.5x and 1.2x, respectively.

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Figure 337: Distribution of SFEF advances among French banks, YE 09

Credit Mutuel 15%

Other 3% Credit Agricole 27%

BNPCE 20% Société Générale 18%

BNP Paribas 17% Source: Individual bank reports, Barclays Capital

Figure 338: SFEF public debt, May 2010

58.6

25

60

23.5

70

2014

Maturity structure (€bn) 22.8

Currency structure

2012

Issuance (€bn)

20 15.1

50 USD 38%

30

15

EUR 62%

11.0

20

10

8.2

40

5

10

2010

2009

2008

2011

0

0

Source: Dealogic DCM Analytics, Barclays Capital

Unédic (UNEDIC) Fritz Engelhard +49 69 7161 1725 [email protected]

Central organisation in the French unemployment benefit system

10 June 2010

Risk weighting – Basel II RSA: 0%. Unédic is the central organisation in the French unemployment benefit system. It was created in 1958 as an association with a public service mission to provide unemployment insurance benefits. It is jointly managed as a not-for-profit entity by employers’ associations and trade unions, which set levels of welfare contributions and benefits, subject to central government agreement and to maintaining financial balance. Unédic is not an EPIC, and thus does not benefit from the solvency and liquidity support typical of that status. However, there is a track record of the government providing support through debt guarantees or subsidies. The 2008 reform confirmed the strategic role of Unédic within the French Public Service of Employment. It contained not only the merger of Unédic’s operational network (Assédic) and the state employment agency (ANPE) into a new state institution (Pôle emploi), but also confirmed role of Unédic as the legal and financial manager of the national unemployment insurance system.

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Operating deficits over the period from 2001-05 were reflected in an expanding accumulated deficit, which was partly funded through the issuance of long-term debt issues in 2003 and 2005. Conversely, a move back into operating surplus in 2006 (€1.5bn), followed by an increased surpluses in 2007 (€3.7bn) and 2008 (€4.9bn), reflecting strengthening economic conditions, has reduced the accumulated deficit substantially (-€7.8bn between 2006 and 2008). Consequently, the large redemption in September 2008 did not necessitate any bond refinancing. However, Unédic forecasts a deficit of €0.9bn for 2009 and a €1.6bn deficit for 2010. Thus funding needs may well increase over the next 12 months. This is reflected in the 3Y €4bn benchmark bond issued in November 2009, which helped the organisation not only refinance a €2.2bn benchmark bond maturing in February 2010, but also cope with additional future funding needs. Unédic has set up a €12bn EMTN programme and a €6bn CP programme in order to cope with future total funding needs of €18bn. Debt issuance is purely in €-denominated format.

Figure 339: Unédic debt, May 2010

4.0

4.5

4.0

4.0

EUR 100.0%

3.2

3.5

Maturity structure (€bn) 4.0 3.5

3.0

3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

-

0.5 2010 yt May

2009

2008

2007

2006

2005

2004

2003

0.0

0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029

4.5

Currency structure

4.0

Issuance (€bn)

Source: Dealogic DCM Analytics, Barclays Capital

10 June 2010

408

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US AGENCIES PROFILES

10 June 2010

409

Barclays Capital | AAA Handbook 2010

Fannie Mae (FNMA)

Rajiv Setia, James Ma

Description

Ratings table

% $ Index

% £ Index

Total assets

3.148

0.038

USD869bn

Fannie Mae is one of the two largest suppliers of funds to the US secondary market in mortgages. Its core function is to securitise mortgage loans originated by lenders in the primary market into FNMA MBS. It also operates a substantial investment to facilitate liquidity and stability in the secondary mortgage markets. In September 2008, FHFA placed FNMA under conservatorship, while agreeing to service senior and subordinate debt. As part of the conservatorship, FNMA receives preferred equity investments from the US Treasury to make up for any GAAP net asset shortfall.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

Outlook

Risk weighting 20%

Key features of the credit „

„

„

Purpose: Fannie Mae was established in 1938 to provide additional liquidity to the mortgage market and thereby improve the accessibility and affordability of home ownership throughout the US. It is the largest provider of funds to the mortgage market, through the purchase of residential mortgages and MBS for its own portfolio and, through its credit guarantee business, by the creation and securitisation of MBS. Ownership and capital structure: Fannie Mae is a federallychartered private corporation and has the status of a Government Sponsored Enterprise (GSE). Originally established as a wholly-owned government corporation, private shareholding was introduced in two stages – by the FNMA Charter Act in 1954 and by 1968 amendments to the Charter Act. It continues to be regulated by the US government via the FHFA (Federal Housing Finance Agency). FHFA is responsible for Fannie Mae’s safety and soundness, and also has authority over capital standards, mission supervision and receivership in case of default. FHFA placed FNMA into conservatorship in September 2008, with the goal of restoring operational soundness. As part of the conservatorship, the US Treasury established a Preferred Stock Purchase Agreement (PSPA) with FNMA, and thus far has purchased $75bn in senior preferred shares, along with warrants for 79.9% of common shares. Asset structure and quality: Fannie Mae operates solely in the secondary market for mortgages and its business is concentrated in two main areas. First, it owns a portfolio of mortgage-related securities, which is funded through the issuance of debt securities. The bulk of the portfolio is in agency MBS/loans, but non-agency securities comprise about $89bn (12%) of the retained portfolio. FNMA also has significant offbalance sheet liabilities, created via its role as a guarantor of

MBS ($3.2trn outstanding in Q1 10). FNMA generates fee income from these guarantees, but is also exposed to credit losses. While the bulk of its credit book is in agency-conforming MBS, roughly $284bn (10%) is in Alt-A product. „

Capital adequacy: The legislation governing FNMA provides the basis for minimum, risk-based and critical capital requirements monitored by FHFA. Under conservatorship, the US Treasury has committed to inject senior preferred equity into FNMA in any quarter where there is a net asset shortfall (ie, GAAP assets < liabilities), in the amount of the deficit. FNMA has eliminated its common and preferred dividends as a result. Through Q1 10, the cumulative draw was $75bn for FNMA. The Treasury’s commitment under the PSPA is available indefinitely with no cumulative limit through 2012, and a maximum additional $200bn thereafter. The Treasury lacks the authority to increase the limit without consulting Congress.

„

Financial performance: Results have been sharply negative since Q3 08, but net losses date back to Q3 07; FY 09 net losses totalled $72bn. Credit loss provisions in the guarantee book were the primary contributor to the loss, alone totalling $72bn in 2009. OTTI on non-agency MBS in the retained portfolio and MTM losses on derivatives were also significant drags on earnings (in respective order). We expect losses to stay concentrated in the guarantee book, as portfolio non-agency MBS holdings have already been marked down severely.

„

Funding: In 2010, net portfolio growth should be relatively light; as of Q1 10, FNMA had $84bn of room to grow under the $810bn portfolio cap after shrinking by more than $50bn. With the Fed having exited the market, FNM has favoured discount notes as an economically-advantageous source of funds.

Strengths

Weaknesses

„

„

FNMA could be used as a policy instrument instead of for profit.

„

After Fed purchases end, equilibrium valuations for GSE debt are uncertain, as is the GSE’s ultimate form post-conservatorship.

„

The administration has shown some capriciousness in changing FNMA’s portfolio and debt limits under conservatorship. However, we expect the portfolio business to be de-emphasised, ensuring the long-term supply backdrop remains favourable.

„

Under conservatorship, FHFA commits to paying interest and principal to bondholders while the Treasury ensures solvency. Strong government support, Fed purchases, and access to liquidity and capital backstops from the Treasury.

Key points for 2010-11 „

As the Treasury stake in FNMA grows, dividend payments on preferred equity injections should surpass steady-state earnings. Closer ties to the government are inevitable and should increase investor comfort in FNMA paper as a Treasury surrogate.

10 June 2010

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Barclays Capital | AAA Handbook 2010

Public sector

Fannie Mae (FNMA)

Financial summary – YE December 2009 $

2006

2007

Fannie Mae benchmark spreads versus Treasuries (bp) 2008

% ch 2009 (08-09)

Balance sheet summary ($ bn) Total assets 841 879 912 869 729 728 792 773 Retained mortgage portfolio Tot. issued MBS 2,705 3,027 3,311 3,339 Tot. mortgage credit book 2,526 2,888 3,109 3,241 Investments 379 294 266 238 200 180 229 220 Holdings of FNMA MBS Tot. equity 42 44 -15 -15 42 45 -9 NA Core capital* Tot. debt securities 774 806 883 786 Sub-debt 11 9 7 7 16 75 Senior preferred stock Preferred stock 9 17 21 20 Income statement summary ($ mn) Net interest income 6,752 4,581 8,782 14,510 Guarantee fee income 4,250 5,071 7,621 7,211 -1,744 -4,668 -20,129 -2,811 Non-int. (derivatives) income 9,258 4,984 -3,726 18,910 Tot. operating income Tot. administrative expenses 3,076 2,669 1,979 2,207 4,270 8,320 32,860 77,552 Tot. non-interest expenses 783 5,012 29,809 73,536 Credit related expenses Pre-tax profit 4,213 -5,126 -44,549 -73,007 Net income 3,548 -2,563 -59,776 -72,022 Diluted common shares 972 973 2,487 5,666 3.7 -2.6 -24.0 -12.7 Net income per share ($) Dividends/Common share ($) 1.18 1.90 0.75 Profitability (%) Return on assets 0.4 -0.3 -6.7 -7.9 8.8 -6.0 -416.6 -33.1 Return on equity Oper. exp./Net income 86.7 -104.1 -3.3 -3.1 0.37 0.31 0.22 0.2 Oper. exp./Assets 22.1 -195.6 -49.9 -102.1 Credit expenses/Net income Net int. margin 0.81 0.53 0.98 1.58 Balance sheet & capital ratios (%) Retained portfolio/Assets 86.6 82.8 86.8 88.9 Tot. debt securities/Assets 92.0 91.7 96.8 90.4 Core capital/Assets 5.0 5.2 -0.9 NA Note: *Regulatory capital requirement not binding during conservatorship

-5% -2% 1% 4% -11% -4% 1%

53.9%

150 100 50 0 Jan-08

363% -4% 65% -5% 86% 608% 12% 136% 147% -64% -20% 128% 47%

-18% 92% 7% 9% -105% 62%

250 200 150 100 50 0 -50 -100 Jan-08

Jan-10 30yr

Jul-08

Jan-09

2yr

5yr

Jul-09

Jan-10

10yr

30yr

200 175 150 125 100 75 50 25 0

2% -7%

Callable 2005

Benchmark Sub Debt Other bullets Note 2006 2007 2008 2009

Bullet maturity profile ($bn), as at 5 May 2010 300 270

0.9%

51.9%

42.7%

39.7%

46.8%

200

26.7%

21.8%

26.7%

150

29.4%

37.7%

21.8%

Jul-09 10yr

Gross term debt issuance ($bn)

0.8%

22.4%

5yr

Fannie Mae benchmark asset swap levels (bp)

1.1%

24.9%

Jan-09

2yr

1.4%

22.1%

Jul-08

-11%

Outstanding debt profile ($bn) 1.6%

200

2005 2006 2007 Discount Notes Non Callable Securities

250

25.5%

2008 2009 Callable Securities Sub-Debt

Fannie Mae retained portfolio and debt cap ($bn)

119

100

55

50

37

45

16

18

15 16

17

7

18

1

6

18

19 20 20+

0

0 10

11 12

13

14

Government capital infusion ($bn)

1,100

19.0

20 15.2

1,000

15

900

15.0

15.3

3Q09

4Q09

10.7

10

800 700 Jan-07

5 Oct-07

FNMA Debt Out

10 June 2010

Jul-08

Apr-09

Jan-10

Old FNMA Cap

Oct-10 New Caps

0 4Q08

1Q09

2Q09

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Barclays Capital | AAA Handbook 2010

Fannie Mae (FNMA)

Public sector

Guarantee fees versus operating income 30 20 10 0 -10 -20

Cumulative provisions and charge-offs ($bn)

$ bn

200% 100% 0% -100% -200% -300%

2005

2006 2007 2008 2009 Operating income (ex. guarantee fees) Guarantee fees Fees/Operating income ratio (RHS)

Single family mortgage delinquencies

Mortgage credit book: Mostly fixed rate 15%

5.0% 4.0%

10%

3.0% 2.0%

5%

1.0% 0.0% 2006 2007 Non-credit enhanced Total Single Family

2008

0% 2009 Credit enhanced (RHS)

Geographical distribution of mortgage credit book 24%

23%

24%

26%

16%

16%

16%

16%

15%

23%

24%

25%

25%

24%

19%

19%

19%

17%

17%

17%

19% 16%

19% 16%

2008 Southwest

2009 West

2006 Northeast

2007 Southeast

Net interest income and net interest margin ($bn)

FNMA MBS in portfolio as % outstanding stabilises ($bn) 7.4%

3,000

200

234

2,000 1,000

2,337

2,506

180

229

6.0% 2,847

6.9%

0 2005 2006 2007 MBS held by Others % of PC owned (RHS) 10 June 2010

3,082

220 6.6% 3,118

13%

11%

10%

9%

21%

19%

18%

16%

16%

65%

68%

71%

74%

75%

2006

2007

2008

2005

Long-term Fixed

Other Fixed

2009 ARMs

7% 16% 17%

10%

60%

2005 < 60%

18% 17%

20% 19% 15%

55% 2006 60% to 70 %

34%

37%

17% 13%

19% 13%

46%

36%

31%

2007

2008

2009

70% to 80%

above 80%

Investment portfolio mainly in agency MBS ($bn), 31 Mar 10

30 $ bn 2.0% 25 1.5% 20 15 1.0% 10 0.5% 5 0 0.0% 2005 2006 2007 2008 2009 Net interest income Net interest margin (RHS)

$bn 9.1% 4,000

14%

Mortgage credit book: Current loan to value ratio

25%

2005 Midwest

120 Cumulative, $bn 100 80 60 40 20 0 2004 2005 2006 2007 2008 1Q09 2Q09 3Q09 4Q09 FNMA Provisions FNMA Charge-offs

10% 8% 5% 3%

0% 2008 2009 MBS in Retained Portfolio

Non-Agency MBS, 89.1, Other 12% Agency MBS, 25.5, 4%

Mortgage Loans, 292.4, 40%

Agency MBS (FNMA), 318.8, 44%

Total = $726bn

Retained portfolio: Liquidity ratios ($bn) 100 80 60 40 20 0

$ bn

12.5%

9.0%

7.1% 52.2

15%

11.7%

9.5%

10% 69.4

91.0

93.0

5% 69.4

0% 2005 2006 2007 2008 2009 Liquidity portfolo (short term investments + cash) Ratio of liquidity/Retained portfolio (RHS)

412

Barclays Capital | AAA Handbook 2010

Federal Home Loan Banks (FHLB) Description

Rajiv Setia, James Ma Ratings table

% $ Index

% £ Index

Total assets

2.231

NA

USD1,016bn

The FHLB system comprises 12 banks situated in Boston, New York, Pittsburgh, Atlanta, Cincinnati, Indianapolis, Chicago, Des Moines, Dallas, Topeka, San Francisco and Seattle. The banks are GSEs and are owned as co-operatives by “member” financial institutions to which they supply advances in support of their lending programmes. The FHLBs issues consolidated obligations, consisting of bonds and discount notes, which are the joint and several obligations of the 12 banks and are not guaranteed by the US government. The system is regulated by the Federal Housing Finance Agency.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

Outlook

Risk weighting 20%.

Key features of the credit „

Purpose: The 12 FHL banks are US Government Sponsored Enterprises (GSEs), organised under the authority of the FHLB Act of 1932, as amended. Their primary purpose is to provide liquidity to member financial institutions to assure the flow of credit and other services for housing/community development.

„

Ownership, support, and regulation: Each of the 12 FHL banks is owned in a co-operative structure by its member banks. The FHL Bank system and the Office of Finance are regulated by the Federal Housing Finance Agency (FHFA), as part of the GSE reform legislation bringing regulation of FNMA/FHLMC and FHLB under one part of the Executive branch. The FHFA ensures that the FHL banks operate in a safe and sound manner by setting and enforcing capital and leverage limits, monitors the banks’ execution of their housing mission, and also holds receivership authority. All 12 banks have completed their SEC registration. The government does not guarantee FHLB debt, but the debt enjoys favourable market treatment due to its GSE status. Also, the FHL banks are exempt from paying federal, state and local taxes, with the exception of real property taxes. Instead, they are obligated to make payments to the Resolution Funding Corporation (REFCORP) and towards the Affordable Housing Program (AHP). By statute, MBS assets held in FHLB investment portfolios cannot exceed 300% of the bank’s capital. However, to help alleviate secondary market stress, in Q1 08 the FHFB authorised the FHLBs to temporarily increase MBS purchases up to 600% of capital for a two-year period.

„

Asset structure and quality: The assets of FHL banks consists primarily of advances made to members, mortgage assets acquired through the Mortgage Purchase Program (MPP) and Mortgage Partnership Finance (MPF), MBS held in investment portfolios and liquid short-term assets. Advances have traditionally been the main assets on the balance sheet ($631bn as of YE 09); mortgage loans comprise $71bn, MBS $132bn and other investments $152bn. Although the advance business has remained healthy, impairments on non-agency MBS portfolio holdings will remain a drag on earnings in 2010.

„

Capital adequacy: The Gramm-Leach-Bliley (GLB) Act introduced a number of changes in the capital structure of the FHL banks to be implemented by the Finance Board. On 18 July 2002, the Finance Board approved the capital plan submission of banks and gave them up to three years from the effective date of their capital plan to implement the plans. Each bank’s plan was required to address the different classes of stock with which the bank would capitalise itself. Each FHLB is subject to risk-based capital rules under the new act. As of May 2010, 11 banks have already implemented the new capital plans. The exception, FHLB Chicago, remains bound by the pre-GLB Act requirements in addition to the recent agreements with FHFA.

„

Funding: In 2009, the FHLBs decreased their lending activity as the banking sector deleveraged, and advances shrank by 32% to $631bn. However, the FHLB continues to play an important role in providing liquidity to member institutions. As most of the advances were funded via discount notes, this funding vehicle ran off significantly. In 2010, we expect these advances to keep running off as banks remain flush with cash.

Strengths

Weaknesses

„

Joint and several liability lowers potential for localised default risk in Systemwide securities.

„

„

High quality asset portfolio, particularly in the advance business.

Although significantly lower than FNMA/FHLMC, the System does have some Alt-A and prime jumbo exposure, which could cause credit losses.

„

Central role in home finance for small- and medium-sized/ regional banks less easily-serviced by FNMA/FHLMC.

„

As FHLB’s reported financial condition has remained solvent, it has also received a lesser degree of government assistance – a somewhat counter-intuitive phenomenon.

„

We expect the FHLB’s capital cushion should suffice to offset non-agency MBS losses; accounting rule changes should allow FHLB to spread out losses over a longer period. Main supply technical likely to be negative as FHLB continues to shrink advances outstanding, but this could be tempered with term-out of the current funding profile.

Key points for 2010-11 „ „

Expect demand for advances to shrink as large-bank borrowers retain access to CD, CP and term unsecured markets. Even at lower 2006-07 levels of interest-earning assets, expect NIM to create enough earnings to offset upcoming credit losses on non-agency MBS.

10 June 2010

„

413

Barclays Capital | AAA Handbook 2010

Public sector

Federal Home Loan Banks (FHLB)

Financial summary – YE December 2006 Balance sheet summary ($ bn) Total assets 1,016 Advances to members 641 Mortgage loans, net 98 Investments 271 Deposits and borrowings 21 Consolidated obligations 934 Total capital 45 Retained earnings 3 Income statement summary ($ mn) Net interest income 4,293 Operating expenses 671 Total assessments 942 Net income 2,612 Profitability (%) Return on assets 0.3 Return on equity 6.0 Oper. exp./Net income 25.7 Oper. exp./Assets 0.07 Assessments/Net income 36.1 Net int. margin 0.42 Balance sheet & capital ratios (%) Advances&Loans/Assets 72.7 Cons. oblig./Assets 91.9 Tot. capital/Assets 4.4

FHLB global note spread to Treasuries (bp)

2007 2008 2009

% ch

1,274 1,349 1,015 -25% 875 929 631 -32% 92 87 71 -19% 299 306 284 -7% 24 17 19 14% 1,179 1,258 935 -26% 54 51 45 -12% 4 3 6 104%

250 200 150 100 50 0 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 2yr

5yr

10yr

30yr

FHLB global note asset swap levels (bp) 4,516 5,243 5,432 714 732 943 1,021 600 830 2,827 1,206 1,855

4% 29% 38% 54%

0.2 5.7 25.3 0.06 36.1 0.35

0.1 2.3 60.7 0.06 49.8 0.39

0.2 71% 3.9 68% 50.8 -16% 0.08 43% 44.7 -10% 0.54 38%

75.8 92.5 4.2

75.3 93.3 3.8

69.2 92.1 4.4

250 200 150 100 50 0 -50 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 2yr

5yr

10yr

30yr

Gross term debt issuance ($bn) -8% -1% 16%

400 300 200 100 0 Callable 2005

2006

2007

Callable bonds

2008

2009

Others, 29, 3%

Investments , 284, 28% 10 June 2010

28

19 16

6

10

6

18

0

Bullets

Investments held by FHLB ($bn), as at Q4 09

Member mortgage assets, 71, 7%

32

>=2020

2005

176

2012

0

50 166

2011

312

2010

374

76

2020

100

2019

150

2018

556

100 354

2009

213

2017

644

190

2013

496

400 200

2008

2016

600

200

2015

250 415

2007

Other Bullet

Majority of debt matures over the next two years

800 398

2006

2014

Outstanding debt ($bn)

Benchmark Note

Advances, 631, 62%

FHLB investment portfolio Investments as of Q4 09 Short-Term* Non-Mortgage Related** Agency MBS Non-Agency MBS Total

Total ($bn) 110.1 21.9 102.4 49.6 284.0

% Total 38.8% 7.7% 36.1% 17.5% 100.0%

Note: *Deposits, Fed Funds sold. **CP/GSE debt/Local housing obligations

Total Assets = $1,015bn

414

Barclays Capital | AAA Handbook 2010

Federal Home Loan Banks (FHLB)

Public sector Advances by membership ($bn)

FHLB Private-label MBS holdings as of Q4 09 ($bn) PLS, Par ($mn) 20,500 12,663 6,851 4,744 2,905 3,551 3,700 1,876 1,199 187 571 35 58,782

System bank San Francisco Atlanta Pittsburgh Seattle Indianapolis Boston Chicago Topeka New York Cincinnati Dallas Des Moines Total

FY Credit OTTI ($mn) -608 -316 -229 -311 -60 -444 -437 -1 -20 0 -4 0 -2,430

FY Non-credit OTTI ($mn) -3,513 -990 -815 -1,039 -352 -885 -967 -8 -120 0 -75 0 -8,764

Unrealized Mark price losses ($mn) Q4 09 (% Par) -1,945 72 -1,620 84 -1,102 80 -1,398 64 -125 84 -1,022 58 -83 64 -199 89 -198 73 0 100 -67 76 -7 80 75 -7,766

Book value equity ($mn) 6,230 8,253 3,713 994 1,746 2,764 2,378 1,946 5,603 3,467 2,822 2,911 42,827

1,000 Par/equity 3.3 1.5 1.8 4.8 1.7 1.3 1.6 1.0 0.2 0.1 0.2 0.0 1.4

Asset distribution among member banks ($bn)

Bo st o ew n Y Pi tts ork bu rg At h la Ci nta nc In in n di an ati ap o Ch li s i c D es ag M o oi ne D s al la s Sa T o pe n Fr an ka ci sc o Se at tl e N

Advances

Mortgage loans (net)

17% 16%

17% 16%

16% 16%

15% 15%

13% 15%

20%

20%

20%

20%

15%

15%

15%

15%

18% 15%

31%

32%

34%

36%

39%

2006 Northeast

189

339

247

456

464

356

2004 2005 2006 2007 2008 Commercial Banks Thrifts Other

2009

600

43

43

46

400

279

308

257

200

255

339

270

134 126

0

60 50 40 30 20 10 0

5.7 4.3

4.5

12.3

14.2

18.8

14.6

9.7

26.9

28.8

29.2

2008

2009

4.4

17.4

18.6

15.6

19.5

20.4

23.1

2004

2005

2006

Commercial Banks

2007 Thrifts

Other

Duration gap (months) for FHLB regional banks

Geographic distribution of MPP/MPF loans

2005 Midwest

73

Capital distribution among members

200 150 100 50 0

Held-to-maturity securities

$ bn

800

2007 2008 2009 Southeast Southwest West

Bank Boston New York Pittsburgh Atlanta Cincinnati Indianapolis Chicago Des Moines Dallas Topeka San Francisco Seatle

2006 2007 2008 2009 min 0.2 0.5 -0.7 2.6 -0.7 0.3 -0.6 -1.2 0.1 -1.2 0.7 1.6 3.5 6.1 0.6 0.8 0.4 5.7 1.8 -1.3 1.0 0.4 -0.2 0.0 -0.6 1.6 1.2 -0.2 -1.8 -1.8 0.9 0.0 -0.3 1.0 -0.3 0.0 -1.4 -7.3 1.2 -7.3 0.2 0.9 2.3 4.8 0.2 1.3 1.4 2.9 0.0 -1.0 0.7 1.5 3.4 3.7 0.6 0.0 0.0 0.2 0.0 -2.2

max 2.6 1.0 6.1 5.7 2.5 1.6 1.0 1.2 4.8 2.9 3.7 1.3

STDV 1.0 0.8 2.0 2.2 1.0 1.4 0.5 2.8 1.5 1.4 1.3 1.1

FHLB regulatory capital sound for now, Q4 09

System bank Boston New York Pittsburgh Atlanta Cincinnati Indianapolis Des Moines Dallas Topeka San Francisco Seattle Chicago Total 10 June 2010

Regulatory Capital ($mn) 3,877 5,879 4,415 9,185 4,151 2,831 2,953 2,897 1,980 14,657 2,690 4,502 60,017

Required Reg Capital ($mn) 2,499 4,578 2,612 6,052 2,855 1,864 2,586 2,604 1,705 7,714 2,044 4,152 41,265

Capital to Assets 6.21% 5.14% 6.76% 6.07% 5.82% 6.08% 4.57% 4.45% 4.65% 7.60% 5.26% 4.34% 5.82%

Capital Surplus ($mn) 1,378 1,301 1,803 3,133 1,296 967 367 293 275 6,943 646 350 18,752

Permanent Capital ($mn) 3,877 5,874 4,415 9,185 4,151 2,831 2,953 2,897 1,668 14,657 2,690 N/A 55,198

Reqd RiskBased Cap ($mn) 1,526 607 2,827 3,010 389 889 827 507 647 6,207 2,158 N/A 19,594

Risk-Based Cap Surp ($mn) 2,351 5,267 1,588 6,175 3,762 1,942 2,126 2,390 1,021 8,450 532 N/A 35,604 415

Barclays Capital | AAA Handbook 2010

Freddie Mac (FHLMC)

Rajiv Setia, James Ma

Description

Ratings table

% $ Index

% £ Index

Total assets

2.814

NA

USD842bn

Freddie Mac is one of the two largest suppliers of funds to the US secondary market in mortgages. Its core function is to securitise mortgage loans originated by lenders in the primary market into FHLMC MBS. It also operates a substantial investment to facilitate liquidity and stability in the secondary mortgage markets. In September 2008, FHFA placed FHLMC under conservatorship, while agreeing to service senior and subordinate debt. As part of the conservatorship, FHLMC receives preferred equity investments from the US Treasury to make up for any GAAP net asset shortfall.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

Outlook

Risk weighting 20%.

Key features of the credit „

Purpose: Created in 1970 by a Congressional charter, Freddie Mac is a Government-Sponsored Enterprise (GSE) with a public mission to help develop a stable and liquid secondary market for residential mortgages and to improve access to mortgage credit.

„

Ownership and capital structure: Freddie Mac is a private corporation, but the US Treasury is a primary investor at the preferred equity level. It is regulated by the US government via the FHFA (Federal Housing Finance Authority), which oversees FNMA/FHLMC, as well as the FHLBs. FHFA is responsible for Freddie Mac’s safety and soundness and has authority over capital standards, mission supervision and receivership in case of default. FHFA placed FHLMC into conservatorship in September 2008, with the goal of restoring operational soundness. As part of that process, the US Treasury established a Preferred Stock Purchase Agreement (PSPA) with FHLMC; thus far, it has purchased $62bn in senior preferred shares, along with warrants for 79.9% of the common shares.

„

Asset structure and quality: Freddie Mac operates solely in the secondary market for mortgages, and its business is concentrated in two main areas. First, it owns a portfolio of mortgage-related securities, which is funded through the issuance of debt securities. The bulk of the portfolio is in agency MBS/loans, but non-agency securities comprise about $171bn (23%) of the retained portfolio. FHLMC also has significant offbalance-sheet liabilities, created via its role as a guarantor of MBS ($2.2trn outstanding at YE 09) – note that changes in accounting treatment have forced FRE to consolidate this amount on to its balance sheet starting Q1 10. It generates fee income from these guarantees, but is also exposed to credit losses. While the bulk of its credit book is in agency-conforming MBS, roughly $141bn (7%) is in Alt-A product.

„

Capital adequacy: The legislation governing Freddie Mac provides the basis for minimum capital, risk-based capital and critical capital requirements that are monitored by FHFA. Under conservatorship, the US Treasury has committed to inject senior preferred equity into FHLMC in any quarter when there is a net asset shortfall (ie, assets < liabilities under GAAP), in the amount of the shortfall. Through Q1 10, the cumulative draw was $62bn. The Treasury’s commitment under the PSPA is available indefinitely with no cumulative limit through 2012, and a maximum additional $200bn thereafter. The Treasury lacks the authority to increase the limit without consulting Congress.

„

Financial performance: Results have been sharply negative since Q3 08, but moderated somewhat from FY 08 to FY 09; 2009 net losses totalled $22bn, with another $4.1bn in dividends paid to the Treasury. Credit loss provisions in the guarantee book, OTTI on non-agency MBS in the retained portfolio, and MTM losses on derivatives have contributed to the loss. We expect losses to stay concentrated in the guarantee business, as most non-agency MBS holdings have already been marked down severely; recent accounting rule changes should cushion price deterioration.

„

Funding: In 2010, net portfolio growth should be moribund; as of Q1 10, FHLMC had less than $60bn of room to grow under the $810bn YE 10 portfolio cap, after zero growth YTD. With the Fed having exited the market, FRE has heavily favoured FRN and callable markets to fund itself economically; we expect this pattern to continue.

Strengths

Weaknesses

„

Under conservatorship, FHFA commits to paying interest and principal to bondholders while the Treasury ensures solvency.

„

FHLMC could be used as a policy instrument instead of for profit.

„

„

Strong government support, Fed purchases and access to liquidity and capital backstops from the Treasury.

After Fed purchases end, equilibrium valuations for GSE debt are uncertain, as is the GSEs’ ultimate form post-conservatorship.

„

The administration has shown some capriciousness in changing FHLMC’s portfolio and debt limits under conservatorship. However, we expect the portfolio business to be de-emphasised, ensuring the long-term supply backdrop remains favourable.

Key points for 2010-11 „

As the Treasury stake in FHLMC grows, dividend payments on preferred equity injections will surpass steady-state earnings. Closer ties to the government are inevitable and should increase investor comfort in FHLMC paper as a Treasury surrogate.

10 June 2010

416

Barclays Capital | AAA Handbook 2010

Public sector

Freddie Mac (FHLMC)

Financial summary – YE December $ 2005 Balance sheet summary ($ bn) Total assets 799 Retained portfolio 710 Tot. issued PCs 1,336 Holdings of FHLMC PCs 361 Tot. mortgage portfolio 1,685 Investments 57 Tot. equity 26 Core capital* 35 Tot. debt securities 740 Sub-debt 6 Senior preferred stock Preferred stock 5 Income statement summary ($ mn) Net interest income 4,627 Mgmt & guarantee income 2,076 Non-int. (derivatives) income -1,073 Tot. operating income 5,630 Tot. administrative expenses 1,535 Tot. non-interest expenses 3,100 Credit related expenses 347 Pre-tax profit 2,530 Net income 2,113 Diluted common shares 694 Net income per share ($) 3 Dividends/Common share ($) 2 Profitability (%) Return on assets 0.3 Return on equity 7.6 Oper. exp./Net income 72.6 Oper. exp./Assets 0.2 Credit expenses/Net income 16.4 Net int. margin 0.6 Balance sheet & capital ratios (%) Retained portfolio/Assets 88.9 Tot. debt securities/Assets 92.7 Core capital/Assets 4.4

Freddie Mac benchmark spreads versus Treasuries (bp)

2006

2007

2008

2009

805 704 1,477 354 1,827 69 27 35 744 6 6

794 721 1,739 357 2,103 42 27 38 739 4 14

851 805 1,827 425 2,207 19 -31 -13 843 5 46 14

842 735 1,870 441 2,251 72 4 N/A 807 1 52 14

3,412 2,393 -307 5,498 1,641 2,809 356 2,282 2,327 683 3 2

3,099 2,635 -2,441 3,293 1,674 8,801 3,060 -5,977 -3,094 652 -5 2

0.3 8.8 70.5 0.2 15.3 0.4 87.5 92.5 4.4

6,796 17,073 3,370 3,033 -32,092 -5,765 -21,926 14,341 1,505 1,651 22,190 36,725 17,529 29,837 -44,569 -22,384 -50,119 -21,553 1,468 1,468 -35 -15 1

-0.4 -6.1 -11.5 -2,501.6 -54.1 -3.0 0.2 0.2 -98.9 -35.0 0.4 0.8 90.7 93.0 4.8

94.6 99.1 -1.5

% ch (08-09) -1.1% -8.7% 2.3% 3.9% 2.0% 281.0% 113.0% -4.3% -77.8% 14.0% -0.8% % 151.2% -10.0% 82.0% 165.4% 9.7% 65.5% 70.2% 49.8% 57.0% 0.0% 57.6% -100.0%

-2.5 -161.3 -7.7 0.2 -138.4 2.0

58.2% 93.6% -155.1% 6.6% -295.8% 144.2%

87.3 95.8

-7.7% -3.3%

200 150 100 50 0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 2yr

27.5%

2yr

12.9%

10.3%

12.0%

14.8%

29.3%

31.8%

29.2%

31.4%

35.3%

37.3%

32.1%

23.7%

20.5%

25.7%

36.3%

25.5% 28.2%

2005 2006 2007 2008 2009 Ref. Bills & Discount Notes Callable Securities $ Reference Notes Other

Retained portfolio and debt cap ($bn)

1,000 900 800

FHLMC Debt Out 10 June 2010

Jul-08

10yr

30yr

Gross term debt issuance ($bn) 200 150 100 50 0 Floating Callable Rate

$ Ref. Notes

2006

Euro Ref. 2007

Sub Debt 2008

Other 2009

Apr-09

350 286 300 250 200 113 150 75 100 43 26 50 0 10 11 12 13 14

17 17

13

4

4

0

15 16

17 18

19

20 20+

13

Government capital infusion ($bn)

1,100

Oct-07

5yr

Bullet maturity profile ($bn)

22.6%

700 Jan-07

30yr

200 150 100 50 0 -50 -100 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10

2005

13.4%

10yr

Freddie Mac benchmark asset swap levels (bp)

Note: *Regulatory capital requirement not binding during conservatorship

Outstanding debt profile ($bn)

5y

Jan-10

Old FHLMC Cap

Oct-10 New Caps

35 30 25 20 15 10 5 0

Capital infusion

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10 417

Barclays Capital | AAA Handbook 2010

Freddie Mac (FHLMC)

Public sector

Guarantee fees versus operating income

Cumulative provisions and charge-offs

20 10 0 -10 -20 -30

100%

$ bn

50% 0% -50% 2005

2006 2007 2008 2009 Operating income (ex. guarantee fees) Guarantee fees Fees/Operating income ratio (RHS)

Single family mortgage delinquencies

Mortgage credit book: Mostly fixed rate 10% 8% 6% 4% 2% 0%

5% 4% 3% 2% 1% 0% 2004

2005

2006

2007

2008

Non-credit enhanced Credit enhanced (RHS)

2009

7.1% 11.5% 20%

14.7% 5.2% 16%

14.1% 4.4% 13%

12.0% 3.4% 13%

56%

60%

63%

67%

71%

2005

2006

2007

2008

2009

30-yr Fixed ARMs/FRN

Total single family

13% 18%

13% 18%

13% 18%

12% 18%

22%

21%

21%

21%

18%

23%

24%

24%

24%

25%

24%

24%

24%

24%

27%

2005

2006

2007

2008

2009

West

Northeast

Southeast

Southwest

Net interest income and net interest margin ($bn) $ bn

10% 20% 18%

25%

56%

52%

41%

2005

2006

2007

8% 18% 18%

< 60%

60% to 70 %

Balloons/Reset Others

2.5%

10

19% 15%

39%

44%

16% 13% 32%

16% 12% 28%

2008

2009

70% to 80%

above 80%

Investment portfolio mainly in agency MBS ($bn) Mortgage Loans, 138.8, 18%

Non-Agency MBS, 175.7, 23%

2.0% 1.5% 1.0%

5 0 2005 2006 Net interest income

2007

0.0% 2008 2009 Net interest margin (RHS)

FHLMC MBS in portfolio as % outstanding rebounds ($bn) 27.1%

24.0%

361

354

974

1,123

20.5%

23.2%

23.6%

357

425

441

1,382

1,403

1,429

30% 20% 10% 0%

2005 2006 2007 PCs held by Others % of PC owned (RHS) 10 June 2010

PCs and Structured Securities, 374.6, 50%

Other Agency MBS, 66.2, 9%

0.5%

$bn 2,500 2,000 1,500 1,000 500 0

15-yr Fixed Multifamily

Mortgage credit book: Current loan–to-value ratio

13% 18%

15

7.5% 9.8% 24%

2010

Geographical distribution of mortgage credit book

North Central

60 Cumulative, $bn 50 40 30 20 10 0 2004 2005 2006 2007 2008 1Q09 2Q09 3Q09 4Q09 1Q10 FHLMC Provisions FHLMC Charge-offs

2008 2009 PCs in Retained Portfolio

Total = $867.1bn

Retained portfolio: Liquidity ratios ($bn) 100 80 60 40 20 0

$bn 9.5%

11.4%

67.8

80.0

7.0% 50.2

8.0% 64.3

9.8%

15% 10%

72.2

5%

0% 2005 2006 2007 2008 2009 Liquidity portfolo (short term investments + cash) Ratio of liquidity/Retained portfolio (RHS) 418

Barclays Capital | AAA Handbook 2010

Federal Farm Credit Bank (FFCB) Description

Rajiv Setia, James Ma Ratings table

% $ Index

% £ Index

Total assets

0.267

NA

USD215bn

The Farm Credit System (Farm Credit) is the oldest of the US Government Sponsored Enterprises, established in 1916 when Congress created the Federal Land Banks. Farm Credit is a cooperative system of lending institutions owned by their respective borrowers. Today, the Farm Credit System comprises 96 lending institutions, five system banks – AgFirst, AgriBank, Farm Credit Bank of Texas, US AgBank, and CoBank – as well as the Federal Farm Credit Banks Funding Corporation, which accesses the bond markets. With $213bn in assets and $163bn in loans, Farm Credit funds approximately 39% of all US farm business debt.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

ST

P-1

A-1+

F1+

Stable

Stable

Stable

Outlook

Risk weighting 20%.

Key features of the credit „

Purpose: Farm Credit was created in 1916 to provide accessible credit to American farmers, ranchers, producers and harvesters of aquatic products, co-operatives and farm-related businesses.

„

Ownership, support, and regulation: Farm Credit is a federally chartered network of lending institutions created to provide loans to farmers and farm-related businesses. As a cooperative, Farm Credit is owned by its borrowers and has issued non-publicly traded stock. Farm Credit operates under authority granted by the Farm Credit Act. As a Government-Sponsored Enterprise (GSE), Farm Credit has access to funds at competitive rates and, as a result, can make competitively priced loans to its borrowers. Its GSE status also subjects Farm Credit to regulation by the federal government through the Farm Credit Administration. The Farm Credit Administration, an independent federal regulatory agency, has jurisdiction over the Farm Credit System institutions and is charged with examining credit and collateral quality, capitalisation, interest rate risk, management effectiveness and adherence to the Farm Credit Act. The Administration’s enforcement capabilities include the ability to issue cease and desist orders, suspend or remove directors, and impose civil or monetary penalties for violations. The Farm Credit Administration did not enforce any penalties on the Farm Credit System during 2009 and none were outstanding at 31 March 2010.

„

among industry categories and geographically, with the largest five states accounting for only 36% of all loans. This protects Farm Credit from climate and natural disasters affecting the ability of its borrowers to repay their loans. „

Capital adequacy: Farm Credit’s administration regulations require that each bank maintain permanent capital of at least 7% of risk-adjusted assets. As of 31 March 2010, all Farm Credit banks met the permanent capital ratios requirement and the ratios ranged between 15.2% and 19.0%. All banks must also hold a net collateral ratio of at least 104% of total liabilities. As of March 2010, all banks were in excess of this requirement, with ratios ranging from 105.5% to 108.9%.

„

Financial performance: Farm Credit’s 2009 net income was $2.9bn. Net interest income (NII) increased sharply (32%) from 2008. Farm Credit’s performance is highly dependent on farm business performance, which has remained healthy for the past 10 years according to the USDA. Farm Credit capital ratios have not grown because of increasing dividend and asset growth.

„

Funding: While financial performance has surpassed that of the housing GSEs, Farm Credit paper cheapened to housing GSE names as it was excluded from Treasury capital support and Federal Reserve purchases. Farm Credit’s banks and associations may not accept deposits and the associations cannot borrow from non-Farm Credit institutions. The banks primarily obtain funds through the issuance of Systemwide debt securities that are joint and several obligations. Longer-term debt issuance by Farm Credit was relatively stable in 2009 at $116bn, from $111bn in 2008. Outstanding Systemwide debt went unchanged during 2009, and actually decreased slightly (-1.0%) in Q1 10.

Asset structure and quality: Farm Credit’s loan portfolio is made up only of retail loans consisting primarily of long-term real estate loans. Net loans increased 2% during 2009. Non-accrual loans as a percent of total loans increased to 2.0% as of Q4 09, more in line with long-term historical norms (this averaged 2.5% in the 1990s). Farm Credit’s loan portfolio is well- diversified

Strengths

Weaknesses

„

Agriculture has long experienced favourable economic conditions due to consistent federal government support.

„

„

Well-diversified loan portfolio and good governance has enabled it to avoid recent scrutiny of housing-related GSEs.

Performance can be directly impacted by factors affecting the agricultural and rural economy, including weather conditions, prices of agricultural commodities and changes in government expenditures on agricultural programmes and price controls.

„

Joint and several liability and the Farm Credit Insurance Corporation reduce geographical concentration risk.

„

Exclusion from government capital and liquidity support, a result of comparatively conservative management, perversely could continue to hurt relative valuations of debt.

„

Less favourable conditions in the agricultural economy could weigh on System financial performance.

Key points for 2010-11 „

Expect a reversal in cheapening relative to housing GSE paper as Fed QE support has recently ended.

10 June 2010

419

Barclays Capital | AAA Handbook 2010

Public sector

Federal Farm Credit Bank (FFCB)

Financial summary – YE December 2009 2006

2007

FFCB-designated bond spread versus Treasuries (bp) 2008

2009

% ch

Balance sheet summary ($bn) Total assets 162.9 186.5 214.4 215.5 1% Net loans 2% 122.7 142.1 160.5 163.5 Investments -4% 30.6 33.8 43.8 42.2 Loan losses allowance 45% 0.7 0.8 0.9 1.4 Capital stock, PC, Pref. Stock 3.6 4.0 4.3 4.8 10% Unallocated surplus 7% 18.7 20.0 21.6 23.0 Fin assistance corp bonds 0.0 0.0 0.0 0.0 Total debt securities -2% 134.5 155.8 180.8 177.3 Income statement summary ($mn) Net interest income 3,584 4,060 4,072 5,392 32% Net non-interest expenses -1,087 -1,135 -1,225 -1,422 -16% LLPs -35 -81 -408 -925 -127% Pre-tax profit 2,462 2,844 3,069 3,045 -1% Net income 2,379 2,703 2,916 2,850 -2% Profitability (%) Return on assets 1.57 1.55 1.46 1.33 -9% Oper. exp/Income ratio 37.6 35.3 37.8 32.0 -15% Net interest margin 2.51% 2.45% 2.13% 2.62% 23% Capital adequacy (%) Total cap/Ttl assets 15.0 14.2 12.7 13.9 10% Debt/Total capital 5.67 6.06 6.90 6.19 -10%

250 200 150 100 50 0 -50 May-08

Aug-08

Nov-08

2y

5y

Feb-09

May-09

10y

FFCB-designated bond asset swap spread (bp) 200 150 100 50 0 -50 -100 May-08

Aug-08

Nov-08

2y

5y

Feb-09

May-09

10y

Total debt maturity profile ($bn) 50

46

40

30

26

30

17

20

13

9

10

7

6

4

3

3

1

16

17 18

19

20 21+

0 10

Bullet debt maturity concentrated in short maturities ($bn) 50 40

41 29

30

20

20

10

10

6

5

3

3

1

1

1

3

0 29.5 45.8 26.4 17 12.6 9.2 5.6 4.4 2.5 3.3 1.2 6.9

Debt distribution, as at 15 May 2009

FRNs 28%

Fixed Rate Non Callable Bonds 24%

10 June 2010

Other Discos 0.1% 7%

11 12

13

14 15

Debt structure ($bn) 200 175 150 125 100 75 50 25 0

0.4 24.2 32.4 37.7 21.5 17.9

2006 Discos Fixed Rate Callables FRNs

0.5 29.1 36.6

0.5 42.3

51.4

0.2

43.0

41.7

42.8

43.8

39.9

25.4 19.7

30.5 16.2

31.3 11.6

2007

2008 2009 Designated Bonds Fixed Rate Non Callable Bonds Other

Loan portfolio, YE 09

Designated Bonds 18% Fixed Rate Callables 23%

Agribusiness Communication Energy & water/ waste disposal 2% 14% Production & 5% Rural Intermediate Rural Residential Residential Term Real Estate Real Estate 24% 3%3% International Real Estate Mortgage 47%

Lease 2% Receivables Lease Receivables 1% 1% 420

Barclays Capital | AAA Handbook 2010

Federal Farm Credit Bank (FFCB)

Public sector

Non-accrual loans and non-performing assets 2.0%

1.0%

0.0%

2.60%

2.47%

0.43%

0.36%

2006

2007

9.08%

12.60%

1.40%

2.02%

2008

Non-performing loans and total risk funds 14% 12% 10% 8% 6% 4% 2% 0%

2.0%

37.3%

3,500 3,000

3,584

35.5% 4,060

37.6%

2006 2007 2008 2009 Nonperforming loans (as % of Loans - LHS) Total risk funds (as a % of loans - RHS)

Net interest margin

2.51%

2.45%

2006

2007

2.62% 2.13%

2.0% 1.5% 1.0%

Nebraska 4%

59.2% 5,392

4,072

2,500

0.5%

80% 60% 40% 20% 0%

Structure/ownership of the Farm Credit System

2008

2009

Net interest income and interest-to-revenue ratio

2006 2007 2008 2009 Net interest income (LHS) Ratio of net int. income/Total int. income (RHS)

10 June 2010

6% 0%

0.44%

2.5%

Net interest income and net interest income to total interest income ratio

4,000

18% 12%

2.12% 1.48% 0.50%

3.0%

6%

4,500

30% 24%

18.3%

3.5%

8% Minnesota Iowa 4% Illinois 4%

16.9%

0.0%

2009

California 10% Texas All other States 64%

18.6%

1.0%

Non-accrual loans/Total loans Non-performing assets/System combined capital

Geographic distribution: Top five states account for 31%, YE 09

19.9%

4,000 3,500 3,000 2,500 2,000 1,500 1,000

24.8%

23.7%

2,379

2,703

26.9%

31.3%

40% 30% 20%

2,916

2,850

10%

0% 2006 2007 2008 2009 Net income Ratio of net int. income/Total int. income (RHS)

Flow of funds

421

Barclays Capital | AAA Handbook 2010

Tennessee Valley Authority (TVA) Description

Rajiv Setia, James Ma Ratings table

% $ Index

% £ Index

Total assets

0.214

0.055

USD37bn

The Tennessee Valley Authority (TVA) is the largest power provider in the US, with 33,716 MW of LT-generating capacity available serving >9mn residents of the Tennessee Valley. Created under the Tennessee Valley Authority Act of 1933, TVA funded its operations through Congressional appropriations until 1959, when it was granted authority to access funding from the capital markets. TVA has been self-sufficient since 1959 and has been required to pay back a portion of its original appropriations investment to the US Treasury each year since. Currently, TVA finances its power operations through internally-generated funds and by issuing debt in global and domestic capital markets with a statutory limit of $30bn debt outstanding at any time. One of TVA’s six strategic objectives calls for it to continue the trend of debt reduction.

Moody’s LT senior unsecured Outlook

S&P

Fitch

Aaa

AAA

AAA

Stable

Stable

Stable

Risk weighting 20%

Key features of the credit „

„

„

Purpose: The TVA is a wholly-owned US government corporation, federally chartered under the Tennessee Valley Authority Act of 1933. Its primary objective is to supply affordable, reliable power and agricultural and industrial development to the Tennessee Valley region and provide flood control and navigation of the Tennessee River. Ownership, support, and regulation: TVA is owned by the US government. However, its debt is not guaranteed by the government and it does not receive any funding from US taxpayers. Instead, its debt obligations are backed solely by the proceeds of its power operations and can be met by raising rates when necessary. However, unlike investor-owned utilities, TVA is chartered as a profit-neutral government entity and must charge “rates as low as are feasible,” providing several benefits as well as additional regulatory oversight. First, TVA is exempt from federal, state and local corporate income taxes (in lieu of taxes, it makes payments of 5% of revenues to the states and localities it serves). Second, it has the authority to borrow up to $150mn from the Treasury under certain circumstances. TVA files annual, quarterly and current reports with the SEC, but is not required to register securities with the SEC. In December 2004, the Consolidated Appropriations Act of 2005 was signed and required the restructuring of the board by increasing the three full-time board members to nine part-time members. Oversight of TVA is handled by the TVA Office of the IG, which conducts audits and investigations of TVA operations and reports findings to the board and Congress.

29 hydro plants, nine combustion turbine plants, 15 solar energy sites, one wind energy site, one pumped-storage plant, and one methane facility; it generated 167bn kWh of electricity in 2009. „

Capital adequacy: TVA’s capital adequacy has steadily improved since 2002, with a total capital/total assets ratio of 10.5% and a total capital/debt funding ratio of 18.6% in 2009, up from 9.6% and 17.5%, respectively, in 2008. TVA is not subject to minimum capital requirements like Fannie Mae and Freddie Mac, but is subject to statutory restrictions that limit the amount of securities outstanding at any time to $30bn, with debt proceeds used solely to fund power operations or refund existing debt.

„

Financial performance: Overall, in 2009, TVA sold 164bn kWh of electricity (versus 176bn in 2008), earning $11.3bn in revenue and resulting in net income of $726mn.

„

Funding and liquidity: While financial performance has surpassed that of the housing GSEs, TVA paper cheapened to housing GSE names as it was excluded from Treasury capital support and Federal Reserve purchases. TVA finances its power operations through internally-generated funds and by issuing debt in global and domestic capital markets. Securities on offer range from overnight discount notes to 50-year maturities. TVA paper consists of discount notes and power bonds, which include innovative structures, such as Valley inflation-indexed power securities (VIPS), Putable Automatic Rate Reset Securities (PARRS) and Electronotes™. TVA’s total debt outstanding has declined steadily from $27.7bn dollars in 1996, to $22.8bn in 2010, consisting primarily of debt with long-term maturities. Along with the $150mn in borrowing from the US Treasury, TVA also has access to unsecured lines of credit of $2.25bn.

Asset structure and quality: TVA has approximately $37.1bn in assets, which include 11 fossil plants, three nuclear plants and

Strengths

Weaknesses

„

Improving capital ratios and structure.

„

„

Has been steadily reducing its financing obligations while increasing profit margins.

Exclusion from government capital and liquidity support – a result of comparatively conservative management – could, perversely, continue to hurt relative valuations of debt.

„

Can raise rates to meet obligations.

„

Exposure to fuel costs and climatic circumstances, eg, drought.

„

Look for liquidity premium to bellwether agencies to decrease due to increased Fed ownership of the latter.

Key points for 2010-11 „

Expect reversal in cheapening relative to housing GSE paper, as Fed QE support is slated to end in 2010.

10 June 2010

422

Barclays Capital | AAA Handbook 2010

Public sector

Tennessee Valley Authority (TVA) TVA Power bonds asset swap spreads (bp)

Financial summary – YE September 2009 2006 Balance sheet summary ($bn) Total assets 34.5 Property, plant & equip. 24.4 Def. nuclear gen units 3.5 Investment funds 1.0 Def charges & other assets 2.9 Retained earnings 1.6 Proprietary capital 1.1 Total capital 2.7 Total debt securities 22.9 Income statement summary ($mn) 8,983 Operating revenue Operating expenses 7,560 Interest expenses, net 1,264 Loss: Impairment/Cancellation 0 Net income 113 Profitability (%) Return on assets 0.3 Oper. income/T revenue 16% Int. exp. as % of revenue 14% Capital adequacy (%) Total cap/Total assets 7.8 Ttl. capital/Debt funding 11.8

2007

2008

2009

% ch

33.7 24.8 3.1 1.2 2.2 1.8 1.0 2.8 22.6

37.1 25.8 2.7 1.0 5.2 2.6 1.0 3.6 22.6

40.0 26.8 2.4 1.0 7.3 3.3 0.9 4.2 22.6

8% 4% -12% 5% 41% 28% -9% 18% 0% % 8% 13% -192% N/A -11%

9,269 10,382 11,255 7,726 8,198 9,282 1,232 1,376 -1,272 0 0 0 423 817 726 1.3 17% 13%

2.2 21% 13%

1.8 18% 11%

-17% -17% -15%

8.3 12.4

9.6 15.8

10.5 18.6

9% 18%

Capital ratios improving 21 18 15 9.7 12 9 6.6 6 2004

6.9 2005

Nov-08 10yr

Oct-09 40yr

Apr-10 50yr

Total debt ($bn) 30 28 26 24 22 20 18 16

24.9

2003

11.8

12.4

7.8

8.3

2006

2007

9.6

2008

18.64 11 10 10.54 9 8 7 6 5 2009

50% 40% 30%

23.3

22.9

22.9

22.6

22.6

22.6

2004

2005

2006

2007

2008

2009

20% 10% 0%

46%

17% 11% 8% 2004

Capital structure ($mn)

43% 36%

29%

Total capital/Debt funding (LHS) Total capital/Total assets (RHS)

3,000 2,500 2,000 1,500 1,000 500 0

Apr-09 30yr

Outstanding debt maturity profile fairly stable 15.8

10.4

300 250 200 150 100 50 0 -50 May-08

10%

43% 31% 15% 10%

2005 2006 ST 11- through 30-yrs

45%

41%

33%

36%

16% 6% 2007

43% 41%

13%

12%

10%

4%

2008 2009 1- through 10-yrs 31- through 50-yrs

Interest expense as % of revenue ($mn)

306

1,244

1,565

1,102

1,148

1,134

1,763

1,041

2,571

992

3,291

927

-1,150

25%

-1,200

20%

-1,250 -1,300

15% 10%

-1,350

5% 0%

-1,400 2003

2004 2005 2006 2007 2008 2009 Other Proprietary Capital Retained Earnings

2004 2005 2006 2007 2008 Interest Expense, net Interest Expense as % of Revenue (RHS)

Outstanding debt maturities ($bn) 3 2 1 0 2010

10 June 2010

2012

2015

2017

2019

2021

2023

2025

2028

2030

2033

2035

2038

2042

2045

2056

423

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424

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JAPANESE PUBLIC SECTOR PROFILES

10 June 2010

425

Barclays Capital | AAA Handbook 2010

Japan Finance Corporation/JBIC (JFC) Description

Joseph Huang Ratings table

% $ Index

% £ Index

Total assets

0.136

NA

JPY28.0trn

The 100% government-owned Japan Finance Corporation (JFC) was formed on 1 October 2008 by merging Japan Finance Corp for Small and Medium Enterprises (JASME), National Life Finance Corp (NLFC), Agriculture, Forestry and Fisheries Finance Corp (AFC) and the international finance operations of the former Japan Bank for International Cooperation (JBIC). The Okinawa Development Finance Corp is also scheduled to be folded into this group in or after FY 12. The former JBIC ceased to exist after the re-organisation, but JFC continues to use the name JBIC. JFC assumed the outstanding debts of the four merged entities and is the bond issuing entity after October 2008.

LT Senior Unsecured (Domestic/Foreign) Outlook

LT Senior Unsecured

Moody’s

S&P

Fitch

Aa2/Aa2

AA/AA

NR

Stable

Negative

NR

R&I

JCR

AAA (Neg)

AAA

Risk weighting Assuming the debts of former JBIC and the other three public finance agencies, JFC is treated as a Japanese public corporation for regulatory capital purposes and maintains a risk weighting of 10%.

Key features of the credit „

Purpose: JFC assumes the policy goals of the four entities that it absorbed: JBIC supports Japanese firm’s trade financing and overseas investment activities. The SME Unit (the former JASME) provides long-term funds and guarantees to SMEs and accepts insurance on the Credit Guarantee Corp’s (CGC) guarantees on SME loans. The Micro Business and Individual Unit (the former NLFC) focuses on educational loans and lending to start-ups. The Agricultural, Forestry, Fisheries and Food Business Unit (the former AFC) mainly supports the utilisation and vitality of industries related to natural resources. In addition to these four main business units, JFC also established its ‘Crisis Response Operations’, which provide credits to designated financial institutions (ie, Development Bank of Japan and Shoko Chukin Bank) in response to the global financial turmoil. Given JFC’s critical policy role as the integrated public financial institution, we believe broad-based government support will continue to underpin its credit profile.

„

Ownership and support: JFC is 100%-owned by the Japanese government. The Ministry of Finance supervises JFC’s budget plans and financial statements, which need approval from the Diet. JFC’s integral link with the central government comprises capital injections, low-cost funding from the Fiscal Investment and Loan Programme (FILP), guarantees for debt issuance and managerial support. Importantly, the government, as JFC’s main creditor, has subordinated its JFC lending to JFC’s own bonds.

„

Massive net loss and capital injection: In the six months ended on 31 March 2009, JFC reported a massive net loss of JPY655bn (c.USD6.6bn), mainly due to a loss of JPY633bn in its Credit Insurance Programme account. This programme was set up in response to the government’s mandate to support SMEs. As such, the government injected JPY972bn to JFC to offset the negative impact from the substantial “policy-directed national burden”. This case strengthened our view that despite all the organisational changes, the strength of state support will remain solid.

„

Asset structure and quality: JFC’s financials were disclosed by the four main business units on a separate basis, with JBIC accounting for c.33% of JFC’s aggregate assets. JBIC’s exposures (ie, loan, investment and guarantees) are entirely non-Japanese, of which 35% are loans to the Asian-Pacific region. JBIC’s asset quality has improved over recent years and is the strongest among the four entities within JFC. At end-September 2009, the non-performing loan (NPL) ratio of JBIC fell 13bp h/h to 2.44%. The former AFC came second after JBIC, with an NPL ratio of 3.5%. The former NLFC came third, with an NPL ratio of 7.7%. The former JASME appeared the weakest, with an NPL ratio of 10.3%. Given the lagging effect of asset quality deterioration after the economic downturn, we believe JFC’s stand-alone asset quality will remain under pressure but that it will be alleviated by the government’s various support mechanisms.

„

Link to sovereign credit quality: JFC’s ratings are highly reliant on sovereign credit quality. As we do not expect any change in JFC’s ownership structure, we also do not foresee any change in this relationship. However, the underlying trend in the Japanese government’s debt dynamics is likely to present challenges over the coming years (ie, the high debt-to-GDP ratio and the increased government budget deficit). Hence, any negative rating actions on Japan’s sovereign creditworthiness would inevitably have an adverse impact on JFC’s ratings as well.

„

Changes on the former JBIC: The erstwhile JBIC has two core operations: the Overseas Economic Cooperation Operation (OECO) and the International Finance Operation (IFO). The IFO account was transferred to JFC and continues its business model. The OECO account, where the bank provides Official Development Assistance (ODA) concessionary loans to developing countries, was taken over by the Japan International Cooperation Agency (JICA).

Strengths

Weaknesses

„

The important and integrated policy roles to support the Japanese economy, especially SMEs.

„

Long-term pressure on Japan’s sovereign credit quality.

„

„

The strong and broad-based support mechanism from the central government.

Asset quality problems stemming from the rapid expansion in directed lending.

Key points for 2010 „

Any negative rating action on Japan’s sovereign ratings will inevitably drag down JFC’s credit ratings as well.

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Public sector

Japan Finance Corporation/JBIC (JFC)

Financial summary – YE Mar

Credit spreads (USD, govt guaranteed, Bid Z-spread, bp)

JPY Balance sheet summary (JPY bn)

FY 06

FY 07

FY 08 % Chg

Total assets

20,822.7 20,098.4

9,757.0

-51.5

Loans

18,828.8 17,625.5

7,243.1

-58.9

Shareholder's equity Total debt

9,030.0

9,428.6

1,945.9

-79.4

10,070.9

9,025.6

6,113.1

-32.3

329.0

307.3

239.2

-22.1

588

588

94

-84.1

Cash and deposit Income statement summary (JPY bn) Interest on loans Net interest revenue

226

246

28

-88.8

Operating profit

202

215

28

-87.0

Operating expenses Net income

26

27

8

-69.8

274

275

27

-90.2

120 100 80 60 40 20 0 May-09 Jul-09

Return on assets

1.3

1.4

0.3

Return on equity

3.0

2.9

1.4

Cost/Income ratio

12.8

12.5

Debt maturity structure, May 2010 800

Total capital/Total assets (%)

643 395

400

235

29.0

111

Government guaranteed bonds

2.1

1.9

3.7

43.4

46.9

19.9

2012 2013

2014 2015

2016 2017

100.0

199.0

70.0

-64.8

88.4

149.5

175.5

17.4

Capital structure, FY 08

2018 >2018

EUR 6%

USD 48%

Solvency and RoE 50%

Others 9%

40%

6%

46.9%

43.4%

41.3%

4%

3.6%

3.0%

30%

2.9%

2% 1.4%

Capital 53%

20%

19.9%

10% FY 06

Return on equity (R)

Asset composition, FY 08

0% -2%

FY 05

FY 07

FY 08

Total capital/total assets (L)

Outstanding loan distribution, FY 08 Others Cash and 6% deposit 2%

Europe 11%

Others 7% Asia-Pacific 35%

Long-term loans 75%

10 June 2010

100

Debt currency breakdown, May 2010

JPY 46%

Clients' liabilities for acceptance & guarantees 17%

50

Bond debt (JPY bn)

Note: All the financials mentioned on this page refer to JBIC, not JFC. FY 06 and FY 07 figures refer to the former JBIC. FY 08 figures refer to the new JBIC under JFM. Fiscal year runs from April to March, but FY 08 covers the period from 1 October 2008 to 31 March 2009. Accounts based on Japanese GAAP (ie, no special public sector accounting standards).

Retained earnings 38%

100

0

Bond issuance (JPY bn) Zaito agency bonds

217

200

Leverage and capital ratios Loans/Total capital (times)

Jan-10 Mar-10

JFCORP 4.625 Dec 2014

600

Profitability (%)

Sep-09 Nov-09

Middle East 23% America 24% 427

Barclays Capital | AAA Handbook 2010

Japan Expressway Holding and Debt Repayment Agency (JEHDRA) Description

Joseph Huang

Ratings table

% $ Index

% £ Index

Total assets

0.006

NA

JPY41.7trn

Japan Expressway Holding and Debt Repayment Agency (JEHDRA) was established as an independent administrative institution on 1 October 2005, with the privatisation of four highway-related public corporations, including Japan Public Highway Corporation. The new expressway agency assumed the vast majority of debts and road assets of these privatised entities and will also undertake new debts related to road construction in accordance with “agreements” established with operating road entities (six new entities). JEHDRA’s total assets stood at JPY41.7trn (USD421bn) at end-March 2009.

LT Senior Unsecured (Domestic/Foreign) Outlook

LT Senior Unsecured

Moody’s

S&P

Fitch

Aa2/NR

AA/AA

NR

Stable

Negative

NR

R&I

JCR

AAA (Neg)

NR

Risk weighting JEHDRA is treated as a Japanese public corporation for capital adequacy and has a weighting of 10%.

Key features of the credit „

Purpose: JEHDRA was established to assume and repay the debts (about JPY40trn in 2005) accumulated by four previous highway-related entities over a 45-year period to minimise the burden on the general public. To do this, JEHDRA will lease the road assets to the six operating road entities, with the proceeds being used to service and ultimately repay its inherited debt. In addition, the new agency may acquire new debt related to the construction of “genuinely needed expressways”.

„

Impact from discount on tolls: To promote the effective utilisation of expressways, under Japan’s economic stimulus package, JEHDRA and expressway firms lowered tolls by offering a special weekend toll ceiling of JPY1,000 (unlimited distance) and an all-day weekday discount of 30-50% for a two-year period ending at end-March 2011. As a result, JEHDRA made JPY2.7trn (c.USD27bn) of provisions for these toll discounts in FY 08 ended on 31 March 2009. To offset this negative impact, JEHDRA recorded a significant one-off profit by offloading JPY3.0trn of debt to the government’s general account.

„

Financial performance: Despite the global economic downturn and its short track record, JEHDRA’s operating performance has been largely stable, helped by low financing costs and steady leasing income. Indeed, the average funding cost of interestbearing liabilities edged up just slightly to 1.62% at end-March 2009, from 1.59% a year earlier. That said, we believe long-term traffic volume projections, in line with demographic trends, will show limited growth prospects. While details of the agreements between JEHDRA and each operating entity are heavily influenced by the assumption of traffic volumes, JEHDRA’s longterm revenue streams will require attention. A more determinable variable will be the amount of new road construction. However, despite privatisation, such plans could still be susceptible to the political motives of central and local governments, in our opinion.

„

Funding: On a management account basis, total debt balance fell 10.8% y/y to JPY31.3trn at end-March 2009, which is JPY432bn lower than the planned debt balance. On a financial statement basis, about 10% of total debt was due within one year. Bonds, accounting for 63% of total debt, were mostly guaranteed or subscribed by the government. Increasingly, the agency is issuing Zaito agency bonds – ie, bonds without government guarantees, which accounted for about 20% of annual bond issuance. JEHDRA was able to extend the duration of its borrowing by issuing 40y bonds: JPY240bn issued in FY 07 and another JPY110bn issued in FY 08. While a degree of refinancing risk remains, funding costs are still low and being well supported by the government. Hence, near-term funding problems are unlikely, in our opinion.

Ownership and support: JEHDRA is 75%-owned by the central government, and the remainder is held by local governments, including Metropolis of Tokyo (4.8%). The Ministry of Land, Infrastructure, Transport and Tourism (MLIT) remains heavily involved in the supervision, planning, budget, debt repayment and funding of JEHDRA’s operations. Given the importance of the road operations to the economy and ownership structure, we believe government support would be forthcoming in the event of financial difficulties. This support could take the form of capital injections, funding and/or debt guarantees. Therefore, we believe JEHDRA’s credit profile is strongly linked to the sovereign.

Strengths „

„

Strong state support, evidenced by 100% government guarantees and capital injections.

Weaknesses ownership,

„

Critical policy role as the manager of expressway assets and debt repayment on behalf of the government.

„

Predictable cash-flow generation (ie, c.JPY900bn net highway lease income), underpinned by the virtual monopoly position of highway operations throughout Japan.

„

Potential political interference.

„

Declining traffic volume over the long term, given Japan’s limited prospect of economic growth.

„

The pressure on Japan’s fiscal position would pose medium-term risk of a downgrade in JEHDRA’s credit ratings.

Key points for 2010 „

Further demonstration of ability to issue longer-dated bonds to lower refinancing risk.

„

Ability to continue to reduce funding costs and meet planned debt-reduction targets.

10 June 2010

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Public sector

Japan Expressway Holding and Debt Repayment Agency (JEHDRA)

Financial summary – YE Mar

Credit spreads (USD, govt guaranteed, Bid Z-spread, bp)

JPY Assets (JPY bn) Current assets

FY 06

FY 07

FY 08 % chg

379.3

271.4

318.7

17.4

Fixed Assets

42,091.7 41,752.9 41,351.8

-1.0

Total Assets

42,471.1 42,024.4 41,670.6

-0.8

Liabilities and Capital (JPY bn) 4,760.0

4,534.2

of which bonds

3,939.3

3,780.2

1,635.3

-56.7

605.5

623.3

1,599.6

156.6

31,818.9 31,067.5 28,439.4

-8.5

60

3,492.0

Debt maturity structure, May 2010

5,881.6

6,411.7

7,107.5

10.9

436.1

836.2

1,405.2

68.0

1,896.3

1,899.7

1,792.6

-5.6

4,000

979.1

986.5

867.4

-12.1

2,000

563.3

-2.8

304.1

-25.3

Net income

383.3

399.0

569.0

42.6

Debt/capital (X) Debt/total assets

6.0 83.8%

5.4 82.6%

4.3 74.1%

Short term debt/total debt

12.8%

12.7%

10.5%

0

Leverage and capital structure

Bond issuance (JPY bn) Zaito agency bonds Government guaranteed bonds

>2018

579.3 407.2

2,1782,107 1,9812,325 2,403

2018

609.2 369.9

878 739 616 1,167

2017

Financial and other expenses Operating profit

5,771

6,000

2010

Net highway leasing income

8,000

2016

-2.9

2015

36,589.5 35,612.6 34,563.0

Income statement summary (JPY bn) Highway leasing and other income

Jan-10 Mar-10

JAPEXP 4.625 Oct 2013

2014

-30.1

of which retained earnings

Sep-09 Nov-09

3.3

7,598.2

Shareholders equity

Jul-09

2013

20,071.1 19,415.0 20,056.8 10,960.7 10,874.7

0 May-09

2012

of which bonds of which borrowings

-23.0

2011

of which borrowings

Total Liabilities

90

30

Current liabilities

Long-term liabilities

120

Bond debt (JPY bn)

Debt currency breakdown, May 2010

530.0

610.0

590.0

-3.3

2,190.0

2,483.0

2,393.0

-3.6

Note: Fiscal year runs from April to March (eg, FY 08 covers April 2008 to March 2009).

JPY 99.8%

USD 0.2%

Organisational structure post privatisation Road operation, management and construction

Succeeded road assets and existing debt of four corporations

Leasing Fees East Nippon Expressway Japan Highway Public Corp Split into three entities

Central Nippon Expressway West Nippon Expressway

To merge after operations stablise Honshu-Shikoku Bridge Authority

Honshu-Shikoku

Metropolitan Expressway Public Corp

Metro Expressway

Hanshin Expressway Public Corp

Hanshin Expressway

10 June 2010

Japan Expressway Holdng and Debt Repayment Agancy (JEHDRA)

Creditors, including FILPs

429

Barclays Capital | AAA Handbook 2010

Japan Finance Organization for Municipalities (JFM) Description

Joseph Huang

Ratings table

% $ Index

% £ Index

Total assets

0.025

0.014

JPY23.4trn

Japan Finance Organization for Municipalities (JFM) is a 100% localgovernment-owned policy institution that specialises in lending to Japanese local governments. As part of structural reforms to Japanese public financial institutions, the assets and liabilities of the former JFM were taken over by Japan Finance Organization for Municipal Enterprises in October 2008. The entity received a c.JPY17bn capital injection from all local governments and returned the same amount of capital to the central government. In June 2009, the entity experienced another organisational change including expanding lending areas and changing its name to the current one. JFM is the largest bond issuer in the domestic market, with about JPY19trn (USD190bn) of bonds outstanding.

LT Senior Unsecured (Domestic/Foreign) Outlook

LT Senior Unsecured

Moody’s

S&P

Fitch

Aa2/Aa2

AA/AA

NR

Stable

Negative

NR

R&I

JCR

AAA (Neg)

NR

Risk weighting JFM is treated as a Japanese public corporation for capital adequacy and has a risk weighting of 10%.

Key features of the credit „

Purpose: The former JFM was established in 1957, with the aim of providing long-term and low-interest-rate funds to local governments to contribute to the sound management of their municipal enterprises. As a conduit for local governments, JFM’s public policy role focuses on maintaining affordable public utility rates (eg, water and sewage systems) and reducing the financial burden of local governments. Its loans stood at JPY22.2trn at end-March 2009, and accounted for around 10% of all local governments’ debt.

„

Changes after the reform: Following the reforms aimed at decentralising government finances, the newly-formed JFM withdrew from lending to local public corporations related to toll roads and housing supply. Instead, the focus of lending has been put back to projects tied to community facilities (eg, water supply, hospitals and public housing). Also after the reform, the new JFM operates two accounts: the General Account comprises new JFM operations while the Management Account warehouses former JFM assets and debt. Central government guarantees on existing debt are unaffected by the reform.

„

Ownership and support: The new JFM is 100% owned by all of Japan’s local governments (ie, prefectures, cities, wards, towns and villages). Despite the lack of direct central government ownership, we believe the new JFM will continue to benefit from the involvement and firm support of the central government, given JFM’s critical policy role. The new JFM is still required to submit budget plans and various financial reports to the Ministry of Internal Affairs and Communications (MIC). However, JFM is not dependent on subsidies and loans from the central government. Instead, JFM relies completely on the bond market for its funding requirements.

„

Reclassification of reserves: After the reform in October 2008, the former JFM transferred its reserve for interest rate volatility to the new JFM. This reserve stood at JPY3.3trn at end-March 2009, and serves as the buffer to cope with any refinancing risk stemming from a rise in interest rates. However, after the reform, the reserve has been accounted as “liability” rather than “net asset” on the balance sheet. This accounting change reduces JFM’s reported capital ratios.

„

Persistent duration gap: JFM has a duration mismatch between assets and liabilities, reflecting the 25y average maturity of its fixed-rate lending and its shorter-dated funding profile (mainly 10y bonds). While the entity has issued longer-dated instruments recently, the average duration of its loans is still 7.71 years, versus 4.76 years for that of bonds outstanding. The duration gap was largely flat y/y and stood at 2.95 years at end-March 2009. JFM’s duration gap poses significant refinancing risks should interest rates climb from the relatively low base at present. In view of this situation, from FY 09 JFM has sought to mitigate interest rate risk by issuing super-long-duration bonds and leveraging interest rate swaps. JFM’s targets include: 1) keeping the outlier ratio (ie, the ratio of interest rate risk to interest volatility reserves and other capital, following a +/-200bp parallel interest-rate shock) below 20%; and 2) keeping the duration gap at two years or less.

„

Asset structure and quality: Long-term loans account for 95% of JFM’s total assets. It is also worth noting that the new JFM lends only to local governments, excluding the previously-eligible local public corporations. JFM’s track record of asset quality remains intact, and this has been assisted by tight supervision from the MIC. JFM’s asset quality is strong, with no defaults on its loans since the inception of the former JFM in 1957. In FY 08 ended on 31 March 2009, there were no loans past due over three months.

Strengths

Weaknesses

„

„

Persistent asset-liability mismatch in terms of durations.

„

Industry concentration, with lending focused on governments, which are generally with high debt burden

„

Important policy role of financing local governments, with very strong backing from the central government. Healthy asset quality, with no non-performing loans.

local

Key points for 2010 „

The progress of terming out debt duration to reduce the duration gap of its loans and bonds.

„

The long-term pressure on Japan’s fiscal position at both national and local levels.

10 June 2010

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Public sector

Japan Finance Organization for Municipalities (JFM)

Financial summary – YE Mar % Chg

Total assets

25,446.8 24,752.2 23,369.6

-5.6

Loans

24,267.4 23,230.0 22,215.3

-4.4 NM 16.8

922.5

255.5

-72.3

Income statement summary (JPY bn)

May 09 Jul 09

Interest on loans

730

687

291

-57.6

Net interest revenue

349

346

136

-60.7

Operating profit

344

341

131

-61.7

2

1

1

-17.9

Operating expenses

GBP JFM 5.75 Aug 2019

Debt maturity structure, May 2010

0

0

-110

NM

4,000

344

341

20

-94.0

3,000

Return on assets

1.4

1.4

0.1

Return on equity

10.9

9.8

38.5

0.5

0.4

0.9

Special gains/losses Net income Profitability (%)

2,000 1,000

7.7

6.6

418.5

12.4

14.1

0.2

Zaito agency bonds

360.0

370.0

310.0

-16.2

Government guaranteed bonds

861.8

772.4

1,018.6

31.9

Total Capital/Total assets (%)

Capital structure, FY 08

EUR and other 1% USD 2%

JPY 97%

Solvency and RoE 16%

Capital 31%

12.1%

10.9%

12%

12.4% 10.8%

14.9%

14.1% 9.8%

8% 0.6% 4% FY 05

FY 06

Return on equity& reserves (R)

Asset composition, FY 08

10 June 2010

845 826

Debt currency breakdown, May 2010

Note: FY 08 covers the period from 1 August 2008 to 31 March 2009, except for bond issuance that covers the 12 months ended on 31 March 2009.

Long-term Loans 95%

1,268 1,070

Bond Debt (JPY bn)

Bond issuance (JPY bn)

Retained earnings 69%

1,613

780

0

Leverage and capital ratios Loans/Total capital (times)

2,921 2,139 1,861 2,228

2010

Cost/Income ratio

Sep 09 Nov 09 Jan 10 Mar 10

>2018

408.1

3,495.4

2018

3,154.4

2017

Cash and deposit

53.1

21,003.9 19,962.9 23,316.5

2016

Total debt

2015

Shareholder's equity

120 100 80 60 40 20 0

2014

FY 08

2013

FY 07

2012

FY 06

2011

JPY Balance sheet summary (JPY bn)

Credit spreads (GBP, govt guaranteed, Bid Z-spread, bp)

FY 07

14% 12% 10% 8% 6% 4% 2% 0%

FY 08

Net assets & reserves/total assets

Bond issuance breakdown in FY 08

Others 4% Cash and Deposit 1%

Zaito agency bonds 8% Government guarantee bonds 82%

Private placement 10%

431

Barclays Capital | AAA Handbook 2010

Development Bank of Japan Inc. (DBJ) Description

Joseph Huang Ratings table

% $ Index

% £ Index

Total assets

0.037

NA

JPY15.0trn

The Development Bank of Japan Inc. (DBJ) is one of Japan’s major policy financial institutions. As part of a long-term privatisation process, DBP was converted to a joint-stock company on 1 October 2008. However, in response to the global economic downturn, the government expanded DBJ’s policy role and amended the DBJ Law in June 2009. The revised law enabled the government to extend its DBJ investment period to end-March 2012, and the timing of DBJ’s full privatisation was extended to 2017-19 from 2013-15. For the nine months ended on 30 September 2009, DBJ had extended JPY2.6trn of emergency measure loans and purchased JPY361bn of commercial paper. With total assets of JPY15trn, DBJ’s balance sheet size is smaller than its peers (JFM and JFC), as well as major private-sector banks.

LT Senior Unsecured (Domestic/Foreign) Outlook

LT Senior Unsecured

Moody’s

S&P

Fitch

Aa2/Aa2

AA-/AA-

NR

Stb

Stb

NR

R&I

JCR

AA

AAA

Risk weighting DBJ is currently 10% risk weighted under the domestic regulations. This could change toward the targeted privatisation period during 2017-19. For instance, if DBJ starts to take deposits, its Basel II risk weight would be 20% under current ratings.

Key features of the credit „

Purpose: DBJ’s prime objective is to provide long-term, low-cost, fixed-interest financing and investments for projects that have a high policy priority but cannot attract sufficient support from the private sector. The bank finances urban redevelopment, power generation, environmental protection, regional transportation, technological development, and industrial revitalisation projects, etc. Since FY 01, DBJ has also become directly involved in supporting distressed private-sector companies. For instance, DBJ had been supporting Japan Airlines (JAL) Group before its filing for bankruptcy in January 2010. Now DBJ is one of the main banks of JAL’s high-profile three-year restructuring plan.

„

A step back from privatisation: Despite its privatisation plan, DBJ has expanded its policy role amid the global financial turmoil. From December 2008, DBJ has been one of the two designated institution leading government’s “crisis response programme” to provide financing to and purchase commercial paper from midand large-sized corporations. In February 2010, the government extended DBJ’s crisis response operations for one year until endMarch 2011. We view the move as near-term credit positive for DBJ, as it reinforced DBJ’s policy importance.

„

Strategic uncertainty: On the other hand, we believe DBJ’s renewed lead in policy lending will weigh on its stand-alone credit fundamentals and impinge on its longer-term strategy to increase self-handled funding (ie, bonds issued without government guarantees). Longer term, we believe that establishing a commercially-viable business model and market niche will be challenging for DBJ. The bank plans to increase businesses related to project screening, structured financing, and fund investment. However, with our expectation of intense competition from megabanks, DBJ’s business will face longterm execution risks, in our view.

„

Asset quality weakened: Loans account for c.88% of DBJ’s total assets. At end-September 2009, based on Financial Revitalisation Law standards used by private-sector banks, DBJ’s NPL balance rose 138% h/h to JPY461bn, equal to 3.44% of total lending. We believe the sharp rise in NPLs was mainly due to DBJ’s increased involvement in the rehabilitation of private-sector firms. The asset quality of DBJ’s loans to local-government-related projects (so-called “third-sector” projects) improved in H1 FY 09 but remained weak. The NPL ratio of third-sector loans fell 110bp h/h to 7.6% at end-September 2009.

„

Capital and funding: DBJ’s capitalisation was strengthened by the government’s capital injection of JPY103bn in September 2009. At end-September 2009, the bank had a solid Tier 1 ratio of 24.4%. DBJ does not collect retail deposits and therefore obtains large amount of its funding from borrowing under the Fiscal Investment and Loan Programme (FILP). It has also actively diversified into government-guaranteed bonds, zaito agency bonds (ie, without explicit government guarantees) and interbank borrowings. Given DBJ’s policy importance and high dependence on wholesale funding, we believe the government will continue to support DBJ’s need for capital and funding, despite DBJ’s longer-term privatisation plan.

„

Ownership and support: DBJ’s credit ratings enjoy a high level of state support, reflecting the government’s 100% ownership. Toward full privatisation, we believe that DBJ will be rated more as a stand-alone entity, but the withdrawal of government support will be protracted. Under the revised DBJ Law, the government plans to review DBJ's current organisation and status by endMarch 2012. DBJ is now supervised by the Ministry of Finance (and the Prime Minister for certain operations). If it collects deposits, it will be supervised by the Japanese Financial Services Agency (FSA).

Strengths

Weaknesses

„

High likelihood of support from the government.

„

Long-term pressure on Japan’s fiscal position.

„

Strong loss absorption capacity due to its solid capital position.

„

Latent asset quality pressure resulting from its crisis response operations.

Key points for 2010 „

Any change in DBJ’s role as a policy lender for wholesale borrowers in Japan.

„

If treated as a deposit-taking financial institution, the new DBJ could become 20% risk weighted.

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Public sector

Development Bank of Japan Inc. (DBJ)

Shareholder's equity Total debt

2,010.3

1,981.4

2,072.6

2,086.5

11,266.3 10,595.6 10,135.7 11,580.9

Cash and deposit

12.0 4.7 0.7 14.3

28.2

40.3

182.9

67.5

-63.1

366

326

306

130

-57.4

Income statement summary (JPY bn) Interest on loans Net interest revenue

96

93

104

52

-50.4

Operating profit

71

69

58

28

-51.8

Operating expenses

26

25

30

18

-40.5

Net income

92

75

53

-128

-344.0

Return on assets

0.7

0.6

0.4

-0.9

Return on equity

4.6

3.8

2.5

-6.2

26.7

27.0

34.0

38.9

Profitability (%)

Cost/Income ratio Leverage and capital ratios

6.4

6.1

5.5

5.8

14.7

15.1

16.5

14.9

Zaito agency bonds

200.0

235.0

289.8

325.5

12.3

Government guaranteed bonds

118.8

373.8

378.4

200.0

-47.1

Total capital/Total assets (%)

Jul 09

Sep 09 Nov 09 Jan 10 DBJJP 4.25% Jun 2015

1,000 800 600 400 200 0

899 529 353

324

333

433

334

Debt currency breakdown, May 2010 EUR 5%

FILP borrowing 52%

Government guarantee bonds 18%

Others 13.9%

8% 6% 4% 2% 0% -2% -4% -6% -8%

6.0% 13.0%

4.6%

15.1%

14.7%

3.8%

20% 14.9%

16% 12%

2.5%

8% 4% -6.2%

0%

Loan breakdown by industry, FY 08 Real estate 12% Long-term loans 85.6%

Utilities 17% Others 21%

10 June 2010

16.5%

FY 04 FY 05 FY 06 FY 07 FY 07 Return on equity (L) Total capital/assets (R)

Asset composition, FY 08 Cash and deposit 0.5%

USD 10%

Solvency and RoE

Zaito agency bonds 13% Other borrowing 17%

230

Bond debt (JPY bn)

JPY 85%

Outstanding debt breakdown, FY 08

335 103

Bond issuance (JPY bn)

Note: Fiscal year runs from April to March (eg, FY 08 covers April 2008 to March 2009). Accounts based on Japanese GAAP (ie, no special public sector accounting standards).

Mar 10

Debt maturity structure, May 2010

2010

Loans/Total capital (times)

May 09

>2018

12,873.2 12,089.8 11,470.5 12,008.9

2018

13,685.9 13,078.9 12,527.0 14,028.1

Loans

2017

Total assets

120 100 80 60 40 20 0

2016

FY08 % Chg

2015

FY07

2014

FY06

2013

FY 05

Balance sheet summary (JPY bn)

2012

JPY

Credit spreads (USD, govt guaranteed, Bid Z-spread, bp)

2011

Financial summary – YE Mar

Transportation 28%

Manufacturing 22%

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Tokyo Metropolitan Government (TOKYO) Description

Joseph Huang Ratings table

% $ Index

% £ Index

Total debt

NA

NA

JPY11.1trn

Tokyo Metropolitan Government (Tokyo) is the largest prefecture in Japan. As the nation’s capital and economic/political centre, Tokyo’s FY 07 GDP (JPY93trn) was larger than Holland’s and accounted for about 18% of Japan’s total GDP It is also the largest local government bond issuer in Japan, with JPY7.1trn of bonds outstanding at endMarch 2009 (ordinary account basis), which is equivalent to about 18% of the total local government bond market, underlining its benchmark status. Tokyo is the largest local government in Japan in terms of revenue (2.6x the revenue of the second-largest prefecture Osaka in FY 08). Also, it does not rely on the central government’s subsidies and ranks highly in terms of intrinsic financial strength.

Moody’s

S&P

Fitch

LT Senior Unsecured (Domestic/Foreign)

NR

AA/AA

NR

Outlook

NR

Negative

NR

R&I

JCR

NR

NR

LT Senior Unsecured

Risk weighting Tokyo Metropolitan Government is treated as a Japanese local government for capital adequacy and has a risk weighting of 0%.

Key features of the credit „

„

„

Economic structure and performance: As the largest prefecture in Japan in terms of economic value, Tokyo is at the centre of the nation’s political and economic infrastructure. Most of Japan’s corporations have head offices in the capital, and it remains the heart of Japan’s financial markets. The prefecture has a relatively high concentration of exposure to the service, wholesale, and financial industries. It has a population of about 12.8mn – 10% of the nation’s total. Public finance: Despite the economic downturn, Tokyo remains the least reliant on the central government transfers, mainly due to its strong local tax base. Its own-source revenue ratio (ownsource revenues/total revenues) is around 82%, significantly exceeding the prefecture average of c.46%. Therefore, Tokyo is the only prefecture not to receive local allocation tax grants from the central government. Tokyo did encounter some fiscal difficulties in 1999, but a successful reconstruction programme has since put finances in order. The programme, launched by then new Governor Shintaro Ishihara, included cutting operating expenses and capital expenditures. In recent years, Tokyo’s fiscal reconstruction has led to a reduction in overall debt levels and thus, a stronger financial profile. Changes in tax allocation: As a result of FY 08 tax revisions, part of the local corporate tax is put under the control of the central government for re-allocation among all local governments. Tokyo expected the impact to result in a reduction in tax revenue of JPY190bn in its FY 09 budget, which appears manageable for Tokyo in terms of size (c.4% of total tax revenue in FY08), in our view.

„

Debt: Tokyo’s outstanding bonds (on all-account basis) peaked at JPY14.1trn in FY 01 and declined steadily since then, reaching JPY11.1trn at end-March 2009. Long-tenor bonds (more than 10y) accounted for 93% of Tokyo’s total bond issuance in FY 09 ended at end-March 2010.

„

Ailing projects: Tokyo may face some pressure from the financial difficulties of so-called third-sector projects (ie, project invested by local governments and private-sector entities). For example, Tokyo set up ShinGinko Tokyo Ltd (SGT) in 2005 to help SMEs, and currently owns an 84% stake in SGT. Faced by SGT’s financial distress, Tokyo injected JPY40bn of capital in 2008 to support the loss-making company. As of end-2009, despite SGT’s aggressive NPL write-offs, the NPL ratio remained high at 11%. SME loans accounted for about two-third of SGT’s total loan balance.

„

Potential drag from peers: Tokyo’s stand-alone credit standing is one of the highest among Japanese local governments and public financial institutions. This reflects Tokyo’s relative financial strength over other local governments and its fiscal discipline during past years. That said, any change in tax regime/allocation across central/local governments is a source of risks for the city, in our view. Given Tokyo’s peer-leading fiscal position, we believe it could be adversely affected by any structural adjustments/transfers to support other heavilyindebted local/regional governments.

„

Political situation: As a result of the elections for the Tokyo Assembly, Democratic Party of Japan won the majority as opposed to the prefecture governor Ishihara who is largely supported by the Liberal Democratic Party of Japan and New Komeito. The complicated assembly situation may delay the policy decision and implementation process, in our view. Furthermore, Ishihara’s current term will end in April 2011.

Strengths

Weaknesses

„

A resilient local tax revenue base and sound fiscal flexibility in Japan’s context.

„

Deterioration in the central government’s fiscal health.

„

Negative long-term demographics.

„

Track record of fiscal reform that has led to Tokyo’s improving credit profile.

„

Fiscal burden from third-sector projects and weak subsidiaries.

Key points for 2010 „

Impact of ongoing reforms on local and central government finances.

„

Impact from third-sector projects and guarantees to weak affiliated public enterprises.

10 June 2010

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Public sector

Tokyo Metropolitan Government (TOKYO)

Financial summary – YE Mar

Fiscal soundness

JPY bn

FY 06

FY 07

FY 08

% chg

150%

Economy Nominal GDP (JPYtrn)

94.1

93.0

-

-

GDP per capita (JPY mn)

7.4

7.3

-

-

12.66

12.76

12.84

0.6%

50% 0%

Population (mn)

100%

106.0%

110.7%

92.6%

85.8%

121.5%

131.9%

140.6%

84.5%

80.2%

84.1%

Revenues Revenues

6,827.8

7,143.6

7,077.4

-0.9%

Local taxes

4,927.1

5,497.3

5,293.3

-3.7%

0.0

0.0

0.0

NM

Subsidies

352.4

348.6

404.4

16.0%

Bond Issuance

214.3

157.3

303.9

93.2%

1,592.8

1,605.9

1,575.5

-1.9%

Debt servicing costs

961.9

752.8

822.6

9.3%

Capital expenditure

669.7

704.3

741.8

5.3%

137.0

95.6

0.8

-99.2%

6,762.8

6,292.6

5,895.6

-6.3%

12,151.0 11,600.0 11,130.3

-4.0%

2004

2005

Others 25%

2008

Service 30%

Manufacturing 9%

Balances and debt

Wholesale & retail 21%

Financial services 15%

Debt maturity structure, May 2010

Financial capability index

1.215

1.319

1.406

2,000

Debt burden ratio

15.5%

11.3%

13.0%

1,500

Current account ratio

84.5%

80.2%

84.1%

Structure of tax revenues, FY 08

678

500

440 390

>2018

2018

2017

2016

2015

2014

0

Bond debt (JPY bn)

Debt currency breakdown, May 2010

Others Consumption 11% tax 6% Habitant tax 18%

976

903 711 819 791

2010

Note: 1) Fiscal year runs from April to March. 2) Ordinary account base. 3) Debt burden ratio = debt servicing cost as percentage of general account revenues. 4) Effective fiscal balance: Final revenue minus final expenditure (nominal balance), as well as the deduction of fiscal sources to be set aside for operations carried over the following fiscal year. 5) Current account ratio: This is a measure of the local government's financial flexibility. The lower the %, the less mandatory expenditures it has compared with revenues. Source: Tokyo Metropolitan Government.

1,000

1,606 1,263

2013

Key ratios

2011

Effective fiscal balance Debt outstanding (ordinary account) Debt outstanding (all accounts)

2007

Current account ratio

Economic structure, FY 07

Expenditures Salary related cost

2006

Financial capability index

2012

Local allocation tax grants

Corporate tax 45%

JPY 98.1%

USD 0.2% EUR 1.7%

Fixed asset tax 20%

Debt outstanding (all accounts) 15 14 13 12 11 10 9 8 2001 2002 2003 2004 2005 2006 2007 2008 Outstanding (JPYtrn) 10 June 2010

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AUSTRALIAN ISSUER PROFILES

10 June 2010

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New South Wales Treasury Corporation (NSWTC) Description

Gavin Stacey

Ratings table

% A$ Index

% £ Index

Total assets

8.1

NA

AUD49bn

New South Wales Treasury Corporation (NSWTC) was established in 1983 under the Treasury Corporation Act 1983 of New South Wales (NSW). It originally operated as part of the NSW Treasury before becoming an independent semi-government entity in 1987. It is the central financing authority for the government of NSW and entities in NSW’s public sector. The credit ratings on NSWTC reflect the ratings on its owner and guarantor, the State of NSW. S&P revised the outlook on NSWTC and NSW back to Stable from Negative in June 2009, to reflect its opinion that the government will remain committed to structural improvement in its budgetary performance.

LT Senior Unsecured (Domestic/Foreign) Outlook

Moody’s

S&P

Fitch

Aaa/Aaa

AAA/AAA

NR

Stable

Stable

NR

Risk weighting The Australian Prudential Regulation Authority has designated a zero-risk weighting to the borrowings of NSWTC.

Key features of the credit „

Purpose: Under the Treasury Corporation Act 1983, NSWTC’s principal objective is “to provide financial services for, or for the benefit of, the NSW government, its public authorities and other public bodies”. All NSW government agencies are required to conduct their borrowing through NSWTC, except temporary bank overdrafts. This enables NSWTC to minimise debt costs by consolidating the borrowing requirements of these agencies into a few benchmark issues. NSWTC also provides liability and asset management services for the government and public authorities, although some of its services are contestable by the private sector.

„

Support mechanism: Payment of interest and principal on the debt securities issued by NSWTC are guaranteed by the government of NSW under section 22A(1) of the Public Authorities (Financial Arrangements) Act 1987 (PAFA Act). Section 22B of the PAFA Act also provides a discretionary guarantee covering derivatives entered into by NSWTC. Since early 2009, NSWTC has also been able to issue AUD-denominated securities guaranteed by the Commonwealth government under the Guarantee Scheme offered to state governments. The Australian government has since announced that the scheme will close to new issuance on 31 December 2010. NSWTC currently has c.AUD22bn of securities under the Guarantee Scheme.

„

Link to state government credit quality: NSWTC and NSW’s ratings are intertwined given NSWTC’s role in issuing debt on behalf of NSW and its dependency on the guarantees provided by the government on its debt, as well as loans to NSW public sector clients (loans to NSW public sector clients accounted for c.77% of NSWTC’s total consolidated assets at end-June 2009). Excluding the state, the electricity sector was NSWTC’s largest borrower at end-June 2009.

„

Credit profile of the state: As with the other Australian states, NSW’s credit profile is underpinned by strong support from the commonwealth government – which provided c.35% of NSW total state sector’s revenues in FY 08-09 (end-June 2009). While the government’s balance sheet is generally robust, it has deteriorated somewhat over the past few years – the government incurred a budget deficit in FY 08-09 and forecasts a deficit of c.AUD1.02bn in FY 09-10. The government also expects net financial liabilities (net debt and unfunded superannuation liabilities) relative to revenue for the non-financial public sector to rise to c.110% by 2013, from c.98% in 2009, given its capital spending plans – it expects capital spending between FY 09-10 to FY 12-13 to total AUD65.5bn. S&P’s trigger band for the ratio is between 120-130%. In response to the pressures on its balance sheet, the NSW government has since demonstrated fiscal discipline by introducing measures to increase revenues and reduce operating expenses and capital spending. The government is forecasting a return to a budget surplus of AUD872mn in FY 10-11.

„

Capital and funding: NSWTC’s domestic Benchmark Bond programme forms the cornerstone of its funding strategy and accounted for c.71% of its total long-term borrowings at endJune 2009. NSWTC also borrows in the offshore market, primarily through its global exchangeable bonds, to diversify its investor base and to smooth its maturity profile. Global exchangeable bonds accounted for c.17% of total long-term borrowings as at end-June 2009.

„

Liquidity: Short-term financial assets (excluding loans to clients) to short-term financial liabilities was roughly unchanged at c.68% from a year ago at end-June 2009.

Strengths

Weaknesses

„

Strong support mechanism from the state government

„

„

Demonstrated support from the commonwealth government through its guarantee of state borrowings

Concentrating borrowings in several benchmark lines may lead to some refinancing pressures, although we expect NSWTC to take steps to pre-fund maturing benchmark lines.

Key points for 2010 „

Progress of the state in improving its budgetary performance and managing its capital spending programme

10 June 2010

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Financials

New South Wales Treasury Corporation (NSWTC)

Financial summary – YE June

Credit spreads (Bid OAS)

AUD FY07 Balance sheet summary (AUD mn) Total assets

FY08

FY09

32,370 37,053 49,020

Cash and liquid assets

287

Due from financial institutions Securities

448

21

21

3,847

5,674

233

% Chg 32.3 -47.9

1,482 6860.6 7,753

36.6

27,704 30,333 37,889

24.9

of which to the Crown

10,485 10,642 13,055

22.7

of which to other clients

17,219 19,692 24,833

26.1

Borrowings

30,375 35,225 47,232

34.1

of which domestic benchmark

12,419 13,790 30,815

123.5

of which global exchangeable

14,431 14,275

7,366

-48.4

Loans

Total equity

43

43

75

73.8

Net interest income

68

65

119

83.5

Fee income

23

21

26

21.2

-22

-28

61

-317.2

Operating income

69

58

205

252.4

Operating expenses

24

26

38

43.0

Net profit

34

24

124

427.1

Loans/total assets

86%

82%

77%

Borrowings/total assets

94%

95%

96%

Gross state product growth

2.0%

2.8%

0.2%

Unemployment rate

4.6%

4.6%

6.4%

Income statement summary

Other income

NSWTC 5.5% '14

100 80 60 40 20 0 -20 -40 Jan-09

Apr-09

Jul-09

Oct-09

Debt maturity structure, as of May 2010 25

Bond debt (AUD bn)

20

10 5 0 2010

2011

2012

2013

Retail 0.5% Total domestic bonds 71.0%

>2015

7.6% Non-benchmark domestic 0.5%

Asset composition, FY 09

Refinancing short-term debt 16%, AUD2.5bn

Others 7% Securities 16%

Loans 77%

Refinancing term debt 19%, AUD3bn

2013 Est

2012 Est

FY 07 FY 08 FY 09 Electricity sector Transport sector Others

2011 Est

0

2010 Budgeted

10

2006

20

2005

30

2009

S&P Trigger Band = 120-130

140 120 100 80 60 40

2008

40

NSW net financial liabilities to total revenue (%)

2007

Breakdown of loan portfolio by sectors, FY 09 (AUDbn)

10 June 2010

2015

Capital index bonds Global 3.5% exchangeable 17.1% Euro MTN

Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June2009). NSWTC’s accounts have been prepared in accordance with the Australian Accounting Standards and other authoritative pronouncements of the Australian Accounting Standards Board. Unemployment rate is the seasonally adjusted unemployment rate at June.

Funding requirement for FY 09-10, AUD5bn pre funded

2014

Long-term borrowing composition, FY 09

State data

FY 06 Crown Water sector

Apr-10

15

Company ratios

New client funding 65%, AUD9.9bn

Jan-10

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Queensland Treasury Corporation (QTC) Description

Gavin Stacey Ratings table

% A$ Index

% £ Index

Total assets

17.0

NA

AUD89bn

Queensland Treasury Corporation (QTC) was established in 1988 under the Queensland Treasury Corporation Act 1988 (Act). It originally operated as part of the Queensland Treasury before becoming a separate, autonomous and accountable central financing authority in 1991. Under the Act, QTC represents the Crown and, subject to the Act, may exercise and claim all the powers, privileges, rights and remedies of the Crown.

LT Senior Unsecured (Domestic/Foreign) Outlook

Moody’s

S&P

Fitch

Aa1/Aa1

AA+/AA+

AA+/AA+

Stable

Stable

Stable

Risk weighting The Australian Prudential Regulation Authority has designated a zero-risk weighting to QTC’s debt.

Key features of the credit „

Purpose: Similar to the treasury corporations in the other Australian states, profit maximisation is not the key objective of QTC. Its responsibilities include raising funds on behalf of its public sector clients in a cost-effective manner, providing financial risk management services and advice, and investing the state’s short to medium-term cash surpluses.

„

Capital and funding: QTC’s main source of funding is its AUDdenominated domestic and global benchmark bonds, which accounted for c.94% of its total borrowings as at 22 April 2010. QTC expects its funding requirement to increase to slightly over AUD25bn in FY 10-11, although the final amount may decline subject to the FY 10-11 State Budget.

„

Support mechanism: Under Section 32 of the Act, payment of principal and interest on inscribed stock issued by QTC are guaranteed by the Treasurer on behalf of the Government of Queensland. Section 33 of the Act enables the Treasurer to guarantee other obligations undertaken by QTC, subject to the approval of the governor in council. Such discretionary guarantees have been granted and operate in support of QTC’s offshore debt facilities. However, it has not been the practice of the Treasurer to guarantee risk-management instruments such as swaps, options, futures and foreign exchange contracts. Queensland took up the Commonwealth Government’s offer to guarantee state borrowings – about AUD49bn worth of QTC’s debt is covered under the guarantee (total debt c.AUD60bn at end December 2009). The Commonwealth Government has since announced that the Guarantee Scheme will close to new issuance on 31 December 2010. Given that QTC has displayed its ability to tap the market without the commonwealth guarantee, we do not expect its removal to have a significant impact on QTC’s fundraising capabilities.

„

Liquidity: QTC’s liquidity position is solid, supported by QTC’s prudent liquidity policies. For example, QTC funds its known and anticipated cash flows (debt service payments and new borrowings) six months ahead of schedule and demonstrated its prudence in managing its liquidity by increasing the time horizon to 12 months during the financial crisis.

„

Credit profile of the state: The State of Queensland’s ratings were downgraded by the rating agencies in 2009, reflecting the weakening in the state’s budgetary performance and increasing debt burden. QTC’s total borrowings at end-June 2009 increased c.54% y/y to c.AUD63bn, from c.AUD41bn. In its mid-year fiscal and economic review, the government forecasted a decline in its general government sector budget from a net operating surplus of AUD35mn in FY 08-09, to a deficit of c.AUD2.4bn in FY 09-10. However, the government is targeting a return to a net operating surplus no later than FY 15-16. The government expects net financial liabilities to total revenue in the non-financial public sector (NFPS) to reach c.148% in FY 12-13, from c.108% in FY 0910. On a positive note, the economic recovery and consequent strengthening in commodity prices should support Queensland’s economy. Reflecting the improved economic conditions, the government revised gross state product growth estimates for FY 09-10 and FY 10-11 to 1% and 3.5%, from -0.25% and 2.75%, respectively.

„

Loan portfolio of QTC: QTC’s asset quality is robust, with negligible impaired loans at end-June 2009. As at end-December 2009, QTC on-lent its funds to 269 customers, with loans to government departments/agencies and government-owned corporations accounting for about 71% of total loans.

Strengths

Weaknesses

„

Strong support from the state government

„

„

Robust asset quality

Some potential refinancing pressure due to concentration of borrowings in benchmark lines, although we expect QTC will prudently manage this risk

Key points for 2010 „

Monitor any introduction of measures to improve the state’s budgetary performance

10 June 2010

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Financials

Queensland Treasury Corporation (QTC)

Financial summary – YE June

Credit spreads (Bid OAS)

AUD FY07 Balance sheet summary (AUD mn) Total assets

FY08

FY09

40,612 49,915 88,988

Cash and liquid assets

0.1

78.3

0.8

-40.7

Securities

16,200 16,694 26,475

58.6

Loans

24,269 32,912 44,408

34.9

to govt dept/agencies/corps

18,138 23,135 30,616

32.3

to others

6,131

1.4

% Chg

9,777 13,792

41.1

Borrowings

32,075 40,728 62,624

53.8

of which domestic

20,154 25,865 51,345

98.5

of which offshore

11,920 14,863 11,279

-24.1

Total equity

373

293

-4,303

NA

QTC 6% '15

100 80 60 40 20 0 -20 -40 Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Debt maturity structure, as of May 2010 30 25

Income statement summary Net interest income

52

-80

35

-143.3

20

Fee income

25

32

42

31.1

15

Other income

15

16

-4,611

NA

10

Operating income

93

-32

-4,534

NA

5

Operating expenses

33

33

51

52.9

0

Net profit

46

-81

-4,595

NA

Loans/total assets

60%

66%

50%

Borrowings/total assets

79%

82%

70%

Gross state product growth

5.5%

4.7%

0.3%

Unemployment rate

3.6%

3.8%

5.5%

Company ratios

2010

2011

2012

2014

2015

>2015

Borrowing composition, 22 April 2010 AUD Global Benchmark Bonds 6%

State data

AUD Domestic Benchmark Bonds 88%

Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June 2009). Financial statements have been prepared in accordance with the requirements of the Financial Management Standard 1997 issued pursuant to the Financial Administration and Audit Act 1977 and Australian Accounting Standards (including Australian Intepretations) adopted by the Australian Accounting Standards Board. Unemployment rate is the seasonally adjusted unemployment rate at June.

Borrowings by investor location, 22 April 2010

Euro CP 2% Others 4%

Asset composition (AUDbn) 100 80 60 40 20 0

Offshore 48%

Onshore 52%

2013

FY 06 FY 07 FY 08 FY 09 Others Long term assets (managed by Q'land Investment Corp) Securities Loans

Annual gross state product growth (%)

NFPS’s projected net financial liabilities to revenue (%) 200

7 6 5 4 3 2 1 0

150 100 50 FY 00

FY 01

10 June 2010

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07

FY 08

FY 09

0 FY 10

FY 11

FY 12

FY 13 441

Barclays Capital | AAA Handbook 2010

South Australian Government Financing Authority (SAFA) Description

Gavin Stacey

Ratings table

% A$ Index

% £ Index

Total assets

1.7

NA

AUD11bn

South Australian Government Financing Authority (SAFA) was established in January 1983 under the Government Financing Authority Act 1982 (Act). SAFA is the central financing authority for the South Australian government and its state-owned entities. It also functions as the captive insurer for the South Australian government. In mid 2009, SAFA took over responsibility of the management of the government’s passenger and light commercial fleet operations.

LT Senior Unsecured (Domestic/Foreign) Outlook

Moody’s

S&P

Fitch

Aaa/Aaa

AAA/AAA

NR

Stable

Stable

NR

Risk weighting The Australian Prudential Regulation Authority has designated a zero-risk weighting to SAFA’s debt.

Key features of the credit „

Purpose: SAFA’s treasury role requires it to provide clients with commercially competitive debt funding and other financial advisory services. Through its insurance division, SAICORP, SAFA insures and reinsures the government’s risks in the Australian and international insurance markets as well as providing insurance and risk management advice to the government.

„

Support mechanism: Under section 15(1) of the Act, liabilities incurred or assumed by SAFA are guaranteed by the Treasurer on behalf of the state. South Australia did not utilise the Commonwealth guarantee for state borrowings.

„

Credit profile of the state: South Australia’s credit profile is underpinned by its modest levels of debt and fiscal discipline, as seen by its use of electric utility sale proceeds to reduce debt in the past. In its FY 09-10 Mid-Year Budget Review, the government forecasted a return to an operating surplus of AUD13mn in FY 10-11, from a deficit of AUD174mn in FY 0910. It also projects the net financial liabilities to revenue for the non-financial public sector (NFPS) to peak at about 114% in FY 11-12. While this is higher than S&P’s trigger band of 8090%, the agency has said that it still views South Australia’s debt levels as consistent with a AAA rating as it is expecting the ratio to decrease in the medium term due to a cyclical recovery in revenues on the back of improved economic growth. The agency also cited the state’s history of under-expenditure on capital and the changes in the discount rate used to value the pension liability as other reasons for its relatively sanguine view regarding the rise in the ratio.

„

Loan portfolio of SAFA: As at end-June 2009, total client loans accounted for about 67% of SAFA’s total assets, with the majority of these loans being on-lent via the Treasurer to the general government sector. Reflecting the robust quality of the loan portfolio, there were no impaired loans as at June 2009.

„

Capital and funding: SAFA concentrates its long-term debt borrowings in its Select Line fixed interest programme to maximise liquidity. As at June 2009, its Select Lines accounted for c.78% of its total long-term borrowings. SAFA’s funding guidelines require it to have a Select Line with a maturity greater than four years. As at end-April 2010, its longest-dated Select Line had a maturity of about five years.

„

Liquidity: SAFA’s liquidity guidelines require it to hold the greater of a minimum liquidity buffer of AUD250mn (about 2% of total assets at June 2009), or sufficient liquid assets to cover debt maturing over the next 60 days. Liquid assets comprise cash, discount securities and other highly marketable securities including commonwealth and semi-government bonds. During FY 08-09. SAFA’s liquidity exceeded the levels required by its guidelines and averaged c.AUD1.4bn.

Strengths

Weaknesses

„

„

High likelihood of government support

Concentrating borrowings in several benchmark lines may lead to some refinancing pressures, although we expect SAFA will prudently manage these risks

Key points for 2010 „

Progress of the state in returning its finances to a sustainable position

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Financials and spreads

South Australian Government Financing Authority (SAFA)

Financial summary – YE June

Credit spreads (Bid OAS)

AUD FY07 Balance sheet summary (AUD mn)

FY08

FY09

% Chg

Total assets

9,197

8,700

11,260

29.4

Cash and liquid assets

2,189

1,798

2,400

33.5

Securities

1,361

1,216

1,172

-3.6

Loans

5,580

5,554

7,500

35.0

of which to general govt

2,994

2,887

4,103

42.1

of which to public corp

2,587

2,667

3,396

27.4

Borrowings

6,059

5,206

7,469

43.5

Total equity

272

232

190

-18.1

Net interest income

32

45

27

-40.4

2.5

Fee income

1.9

1.7

2

-5.9

2.0

Other income

154

-2

15

NA

Operating income

188

45

44

-3.1

13

102

89

-12.8

149

-40

-32

-20.6

Loans/total assets

61%

64%

67%

Borrowings/total assets

66%

60%

66%

Gross state product growth

1.6%

4.5%

1.4%

Unemployment rate

4.9%

4.8%

5.4%

SAFA 6% '13

100 80 60 40 20 0 -20 -40 Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Debt maturity structure, as of May 2010

Income statement summary

Operating expenses Net profit

Bond debt (AUD bn)

1.5 1.0 0.5 0.0

Company ratios

State data

2010

2012

2013

2014

2015

>2015

Long-term debt composition, FY 09

Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June 2009). SAFA’s accounts have been prepared as general purpose financial statements and comply with the requirements of the Australian Accounting Standards (Accounting Standards) and the requirements of the Treasurer’s Instructions relating to financial statements by statutory authorities that are pursuant to the Public Finance and Audit Act, 1987.

Asset composition, FY 09

2011

Select Lines 78%

Others 22%

Loan composition, FY 09

Loans 67%

Others 23%

General government sector 55%

Securities 10%

NFPS’s projected net financial liabilities to revenue (%)

Public financial corporations 18%

Projected general government net operating balance 350

120

Public nonfinancial corporations 27%

AUD mn

250

100 S&P trigger band

80

150 50

60

-50

40 FY08-09 act 10 June 2010

FY 09-10

FY 10-11

FY 11-12

FY 12-13

-150 FY 09-10

FY 10-11

FY 11-12

FY 12-13 443

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Treasury Corporation of Victoria (TCV) Description

Gavin Stacey Ratings table

% A$ Index

% £ Index

Total assets

4.5

NA

AUD27bn

Treasury Corporation of Victoria (TCV) is the central financing authority of the State of Victoria and is the successor to the Victorian Public Authorities Finance Agency. TCV was established under the Treasury Corporation of Victoria Act 1992 (TCV Act) and began operations in 1993. It provides loans and financing services as well as corporate financial advice to state and state-related entities. Similar to the treasury corporations of other Australian states, TCV’s credit ratings are linked to the ratings of the state.

LT Senior Unsecured (Domestic/Foreign) Outlook

Moody’s

S&P

Fitch

Aaa/Aaa

AAA/AAA

NR

Stable

Stable

NR

Risk weighting The Australian Prudential Regulation Authority has designated a zero-risk weighting to TCV’s debt.

Key features of the credit „

Purpose: The TCV Act states that the objectives of TCV are to act as a financial institution for the benefit of the state and participating authorities and to enhance the financial position of itself and its clients. Public entities are required to conduct their borrowing and derivative transactions through TCV and loans to these entities are guaranteed by the state. TCV grants these loans on commercial terms and conditions.

„

Support mechanism: Borrowings and derivative transactions by TCV are guaranteed by the government of Victoria under Section 32 of the TCV Act. TCV decided not to utilise the Commonwealth government guarantee for debt issuance given the strength of Victoria’s budget and the moderate financing requirement in FY 09-10.

„

Credit profile of the state: Victoria’s fundamentals are characterised by its fiscal prudence, diversified economy and strong balance sheet. Its economic growth has generally been in line with the national average and stronger than peer, New South Wales. The Victorian government’s commitment to fiscal prudence is reflected in its financial objective to maintain a general government sector operating surplus (annual net result from transactions) of at least AUD100mn annually. The government is forecasting a net operating surplus of AUD872mn in FY 10-11 and expects a return to a cash surplus (net cash flows from operating activities less investments in non-financial assets) of c.AUD871mn in FY 12-13. However, as in most Australian states, the government expects capital spending to remain elevated – the net infrastructure investment programme by the general government sector is projected to be AUD6.4bn in FY 10-11. According to the government’s calculations, general government net debt to gross state product will consequently increase to 4.3% at end-June 2013, from 2.5% at end-December 2009, before declining to 4.1% at end-June 2014.

„

Loan portfolio of TCV: The quality of TCV’s loan portfolio is sound, in our view, given that its ultimate credit exposure is to the State of Victoria by virtue of the state’s guarantee on TCV’s loans. Furthermore, the majority of TCV’s loans to participating authorities comprise lending to the lower-risk water sector – loans to participating authorities in the water sector accounted for about 72% of total loans to participating authorities as at end-June 2009. There were no past due loans at end-June 2009.

„

Capital and funding: TCV primarily funds itself via debt issuance in the domestic market and concentrates its borrowings in its Domestic Inscribed Stock programme (c.73% of total interestbearing liabilities at end-June 2009). Offshore borrowing is also conducted on an opportunistic basis to diversify TCV’s funding base and accounted for c.16% of total debt funding last year. TCV has a 10% minimum internal target for its capital adequacy ratio. As at end-June 2009, TCV’s total CAR was 20.2%. TCV has largely completed its funding programme for FY 09-10 by raising AUD5.4bn of funds versus a funding requirement of AUD5.6bn. TCV currently forecasts its funding requirement for FY 10-11 to be about AUD5.8bn.

„

Liquidity: TCV’s liquidity profile is supported by its internal liquidity guidelines. According to these, TCV’s liquid assets must comprise at least 3% of its total liabilities on a daily basis, subject to a minimum of AUD500mn. Moreover, at least 60% of the minimum required liquid assets must comprise cash, commonwealth government and semi-government paper.

Strengths

Weaknesses

„

High likelihood of state support given TCV’s integral role.

„

„

History of fiscal discipline.

Concentrating borrowings in several benchmark lines may lead to some refinancing pressure, but TCV’s liquidity guidelines should help to moderate any potential risks.

Key points for 2010 „

Monitor progress of the state in improving its budgetary performance and managing its capital spending programme.

10 June 2010

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Financials

Treasury Corporation of Victoria (TCV)

Financial summary – YE June

Credit spreads (Bid OAS)

AUD FY07 Balance sheet summary (AUD mn) Total assets 17,105 Cash and liquid assets 3,059 Securities 3,163 Loans 10,144 of which to the Crown 5,883 of which to other clients 4,261 Borrowings 12,700 of which domestic 11,773 of which offshore 926 Total equity 148 Income statement summary Net interest income Fee income Other income Operating income Operating expenses Net profit

FY08 21,584 4,587 4,499 11,783 6,267 5,516 13,301 12,516 785 125

FY09 % Chg 26,703 5,320 2,539 16,248 8,811 7,437 18,446 15,552 2,893 174

41 8 -12 37 16 22

29 8 -22 15 16 -1

Company ratios Loans/total assets Borrowings/total assets

59% 74%

55% 62%

61% 69%

State data Gross state product growth Unemployment rate

4.3% 4.6%

4.0% 4.6%

0.8% 6.0%

23.7 16.0 -43.6 37.9 40.6 34.8 38.7 24.3 268.7 38.8

43 46.6 8 3.1 16 -176.2 67 342.3 18 14.8 49 -5240

TCV 5.75% '16

100 80 60 40 20 0 -20 Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Debt maturity structure, as of May 2010 12

Bond debt (AUD bn)

10 8 6 4 2 0 2010

2011

2012

2013

2014

2015

>2015

Borrowing composition, FY 09 Domestic benchmark promissory notes 3% Domestic-

Domestic benchmark inscribed stock 73%

Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June2009). Accounts have been prepared in accordance with Australian Accounting Standards, the requirements of the Financial Management Act 1994, and other mandatory professional reporting requirements. Unemployment rate is the seasonally-adjusted unemployment rate at June.

others 8% Offshore 16%

Asset composition, FY 09

Loans 60%

Breakdown of loan portfolio by sectors (AUDbn) Cash and cash equivalents 20%

20

Securities 10%

5

15 10

0 FY 06

Others 10%

Department of Treasury and Finance projections 6

FY 07 Crown

FY 08

Water sector

FY 09 Others

Net operating balance (AUDbn) 2.0 1.5 1.0 0.5 0.0 -0.5

4 2 0 FY 10

10 June 2010

FY 11 FY 12 FY 13 FY 14 Real gross state product growth (% y/y) Unemployment rate(%)

FY 11

FY 12 FY 13 General government sector Public non-financial corporations Non-financial public sector

FY 14

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Western Australian Treasury Corporation (WATC) Description

Gavin Stacey

Ratings table

% $ Index

% £ Index

Total assets

3.0

NA

AUD19bn

Western Australian Treasury Corporation (WATC) was established in 1986 under the Western Australian Treasury Corporation Act 1986 (Act) as the central borrowing authority of the state. The Act was amended in 1998 to expand WATC’s role to include the provision of financial management services to the Western Australian public sector. Ratings on WATC are linked to the ratings of the state.

LT Senior Unsecured (Domestic/Foreign) Outlook

Moody’s

S&P

Fitch

Aaa/Aaa

AAA/AAA

NR

Stable

Stable

NR

Risk weighting The Australian Prudential Regulation Authority has designated a zero-risk weighting to WATC’s debt.

Key features of the credit „

Purpose: WATC seeks to provide cost-effective debt funding and financial advisory services to its public sector clients. WATC obtains cost-effective funding for its clients by consolidating their debt requirements into benchmark lines. WATC has established short- and long-term borrowing facilities in both the domestic and overseas markets. In the Australian market, each benchmark bond line generally has a minimum issue size of AUD1bn. Loans to clients are made on a commercial basis and primarily driven by the cost of WATC’s borrowings, while pricing for financial advice and funds management is determined on a cost-recovery basis.

„

Support mechanism: Under Section 13(1) of the Act, financial liabilities incurred or assumed by WATC are guaranteed by the Treasurer on behalf of the state. WATC did not utilise the Commonwealth government guarantee on state borrowings.

„

Credit profile of the state: Western Australia’s economy has benefitted from favourable commodity prices over the past few years, resulting in higher economic growth than the other Australian states. The state’s finances have therefore been robust, supported by strong taxation revenue and mining royalties. In its FY 10-11 state budget, the government forecasted an increase in the general government sector’s net operating balance from AUD286mn in FY 10-11 to AUD652mn in FY 11-12, driven by a c.4% y/y increase in revenues and a decline in expense growth However, notwithstanding the improved economic outlook, the government expects the nonfinancial public sector’s net financial liabilities to revenue to increase to c.69.6% in FY 13-14, from c.54% in FY 08-09, due to its capital spending plans (S&P’s trigger for the ratio is 90%).

„

Loan portfolio of WATC: The state only guarantees WATC’s loans to the state government authorities. While loans to the local government do not have the benefit of the state guarantee, we do not consider the lack of a guarantee a significant credit negative for WATC, given that loans to the local government typically account for a small percentage of WATC’s loan portfolio (c.2.9% of total loans at end June 2009). WATC’s largest borrowers (Electricity Networks Corporation, Housing Authority and Water Corporation) accounted for about 64% of total loans at end-June 2009.

„

Capital and funding: WATC’s funding is largely sourced from the domestic markets. Offshore borrowings accounted for c.17% of total borrowings at end-June 2009. About 48% of WATC’s total borrowings had a tenor of less than one year at end-June 2009 (c.38% at end-June 2008).

„

Liquidity: WATC’s liquidity policy requires that holdings of liquid assets and/or standby facilities equal at least 9% of total liabilities. As at end-June 2009, cash and short-term investments accounted for c.31% of borrowings maturing within a year.

Strengths

Weaknesses

„

Strong support mechanism from the state

„

„

State’s economic growth supported by commodities sector

Dependence on the commodities sector may lead to volatility in the state’s finances

„

Review potential measures to shore up state’s finances

Key points for 2010 „

Monitor progress of proposed tax on mining industry

10 June 2010

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Financials

Western Australian Treasury Corporation (WATC)

Financial summary – YE June

Credit spreads (Bid OAS)

AUD FY07 Balance sheet summary (AUD mn) Total assets

13,049

Cash and liquid assets

FY08

FY09

% Chg

14,326 19,110

4

33.4

4

3

-28.9

2,754

2,702

-1.9

11,406 15,887

39.3

Securities

2,711

Loans

9,998

of which maturity < than 1y

2,847

3,876

6,272

61.8

of which maturity > than 1y

7,151

7,530

9,615

27.7

14,070 18,581

32.1

Borrowings

12,665

of which maturity < than 1y

NA

5,218

8,619

65.2

of which maturity > than 1y

NA

8,851

9,962

12.5

Total equity

66

65

87

33.4

Income statement summary

WATC 7% '15

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Debt maturity structure, as of May 2010 5

Bond debt(AUD bn)

4

Net interest income

53

47

27

-41.5

Fee income

0.3

0.3

0.3

0.3

0

0

21

NA

Other income

100 80 60 40 20 0 -20 -40 Jan-09

3 2

Operating income

54

47

49

3.5

1

Operating expenses

40

41

14

-64.9

0

Net profit

10

4

24

437.0

Loans/total assets

77%

80%

83%

Borrowings/total assets

97%

98%

97%

Gross state product growth

5.8%

5.1%

0.7%

Unemployment rate

3.6%

3.1%

5.2%

2010

2011

2012

2013

2014

2015

>2015

Company ratios

Debt composition, FY 09

State data

Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June 2009). WATC’s accounts have been prepared in accordance with Australian Accounting Standards (including the Australian Accounting Interpretations). The financial report also complies with International Financial Reporting Standards. Unemployment rate is the seasonally adjusted unemployment rate at June.

Asset composition, FY 09

Overseas 17%

Loans to clients, FY 09 Others 3%

Loans 83%

Domestic 83%

Securities 14%

Public Others Transport 22% Authority Electricity 7%

Electricity Networks Corporation 25%

Generation Corporation Water 7% Corporation 18%

Forecasted net financial liabilities to revenue (NFPS, %) S&P Trigger Level

100 90 80 70 60 50 40

FY08-09 FY 09-10 FY 10-11 FY 11-12 FY 12-13 Fy 13-14 act 10 June 2010

Housing Authority 21%

Projected general government net operating balance AUD mn 1000 800 600 400 200 0 FY08-09 FY 09act 10

FY 1011

FY 1112

FY 1213

FY 1314 447

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10 June 2010

448

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GERMAN LÄNDER PROFILES

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State of Berlin (BERGER)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total debt

0.260

NA

€60.5bn

The City-State of Berlin (BERGER) was made the capital of the Federal Republic of Germany after reunification in 1990. With a GDP of only €90.1bn in 2009, up 1.7% y/y from €88.6bn in 2008, Berlin ranks among the smaller states in terms of economic strength. The de-facto absence of an industrial basis, the region’s generally weak economic performance, as well as several other factors relating to the reunification of West and East Berlin have put considerable strains on Berlin’s public finances, with contingent liabilities generated by the turmoil surrounding former Bankgesellschaft Berlin (BGB) causing further pressure. After generating budget surpluses in 2007 and 2008, the fiscal situation worsened again in 2009 and caused Berlin to report a budget deficit of 1.62% of GDP.

Moody’s

S&P

Fitch

LT senior unsecured

Aa1

NR

AAA

Covered bond rating

Aa1

NR

AAA

Stable

NR

Stable

Outlook Note: As at 7 June 2010.

Risk weighting Debt issued by the State of Berlin is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

Economics: In contrast to the overall economic development which saw German GDP contracting by 3.5% y/y in 2009, Berlin recorded a 1.7% y/y GDP increase at the same time. Still, Berlin ranks among the economically weaker states, accounting for only 3.7% of German GDP. The state faces a comparatively high unemployment rate – at 16.1% in 2009.

„

Public finances: Berlin strongly relies on federal transfers and on payments attributed to the German financial equalisation scheme which, in 2009, accounted for a combined 30% of the state’s revenues. Tax revenues of €9.4bn accounted for 49% of all revenues in 2009. Yet, as combined revenues amounted to only €19.1bn in 2009, while aggregate expenditures totalled €22bn, a funding gap of €2.8bn had to be closed by tapping the capital market. Of the aggregate €22bn of expenditures scheduled for 2010, a high 11% (€2.4bn) corresponds to interest rate payments. Personnel expenditures account for 30% (€6.6bn) of the scheduled expenditures. Berlin’s estimates indicate that revenues are set to decrease to €19.1bn in 2010, before modestly increasing to €19.2bn in 2011. At the same time, expenditures are set to further increase to €22bn in 2010 and 2011, thereby pointing towards a persistent budget deficit in the years ahead. Berlin plans gross debt issuance totalling €11.3bn in 2010, of which €8.6bn will be used to repay old debt. As at year-end 2009, 40% of Berlin’s debt was issued in the form of Schuldscheindarlehen (SSD) with bonds accounting for 60% of this.

„

Indebtedness: Berlin’s aggregate debt burden has steadily increased since German reunification in 1990. Whereas in 1992, overall debt amounted to €10.5bn, the volume had grown to €60.5bn as at year-end 2009. Berlin’s projections point towards a further increase in its overall debt to €66.2bn by year-end 2010. According to the medium-term financial planning, Berlin’s overall debt will grow to €70.2bn by 2013. Assuming a balanced budget, Berlin estimates this figure to grow to €73.9bn in 2020. Yet, if expenditures increase at the average pace observed between 2008 and 2013, Berlin points out that its aggregate debt will grow to €83.1bn by 2020. With funds received from the so-called solidarity pact set to gradually decline from €1.6bn in 2010 to nil in 2020, funding needs are likely to play a more prominent role in the medium term. Berlin’s claim for federal financial assistance for experiencing an “extreme financial crisis” was rejected by the German Constitutional Court in October 2006, on the basis that the state had not exhausted its potential for revenue and expenditure flexibility.

„

Political environment: Following the regional elections held in September 2006, the City State of Berlin is currently governed by a so-called ‘red-red coalition’ between social-democratic SPD and leftist Die Linke. Whereas the SPD occupies 52 of the 149 parliamentary seats, Die Linke holds 23 seats. With 37 seats, conservative CDU is the state’s second-strongest political power, followed by the Greens, who occupy 24 seats. The Liberal FDP holds 13 seats. The next regional election is not scheduled to be held before Q2 11.

Strengths

Weaknesses

„

„

Berlin will probably benefit from financial support given its role as the German capital.

In the de-facto absence of an industrial sector and considering the steadily declining tax base, Berlin strongly relies on transfer payments within the scope of the German financial equalisation scheme and faces the highest debt/GDP ratio of all German states. Available funds, however, are likely to decline in the long run.

Key points for 2010 „

Carefully monitor Berlin’s efforts to curb its budget deficit and its willingness to further consolidate its public finances.

10 June 2010

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Financials and spreads

State of Berlin (BERGER)

Financial summary € bn Economy

Financial deficit/GDP 2006

2007

2008

2009

Nominal GDP (€bn)

80.6

83.6

87.5

90.1

Real GDP growth (%)

1.2

2.0

1.1

-0.7

GDP per capita (€'000)

23.7

24.5

25.6

26.3

3.4

3.4

3.4

3.4

9.1

10.0

10.7

9.7

Population (mn)

Revenues

8% 4% 0% -4% 1991

Tax revenues Federal transfers

4.3

4.4

4.4

4.0

Financial equalisation

2.7

2.9

3.3

3.1

Other revenues

2.6

8.0

3.4

2.0

Total revenues

18.7

25.4

21.7

18.8

Staff

6.3

6.2

6.3

6.3

Interest costs

2.4

2.5

2.3

2.2

Investment spending

1.8

1.8

1.6

1.6

0.00

0.00

0.00

0.0

Other expenditures Total expenditure

9.9

10.3

10.7

9.3

20.4

20.7

20.9

19.4

1999

-1.8

4.6

0.8

-1.50

Debt outstanding

59.0

56.6

56.0

58.8

Taxes/Total revenues

48.5

39.5

49.1

51.7

Expend./GDP

25.4

24.8

23.8

21.5

Financial balance/Revenues

-9.5

18.3

3.9

-8.0

Debt/Revenues

316

223

258

313

Debt per capita (€)

17.3

16.6

16.3

17.1

Political representation (% of votes) Greens 13% FDP 8%

Left Party 13%

SPD 31%

Others 14% CDU 21%

Debt structure, 2009

Ratios (%)

Domestic credit (incl Schuldscheine) 40% Bonds 58%

Other Capital makets 2%

Note: Debt outstanding in this table and in the debt structure chart excludes intra-Government debt.

Structure of tax revenues, 2009 Withholding tax on interest 3% Income and Corporate Taxes 38%

10 June 2010

2007 all Länder

Balances and debt Financial balance

2003

Berlin

Expenditure

Transfers to munis

1995

Debt/GDP 80%

VAT 46%

60% 40% Municipal trade taxes 1%

Own taxes 12%

20% 0% 1992

1996 Berlin

2000

2004 all Länder

2008

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State of Hesse (HESSEN)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total debt

0.178

NA

€36.2bn

Despite a 2.2% y/y contraction in its GDP to €216.5bn in 2009, from €221.4bn in 2008, Hesse ranks among the economically stronger German regions, accounting for 9.2% of Germany’s 2009 GDP (€2107.2bn). Geographically, Hesse makes up 5.9% of Germany with a population of 6.1mn in 2009. Despite being the fourth-largest German state in terms of aggregate GDP, the nominal per capita income of €69,500 is the second-highest one in Germany and stands at 116.2% of the national average. Hesse is among the strongest contributors to the German financial equalisation scheme.

Moody’s

S&P

Fitch

LT senior unsecured

NR

AA

AAA

Covered bond rating

NR

AA

AAA

Outlook

NR

Stable

Stable

Note: As at 7 June 2010.

Risk weighting Debt issued by the State of Hesse is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

„

Economics: Hesse is among Germany’s most affluent states, with the disposable per capita income standing at 121% of the domestic average at the time of writing. Economic growth is supported by the region’s strong transport infrastructure, its leading role in the German financial services sector and by the chemical and pharmaceutical industry in the heavily industrialised Rhine-Main area. Owing to strong growth in the finance industry, Hesse benefited from above-average GDP growth rates between 1995 and 2001. It also benefits from a relatively moderate unemployment rate of 7.5%, as at end-April 2010, the latest date for which was available. Overall, the financial and corporate services sector accounted for 38.8% of the gross value added (GVA) in 2009, which is significantly above the German average of 31%. The manufacturing sector accounted for 17.5% and thus less than the domestic average (22%).

„

Public finances: Despite the 2.2% y/y decline in Hesse’s GDP, which fell to €216.5bn in 2009, from €221.4bn in 2008, Hesse is still among the largest contributors to the German financial equalisation scheme, with payments scheduled to amount to €2.2bn in 2010, ie, 5% y/y less than in 2009 (€2.3bn). Overall, Hesse estimates its 2010 expenditures will climb to €27.8bn in 2010, from €27.7bn in 2009. Thereof, €1.5bn will correspond to interest rate payments with €3.9bn scheduled for the repayment of debt. Personnel expenditures are estimated to increase to €7.8bn in 2010, from €7.7bn in 2009, thus accounting for 40% of Hesse’s total expenditures.

„

Political environment: Following the regional elections held in January 2009, Hesse is governed by a CDU/FDP coalition government, which holds 66 of the parliaments 118 seats. Conservative CDU secured 37.2% of the vote, and is thus the state’s strongest political party, followed by the socialdemocratic SPD, whose share of the vote stood at 23.7%. The Liberal FDP secured 16.2% of the vote, followed by the Greens (13.7%) and leftist Die Linke (5.4%). In May 2010, Prime Minister Roland Koch (CDU) announced his resignation. We do not expect this move to have any significant implications.

Indebtedness: Hesse’s overall debt has steadily increased over the course of the past few years, growing from €31.2bn at yearend 2005, to €32.3bn in 2008 and €36.2bn in 2009. In anticipation of net new capital market borrowing of €3.4bn in 2010, Hesse expects its debt level to grow to €39.6bn by yearend 2010. In line with this development, net new debt has sharply increased to €3.4bn in 2010, from €2.9bn in 2009 and €894mn in 2008.

Strengths

Weaknesses

„

„

Hesse is among the economically stronger German states and benefits from a sound structural mix of its industrial and services sector.

Hesse’s reliance on capital market funding has steadily increased over the course of the past few years, with corresponding growth in the overall amount of debt outstanding. At the same time, tax revenues have markedly declined since 2007.

Key points for 2010 „

Monitor the further development of Hesse’s public finances, which, despite a previously sound fiscal management, have come under pressure as of late.

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Financials and spreads

State of Hesse (HESSEN)

Financial summary

Structure of tax revenues, 2009

€ bn Economy Nominal GDP (€bn) Real GDP growth (%)

2005

2006

2007

2008

2009

202.7 1.0

209.2 2.8

216.7 2.3

220.8 1.3

216.5 -4.3

GDP per capita (€'000) Population (mn)

33.3 6.1

34.4 6.1

35.7 6.1

36.4 6.1

35.7 6.1

Revenues Tax revenues

13.1

15.1

17.1

16.8

14.8

Federal transfers Other revenues Total revenues

1.3 2.6 17.0

1.4 2.4 18.9

1.4 2.0 20.5

1.4 1.8 20.0

1.4 1.3 17.4

Expenditure Staff

6.8

7.0

7.2

7.4

7.7

30%

Interest costs Investment spending

1.4 1.6

1.4 1.7

1.4 1.8

1.4 1.8

1.3 1.8

20%

Transfers to munis Other expenditures Total expend before fin equal Fin equal contributions

3.2 3.4 16.4 1.3

3.4 3.5 16.9 2.2

4.1 3.5 17.9 3.2

4.1 3.7 18.4 2.6

3.2 2.9 17.0 1.8

Total expenditure Balances and debt Financial balance Debt outstanding

17.7

19.1

21.1

21.0

18.8

-0.6 30.2

-0.3 29.4

-0.6 30.0

-1.1 30.6

-2.60 33.4

Ratios (%) Taxes/Total revenues Expend. before Fin Eq/GDP

77.0 8.1

80.1 8.1

83.6 8.3

84.3 8.3

84.7 7.8

2

Financial balance/Revenues Debt/Revenues

-3.7 177.5

-1.3 155.5

-3.0 146.6

-5.4 153.0

-14.9 191.5

1

Debt per capita (€)

4,959

4,831

4,937

5,034

5,513

Note: Debt outstanding in this table and in the debt structure chart excludes intra-Government debt.

SPD 23.7%

CDU 37.2%

10 June 2010

Municipal trade taxes 4%

Income and Corporate Taxes 52%

Own taxes 11%

Debt/GDP

10% 0% 1991

1995 Hesse

1999

2003 2007 all Länder

Financial deficit/GDP

0 -1 1992

1996 Hesse

Political representation (% of votes)

VAT 28%

Withholding tax on interest 5%

2000

2004

2008

all Länder

Debt structure, 2009

Greens 13.7%

Domestic credit (incl Schuldscheine) 35%

FDP 16.2% The Left 5.4% Others 3.8%

Bonds 64%

Other Capital makets 1%

453

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State of Saxony-Anhalt (SACHAN) Description

Leef H Dierks Ratings table

% € Index

% £ Index

Total assets

0.094

NA

€19.8bn

With a GDP of €51.5bn in 2009, down a strong 4.2% y/y from €53.7bn in 2008, Saxony Anhalt (SACHAN) ranks among the weaker German states in terms of economic strength. Its GDP accounted for a low 2.1% of the overall German GDP of €2,407bn in 2009. Following a very strong economic growth in the wake of German reunification, growth rates have slowed markedly and, in recent years, moved in line with the average development.

Moody’s

S&P

Fitch

LT senior unsecured

Aa1

AA-

AAA

Covered bond rating

NR

NR

AAA

Stable

Stable

Stable

Outlook Note: As at 7 June 2010.

Risk weighting Debt issued by the State of Saxony-Anhalt is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

Economics: Following German reunification in 1990, the State of Saxony-Anhalt has been subject to a marked population decline. In 2009, the state’s population amounted to only 2.4mn, down from 2.9mn in 1990. By 2025, this figure is expected to have declined further to 2mn. As this development has constrained economic growth in recent years, GDP growth has fallen behind that of the domestic average over the past few years. As is the case for other East German states, SACHAN’s per capita GDP converged upwards towards the national average in recent years but still stands at only 71% of the national average, and is thus broadly in line with its peers. In April 2010, the latest date for which data were available, Saxony-Anhalt recorded an unemployment rate of a high 13.2%.

„

Public finances: According to the 2010-11 budget, SaxonyAnhalt plans to generate revenues of €9.9bn in 2010 and €9.8bn in 2011. With €4.5bn and €4.6bn, respectively, tax revenues will account for a relative low 45% of the state’s total revenues. At the same time, Saxony-Anhalt estimates transfer payments to amount to a combined €3.2bn in each 2010 and 2011, highlighting the state’s high reliance on external funding. Net new borrowing is estimated to amount to €660mn in 2010 and €500mn in 2011 before declining to €250mn in 2012. In 2010, 8.9% of Saxony-Anhalt’s expenditures were related to interest payments, which is expected to increase to 9.4% in 2011, 10.1% in 2012, and 10.5% in 2013. Saxony-Anhalts plans to present a balanced budget in 2013.

„

Indebtedness: In the years ahead, the aggregate amount of debt outstanding is set to steadily increase. Whereas total debt stood at €19.8bn as per year-end 2009, the volume will grow to €20.5bn in 2010 and €21.0bn in 2011 before remaining stable at €21.3bn, according to the 2010-11 budget plan. This corresponds to a relatively high per capita debt of €8,353 in 2009 which will grow to €9,319 by 2013, also as a result of the ongoing population loss.

„

Political environment: Following the regional elections held in March 2006, the State of Saxony-Anhalt is governed by a socalled “grand coalition” between conservative CDU and socialdemocratic SPD. Whereas the CDU occupies 40 of the 97 parliamentary seats, the SPD holds 24 seats, thereby securing a strong 35 seat majority. Leftist Die Linke, with 24% of the vote, is the state’s second strongest political power holding 26 seats, followed by liberal FDP, which holds seven seats. The next regional elections are scheduled to be held in Q2 11.

Strengths

Weaknesses

„

„

Saxony-Anhalt (strongly) relies on funds from the German financial equalisation scheme. In the long run, however, amounts will likely decline.

Saxony-Anhalt has become subject to a pronounced population loss after German reunification, which, in combination with the absence of a sound industrial basis and a high unemployment rate, reduces the state’s potential tax base.

Key points for 2010 „

Monitor the development of the expected tax revenues as a shortfall is likely to increase Saxony Anhalt’s borrowing requirements.

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Financials and spreads

State of Saxony-Anhalt (SACHAN)

Financial summary € bn Economy Nominal GDP (€bn)

Political representation (% of votes) 2005

2006

2007

2008

2009

47.4

48.7

51.0

53.8

51.5

Real GDP growth (%)

-0.2

1.8

2.1

3.0

-4.7

GDP per capita (€'000)

19.1

19.8

21.0

22.4

21.7

2.5

2.5

2.4

2.4

2.4

Population (mn)

SPD 21.4%

Greens 3.6%

4.2

4.6

5.0

5.2

4.9

Federal transfers

3.3

3.2

3.2

3.1

2.7

Financial equalisation

0.6

0.6

0.6

0.7

0.5

Other revenues

1.1

1.1

1.0

0.9

0.5

Total revenues

9.1

9.5

9.9

9.9

8.7

FDP 6.7%

CDU 36.2%

Revenues Tax revenues

PDS 24.1%

Others 8.1%

Debt structure, 2009 Domestic credit (incl Schuldscheine) 32.1%

Expenditure Staff

2.3

2.3

2.2

2.2

2.3

Interest costs

0.9

0.9

0.9

1.0

0.8

Investment spending

2.0

1.7

1.6

1.5

1.6

Transfers to munis

3.3

3.3

2.8

2.7

2.2

Other expenditures Total expenditure

1.7

1.8

2.2

2.4

1.3

10.2

10.1

9.8

9.8

8.3

Bonds 65%

Other Capital makets 3%

Balances and debt Financial balance

-1.1

-0.5

0.1

0.1

-0.20

Debt outstanding

19.2

19.3

20.1

19.8

19.8

46.4

48.8

50.7

52.7

56.1

Ratios (%)

Financial deficit/GDP 6%

Taxes/Total revenues Expenditure/GDP Financial balance/Revenues Debt/Revenues Debt per capita (€)

21.5

20.6

19.3

18.3

16.0

-11.6

-5.7

1.2

0.5

-2.3

211

203

202

201

227

7,770 7,883 8,269 8,259 8,368

Note: Debt outstanding in this table and in the debt structure chart excludes intra-Government debt.

Structure of tax revenues, 2009

1991

1995 1999 Sachsen-Anhalt

2003

2007 all Länder

50%

7% 25% Income & Corp Taxes 23% Withholding tax 1%

10 June 2010

-2%

Debt/GDP

Muni trade taxes 1% Own taxes VAT 68%

2%

0% 1991

1995

1999

Sachsen-Anhalt

2003

2007 all Länder

455

Barclays Capital | AAA Handbook 2010

Free State of Thuringia (THRGN) Description

Leef H Dierks Ratings table

% € Index

% £ Index

Total debt

NA

NA

€15.7bn

Founded within the scope of German reunification in 1990, the Free State of Thuringia is among the economically weaker German states. It accounts for only 2% of the German GDP and for 2.8% of Germany’s population. Among the industrial centres is Eisenach (automotive), Erfurt (microelectronics), Jena (information technology and optical electronics and pharmaceuticals.) Following German reunification, Thuringia has suffered strong emigration from which the state has still not recovered. Owing to a low and declining tax base, its revenues structure is very heavily biased towards federal and EU transfer payments.

Moody’s

S&P

Fitch

LT senior unsecured

NR

NR

AAA

ST

NR

NR

NR

Outlook

NR

NR

Stable

Note: As at 7 June 2010.

Risk weighting Debt issued by the Free State of Thuringia is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

„

Economics: With a GDP of €48.9bn in 2009, down 3% y/y from €50.4bn in 2008, Thuringia’s GDP ranks among the lower of the German states and accounted for only 2.0% of total German GDP of €2,407bn in 2009. As in the case of other former East German states, Thuringia has been subject to pronounced emigration, with its population falling to 2.3mn in 2009, from 2.7mn in 1989. Net emigration currently stands at 10,000 annually. Thuringia, which, together with the Free State of Saxony ranks among the economically stronger East German states, hosts major industries in telecoms, microelectronics and optical electronics. The construction sector, as well as primary activities and services, provide relatively high proportions of GDP. Financial services, in contrast, remain under-represented. As with other East German states, Thuringia’s per capita GDP has converged upwards towards the national average in recent years, but still stands at only 71% of this average, and is thus broadly in line with its peers. With an unemployment rate of 11.5% as at end-April 2010, the latest date for which data were available, Thuringia features a lower unemployment rate than the East German average (13.5%), but a markedly higher one than the West German states (7.2%).

„

Public finances: As in the years before, the Free State of Thuringia strongly relies on federal transfers and on payments from the German financial equalisation scheme. According to the 2009-13 budget plan, a very high 37% of the estimated revenues of €9.9bn correspond to the above measures, with tax revenues accounting for only €4.3bn (or 43%) of the revenues. This level is expected to further decline in 2010. Overall, at 47.6% of the national average, Thuringia’s taxation base is remarkably low. At the same time, with expected expenditures climbing from €9.9bn in 2010, to €10.0bn in 2011, €10.1bn in 2011, and €10.2bn by 2013, net new borrowing is estimated to amount to €880mn in 2010, €750mn in 2011, €917mn in 2012, and €988mn in 2013. Whereas personnel expenditures are set to increase to €2.5bn by 2013 from €2.3bn in 2010, expenditures related to investments are set to decline to €1.6bn by 2013, from €1.9bn in 2010. The share of expenditures related to the payment of interest will increase to 7.7% by 2013, from €6.9% in 2010.

„

Indebtedness: According to Thuringia’s 2009-13 budget plan, the amount of debt outstanding, which stood at €15.7bn as at year-end 2009, is set to markedly increase, growing to €16.6bn in 2010, €17.2bn in 2011, €17.6bn in 2012, and €17.5bn in 2013. Yet, between 2007 and 2009, the amount of debt outstanding remained stable as net new borrowing stood at nil.

Political environment: Following the regional elections held in August 2009, the Free State of Thuringia is governed by a socalled grand coalition government formed by conservative CDU and social democratic SPD. Whereas the CDU secured 31.2% of the vote, the SPD secured 18.5% and thus is the state’s thirdstrongest political party behind leftist Die Linke with 27.4% of the vote. Liberal FDP secured 7.6% followed by the Greens (6.2%). The next elections are scheduled to be held in autumn 2014.

Strengths

Weaknesses

„

„

Thuringia (heavily) relies on funds from the German financial equalisation scheme. Amounts are likely to decline in the long run.

Thuringia’s reliance on tax revenues has fallen in recent years with the proportion on funding related to transfer payments, in contrast, steadily growing. With an already low tax base and strong emigration, we believe Thuringia’s public finances are likely to remain under pressure in the years ahead.

Key points for 2010 „

The growing imbalances between Thuringia’s (tax) revenues and public sector expenditures need to be carefully monitored, particularly in light of the strong reliance on federal transfer payments. However, we expect this to decline in the years ahead.

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Financials and spreads

Free State of Thuringia (THRGN)

Financial summary

Financial deficit/GDP

€ bn Economy Nominal GDP (€bn)

2006

2007

2008

2009 48.9

6%

46.2

48.1

49.8

Real GDP growth (%)

2.7

2.0

1.9

-4.3

GDP per capita (€'000)

19.9

20.9

21.9

21.7

2.3

2.3

2.3

2.3

Tax revenues Federal transfers

4.2 2.8

4.9 2.9

5.0 2.8

4.6 2.5

Financial equalisation

0.6

0.7

0.7

0.5

Debt/GDP

Other revenues Total revenues

0.9 8.5

0.8 9.3

0.9 9.4

0.5 8.2

40%

Staff

2.4

2.4

2.1

2.2

Interest costs

0.7

0.7

0.7

0.6

Investment spending

1.6

1.6

1.4

1.4

Transfers to munis

2.9

2.9

2.7

2.4

Other expenditures

1.3

1.4

2.1

1.1

Total expenditure

9.0

9.1

9.0

7.7

Financial balance

-0.5

0.2

0.4

-0.2

Debt outstanding

15.8

15.7

15.3

15.7

Taxes/Total revenues

49.2

52.8

53.9

56.6

Expenditure/GDP

19.5

18.8

18.1

15.7

Financial balance/Revenues

-5.6

2.2

3.8

-2.4

185 6,820

170 6,826

164 7,891

192 6,959

Population (mn)

2%

-2%

Revenues

1991

1995 Thuringia

1999

2003 2007 all Länder

1995

1999

2003

Expenditure

Balances and debt

20%

0% 1991

Thuringia

Debt structure, 2009 Other Capital makets 1%

Ratios (%)

Debt/Revenues Debt per capita (€)

2007 all Länder

Domestic credit (incl Schuldscheine) 61%

Bonds 38%

Note: Debt outstanding in this table and in the debt structure chart excludes intra-government debt.

Structure of tax revenues, 2009

Political representation (% of votes)

Muni trade taxes 1% Own taxes 7%

PDS 26.1%

SPD 14.5%

Greens 4.5%

Income & Corp Taxes 22% VAT 69%

Economic structure (% of gross value added) Financial Services 23.3% Trade, Transport, hotels etc 15.4% Construction 5.4%

10 June 2010

Other Services 25.3% Agric, For, Fish 1.8% Manufacturing 28.9%

Others 12.0%

CDU 43.0%

Withholding tax 1%

GDP growth rates (%) 15 10 5 0 -5 1992

1996 Thuringia

2000

2004 Germany

2008

457

Barclays Capital | AAA Handbook 2010

State of North Rhine-Westphalia (NRW) Description

Leef H Dierks Ratings table

% € Index

% $ Index

Total debt

0.234

0.005

€122.5bn

With a GDP of €521.8bn in 2009, or 21.7% of the entire German GDP, North Rhine-Westphalia (NRW) is the economically strongest German state. North Rhine-Westphalia, which was founded in 1946, borders the Netherlands and Belgium. Compared with other economies, North Rhine-Westphalia would be ranked 17th on a global scale. Overall, the region’s economy is highly diversified, with a sector breakdown of the gross value added (GVA), which mirrors the national average. The per capita income of its 18mn inhabitants, corresponding to 22% of Germany’s entire population, mostly reflects the domestic average,

Moody’s

S&P

Fitch

LT senior unsecured

Aa1

AA-

AAA

Covered bond rating

Aa1

AA-

AAA

Stable

Stable

Stable

Outlook Note: As at 7 June 2010.

Risk weighting Debt issued by the State of North Rhine-Westphalia is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

„

Economics: Following a sharp 4.7% y/y contraction in 2009, North Rhine-Westphalia’s GDP fell to €521.8bn in 2009 from €547.5bn a year before. This corresponds to 21.7% of Germany’s GDP of €2,407bn in 2009. In the years before, North RhineWestphalia had recorded sound economic growth, which peaked at 5.5% y/y in 2007. Compared with other economies, North Rhine-Westphalia would be ranked 17th on a global scale. Overall, the region’s economy is highly diversified, with a sector breakdown of the gross value added (GVA), which mirrors the national average. At the time of writing, 10 of the German corporates listed in the DAX-30 had their headquarters in NRW with 37 of the biggest 100 corporates headquartered in NRW. 99% of all companies and more than 70% of all employers belong to smaller and medium-sized companies (SME).

„

Indebtedness: According to the 2009-13 budget plan, which was adopted before the regional elections held in May, North Rhine-Westphalia’s total debt will markedly increase in the years ahead. Whereas the region’s total debt stood at €125.5bn as per year-end 2009 (€53bn in 1992), the current budget foresees an increase to €129.1bn by 2010, €135.7bn by 2011, €142.1bn by 2012, and €148.5bn by 2013. Net new borrowing is not set to markedly decrease in the years ahead but will instead remain largely stable at about €6.6bn between 2011 and 2013 because of a “dramatic decline in tax revenues”. Interest payments as a percent of overall expenditures amounted to 8.6% in 2009 and are set to increase to 8.7% in 2010 and to 10.3% by 2013.

„

Political environment: The previous CDU/FDP coalition government lost its parliamentary majority in recent regional elections which were held in May 2010. The conservative CDU secured 67 seats. At the time of writing, the SPD’s (67 seats) coalition talks with FDP (13 seats), Greens (23 seats), and leftist Die Linke (11 seats) had failed, with the outcome thus pointing towards a grand (CDU/SPD) coalition or (less likely, though) towards new elections. Alternatively, a coalition between SPD, FDP and the Greens could emerge.

Public finances: According to North Rhine-Westphalia’s 2010 budget, tax revenues are generated to amount to €37bn in 2010, down €1.5bn y/y from €38.5bn in 2009. Tax revenues accounted for 69.6% of all revenues in 2009. Public sector expenditures, in contrast, are set to decline only modestly, thereby requiring NRW to gradually increase its net borrowing to €6.5bn in 2010 after €5.9bn in 2009. For the time being, the volume of investments has been cut €2bn y/y to €5bn in 2010. Personnel expenditures, which account for 39.1% of all expenditures, increase to €20.8bn in 2010 from €20.6bn in 2009. North Rhine-Westphalia recorded expenditures of €200mn within the scope of the German financial equalisation scheme in 2009, but it expects this volume to decline to €100mn annually in the years ahead.

Strengths

Weaknesses

„

„

North Rhine-Westphalia is the strongest states in Germany in economic terms, benefiting from a well diversified economy, particularly in the heavily industrialised Rhine-Ruhr area. Attributed to the fact that more than a fifth of the entire German population lives in the state, it benefits from a broad tax base.

At €122.5bn, North-Rhine-Westphalia had the highest volume of debt outstanding of all German states with no balanced budget expected in the years ahead. Net new borrowing is set to total €6.6bn annually between 2010 and 2013.

Key points for 2010 „

Monitor the development of North Rhine-Westphalia’s 2010 tax revenues, which, in the case of being markedly lower than expected, could lead to higher borrowing needs.

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Financials and spreads

State of North Rhine-Westphalia (NRW)

Financial summary

Political representation (seats), 2010

€ bn Economy

2006

2007

2008

2009

Nominal GDP (€bn)

505.9

529.4

541.1

521.7

Real GDP growth (%)

2.6

2.6

1.7

-5.8

GDP per capita (€'000)

28.0

29.4

30.1

29.2

Population (mn)

18.0

18.0

18.0

18.0

CDU 67 SPD 67

Die Linke 11

Revenues Tax Revenues

37.0

40.5

42.1

38.5

3.8

3.8

3.6

3.9

Federal transfers Other Revenues

3.6

3.7

4.3

2.8

Total Revenues

44.4

48.0

50.0

45.2

18.6

19.4

19.0

19.9

Greens 23

FDP 13

Debt structure, 2009

Expenditure Staff Interest costs

4.6

4.7

4.8

4.6

Investment spending

4.6

4.5

4.8

5.4

Transfers to munis

10.1

11.2

12.2

10.7

Other expenditures Total expend before Fin Equal

9.5 47.5

9.1 48.9

9.2 50.0

6.1 46.7

Fin Equal contributions Total expenditure

Debt Outstanding

Bonds 56% Other Capital makets 6%

0.3

0.1

0.0

0.0

47.8

49.0

50.0

46.7

-3.4

-1.0

0.1

-4.70

112.9

114.1

113.6

120.5

2 1

Balances and Debt Financial Balance

Domestic credit (incl Schuldscheine) 37%

Financial deficit/GDP

Ratios (%) Taxes/total revenues

83.4

84.5

84.2

85.1

Expend. Before Fin Eq/GDP

9.4

9.2

9.2

9.0

Financial balance/revenues

-7.6

-2.1

0.2

-10.4

Debt/Revenues

254.1

237.8

227.0

Debt per capita (€)

6,260

6,335

6,322

266.7

0 -1

6,734

1991

Note: Debt outstanding in this table and in the debt structure chart excludes intra-government debt.

Structure of tax revenues, 2009 Withholding tax on interest 3%

Income and Corporate Taxes 49%

10 June 2010

1995

1999

2003

NRW

2007 all Länder

Debt/GDP VAT 33%

25 20

Municipal trade taxes 3% Own taxes 11%

15 10 1991

1995 NRW

1999

2003

2007

all Länder

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Barclays Capital | AAA Handbook 2010

State of Baden-Württemberg (BADWUR) Description

Leef H Dierks Ratings table

% € Index

% £ Index

Total debt

0.134

NA

€41.7bn

The state of Baden-Württemberg (BADWUR) is located in the southwest of Germany, bordering France and Switzerland. BadenWürttemberg was founded in 1952 following a referendum on the merger of the states of Württemberg-Baden, WürttembergHohenzollern and Baden. It is Germany’s third-largest state in terms of land area (10%), population (13%) and GDP (16 %). With the per capita disposable income at 110% of the domestic average at the time of writing, Baden-Württemberg is among Germany’s most affluent states. It has a strong and diversified economy, with a particularly strong export-oriented manufacturing and automotive base.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AA+

AAA

Covered bond rating

NR

AA+

NR

Stable

Stable

Stable

Outlook Note: As at 7 June 2010.

Risk weighting Debt issued by the State of Baden-Württemberg is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

„

Economics: Attributed to the importance of the industrial sector and its focus on engineering, automotive and manufacturing, the GDP sharply contracted 5.8% y/y in 2009, down from a 2.1% y/y growth in 2008 and a 4.8% y/y growth in 2007. This decline was only surpassed by the economically markedly weaker Saarland (-7.1% y/y). Overall, with a GDP of €344bn in 2009, which accounted for 16.1% of Germany’s aggregate GDP (€2.124bn in 2009), Baden-Württemberg is the economically third-strongest German state after North Rhine-Westphalia and Bavaria. With the disposable per capita income standing at 110% of the domestic average at the time of writing, Baden-Württemberg is among Germany’s most affluent states. Baden-Württemberg’s economic structure is dominated by the manufacturing sector, which accounted for one third of the state’s gross value added (GVA) – ie, markedly more than the sector’s 29% share in the national GVA. Furthermore, on a nationwide basis, Baden-Württemberg’s manufacturing sector accounts for c.20% of the domestic total. Baden-Württemberg’s manufacturing sector, which accounts for 40% of all employment, is strongly geared towards exports (benefiting from its geographical location). As of late, the structural change has caused the weight of the tertiary sector to increase, to 60%. Political environment: Following the regional elections held in March 2006, the State of Baden-Württemberg, which is generally considered a stronghold of the conservative CDU, is currently governed by a coalition of the CDU (59 seats) and liberal FDP (15 seats), which together hold a comfortable 84seat majority in the 139-seat state parliament. The socialdemocratic SPD, which with 27.3% of the vote is BadenWürttemberg’s second-strongest political power, occupies 38 seats, followed by the Greens, which hold 17 seats. The next regional elections are scheduled to be held in Q2 11.

„

Public finances: Following a budget surplus of €1.5bn in 2007 and €1.4bn in 2008, Baden-Württemberg generated a €1.4bn budget deficit in 2009. Tax revenues, which accounted for 74% of all revenues in 2009, fell to €24.7bn from €28bn in 2008. Expenditures, at the same time, increased to €34.6bn in 2009 from €31.5bn in 2008. In 2009, Baden-Württemberg contributed €1.5bn (2008: €2.5bn) to the German financial equalisation scheme, thereby being the third-largest payer after Bavaria and Hesse. The contribution corresponded to 6.1% of its 2009 tax revenues. The 2010-11 budget foresees expenditures of €34.9bn in 2010 and €35.1bn in 2011 of which more than 40% are related to personnel expenditures. Provided these figures materialise, Baden-Württemberg will generate budget deficits of €2.8bn in 2010 and €3.0bn in 2011.

„

Indebtedness: As per year-end 2009, BADWUR’s capital market debt amounted to €41.7bn, and this stood largely unchanged largely from the 2008 volume. Interest payments amounted to €1.6bn in 2009 and are expected to increase to €1.9bn in 2010 and €2bn in 2011. Hence, 8.1% of the 2010 expected tax revenues will be used for interest payments. We expect net borrowing, which in 2009 amounted to a negative €16mn, to surge to €2.7bn in 2010 before gradually declining to €2.1bn in 2011.

„

Employment: At 5.1% at year-end 2009, Baden-Württemberg benefits from one of the lowest unemployment levels in Germany. This comes despite one of the strongest population growth rates in Germany, which is due to natural growth and migration.

Strengths

Weaknesses

„

„

Baden-Württemberg is one of the economically strongest states in Germany. A pick-up in global economic growth will likely be reflected in an above average recovery of the region’s exportoriented manufacturing sector.

After generating budget surpluses in 2007 and 2008, BadenWürttemberg reported a €1.4bn budget deficit in 2009 as tax revenues fell while expenditures increased.

Key points for 2010 „

Monitor the development of BADWUR’s public finances, particularly given the pronounced increased in net new borrowing as foreseen in the 2010-11 draft budget.

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Financials and spreads

State of Baden-Württemberg (BADWUR)

Financial summary € bn Economy Nominal GDP (€bn) Real GDP growth (%) GDP per capita (€'000) Population (mn) Revenues Tax revenues Federal transfers Other revenues Total revenues Expenditure Staff Interest costs Investment spending

Structure of tax revenues, 2009 2006

2007

2008

2009

337.6 4.4 30.1 10.7

353.0 2.8 31.4 10.7

364.3 0.5 32.8 10.8

343.7 -7.4 32.0 10.8

24.0 2.3 5.7 31.9

26.9 2.1 5.3 34.4

28.0 2.1 5.7 35.8

24.7 2.4 5.0 32.1

Income and Corporate Taxes 53%

Withholding tax on interest 3% VAT 30% Municipal trade taxes 3%

Own taxes 11%

Political representation (% of votes) 13.0 2.3 3.0

12.8 1.9 2.8

13.1 1.9 3.0

13.6 1.6 3.4

Transfers to munis Other expenditures Total expend before fin equal Fin equal contributions Total expenditure Balances and debt Financial balance Debt outstanding

7.6 4.8 30.6 2.2 32.9

8.1 5.0 30.7 2.1 32.9

8.6 5.3 31.9 2.6 34.5

9.1 1.6 29.3 1.9 31.2

-0.9 41.1

1.5 41.7

1.4 41.7

-1.4 41.7

Ratios (%) Taxes/Total revenues Expend. before fin eq/GDP Financial balance/Revenues Debt/Revenues Debt per capita (€)

75.2 9.1 -2.9 128.7 3,823

78.4 8.7 4.4 121.4 3,881

78.1 8.7 3.8 116.4 3,878

76.9 8.5 -4.4 129.9 3,879

FDP/DVP 10.7%

SPD 25.1%

Greens 11.7% Others 8.4%

CDU 44.1%

Financial deficit/GDP 2%

0%

Note: Debt outstanding in this table and in the debt structure chart excludes intra-Government debt.

-2% 1992

1996

2000

Baden Württenberg

Debt/GDP

2004

Debt structure, 2009

30% Domestic credit (incl Schuldscheine) 64%

20% 10%

Other Capital makets 6%

0% 1991

10 June 2010

2008

all Länder

1995 1999 Baden Württemberg

2003

2007 all Länder

Bonds 26%

Intra Govt Debt 4%

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State of Bavaria (BAYERN)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total debt

0.085

NA

€27.6bn

The Free State of Bavaria (BAYERN) is located in south east Germany and borders Austria and the Czech Republic. It is the largest German state in terms of land area (15%). With a GDP of €429.9bn in 2009, sharply down from €444.8bn in 2008, which corresponds to 17.8% of the entire German 2009 GDP (€2,407bn), Bavaria is the second-strongest regions in terms of economic strength, only surpassed by North Rhine-Westphalia. With a disposable per capita income of 117% of the national average, Bavaria is among the most affluent German states. Also, Bavaria is the only German state that was Aaa/AAA/AAA-rated at the time of writing.

Moody’s

S&P

Fitch

LT senior unsecured

Aaa

AAA

AAA

Covered bond rating

Aaa

AAA

AAA

Stable

Stable

Stable

Outlook Note: As at 7 June 2010.

Risk weighting Debt issued by the Free State of Bayern is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

Economic environment: The Free State of Bavaria benefits from a strong and well-diversified economy, with a sector structure very close to the domestic average. Within the manufacturing sector, the focus is on the automotive and technology sectors with large corporates such as BMW or Siemens, among others, being headquartered in Bavaria. Overshadowed by the globally decelerating economic growth and the global financial crisis, in 2009, Bavaria’s GDP contracted a strong 3.4% y/y to €429.9bn from €444.8bn in 2008. In 2008 and 2007, economic growth still amounted to 2.5% y/y and 4.6% y/y, respectively – ie, largely reflecting the development of the aggregate German GDP.

„

Public finances: In 2009, Bavaria generated tax revenues of €31bn, down from €33.3bn in 2008. This amount corresponded to 78.9% of all 2009 revenues (ie, down slightly from 81% in 2008). Personnel expenditures accounted for 41.4% in 2009 with the investment ratio standing at a high 13.6% of all expenditures. Following the adoption of rescue measures for Bayerische Landesbank in 2008 and 2009, however, Bavaria reported a budget deficit of €8.0bn – the highest of all German regions. In 2008, the budget deficit still stood at €139mn after a surplus of €2.6bn was generated in 2008. In 2010, Bavaria expects total revenues to amount to €42.3bn, of which €28.7bn (or 67.8%, -5.0% y/y) is tax-related. Expenditures are forecast to grow by 2.1% y/y to €42.4bn, of which €17.2bn will be personnel costs.

„

Indebtedness: With expenditures scheduled to be in line with revenues, Bavaria plans to present a balanced 2010 budget within the line of its 2009-10 budget. Net new capital market borrowing is expected to be nil in 2010. This, however, could come under pressure in case of further financing needs of Bayerische Landesbank. In 2009, Bavaria contributed €3.4bn within the scope of the German financial equalisation scheme. This amount is expected to stand largely stable at about €3.5bn in 2010. Overall, attributed to a prolonged track record of sound fiscal management, Bavaria’s debt-to-GDP ratio is the lightest among the German states by a substantial margin. Compared with other German regions, interest payments stood at a markedly lower level than those of its peers, amounting to a moderate 2.7% in 2009. This figure is expected to increase gradually to 3.1% in 2010. Overall, debt per capita stood at €2,606 in 2009– clearly below the national average of €5,417.

„

Political environment: The Bavarian political scene is characterised by a high degree of stability, having been dominated and governed by the conservative Christian Social Union (CSU) since 1945. Still, in the elections held in autumn 2008, the CSU’s share of the vote fell to 44%, from 61% in 2003, with the number of parliamentary seats falling to 92 from 124 (out of 187). This forced the party into a coalition government with the liberal FDP (16 seats). The Social-democratic SPD, the state’s second-largest political power, secured 38 seats, followed by the Greens (20 seats) and the Free Voters (19 seats).

Strengths

Weaknesses

„

„

Bavaria is one of the economically strongest regions in Germany and, despite the high budget deficit recorded in 2009, generally benefits from solid public finances, which makes it a key contributor to the Financial Equalisation System.

Bavaria’s public finances have come under pressure in 2008-09 as a result of capital injections into state-owned Bayerische Landesbank.

Key points for 2010 „

The effect of potential capital injections into Bayerische Landesbank on Bavaria’s public finances needs to be monitored carefully.

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Financials and spreads

State of Bavaria (BAYERN)

Financial summary € bn Economy Nominal GDP (€bn) Real GDP growth (%) GDP per capita (€'000) Population (mn)

Political representation (% of votes) 2005

2006

2007

2008

2009

323 1.7 32.2 12.5

338 3.3 33.2 12.5

353 2.8 34.7 12.5

364 1.4 35.5 12.5

344 -5.0 34.4 12.5

Revenues Tax revenues

25.9

27.9

31.1

33.3

31.0

Federal transfers Other revenues Total revenues

2.6 4.6 33.2

2.7 4.8 35.5

2.7 4.7 38.5

2.7 5.1 41.1

2.8 3.9 37.7

Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures

14.8 1.0 4.0 6.5 5.8

15.1 1.1 4.2 7.0 5.7

15.3 1.0 4.2 7.6 5.4

15.8 0.9 7.7 8.1 5.6

16.6 0.9 3.5 6.9 4.1

32.2 2.2 34.4

33.1 1.9 35.0

33.6 2.3 35.9

38.1 3.1 41.2

32.0 3.6 35.6

-1.3 23.1

0.5 23.1

2.6 22.8

-0.1 22.1

-8.0 27.6

78.2 10.0 -3.8 70 1,851

78.6 9.8 1.3 65 1,847

80.7 9.5 6.7 59 1,821

81.0 10.5 -0.3 54 1,767

82.2 9.3 -21.2 73 2,206

Total expend before fin equal Fin equal contributions Total expenditure Balances and debt Financial balance Debt outstanding Ratios (%) Taxes/Total revenues Expend. before fin eq/GDP Financial balance/Revenues Debt/Revenues Debt per capita (€)

FW 10%

SPD 19%

Greens 9% FDP 8% The Left 4%

CSU 44%

Others 6%

Debt structure, 2009

Note: Debt outstanding in this table and in the debt structure chart excludes intra-government debt.

Other Capital makets 3% Domestic credit (incl Schuldscheine) 61%

Bonds 36%

Financial deficit/GDP 2% 1% 0% -1% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Bavaria

Structure of tax revenues, 2009 Withholding tax on interest 3%

Income and Corporate Taxes 52%

Debt/GDP VAT 29% Municipal trade taxes 3% Own taxes 12%

30% 20% 10% 0% 1992

1996 Bavaria

10 June 2010

all Länder

2000

2004

2008

all Länder

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State of Brandenburg (BRABUR) Description

Leef H Dierks Ratings table

% € Index

% £ Index

Total debt

0.048

NA

€18.1bn

Geographically, the former East German State of Brandenburg (BRABUR) surrounds the city state of Berlin. With a GDP of €53.9bn in 2009, down 0.9% y/y from €54.4bn in 2008, Brandenburg ranks among the economically weaker German states. Its GDP accounts for only 2.2% of the German GDP (€2.4bn). In terms of land area, however, Brandenburg, which lacks any noteworthy industry basis, accounts for 8.7% of Germany. As in the case of its East German peers, tax revenues, which Brandenburg estimates to total €4.8bn in 2010, down €744mn y/y, only account for only a small proportion (45.7%) of all revenues. Transfer payments as well as “revenues from the issuance of new debt” will account for 30.9% and 20.2%, respectively, thereby highlighting Brandenburg’s ongoing reliance on federal transfers and fiscal equalisation payments.

Moody’s

S&P

Fitch

LT senior unsecured

Aa1

NR

AAA

Bond rating

Aa1

NR

AAA

Stable

NR

Stable

Outlook Note: As at 7 June 2010.

Risk weighting Debt issued by the State of Brandenburg is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

„

Economics: Being the geographically largest state in what previously was East Germany, the State of Brandenburg, which covers 8.3% of the German land area, surrounds the city state of Berlin. In strong contrast to other former East German states, the State of Brandenburg has not been subject to a pronounced emigration but, largely attributed to its vicinity to Berlin, has managed to keep its population figures stable at about 2.5mn since 1990. In terms of the age structure, a high 34% of Brandenburg’s population was older than 55 years in 2008. Adding to a potential strain on the public finances is Brandenburg’s relatively high unemployment rate in 2009 of 14.5%.

„

Public finances: Following a €460mn budget surplus in 2007 and a deterioration of public finances in 2008 that led to a €144mn budget deficit, Brandenburg generated a budget deficit of €513mn, or 1% of GDP, in 2009. Whereas revenues amounted to €9.5bn in 2009, stable from 2008 but down from €10.3bn in 2007, expenditures sharply increased to €10bn in 2009 from €8.4bn in 2008. In 2010, Brandenburg expects its total revenues to increase to €10.5bn, with expenditures largely comparable – ie, in principle anticipating a balanced budget.

„

Political environment: Following the regional elections held in September 2009, the State of Brandenburg is governed by a socalled “red-red coalition” between the social-democratic SPD and leftist Die Linke. Whereas the SPD occupies 31 of the 88 parliamentary seats, Die Linke holds 26 seats, thereby securing a comfortable 13 seat majority. Conservative CDU holds 19 seats followed by liberal FDP (seven seats) and the Greens (five seats). The next elections will be held in autumn 2014.

Indebtedness: Brandenburg’s aggregated debt sharply increased since German reunification in 1990. Whereas Brandenburg’s debt amounted to €2.8bn in 1992, it has since climbed to €18.0bn in 2008. Taking into consideration a population loss of annually 10,000 inhabitants, however, the per-capita income has increased to €7,117. Brandenburg’s interest payments have recorded an annual average increase of 37% since 1991 and meanwhile account for a high 14% of all tax revenues. The recent 2009-13 finance plan foresees that net new debt, which is scheduled to amount to €651mn in 2010, will be reduced to €500mn in 2011 and €350mn in 2012. After a final €200mn borrowing in 2013, Brandenburg expects to present a balanced budget – “provided taxes are not lowered”. Despite this development, the overall amount of debt outstanding is set to increase further from €18.8bn in 2010 to €19.3bn in 2011, €19.6bn in 2012 and to €19.8bn in 2013. This translates into a per capita debt of €7,869 by 2013, provided the population number remains stable.

Strengths

Weaknesses

„

„

Brandenburg (strongly) relies on funds from the German financial equalisation scheme. In the long run, amounts will likely decline.

Brandenburg is exposed to an ageing population and a population loss of c.10,000 annually. In combination with the absence of a sound industrial base, this reduces the potential tax base.

Key points for 2010 „

The (political) willingness to curb new borrowing needs to be carefully monitored, particularly in light of the €650mn Brandenburg plans to borrow this year.

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Financials and spreads

State of Brandenburg (BRABUR)

Financial summary € bn Economy

Political representation (% of votes) 2005 2006 2007 2008 2009

Nominal GDP (€bn) Real GDP growth (%)

49.0 0.9

50.2 1.3

52.6 2.0

54.9 1.5

53.9 -2.1

GDP per capita (€'000)

19.1

19.7

20.7

21.7

21.4

2.6

2.6

2.5

2.5

2.5

Population (mn)

Greens 3.6% SPD 31.9%

Revenues Tax revenues

4.3

4.8

5.5

5.6

Federal transfers

3.1

3.1

3.1

3.1

2.7

Financial equalisation

0.6

0.6

0.7

0.6

0.6

Other revenues Total revenues

1.8 9.2

1.8 9.7

1.7 10.3

1.6 10.2

1.1 8.8

5.0

Staff

2.1

2.0

2.0

2.0

2.0

Interest costs

0.8

0.8

0.8

0.8

0.7

Investment spending

1.8

1.8

1.7

1.6

1.7

Transfers to munis

3.2

3.3

3.3

3.5

2.7

Other expenditures

1.9

2.0

2.0

2.1

1.1

Total expenditure

9.7

10.0

9.8

10.1

8.3

Expenditure

PDS 28.0% DVU 6.1%

CDU 19.4%

FDP Others 3.3% 7.7%

Debt structure, 2009 Other Capital makets 1%

Domestic credit (incl Schuldscheine) 39%

Bonds 59%

Balances and debt Financial balance

-0.5

-0.3

0.5

0.1

-0.5

Debt outstanding

17.0

17.2

17.4

17.2

17.4

Financial deficit/GDP 10%

Ratios (%) Taxes/Total revenues

47.3

49.2

53.2

54.7

56.8

Expend./GDP

19.7

19.9

18.7

18.3

15.4

Financial balance/Revenues

-5.6

-3.0

4.5

1.4

-5.7

Debt/Revenues Debt per capita (€)

186 178 168 169 198 6,640 6,749 6,827 6,803 6,929

6% 2% -2%

Note: Debt outstanding in this table and in the debt structure chart excludes intra-government debt.

Structure of tax revenues, 2009

1991

1995

1999

Brandenburg

2003

2007

all Länder

Debt/GDP

Muni trade taxes 1% Own taxes

40%

8% 20% VAT 63%

Income & Corp Taxes 27% Withholding tax 1%

10 June 2010

0% 1992

1996

2000

Brandenburg

2004

2008

all Länder

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State of Lower Saxony (NIESA)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total debts

NA

NA

€53.2bn

With a GDP of €206bn in 2009 and thus contributing 8.8% of Germany’s total GDP, the state of Lower Saxony (NIESA) is Germany’s fifth-largest state in terms of economic strength. It accounts for 13% of the German land area, thereby ranking second only to the Free State of Bavaria. As at year-end 2009, Lower Saxony had a population of c.8mn (or 10% of the German total of 82mn). In 2010, Lower Saxony expects to receive €169mn within the scope of the German financial equalisation scheme.

Moody’s

S&P

Fitch

LT senior unsecured

NR

NR

AAA

Covered bond rating

NR

NR

NR

Outlook

NR

NR

Stable

Note: As at 7 June 2010.

Risk weighting Debt issued by the State of Lower Saxony is subject to a risk weighting of 0% within the Basel II RSA.

Key features „

„

Economics: With a GDP of €205.6bn in 2009, down 3.5% y/y from €213.1bn in 2008, Lower Saxony contributed 8.8% to the total German GDP of €2,407bn in 2009. At the same time, the state’s per capita GDP stands at only 88% of the domestic average, living standards (statistically) are towards the lower end of the range for the former West German states. The neighbouring City State of Hamburg, for example, had a percapita GDP in excess of 164% of the domestic average. Lower Saxony’s industrial structure largely resembles the German average, albeit financial services are slightly under-represented. Also, being a so-called “territorial state”, Lower Saxony is subject to an above-average weight in agriculture, manufacturing and construction. The state’s industrial centre lies in the Hannover-Braunschweig-Wolfsburg triangle, where several car and car parts makers are located, among them Europe’s largest car maker Volkswagen.

„

Indebtedness: Lower Saxony’s indebtedness has more than doubled since 1990 when it stood at €20.6bn. As at year-end 2009, the latest date for which data were available, the amount had increased to €53.2bn, up from 50.2bn in 2008. According to the 2009-13 budget plan, the states overall (capital market) debt is set to further grow to €56.1bn in 2010, €58.2bn in 2012, and €61.0bn in 2013. Lower Saxony plans to reduce net borrowing to nil by 2017.

„

Public finances: With Lower Saxony estimating its expenditures to total €25.2bn in 2010, the state will be subject to a budget deficit, which it plans to cover by net new borrowing of €2.3bn. This volume is set to decline to €2bn in 2011, €1.6bn in 2012 and €1.3bn in 2013. Gross borrowing is expected to amount to a high €9.0bn in 2010. Tax revenues are estimated to amount to €15.5bn in 2010, thereby accounting for 62% of all revenues. Still, Lower Saxony will also receive €169mn of transfer funds from the German financial equalisation scheme. With regards to its expenditure structure, with €9.6bn, personnel expenditures are likely to account for a large part of (38%) the budget. Interest payments account for 9.6% of all expenditures and are set to grow from €2.2bn in 2009, to €2.4bn in 2010, €2.5bn in 2011, €2.8bn in 2012 and to €2.9bn by 2013. The respective quota in terms of all spending will grow to 10.9% by 2013, from 10.6% in 2012, and 10.0% in 2011. In terms of the interest payment to tax revenues ratio, the state expects the current level of 12.7% to increase to 15.1% by 2013. Note that in 2010, Lower Saxony plans to take an additional €789mn from its accrued reserves.

Political environment: Following the regional elections held in January 2008, the state of Lower Saxony is governed by a coalition of conservative CDU and liberal FDP, which is in its second term. Whereas the major parties, ie, the CDU and socialdemocratic SPD lost 6pp (to 42.5%) and 3pp (to 30.3%), respectively, leftist Die Linke obtained 7.1% of the vote, thereby winning the right to parliamentary representation.

Strengths

Weaknesses

„

„

With a GDP of €205.6bn, Lower Saxony is the fifth-largest German state in terms of economic power and benefits from a relatively well balanced structure of the manufacturing and services industry.

Despite an already relatively high debt level of €53.2bn at the time of writing, Lower Saxony will not cut its net new borrowing to nil before 2017, thereby causing the overall amount of debt outstanding to grow to €61.0bn by 2013.

Key points for 2010 „

In light of net new borrowing of €2.3bn in 2010, the consolidation efforts of Lower Saxony’s public finances should be carefully monitored.

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Financials and spreads

State of Lower Saxony (NIESA)

Financial summary

Political representation (% of votes)

€ bn Economy

2005 2006 2007 2008

2009

Nominal GDP (€bn) Real GDP growth (%)

192.7 199.0 206.6 214.4 2.2 2.4 2.0 1.9

205.6 -4.7

GDP per capita (€'000)

24.1

24.9

25.9

26.9

25.9

8.0

8.0

8.0

8.0

8.0

14.1

16.0

16.7

17.7

17.4

Federal transfers

2.1

2.1

2.1

1.9

1.8

Financial equalisation

0.3

0.3

0.3

0.4

0.1

Other revenues

2.8

3.5

4.0

3.4

3.1

Total revenues

19.0

21.5

22.8

23.0

22.2

Population (mn)

PDS 7.1%

Revenues Tax revenues

Greens 8.0% FDP 8.2%

CDU 42.5%

SPD 30.3%

Others 3.9%

Debt structure, 2009 Other Capital makets 3.7%

Expenditure Staff

8.4

8.5

8.7

8.9

9.2

Interest costs

2.3

2.3

2.2

2.2

2.2

Investment spending

1.9

1.5

2.3

1.9

2.0

Transfers to munis Other expenditures

4.9 4.3

5.2 4.3

6.0 4.2

6.0 4.5

5.8 3.4

21.8

21.8

23.4

23.5

22.6

Total expenditure

Domestic credit (incl Schuldscheine) 51.1%

Bonds 45.2%

Balances and debt Financial balance

-2.8

-0.3

-0.7

-0.4

-1.50

Debt outstanding

47.9

48.8

49.4

50.2

51.5

74.3

74.2

73.3

76.8

78.2

Expenditure/GDP 11.3 Financial balance/Revenues -14.6

10.9 -1.3

11.3 -2.9

10.9 -1.8

11.0 -6.8

252 227 217 218 5,982 6,107 6,191 6,301

232 6,477

Ratios (%)

Financial deficit/GDP 3%

Taxes/Total revenues

Debt/Revenues Debt per capita (€)

1%

-1%

Note: Debt outstanding in this table and in the debt structure chart excludes intra-Government debt.

1991

1995

1999

Lower Saxony

Structure of tax revenues, 2009 VAT 44%

10 June 2010

2007

all Länder

Debt/GDP Municipal trade taxes 3% Own taxes 10%

Withholding tax on interest 2%

2003

Income and Corporate Taxes 41%

25% 20% 15% 10% 1991

1995

1999

Lower Saxony

2003

2007 all Länder

467

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This page is intentionally left blank

10 June 2010

468

Barclays Capital | AAA Handbook 2010

PFANDBRIEF ISSUER PROFILES

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469

Barclays Capital | AAA Handbook 2010

Aareal Bank AG (AARB)

Fritz Engelhard

Description

Ratings table

% € Index

% £ Index

Total assets

0.030

NA

€40bn

Aareal Bank AG (AARB) is a specialised property finance bank focusing on structured property finance, consulting and property management services. While 63% of its shares are free float, a 37% stake is held by a holding company, which is largely owned by German insurance companies. At YE 09, Aareal Group had total assets of €39.6bn and about 2,300 employees. Lending activity was secured by property located in more than 25 countries. Reacting to ongoing disruptions in financial markets, the bank adopted a “buymanage-hold approach”. While it remained profitable, in March 2009 it agreed with the German Financial Markets Stabilisation Fund (SoFFin) to receive €525mn of Tier 1 capital through a silent participation. SoFFin also provided a €4.0bn guarantee facility. Both measures were taken to ensure the “long-term future” of the bank’s business and to help it “get through the difficult market environment”. Aareal Bank expects markets to remain challenging this year, but anticipates a recovery in 2011 and plans to pay back a first tranche of it‘s SoFFin participation in early 2011.

Moody’s

S&P

Fitch

LT senior unsecured

NR

NR

A-

Covered bond rating*

NR

NR

AAA/AAA

Outlook

NR

NR

Stable

Discontinuity factor**

-

-

24.6/5.6

Collateral score**

-

-

-

Note: *Mortgage Pfandbriefe/Public sector Pfandbriefe, **In %

Risk weighting Pfandbriefe carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.

Strengths

Weaknesses

„

Resilient bottom line income: Aareal Group reported net income of €67mn in FY 09. While this is 14% down from FY 08, we think this is very impressive given the challenging environment in its core markets. Net interest income remained above €450mn. Net fees and commission income continued to contribute to a diversification of earnings, amounting to €133mn in FY 09, down from €150mn in FY 08, mainly because of more prudent new business origination. The €67mn swing in the bank’s trading income was largely due to revaluations of credit derivative positions. This swing helped to compensate for the €70mn increase in loan-loss provisions, which was at the upper end of the bank’s projections for FY 09.

„

Challenging conditions in core markets: Market conditions in some of the bank’s target sectors have become more challenging over the past 12 months. The economic slowdown in many industrial countries has had a negative impact on tenant quality and it also has put pressure on the achievable rental income, as well as the valuation of underlying properties. Notwithstanding this, pressure on risk provisions is mitigated by the bank’s strong track record of managing its exposure through different market cycles. This is reflected in the benign increase of the bank’s NPL ratio from 2.9% at YE 08 to 3.9% at YE 09. In addition, the portfolio provision of €34mn created at YE 08 was not utilised, but increased by €14mn at YE 09.

„

Sound business franchise: The disruptions in financial markets offer Aareal Bank the opportunity to leverage its sound business franchise more strongly. As many of its peers struggle to remain competitive, profitability in the bank’s core business is increasing. Also, its international profile, which incorporates real estate lending in 25 countries, gives it the flexibility to benefit from a broad spectrum of market opportunities and diversify its credit exposure across different property cycles.

„

Securities holdings: As of 31 December 2009, Aareal Bank AG added a net €3,872mn or 28% of the group’s debt securities holdings to the fixed-assets account. The non-realised loss on the portfolio amounts to €298mn, or 14% of total group equity as of YE 09. While this appears manageable, we note that swap spreads, in particular for some public sector debtors, remain volatile and this in turn exposes the bank to potential write-offs.

„

„

Strengthened capitalisation: The bank’s Tier 1 ratio increased from 8.0% at YE 08 to 11.0% at YE 09. This was mainly the result of the €525mn capital injection in Mar 09. In addition, risk-weighted assets decreased by €1.4bn or 5.9% in 2009. The bank also increased its wholesale deposits (YE 09: €8.1bn versus YE 08: €7.2bn), which also included €3.8bn of deposits from the institutional housing sector.

„

Potential support: While Aareal Bank, unlike many other Pfandbriefbanks, is not part of a larger banking group, we would expect it to gain support from the German private banking sector, as it has a sizeable (€10.2bn at YE 09) volume of outstanding Pfandbriefe, as well as €8.5bn of Schuldscheindarlehen held by non-banks.

Regulatory challenges: Some of the planned changes to the international regulatory environment for credit institutions may be quite challenging for Aareal Bank. For example, the EU proposed a further harmonisation of the risk-weighting approach to commercial mortgage credit. This could eventually lead to a doubling of the capital charge on these types of assets. In addition, the maintenance of a liquidity buffer, as stipulated by the Basel Committee as well as proposed amendments to the Capital Requirements Directive, could have a lasting negative impact on the bank’s profitability and internal capital generation capacity.

„

Event risk: According to German newspaper Boersen-Zeitung, Aareal Bank is among the bidders for Westdeutsche Immobilienbank, a subsidiary of WestLB AG. An acquisition could potentially have a negative impact on the credit profile.

„

Track acquisition activities and their impact on the portfolio composition as well as capitalisation levels.

Key points for 2010 „

Monitor the development of the bank’s NPL ratio and risk provisioning.

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Barclays Capital | AAA Handbook 2010

Financials and spreads

Aareal Bank AG (AARB)

Financial summary – YE Dec € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortg. Pfandbriefe Total equity Profitability (%) Net int. margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

Net interest margin, credit costs and RoA 2006

2007

2008

2009

1.5%

379.0 145.0 13.0 605.0 356.0 249.0 89.0 160.0 125.0

399.0 142.0 -26.0 751.0 361.0 390.0 77.0 313.0 308.0

456.0 150.0 -23.0 538.0 347.0 191.0 80.0 111.0 78.0

456.0 133.0 44.0 601.0 361.0 240.0 150.0 90.0 67.0

1.0%

38,274 23,341 1,735 20,682 9,707 22,643 2,685 3,119 1,372

40,202 24,985 1,738 22,550 9,117 23,834 3,090 4,714 1,627

41,159 24,771 1,875 22,813 7,310 22,330 2,985 7,016 1,429

39,569 23,459 1,717 21,288 8,066 23,517 2,811 7,368 2,077

0.98 0.3 9.6 58.8 62.6

1.02 0.8 20.5 48.1 53.1

1.12 0.2 5.1 64.5 84.8

1.13 0.2 3.8 60.1 75.9

35.7 1.4 4.6 29.5

19.7 0.7 2.3 32.8

41.9 0.9 2.9 31.2

62.5 1.2 3.9 29.4

8.2 13.5 3.6

8.0 12.3 4.0

8.0 12.0 3.5

11.0 15.0 5.2

-0.5% 01

02 03 04 05 Net interest margin

06 07 Credit costs

08

09 RoA

Efficiency 100%

1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0%

80% 60% 40% 20% 0% 01

02

03

04

05

06

07

08

09

Cost/Assets Ratio (RS)

Capital 20% 15% 10% 5% 0% 01

02

03

04

Tier 1 ratio

05

06

07

08

09

Total capital ratio

Securities portfolio (€13.8bn) – by product type, YE 09

12% 10% 8% 6% 4% 2% 0%

60% 50% 40% 30% 20% 10% 0% 05

06

07

Prob loans/Gr loans (LS)

08

09

Coverage ratio (RS)

Over-collateralisation – mortgages €bn 10

0 Dec-05 Dec-06 Dec-07 Restricted assets Over-collateralisation

ABS 4% Bank debt 16% Public sector 71%

Covered Bonds 9%

Counterparty type – mortgages, YE 09 OC (x) 2.0 1.5

5

10 June 2010

0.0%

Cost/Income ratio

Asset Quality

04

0.5%

1.0 0.5 0.0 Dec-08 Dec-09 Covered bonds

Logistics 14% Hotel 12% Wholesale/ Retail 22%

Residential 13% Other 3%

Office 36%

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Barclays Capital | AAA Handbook 2010

Bayern LB (BYLAN)

Fritz Engelhard

Description

Ratings table

% € Index

% £ Index

Total assets

0.313

0.019

€339bn

With total assets of €339bn as at year-end 2009, BayernLB (BYLAN) is Germany’s second-largest Landesbank. Through BayernLB Holding AG, the bank is owned by the Free State of Bavaria (94.03%) and the Association of Bavarian Savings Banks (5.97%). In April 2008, BYLAN received €4.8bn of protection from its owners against default risks of its ABS investments. Following EU approval, between December 2008 and March 2009, the Free State of Bavaria injected a total of €10bn of fresh capital into BYLAN. In December 2008, SoFFIn agreed to provide €15bn worth of federal guarantees to support the banks refinancing activities. Only €5bn of this amount was used and the remaining €10bn was cancelled with SoFFIn in October 2009. On 14 December 2009, BayernLB transferred its 67.08% stake in Hypo Alpe Adria Bank International AG (HGAA) for €1 to the Republic of Austria, committed to maintain existing liquidity facilities for HGAA and waived €825mn of its claims against HGAA. On 21 December 2009, Bayern LB announced the sale of 25.2% of its shares in SaarLB to the State of Saarland and thus reduced its ownership from 75.1% to 49.9%.

Moody’s

S&P

Fitch

*

**

*

**

*

**

LT senior unsecured

A1

Aaa

NR

NR

A+

AAA

Public sector Pfandbriefe

Aaa

Aaa

NR

NR

AAA

AAA

Mortgage Pfandbriefe

Aaa

Aaa

NR

NR

AAA

AAA

Outlook Discontinuity factor*** Collateral score***

Stable

-

Watch neg.

-

-

19.0/8.3

12.2/7.4

-

-

Notes: *Non guaranteed **Guaranteed ***In % Mortgage/Public sector

Risk weighting Pfandbriefe carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.

Strengths

Weaknesses

„

Ownership support: BYLAN is indirectly owned through a holding model by the Free State of Bavaria and the Association of Bavarian Savings Banks. Ownership support became apparent during the course of 2008, when BYLAN repeatedly benefited from guarantee and capital measures.

„

„

Restructuring and recapitalisation: In early 2009, the bank triggered a restructuring plan called “Hercules”. It included a discontinuation of certain activities, the reduction of risk assets head count and expenses as well as the focus on four major segments, namely institutional clients, commercial real estate, SMEs and retail banking. The transfer of HGAA was the major event that helped progress with the restructuring. Riskweighted assets decreased by €62bn, or 31% in FY 09. As the decrease in core capital only amounted to €3.3bn or 18.2%, the bank’s core capital ratio increased from 9.2% at YE 08 to 10.9% at YE 09.

Fallout from financial market crisis and HGAA: The deconsolidation of HGAA was a major step in the restructuring of BYLAN, but it weighed significantly on the bank’s FY 09 results. BYLAN claims that the HGAA transfer has put a €3.3bn strain on FY 09 operating earnings. While the bank’s legacy structured credit position (YE 09: €17.5bn) benefit from the risk shield of the Free State of Bavaria, EU approval for the state aid provided by the bank’s owners is expected in Q2 10.

„

Asset quality: Although headline asset quality measures improved in 2009 on the back of the deconsolidation of HGAA, the bank remains exposed to some headwinds. In particular the €51bn gross commercial property financing portfolio, which at YE 09 made up 14% of total gross credit risk exposures (YE 08: 12%) might suffer from an increase in NPLs and write-downs, as market conditions remain challenging in this segment. In addition, the bank still has significant exposure to some regional hotspots, including €11.4bn to Hungary, €9.7bn to Spain, €6.8bn to Italy, €2.1bn to Portugal and €1.5bn to Greece.

„

Event risk: Ongoing ownership discussions across German public sector banks might change the risk profile of the bank. In particular, acquisitions might induce Landesbanks to increase the respective debt financing. Yet, in our opinion, given the substantial support mechanisms within the German savings banks finance group (Sparkassen Finanzgruppe), a deterioration of the credit profile is unlikely.

„

Track BYLAN’s high risk exposures and their impact on bottomline earnings.

„

Pfandbrief over-collateralisation: As at end-March 2009, public-sector Pfandbriefe issued by BYLAN benefited from an over-collateralisation of 34% on a nominal basis and 29% on a present value basis. At the same time, its mortgage Pfandbrief investors benefited from an over-collateralisation of 37% on a nominal basis and 38% on a present value basis.

Key points for 2010 „

Monitor ownership support, the execution of the bank’s restructuring plan and EU state aid procedures.

10 June 2010

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Barclays Capital | AAA Handbook 2010

Financials and spreads

Bayern LB (BYLAN)

Financial summary – YE Dec € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which mortgages Customer deposits Debt funding of which PS Pfandbriefe of which mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

Capital ratios 2006

2007

2008

2009

1,820 404 656 2,980 1,466 1,514 0 1,332 1,000

2,170 380 -696 1,987 1,765 222 115 255 92

2,670 584 -4,207 -953 2,620 -3,573 1,656 -5,166 -5,084

2,561 434 -450 2,545 2,125 420 3,277 -2,765 -2,619

344,369 137,097 35,217 21,413 76,704 115,760 50,808 4,576 12,559

415,639 175,567 33,558 25,518 92,617 135,348 53,897 5,472 12,893

421,666 202,567 30,548 22,533 91,307 129,300 35,747 3,484 11,265

338,818 158,962 31,477 22,724 92,197 101,685 26,675 5,707 14,061

0.30 8.1 49.2 61.1

0.02 0.7 88.8 109.2

80%

Bancaja

471

6.678

5.10

5.06

47

61

239

28

44.7

32.9

22.4

14.3

CAM

276

10.886

4.97

4.00

73

59

236

35

44.3

30.0

19.0

14.1 16.9

Caixa Catalunya

261

8.384

5.29

5.49

47

61

250

32

59.0

7.7

33.2

Ibercaja

375

5.875

2.74

3.38

74

60

272

36

68.4

3.6

23.9

9.4

Caixa Galicia

225

7.502

4.81

4.93

42

58

250

36

68.3

9.0

21.6

11.1

Unicaja

193

8.345

2.94

2.50

139

55

239

48

68.5

5.6

12.6

4.0

Cajasol

298

5.642

6.36

5.11

51

63

225

47

59.6

8.0

14.4

10.1 6.7

CCM

230

5.383

na

na

na

58

230

37

52.6

10.7

17.4

Caja Murcia

249

4.524

3.05

2.32

90

59

177

44

64.0

6.1

18.7

5.0

Caja Espana

271

4.142

4.60

5.50

53

62

241

46

51.0

6.2

38.1

10.9

Cajasur

236

4.624

10.91

10.86

50

58

230

54

65.9

4.6

15.0

5.8

BBK

336

3.863

2.93

2.53

98

60

283

41

79.3

4.3

9.7

19.5

Caixa Penedes

247

4.809

5.09

6.36

44

55

247

38

77.3

5.8

7.1

5.2

Kutxa

461

1.800

3.01

2.83

114

54

244

46

73.7

16.4

7.0

15.0

Caja Duero

263

3.837

5.24

5.38

48

60

283

41

79.3

4.3

9.7

19.5

Caja Navarra

283

3.113

3.81

2.54

72

60

290

49

71.7

7.3

15.1

9.8

Caixanova

266

3.207

4.46

4.96

79

58

261

42

53.3

9.3

33.0

8.3

Caixa Sabadell

208

3.485

5.80

4.60

40

61

278

48

66.4

6.4

17.1

7.7

Caja G. Canarias

229

3.287

4.53

3.79

65

64

265

53

59.2

9.2

12.4

14.3

CajaStur

336

2.515

2.31

3.09

92

57

236

40

62.2

3.5

9.9

13.7

Cja Granada

294

2.526

5.31

5.02

71

62

234

47

59.7

6.2

16.0

11.7

Sanostra

200

3.386

4.92

5.13

40

50

218

40

62.5

10.6

16.3

6.3

Caixa Laietana

201

2.997

5.68

6.19

32

58

318

54

58.0

24.3

16.3

7.2

Caja Cantabria

209

3.005

5.18

5.55

53

60

261

43

70.5

7.0

16.5

11.2

Caixa Terrassa

198

2.910

6.69

6.34

47

56

323

34

62.7

3.9

31.0

7.7

Caja Burgos

222

2.646

5.28

4.58

63

58

175

37

59.7

12.2

28.2

14.8

CAI

410

1.365

4.24

3.83

54

59

208

46

50.7

8.7

35.2

18.7

Caja I. Canarias

207

2.370

8.68

8.38

23

61

239

51

78.2

5.9

14.2

4.2

Caixa Tarragona

244

1.835

6.41

4.36

37

58

305

43

68.3

5.5

25.4

9.1

Caixa Girona

298

1.495

5.24

4.72

46

60

264

44

60.7

6.5

32.4

10.8

Vital Kutxa

442

1.102

3.22

2.40

74

65

221

45

57.3

8.3

26.7

22.5

Caja Extremadura

501

0.800

3.44

3.98

117

47

228

47

55.3

9.4

13.0

9.8

Caixa Manresa

217

1.756

3.05

1.92

72

59

276

51

61.3

2.7

25.9

9.8

Caja Avila

284

1.270

9.34

6.54

56

66

206

36

32.5

2.6

49.9

10.9

Caja Segovia

209

1.526

3.15

3.84

85

60

258

43

51.7

8.0

39.8

11.8

Circulo Burgos

337

0.705

5.49

4.32

131

58

154

46

37.8

9.2

42.9

11.7

Caja Rioja

364

0.521

3.37

4.45

84

57

229

44

49.2

18.5

24.6

7.7

Caja Badajoz

295

0.601

3.79

4.05

73

58

251

48

68.3

6.8

21.2

6.3

Caixa Manlleu

252

0.610

5.88

6.18

28

49

249

44

65.6

5.6

23.3

5.4

Guadalajara

298

0.334

4.01

4.16

55

57

251

40

52.7

5.6

28.6

6.1

Caixa Ontinyent

297

0.195

4.39

4.28

50

63

43

227

52.8

10.9

20.9

12.4 3.7

Caja Jaen

243

0.241

4.77

5.04

61

54

46

228

53.9

19.5

14.1

Caixa Pollenca

1,121

0.020

2.00

1.81

102

49

50

252

47.7

10.4

7.4

2.5

Total

273

136.095

4.72

4.55

66

59

246

41

58.5

13.4

21.4

11.5

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521

Barclays Capital | AAA Handbook 2010

Bancaja (CAVALE)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.091

NA

€111.5bn

With total assets of €111.5bn at year-end 2009, up 4.7% y/y from €106.5bn a year before, Bancaja, ie, Caja de Ahorros de Valencia, Castellón y Alicante (CAVALE) is Spain’s third largest savings bank and the country’s sixth largest financial institution. CAVALE is the result of the merger of five Valencia-based savings banks and Sindibank. Headquartered in Castellón, CAVALE is the largest financial institution in Comunidad Valenciana. The lender focuses on providing retail and private banking services as well as insurance and real estate services to more than 2.5mn clients via more than 6,000 employees in more than 1,100 branch offices, of which more than half (57%) were located in Comunidad Valenciana where CAVALE has a c.25% market share. Following a countrywide expansion in previous years, CAVALE meanwhile generates 40% of its business volume outside of Comunidad Valenciana. CAVALE’s roots date back to 1878, when the Real Sociedad Económica de Amigos del País de Valencia founded the parent company, Caja de Ahorros de Valencia.

Moody’s

S&P

Fitch

LT senior unsecured

A3

NR

BBB

Covered bond rating

Aaa

NR

NR

Negative

NR

Stable

-

-

-

32.2

-

-

Outlook Discontinuity factor Collateral score Note: as at 7 June 2010.

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

„

Asset quality: As at year-end 2009, CAVALE’s non-performing loan ratio (NPL) stood at 4.6%, up from 4.1% a year before. The coverage ratio fell to 54.5% from 58.2% as per year-end 2008. Overall, non-performing loans stood at €4.0bn in 2009, up from €3.7bn a year before. Despite standing slightly below the national average, CAVALE’s NPL could become subject to a further increase in light of the macroeconomic development in Spain where we expect the GDP to contract by 0.6% y/y in 2010. Also, as c.98% of all mortgage loans granted in Spain are pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 2011, however), need to be watched.

„

Bancaja Habitat: Approximately 20% of CAVALE’s overall risk exposure refers to lending to property developers, among them the fully-owned (100%) entity Bancaja Habitat. This, in our view, needs to be carefully monitored, particularly in light of the ailing Spanish housing market, which remains subject to a pronounced supply overhang.

„

Market consolidation: a potential merger with one or more domestic peers, which could arise from the ongoing consolidation process on the Spanish savings banks market, needs to be carefully monitored.

„

Funding profile: Following a strong 16.5% y/y increase in its customer deposits to €50.7bn in 2009 from €43.5bn in 2008, CAVALE markedly reduced its dependency on capital market access for refinancing purposes. Nonetheless, in between 2008 and 2009, CAVALE had strongly relied upon the issuance of government-guaranteed debt instruments. Whereas the customer deposit to loan ratio grew to 63% in 2009 from 52% a year before, the percentage of wholesale funding to total funding fell to 50% from 55%. Customer lending, in contrast, contracted at a pace of 3.4% y/y with mortgage lending growing by a modest 0.6% y/y to €56.5bn and thus 70% of all lending as per year-end 2009. At the same time, however, the surge in deposit taking appears to have affected CAVALE’s net interest margin (NIM), which fell by 8.2% y/y to €1.3bn in 2009 from €1.4bn in 2008. In light of the ongoing consolidation on the Spanish banking market, this effect could gain further momentum as higher interest rates paid on customer deposits could have a detrimental impact on CAVALE’s NIM and thus its profitability. Support mechanism: Like any other Spanish savings bank, CAVALE benefits from internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederación Española de Cajas de Ahorros (CECA) which offers technological and advisory services – which are particularly relevant for smaller savings banks – but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAVALE benefits from the depositor guarantee fund – Fondo de Garantía de Depósitos (FGD) – of Spanish savings banks. In addition to the FGD, cajas benefit from federal support in the form of the FROB (Fondo De Reestructuración Ordenada Bancaria), which, if necessary, provides funding for the sector’s consolidation.

Note: At the time of writing, CAVALE had a €750mn Cédulas Hipotecarias outstanding. Mortgage loans granted amounted to c.€56bn as per year-end 2009, the latest date for which data were available.

Key points for 2010 „

Monitor eventual changes in CAVALE’s refinancing strategy which has so far been reliant on customer deposits and the issuance of government-guaranteed debt instruments.

10 June 2010

522

Barclays Capital | AAA Handbook 2010

Financials and spreads

Bancaja (CAVALE) Efficiency

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

2006

2007

2008

2009

1,150 282 576 2,008 705 1,303 310 1,246 867

1,326 342 59 1,803 771 1,031 463 774 604

1,443 325 105 1,864 855 1,009 720 531 499

1,324 305 466 2,039 848 1,191 965 371 370

79,577 65,586 276 44,050 32,110 30,235 0 3,092

99,585 106,500 111,459 79,963 83,902 81,011 316 468 524 54,232 56,023 56,345 36,732 43,490 50,668 40,362 34,322 35,015 0 1,000 1,750 3,564 3,753 3,907

1.2 31.9 35.1 57.3

0.7 18.1 42.8 73.5

0.5 13.7 45.9 77.4

0.3 9.7 41.6 65.0

23.8 0.5 0.5 350.2

44.9 0.6 0.9 230.4

71.4 0.8 4.3 56.8

81.0 1.2 4.7 54.2

7.4 13.1 3.9

7.5 11.9 3.6

7.5 11.1 3.5

8.1 12.3 3.5

50%

48.9% 1.0%

40%

1.0%

1.1% 41.6%

0.9%

0.9%

0.8% 0.8%

35.1% 30%

0.7% 2005 2006 2007 Cost/Income ratio

2008 2009 Cost/Assets ratio

Customer deposits to customer loan 75%

57.8%

45%

60% 54.9%

54.0%

60% 57.0% 41.9%

62.5% 49.0%

51.8%

50%

49.9%

45.9%

30%

40% 2005

2006 2007 2008 2009 Custumer deposits to loans Wholesale funding % of total funding

Net interest margin, credit costs, and RoA 2%

1.5%

1.6%

1.5%

1.4%

1.2% 1%

0.7%

0.6% 0.4%

0.7%

0.5% 0.5%

0.4%

1.2% 0.9% 0.3%

0% 2005

2006

Net interest margin

10 June 2010

45.9%

42.8%

2007

2008

Credit costs

2009 RoA

523

Barclays Capital | AAA Handbook 2010

Banco Bilbao Vizcaya Argentaria (BBVASM) Description

Leef H Dierks Ratings table

% € Index

% £ Index

Total assets

0.564

0.043

€535bn

With total assets of €535bn, down 1.4% y/y from €543bn in 2008, Banco Bilbao Vizcaya Argentaria – BBVA (BBVASM) is Spain’s secondlargest commercial bank and among the 20 largest credit institutions in Europe. It was created through the merger of Banco Bilbao Vizcaya (BBV) and Argentaria in 1999. BBVASM provides retail, wholesale and investment banking services, as well as leasing, factoring and asset and pension fund management services in Spain, Mexico (via Bancomer and Grupo de Hipotecaria Nacional), the US (via Compass), and South America (via Forum in Chile and Granahorrar in Colombia). As a result of its international expansion in recent years, BBVASM generated only 41% of its 2009 pre-tax income in Spain and Portugal. Operations in Mexico accounted for 23% of the lender’s pre-tax income. As per year-end 2009, BBVASM had a total of 103.721 employees (down 4.8% y/y) in 7,466 branch offices (down 4.1% y/y), of which 41% are located in Spain.

Moody’s

S&P

Fitch

LT senior unsecured

Aa2

AA

AA-

Covered bond rating

Aaa

NR

NR

Negative

Negative

Positive

-

-

-

23.6/6.3

-

-

Outlook Discontinuity factor Collateral score Note: As at 7 June 2010.

Risk weighting As Spanish Cédulas Hipotecarias and Cédulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

Funding base: As per year-end 2009, BBVASM’s customer deposits corresponded to a high 79% of all lending, thereby keeping the reliance on the wholesale funding markets at moderate levels. Despite a 0.4% y/y decrease in customer deposits, this level has not markedly changed over the course of the past few years, particularly as overall lending fell 3.5% y/y in 2009. Wholesale funding accounted for 43% of BBVASM’s total funding. The latter was relatively strongly geared towards refinancing through mortgage-covered bonds, which as per end H1 09, the latest date for which data were available, accounted for 48% of its long-term debt funding. At the same time, public sector covered bonds accounted for an additional 8%.

„

„

Profitability: Despite the second consecutive decline in BBVASM’s net income to €4.6bn in 2009 (-14.7% y/y), the net interest income experienced an 18.8% y/y increase to €13.9bn in 2009. This more than offset the 32.8% y/y fall in trading income to €892mn in 2009 from €1.3bn in 2008. At the same time, BBVASM’s net interest margin (NIM) increased by 23bp to 264bp in 2009, from 241bp in 2008; an important development when considering that net interest income accounted for 72% of the 2009 operating income of €19.2bn. The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental impact on BBVASM’s NIM and thus, its profitability.

„

International expansion: In 2009, BBVASM generated only 41% of its ordinary income in its domestic market, ie, in Spain and Portugal. This illustrates the increasing importance of the lender’s international operations, particularly in Latin America, which should be a well-suited buffer with which to weather potentially adverse developments in the Spanish housing markets.

Asset quality: Over the course of the past 12 months, the aggregate amount of doubtful assets has nearly doubled to €15.9bn per year-end 2009, from €8.7bn in 2008, thereby taking the overall non-performing loan ratio (NPL) to 4.3%. The coverage ratio stood at 57%. With regard to the Spanish and Portuguese operations, the respective NPL ratio stood at 5.1%, ie, largely in line with the national average, with a coverage ratio of c.48%. Doubtful mortgage loans in Spain and Portugal stood at €6.4bn. As a result of this development, loan-loss provisions nearly doubled to €5.2bn in 2009, from €2.8bn in 2008, thereby putting considerable strains on BBVASM’s net income, which fell by 15% y/y to €4.6bn in 2009. Nonetheless, over the course of the past year, the gross amount of new NPLs in Spain and Portugal has started to slow gradually, falling to €2bn in Q4 from €2.2bn in Q1 09. Still, with regard to mortgage lending, which accounted for c.40% of BBVASM’s total lending as per year-end 2009, a total of €17.7bn has been granted to property developers. Thereof, 17% (or €3bn) has been characterised as doubtful. Expected losses amount to €917mn, for which specific provisions of €1bn have been made. Despite the gradual moderation of late, the further NPL development needs to be carefully monitored, particularly in light of macroeconomic developments in Spain, where we expect the GDP to contract by 0.6% y/y in 2010. Also, as c.98% of all mortgage loans granted in Spain are pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), need to be watched.

„

US operations: Despite being irrelevant for the quality of the collateral pool of BBVASM’s covered bonds, the further development of the US operations, which generated a pre-tax loss of €1.6bn in 2009, needs to be monitored. Overall, BBVASM’s net income fell for the second consecutive year.

Note: As at year-end 2009, BBVASM had covered bonds outstanding totalling €34.5bn.

Key points for 2010 „

Carefully watch further development of mortgage loans granted to property developers (and individual clients) in Spain, particularly in light of the ongoing economic deceleration.

10 June 2010

„

Public sector lending almost doubled to €38.4bn in 2009, from €19.8bn in 2008. This development, in our view, needs to be monitored, particularly in light of potentially higher funding needs for the Kingdom of Spain. 524

Barclays Capital | AAA Handbook 2010

Financials and spreads

Banco Bilbao Vizcaya Argentaria (BBVASM)

Financial summary € mn 2006 Income statement summary 7,995 Net interest income Net fees & com's 4,335 Trading income 1,261 14,959 Operating income Operating expenses 6,480 8,479 Pre-provision income Loan loss provisions 1,477 Pre-tax profit 7,030 Net income 4,736 Balance sheet summary Total assets 411,916 Customer loans 256,565 of which public sector 17,964 of which mortgages 107,837 Customer deposits 192,374 Debt funding 91,271 of which Cedulas 36,029 Total equity 22,319 Profitability (%) Return on avg assets 5.1 Return on avg equity 24.6 Cost/Income ratio 43.3 Net int inc/Op inc 53.4 Asset quality (%) 17.4 LLPs/Pre-prov inc LLRs/Gross loans 2.6 Prob loans/Gr loans 0.9 Coverage ratio 277.1 Capital adequacy (%) Tier 1 ratio 7.8 Total capital ratio 12.0 Equity/Assets ratio 5.4

Breakdown by type of borrower, Q1 10 2007

2008

2009

9,422 4,723 1,545 16,136 7,199 8,937 1,902 8,495 6,126

11,686 4,527 1,328 17,541 7,756 9,785 2,797 6,926 5,385

13,882 4,430 892 19,204 7,662 11,542 5,199 5,736 4,595

502,204 310,882 17,573 123,998 236,183 117,909 39,730 27,943

542,650 335,260 19,576 125,540 255,236 121,144 38,481 26,705

535,065 323,442 38,345 127,957 254,183 117,817 34,708 30,763

5.6 27.2 44.6 58.4

4.4 21.0 44.2 66.6

3.5 16.1 39.9 72.3

21.3 2.2 1.1 208.2

28.6 2.2 2.6 83.9

45.0 2.6 4.8 54.7

7.3 10.7 5.6

7.9 12.2 4.9

9.4 13.6 5.7

Customer deposits to loans (net) 120%

37% 38% 42% 44% 44% 44% 47% 42% 43%

Commercial 24%

Residential 76%

Geographical split, Q1 10 Basque 4% Andalusia 16% Castilla Leon 4% Madrid 20%

50%

95% 86% 84% 75% 76% 76% 79%

10 June 2010

2003 2005 2007 2009 Cust. deposits to loans Wholesale funding % of total funding

Catalonia 19%

5%

4.3%

2.0%

3% 0.7% 0.6% 0.6% 0.4% 0.2% 0.3% 0.3% 0.3% 0%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Gross NPLs/Mortgage loans

160

11.2x

6.8x 5.6x77.0 64.0 80 56.0 57.0 63.6 4.1x

107.8

124.0 125.5 128.0

12 8

36.0 39.7 38.5 34.7 4 26.9 18.9 5.0 8.4 11.4 3.3x 3.0x 3.1x 3.3x 3.7x 0 0 2001 2003 2005 2007 2009 Residential mortgages Cedulas Over-collateralisation

40 0%

2001

Balearic Islands 3% Other 13%

Over-collateralisation (€bn)

25%

40%

Canary Islands 5%

Domestic asset quality

120 80% 111% 104%

Valencia Galicia 12% 4%

525

Barclays Capital | AAA Handbook 2010

Bankinter (BKTSM)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.05

NA

€54.5bn

With total assets of €55bn as per year-end 2009, largely stable versus a year before, Bankinter (BKTSM) currently is Spain’s sixthlargest commercial bank. BKTSM focuses on providing retail banking services to 793,000 private medium- and high-income individuals, as well as small- and medium-sized enterprises (SMEs) through its 369 branch offices and more than 4,500 employees. BKTSM also benefits from a strong internet banking franchise. Headquartered in Madrid, Bankinter SA (BKT) was originally established in June 1965 as a wholesale bank via a joint-venture with Banco de Santander and Bank of America. In 1972, BKTSM was listed on the Spanish stock exchange, thereby gaining full independence from its founders.

Moody’s

S&P

Fitch

LT senior unsecured

A1

A

A+

Covered bond rating

Aaa

NR

AAA

Negative

Stable

Stable

-

-

41.2

21.2

-

-

Outlook Discontinuity factor Collateral score Note: As at 7 June 2010.

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

„

SME business: Spurred by a €49bn loss in its SME division in 2009 (after generating a €48bn income in 2008), BKTSM’s 2009 earnings were mostly driven by its capital market activity. Earnings in all customer business divisions, in contrast, contracted. Further development needs to be monitored carefully, in our view, particularly in light of BKTSM’s exposure to the Spanish SME sector, which could be affected by more than the average from a further delay in the economic recovery. (We expect the Spanish GDP to contract 0.6% y/y in 2010.) Still, this potential weakness is partly mitigated by the fact that lending to SMEs remained stable over the past year, thereby not increasing BKTSM’s exposure towards this market segment.

„

Capital market reliance: With customer deposits falling 5% y/y to €21.8bn in 2009 and lending to customers contracting 0.6% y/y to €39.9bn in 2009, BKTSM’s overall reliance on capital markets has gradually increased. As per year-end 2009, deposits accounted for 55% of all lending, down from 57% a year before. Overall, the proportion of wholesale funding versus total funding grew to 47% in 2009 from 39% in 2008. Despite the benign conditions on global capital markets at the time of writing, this development, in our view, needs to be monitored. Overall, the wholesale funding structure appears to be relatively well balanced, however, with senior debt accounting for 24.4% as per year-end 2009, followed by covered bonds (22.9%), securitisations (20.3%), commercial paper (15.4%), and interbank liabilities (15.2%), among others.

„

Capitalisation: With 7.4%, BKTSM’s Tier 1 ratio was below market average as at end 2009.

„

Asset quality: As per year-end 2009, BKTSM benefited from a comparatively sound asset quality, with the non-performing loan (NPL) ratio standing at 2.8%. Despite having nearly doubled from 1.5% a year before, it stands clearly below the sector average of 5.1%. At the same time, the coverage ratio stands at 73%. With regard to BKTSM’s mortgage loan book, which accounted for a high c.71.5% of all lending as per yearend 2009, the respective NPL ratio stood at 2%, more than double the level observed in 2008 (0.9%) but markedly below the national average. Whereas BKTSM’s market share in mortgage lending stood at c.4%, its share in lending to property developers stood at a very low 0.3%. A reason for concern, however, could arise from the fact that the quarterly gross NPL entries steadily increased throughout 2009. Net NPL entries fell at the same time as recoveries markedly picked up. Also, note that BKTSM’s lending to the public sector more than quintupled to €213mn in 2009 from €39mn in 2008. Despite the overall volume being fairly modest, this further development should be watched closely. Profitability: Despite the 14% y/y increase in loan-loss provisions to €221mn in 2009 from €193mn in 2008, which we believe is moderate in comparison with its domestic peers, BKTSM could keep its 2009 net income stable at €254mn after €252mn in 2008. This is mostly attributable to the 17.7% y/y increase in BKTSM’s net interest income, which amounted to €793mn in 2009 after €673mn in 2008, thereby offsetting the c.10% declines in net fee and commission and trading income, respectively. Overall, net interest income accounted for 71% of all operating income, with BKTSAM benefiting from a 16bp increase in its net interest margin to 151bp in 2009 from 135bp in 2008. The ongoing consolidation on the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental effect on BKTSM’s NIM and, thus, its profitability. Also, over 2009, BKTSM’s cost-to-income ratio was subject to a marked increase to 57% from 47% a year before.

Note: At the time of writing, BKTSM had two benchmark EUR-denominated Cédulas Hipotecarias outstanding, totalling €2.0bn.

Key points for 2010 „

Carefully monitor the further performance of BKTSM’s exposure towards domestic smaller to medium-sized enterprises business in light of the expected 2010 GDP contraction in Spain.

10 June 2010

526

Barclays Capital | AAA Handbook 2010

Financials and spreads

Bankinter (BKTSM)

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

10 June 2010

NIM, credit costs and RoA 2006

2007

2008

2009

457 217 98 818 402 416 97 316 208

569 244 74 947 512 435 76 484 362

673 226 103 1,056 498 558 193 337 252

793 202 89 1,111 632 478 221 346 254

46,076 31,654 na 24,622 17,471 14,794 0 2,521

49,649 37,580 60 25,975 21,285 16,805 0 1,745

53,468 40,144 39 28,537 22,914 14,352 2,000 1,965

54,468 39,884 213 28,498 21,783 19,090 2,000 2,553

0.5 8.3 49.2 55.9

0.8 17.0 54.1 60.0

0.5 12.1 47.2 63.8

0.5 12.2 56.9 71.4

23.3 0.3 0.3 571.0

17.4 0.2 0.4 371.0

34.6 0.5 1.5 116.6

46.1 0.6 2.8 72.5

2.0% 1.0% 1.0%

0.8%

0.5%

6.3 9.6 3.5

7.4 10.2 3.7

7.4 10.4 4.7

0.5%

0.5%

0.4%

0.4%

0.2%

0.2% 0.0%

2006 2007 Net interest margin

2008 Credit costs

2009 RoA

Efficiency 75% 57% 47%

50% 54%

49%

1.2%

1.1%

25%

1.8%

1.3%

0.9% 1.0%

0% 2006 2007 Cost/Income ratio

0.8%

2008 2009 Cost/Assets ratio

Customer deposits to loans 60%

6.9 10.0 5.5

1.5%

1.4%

1.2%

55%

46.7% 38.5% 57.1%

50%

40% 54.6%

50%

30% 2008 2009 Customer deposits to loans Wholesale funding in % of total funding

527

Barclays Capital | AAA Handbook 2010

Banco Santander (SANTAN)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.50

0.196

€1,111bn

With total assets amounting to €1,111bn as at year-end 2009, up 6% y/y from €1.050bn as at year-end 2008, Banco Santander (SANTAN) is Spain’s largest commercial bank and ranks among the world’s largest financial institutions. At year-end 2009, SANTAN was the 8th largest bank in the world by market value. It is headquartered in Madrid and provides global universal banking services through nearly 170,000 employees in more than 13,500 branch offices. As at year-end 2009, SANTAN had 92mn customers of which 29% were located in Europe, 27% in the UK, and 43% in the Americas. In addition to its own issues of Cédulas Hipotecarias and Cédulas Territoriales, SANTAN also backs the Multi-Cédulas Programme PITCH, and regularly taps the market through its subsidiaries Abbey (UK), and Banco Santander Totta (Portugal). Also, Santander Consumer Finance has issued a benchmark Cédulas Hipotecarias.

LT senior unsecured Covered bond rating (Cédulas Hipotecarias) Covered bond rating (Cédulas Territoriales) Outlook Discontinuity factor Collateral score

Moody’s

S&P

Fitch

Aa2

AA

AA

Aaa

AAA

AAA

Aaa

NR

AAA

Negative 21.0

Negative -

Stable 40.8 -

Note: As at 7 June 2010.

Risk weighting As Spanish Cédulas Hipotecarias and Cédulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

Profitability: Following a 41% y/y increase in SANTAN’s net interest income to €26.3bn in 2009, from €18.6bn in 2008, the lender’s overall profitability remained high, with net income largely unchanged at €9.5bn (+1.4% y/y) in 2009 versus €9.3bn in 2008. This arose despite a sharp 59% y/y increase in SANTAN’s loan-loss provisions. At the same time, the average net interest margin (NIM) increased to 243bp in 2009 from 190bp in 2008 and 175bp in 2007. Taking into consideration that SANTAN started attracting customer deposits via relatively high interest rates in early 2010, the lender’s NIM and thus its profitability could come under pressure.

„

„

Asset quality: Approximately 58% of all lending (of which Spain and Portugal combined accounted for 41%) conducted on behalf of SANTAN was backed by mortgage loans. Still, as 96% of all mortgage loans granted are subject to a variable interest rate, potential rate hikes might leave their mark on SANTAN’s asset quality. In our view, this is mitigated by the facts that c.94% of all mortgage loans are secured on first homes and the average LTV stands at a modest 56%.

Loan-loss provisions: With the non-performing loans ratio increasing to 324bp in 2009, from 204bp in 2008 (but still remaining below the 505bp industry average), SANTAN’s net loanloss provisions experienced a marked 43.7% y/y increase to €9.5bn in 2009 from €6.6bn in 2008. Overall, non-performing loans amounted to €24.6bn in 2009, up a strong 73% y/y from €14.2bn in 2008. With loan-loss allowances standing at €18.5bn in 2009 versus €6.7bn in 2008, the respective NPL coverage stands at 75.3% in 2009, down from 90.6% in 2008 and 151% in 2007. Similarly to its domestic peers, SANTAN has created a new business unit designed to recover loans. Still, taking into consideration the economic situation in Spain (which accounts for €115bn and thus c.17% of all lending) as well as potential ECB rate hikes (which we do not expect to occur before Q1 11) we caution that the potentially deteriorating asset quality could trigger a medium-term increase in SANTAN’s loan-loss provisions.

„

Property developers: As at year-end 2009, SANTAN’s exposure to property developers in Spain amounted to €12.2bn, or c.1.6% of its global credit portfolio. Even though this reflects a 9.3% y/y decline versus 2008, we caution that this sector will probably cause further write-offs, particularly as the respective NPL ratio stood at 6.2% and thus clearly above SANTAN’s average of 3.2%. At the same time, SANTAN has reduced markedly the volume of its property acquisitions, which amounted to €2.9bn in 2009, down from €3.8bn in 2008. Note that property is being sold through SANTAN’s fully-owned subsidiary Altamira.

„

Geographical diversification: Over the past few years, SANTAN has steadily increased its international presence. At the time of writing, the lender had concentrated its operations in nine major markets, eg, Spain, Portugal, Germany, the UK, the US, Brazil, Mexico, Chile, and Argentina. Underlining this international presence, in 2009 only c.37% of SANTAN’s profits were generated in Spain and Portugal.

„

Capitalisation: As at year-end 2009, SANTAN’s Tier 1 ratio stood at a high 10.1%, up from 9.1% a year before and 7.7% in 2007. The total capital ratio stood for 2009 was 14.2% versus 13.3% in 2008.

Note: In Q3 09, the latest date for which data were available, SANTAN had issued Cédulas Hipotecarias with a nominal amount of €25.560bn. The respective overcollateralisation stood at 219%

Key points for 2010 „

The further development of SANTAN’s NPL ratio, which stood at 324bp as at year-end 2009, needs to be carefully monitored, particularly in light of the economic situation in Spain.

10 June 2010

528

Barclays Capital | AAA Handbook 2010

Financials and spreads

Banco Santander (SANTAN)

Financial summary € mn 2006 Income statement summary Net interest income 12,480 Net fees & com's 7,024 Trading income 2,149 Operating income 21,936 Operating expenses 10,025 11,911 Pre-provision income Loan loss provisions 2,551 Pre-tax profit 8,779 Net income 6,582 Balance sheet summary Total assets 833,873 Customer loans 484,790 of which public sector 5,329 of which mortgages 302,587 Customer deposits 314,377 Debt funding 204,832 of which CH 22,500 of which CT 2,000 Total equity 42,431 Profitability (%) Return on assets 0.80 Return on equity 16.0 Cost/Income ratio 45.7 Net int inc/Op inc 56.9 Asset Quality (%) LLPs/Pre-prov income 21.4 LLRs/Gross loans 0.5 Problem loans/Gr loans 0.9 Coverage ratio 187.5 Capital adequacy (%) Tier 1 ratio 7.4 Total capital ratio 12.5 Equity/Assets ratio 5.1

Customer deposits to customer loans 2007

2008

2009

15,295 8,040 2,998 27,065 10,940 16,125 3,470 10,910 8,631

18,625 8,451 2,802 29,878 11,892 17,986 5,976 11,370 9,332

26,299 9,080 3,423 39,382 14,824 24,558 9,484 11,764 9,458

912,915 533,751 5,633 322,687 317,043 241,935 26,500 2,000 57,558

1,049,632 1,110,529 611,811 664,146 7,668 9,803 353,327 411,778 405,615 487,681 265,465 243,295 24,950 25,560 2,000 2,000 60,001 73,871

0.99 17.3 40.4 56.5

0.95 15.9 39.8 62.3

0.88 14.1 37.6 66.8

21.5 0.6 1.1 150.5

33.2 1.0 2.3 90.6

38.6 1.4 3.6 75.3

120% 37.4% 45.2% 47.4% 50.2% 60% 36.0% 39.4% 35.6% 46.9% 46.9% 40% 80% 104%103% 92% 88% 20% 72% 65% 59% 66% 73% 40%

0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding in % of total funding

Over-collateralisation 100

€ bn 8.9x

50 23.3 26.7 0

0.0x

35.1

43.3

51.1

26.3 25.6

5

2.0x 2.2x

Asset quality (Spain)

7.7 12.7 6.3

9.1 13.3 5.7

Geographical split (consumer loans), 2010

10 June 2010

22.5 26.5

0 2003 2005 2007 2009 Cedulas Over-collateralisation (x) rhs

10.1 14.2 6.7

200% 156% 166% 182% 188% 151% 133% 2 150% 2.27 2.17 2.20 91% 136% 1.84 1 75% 100% 1.20 1.06 0.93 1.14 3

50%

0 2003

2005

Gross NPLs/Spanish loans

US 5%

53.8 56.0

59.4

19.0 3.5x 3.6x 10.0 12.0 3.0 2.7x 2.6x 3.1x

2001 Mortgages

2001

Continental Europe 47%

10

83.3

United Kingdom 33% Latin America 15%

2007

2009 Reserve coverage

LTV ratios, 2010 60-80% 26%

80-100% 15% 0-20% 9%

40-60% 27%

20-40% 23%

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Banco Popular (POPSM)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.149

NA

€129bn

Moody’s

S&P

Fitch

LT senior unsecured

Aa3

A

AA-

Covered bond rating

Aaa

NR

AAA

Negative

Negative

Negative

-

-

41.3

22.2%

-

-

Founded in 1926, Banco Popular (POPSM) is Spain’s third-largest commercial bank (and fifth-largest banking group) with total assets amounting to €129bn as at year-end 2009, up a strong 17.1% y/y from €110bn as per year-end 2008. In addition to retail banks operating on a country-wide level, Banco Popular comprises five regional retail banks, Banco de Andalucía, Banco de Castilla, Banco de Crédito Balear, Banco de Vasconia, and Banco de Galicia Operations are limited to retail and commercial banking, serving 6.7mn clients through 14,400 employees in 2,420 branch offices. POPSM’s overall market share amounted to 4.4%. In addition to its domestic operations, POPSM has operations in Portugal and the US (Totalbank), respectively. POPSM also controls Banco Popular Hipotecario, a fullyowned subsidiary that specialises in property financing.

Note: as at 7 June 2010

Strengths

Weaknesses

„

„

Non-performing loans: As at year-end 2009, POPSM’s nonperforming loan (NPL) ratio stood at 4.8%, strongly up (201bp) from 2.8% a year before as gross NPL had increased by 81% y/y to €5.5bn, from €3.0bn in 2008. Gross lending, however, increased at a pace of 3.5% y/y. The coverage ratio stood at 50.3% in Q4 09, with overall loan-loss provisions amounting to €2.7bn. Mortgage lending to property developers amounted to €7.5bn or 15.7% of all lending as per year-end 2009. This corresponds to a 10% y/y (€831mn) decline.

„

Exposure to SME sector: Further developments need to be carefully monitored, particularly in light of POPSM’s exposure to the Spanish SME and corporate sector, which accounted for 58% of all 2009 revenues. In our view, POPSM might be affected by more than the average from a further delay in the economic recovery. (We expect Spanish GDP to contract by 0.6% y/y in 2010.) Mitigating potential adverse effects on POPSM’s asset quality is the fact that roughly 50% of POPSM’s loan book consists of mortgage lending. Potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), therefore could be less significant for the quality of POPSM’s loan book than for its domestic peers. Still, public sector lending on behalf of POPSM almost trebled to €420mn in 2009, from €144mn in 2008. This development, in our view, needs to be monitored, particularly in light of potentially higher funding needs for the Kingdom of Spain and the respective autonomous communities.

„

Funding structure: With customer deposits recording a 15.3% y/y increase to €59.6bn in 2009, from €51.7bn in 2008, and customer lending growing at a more moderate 3.5% y/y to €95.0bn from €91.7bn over the same period, POPSM’s depositto-loan ratio increased to 62.7% in 2009, from 56.3% a year before. In light of interbank deposits nearly doubling to €20.8bn in 2009 from €10.6bn in 2008, however, the overall reliance on wholesale funding stood stable at around 47% of all funding. With regard to the €34.4bn wholesale funding, 29% was accounted for by covered bonds, followed by the EMTN programme (24%), and POPSM’s ECP programme (17%). The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental impact on POPSM’s NIM (257bp in 2009) and thus the lender’s profitability. Eventually, any such development might drive POPSM to increase its reliance on wholesale funding. Over-collateralisation: With a total of €16bn of covered bonds outstanding as at year-end 2009 and a collateral pool comprising €33.5bn, the over-collateralisation of the covered bonds issued by POPSM stood at a sound 210%. Yet, only €19.4bn and thus 57.9% of the collateral pool corresponded to residential mortgage loans of which, however, 81% were secured by loans on first homes. From a geographical point of view, the Mediterranean Rim regions of Andalusia (24%), Comunidad Valenciana (9%), and Catalonia (9%), accounted for the bigger portion (42%), followed by Galicia (22%), and Madrid (15%). The weighted average LTV stood at 57%, with a high 32% of all residential mortgage loans, however, being subject to a LTV of 70% or higher. All mortgage loans were selforiginated.

Outlook Discontinuity factor Collateral score

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Note: In addition to its covered bond programme, POPSM was involved in the InterMoney Cédulas covered bond programme. For more detailed information on the InterMoney Cédulas issues, please refer to the respective profile within this section.

Key points for 2010 „

Following a 201bp increase over the course of 2009, the further development of POPSM’s NPL ratio, which stood at 4.8% as at year-end 2009, needs to be closely monitored.

10 June 2010

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Barclays Capital | AAA Handbook 2010

Financial and spreads

Banco Popular (POPSM)

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

Breakdown of mortgages by LTV, 2010 2007

2008

2009

2,284 884 73 3,336 1,108 2,228 342 1,943 1,337

2,535 865 74 3,567 1,216 2,351 998 1,461 1,052

2,822 763 356 3,950 1,188 2,762 1,752 1,073 766

107,169 86,642 130 46,860 42,662 36,323 9,400 6,641

110,376 91,702 144 48,276 51,665 31,825 9,160 7,058

129,290 94,956 420 47,656 59,558 32,154 10,694 8,448

1.5 22.8 33.2 68.5

1.1 17.0 34.1 71.1

0.7 11.0 30.1 71.4

15.4 2.1 0.9 218.4

42.5 2.4 3.2 73.0

63.4 2.8 4.8 50.3

8.1 9.1 6.4

9.1 9.6 6.5

LTV 25%50% 26%

LTV 50%75% 44%

Breakdown of mortgages by region, 2010 Madrid 15%

Andalucia 24%

Cataluña and C.Valenciana 18% Others 21%

Galicia 22%

Domestic asset quality 300

222 206

7.9 9.7 6.2

LTV 70% 32%

262

249

5.6 218

200 100

4

73 3.2

0.9 0.8

0 2003

6

50

2

0.9

0.9

0

0.8

2005

2007

Coverage ratio

2009

Prob loans/Gross loans

Customer deposits to customer loan 75

37.2

39.2

49.3

54.0 51.7

45.1

47.1

40

50 25

66.5

64.4

52.4

0 2003 2004 2005 Cust deposits/loans

10 June 2010

60

47.8

49.2

56.3

62.7

20

0 2006 2007 2008 2009 Wholesale funding/Tot. funding

531

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Banco Sabadell (BANSAB)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.122

NA

€83bn

Moody’s

S&P

Fitch

LT senior unsecured

A2

A

A

Covered bond rating

Aaa

NR

NR

Negative

Stable

Negative

-

-

-

26.6

-

-

With total assets of €83bn as at year-end 2009, up 3% y/y, Banco Sabadell (BANSAB) is Spain’s fourth-largest banking group. In addition to its Banco Sabadell brand, BANSAB operates through Sabadell Atlántico, Banco Herrero, Solbank, ActivoBank, and Banco Urquijo. BANSAB provides corporate, commercial and private banking services as well as asset management services. In 2008, BANSAB sold 50% of its insurance operations to Zurich. BANSAB, which operates through nearly 9,500 employees in 1,200 branch offices, was originally founded in 1881 to provide commercial banking services to the industry in Catalonia, which is still BANSAB’s core market. In addition, Banco Sabadell holds a 40% stake in Dexia Sabadell Banco Local, an entity specialising in medium- and long-term financing to the various territorial governments in the Spanish market.

Note: as at 7 June 2010

Strengths

Weaknesses

„

Funding profile: With customer deposits of €39.1bn as at yearend 2009, ie, virtually unchanged from year-end 2008 (€39.2bn), BANSAB’s reliance on wholesale funding remained relatively moderate, despite increasing by 4pp to 46% in 2009, from 42% in 2008. In aggregate, customer deposits accounted for nearly two-thirds (62%) of all customer lending in 2008 and 2009. This stability is largely attributed to the moderation in customer lending, which grew at a pace of only 0.3% y/y to €63.2bn in 2009, from €63.1bn in 2008. Mortgage lending, which accounted for 51% of all lending, increased at a pace of 2.1% y/y.

„

„

Profitability: Despite the challenging conditions in its domestic market, BANSAB’s net interest income increased by 10% y/y to €1.6bn in 2009, from €1.5bn in 2008 and €1.3bn in 2007. At the same time, the net interest margin (NIM) increased to 200bp from 180bp in 2008 and 170bp in 2007. The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates being paid on customer deposits. This, in turn, could have a detrimental impact on BANSAB’s net interest margin and thus the lender’s profitability.

„

Capitalisation: Following the issuance of preference shares and subordinated bonds, which are mandatorily convertible into shares, BANSAB increased its Tier 1 and core capital ratios. In early 2010, BANSAB conducted a ‘sale and lease-back operation’ on 378 properties worth €403mn. Even though this elevated the lender’s core capital by another 30bp, we highlight that this is a one-off effect.

Asset quality: Over the course of the past year, the proportion of non-performing loans (NPL) has increased to 3.7% (or €2.7bn) of all lending, from 2.4% in 2008 (€1.6bn) and 0.5% in 2007. Despite this ratio being below the national average, BANSAB’s coverage ratio has markedly fallen of late, declining to c.69% as at year-end 2009 from c.107% at year-end 2008. Including mortgage loans, the coverage ratio stands at c.125%. Roughly 60% of the doubtful loans are secured by mortgage loans. Since Q3 09, the net increase in NPLs has started to gradually decline and grew at a pace of €215mn in Q4 09, up from €208mn in Q3, but down from €265mn in Q2 and €325mn in Q1 09. As at yearend 2009, €32bn (+3% y/y) and thus 49% of BANSAB’s total loan portfolio (€65bn) consisted of mortgage lending. Loans to property developers accounted for 11%, followed by lending to the construction sector, which corresponded to 5% of all lending. Despite this moderation, further NPL development needs to be carefully monitored, particularly in light of macroeconomic developments in Spain, where we expect GDP to contract by 0.6% y/y in 2010. Also, as c.98% of all mortgage loans granted in Spain are pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), need to be watched.

„

Solvia: The latter is BANSAB’s subsidiary, which manages real estate assets that are not connected with the banking business and are held for sale. As at year-end 2009, assets amounted to €1.5bn; of these, 52% was development land. Plots prepared for development made up 33% and the remaining 15% of the portfolio was split between rental property and real estate developments for sale. 75% of the assets were residential properties. 50% of the assets were located in Catalonia, mainly in Barcelona, and another 25% were in Madrid.

Outlook Discontinuity factor Collateral score

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Note: At the time of writing, BANSAB had a total of six benchmark Cédulas Hipotecarias totalling €8.5bn outstanding. Mortgage loans granted amounted to c.€32bn as at year-end 2009, the latest date for which data were available.

Key points for 2010 „

Carefully monitor further NPL developments in light of the ongoing economic deceleration in Spain. BANSAB’s asset quality could also come under (renewed) pressure in the case of (earlier-then-expected) ECB hikes.

10 June 2010

532

Barclays Capital | AAA Handbook 2010

Financials and spreads

Banco Sabadell (BANSAB)

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

Geographical split (consumer loans), 2010 2006

2007

2008

2009

1,076 550 36 1,793 849 944 249 712 572

1,292 630 93 2,175 1,025 1,150 212 990 788

1,453 558 68 2,227 979 1,248 879 686 676

1,601 511 248 2,505 1,037 1,468 838 568 522

72,780 54,557 143 23,240 30,091 25,690 5,950 4,159

76,776 61,999 266 33,881 33,350 29,000 7,500 4,605

80,378 63,066 na 31,375 39,199 24,118 8,700 4,448

82,823 63,233 na 32,022 39,131 24,852 13,109 5,297

0.9 15.3 47.4 60.0

1.1 18.0 47.1 59.4

0.9 14.9 44.0 65.2

0.6 10.7 41.4 63.9

26.4 0.4 0.5 429.4

18.5 0.3 0.5 367.5

70.5 1.4 2.5 107.1

57.1 1.3 3.7 69.2

7.3 11.4 5.7

7.2 10.9 6.0

7.3 9.8 5.5

9.1 10.8 6.4

Andalusia 6%

Madrid 14%

Valencia & Balearics 7% Asturias 4%

Catalonia 40%

Other 27%

Breakdown of mortgages by type, 2010 Other 5%

Developers 25%

Residential 52% Commercial 18%

Over-collateralisation € mn 7.5x 40 20

11.3 1.5

Over-collateralisation (x) 5.8x 14.6 2.5

33.9 4.8x 23.2 20.0 4.2

8

32.0

31.4

6

4.5x

3.9x 6.0

7.5

3.2x 9.8

13.1 4 2.4x2

0

0 2003 2004 Mortgages

2005 2006 Cédulas

2007 2008 2009 Overcollateralisation

Customer deposits to customer loan (net) 100%

60% 50% 49%

80% 91%

41% 83% 36% 36%

60%

27% 72% 73%

24%

42%

46% 40%

61% 55% 54% 62% 62%

40%

20% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding

10 June 2010

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Barclays Capital | AAA Handbook 2010

Banco Pastor (PASTOR)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.067

NA

€32bn

Moody’s

S&P

Fitch

LT senior unsecured

A3

NR

NR

Covered bond rating

Aaa

NR

NR

Negative

NR

NR

-

-

-

25.5

-

-

With total assets of €32.3bn as per year-end 2009, up 19% y/y from €27.1bn as per year-end 2008, Banco Pastor (PASTOR) is among the medium-sized commercial banks in Spain, focusing on the provision of domestic retail banking, ie, deposit-taking and lending services to individual customers and small- and medium-sized enterprises (SMEs) through 4,200 employees in 610 branch offices. PASTOR, which was founded in 1776 and thus is Spain’s secondoldest bank, is headquartered in La Coruña. More than a third (233 or 38%) of PASTOR’s branch offices are located in the lender’s core market, Galicia, where it benefited from a sound 10.1% market share and where 32% of all loans were granted as at year-end 2009. At the time of writing, PASTOR was the seventh-largest banking group in Spain.

Note: As at 7 June 2010.

Strengths

Weaknesses

„

Funding profile: As at year-end 2009, customer deposits of €13.7bn, up 2.6% y/y, accounted for a high 67% of all lending, which at the same time stood at €20.8bn, down 2% y/y. In consequence, PASTOR’s reliance on wholesale funding stood at a relatively moderate 41% as per year-end 2009, up from 37% a year before. In terms of its institutional funding structure, covered bonds accounted for 42% of wholesale funding, followed by interbank deposits (23%), floating rate notes (FRN) (15%), and securitisations (13%).

„

„

Ownership structure: With the Pedro Barrié de la Maza Foundation (PBMF), ie, the descendants of the bank’s founding family holding a 42.2% stake of the share capital as at year-end 2009, PASTOR benefits from a stable ownership structure. Retail investors held 24.11% of the shares as at year-end 2009, followed by institutional investors (18.0%) and domestic rival Caixanova, which holds a 5.4% stake. Ponte Gadea Group and Casagrande Cartagena hold a 5.1% stake each. Note that apart from Caixanova, which acquired the respective stake in 2007, these ratios have not changed materially during the past few years.

„

Profitability: Despite the net interest margin (NIM) declining to 190bp in 2009 from 210bp in 2008 to €547mn, PASTOR generated the highest net interest income in its history. The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental impact on PASTOR’s NIM and thus the lender’s profitability. Also, over the course of the past few years, PASTOR’s cost-income ratio has steadily declined, falling to a low 33% in 2009, from 39% in 2008 and 42% in 2007. Among the drivers behind this development, which are supportive for the lender’s operating income, is the closure of 55 branch offices over the course of the past year.

„

Capitalisation: In 2009, PASTOR’s Tier 1 ratio improved to 10.6%, from 7.5% in 2008.

Outlook Discontinuity factor Collateral score

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Asset quality: In 2009, PASTOR’s loan-loss provisions amounted to €604mn, up 172% y/y from €245mn in 2008. At the same time, loan-loss reserves increased to €830mn, from €493mn in 2008, thereby taking the coverage ratio to 118.7% as per yearend 2009 from 114.2% a year before. As per year-end 2009, PASTOR’s overall NPL ratio stood at 4.9% and thus only slightly below the sector’s NPL average of 5.1%. Yet, as of recent, NPL growth has started showing signs of a slowdown, remaining unchanged in Q4 09. Overall, net NPL entries have steadily fallen over the course of the past five quarters, amounting to €118mn in Q4 09. Still, as per year-end 2009, the volume outstanding of repossessed properties amounted to €921mn, with a loss provision of 15%. As per year-end 2009, €12.1bn (-2% y/y) and thus 59% of PASTOR’s total loan portfolio (€20.4bn) consisted of mortgage lending. Loans to property developers accounted for 9% of all lending. Whereas €6.7bn or 56% of PASTOR’s mortgage portfolio consisted of commercial mortgage lending (average LTV: 48.1%), the remaining 44% (€5.2bn) were residential mortgage loans (average LTV: 59.7%). Despite the moderation in NPL growth, further development needs to be carefully monitored, particularly in light of macroeconomic developments in Spain, where we expect GDP to contract by 0.6% y/y in 2010. Also, as 95.7% of all mortgage loans granted by PASTOR are pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), need to be watched. Also, note that between April and November 2009, PASTOR increased its market share in mortgage lending to 3.3% from 1.0%, thereby making it potentially more vulnerable to a further downturn on the Spanish housing market.

Note: At the time of writing, PASTOR had four EUR-denominated benchmark covered bonds outstanding with an aggregate amount of €4.2bn.

Key points for 2010 „

Carefully monitor further NPL developments given the ongoing economic deceleration in Spain. PASTOR’s asset quality could also come under (renewed) pressure in the case of (earlierthen-expected) ECB hikes.

10 June 2010

„

Over-collateralisation: As at end-February 2010, the latest date for which data were available, the amount of PASTOR’s Cédulas Hipotecarias outstanding amounted to €5.5bn. Mortgage loans eligible for inclusion in the collateral pool amounted to €8.0bn, thereby taking the over-collateralisation to 114%. 534

Barclays Capital | AAA Handbook 2010

Financial and spreads

Banco Pastor (PASTOR)

Financial summary

Shareholder structure, 2010

€ mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which Mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

2006

2007

2008

2009

442 143 9 611 281 330 92 251 162

527 161 24 730 304 426 127 295 209

526 163 156 851 331 520 245 221 164

547 154 343 1044 345 699 604 131 101

23,782 19,681 42 11,384 10,966 9,229 2,000 1,155

25,326 20,428 46 11,121 12,956 7,682 2,000 1,278

27,121 20,788 213 11,746 13,330 7,197 3,430 1,370

32,325 20,385 204 12,080 13,683 7,983 4,000 1,430

1.0 17.6 46.0 72.3

1.0 18.0 41.7 72.3

0.7 12.9 38.8 61.8

0.4 7.4 33.0 52.4

27.9 2.0 273.9

29.8 2.7 277.0

47.1 2.3 114.2

86.4 3.9 118.7

7.2 11.7 5.0

7.5 10.6 5.0

10.6 12.5 4.4

NIM, credit costs and RoA 3 2

2.3

2.3

1.3

Caixanova 5% Casagrande Cartagena 5% Institutional lnvestors 18%

Pontegadea Inversiones 5% Retail lnvestors 24%

Regional structure, 2010 Madrid 16%

Other 16%

Andalucia 11%

Levante 13%

Catalunya 13%

Galicia 31%

Customer deposits to loans 50

93 87

48

38

2.1

14

12

21

67

33 57

63 64

67

10

100

75

50 2001

2003 2005 2007 2009 Wholesale funding to total funding Customer deposits to loans

340

284

1.9

267

274

277

0.5 0.7

140

0.4

3.7

4

119

2

2.2

0.9 1.0

41

56

240

1 0

37

Domestic asset quality, 2010

1.3

1.0

40

76

30 7.3 12.3 4.9

P. Barrié de la Maza Foundation 42%

Board of Directors 0.2%

1.0 0.7

0.8

0.7

2004

2005

2006

114

40 2006 NIM

10 June 2010

2007

2008 Credit costs

2009 RoA

0 Coverage ratio

2007

2008

2009

Problem loans/Gross loans

535

Barclays Capital | AAA Handbook 2010

Banesto (BANEST)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.221

NA

€122bn

Moody’s

S&P

LT senior unsecured

Aa3

AA

AA

Covered bond rating

Aaa

NR

AAA

With total assets of €122bn as at year-end 2009, up 4.4% y/y from €117bn in 2008, Banco Español de Crédito Banesto (BANEST) is the fifth-largest bank in Spain. BANEST’s main focus is on providing commercial, wholesale, and retail banking services to its more than 2.2mn individual and c.400,000 small- and medium-sized corporate clients (SMEs). After a pronounced reduction in headcount over the course of the past year, BANEST had 8,905 employees (down 813 y/y) in 1,773 branch offices (down 142 y/y) as at year-end 2009. Its average market share stood at around 9% in 2008, but had increased to 10.4% in new lending in 2009. BANEST was originally founded in 1902 and has become a majority-owned subsidiary (87% as at year-end 2009) of Banco Santander (SANTAN).

Note: As at 7 June 2010

Strengths

Weaknesses

„

Funding structure: Following a moderate 1.9% y/y decline in customer deposits to €57.1bn in 2009, from €58.2bn in 2008 and a 2.8% y/y decline in customer lending to €75.6bn, from €77.8bn at the same time, BANEST’s 2009 deposit-to-loan ratio stood at a sound 75.5%, slightly up from 74.8% in 2008. At the same time, wholesale funding, among it more than €16bn of covered bonds, accounted for 53.5% of BANEST’s total funding.

„

„

Profitability: Over the course of 2009, BANEST increased its net interest income, which accounted for 69.4% of the lender’s operating income, by 9.6% y/y to €1.7bn, from €1.6bn a year before, thereby offsetting the 1.9% y/y decline in the net interest and commission income, which fell to €608mn in 2009, from €619mn a year before. At the same time, the net interest margin (NIM) remained stable at 152bp. The ongoing consolidation in the Spanish banking market could eventually lead to higher interest rates paid on customer deposits, which in turn could have a detrimental impact on CAIXAB’s NIM and thus its profitability. Still, we regard BANEST’s closure of 142 branch offices and the lay-off of 813 employees over the course of 2009 as the right measure to position itself for the challenging environment in the Spanish banking sector. BANEST’s cost-toincome ratio fell to a low 35.9% in 2009, from 38.5% in 2008.

„

Ownership: As at year-end 2009, Banco Santander (SANTAN) held an 87% stake in BANEST. Considering its strategic importance and the close integration, especially with regards to IT-systems and the insurance business, BANEST’s individual credit ratings are likely to remain strongly dependent on the close ties between both banks. Also, in our view, this makes the likelihood of potential support in the event of distress relatively high.

Outlook

Fitch

Negative

Negative

Stable

Discontinuity factor

-

-

41.5

Collateral score

-

-

-

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Increase in NPL ratio: With a non-performing loan (NPL) ratio of 2.9% as per year-end 2009, BANEST benefitted from a relatively high asset quality compared to its domestic peers. Still, as this ratio stood at 1.6% as at year-end 2008 and only 0.5% at yearend 2007, further developments need to be carefully monitored, particularly in light of BANEST’s exposure to the Spanish SME sector, which could be affected above average from a further delay in the economic recovery. (We expect Spanish GDP to contract by 0.6% y/y in 2010.) In total, NPLs stood at €2.6bn in 2009, of which €1.3bn were secured with expected losses amounting to €839mn. With loan-loss provisions of €1.6bn, the coverage ratio stood at 63.4%, down from 105.37% as per yearend 2008. Mitigating the potential adverse effects on BANESTs’ asset quality is the fact that only 49% of BANEST’s loan book consists of mortgage lending. Potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), therefore could be less significant for the quality of BANEST’s loan book than for its domestic peers. Still, we note that public sector lending on behalf of BANEST increased by 35.6% y/y to €2.0bn in 2009, from €1.4bn in 2008. This development, in our view, needs to be monitored, particularly in light of potentially higher funding needs for the Kingdom of Spain.

Note: Banco Santander (SANTAN), BANEST’s parent company, is extensively covered in a subsequent profile within this section.

Key points for 2010 „

Monitor further development of BANEST’s non-performing loans, which, however, are markedly lower than that of most domestic peers.

10 June 2010

536

Barclays Capital | AAA Handbook 2010

Financials and spreads

Banesto (BANEST)

Financial summary

Customer deposits to customer loans (net)

€ mn 2005 2006 2007 2008 2009 Income statement summary 1,109 1,235 1,461 1,578 1,731 Net interest income Net fees & com's 514 546 574 619 608 105 125 138 151 157 Trading income Operating income 1,701 1,874 2,137 2,309 2,495 Operating expenses 785 819 859 889 895 Pre-provision income 916 1,055 1,278 1,420 1,601 151 190 229 300 382 Loan loss provisions Pre-tax profit 850 1,927 1,100 1,146 1,157 Net income 570 1,451 765 780 560 Balance sheet summary Total assets 84,453 104,504 110,068 117,186 122,301 Customer loans 48,106 61,154 74,201 77,802 75,617 of which public sector 923 762 959 1,448 1,964 of which mortgages 26,536 33,279 37,110 37,292 37,364 Customer deposits 35,800 45,161 53,340 58,179 57,076 Debt funding 20,082 26,038 30,293 30,552 32,574 of which Cedulas 10,250 13,250 14,958 14,918 16,050 Total equity 3,431 4,315 4,748 5,070 5,299 Profitability (%) Return on average assets 0.8 1.7 0.8 0.7 0.5 Return on average equity 17.7 39.5 18.4 17.8 11.5 Cost/Income ratio 46.1 43.7 40.2 38.5 35.9 Net int inc/Op inc 65.2 65.9 68.4 68.4 69.4 Asset quality (%) LLPs/Pre-prov inc 16.5 18.0 17.9 21.1 23.9 LLRs/Gross loans 2.1 1.9 1.8 1.9 2.1 Prob loans/Gr loans 0.6 0.5 0.5 1.8 3.2 Coverage ratio 371.7 393.1 329.5 108.8 65.2 Capital adequacy (%) Tier 1 ratio 7.1 7.4 7.0 7.7 8.7 Total capital ratio 11.4 11.2 10.4 10.7 11.3 Equity/Assets ratio 4.1 4.1 4.3 4.3 4.3

80% 40%

58.4%

59.3%

58.7%

78%

74%

2004

2005

52.5%

54.3%

53.5%

74%

72%

75%

74.4%

2006

2007

2008

2009

25% Custumer deposits to loans Wholesale funding % of total funding

Asset quality 4%

372

359

20

33.3

0

9.8

37.1

37.3

37.4

12x

26.5

17.7 13.3 10.3 5.3x 6.4 2.8x 2.6x

13.3 2.5x

15.0 14.9

329 1.8%

2% 0.7%

0.6%

0.5%

0.5%

2004

2005

2006

2007

10 June 2010

250

109

65

0%

0 2008

Prob Loans/Gross Loans

2009

Coverage Ratio

NIM, credit costs and RoA 2

1.7%

1.6%

1.7%

0.7%

0.8%

1.4%

1

1.5%

1.5%

0.8%

0.7%

1.5%

0.5%

0.3%

0.3% 0.2%

0.2%

0 2004

2.5x 2.5x

Cedulas (€ bn)

60%

8x

40%

4x 2.3x

20%

0x

0%

16.1

2005

2006

0.2% 2007

0.3% 2008

Credit costs

2009 RoA

50.9%

46.1%

43.7%

4% 40.2%

38.5%

35.9% 2%

2002 2003 2004 2005 2006 2007 2008 2009 Mortgages (€ bn)

500

3.2%

393

Efficiency

40 9.8x

45%

0%

Net interest margin

Over-collateralisation

65%

Over-collateralisation

1.4% 2004

1.1%

1.0%

0.9%

2005

2006

2007

Cost/Income ratio

0.9%

0.8%

2008

2009

0% Cost/Assets ratio

537

Barclays Capital | AAA Handbook 2010

Bilbao Bizkaia Kutxa (BILBIZ)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.014

NA

€30bn

Bilbao Bizkaia Kutxa (BILBIZ) was formed as a result of the merger between Caja de Ahorros y Monte de Piedad Municipal de Bilbao and Caja de Ahorros Vizcaína (in February 1990). With total assets of €30bn, it ranks among the medium-sized savings banks, providing retail banking services through 413 branch offices of which 238 are located in Bizcaia region. As at year-end 2009, BILBIZ, which is headquartered in Bilbao, had 3,000 employees.

Moody’s

S&P

LT senior unsecured

A1

NR

A+

Covered bond rating

Aaa

NR

NR

Negative

NR

Stable

-

-

-

16.6

-

-

Outlook Discontinuity factor Collateral score

Fitch

Note: As at 7 June 2010

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

„

Market consolidation: In late May, merger talks between BILBIZ and Caja de Ahorros del Mediterráneo (CAM) collapsed. In light of the ongoing consolidation on the Spanish savings bank sector, any potential mergers involving BILBIZ need to be monitored.

„

Domestic exposure: As a result of its business model, BILBIZ’ operations are exclusively limted to the Spanish market.

Asset quality: As at year-end 2009, the non-performing loan ratio (NPL) of BILBIZ stood at a very moderate 2.49%, up only 30bp from 2.19% a year before. This is significantly below the industry’s average of 5.1%. The overall coverage ratio stood at 100.3% of doubtful assets for 2009. At the same time, the covered bonds issued by BILBIZ (€3.8bn, of which €1.0bn was issued publicly) benefited from a collateral pool of €8.0bn, implying a very sound over-collateralisation of 210%. Still, with mortgage lending accounting for a high €15.4bn, or 72% of all lending, up from €14.7bn at year-end 2008, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11), need to be carefully monitored as they could trigger a deterioration of BILBIZ’ asset quality. This becomes particularly evident as 75% of all lending corresponds to floating rate loans tied to the Euribor. Still, BILBIZ’ impairment losses increased by 18.4% to €182.7mn in 2009 from €154.4mn in 2008, thereby reducing the lender’s net income by 14.4% y/y to €293mn in 2009 from €342mn in 2008.

„

Profitability: In 2009, BILBIZ’ net interest income increased by 21.5% to €457mn, up from €376mn a year before. This development is attributed to lower interest rates paid on customer deposits, which fell from an average of c.5% in 2008 to c.2% in 2009. In light of the ongoing consolidation in the Spanish banking market, this effect could be reversed again as higher interest rates paid on customer deposits could have a detrimental impact on BILBIZ’ NIM and thus its profitability.

„

Funding profile: As at year-end 2009, BILBIZ benefited from a very sound funding profile with customer deposits accounting for 90% of all lending, slightly down from 97% in 2008. At the same time, wholesale funding as a percentage of all funding stood at a modest 22% in 2009 versus 17% in 2008.

Note: At the time of writing, BILBIZ had one benchmark covered bond outstanding totalling €1.00bn. Overall, the €3.8bn of Cédulas Hipotecarias issued were secured by a mortgage pool of €8.0bn as at year-end 2009.

Key points for 2010 „

The impact of potential ECB rate hikes on BILBIZ’ hitherto sound asset quality needs to be carefully monitored.

10 June 2010

„

A potential merger with other domestic savings banks needs to be carefully assessed, particularly if BILBIZ has to rely on the FROB.

538

Barclays Capital | AAA Handbook 2010

Financials and spreads

Bilbao Bizcaia Kutxa (BILBIZ)

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which CH Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

10 June 2010

Customer deposits to customer loans 2008

2009

376 127 83 838 308 530 155 327 342

457 134 82 849 310 539 204 275 293

29,667 20,978 608 14,688 20,334 2,512 2,720 3,914

29,806 21,178 795 15,361 19,086 3,864 3,832 4,123

100

75

30

21.8

17.2

20 90.1

96.9

10

50

0 2008 Cust deposits/loans

Wholesale funding/Tot. funding

NIM, credit costs, and RoA 2

2 1.3 1

1.5 0.7 0.98

1.15 0.5

0

0 2008

1.2 8.7 36.7 44.9

1.0 7.3 36.5 53.8

29.3 na 2.2 na

37.9 2.5 2.5 100.3

14.0 21.5 13.2

14.6 22.2 13.8

1

Credit costs

2009 RoA

NIM

539

Barclays Capital | AAA Handbook 2010

Caixa d’Estalvis de Catalunya (CAIXAC) Description

Leef H Dierks Ratings table

% € Index

% £ Index

Total assets

0.018

NA

€63.7bn

With total assets of €63.7bn at year-end 2009, virtually unchanged from year-end 2008, Caixa d’Estalvis de Catalunya (CAIXAC) is Spain’s third-largest savings bank. CAIXAC was founded as Caja de Ahorros Provincial de la Diputación de Barcelona in 1926 to provide banking services to the local industry, especially to smaller- and medium-sized enterprises (SME), public-sector entities and corporates. Today, CAIXAC focuses on providing retail banking services through nearly 6,900 employees in 1,155 branch offices, of which 725 (almost two-thirds) were located in Catalonia, where CAIXAC is the second-largest savings bank in terms of market share at roughly 15% in 2009. CAIXAC’s domestic market share stood at c.5%. At the time of writing, Caixa Catalunya had agreed to merge with Caixa Tarragona and Caixa Manresa to a new entity called Caja Catalana, which is scheduled to start operations on 1 July 2010.

Moody’s

S&P

Fitch

LT senior unsecured

A3

NR

NR

Covered bond rating

Aaa

NR

NR

Negative

NR

NR

-

-

-

33.1/11.6

-

-

Outlook Discontinuity factor Collateral score Note: As at 7 June 2010.

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

Funding profile: CAIXAC’s funding profile markedly improved over 2009, with the customer deposit-to-loans ratio growing to 61.4% from 53.6% a year before. At the same time, with interbank liabilities standing at nil in 2008 and 2009, CAIXAC’s reliance on wholesale funding remained relatively moderate and stood at 43.4% in 2009 after 42.5% in 2008.

„

„

Support mechanism: As with any other Spanish savings bank, CAIXAC benefits from the internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederación Española de Cajas de Ahorros (CECA), which not only offers technological and advisory services – particularly relevant for smaller savings banks – but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAIXAC benefits from the depositor guarantee fund – Fondo de Garantía de Depósitos (FGD) – of Spanish savings banks.

Non-performing loan ratio: In Q4 09, CAIXAC reported a nonperforming loan (NPL) ratio of 5.3%. Despite this being down from 5.7% in Q3, 5.4% in Q2 and 5.7% in Q1, the overall level remains high and stands above the sector’s average of 5.1%. The coverage ratio fell to 48.2% as per year-end 2009. Net impairment losses surged to €256mn in 2009, from €110mn in 2008 with noncurrent assets held for sale comprising €887.6mn of properties foreclosed in connection with non-performing loans held for sale and not as part of the group‘s ordinary course of business. In light of the current economic situation in Spain and potential rate hikes on behalf of the ECB (which we do not expect before Q1 11), CAIXAC’s NPL ratio could increase further, thereby triggering the need for further write-downs, which would adversely affect the lender’s profitability. With mortgage lending accounting for a high 74.6% of CAIXAC’s total lending as at year-end 2009, any increase in the 12 months Euribor (ie, the interest rate to which 98% of all Spanish mortgage loans are pegged) would likely also leave its mark on the lender’s NPL ratio.

„

Profitability: Driven by a surge in “net impairment losses on other assets” to €525.9mn in 2009 from €110.4mn in 2008, CAIXAC’s net income more than halved (-58.2% y/y) to €77mn in 2009 from €185mn in 2008 and €493mn in 2007. Adding to the pressure was the 7.2% y/y decline in net interest income and the 17.4% slump in net fee and commission income, which could not be offset by the sharp increase in CAIXAC’s trading income to €133mn in 2009 from €49mn in 2008.

„

PROCAM: CAIXAC faces a high exposure to the Spanish property market through its fully-owned property developer PROCAM which comprises 49 investment companies and 29 associated developers.

Key points for 2010 „

Monitor Caixa Catalunya’s merger with Caixa Manresa and Tarragona to new ‘Caja Catalana’, particularly in light of support of €1.25bn provided by the Spanish Orderly Bank Restructuring Fund, the so-called FROB.

10 June 2010

540

Barclays Capital | AAA Handbook 2010

Financials and spreads

Caixa d’Estalvis de Catalunya (CAIXAC)

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which mortgages Customer deposits Debt funding Of which cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPS/Pre-prov inc LLRS/Gross loans NPLs/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

Domestic asset quality 2006

2007

2008

2009

630 300 132 1,107 595 512 217 479 360

787 323 -6 1,158 647 511 345 594 493

897 350 49 1,293 666 626 771 205 185

832 289 133 1,254 633 621 22 75 77

67,551 42,737 28,872 24,870 17,336 1,750 2,200

68,201 50,514 33,368 26,514 21,912 3,250 2,619

63,627 50,011 35,533 26,828 19,806 5,000 2,766

63,650 44,381 33,096 27,256 20,864 8,434 2,835

0.6 17.5 53.7 57.0

0.7 20.5 55.9 68.0

0.3 6.9 51.6 69.4

0.1 2.8 50.5 66.4

42.4 1.9 0.8 253

67.5 2.0 1.1 194

123.1 2.9 5.3 57

3.6 2.5 5.3 48

NPLs/Gross loans 5.3%

6% 213

230

253

1.0%

0.9%

0.8%

3%

194

250 57

1.1%

48 0

0% 2004 2005 2006 2007 Prob loans/Gross loans

2008 2009 Coverage ratio

Customer deposits to customer loan (net) 75% 50% 25%

37.9% 41.1%

45.2%

42.5%

43.4%

66.6%

63.2% 58.2%

52.5%

53.6%

61.4%

2004

2005 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding in % of total funding

50%

31.4% 25%

0%

0%

Over-collateralisation (€bn)

8.3 11.5 3.3

5.5 6.3 3.8

6.3 10.1 4.3

6.1 9.4 4.5

40 28.9 30

22.0

1.8

0

33.1

20 15

10.3x

20 10

35.5

33.4 16.5x

12.6x

2005 Mortgages

10 June 2010

Coverage ratio 5.3% 500

3.3

7.1x 5.0

10 8.4 3.9x 5

0 2006 2007 2008 2009 Cedulas Over-collateralisation (x) rhs

541

Barclays Capital | AAA Handbook 2010

Caixa Galicia (CAGALI)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.055

NA

€46.3bn

With total assets of €46.3bn in 2009, Caixa Galicia (CAGALI) is Spain’s sixth-largest savings bank and among the country’s 10 largest financial institutions. CAGALI is the result of the 1978 merger between Caja de Ahorros y Monte de Piedad de La Coruña y Lugo and Caja de Ahorros de El Ferrol. It focuses on retail banking as well as on providing financial services to small and medium-sized enterprises (SMEs). Attributed to its historical roots and its headquarters in La Coruna, CAGALI has a strong presence in the autonomous region of Galicia, where 444 (-20 y/y) of its 828 (-63 y/y) branch offices were located and where it is market leader with a share of c.20% in retail banking. Recently, CAGALI has started to extend its international presence, with offices being opened in the US and Portugal.

Moody’s

S&P

Fitch

LT senior unsecured

A3

NR

BBB+

Covered bond rating

Aaa

NR

NR

Negative

NR

Stable

-

-

-

24.2

-

-

Outlook Discontinuity factor Collateral score Note: As at 7 June 2010

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standardised Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

„

Profitability: Driven by a sharp 62% y/y fall in trading income to €151mn in 2009 from €395mn in 2008, CAGALI’s net income fell by nearly 60% to €91mn from €225mn a year before. In light of the ongoing consolidation in the Spanish banking market, we caution that this effect could become even more pronounced in the near term as higher interest rates paid on customer deposits could have a detrimental impact on CAGALI’s NIM (which nonetheless increased by 8bp to 146bp in 2009 from 138bp in 2008) and thus, its profitability.

„

Non-performing loan ratio: As at year-end 2009, the proportion of CAGALI’s non-performing loans (NPL) to total loans stood at a high 4.9%, up 150bp from 3.4% in 2008 and 0.7% in 2007. This is only marginally below the sector’s average which stood at 5.1% for the same timeframe. Overall, doubtful assets increased by €500mn to €1.9bn in 2009 versus €1.4bn in 2008. Note that in 2009, CAGALI made an extraordinary provision of €58.7mn “to anticipate future deterioration in the value of the real estate portfolio”. In 2008, the respective figure amounted to €27.8bn. A positive, however, is the €886mn y/y reduction in lending to property developers and larger corporates, which more then offset the increase in lending to households and SMEs (+€373mn y/y) and the public sector (+€102mn y/y). In terms of new financing, mortgage lending increased by €1.1bn in 2009, followed by lending to property developers, which grew by €925mn y/y.

„

Market consolidation: With many of CAGALI’s domestic peers in the process of merging to larger institutions as of late, further activities on behalf of CAGALI need to be carefully monitored.

„

Funding profile: As per year-end 2009, CAGALI benefited from a relatively sound funding profile with customer deposits, which were up 6% y/y to €28.6bn in 2009 from €26.9bn in 2008, accounting for 80% of all lending. Customer lending, in contrast, modestly contracted by 2.3% y/y to €35.3bn in 2009 from €36.2bn in 2008. At the same time, the percentage of wholesale funding to all funding stood at a moderate 33%, thereby illustrating CAGALI’s relatively modest capital market reliance. Nonetheless, in between 2008 and 2009, CAGALI had strongly relied on the issuance of government-guaranteed debt instruments. Support mechanism: Similarly to any other Spanish savings bank, CAGALI benefits from internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederación Española de Cajas de Ahorros (CECA) offers technological and advisory services – these are particularly relevant for smaller savings banks – but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAIXAC benefits from the depositor guarantee fund – Fondo de Garantía de Depósitos (FGD) – of Spanish savings banks. In addition to the FGD, cajas benefit from federal support in the form of the FROB, which, if necessary, provides funding for the sector’s consolidation.

Note: At the time of writing, CAGALI had one EUR-denominated benchmark Cédulas Hipotecarias outstanding with a nominal value of €1.50bn.

Key points for 2010 „

With CAGALI’s NPL ratio standing only slightly below the industry’s average of 5.1% as at year-end 2009, the further development of the lender’s asset quality needs to be carefully monitored, particularly in light of potential ECB rate hikes.

10 June 2010

„

Monitor the ongoing merger activity on the Spanish savings bank sector

542

Barclays Capital | AAA Handbook 2010

Financials and spreads

Caixa Galicia (CAGALI)

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which Mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

NIM, credit costs and RoA 2006

2007

2008

2009

477 119 343 1002 384 619 155 443 357

580 143 380 1214 458 756 279 454 401

651 137 395 1250 514 736 596 191 225

677 155 151 1036 462 573 430 73 91

42,813 28,098 1,056 16,294 21,680

47,726 35,229 1,200 21,477 23,560

46,626 36,165

46,340 35,335

0 2,570

1,500 2,682

21,987 26,938 9,656 1,500 2,318

23,097 28,554 11,247 1,500 2,300

0.9 15.8 38.3 47.6

0.9 15.3 37.7 47.8

0.5 9.0 41.1 52.1

0.2 3.9 44.6 65.4

25.0 1.3 390.2

36.9 0.9 368.0

81.0

75.0

5.0 9.7 6.0

6.1 10.7 5.6

6.6 10.1 5.0

8.5 11.3 5.0

2

1

1.46

1.38

1.28

1.20

1.00

1.11 0.90

0.40

0.89

0.16 0.20 2009

0.48

0 2006

2007

2008

NIM

Credit costs

RoA

Customer deposits to loans

40 20

125

36.4

39.3 29.1 91.7

32.9 23.5 66.9

80.8

77.2

75 50

0 2005

2006

2007

2008

2009

Wholesale funding in % of total funding Customer deposits to loans

Domestic asset quality 0.7

800 0.56 600 400 335

631

578 0.47 487 0.37 353

0.5 0.31 0.27

390 0.33

368

0.3

0.25 0.1

200 2001 2002 2003 Coverage ratio

10 June 2010

100

74.5

2004 2005 2006 2007 Problem loans/Gross loans

543

Barclays Capital | AAA Handbook 2010

Caja Mediterráneo (CAJAME)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.065

NA

€75.5bn

Moody’s

S&P

Fitch

LT senior unsecured

A3

NR

BBB+

Covered bond rating

Aaa

NR

NR

Negative

NR

Negative

-

-

-

38.1

-

-

Caja Mediterráneo (CAJAME) is the fourth-largest savings banks in Spain with total assets amounting to €75.5bn at year-end 2009, largely unchanged from €75.0bn a year before. CAJAME’s focus lies in providing retail banking services as well as financial services to small- and medium-sized enterprises (SME). Over the course of the past 133 years, CAJAME in its current form emerged from more than 30 savings banks in the regions of Comunidad Valenciana and Alicante, where nowadays nearly 600 of its 1,000 offices are located. A total of 115 offices were closed over the course of 2009, thereby improving CAJAME’s cost/income ratio to 33% in 2009, from 46% a year before. In late May, CAM announced that it would merge with Cajastur, Caja Santander y Cantabria, and Caja Extremadura.

Note: As at 7 June 2010.

Strengths

Weaknesses

„

„

Non-performing loans: The proportion of CAJAME’s nonperforming loans (NPL) to total loans stood at 4.5% as at year-end 2009, up from 3.8% in 2008. Overall, doubtful loans amounted to €2.5bn in 2009. Taking into consideration that a high 72% of all lending is backed by mortgage loans, the impact of potential ECB rate hikes needs to be carefully monitored as it could lead to a deterioration of CAJAME’s asset quality, particularly as c.99% of all mortgage loans granted in Spain are pegged to the 12m Euribor.

„

Mediterranean CAM International Homes: Mediterranean CAM International Homes was set up in early 2007, in line with CAJAME’s strategic expansion plans throughout Spain. Whereas in its initial stages, Mediterranean CAM International Homes sold properties developed by CAM’s real estate clients, at the end of 2008, CAJAME decided to increasingly focus on the sale of properties owned by CAJAME, among them repossessed properties, both new-builds and previously owned properties, commercial premises, offices, plots, storage facilities and garages.

„

Consolidation pressures: Despite being among the larger players, CAJAME might be affected by the consolidation process in the Spanish savings banks market. New entities emerging from the potential merger[have these potential mergers been reported upon?] of its peers Unicaja, Caja Jaen, and CajaSur to Unicajasur, for example, could put pressure on CAJAME in its core market. In response, in late May, CAM announced that it would merge with Cajastur, Caja Santander y Cantabria, and Caja Extremadura.

Interest income: Despite the currently prevailing low interest rate environment in Spain, CAJAME’s net interest income increased by 33.2% y/y to €1.6bn in 2009, from €1.2bn in 2008, despite mortgage lending falling by 9.0% y/y to €38.5bn in 2009, from €42.3bn in 2008. Deposit taking fell by 1.8% y/y to €41.2bn in 2009, from €41.9bn in 2008. At the same time (and in contrast to most its domestic peers), CAJAME increased its net interest margin (NIM) by 50bp to 213bp in 2009, from 163bp in 2008. This development, in our opinion, is favourable and could further benefit from potential ECB rate hikes, which, however, we do not expect to occur before Q1 11. Yet, the increasing competition for customer deposits in Spain could potentially reduce CAJAME’s NIM in the months ahead.

„

Funding structure: Customer deposits accounted for a high 77.8% of all lending in 2009, up from (an already high) 71.6% in 2008. Accordingly, CAJAME’s reliance on wholesale funding remained largely stable at around 38.8% of all funding in 2009, ie, unchanged from the years before.

„

Support mechanism: Like its domestic peers, CAJAME benefits from the internal support mechanisms of the domestic savings bank system. It is part of the Spanish savings banks association, Confederación Española de Cajas de Ahorros (CECA). Not only does the latter offer technological and advisory services – which are particularly relevant for smaller savings banks – but it also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAJAME benefits from the depositor guarantee fund – Fondo de Garantía de Depósitos (FGD) – of Spanish savings banks. In addition to the FGD, cajas benefit from federal support in form of the FROB, which, if necessary, can provide funding for the sector’s consolidation.

Outlook Discontinuity factor Collateral score

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Note: At the time of writing, CAJAME had two Cédulas Hipotecarias totalling €2bn outstanding. The issuer had previously also participated in various MultiCédulas transactions.

Key points for 2010 „

Monitor the further development of CAJAME’s NPL ratio, which stood only slightly below the industry’s average at the time of writing.

10 June 2010

544

Barclays Capital | AAA Handbook 2010

Financials and spreads

Caja Mediterráneo (CAJAME)

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

Customer deposits to loans 2007

2008

2009

1,128 191 112 1,606 630 976 573 602 440

1,206 193 -35 1,527 701 826 982 387 432

1,606 165 273 2,227 734 1,493 847 322 265

72,871 58,339 897 42,483 41,415 15,388 0 3,946

75,473 58,495 869 42,288 41,910 13,352 1,000 3,576

75,532 52,896 977 38,478 41,175 16,094 2,000 3,806

80%

0.6 11.5 45.9 78.9

0.4 7.2 33.0 72.1

58.7 1.0 0.7 201.0

118.8 1.7 3.8 51.0

56.7 1.6 4.5 71.0

38.2%

38.8%

30% 71.0%

77.8%

71.6%

40%

20% 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding

Net interest margin, credit costs and RoA 3% 2%

0%

2.1% 1.7% 0.8% 0.6% 2007

1.6% 1.1%

1.3% 0.6%

0.4%

2008

2009

Net interest margin

Credit costs

RoA

Efficiency ratios 50%

1.2% 45.9%

7.4 11.7 5.4

7.6 10.5 4.7

9.1 11.4 5.0

40%

39.2% 0.93%

0.97%

1.0%

0.95% 33.0%

30%

0.8% 2007 Cost/Income ratio

10 June 2010

40%

60%

1% 0.6 11.6 39.2 70.2

38.0%

2008

2009 Cost/Assets ratio

545

Barclays Capital | AAA Handbook 2010

La Caixa (CAIXAB)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.393

NA

€272bn

With total assets of €272bn as at year-end 2009, up 4.2% y/y, La Caja de Ahorros y Pensiones de Barcelona (CAIXAB) is Spain’s largest savings bank and the country’s third-largest financial entity. CAIXAB operates as a universal bank, focusing on the provision of retail banking and insurance services to more than 10.5mn retail and SME clients through more than 27,000 employees in 5,300 branch offices of which 1,665 are located in Catalonia. CAIXAB is market leader with a 30% market share in online banking services in Spain. In deposit taking and lending, CAIXAB, which is the result of the 1990 merger of Caja de Pensiones, founded in 1904, and Caja de Barcelona, founded in 1844, had market shares of 10.4% and 10%, respectively. Also, with a market share of 10.5%, CAIXAB was leader in mortgage lending in 2009. Through its investment vehicle CaixaCorp, CAIXAB held a 20% stake in Mexican Inbursa, 30% in Portuguese Banco BPI, 15% in Hong Kong’s Bank of East Asia, and 10% of Austrian Erste Group Bank, as well as Gas Natural and Abertis, among others, as at year-end 2009.

Moody’s

S&P

Fitch

LT senior unsecured

Aa2

AA-

AA-

Covered bond rating

Aaa

AAA

NR

Negative

Negative

Negative

-

-

-

21.0

-

-

Outlook Discontinuity factor Collateral score Note: As at 7 June 2010.

Risk weighting As Spanish Cédulas Hipotecarias and Cédulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

Profitability: Notwithstanding the third consecutive decline of CAIXAB’s net income to €2bn in 2009 (-14% y/y), from €2.3bn in 2008, owing to a doubling in loan-loss provisions to €1.4bn in 2009, from €600mn in 2008, CAIXAB’s net interest income increased by 12% y/y to €3.9bn from €3.5bn a year before. At the same time, the net interest margin (NIM) increased by 10bp to 148bp from 138bp a year before. The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental impact on CAIXAB’s NIM and thus its profitability.

„

„

Market position: As at year-end 2009, CAIXAB was market leader in mortgage lending in Spain, benefiting from a market share of 10.5%. In deposit taking and lending, CAIXAB had market shares of 10.4% and 10%, respectively, thereby ranking second on the domestic market. Also, with a 30% share, CAIXAB was the clear market leader in online banking services in Spain.

Asset quality: In 2009, CAIXAB’s doubtful loans increased by 36.8% y/y to €6.2bn, up from €4.5bn as per year-end 2008. Overall, the non-performing loan (NPL) ratio amounted to 3.4% as at year-end 2009, clearly below the national average of 5.1%. The coverage ratio stood at 127%. Over the course of the year, total NPL stood relatively stable at between 3.4% and 3.5%, gradually declining towards the end of the year. Of the €6.3bn of nonperforming loans, €4.1bn corresponded to mortgage loans. In addition to the comparatively moderate NPL ratio, CAIXAB, in our view, benefits from the fact that 66% (or €114bn) of its total loan book (€174bn) was mortgage lending, of which 90% was secured on first and primary homes. Further mitigating the NPL ratio was a very low weighted average LTV of 49% in the mortgage loan book.

„

Servihabitat: The latter is CAIXAB’s subsidiary, which manages real estate assets which are not connected with the banking business but are held for sale. As at year-end 2009, assets amounted to €3.1bn. Of these, €2.7bn was related to properties available for sale. Thereof, €1.9bn corresponded to properties from developers. Over the course of 2009, the portfolio increase attributed to property developers steadily slowed to €104mn in Q4, from €1.2bn in Q1 09.

„

Funding structure: As at year-end 2009, CAIXAB’s customer deposits corresponded to a high 75% of all lending, thereby keeping the reliance on wholesale funding markets at moderate levels. In 2009, wholesale funding accounted for 37% of CAIXAB’s total funding.

„

Participations: Despite potentially adding unwanted volatility to the investment portfolio, CAIXAB’s participations in Mexican Inbursa, Portuguese Banco BPI, Hong Kong’s Bank of East Asia, Austrian Erste Group Bank, Gas Natural, or Abertis, among others, diversify the lender’s revenue structure. Also, unrealised gains of €4.0bn on listed investments in 2009 serve as a certain buffer.

Note: As at year-end 2009, CAIXAB had covered bonds outstanding totaling €26.75bn.

Key points for 2010 „

Closely monitor whether the gradual fall in the volume of NPL is a sustainable development.

10 June 2010

„

Public sector lending on behalf of CAIXAB increased 36.1% y/y to €6.3bn in 2009, from €4.6bn in 2008. This development, in our view, needs to be monitored, particularly in light of potentially higher funding needs for the Kingdom of Spain.

546

Barclays Capital | AAA Handbook 2010

Financials and spreads

La Caixa (CAIXAB)

Financial summary

Geographical split, 2010

€ mn 2006 Income statement summary Net interest income 2,521 Net fees & com's 1,299 Trading income 1,214 Operating income 6,761 Operating expenses 2,633 Pre-provision income 4,128 Loan loss provisions 478 Pre-tax profit 4,013 Net income 3,143 Balance sheet summary Total assets 209,123 Customer loans 138,706 of which public sector 2,353 of which mortgages 99,137 Customer deposits 117,685 Debt funding 39,457 Of which cedulas 23,750 Total equity 10,769 Profitability (%) Return on assets 1.6 Return on equity 33.1 Cost/Income ratio 38.9 Net int inc/Op inc 37.3 Asset quality (%) LLPS/Pre-prov inc 11.6 LLRS/Gross loans 1.5 Prob loans/Gr loans 0.3 Coverage ratio 446.0 Capital adequacy (%) Tier 1 ratio 8.3 Total capital ratio 11.3 Equity/Assets ratio 5.1

2007

2008

2009

3,348 1,257 415 5,624 2,815 2,809 582 2,725 2,625

3,508 1,250 163 6,752 3,050 3,702 617 2,616 2,317

3,932 1,303 130 7,187 3,084 4,103 1,401 2,131 2,004

248,495 158,642 2,516 113,930 127,077 50,796 26,250 14,415

260,827 175,471 4,616 117,924 134,734 49,837 28,300 15,619

271,873 173,641 6,298 114,360 129,831 52,738 26,750 16,696

1.1 20.8 50.1 59.5

0.9 15.4 45.2 52.0

0.8 12.4 42.9 54.7

20.7 1.6 0.6 281.0

16.7 1.7 2.5 67.3

34.1 2.2 3.6 61.0

9.8 12.1 5.8

10.1 11.0 6.0

10.4 11.0 6.1

Customer deposits to loans (net)

110% 102%

95% 90% 85% 80% 77% 75%

20% 10%

50% 2002 2003 2004 2005 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding in % of total funding

10 June 2010

Catalonia+ Balearics 41%

Andalusia 13% Madrid+ Castilla 22%

Lending to private borrowers, 2010 Other collateral 10%

Mortgage collateral 90%

Over-collateralisation 160

€ bn 7.3x

120 80

5.2x

61.7

49.1

40

5.6x

99.1

79.2

11.8

4.2x 14.3

8

113.9 117.9

23.8

4.3x

114.4 4.2x 4.3x

26.3

26.8

4 28.3

0

0 2003 2004 2005 2006 2007 2008 2009 Mortgages Cedulas Over-collateralisation (rhs)

NIM, credit costs, and RoA

33.9%31.9%36.7% 40% 125% 22.6% 30.6% 25.8% 25.3% 24.9% 30% 100% 75%

Other 24%

3% 1.9%

1.9%

2% 1%

0.7%

0.8% 0.3%

0.3%

1.7% 0.8%

1.4% 1.1%

0.3% 0.2%

1.6% 1.3%

1.5%

1.1% 0.2% 0.3%

0.9% 1.4% 0.2%

2006

2008

1.5% 0.5% 0.8%

0% 2002

2003

2004

2005

Net interest margin

2007

Credit costs

2009 RoA

547

Barclays Capital | AAA Handbook 2010

Caja Madrid (CAJAMM)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.414

NA

€191.4bn

Caja de Ahorros y Monte de Piedad de Madrid (CAJAMM) is Spain’s second-largest savings bank and fourth-largest financial institution in terms of total assets, which amounted to €191.4bn in 2009, up 6% y/y from €181.0bn in 2008. CAJAMM, which was founded in 1869, provides universal banking services (ie, retail, private, commercial, and wholesale banking as well as asset management services) with a focus on smaller- and medium-sized enterprises (SMEs) particularly in the greater Madrid region. As at year-end 2009, CAJAMM, which serves more than 7mn clients, had 15,259 employees in 2,175 branch offices (of which more than 1,050 were located in Madrid), 22 of which corresponded to its US operations (City National Bank of Florida). CAJAMM benefited from a market share of 6.9% in customer lending and 7.4% in deposit taking in 2009. In addition to its banking operations, CAJAMM has formed an alliance in the country’s insurance sector by holding a 14.95% stake in Mapfre, which has a market share of more than 17%. Also, through Cibeles, CAJAMM has a 10.36% interest in Mapfre América, a holding company whose activity is concentrated in 11 countries in Latin America, mainly Brazil and Mexico, and whose market share in non-life insurance is above 6%.

Moody’s

S&P

Fitch

LT senior unsecured

A1

A

A+

Covered bond rating

Aaa

NR

AAA

Negative

Negative

Negative

-

-

41.5

20.8

-

-

Outlook Discontinuity factor Collateral score Note: As at 7 June 2010

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

International business: Caja Madrid’s international business is concentrated in the US and Mexico, where, through its daughter Cibeles, it holds an 83% shareholding in retail-banking focused City National Bank of Florida, which was acquired in late 2008 and a 40% shareholding in Grupo Hipotecarias Su Casita, which, at the time of writing, is Mexico’s second-largest mortgage company.

„

„

Funding profile: Following the 7.2% y/y growth in customer deposits to €89.9bn in 2009, from €83.9bn in 2008, and the gradual 0.6% y/y decline in customer lending to €117.8bn in 2009, from €118.4bn in 2008, CAJAMM’s deposit to loan ratio improved to 76.4% in 2009, from 70.8% in 2008. At the same time, the ratio of wholesale funding as a percentage of all funding fell to 46.1%, from 47.1%. This decline is less pronounced as interbank liabilities had increased by €1.2bn to €21bn in 2009.

„

Support mechanism: Like any other Spanish savings bank, CAJAMM benefits from the internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederación Española de Cajas de Ahorros (CECA), which not only offers technological and advisory services –particularly relevant for smaller savings banks – but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAJAMM benefits from the depositor guarantee fund – Fondo de Garantía de Depósitos (FGD) – of Spanish savings banks. As no savings bank has ever defaulted on its obligations since the sector emerged in 1837, the FGD has accumulated significant reserves that it is authorised to use to rescue or manage the liquidation of a troubled savings bank.

Non-performing loan ratio: As at year-end 2009, CAJAMM’s non-performing loan (NPL) ratio stood at a relatively high 5.4%, up from 4.9% a year before. This level is slightly above the sector’s average which, in our view, is partly due to the fact that CAJAMM’s risk exposure towards construction and property development accounted for a high 19.7% of all credit risk in 2009, slightly down from 22.9% in 2008. Whereas corporate risk exposure accounted for 47.5% of the total exposure at year-end 2009, the credit risk arising from mortgage lending to individuals accounted for 33.6% of the total credit risk. Overall, impairment losses climbed to €3.1bn in 2009, from €2.9bn in 2008. Total provisions increased to €3.4bn as at year-end 2009, with the coverage ratio falling to 43.4% in 2009, from 43.3% in 2008. Given the current economic situation in its domestic market, we expect the NPL ratio is likely to further increase over the course of the year. This could leave its mark on the lender’s profitability, which had come under pressure in 2009 already as loan-loss provisions were up 65.7% y/y to €1.4bn, from €869mn in 2008. arr ear

„

Market exposure: As at year-end 2009, mortgage lending accounted for a high two-thirds of all lending (65.8%) and through its 27.7% stakeholding in Realia, CAJAMM faces a sizeable exposure to the Spanish real estate market –which has experienced pronounced price declines in the past quarters. Note that (as many of its domestic peers), CAJAMM has meanwhile started selling residential property directly. Overall, the downturn experienced by the property market has led to a further decline in financing to the property developer segment, with the number of properties financed falling by 14.2% y/y to 83,238 units in 2009.

„

The recently announced merger between Caja Madrid, Caja Canarias, Caixa Laietana, Caja de Avila, Caja Segovia, and Caja Rioja needs to be carefully assessed.

Key points for 2010 „

The steady increase of CAJAMM’s NPL ratio, which climbed to 5.4% in 2009, from 4.9% in 2008, needs to be carefully monitored as it increasingly has an impact on the lender’s profitability.

10 June 2010

548

Barclays Capital | AAA Handbook 2010

Financials and spreads

Caja Madrid (CAJAMM)

Financial summary

Domestic asset quality

€ mn 2006 Income statement summary Net interest income 1,659 Net fees & com's 825 Trading income 196 Operating income 3,156 Operating expenses 1,372 Pre-provision income 1,784 Loan loss provisions 443 Pre-tax profit 1,322 Net income 1,032 Balance sheet summary Total assets 136,952 Customer loans 95,078 of which public sector 3,010 of which mortgages 63,197 Customer deposits 57,515 Debt funding 49,392 of which Cedulas 20,250 Total equity 9,635 Profitability (%) Return on assets 0.83 Return on equity 13.2 Cost/Income ratio 43.5 Net int inc/Op inc 52.6 Asset quality (%) LLPs/Pre-prov inc 24.8 LLRs/Gross loans 1.9 Prob loans/Gr loans 0.7 Coverage ratio 265 Capital adequacy (%) Tier 1 ratio 7.4 Total capital ratio 12.8 Equity/Assets ratio 7.0

2007

2008

2009

1,997 853 2,505 5,682 1,495 4,187 965 3,366 2,869

2,209 803 346 3,490 1,747 1,743 869 1,206 841

2,532 771 600 3,871 1,587 2,285 1,441 364 267

158,855 107,759 3,063 70,242 58,522 58,918 23,500 9,636

180,971 118,437 3,373 73,753 83,866 55,015 24,500 10,220

191,904 117,780 4,116 77,518 89,924 56,302 24,100 10,268

1.94 29.8 26.3 35.1

0.49 8.5 50.0 63.3

0.14 2.6 41.0 65.4

23.1 2.2 1.0 210

49.9 2.4 5.4 44

63.1 2.6 6.2 42

8.7 12.0 6.1

7.7 10.1 5.6

8.9 10.6 5.4

Gross NPLs/mortgages 6% 4%

221%198%

267%297%238%265%

2.5%

2.1

2.1

2.1

0%

0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Gross NPLs/loans Reserve coverage – mortgages

1.6 1.3

1.5% 0.8

0.5% 0.0%

0.7

0.7

0.7 0.3

0.4

0.3

0.8 0.2

0.8 0.3

1.4

1.4

1.3

0.8 0.4

0.7

0.5 0.5

0.8 0.1

0.3

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Net interest margin

10 June 2010

42%

Customer deposits to customer loan 100% 75% 40.8 39.1 40.9 38.9 44.0

49.4 50.6

55.1

75% 47.1 46.2 50%

50% 25%

25% 88% 89% 84% 83% 73% 64% 60% 54% 71% 76% 0%

0% 2000

2003 2006 2009 Customer deposits to loans Wholesale funding % of total funding

Over-collateralisation (€bn) 100 80 60 40 20 0

75%

1.9 1.6

1.0%

200%

0.8% 0.9% 0.8% 0.6% 0.7% 0.7% 1.0%

12 10 63.2 8 48.0 5.7x 23.5 36.8 6 29.0 3.6x11.5 16.5 20.3 24.1 3.7x 3.0x24.5 24.1 4 3.1x 17.1 19.8 3.2x 2.9x 2 1.5 3.5 6.5 8.0 3.0x 3.2x 0 2000 2003 2006 2009 11.4x

77.5 70.2 73.8

Cedulas

Overcollateralisation (rhs)

Efficiency

2.0

2.0%

5.4% 44%

2%

Mortgages

NIM, credit costs and RoA

210%

Reserve coverage (mortgages) 6.2% 400%

Credit costs

RoA

50%

1.8 59.0

1.8 60.3

2.0% 1.6 56.4

51.2 1.5

50.0

43.5 1.1

25%

1.0

1.0

26.3

41.0 1.0% 0.9

0%

0.0% 2002

2003

2004

2005

Cost/Income ratio

2006

2007

2008

2009

Cost/Assets ratio (rhs)

549

Barclays Capital | AAA Handbook 2010

Cedulas TDA (CEDTDA)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.241

NA

NA

Cédulas Titulización de Activos (CEDTDA), which was established in 1992, operates as a fund designed to refinance Cédulas Hipotecarias (CH) issued by smaller- and medium-sized Spanish commercial and savings banks under the Spanish Securitisation Law. Technically, CEDTDA purchases separate non-benchmark CH originated by commercial and savings banks, which have the same coupon, payment date and maturity, and then issues a (benchmark) multicédulas with a principal amount equal to the sum of the separate CH. Its activities are managed by TdA SGFT; an entity authorised by the Ministerio de Economía y Hacienda and supervised by the Comisión Nacional de Mercado de Valores CNMV, the Spanish financial markets supervisory authority. At the time of writing, CEDTDA had a total of 11 benchmark multi-cédulas outstanding in the combined amount of €22bn.

Moody’s

S&P

Fitch

LT senior unsecured

NA

NA

NA

Covered bond rating

Aaa

AAA

AAA*

Outlook

NA

NA

NA

Discontinuity factor

-

-

-

Collateral score

-

-

-

Note: Watch Negative. As at 7 June 2010

Risk weighting As Spanish Cédulas Hipotecarias and Cédulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach when appraising the underlying assets.

Strengths

Weaknesses

„

„

Funding costs: In light of the currently more attractive funding levels when issuing plain-vanilla Cédulas Hipotecarias, several Spanish savings banks, which previously relied upon CEDTDA’s multi-cédulas structure for their refinancing purposes, have meanwhile started tapping capital markets on their own.

„

Consolidation pressures: In our view, the ongoing consolidation among Spanish savings banks, which is likely to result in larger institutions with higher refinancing needs and direct capital market access, could trigger more savings banks tapping the capital markets on their own. As CEDTDA’s multi-cédulas transactions involve up to 11 different smaller and medium-sized Spanish savings banks, the sector’s consolidation could result in potential headline risks for CEDTDA.

„

Non-performing loan ratio: Over the past few months, the nonperforming loan (NPL) ratio of Spanish savings banks has steadily increased with the sector’s average standing at 5.1% at the time of writing. In light of the economic situation in Spain, we believe that the NPL ratios of some of the savings banks involved could be subject to further increases, particularly in light of their exposure towards mortgage lending and lending to property developers, where the respective NPL ratio had reached 9.6% at the time of writing.

„

Ownership structure: Shareholders of CEDTDA include Caja Castilla La Mancha (CCM), which holds a 12.9% stake (at the time of writing) but had to be bailed out after merger talks with domestic rival, Unicaja, were discontinued. Other shareholders include Caja Madrid, Caja de Ahorros del Mediterráneo, EBN Banco, Caja de Burgos, Unicaja, and IberCaja, which each hold 12.9%, as well as JP Morgan, which holds a 10% stake.

„

„

Liquidity facility: CEDTDA’s multi-cédulas transactions benefit from the provision of a liquidity facility provided by Caja Madrid (CAJAMM), Spain’s second-largest savings bank in terms of total assets at the time of writing. The liquidity facility is designed to provide additional safety and ensure the timeliness of repayments to investors, thereby reducing the bonds’ default probability. Also, in terms of exchanging debt instruments for liquidity, CEDTDA (in contrast to Spanish plain vanilla covered bond issuers) benefits from its direct access to Banco de España. Diversification: CEDTDA multi-cédulas typically involve up to a dozen Spanish savings banks, thereby offering multi-cédulas investors credit exposure to the Spanish savings banks sector as a whole. Covered bond investors thus benefit from a potentially higher degree of geographical diversity across Spain than in the case of some plain-vanilla Cédulas Hipotecarias. Transaction structure: In order to ensure that deals generate sufficient excess spread to cover the general expenses of the fund, coupons on the multi-cédulas are higher than the joint CH. Note that payments from individual CH into CEDTDA are due two working days before the payments are due on the Multi Cédulas to guarantee sufficient time to rectify any potential cash-flow problems

Key points for 2010 „

Monitor potential spill-over effects from ongoing consolidation in the Spanish savings bank sector that might reduce the number of savings banks relying on CEDTDA for refinancing purposes.

10 June 2010

550

Barclays Capital | AAA Handbook 2010

Financials and spreads

Cedulas TDA (CEDTDA)

Outstanding issues Coupon %

ISIN

Maturity

Cédulas TDA 1

3.250

ES0317018002

16 Jun 10

Cédulas TDA 2

4.500

ES0317019000 26 Nov 13

2.000 Caixa Catalunya, Caja Laboral, Caja Terrassa, Caixanova, Caja Espana, Unicaja, Caja Madrid, CCM, Ibercaja, Caixa Tarragona, Banco Gallego

Cédulas TDA 3

4.375

ES0317043000 03 Mar 16

2.000 Caja Madrid, Caixa Penedes, Caja Castilla La Mancha, Caja Laboral, Unicaja, Caja Burgos, Caixa Terrassa, Caixa Girona, Caixa Manresa, Caixanova, Banco Gallego

Cédulas TDA 5

4.125

ES0317045005 29 Nov 19

1.500 Ibercaja, CAM, Caixa Penedes, Unicaja, CCM, Caja Madrid, Caja Laboral, Bnanco Gallego, Caixa Manresa

Cédulas TDA 6

3.875

ES0317046003 23 May 25

3.000 Banco Gallego, Caixa Manresa, Caixa Penedes, Caixa Terrassa, Ibercaja, Caixanova, Caja Madrid, Unicaja

Cédulas TDA 7

3.500

ES0317047001

2.000 Caja Murola, Caja Duero, Caixa Penedes, Caixa Terrassa, Ibercaja, Caixa Girona, Caja Madrid, CCM, Unicaja, Sa Nostra, Banco Gallego

Issue

20 Jun 17

Volume € bn

Involved parties

1.750 Caja Madrid, Caja Burgos, CAM, CCM, Ibercaja, Unicaja

Cédulas TDA A-3

4.000

ES0371622038 23 Oct 18

1.150 Caixa Sabadell, Sa Nostra, Caixa Laietana, Unicaja, CCM, Cajasol

Cédulas TDA A-4

4.125

ES0371622012 10 Apr 21

2.250 Caixa Sabadell, Sa Nostra, Caixa Laietana, Unicaja, CCM, Ibercaja, Caja Madrid, Caja Murcia, Caixa Girona, Caja Espana, Caja Cantabria, Caixa Terrassa

Cédulas TDA A-5

4.250

ES0371622046 28 Mar 27

1.310 CCM, Caja Madrid, Caixa Girona, Caja Espana, Cajasol, Caja Burgos

Cédulas TDA A-6

4.250

ES0371622020 10 Apr 31

3.805 Caixa Sabadell, Sa Nostra, Caixa Laietana, Unicaja, CCM, Caja Duero, Caja Madrid, Caixanova, Caixa Manresa, Caja Espana, Caixa Terrassa, Cajasol

Source: TdA Titulización de Activos, 31 March 2010

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Intermoney Titulizacion (IMCEDI) Description

Leef H Dierks Ratings table

% € Index

% £ Index

Total assets

0.134

NA

NA

InterMoney Titulización (IMCEDI) operates as a fund that refinances Cédulas Hipotecarias (CH) issued by smaller- and medium-sized Spanish savings banks under the Spanish Securitisation Law. Technically, IMCEDI purchases separate non-benchmark CH originated by commercial and savings banks, which have the same coupon, payment date and maturity, and then issues a (benchmark) multi cédulas with a principal amount equal to the sum of the separate CH. At the time of writing, IMCEDI had a total of 13 multicédulas transactions outstanding with a nominal volume of nearly €20bn, four of which with an aggregated volume of €7bn were originated on behalf of Grupo Banco Popular (GBPCED), exclusively. The latest issue was launched in November 2007. IMCEDI is owned by holding company CIMD, of which, in turn, two-thirds is owned by financial institutions, among them: ICAP (20%), Cajasol (10.7%), Cajamar (9.1%), BBVA (8.6%), Crédito Agricola (8.1%), Grupo Banco Popular (5.4%), and Cajacírculo (5.4%).

Moody’s

S&P

Fitch

LT senior unsecured

NA

NA

NA

Covered bond rating

Aaa

NR

AAA*

Outlook

NA

NA

NA

-

-

-

-

-

Discontinuity factor Collateral score Note: *Watch Negative. As at 7 June 2010

Risk weighting As Spanish Cédulas Hipotecarias and Cédulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach when looking through the underlying assets.

Strengths

Weaknesses

„

Liquidity facility: IMCEDI’s multi-cédulas transactions benefit from the provision of a liquidity facility provided by the IXIS CIB and HSBC, designed to give additional safety and ensure the timeliness of repayments to investors, thereby reducing the bonds’ default probability. In terms of exchanging debt instruments for liquidity, IMCEDI (in contrast to Spanish plain vanilla covered bond issuers) benefits from direct access to Banco de España.

„

Funding costs: In light of the currently more attractive funding levels when issuing plain-vanilla Cédulas Hipotecarias, several Spanish commercial and savings banks, which previously relied upon IMCEDI’s multi-cédulas structure for their refinancing purposes, have meanwhile started tapping capital markets on their own. As a consequence of this development, the last benchmark issuance of a multi-cédulas by IMCEDI on the primary market dates back to November 2007.

„

Diversification: IMCEDI’s multi-cédulas typically involve up to 10 Spanish commercial and savings banks, thereby offering multicédulas investors credit exposure to the Spanish savings banks sector as a whole. Covered bond investors thus benefit from a potentially higher degree of geographical diversity across Spain than in the case of some plain-vanilla Cédulas Hipotecarias.

„

„

Transaction structure: In order to ensure that deals generate sufficient excess spread to cover the general expenses of the fund, coupons on the multi-cédulas are higher than the joint CH. Payments from individual CH into IMCEDI are due two working days before the payments are due on the multi cédulas to guarantee sufficient time to rectify any potential cash-flow problems.

Non-performing loan ratio: Over the past few months, the nonperforming loan (NPL) ratio of Spanish commercial and savings banks has steadily increased, with the sector’s average standing at 5.1% at the time of writing. In light of the economic situation in Spain, we believe that the NPL ratios of some of the savings banks involved could be subject to further increases, particularly given their exposure to mortgage lending and lending to property developers, where the respective NPL ratios had reached 9.6% at the time of writing.

„

Consolidation pressures: In our view, the ongoing consolidation among Spanish banks, which is likely to result in larger institutions with higher refinancing needs and direct capital market access, could trigger more banks tapping the capital markets on their own. As IMCEDI’s multi-cédulas transactions involve up to a dozen different smaller and medium-sized Spanish banks, the sector’s consolidation could result in potential headline risks for IMCEDI.

Note: Of the 13 IMCEDI multi-cédulas outstanding, four deals (CEDGBP) refer to Grupo Banco Popular (POPSM) and its subsidiaries, exclusively. These are the 5.75% CEDGBP June 2010, the 3.75% CEDGBP April 2011, the 4.250% February 2014, and the 4.25% CEDGBP April 2017, and. For detailed information on POPSM, please refer to the respective issuer profile within this section.

Key points for 2010 „

Monitor potential spill-over effects from ongoing consolidation in the Spanish savings bank sector, which might reduce the number of savings banks relying on IMCEDI for refinancing purposes.

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Financials and spreads

Intermoney Titulizacion (IMCEDI)

Multi-Cédulas outstanding Coupon %

ISIN

Maturity

IM Cédulas 1 GBP

4.250

ES0347858005

12 Feb 14

2.000 Banco Popular Espanol

IM Cédulas 2

4.500

ES0347859003

11 Jun 14

1.475 Caja Laboral Popular, Banco de Valencia, Banca March, Caixa Penedés, Banco Espirito Santo

IM Cédulas 3

4.000

ES0347852008 19 Nov 14

1.060 Cajamar, Caja Laboral Popular, Banco de Valencia, Banco Espirito Santo, Caixa Manresa, Caixa Tarragona, La Caja de Canarias

IM Cédulas 4

3.750

ES0347848006 11 Mar 15

2.075 Banco de Valencia, Caja Cantabria, Banco Pastor, Cajamar, Caixa Terrassa, Caja Espana, Cajasol, Caixa Manresa, Ipar Kutxa, La Caja de Canarias

IM Cédulas 5

3.500

ES0347849004

1.250 Caja Laboral Popular, Banca March, Caja Espana, Banco de Valencia, Caixa Terrassa, Sa Nostra, Caixa Girona

IM Cédulas M1

3.500

ES0362859003 02 Dec 15

1.655 Cajamar, Caja Laboral Popular, Caja Murcia, Banco Gallego, Caja Cantabria, Caja Segovia

IM Cédulas 7

4.000

ES0347784003 31 Mar 21

1.250 Caja Laboral Popular, Caja San Fernando, Banca March, Ipar Kutxa, Caixa Terrassa

Cédulas GBP 2

3.750

ES0318821008

12 Apr 11

3.000 Banco Popular Espanol

IM Cédulas 9

4.250

ES0347785000

09 Jun 16

1.275 Cajamar, Caja Laboral Popular, Banca March, La Caja de Canarias, Banco Espirito Santo, Caja Cantabria

IM Cédulas 10

4.500

ES0349045007

21 Feb 22

1.300 Caja Murcia, Banca March, Caixa Manrea, Banco Guipuzcoano, Caja San Fernando, Banco Gallego, Caixa Girona

Issue

15 Jun 20

Volume € bn

Cédulas GBP 3

4.250

ES0318822006

26 Apr 17

2.000 Banco Popular Espanol

Cédulas GBP 4

5.750

ES0316988007

25 Jun 10

1.000 Banco Popular Espanol

IM Cédulas 14

3.250

ES0347462006 31 Mar 15

Involved parties

1.200 Caixa Murcia, Caixanova, Cajastur, Caja Cantabria

Source: Intermoney Titulización, 31 March 2010

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Unicaja (UNICAJ)

Leef H Dierks

Description

Ratings table

% € Index

% £ Index

Total assets

0.029

NA

€34.2bn

Montes de Piedad y Caja de Ahorros de Ronda, Cádiz, Almería, Málaga y Antequera, ie, Unicaja (UNICAJ) is the result of the 1991 merger between five Andalusia-based savings banks: Monte de Piedad y Caja de Ahorros de Ronda, Caja de Ahorros y Monte de Piedad de Cádiz, Monte de Piedad y Caja de Ahorros de Almería, Caja de Ahorros Provincial de Málaga and Caja de Ahorros y Préstamos de Antequera. With total assets of c. €34bn as per year-end 2009, UNICAJ is among the medium-sized Spanish savings banks providing retail banking services through its 902 branch offices. With headquarters in Malaga, UNICAJ’s activity is geared towards the autonomous community of Andalusia, where it claims to be market leader in retail banking. Since late 2009, UNICAJ has been in merger talks with domestic peer CajaSur and Caja Jaen. The potential merger, which has partly been approved already by regulators, would create a new entity (‘UnicajaSur’) with total assets of c. €60bn. Yet, in late May, talks collapsed and CajaSur was seized by Banco de España and has now been put into administration by the FROB.

Moody’s

S&P

LT senior unsecured

Aa3

NR

A+

Covered bond rating

Aaa

NR

NR

Negative

NR

Stable

-

-

-

14.3

-

-

Outlook Discontinuity factor Collateral score

Fitch

Note: As at 7 June 2010

Risk weighting As Spanish Cédulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standardised Approach. They may qualify for lower risk weightings in the IRB Approach.

Strengths

Weaknesses

„

„

Loan-loss provisions: Over the course of 2009, UNICAJ’s loan-loss provision increased 35% y/y to €398mn in 2009, from €294mn a year before. This affected the lender’s net income, which fell by 28% y/y to €205mn in 2009, from €286mn a year before.

„

Dependency on interest income: Given its focus on retail banking, 68% or €756mn of UNICAJ’s operating income (€1.1bn) was accounted for by the lender’s net interest income. Despite developing favourably over the course of the past two years with the net interest margin (NIM) increasing to 228bp in 2009, from 203bp in 2008 and 186bp in 2007, we caution that in light of ongoing consolidation in the Spanish banking market, UNICAJ’s NIM could come under pressure as a result of higher interest rates paid on customer deposits. This, in turn, could possibly have a detrimental impact on UNICAJ’s NIM and thus its profitability.

„

Market consolidation: Following the failure of merger talks between Unicaja, CajaSur and Caja Jaen in late May, pressure to merge its operations with one or more domestic peers is likely to increase in the months ahead.

„

Funding profile: In 2009, UNICAJ’s customer deposit to loan ratio stood at a very high 99%, only marginally down from 100% in 2008, thereby indicating that in principle, all loans granted (€24.0bn in 2009, down 1.8% from €24.4bn in 2008) could be refinanced through deposit taking (€23.8bn in 2009, down 2.5% y/y from €24.4bn in 2008). This leaves UNICAJ’s capital market reliance standing on a relatively low level, with wholesale funding accounting for only 21% of all funding in 2009, albeit sharply up from 14% in 2008. Support mechanism: Like any other Spanish savings banks, UNICAJ benefits from the internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederación Española de Cajas de Ahorros (CECA), which offers technological and advisory services – particularly relevant for smaller savings banks – but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, UNICAJ benefits from the depositor guarantee fund – Fondo de Garantía de Depósitos (FGD) – of Spanish savings banks. In addition to the FGD, cajas benefit from federal support in the form of the FROB, which, if necessary, provides funding for the sector’s consolidation.

Note: At the time of writing, UNICAJ had one EUR-denominated benchmark Cédulas Hipotecarias with a nominal amount of €1bn outstanding.

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Financials and spreads

Unicaja (UNICAJ)

Financial summary € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

10 June 2010

Customer deposits to loans 2007

2008

2009

611 136 82 950 382 567 107 458 358

660 134 157 1,032 395 637 294 338 286

756 126 157 1,102 394 708 398 231 205

32,845 23,964

32,156 24,396

34,185 23,955

120

30 16.1

20.6

20

13.8

100

100.1

97.1

10

99.4

80

0 2007 2008 2009 Customer deposits to loans Wholesale funding in % of total funding

NIM, credit costs and RoAA 3 1.9

2 23,267 3,085 3,216

24,422 3,122 230 2,724

23,815 5,033 1,580 2,908

1.1

1

0.3

0

2007 1.1 11.1 40.3 64.4

0.9 9.6 38.3 64.0

0.6 7.3 35.8 68.6

18.9

46.2

56.1

9.8

10.2 13.2 8.5

8.5

NIM

2.0

2.3

0.9

1.2

0.9

0.6

2008 Credit costs

2009 RoAA

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FRENCH COVERED BOND PROFILES

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Banque Fédérative du Crédit Mutuel (CMCICB) Description

Fritz Engelhard

Ratings table

% € Index

% £ Index

Total assets

0.077

NA

€421bn

Banque Fédérative du Crédit Mutuel (BFCM) is the issuing vehicle for the French regional banking group Crédit Mutuel Centre Est Europe (CMCEE) and Crédit Industriel et Commercial (CIC). CMCEE is itself part of a federation of co-operative banks that form Groupe Crédit Mutuel. CMCEE operates predominantly in France, where it has a strong domestic presence, with a domestic market share of 12% in term of deposits and 18% in terms of loans at YE 09. In July 2007, CMCICB issued its first French common law covered bond. In December 2008, CM Group received a €1.2bn capital injection via super subordinated debt (TSS: “titres super subordonnées”) through the French bank rescue fund (SPPE: “Société de prise de participation de l’État”).

Moody’s

S&P

Fitch

LT senior unsecured

Aa3

A+

AA-

Covered bond rating

Aaa

AAA

AAA

Stable

Stable

Stable

-

-

19.8

6.1

-

-

Outlook Discontinuity factor* Collateral score* Notes: *In %

Risk weighting Currently, CMCICB covered bonds are treated as senior bank debt and thus carry a 20% risk weighting under the RSA approach.

Strengths

Weaknesses

„

Size and support: With total assets of €421bn as of YE 09, Crédit Mutuel Group is an important member of the French banking market. The key role BFCM plays in the activities of CMCEE, which itself is a key part of the Crédit Mutuel Group, means that support would most likely be forthcoming should BFCM require it. The fact that in 2008 the French government included CM Group in its recapitalisation measures for the French banking system highlights that it regards CM Group as systemically relevant.

„

Fallout from financial market crisis: Mid-2008, Crédit Mutuel Group reclassified €18.8bn of assets it held on its trading book and €6.5bn it held in AfS accounts. Among the assets that were re-classified were high-risk exposures, which at YE 09 amounted to €13.1bn (YE 08: €17bn) and included €5.3bn of RMBS, €2.1bn of US RMBS, €1.8bn of CLO/CDO, €1.5bn of other ABS and €2.1bn of leveraged loans. As the market environment in these sectors remains volatile, the group is exposed to potential writeoffs from these exposures.

„

Improved capitalisation and funding profile: Given that CM Group’s main exposure is to low risk residential mortgage and retail banking businesses, we consider its Tier 1 capital ratio of 10.3% (YE 09), which has increased from 8.8% at YE 08, to be reasonably sound. Furthermore, the group managed to increase its deposit base €17.3bn or 20% in FY 09. As growth in customer loans was 3%, the deposit-to-loan ratio increased from 60% at YE 08 to 69% at YE 09.

„

Exposure to cyclical downturn: The group’s total loan book (YE 09: €152bn) suffered from the more challenging economic environment. This is reflected in an increase of NPLs and writedowns. The group’s loan provisions nearly doubled in 2009, and the NPL ratio increased from 2.9% at YE 08 to 4.0% at YE 09. However, further fallout should be mitigated by the bank’s conservative risk appetite and the fact that its core market in France benefits from a high degree of fiscal economic support.

„

Covered bond programme: CM Group’s covered bond programme contributes positively to the liquidity management of the group, as it helps to lengthen the liability structure and also facilitates access to central bank funding. The credit enhancement for the covered bonds, which is expressed as an asset percentage level of 78.9%, has increased from 88.7% at YE 09. Furthermore, the cover pool contains a quite high ratio (Q1 10: 84%) of owner-occupied home loans.

„

Intra-group exposures: Within the covered bond programme, a substantial percentage (58%) of the cover pool assets are secured by a guarantee provided by specialist insurance companies, which are partly owned by CM Group (CMH: ‘Cautionnement Mutuel de l’Habitat). The respective default risk is mitigated by the fact that upon a downgrade of BFCM below A-, the programme foresees that BFCM will pay and maintain the registration cost of the respective mortgages or similar legal privileges, securing the payment of the respective home loans granted by the counterparties belonging to the group.

„

Track the effect of financial market volatility on the group’s bottom-line results.

Key points for 2010 „

Monitor the evolution of the balance sheet and the level of provisioning.

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Financials and spreads

Banque Fédérative du Crédit Mutuel (CMCICB) Net interest margin, credit costs and RoA

Financial summary – YE Dec € mn 2006 Income statement summary Net interest income 662 Net fees & com's 1,214 Trading income 2,616 Operating income 5,557 Operating expenses 3,002 Pr e-provision income 2,555 Loan loss provisions 90 Pr e-tax profit 2,606 Net income 1,642 Balance sheet summary Total ass ets 339,025 Customer loans 99,963 of which Mortgages 39,954 Customer deposits 61,080 Debt funding 79,166 of which covered bonds 0 Total equity 8,394 Profitability (%) Return on assets 0.48 Return on equity 22.0 Cos t/Income r atio 54.0 Net int inc/Op inc 11.9 Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Pr ob loans/Gr loans Cover age ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

2007

2008

2009

97 1,475 2,768 5,387 3,085 2,302 128 2,253 1,464

1,559 1,490 117 3,902 3,154 748 1,016 -167 29

4,502 2,115 7,497 4,448 3,049 1,892 1,504 808

395,910 121,660 49,682 69,980 106,518 4,500 9,492

425,223 147,689 55,006 88,306 109,430 14,155 11,475

420,516 152,072 56,408 105,649 94,788 14,155 15,171

0.37 16.4 57.3 1.8

0.01 0.3 80.8 40.0

0.19 6.1 59.3 60.1

3.5 0.37 1.28 28.8

5.6 0.52 1.76 29.3

135.8 0.56 2.87 19.7

62.1 0.73 3.97 18.3

9.2 11.8 2.5

8.8 10.8 2.4

8.8 9.0 2.7

10.3 10.0 3.6

Asset quality 29

29

4.0

20

3

18

2.9

2 1

1.3

2006

2007 NIM

2008 Credit costs

2009 RoA

Efficiency 90% 70%

2.0%

81% 54%

57%

0.9%

0.8%

59%

1.5%

50% 30% 10%

1.0%

1.1% 0.7%

0.5%

-10%

0.0% 2006 2007 2008 Cost/Avg assets (RS)

2009 Cost/Income

Customer deposits to loans 120% 100% 80% 60% 40% 20% 0%

80% 75%

61

58

60

69

2006

2007

2008

2009

70% 65% 60% 55%

Cust deposits/Loans (LS) Wholesale funding/Tot. funding

Capital ratios (%)

5 4

1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0%

1.8

0 2006 2007 Prob loans/Gr loans

2008

30 25 20 15 10 5 0

2009 Coverage ratio (RS)

CMCICB CB: Breakdown by loan type, Q1 10

14 12 10

11.8 10.8 9.2

8.8

10.0 10.3

9.0 8.8

8 6 2006

2007 2008 Capital adequacy (%)

2009 Tier 1 ratio

CMCICB CB: Breakdown by security type, Q1 10

Buy to let 14% Owener Occupied 83%

10 June 2010

Second Home 3%

Mortgages 42%

Guaranteed exposures 58%

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BNP Paribas (BNP)

Fritz Engelhard

Description

Ratings table

% € Index

% £ Index

Total assets

0.223

NA

€2,058bn

BNP Paribas (BNP) is a large, well-diversified international banking group organised around three business lines: Retail Banking; Corporate and Investment Banking (CIB) and Investment Solutions (Private Banking, Asset Management, Securities Services, Insurance). BNP operates in more than 80 countries, although France, Italy, Belgium and Luxembourg, its core markets, remain most important, with 53% of total commitments as of YE 09. The US and Asia/Pacific represent about 20% of credit risk exposures, while western European countries make up 17%. In 2006, BNP acquired BNL, the seventh-largest bank in Italy. Following shareholder approval in Q2 09, BNP acquired the Fortis activities in Belgium and Luxembourg. With regards to covered bond funding, in November 2006, BNP introduced the first French common law covered bond programme (BNPPCB), and in February 2009, it started its Obligations Foncières programme with issuance via BNP Paribas Public Sector SCF (BNPSCF).

Moody’s

S&P

Fitch

LT senior unsecured

Aa2

AA

AA

Covered bond rating*

Aaa/Aaa

AAA/AAA

AAA/AAA

Stable

Negative

Negative

-

-

20.3/11.8

6.4/8.1

-

-

Outlook Discontinuity factor*/** Collateral score** Note: *BNP PCB/SC F, **In %

Risk weighting Currently, BNPPCB covered bonds are treated as senior bank debt and thus carry a 20% risk weighting under the RSA approach. The bank’s Obligation Foncières carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.

Strengths

Weaknesses

„

Recovery of bottom-line performance: Following a 61% drop in net income in FY 08, the bank’s FY 09 bottom-line performance increased by 93% and reached €5.8bn. This was largely due to the increase in the bank’s revenues from retail banking operations as well as the recovery of its CIB businesses.

„

„

Strengthened capitalisation: The bank improved its solvency position through both the control of risk-weighted assets and the increase of Tier 1 equity. The impact of the €166bn increase in risk-weighted assets from the Fortis acquisition in H1 09, was compensated through €73bn of reductions, which mainly came from reductions in capital market risk positions (-€68bn). Tier 1 capital increased by 51%, from €41.8bn at YE 08, to €62.9bn at YE 09, mainly through an increase in core Tier 1 capital (+€20.6bn). Organic capital generation contributed €4.6bn to this increase, highlighting the bank’s good internal capital generation capacity.

Exposure to cyclical downturn: The global economic downturn led to decreasing corporate earnings and rising unemployment. This has left its mark on BNP’s substantial customer financing activities (YE 09: €670bn). The bank’s NPL ratio increased from 3.7% at YE 08 to 5.1% at YE 09. The cost of risk in BNP’s CIB financing business increased from €355mn in FY 08, to €1.4bn in FY 09. However, further fallout should be mitigated somewhat by the bank’s conservative risk appetite, a high degree of sector diversification and the fact that core markets in France, Belgium and Italy benefit from a high degree of fiscal economic support.

„

Event risk: The acquisitions of BNL in 2006 and Fortis in 2009 underline BNP’s ambitions to continue expanding internationally. This generates an element of event risk, which, at best, in our view, is likely to be credit neutral.

„

Competition: The French banking market is characterised by fierce competition. Following the merger of Credit Agricole and Lyonnais and, more recently, the merger between Group Caisse d’Épargne and Groupe Banque Populaire, competitive pressure, particularly in French retail banking, is rising.

„

Changes to the cover pool composition: Between the inception of the common law covered bond programme in November 2006 and February 2010, the latest available reporting date, the share of buy-to-let home loans increased from 12.7% to 15.9%. Over the same period, the weighted average indexed LTV increased from 58% to 64%. The change in these risk factors not only mirrors the development of existing cover assets over time, but also reflects that the composition of the cover pool can be influenced by portfolio additions from BNP. However, larger shifts in the risk profile of the pool are limited through the bank’s strategic commitment to the covered bond programme, transparent reporting and rating agency surveillance.

„

Track the development of cover pool assets.

„

„

Diversity and size: BNP is one of Europe’s largest banking companies. Following the acquisition of Fortis’ activities in Belgium and Luxembourg, it has a €605bn (YE 09) deposit base (YE 08: €414bn) – the largest in the eurozone. In addition, through its US subsidiary, BancWest, BNP is the fourth-largest bank in California. The contribution of the more volatile trading income to the group’s operating income stood at a low 14% in FY 09. This compares with an average of 31% between 2001 and 2007. Asset management: With the acquisition of Fortis, BNP further strengthened its asset management activities in France and the rest of Europe. As of YE 09, the group had €588bn assets under management and ranks among the top 10 asset managers in Europe.

Key points for 2010 „

Monitor the evolution of the balance sheet and the level of provisioning.

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Financials and spreads Financial summary € mn 2006 2007 2008 2009 Income statement summary Net interest income 9,124 9,708 13,498 21,021 Net fees & com's 6,104 6,322 5,859 7,467 Trading income 8,940 10,350 3,157 5,649 27,943 31,037 27,376 39,319 Operating income Operating expenses 16,137 17,773 17,324 21,958 Pr e-provision income 11,806 13,264 10,052 17,361 Loan loss provisions 810 1,472 3,783 7,818 Pr e-tax profit 10,570 11,058 3,924 9,000 Net income 7,308 7,822 3,021 5,832 Balance sheet summary Total ass ets 1,440,343 1,694,454 2,075,551 2,057,698 Customer loans 393,133 445,103 494,401 678,766 of which Mortgages na na na na Customer deposits 298,652 346,704 413,955 604,903 Debt funding 139,519 159,697 175,831 239,238 of which covered bonds 0 11,000 12,700 19,533 Total equity 44,487 50,527 54,758 68,326 Profitability (%) Return on assets 0.54 0.50 0.16 0.28 Return on equity 17.2 16.5 5.7 9.5 Cos t/Income r atio 57.7 57.3 63.3 55.8 Net int inc/Op inc 32.7 31.3 49.3 53.5 Asset quality (%) LLPs/Pre-prov inc 6.9 11.1 37.6 45.0 LLRs/Gross loans 3.43 2.81 2.91 3.79 Pr ob loans/Gr loans 3.23 2.87 3.65 5.08 Cover age ratio 106.3 98.0 79.8 74.5 Capital adequacy (%) Tier 1 ratio 7.4 7.4 7.8 10.0 Total capital ratio 10.5 10.5 11.1 14.1 Equity/Assets ratio 3.1 3.0 2.6 3.3

BNPSCF programme: Asset coverage 3.0 2.5 2.0 1.5 1.0 0.5 0.0

€bn

BNP Paribas (BNP) Net interest margin, credit cost and return on equity 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0%

0.68%

0.68%

0.62%

0.54%

0.52% 0.05%

0.06%

2005 NIM

2006

0.38%

0.50%

0.20%

0.09%

0.16%

2007 Credit costs

2008

0.28% 2009

RoA

Customer loans to deposits 160%

47%

49%

49%

47%

50%

43%

120%

45%

80% 40%

40% 82%

76%

89%

84%

78%

35%

0%

30% 2005

2006 2007 2008 2009 Cust deposits/Loans (LS) Wholesale funding/Tot. Funding (RS)

Capital ratios (%) 14.1

16 14 12 10

11.0

10.5

10.5

11.1

7.6

7.4

7.4

7.8

10.0

8 6 2005

2006 Tier 1 ratio

2007

2008 2009 Total capital ratio

Asset quality 10% 8%

106%

98%

82%

80%

74%

6% 4% 2%

4.1%

5.1% 3.2%

2.9%

2006

2007

0% 2005

Mar-09 Aug-09 Dec-09 Feb-10 Cover Assets Outstanding Covered Bonds

BNPPCB programme: Asset coverage 25 20 15 10 5 0

1.02% 0.72%

€bn

Feb-07

10 June 2010

Jun-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aggregate CB outstanding principal amount Adjusted Aggregated Asset Amount

Prob loans/Gr loans (LS)

3.7% 2008

120% 100% 80% 60% 40% 20% 0%

2009

Coverage ratio (RS)

BNPPCB programme: Share of buy-to-let and WA LTV 18%

66%

16%

62%

14%

58%

12%

54%

10% 50% Feb-07 Jun-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 % buy-to-let (LS) Weighted average indexed LTV (RS)

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BPCE Group (BPCOV / CDEE)

Fritz Engelhard

Description

Ratings table

% € Index

% £ Index

Total assets

NA

NA

€1,029bn

BPCE Group was formed in mid-2009 through the merger between Groupe Banques Populaires (GBP) and Group Caisse d’Épargne (GCE). Its ambition is to provide “a full range” of services to “all types of customers”. Through GBP it has a nationwide presence via 20 regional Banques Populaires with a total of 6.5mn personal customers and leading market shares among SMEs. Through GCE, it has a countrywide presence via 17 regional savings banks with a focus on retail and commercial banking. Furthermore, it owns a number of specialised entities through which it provides corporate and investment banking (CIB) services and real estate financing. In 2008, prior to their merger, GBP and GCE have set up individual French common law covered bond programmes. The respective issuing entities were named Banques Populaires Covered Bonds (BPCOV) and GCE Covered Bonds (CDEE) and continue to operate as separate funding units. Via Caisses d’Epargne Participations, BPCE, also owns Credit Foncier de France and thus it is also the final owner of Compagnie de Financement Foncier (CFF), the largest French covered bond issuer.

Moody’s

S&P

Fitch

LT senior unsecured

Aa3

A+

NR

Covered bond rating

Aaa

AAA

NR

Stable

Stable

-

-

-

-

7.4

-

-

Outlook Discontinuity factor* Collateral score* Notes: *In %

Risk weighting Currently, BPCOV and CDEE covered bonds are treated as senior bank debt and thus carry a 20% risk weighting under the RSA approach.

Strengths

Weaknesses

„

Size and support: With total assets of €1,029bn as of YE 09, BPCE is an important player in the French banking market, with a strong local presence across the country and a group-wide €368bn deposit base. This means that it benefits from a strong element of systemic support. The fact that the French government included BPCE in its recapitalisation measures for the French banking system highlights that the government regards the group as systemically relevant. Furthermore, we note that the group is headed by a former government official.

„

„

Restructuring and capitalisation: BPCE SA is the central holding entity of the group. It is in charge of strategic decision making, risk policy and treasury operations, including wholesale funding. The three-year strategic project ‘Ensemble’ (‘Together’), includes the concentration on bank insurance businesses, the realisation of synergies from the merger (cost: €1bn pa; revenues: €0.8bn pa) and the simplification of the group structure. The group’s capitalisation was strengthened in the course of 2009. While the group’s former central bodies, Banque Fédérale des Banques Populaires (BFBP) and Caisse Nationale des Caisses d'Epargne (CNCE) had a Tier 1 ratio of 6.4% and 8.1%, respectively, at YE 08, BPCE had a Tier 1 ratio of 9.1% at YE 09.

Fall-out from financial market crisis: In FY 09, BPCE reported a net pre-tax loss of €368mn, following a pro-forma pre-tax loss of €3.7bn. While pre-tax income from the group’s core banking and insurance businesses increased by €1.5bn, pre-tax income from CIB and specialised services decreased by €1.1bn and results from the workout portfolio together with other operations burdened FY 09 group pre-tax results with a €3.0bn loss, following a €6.4bn loss in FY 08. The group remains exposed to a total of €24.2bn of “sensitive” risk positions, which include €8.2bn of leveraged loans, €7.4bn of RMBS, €6.1bn of CDO and a €1.4bn monoline exposure. As the situation in financial markets remains volatile, the new group remains exposed to further fallout.

„

Exposure to cyclical downturn: The global economic downturn has led to decreasing corporate earnings and rising unemployment. This exposes BPCE’s loan book, which amounted to €517bn as of YE 09, to an increase in NPLs and write-downs. However, the total fallout should be mitigated by the conservative risk management of the group’s loan business and the fact that its core market in France benefits from a high degree of fiscal economic support. This is also reflected by the fact that the combined NPL ratio of the GBP and GCE networks so far increased only slightly from 2.9% at YE 08, to 3.3% at YE 09.

„

Intra-group exposures: Within both covered bond programmes, a substantial percentage (BPCOV: 55%; CDEE: 65%) of cover pool assets are secured by a guarantee provided by specialist insurance companies, which also belong to the group. The respective default risk is mitigated by the fact that upon a downgrade of the sponsor bank below A- the programme foresees that the sponsor bank will pay and maintain the registration cost of the mortgages or similar legal privileges, securing the payment of the respective home loans granted by the counterparties belonging to the group.

„

Track the development of the group’s structured credit exposures and their impact on bottom-line earnings.

„

Covered bond programmes: The BPCOV and CDEE covered bond programmes contribute positively to the liquidity management of the group, as they help to lengthen the liability structure and also facilitate access to central bank funding. As of January 2010, both cover pools were characterised by a benign weighted average indexed LTV (BPCOV: 62%; CDEE: 60%) and a quite high ratio of owner-occupied home loans (BPCOV: 90%; CDEE: 94%).

Key points for 2010 „

Monitor the restructuring of the group and its impact on funding activities and profitability.

10 June 2010

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Financials and spreads

BPCE Group (BPCOV / CDEE)

Financial summary – YE Dec € mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which Mortgages Customer deposits Debt funding of which covered bonds* Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio

Pre-tax profit by business line 2008

2009

na na na 16,096 16,337 -241 3,146 -3,740 -1,847

na na na 21,227 16,359 4,868 4,145 -368 537

1,143,679 512,363 na 371,053 229,856 113,840 31,514

1,028,802 517,440 na 367,717 219,391 115,412 43,988

na na 101.5 na

0.05 1.4 77.1 na