18.06.2012

By Simon Miller

Spanish banks chase for collateral to pledge to the European Central Bank (ECB) has damaged the over-collateralisation enjoyed by covered bondholders, Moody's has warned.

In it's weekly credit outlook, the ratings agency said that as of 13 June the issuance of more than €16bn (£12.9th) of covered bonds to meet requirements for ECB funding had created a credit negative by diminishing the over-collateralisation enjoyed by covered bondholders as it dilutes their protection.

It wrote: "As opposed to securitisations, covered bonds are on-balance sheet debt instruments that a dynamic cover pool backs. If the cover pool does not grow, but issuance increases, covered bonds' over-collateralisation decreases, because more covered bondholders have the sMe rights against the same cover assets."

In addition, the decline in Spanish mortgage lending will further reduce the over-collateralisation, said Moody's.

The rating agency cited Caixabank which has issued a record €11bn mortgage covered bonds. According to Moody's, this has resulted in a decline of more than one-third of the ove-collateralisation of it's covered bondholders, which dropped the protection for each euro to bond to €1.8 of mortgage loans from €2.25.

The drastic decline in mortgage lending will also reduce over-collateralisation because "new mortgage lending will be insufficient to replenish the loan redemptions and write-offs of defaulted loans in a covered pool".

"As a result, fewer cover assets will back an increasing volume of outstanding covered bonds. Our estimate for the next 18 months suggests an average 30% decline of over-collateralisation," Moody's added.