FINANCIAL INSTITUTIONS a Research Publication by DZ BANK AG

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FINANCIAL INSTITUTIONS A Research Publication by DZ BANK AG

EU Commission’s finalised LCR rules BONDS spring no surprises

Flash » The EU Commission has published a delegated act setting out the details of 21 Oct 2014 how the liquidity coverage requirement (LCR) ratio is to be calculated. Alt-

hough the detailed LCR ratio is based on the liquidity ratio defined in the Basel 3 framework, the EU Commission took the view that the Basel standard could not be implemented in Europe without being adapted to the specificities of the

EU.

Greater recognition is to be given to certain covered bonds which emerged » from the technical analysis carried out by the European Banking Authority (EBA) as excellent performers in terms of liquidity and credit rating. This greater recognition will be subject to a number of conditions. Thus covered bonds

with ECAI 1 ratings may account for up to 70% of the liquidity buffer and have a 7% haircut applied to their value, while ECAI 2-rated covered bonds may make up a maximum 40% of the liquidity buffer and take a 15% haircut. Now on Bloomberg: DZBR

» With regard to ABS the EU Commission is proposing to permit a broader range of securitised assets rather than just residential mortgage-backed securities (RMBS). The limit of 15% of banks' liquidity buffer for Level 2B assets may also include a number of other types of ABS, such as auto ABS, which the Commission believes have demonstrated adequate liquidity. A couple of smaller ABS classes with a solid liquidity and credit quality history, which play an important role in financing loans to SMEs and consumers – i.e. securitisations backed by consumer credit assets and loans to SMEs – will also be permitted.

» The introduction of the binding minimum LCR ratio of 60% from 1 October 2015 is unlikely to have a huge impact on demand for the different asset categories, as the banks have already significantly boosted their LCR ratios in recent years. However, there could be switches within the current liquidity portfolio that could lead to shifts in demand for individual asset classes. In addition, Authors: the rating sensitivity of covered bonds could increase around the rating thresh- Dr. Abdoulaye Aboubakar, ANALYST old of AA- / A+ in future. Thorsten Euler, ANALYST Ann-Kristin Möglich, ANALYST Oliver Piquardt, ANALYST

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FINALISED LIQUIDITY COVERAGE REQUIREMENT (LCR) RULES

The EU Commission has published a delegated act setting out the details of how the Detailed LCR ratio liquidity coverage requirement (LCR) ratio is to be calculated. The detailed LCR ratio is based on the liquidity ratio defined in the Basel 3 framework, according to which banks must have sufficient high-quality liquid assets (HQLA) in their liquidity buffer to cover the difference between the expected cash outflows and the expected capped cash inflows over a 30-day stressed period. However, the EU Commission took the view that the Basel standard could not be implemented in Europe without being adapted to the specificities of the EU.

One reason for this is the fact that the Basel agreement was designed for implemen- Deviation from Basel standard to tation by a small number of internationally active financial institutions, whereas the take account of EU specificities EU will apply the LCR to all 8,000 EU banks. A second is that the Basel 3 liquidity coverage standard applies only at the consolidated level, while the EU will apply the LCR ratio at both individual institutional and consolidated levels. Thirdly, the Basel 3 definition of eligible assets is confined to a group of assets (notably government bonds, cash positions and risk exposures to central banks) deemed to be highly liquid in all BCBS jurisdictions and hence eligible for inclusion in the liquidity buffer without upper limit or haircut. However, this fails to give adequate recognition to certain specific assets which might demonstrate higher liquidity in some of those jurisdictions than is assumed in the Basel agreement. These assets need to be accorded greater eligibility as HQLA than is currently envisaged in the Basel agreement. In the European Union the liquidity and/or rating performance of certain asset classes (notably top-quality covered bonds and asset-backed securitisations backed by auto loans) has been equal or even superior to that of the asset classes defined as eligible under Basel 3.

Against this backdrop the EU Commission has proposed the following changes with Adjustments for covered bonds and regard to covered bonds and ABS: ABS

» Greater recognition is to be given to certain covered bonds which emerged from Eligibility criteria for covered bonds the technical analysis carried out by the European Banking Authority (EBA) as to be loosened excellent performers in terms of liquidity and credit rating. This greater recognition will be subject to a number of conditions (aggregated upper limit, haircuts, diversification requirements). Thus covered bonds with ECAI 1 ratings may account for up to 70% of the liquidity buffer and have a 7% haircut applied to their value, while ECAI 2-rated covered bonds may make up a maximum 40% of the liquidity buffer and take a 15% haircut (for details, see the “LCR criteria for covered bonds” section below).

» With regard to asset-backed securities the EU Commission proposes the inclu- Broader pool of eligible ABS sion of a broader range of securitisations rather than just residential mortgage- backed securities (RMBS). Under the 15% liquidity buffer cap applicable to Lev- el 2B assets the plan is to allow certain other ABS types, such as auto ABS, which have demonstrated high levels of liquidity. In addition, recognition should also be given to a number of smaller ABS categories that likewise display strong liquidity and rating performance and play an important role in financing lending to SMEs and consumers, namely securitisations backed by consumer credit assets and by loans to SMEs. The EU Commission takes the view that these in-

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struments are compatible with the overarching supervisory objective of ensuring adequate liquidity coverage, while their recognition would avoid the unintended effect of not including them, i.e. a decrease in present and future demand for these instruments with adverse consequences for the financing of the underlying activities of SMEs and consumers (see the “LCR criteria for securitisations” section below).

» Finally, the EU Commission’s LCR rules introduce a number of other important Centrally managed liquidity in net- specifications. For example, the delegated act clarifies the treatment of the cen- works of cooperatives trally managed liquidity of networks of cooperatives and banks participating in institutional protection schemes not covered by the international standard. Ac- cording to the EU Commission, these types of credit institutions would otherwise face considerable uncertainty or substantial difficulties. The proposed rules likewise clarify the treatment of specialist intermediaries in areas such as leasing and factoring which play an important role in the financing of companies, and especially SMEs, in the real economy.

Accordingly, the LCR is as follows:

High-quality liquid assets (HQLA) LCR= > 100% Net cash outflows – Capped net cash inflows

The delegated act lays down the requirements that determine which assets are eligible as HQLA and how the expected cash outflows and inflows are to be calculated in stressed conditions.

Liquid assets The LCR rules define liquid assets as various categories of assets that must gener- Valuation of liquid assets ally have high or extremely high liquidity and credit quality. Depending on their quality and liquidity, these assets are factored into the calculation of the numerator of the LCR formula at their market value minus a possible discount (haircut). To be eligible as liquid, assets must » be unencumbered or readily retrievable from a collateral pool,

» originate from an issuer outside the banking group,

» have a market price or a price that can be calculated using a simple formula on the basis of publicly available information rather than strong assump- tions,

» be recognised as eligible collateral for the normal monetary policy operations of a central bank in a member state or a third country (where cash outflows in that country are to be covered),

» be listed on a recognised exchange or realisable by outright sale or a straightforward repurchase (repo) contract on recognised repo markets.

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ASSETS ELIGIBLE AS HQLA

Haircut on Assets Cap market value

Level 1 assets minimum 60% Cash deposits no cap 0% Central bank deposits no cap 0% Bonds issued by public sector entities no cap 0% Securities issued by state-guaranteed banks or development 0% no cap banks Bonds issued by multilateral development banks no cap 0% Covered bonds with ECAI 1 rating maximum 70% 7% Level 2 assets maximum 40% Level 2A assets maximum 40% Bonds issued by public sector entities in a member state (risk maximum 40% 15% weight 20%) Bonds issued by public sector entities in a third country (risk maximum 40% 15% weight 20%) Covered bonds with ECAI 2 rating maximum 40% 15% Other covered bonds maximum 40% 15% Other corporate bonds maximum 40% 15%

Level 2B assets maximum 15%

RMBS maximum 15% 25% Auto ABS maximum 15% 25% SME ABS maximum 15% 35% Consumer loan ABS maximum 15% 35% Certain corporate bonds maximum 15% 50% Certain shares and equity interests maximum 15% 50% Central bank funding commitments subject to restrictions maximum 15% 25% Unrated high-quality covered bonds maximum 15% 30% Certain non-interest-bearing assets maximum 15% 50% Certain deposits with cooperative central institutions maximum 15% 25%

Source: EU Commission

Eligible HQLA are divided into three categories:

1) Level 1 assets Level 1 assets are the most liquid of all. They may be used without limit in the liquidity buffer and are not subject to a haircut on their market value. They include cash, deposits at the central bank and certain covered bonds, although the last of these are subject to a 70% cap in the liquidity buffer and a 7% haircut.

2) Level 2A assets These may account for up to 40% of the liquidity buffer and are subject to a minimum 15% haircut. They include third-country government bonds and bonds issued by public entities with a 20% risk weight, EU covered bonds with an ECAI 2 rating and non-EU covered bonds rated ECAI 1.

3) Level 2B assets These may account for a maximum of 15% of the liquidity buffer and are subject to a minimum haircut varying between 25% and 50%. They include RMBS, auto ABS,

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SME ABS, consumer loan ABS, corporate bonds rated at least ECAI 3, shares that are part of a major stock index and certain other high-quality covered bonds.

The composition of the liquidity buffer is to meet the following requirements at all times:

a) At least 60% of the liquidity buffer must consist of Level 1 assets.

b) At least 30% of the liquidity buffer must consist of Level 1 assets other than extremely high-quality covered bonds.

c) No more than 15% of the liquidity buffer may be made up of Level 2B assets.

The delegated act contains detailed definitions not only of HQLA but also of the cash outflows and inflows used to calculate the LCR. The main points of divergence between the EU Commission proposals and the EU Capital Requirements Regulation (CRR) are described below.

Net cash outflows Net cash outflows are calculated by multiplying the outstanding totals for the various Calculating net cash outflows categories or kinds of balance sheet liabilities and off-balance sheet commitments by the expected percentage outflow rate.

As in the CRR the basic outflow rate is set at 5% for stable retail deposits covered Different rate envisaged for retail cli- by deposit guarantee schemes and at 10% for those not covered by deposit guaran- ent deposits from 2019 onwards tee. However, unlike in the CRR, from 2019 onwards a lower outflow rate of 3% is envisaged for retail deposits subject to request by the member state and approval by the EU Commission.

On the other hand, other retail deposits may be subject to higher outflows. Whereas the CRR envisaged that these outflows would be determined on the basis of the EBA guidelines, the proposed delegated act sets out clear rules of its own. Based on a simplified set of criteria modelled closely on the EBA guidelines and including criteria such as volume, remuneration, depositor residence / deposit currency and distribution channel (Internet), deposits of this kind must be divided by the banks into two risk brackets: one with an outflow of 10% to 15%, the other with an outflow of 15% to 20%.

A new feature is that the competent authority can permit the outflow to be calculated on a net basis if accompanied by an inflow that clearly meets certain defined criteria.

As under the CRR, a reduced outflow rate is foreseen for operational deposits. Clear criteria based on EBA recommendations have been defined for “other” operational deposits. If the deposits held with the central institution of a cooperative network or an institutional protection scheme (IPS) are treated as liquid assets, no additional liquidity is created by requiring a corresponding reduction in the central institution’s liquid assets if the part treated as Level 1 assets for the depositing institution exceeds 60%.

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Special consideration has been given to the activities of cooperative banks and a more favourable outflow rate will apply to deposits with such institutions.

The competent authorities may allow a more favourable treatment of outflows from institutions within the same banking group or institutional protection scheme, providing certain criteria (corresponding in essence to the EBA recommendations) are fulfilled.

Additional outflows are prescribed for derivatives, based on the EBA’s regulatory technical standard.

For the sake of legal certainty the delegated act provides a formal definition of credit and liquidity facilities. It also includes specific outflow rates for insurance companies, private investment firms and trusts.

Cash inflows As in the CRR, a feature specific to the EU is that a 20% inflow rate must be applied to assets that do not have a defined contractual deadline.

Under the EU Commission’s proposals certain inflows may be excluded entirely Narrower definition of certain in- while other inflows are subject to a 90% inflow rate. The inflows eligible for this flows treatment are generally more narrowly defined than in the CRR. On the whole the treatment applied to certain inflows (e.g. for specialised credit institutions engaged in leasing and factoring) is not entirely in line with the Basel standards.

The competent authorities may allow a more favourable treatment for inflows arising More favourable treatment for intra- from undrawn credit and liquidity facilities within a group or an institutional protection group inflows scheme, providing certain criteria – which correspond in essence to the EBA recommendations – are fulfilled. However, if this preferential rate exceeds the default rate of 40%, the approval of the competent authority is required and, to avoid the loss of liquidity in an internal market context, the inflow and outflow rates are sym- metrical.

Timetable for introducing the LCR The delegated act in its present form was originally scheduled to be adopted by 30 Delays owing to technical complexi- July 2014 so that it could enter into force at the end of December 2014. However, ty the technical complexity of the issues involved has resulted in delays. The EU Commission has pointed out that it has the power to enact the LCR delegated act for an unlimited period from 31 December 2014 onwards. The delegated act is subject to review by the European Parliament and the Council. The Commission will remain authorised to review the delegated act for an unlimited period. It will make use of this power in order to update the wording of the act in line with changes in market conditions and to monitor which other assets might be sufficiently liquid for inclusion in a bank’s liquidity buffer and which assets ought no longer to be included.

The timetable for introducing the LCR is essentially the same as in the CRR. The de- Timetable remains essentially un- tailed LCR ratio will be introduced in stages, rising from 60% in 2015 to 100% by changed 2018, one year earlier than required by the Basel standard. The CRR envisages en- try into force in 2015. Given the possibility of a six-month veto period for the legislat- ing bodies and the need to allow the sector some time to make preparations, the

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plan is for the LCR to enter into force on 1 October 2015. Pursuant to Art. 412 (5) CRR, however, individual countries may require their banks to have an LCR ratio of 100% even before 2018.

LCR TO BE ALREADY FULLY IMPLEMENTED BY JANUARY 2018

PHASED INTRODUCTION

100%

80% 70% 60%

1-Oct-15 1-Jan-16 1-Jan-17 1-Jan-18

Source: EU Commission, DZ BANK Research

LCR CRITERIA FOR COVERED BONDS

The final LCR rules for covered bonds proposed by the EU Commission generally EU Commission allows some cov- spring no surprises compared with the draft versions that have repeatedly leaked out ered bonds to count as Level 1 as- in recent weeks. On the whole, we think they can be seen as positive for issuers and sets investors. The Commission’s decision – against the practice of the Basel Committee and the recommendation of the EBA – to recognise certain covered bonds as merit- ing inclusion not only as Level 2A assets but also as Level 1 is likely to come as a particular relief for some investors. The only point on which the LCR delegated act comes as a slight surprise compared with the earlier drafts is the inclusion in the Level 2B asset category of certain covered bonds with ratings lower than A- or with no ratings at all. The LCR eligibility requirements for covered bank bonds (Level 1, Level 2A or Level 2B) are summarised in the table below. As well as issues from the European Union (EU), covered bonds from third countries may also be eligible as Level 2A Assets.

For the covered bonds of issuers domiciled outside the EU to qualify as Level 1, UCITS-conformity is a minimum re- Level 2A or Level 2B assets, they must by way of legal basis comply at least with the quirement general requirements laid down in Art. 52 para. 4 UCITS Directive, notably those concerning special public supervision of the issuer and the need for creditors’ claims to be secured by a cover pool. Alternatively, covered bonds for which preferential capital requirements apply under Art. 129 para. 4 and para. 5 CRR are also admis- sible. However, since these must in any case satisfy the aforementioned UCITS requirements as well, Art. 52 para. 4 UCITS Directive is to all intents and purposes the minimum requirement.

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SUMMARY OF LCR CRITERIA FOR COVERED BONDS

Level 1 Level 2A Level 2B

Issuer domiciled in the EU Issuer domiciled in the EU Issuer domiciled outside the EU Issuer domiciled in the EU

A) Art. 52 para. 4 UCITS directive The national covered bond legislation must stipulate that - the covered bonds are issued by a bank or its wholly owned or subsidiary, Art. 129 para. 4 or 5 CRR are - the covered bonds are secured and the covered bond creditors fulfilled enjoy a priority claim against the collateral in the event of the issuer's insolvency. Art. 52 para. 4 UCITS directive Art. 52 para. 4 UCITS directive The cover pool for these B) or or covered bonds may only Legal framework The issuer and the covered bonds are subject to special public contain: supervision for the protection of bond creditors and the Art. 129 para. 4 or 5 CRR are Art. 129 para. 4 or 5 CRR are - bonds issued by public sector monitoring and supervisory regime in the third country is at least fulfilled fulfilled entities, equivalent to that of the European Union. - private mortgage loans, - guaranteed private real estate C) loans from France. The cover pool for these covered bonds may only contain: - bonds issued by public sector entities, All collateral assets must - private and commercial mortgage loans, qualify for a 35% risk weight - ship mortgages. under Art. 125 CRR. Further, Art. 208 and Art. 229 para. 1 CRR must be fulfilled.

minimum AA- minimum A- minimum AA- Covered bond rating no minimum rating (credit quality step 1) (credit quality step 2) (credit quality step 1)

minimum EUR 500 m (or local minimum EUR 250 m (or local minimum EUR 250 m (or local Issue volume no minimum issue volume currency equivalent) currency equivalent) currency equivalent)

minimum 10% (issuer must Overcollateralisation minimum 2% minimum 7%* minimum 7%*** give public confirmation each requirement month)

Investor and issuer fulfil Investor and issuer fulfil Investor fulfills Transparency requirement Investor and issuer fulfil Art. 129 para. 7 CRR Art. 129 para. 7 CRR Art. 129 para. 7 CRR Art. 129 para. 7 CRR****

Claims against banks Claims against banks (minimum rating: AA-) account (minimum rating: AA-) account Claims against banks (minimum rating: AA-) account for max. Other requirement for max. 15% of outstanding g cfor max. 15% of outstanding 15% of outstanding covered bonds** -- covered bonds** covered bonds (Art. 129 para. 1 (c) CRR) (Art. 129 para. 1 (c) CRR) (Art. 129 para. 1 (c) CRR)

Applicable haircut on market minimum 7% minimum 15% minimum 15% minimum 30% value

Maximum proportion of LCR 70% 40% 40% 15% a sse ts

Source: European Commission, DZ BANK Research, EU = European Union; *If the covered bond rating is at least AA- and the issue volume is between EUR 250 m and EUR 500 m, the overcollateralisation requirement is reduced to minimum 2%. **After consultation with the EBA, national supervisory authorities may reduce the minimum rating for banks to A-. ***If the issue volume is EUR 500 m or more (or the local currency equivalent): minimum 2%. ****The issuer must supply the information at least every quarter.

Covered bonds qualifying as Level 1 assets must in addition have an external rating Other requirements for Level 1 and of at least AA- (Level 2A: at least A-) and a minimum issue volume of EUR Level 2A 500 million (Level 2A: at least EUR 250 million). There must also be available overcollateralisation of at least 2% (Level 2A: at least 7% or, if certain conditions are fulfilled, at least 2%). An additional requirement is that, regardless of whether the covered bonds count as Level 1 or Level 2A assets, investors must be supplied with the up-to-date information on the cover pool and the outstanding covered bonds stipulated in Art. 129 para. 7 CRR at least every six months. Claims against banks contained in the cover pool may only account for up to 15% of the volume of outstanding covered bonds, and the issuer banks must have ratings of at least AA-. Only in the case of Level 1 covered bonds can the national supervisory authorities reduce the minimum rating to A- after consultation with the EBA.

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The classification of covered bonds in the Level 1 category has two benefits for Level 1 assets offer two benefits banks. Firstly, the haircut on the market value of the bonds is 7%, less than half the 15% haircut applied to covered bonds qualifying as Level 2A assets. This smaller haircut means that, all other things being equal, fewer covered bonds would be needed to achieve the required minimum volume of HQLA. Secondly, Level 1 covered bonds are allowed to account for up to 70% of the HQLA buffer, whereas the upper limit for Level 2A assets is 40%. Since at least 30% of the total HQLA buffer must be made up of Level 1 assets other than covered bonds, it would not be possible (for example) to have 70% of the buffer consisting of Level 1 covered bonds with the remaining 30% of the required HQLA made up of Level 2 covered bonds.

Unlike in the Basel Committee rules and the EU Commission’s earlier draft pro- Level 2B covered bonds posals, besides Level 1 and Level 2A assets there are also certain covered bonds which are rated worse than A- or do not have any rating at all that will be deemed LCR-eligible as Level 2B assets. The principal conditions attaching to these covered bonds are the higher overcollateralisation requirement of at least 10% (compliance with which must be publicly confirmed by issuers on a monthly basis) and the con- siderably higher 30% haircut on the instruments’ allowable market value. A further condition is that issuers must make the required information on the cover pool available to investors every quarter rather than only every six months. Level 2B covered bonds must not make up more than 15% of the total HQLA buffer.

In addition to covered bonds from EU issuers, banks can also use covered bonds Covered bonds from third countries from third countries for LCR purposes, albeit only as Level 2A assets. A precondition also permitted for this, however, is that the bonds must be subject to rules comparable to the provisions of Art. 52 para. 4 UCITS Directive and the cover pool may only contain certain assets (see “Legal framework” entries in the table above). The permitted types of collateral include bonds issued by public sector entities, residential and commercial mortgage loans and ship mortgages (Art. 129 para. 1 items (b), (d) (i), (f) (i) or (g) CRR). In the case of real estate collateral the property valuation must fulfil criteria set out in Art. 208 CRR (incl. the rule that property values must be reviewed at least every three years, or every year in the case of commercial properties) and Art. 229 CRR (the requirement that property valuations be carried out by independent sur- veyors).

For non-EU covered bonds to be recognised as Level 2A assets they must have an Covered bonds from Australia, Can- agency rating of AA- or better, i.e. three rating notches better than their EU counter- ada and New Zealand should gener- parts. In addition, the information on the covered bond programme stipulated in Art. ally be LCR-eligible… 129 para. 7 CRR must be made available to the investors. Some of these transparency requirements are rather vaguely worded, leaving what we see as a great deal of room for interpretation. Even so, we believe there is cause for concern regarding the content of the investor reports of Australian and New Zealand covered bond issuers (as at August/September 2014) as well as the local statutory transparency requirements for Canadian banks, especially with regard to three pieces of information ... providing additional information is required under Art. 129 para. 7 CRR. Most of the aforementioned issuers fail to give included in the investor reports a summary of the maturity structure of the covered bonds (exception: Westpac Banking Corporation and Westpac New Zealand). Moreover, in most cases information on the associated interest rate and currency risks is provided at best only indirectly. Because the LCR rules will not enter into force until 1 October 2015, issuers from Australia, Canada and New Zealand should have enough time to revise their

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investor reports so as to avoid any risk of their covered bonds being declared LCR- ineligible in Europe.

With regard to the rating requirement it should generally be noted that, as we under- Banks could in theory arrive at dif- stand it, investor classifications may be based only on the ratings given by the rating ferent LCR classifications agencies they designate in line with the CRR. Thus it is theoretically possible for two banks to arrive at two different LCR classifications for one and the same covered bond, if the two banks have designated different rating agencies and those agencies assign different ratings to the programme concerned.

If a bank has designated multiple rating agencies in accordance with the CRR rules Multiple ratings? The second-best is and this means that more than one rating exists for a given covered bond, our opin- the one that counts. ion is that the provisions of Art. 138 para. (e) and (f) CRR apply and the second-best rating for that bond should be used. If only one rating from a designated agency is available, that rating will apply.

The Annex includes a table showing the potential LCR liquidity categories which in The table in the Annex gives our po- our view would apply to the mortgage-backed and public sector covered bond pro- tential LCR classifications grammes we cover solely with reference to the UCITS-compatibility and rating requirements. These potential LCR classifications are all based on the assumption that the investor has designated all four rating agencies and that the second-best rating is the one used for LCR classification purposes. Our classifications are merely indicative, since in addition to UCITS-conformity and the rating requirement other criteria need to be fulfilled for each liquidity class and we have not taken these into consideration.

LCR CRITERIA FOR SECURITISATIONS

After the Basel Committee's discussion paper of January 2013 (BCBS 238) had orig- RMBS, auto ABS, SME ABS and inally only envisaged RMBS that met certain criteria as Level 2B assets, the EU consumer loan ABS eligible for the Commission has now also included high quality securitisations of RMBS, auto ABS, LCR as Level 2B HQLA SME ABS (including certain lease ABS) and consumer loan ABS (including credit card ABS) in its LCR regulations. As Level 2B HQLA, these securitisations can in future account for up to a maximum of 15% of the liquidity buffer, subject to a haircut of between 25% and 35%. The haircut amounts to 25% for RMBS and auto ABS and 35% for SME and consumer loan securitisations. The differences in the haircuts reflect the results of the empirical analyses carried out by the EBA and the Commis- sion into the liquidity levels of the different securitisation asset classes.

The Commission justified its departure from the original Basel definitions and EBA Reasons for expanding the list recommendations regarding the eligibility of securitisation assets for the LCR on the grounds that certain ABS in the EU, including auto securitisations, showed to have high levels of liquidity. Moreover, according to the Commission the addition of further asset classes from the securitisation segment will increase diversification within the banks' liquidity buffer and so reduce the risk of excessive concentration in just one securitisation asset class. The Commission also argues that the market data shows that there is a low correlation between securitisations and other liquid assets and the inclusion of securitisations could therefore help to break the bank-sovereign nexus.

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REQUIREMENTS FOR SECURITISATIONS TO BE ELIGIBLE FOR THE LCR

Requirement Description

Rating requirement for the securitisation at issue and during the term: credit quality step 1 awarded by a nomi- Credit quality nated ECAI (External Credit Assessment Institution) (S&P and Fitch: AAA to AA-; Moody’s: Aaa to Aa3; DBRS: AAA to AAL) Maximum seniority Only the senior tranche or tranches of a transaction are eligible for the LCR The transfer must be enforceable against third parties and the exposures must be beyond the reach of the seller (originator, sponsor or original lender) and its creditors, even in the event of the seller's insolvency "True sale" and absence of severe "claw back"

provisions The transfer of the underlying exposures to the SPV may not be subject to any severe claw-back provisions in the seller's jurisdiction Servicing continuity. At a minimum: default or insolvency of the servicer does not result in the termination of ser- Continuity provisions for the replacement of vicing servicers, derivative partners and liquidity pro-

viders Replacement of derivative counterparties and liquidity providers in the event of their default or insolvency Residential loans: - Loans secured with a first-ranking mortgage and/or fully guaranteed (in accordance with CRR Art. 129 (1 )e) - Average LTV ≤ 80% (Possible to derogate from this limit in the case of mortgage loans only)

Loans, leases and credit facilities granted to companies, particularly SMEs: - Commercial loans, leases and credit facilities granted to undertakings to finance capital expenditures or business operations other than the acquisition or development of commercial real estate, provided that at least 80% of the portfolio at the time of issuance of the securitisation are SMEs

Auto loans and leases - Loans and leases to finance a broad range of vehicles (including ancillary insurance and service products or vehicle components as well as residuals in the case of Homogenous eligible underlying exposures leases) - Loans/leases secured with a first-ranking charge or security over the vehicle or an appropriate guarantee

Consumer loans and credit card receivables: - Loans and credit facilities granted to individuals, families or households for con- sumption purposes

The underlying exposures may not have been originated by the financial institution holding the securitisation in its liquidity buffer, its subsidiaries, parent company or other any company closely linked with the financial institution.

CMBSs and CDOs are not eligible

Resecuritisations and synthetic securitisations are not eligible Derivatives may only be used to hedge currency and interest rate risk Restricted use of derivatives and transferable financial instruments The underlying portfolio may not contain any transferable financial instruments (i.e. CDOs), except for financial instruments issued by the SPV itself (master trust structures) At the time of issuance of the securitisation or when incorporated in the pool of exposures at any time after issuance, the underlying exposures may not include any exposures to credit-impaired borrowers Absence of credit-impaired borrowers

No sub-prime loans At the time of issuance of the securitisation or when incorporated in the pool of exposures at any time after issu- Absence of loans in default in the portfolio ance, the underlying exposures may not include any exposures in default (as defined by Article 178 of EU Regu- lation 575/2013) The repayment of a securitisation position may not have been structured to depend predominantly on the sale of Reliance on the future sale of assets securing the assets securing the underlying exposures. However, this provision is not intended to prevent exposures from the exposures being subsequently rolled over or refinanced In the case of revolving structures the transaction documentation must provide for appropriate early amortisation events including, at a minimum, all of the following: - a deterioration in the credit quality of the underlying exposures - a failure to generate sufficient new underlying exposures of at least similar credit Early amortisation provisions for revolving quality structures - the occurrence of an insolvency-related event involving the originator or servicer

Sufficient protection should be provided for investors by the inclusion of provisions which trigger amortisation of all payments at the occurrence of adverse events such as those listed above.

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Requirement Description

At least one payment at the issuance date At the time of issuance of the securitisation the borrower must have made at least one payment Absence of self-certified loans Securitisations backed by residential loans may not contain any self-certified loans in the portfolio In the case of securitisations where the underlying exposures are residential loans, auto loans and leases or Assessment of retail borrowers' creditworthi- consumer loans and credit facilities, there must be a thorough assessment of the borrowers' creditworthiness (in ness accordance with the Mortgage Credit Directive (Directive 2014/17/EU) or the Consumer Credit Directive (Di- rective 2008/48/EC) or other applicable regulations) Securitisation must meet the transparency requirements of the CRR

From 2017 information regarding structured finance instruments will be published centrally on a website set up by the European Securities and Markets Authority Transparency and disclosure of loan-level data

Where neither the issuer, nor the originator, nor the sponsor of a securitisation is established in the EU, compre- hensive standardised loan-level data must be made available to existing and potential investors on a regular basis Pass-through requirement for non-revolving Cash proceeds from the underlying exposures should flow to investors in a simple and transparent manner. structures Structures with a bullet payment etc. do not comply with this pass-through profile and are therefore excluded Securitisations must be listed on a regulated market/recognised exchange, or admitted to trading on another or- ganised venue with a robust market infrastructure or Listing requirement

Tradeable on generally accepted repo markets Minimum issue size Minimum issue size of EUR 100 million Maximum weighted average time to maturity Weighted average time to maturity ≤ 5 years

Source: European Commission, DZ BANK Research

However, to qualify as assets eligible for the LCR, securitisations first have to meet High quality and liquidity require- certain criteria to qualify as high quality securitisations (the criteria are in large part ments must be met to qualify as identical to those under the Solvency II delegated act of 10 October 2014) and, sec- LCR-eligible assets ond, fulfil certain additional liquidity requirements (cf. Art. 13 of the delegated act on the Liquidity Coverage Requirement). The latter include a minimum issuance size and maximum term. The requirements are set out in the table below. The requirements in black are largely the same as the high quality securitisation requirements in the Solvency II delegated act, whereas the orange requirements represent additional liquidity requirements as defined by the LCR delegated act.

According to the Commission, the decision to include high-quality securitisations in Same objectives as the ECB's AB- the LCR is justified first by their high liquidity and secondly by their ability to play an SPP important part in channelling additional funds to the real economy. The EU Commis- sion's decision is therefore in line with the objectives being pursued by the ECB in its purchase programme for ABS securities (ABSPP), i.e. to boost lending to companies and SMEs in order to strengthen growth and employment. Securitisations are expected to contribute to help easing the financial blockages for SMEs by enabling banks to refinance their exposure to SMEs and so free up room for new lending. And not only SMEs but the real economy in general should benefit from banks freeing up their balance sheets by using securitisations, so enabling them to make new loans.

Discussions about the issue of high-quality securitisations are currently not only go- High quality securitisation criteria ing on in the EU, but also at international level. The BCBS-IOSCO expert group is al- may have to be amended later ready working on global simplicity and transparency standards for securitisations which will then form the basis for appropriate regulatory and prudential frameworks. The delegated acts for LCR and Solvency II are the first acts containing a nuanced approach to securitisations. The criteria for high quality securitisations contained in them are based on the proposals of EIOPA and the EBA's liquidity analysis. Howev-

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er, due to the difference in timing between the EU's delegated acts and the conclu- sions of the BCBS-IOSCO expert group (which are still to be finalised), it is possible that the two sets of criteria may have to be brought into line with each other later. A uniform high quality securitisation standard would be desirable, although it is doubt- ful whether it will be possible to implement such a uniform standard in practice. Even the quality criteria in the two EU delegated acts are not identical; the LCR delegated act contains minimum issue volume and maximum term as additional criteria which are intended to ensure that securitisations have a certain minimum liquidity level.

The broad range of asset classes eligible for the LCR had largely been expected by Our view of the LCR delegated act the market and was therefore already priced in. We regard it as a positive that the from a securitisation perspective minimum issue volume was left at EUR 100 million, which means that the majority of the ABS transactions traded on the market will now be able to meet this criterion. Minimum issue sizes of up to EUR 500 million had been under discussion in some quarters. However, the sticking points of the LCR eligibility requirements are in the detail. For example, the servicing continuity requirement could lead to a number of highly liquid securitisations being excluded, as the documentation for some of the series does not contain any provision for a back-up servicer yet. An LTV of ≤ 80% could also become a stumbling block for the LCR eligibility of Dutch RMBS in particular. For historical reasons these often have significantly higher LTVs, but they are nevertheless one of the most liquid asset classes on the ABS market. The external rating requirement contained in the regulations is also a significant issue as well as a possible point of criticism. A rating from a nominated ECAI corresponding to at least credit quality step 1 is a precondition for a securitisation being included in the LCR as an HQLA. Dependence on external ratings, so often criticised in the past – not least by the EU Commission itself – has now been moved back centre stage by this requirement. As a result securitisations will once again be subject to significant rating sensitivity. Meanwhile the preferential regulatory treatment and capital requirements applying to high quality securitisations remains an outstanding issue that is also essential to activating investor demand. The delegated act has largely removed the uncertainty for banks and insurers as ABS investors with regard to the eligibility of asset-backed securities for the LCR and as High Quality Securitisations. In princi- ple this is a positive development. However, as a corollary the introduction of the high quality securitisation standard in the LCR is likely to lead to a split in the securitisation market, as trading activities split into LCR and non-LCR segments and there is a greater spread differentiation within the LCR asset classes between LCR-eligible securitisations and other ABS series.

ASSESSMENT

The introduction of the binding minimum LCR ratio of 60% from 1 October 2015 is Most banks meet the LCR require- unlikely to have a huge impact on the demand for the different asset categories, as ments the banks have already significantly boosted their LCR ratios in recent years. The EBA conducts a survey on the implementation status of the Basel 3 regulations at large internationally active banks (Group 1 banks) and small and medium-sized banks (Group 2 banks) twice a year. Based on these survey results the average LCR ratio at large banks rose from 68% in mid-2011 to 107% at the end of 2013 and from 82% to 151% at small and medium-sized banks (see chart below).

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ON AVERAGE EUROPEAN BANKS ALREADY MEET THE LCR RATIO AVERAGE LCR RATIO OF A CONSISTENT SAMPLE OF BANKS 151% 135% 141% 122% 109% 101% 102% 107% 82% 81% 68% 68%

Jun-11 Dec-11 Jun-12* Dec-12 Jun-13 Dec-13

Group 1 banks Group 2 banks

Source: EBA, DZ BANK Research; Group 1: large internationally active banks, Group 2: small and medium-sized banks; *amended Basel 3 definition of the LCR ratio applied from June 2012

As a result the shortfall of liquid assets for those banks which do not yet meet the Shortfall of liquid assets: EUR 30 bil- 100% minimum ratio has fallen from EUR 1.15 trillion to EUR 154 billion over the lion (60% limit) or EUR 154 billion same period. According to the EBA's calculations, only an additional EUR 30 billion (100% limit) of liquid assets would be required for all banks to meet the minimum ratio of 60%. Taking account of the fact that the EU implementation of the LCR will be slightly more lenient than the Basel 3 requirements on which the EBA surveys are based, and in addition that the banks have made further progress in preparing their balance sheets since the beginning of the year, the demand for additional liquid assets is likely to have fallen further.

LIQUIDITY REQUIRED TO REACH A MINIMUM LCR OF 100% EUR TRILLION; TOTAL SHORTFALLS OF BANKS WITH A RATIO OF UNDER 100%

1.15 1.17

0.23 0.26 0.15

Jun-11 Dec-11 Dec-12* Jun-13 Dec-13

Source: EBA, DZ BANK Research; *amended Basel 3 definition of the LCR ratio applied from Dec 2012

However, even if the total volume of additional liquid assets required by the banks Has the composition of the liquidity contained in the sample is relatively low, there could be switches within the current portfolio changed? liquidity portfolio that could lead to shifts in demand for individual asset classes. The two charts below show changes in the composition of the liquidity portfolio of group 1

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and group 2 banks over time. They confirm that there have in fact been significant shifts within the portfolios.

Group 1 banks reduced the proportion of cash and central bank balances from 46% Group 1 banks have significantly re- of their overall liquidity portfolios to 36% between the end of 2012 and the end of duced their cash holdings/central 2013 (see chart below). This reduction was primarily counterbalanced by an in- bank balances crease in Level 1 securities (predominantly government bonds) by 5 percentage points. These now account for almost half of the liquidity portfolio. Total holdings of Level 2 assets also increased from 13% to 17%.

BREAKDOWN OF THE LIQUIDITY PORTFOLIO GROUP 1 BANKS

5% 5% 7% Level 2b 8% 9% 10%

Level 2a 46% 41% 36%

Level 1 (cash and central bank reserves) 42% 45% 47% Level 1 (other assets)

Dec-12 Jun-13 Dec-13

Source: EBA, DZ BANK Research

If one looks at the Group 2 banks sample it is noticeable that these banks keep a Group 2 banks have also switched much lower proportion of their liquidity portfolio in the form of cash and central bank some of their assets balances. On the other hand Level 1 securities account for almost two thirds of their liquidity portfolio. These banks have also shifted out of cash and central bank balances over the past year, but in this case solely into Level 1 securities.

BREAKDOWN OF THE LIQUIDITY PORTFOLIO GROUP 2 BANKS

4% 3% 3% Level 2b 12% 13% 13%

26% 21% 21% Level 2a

Level 1 (cash and central bank 62% 63% 57% reserves) Level 1 (other assets)

Dec-12 Jun-13 Dec-13

Source: EBA, DZ BANK Research

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Even if the adjustments to the EU regulations were pretty much in line with expecta- Optimising returns not the first prior- tions, it is likely that, given the certainty that covered bonds and ABS will enjoy ity in liquidity management greater recognition as liquid assets, the banks will invest more heavily in them from now on. However, we do not expect the banks to try and maximise the return from their liquidity portfolio by investing the highest possible proportion in securities with weaker credit quality and liquidity. Optimising the interest income is likely to be a secondary consideration for the banks' liquidity management. This is borne out by the fact that they are still holding a relatively high proportion of their liquidity portfolio in cash and central bank balances. Moreover, liquidity managers at large banks have indicated that they will limit the proportion of covered bonds in their portfolios out of concern that there might be insufficient liquidity in these bonds in stress situa- tions. We therefore expect banks to hold the majority of their liquidity portfolio in comparatively liquid assets with strong credit ratings and only a small proportion in the less liquid 2A and 2B assets. Banks are also likely to display a "home bias", with Spanish banks tending to increase their holdings of Spanish covered bonds to the limit, while German banks are likely to concentrate more on Pfandbriefe.

We do not expect immediate positive spread moves from peripheral covered bonds No major impact expected from the and ABS as a result of the easing of the criteria for liquid assets, as the regulations less restrictive LCR definition; ECB turned out as expected by the majority of market participants. The asset purchase asset purchase programme more programme announced by the ECB is more likely to lead to further spread narrowing important for ABS and covered above and beyond the positive spread reaction that has already been seen. In addi- bonds tion it is inevitable that the introduction of the high quality securitisation standard for ABS will lead to a split in trading activities into LCR and non-LCR segments and that within the LCR asset classes there will be greater spread differentials between securitisations eligible for the LCR and other ABS series.

In terms of covered bonds one side-effect of the European LCR regulations will Rating sensitivity of covered bonds probably be to increase the rating sensitivity of investors from the banking sector. will increase The rating threshold between AA- and A+ will become doubly important in future. Firstly, a rating of AA- will be the threshold for deciding whether a covered bond can attain Level 1 status. Secondly, covered bank bonds will have to have a rating of at least AA- in order for banks to be able to apply a preferential risk weight of 10% in accordance with Art. 129 CRR. In other words, if a covered bond with favourable regulatory treatment is in future downgraded to A-, this could lead banks in particular to sell this bond for regulatory reasons and so trigger severe adverse spread moves. This applies even more to ABS, as here an ECAI rating of at least credit quality step 1 is an essential precondition for an ABS security being eligible for the LCR in the first place. As a result the dependence on external ratings will increase fundamental- ly for securitisations.

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ANNEX

The two tables below set out the potential LCR liquidity category the mortgage and LCR classification of covered bonds public sector covered bond programmes covered by us would fall into taking account of the UCITS and rating requirements. Our potential LCR classification assumes that the investor has nominated all four rating agencies for the purposes of the CRR and that the second-best rating determines the LCR classification (Art 138 (e) and (f) CRR). Our classification is only intended to provide an indication, as there are other conditions that need to be met in addition to the UCITS conformity and the rating requirement and we have not reviewed these.

Mortgage covered bond programmes

INDICATIVE POTENTIAL LCR CLASSIFICATIONS FOR MORTGAGE-BACKED COVERED BOND PRO- GRAMMES

Art. 52 (4) of Potential LCR Issuer Moody's S&P Fitch DBRS UCITS met? category**

Australia AUST & NZ BANKING GROUP Aaa AAA No* Level 2A COMMONWEALTH BANK AUST Aaa AAA No* Level 2A NATIONAL AUSTRALIA BANK Aaa AAA No* Level 2A WESTPAC BANKING CORP Aaa AAA No* Level 2A Austria BAWAG P.S.K. Aa1 Yes Level 1 ERSTE GROUP BANK AG Aa1 Yes Level 1 HYPO NOE GRUPPE BANK AG Aaa Yes Level 1 RAIFFEISEN LB NIEDEROEST Aaa Yes Level 1 RAIFFEISEN LB STEIERMARK Aaa Yes Level 1 UNICREDIT BK AUSTRIA AG Aa1 Yes Level 1 VORARLBERG LND-HYPOBK AG Aaa Yes Level 1 Belgium BELFIUS BANK SA/NV AAA AAA Yes Level 1 ING BELGIUM SA Aaa AAA Yes Level 1 KBC BANK NV Aaa AAA Yes Level 1 Canada BANK OF MONTREAL Aaa AAA AAA No* Level 2A BANK OF NOVA SCOTIA Aaa AAA AAA No* Level 2A CAISSE CENTRALE DESJARDN Aaa AAA No* Level 2A CANADIAN IMPERIAL BANK Aaa AAA No* Level 2A NATIONAL BANK OF CANADA Aaa AAA AAA No* Level 2A ROYAL BANK OF CANADA Aaa AAA AAA No* Level 2A TORONTO-DOMINION BANK Aaa AAA No* Level 2A Denmark DANSKE BANK A/S AAA AAA Yes Level 1 DLR KREDIT A/S AAA Yes Level 1 NYKREDIT REALKREDIT AS AAA Yes Level 1 REALKREDIT DANMARK AAA AA+ Yes Level 1

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Art. 52 (4) of Potential LCR Issuer Moody's S&P Fitch DBRS UCITS met? category**

Finland AKTIA BANK PLC Aaa Yes Level 1 AKTIA HYPOTEKSBANK ABP Aa2 Yes Level 1 DANSKE BANK OYJ Aaa Yes Level 1 NORDEA BANK FINLAND PLC Aaa Yes Level 1 OP MORTGAGE BANK Aaa AAA Yes Level 1 France AXA BANK EUROPE SCF Aaa AAA Yes Level 1 BANQUES POPULAIRES CB Aaa AAA No Not eligible BNP PARIBAS HOME LOAN CO AAA AAA Yes Level 1 BPCE SFH - SOCIETE DE FI Aaa AAA Yes Level 1 CAISSE REFINANCE L'HABIT Aaa AAA Yes Level 1 CIE FINANCEMENT FONCIER Aaa AAA AA+ Yes Level 1 CIF EUROMORTGAGE Aa2 AA+ Yes Level 1 CREDIT AGRICOLE HOME LOA Aaa AAA AAA Yes Level 1 CREDIT MUTUEL ARKEA HOME AAA Yes Level 1 CRED MUTUEL- CIC HOME LO Aaa AAA AAA Yes Level 1 GCE COVERED BONDS Aaa AAA No Not eligible GENERAL ELECTRIC SCF Aaa AAA Yes Level 1 HSBC SFH FRANCE Aaa AAA Yes Level 1 LA BANQUE POST HOME LOAN AAA Yes Level 1 SOCIETE GENERALE SFH Aaa AAA Yes Level 1 Germany AAREAL BANK AG AAA Yes Level 1 BAYERISCHE LANDESBANK Aaa AAA Yes Level 1 BERLIN HYP AG Aaa AA+ Yes Level 1 COMMERZBANK AG Aaa AAA Yes Level 1 COREALCREDIT BANK AG AA Yes Level 1 DEUT APOTHEKE AERZTEBANK AAA Yes Level 1 DEUT PFANDBRIEFBANK AG Aa2 AA+ Yes Level 1 DEUTSCHE BANK AG Aaa Yes Level 1 DEUTSCHE GENOSSEN-HYPOBK AAA Yes Level 1 DEUTSCHE HYPOTHEKENBANK Aa2 Yes Level 1 DEUTSCHE KREDITBANK AG Aa1 Yes Level 1 DEUTSCHE POSTBANK AG Aaa AAA Yes Level 1 HAMBURGER SPARKASSE Aaa Yes Level 1 HSH NORDBANK AG Aa3 Yes Level 1 HYPOTHEKENBANK FRANKFURT A1 Yes Level 2A ING-DIBA AG Aaa Yes Level 1 KREISSPARKASSE KOELN Aaa Yes Level 1 LANDBK HESSEN-THUERINGEN AAA Yes Level 1 LB BADEN-WUERTTEMBERG Aaa Yes Level 1 MUENCHENER HYPOTHEKENBNK Aaa Yes Level 1 NATIXIS PFANDBRIEFBK AG Aaa Yes Level 1 NORDDEUTSCHE LANDESBANK Aaa Yes Level 1 SEB AG Aa1 Yes Level 1 SPARKASSE KOELNBONN Aaa Yes Level 1 UNICREDIT BANK AG Aa1 AAA Yes Level 1 WL BANK AAA Yes Level 1

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Art. 52 (4) of Potential LCR Issuer Moody's S&P Fitch DBRS UCITS met? category**

WUESTENROT BANK PFANDBRF AAA Yes Level 1 Ireland AIB MORTGAGE BANK Baa1 A A Yes Level 2A BANK OF IRELAND MTGE BNK A3 AL Yes Level 2A EBS MORTGAGE FINANCE Baa1 A Yes Level 2B Italy BANCA CARIGE SPA Ba1 BBB+ Yes Level 2B BANCA MONTE DEI PASCHI S Baa3 A Yes Level 2B BANCA POP EMILIA ROMAGNA A3 Yes Level 2A BANCA POPOLARE DI MILANO Baa1 BBB+ Yes Level 2B BANCA POPOLARE SONDRIO A Yes Level 2A BANCO POPOLARE SC A3 BBB+ Yes Level 2B CREDITO EMILIANO SPA A2 A+ Yes Level 2A INTESA SANPAOLO SPA A2 Yes Level 2A MEDIOBANCA SPA A Yes Level 2A UNIONE DI BANCHE ITALIAN A2 A+ Yes Level 2A UNICREDIT SPA A2 AA AA- Yes Level 1 Netherlands ABN AMRO BANK NV Aaa AAA AAA Yes Level 1 ACHMEA BANK NV Aa2 AAA No Not eligible ING BANK NV Aaa AAA AAA Yes Level 1 NIBC BANK NV AAA AAA Yes Level 1 SNS BANK NV Aa2 AA+ Yes Level 1 New Zealand ANZ NEW ZEALAND INTL/LDN Aaa AAA No* Level 2A ASB FINANCE LTD LONDON Aaa AAA No* Level 2A BNZ INTL FUNDING/LONDON Aaa AAA No* Level 2A WESTPAC SECURITIES NZ LT Aaa AAA No* Level 2A Norway DNB BOLIGKREDITT AS Aaa AAA Yes Level 1 EIKA BOLIGKREDITT AS Aa2 Yes Level 1 KLP KOMMUNEKREDITT AS Aaa AAA Yes Level 1 MORE BOLIGKREDITT AS Aaa Yes Level 1 NORDEA EIENDOMSKREDITT Aaa Yes Level 1 SPAREBANK 1 BOLIGKREDITT Aaa Yes Level 1 SPAREBANKEN VEST BOLIGKR Aaa Yes Level 1 STOREBRAND BOLIGKREDITT Aaa Yes Level 1 Portugal BANCO BPI SA Baa2 A- BBB+ Yes Level 2B BANCO COMERC PORTUGUES Ba1 BBB- AL Yes Level 2B BANCO SANTANDER TOTTA SA A3 BBB+ AL Yes Level 2A CAIXA ECO MONTEPIO GERAL Ba1 BBB AL Yes Level 2B CAIXA GERAL DE DEPOSITOS Baa2 BBB A Yes Level 2B NOVO BANCO SA Ba1 BBBL Yes Level 2B Spain BANCO BILBAO VIZCAYA ARG A1 AA- AH Yes Level 2A BANCO DE SABADELL SA A3 A Yes Level 2A BANCO MARE NOSTRUM SA BBB+ Yes Level 2B BANCO POPULAR ESPANOL SA Baa1 BBB A Yes Level 2B

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Art. 52 (4) of Potential LCR Issuer Moody's S&P Fitch DBRS UCITS met? category**

BANCO SANTANDER SA A1 AA Yes Level 2A BANKINTER SA A1 A+ Yes Level 2A CAIXABANK A1 AA- Yes Level 2A CAJA RURAL DE NAVARRA A1 Yes Level 2A CAJAS RURALES UNIDAS Ba2 BBB- BBB+ BBBH Yes Level 2B CATALUNYA BANC SA Ba1 BBB- Yes Level 2B CAJA DE AHORROS Y MONTE Baa1 A Yes Level 2B KUTXABANK SA A2 AA- Yes Level 2A NCG BANCO SA Ba2 BBB BBB+ Yes Level 2B SANTAN CONSUMER FINANCE A1 Yes Level 2A UNICAJA BANCO SA Baa1 Yes Level 2B Sweden LANDSHYPOTEK BANK AB AAA Yes Level 1 LANSFORSAKRINGAR HYPOTEK Aaa AAA Yes Level 1 NORDEA HYPOTEK AB Aaa AAA Yes Level 1 SKANDINAVISKA ENSKILDA Aaa Yes Level 1 STADSHYPOTEK AB Aaa Yes Level 1 SWEDBANK HYPOTEK AB Aaa AAA Yes Level 1 SWEDISH COVERED BOND Aaa Yes Level 1 Switzerland CREDIT SUISSE Aaa AAA No Not eligible UBS AG Aaa AAA No Not eligible UK ABBEY NATL TREASURY SERV Aaa AAA AAA Yes Level 1 BARCLAYS BANK PLC Aaa AAA AAA Yes Level 1 BRADFORD & BINGLEY BS Aa1 AAA AA+ Yes Level 1 CLYDESDALE BANK Aa1 AAA Yes Level 1 COVENTRY BLDG SOCIETY Aaa AAA Yes Level 1 HSBC BANK PLC Aaa AAA Yes Level 1 LEEDS BUILDING SOCIETY Aaa AAA Yes Level 1 BANK OF SCOTLAND PLC Aaa AAA AAA Yes Level 1 LLOYDS BANK PLC Aaa AAA Yes Level 1 NATIONWIDE BLDG SOCIETY Aaa AAA AAA Yes Level 1 ROYAL BK OF SCOTLAND PLC Aaa AAA Yes Level 1 YORKSHIRE BUILDING SOC Aa1 AAA Yes Level 1

Source: Bloomberg, DZ BANK Research; *The issue is not compliant with Article 52 (4) of the UCITS Directive, but the country has comparable domestic regulations. **Where a covered bond programme has more than one rating, we have used the second-best rating for the purposes of the LCR classification (Art. 138 (e) and (f) CRR). However, our classification only represents an indication, as other conditions need to be met in addition to UCITS conformity and the rating requirement and we have not reviewed these.

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Public sector covered bond programmes

INDICATIVE POTENTIAL LCR CLASSIFICATIONS FOR PUBLIC-SECTOR COVERED BOND PRO- GRAMMES

Art. 52 (4) of Potential LCR Issuer Moody's S&P Fitch DBRS UCITS met? category**

Austria BAWAG P.S.K. Aa1 Yes Level 1 ERSTE GROUP BANK AG Aaa Yes Level 1 HYPO NOE GRUPPE BANK AG Aaa Yes Level 1 KOMMUNALKREDIT AUSTRIA A Aa3 Yes Level 1 RAIFFEISEN LB STEIERMARK Aaa Yes Level 1 UNICREDIT BK AUSTRIA AG Aaa Yes Level 1 France BNP PARIBAS PUB SEC SCF AAA AA+ Yes Level 1 CREDIT AGRICOLE PUBLIC S Aaa AAA Yes Level 1 CAISSE FRANCAISE DE FIN Aaa AA+ AA+ Yes Level 1 CREDIT MUTUEL ARKEA PUB Aaa AA+ Yes Level 1 SOCIETE GENERALE SCF Aaa AA+ Yes Level 1 Germany AAREAL BANK AG AAA Yes Level 1 BAYERISCHE LANDESBANK Aaa AAA Yes Level 1 BERLIN HYP AG Aa1 AA+ Yes Level 1 COMMERZBANK AG Aaa AAA Yes Level 1 DEKABANK Aaa Yes Level 1 DEUTSCHE HYPOTHEKENBANK Aa2 Yes Level 1 DEUTSCHE GENOSSEN-HYPOBK AAA Yes Level 1 DEUTSCHE KREDITBANK AG Aa1 Yes Level 1 DEXIA KOMMUNALBANK AG A+ Yes Level 2A LANDBK HESSEN-THUERINGEN Aaa AAA Yes Level 1 HSH NORDBANK AG Aa2 Yes Level 1 HYPOTHEKENBANK FRANKFURT Aa3 Yes Level 1 KREISSPARKASSE KOELN Aaa Yes Level 1 LANDESBANK BERLIN AG Aaa Yes Level 1 LB BADEN-WUERTTEMBERG Aaa AAA Yes Level 1 MUENCHENER HYPOTHEKENBNK Aaa Yes Level 1 NORDDEUTSCHE LANDESBANK Aaa AAA Yes Level 1 DEUT PFANDBRIEFBANK AG Aa1 AA+ Yes Level 1 DEUTSCHE POSTBANK AG Aaa AA Yes Level 1 SEB AG Aa1 Yes Level 1 SPARKASSE KOELNBONN Aaa Yes Level 1 UNICREDIT BANK AG Aa1 AAA AAA Yes Level 1 WL BANK AAA Yes Level 1 WUESTENROT BANK PFANDBRF AAA Yes Level 1 Ireland DEPFA ACS BANK Aa3 BBB A Yes Level 2A EAA COVERED BOND BNK PLC Aa2 Yes Level 1 Norway KLP KOMMUNEKREDITT AS Aaa AAA Yes Level 1

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Art. 52 (4) of Potential LCR Issuer Moody's S&P Fitch DBRS UCITS met? category**

Portugal BANCO BPI SA Baa3 BB- Yes Level 2B Spain BANCO BILBAO VIZCAYA ARG A1 Yes Level 2A BANCO CAM SA A3 Yes Level 2A BANCO POPULAR ESPANOL SA Baa1 Yes Level 2B BANCO SANTANDER SA A1 Yes Level 2A CAIXABANK A1 Yes Level 2A UNICAJA BANCO SA Baa1 Yes Level 2B

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FIXED INCOME RESEARCH: RATING CHANGES WITHIN THE LAST 12 MONTHS ABN AMRO Bank 23.10.2013 Underperformer REPUBLIC OF ITALY 22.10.2013 Marketperformer Aareal Bank 23.10.2013 Underperformer Rabobank 23.10.2013 Underperformer Allied Irish Banks 23.10.2013 Outperformer Raiffeisen Bank International 27.02.2014 Underperformer BANQUE FEDERATIVE DU CREDIT MUTUEL SA 23.10.2013 Underper- Renault 13.02.2014 Outperformer former Royal Bank of Scotland 27.02.2014 Outperformer BBVA 23.10.2013 Outperformer Royal Bank of Scotland 23.10.2013 Underperformer BMW 05.08.2014 Underperformer SAP 22.09.2014 Marketperformer BMW 06.05.2014 Marketperformer SEB 23.10.2013 Underperformer BMW 02.04.2014 Outperformer STADA 16.05.2014 Underperformer BNP Paribas 23.10.2013 Underperformer Siemens 06.08.2014 Underperformer Banca Monte dei Paschi di Siena 15.01.2014 Outperformer Siemens 17.06.2014 Marketperformer Banca Monte dei Paschi di Siena 16.12.2013 Underperformer Siemens 12.05.2014 Underperformer Banca Monte dei Paschi di Siena 23.10.2013 Outperformer Société Générale 23.10.2013 Underperformer Banco Comercial Portugues 23.10.2013 Outperformer Svenska Handelsbanken 23.10.2013 Underperformer Banco Popular Espa?ol 23.10.2013 Outperformer Südzucker 22.11.2013 Marketperformer Banco Santander 23.10.2013 Outperformer Telecom Italia 12.11.2013 Marketperformer Bank of America 17.07.2014 Marketperformer Telefónica 24.10.2013 Outperformer Bank of America 23.10.2013 Underperformer Telekom Austria 14.05.2014 Marketperformer Bank of Ireland 23.10.2013 Outperformer Telekom Austria 27.02.2014 Outperformer Barclays Bank 23.10.2013 Underperformer Telekom Austria 14.11.2013 Marketperformer Bayer 09.05.2014 Underperformer Telekom Austria 23.10.2013 Underperformer Bayerische Landesbank 23.10.2013 Underperformer Tesco 01.07.2014 Marketperformer Bertelsmann 14.05.2014 Outperformer ThyssenKrupp 21.05.2014 Outperformer CREDIT AGRICOLE SA 23.10.2013 Underperformer UBS 23.10.2013 Underperformer Casino Guichard-Perrachon 01.08.2014 Underperformer Unicredit 23.10.2013 Outperformer Commerzbank 23.10.2013 Marketperformer VOLKSWAGEN AG 30.04.2014 Outperformer Credit Suisse 23.10.2013 Underperformer Vodafone 27.08.2014 Marketperformer Crédit Mutuel Arkéa 23.10.2013 Underperformer Vodafone 10.02.2014 Underperformer DEXIA SA 23.10.2013 Outperformer DNB Bank Group 23.10.2013 Underperformer Daimler 24.07.2014 Underperformer Deutsche Bahn 05.03.2014 Marketperformer Deutsche Bahn 31.01.2014 Underperformer Deutsche Bahn 24.10.2013 Marketperformer Deutsche Bank 23.10.2013 Underperformer Deutsche Post 17.03.2014 Underperformer Deutsche Post 24.10.2013 Marketperformer Deutsche Telekom 14.10.2014 Marketperformer Deutsche Telekom 10.06.2014 Underperformer E.ON 13.05.2014 Underperformer Electricité de France 31.07.2014 Underperformer EnBW 12.05.2014 Underperformer Enel 09.05.2014 Outperformer Enel 24.10.2013 Marketperformer Erste Group Bank 04.07.2014 Underperformer FEDERAL REPUBLIC OF GERMANY 22.10.2013 Underperformer FRENCH REPUBLIC 10.12.2013 Underperformer FRENCH REPUBLIC 22.10.2013 Marketperformer Fraport 06.11.2013 Marketperformer GDF Suez 04.08.2014 Underperformer HSBC Holdings 23.10.2013 Underperformer ING BANK NV 23.10.2013 Underperformer Iberdrola 07.05.2014 Outperformer Iberdrola 20.02.2014 Marketperformer Iberdrola 23.10.2013 Outperformer Intesa Sanpaolo 23.10.2013 Outperformer JP Morgan Chase & Co 23.10.2013 Underperformer K+S 17.03.2014 Outperformer K+S 20.12.2013 Marketperformer KBC GROEP NV 08.08.2014 Underperformer KINGDOM OF SPAIN 22.10.2013 Outperformer KINGDOM OF THE NETHERLANDS 22.10.2013 Underperformer Koninklijke KPN 08.07.2014 Marketperformer Landesbank Baden-Württemberg 23.10.2013 Underperformer Lanxess 21.03.2014 Underperformer Linde 06.05.2014 Marketperformer Lloyds Banking Group 23.10.2013 Underperformer MAN SE 04.12.2013 Marketperformer Mediobanca 23.10.2013 Outperformer Merck KGaA 24.09.2014 Underperformer Metro 04.09.2014 Marketperformer Metro 08.05.2014 Underperformer Morgan Stanley 17.01.2014 Marketperformer Morgan Stanley 23.10.2013 Outperformer NORD/LB 23.10.2013 Underperformer Nordea 23.10.2013 Underperformer Novo Banco 23.10.2013 Outperformer Orange 26.09.2014 Marketperformer Orange 21.03.2014 Underperformer POHJOLA BANK OYJ 23.10.2013 Underperformer PORTUGUESE REPUBLIC 22.10.2013 Outperformer PSA Peugeot Citroen 13.08.2014 Outperformer PSA Peugeot Citroen 19.11.2013 Underperformer Portugal Telecom 02.09.2014 temporary removed Portugal Telecom 16.07.2014 Marketperformer Portugal Telecom 03.07.2014 Underperformer Portugal Telecom 24.10.2013 Outperformer REPUBLIC OF AUSTRIA 22.10.2013 Underperformer REPUBLIC OF FINLAND 22.10.2013 Underperformer REPUBLIC OF IRELAND 22.10.2013 Outperformer REPUBLIC OF ITALY 14.03.2014 Outperformer

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RESPONSIBLE

Head of Credit Research Financials and Structured Cred- Oliver Piquardt ,CFA, FRM +49 – (0)69 – 74 47 – 33 72 [email protected] its

AUTHORS

Dr. Abdoulaye Aboubakar Analyst Financial Institutions +49 - (0)69 - 74 47 - 26 50 [email protected] Thorsten Euler, CFA Analyst Covered Bonds +49 - (0)69 - 74 47- 9 96 44 [email protected] Ann-Kristin Moeglich Analyst ABS & Structured Credits +49 - (0)69 - 74 47 - 38 18 [email protected] Leiter Credit Research Financials und Structured Oliver Piquardt, CFA, FRM +49 - (0)69 - 74 47 - 33 72 [email protected] Credits

CONTACTS

Capital Markets Institutional Clients Head of Capital Markets Institutional Clients + 49 – (0)69 – 74 47 – 69 62 H.-Theo Brockmann Sales Institutional Clients Head of Sales Financial Institutions + 49 – (0)69 – 74 47 – 45 36 Norbert Schäfer Head of Sales Banks Europe + 49 – (0)69 – 74 47 – 12 70 Lars Carlsen Head of Sales Institutional Clients + 49 – (0)69 – 74 47 – 4 24 20 Tilo Sperling Head of Sales Banks Germany + 49 – (0)69 – 74 47 – 34 32 Jörn Schneider Head of Sales Southern Asia + 65 – 65 80 – 16 24 Anand Subramanian Head of Sales Northern Asia + 8 52 – 2 86 43 – 1 82 Li Zhiming Head of Sales Central Banks + 49 – (0)69 – 74 47 – 99 39 9 Lars Carlsen Corporates Head of Corporates + 49 – (0)69 – 74 47 – 23 69 Roland Weiß Head of Money Market and Short Term Investment + 49 – (0)69 – 74 47 – 18 50 Hans-J. Gretscher Head of Interest Rate & FX Executions Small Caps + 49 – (0)69 – 74 47 – 43 54 Klaus Langer Head of Derivative Solutions Large Caps + 49 – (0)69 – 74 47 – 44 00 Tobias Strumpel Head of Derivative Solutions Small Caps + 49 – (0)69 – 74 47 – 44 26 Evelyne Thiessen Debt Capital Markets Head of Debt Capital Markets + 49 – (0)69 – 74 47 – 49 97 Arnold Fohler Head of Origination Germany + 49 – (0)69 – 74 47 – 48 00 Jörg Müller Head of Origination Non-Germany + 49 – (0)69 – 74 47 – 17 10 Kai-Henning Poerschke Head of Corporate Origination + 49 – (0)69 – 74 47 – 71 45 Bettina Streiter

CG502e

1) – 9) Important: Please read the references to possible conflicts of interest and disclaimers/disclosures at the end of this report.