An Examination of Covered Bonds

An Examination of Covered Bonds Bachelor Thesis in Banking and Finance Department of Banking and Finance University of Zurich Prof. Dr. Kjell Nyborg Assistant: Jiri Woschitz Romano Gruber 09-724-915 Salviastrasse 8 7205 Zizers +41 79 406 11 42 [email protected] June 8, 2012 Abstract This thesis explores Covered Bonds by providing a theoretical overview and investigating the development of the respective market in recent time. We collate jurisdictions and find crucial distinctions in the frameworks between es- tablished and developing Covered Bond markets. By analyzing the outstanding amounts of 23,363 Covered Bonds we observe a strongly declining public and an expanding mortgage Covered Bond market. The average yield spreads calcu- lated by country show an increase for Anglo-Saxon countries after the Lehman bankruptcy and a strong surge for euro area countries deep in debt. Keywords: Structured Finance, Covered Bonds, Bank Funding, Pfandbriefe JEL Classification: G10, G12, G15, G21 I Bachelor Thesis in Banking and Finance (Focus Economics) by Romano Gruber Romano Gruber Salviastrasse 8 7205 Zizers An examination of Covered Bonds Covered Bonds (for instance in Switzerland called Pfandbriefe) are bonds which are issued by specific firms by country. These bonds are backed by very liquid and cash flow generating assets such as public sector loans and mortgages. Compared to off-balance sheet instruments, called asset-backed securities, where these collaterals are put in separate ve- hicles (called Special Purpose Vehicle (SPV)) and refinanced separately, these bonds are remained on the balance sheet of the specific firm. This thesis focuses on Covered Bonds. In a first part the thesis focuses on how Covered Bonds are treated in different countries. Second, you collect data from the (different) firms which issue Covered Bonds in each country and compare them by adequate descriptive statistics. A third section focuses on the question of how Covered Bonds are treated by rating agencies. In a fourth section, you establish the differences between Covered Bonds and asset-backed securities. In the last section you try to figure out, if there exists data on SPV performance over time. If this exists, it should be compared to the collected Covered Bond data. The following paragraphs explain in more detail the different potential parts: The first part of the thesis focuses on how Covered Bonds are treated in different countries. Basically, this is a comparison of different aspects (for instance differences in law aspects, differences in requirements on the cash generating collaterals, which firms (are allowed to) issue Covered Bonds, etc.) in different countries1. Here the focus should lie on the question which aspects and differences could have an influence on the fact that Covered Bonds issued by different countries should be treated differently (for instance differences in the law of two countries on which assets may be used as cash flow generating collaterals may have an influence on the certainty of Covered Bonds). 1 The ECBC (European Covered Bond Council) has issued the ECBC Covered Bond Fact Book 2011. This can be downloaded after registration on http://ecbc.hypo.org/Content/Default.asp?PageID=501 and is about the Covered Bond market. The second part of the quite comprehensive reading is about all these aspects well-arranged by country. ECBC also provides a tool (comparative database findable on http://www.ecbc.eu) where this comparison can be done per aspect for two countries. II In the second part you collect data in Datastream and/or Bloomberg on Covered Bonds performance in the past2. This should be done for every firm in all the countries which are listed in the ECBC Covered Bond Fact Book 2011 (c.f. www.ecbc.eu). After collecting the data (do not underestimate this task, it might be quite time consuming), Covered Bond performance in different countries (maybe for different issuers) should be compared by descriptive statistics. Do you see any parallels with respect to the aspects found in the first part of the thesis (for example, if the law on which assets can be used as collaterals is very limp in one country but very strict in the other, do you see that the Covered Bonds in the more strict country is less volatile and vice versa?). If you find that such differences in the law of countries might lead to different trends in historical Covered Bond prices, volume etc. it might be worth to establish further statistical analyzes which show these potential relationships. The third part of the thesis focuses on how rating agencies treat covered debt? Maybe there is practical (or maybe even academic) literature on how rating agencies treat Cov- ered Bonds from different countries. Potential findings should be compared to findings in the first part of the thesis. Furthermore, do there exist CDS contracts on Covered Bonds? If yes, does the performance of such CDS contracts reflect what you expected in terms of the findings in the first section of the thesis? The fourth part should focus on the differences between on-balance sheet (Covered Bonds) and off-balance sheet instruments (Asset-backed Securities). What are the consequences that follow from this simple difference that Covered Bonds are on balance sheet and ABS are off balance sheet in terms of risk (different sorts of risk such as liquidity risk, credit default risk, etc.) and return from a theoretical perspective? The fifth and last part focuses on historical data for asset-backed-securities. Is it pos- sible to find such data on Bloomberg or Datastream (or even other databases)? If yes, show a descripitve analysis (maybe the same analysis you did in the second part on the Covered Bond data). Can you find obvious differences? This thesis is a quite heavy workload. Do not underestimate the different parts since some of them might be more time consuming than one thinks before starting. The goal of the thesis is not to answer every question in these five parts in every detail since time will be too short to do this. However, try to focus on each part at least a little bit and then decide on which parts you can add most insights. It might, for instance, be that there is no historical data findable on asset-backed securities in Bloomberg or Datastream. However, do at least figure out if it exists or not. It is not your fault if it does not exist. 2 Do also make a short list of other variables that can be found in the databases, e.g. volume outstanding, trading volume, etc. III Course of your thesis: • After completing the subdata 23 sheet you will have a first meeting with your advisor to discuss in detail how to proceed in detail. • If you have questions you can ask your advisor for an appointment. However, the goal is to acquire the knowledge on your own and try to solve problems on your own, but to discuss your own solution to a problem with your advisor. Formal criteria and submission: • You compose the thesis in English. • Quality comes before quantity. Be brief and compact in writing. Your thesis should not be longer than 40 pages. Take journals as the JFE or JF as references how your work should look like. • Pay attention on writing correctly and watch out for a scientifically, concise, but a fluent writing style. Do also pay attention on a correct use of citation (in the text not full information, only author and year) like commonly used in Journal of Finance or Journal of Financial Economics. Also in other formal aspects use the layout of these two Journals. Only use sufficiently described black-white graphs. Graphs and tables should be self-explanatory and understandable also without reading the whole thesis. • At the beginning of the thesis write a short abstract (question, result) like in JFE or JF. This abstract is short and even more concise than an Executive Summary and comprises not more than 100 words. • Create a maximally four-sided Executive Summary (question, procedure, results, and general evaluation), which is typically similar to the introduction of the thesis. • You deliver three copies of your thesis to the dean’s office. The Executive Summary and the ordering are directly after the front page of the thesis. Furthermore, you submit 2 CD’s with the title of the thesis, your name, your address and your phone number on it: (1) One CD contains only the front page of your thesis (without your address and phone number), the Executive Summary separately, a combination of these two (front page without your address and phone number together with the Executive Summary) and also your full thesis. Deliver this in pdf and in word or preferably LaTeX; (2) A second CD with the whole thesis in word or LaTeX, the whole used data material, all computer codes to replicate your findings, and all the electronically saved references (for instance, papers in pdf format). The Department of Banking and Finance has the rights of your thesis and may use part of it within the scope of science. IV If you have questions or if you want to discuss your thesis you can contact Jiri Wos- chitz: [email protected]. We wish you good luck with the thesis. Zurich, 31 January, 2012 Prof. Dr. Kjell Nyborg V Executive Summary Problem Covered Bonds are one of the most important refinancing instruments for banks in Europe and the respective market is one of the biggest private debt markets. Nevertheless, there is very little academic research on this topic. Since each country has adopted its own Covered Bond legislation, Covered Bonds might be treated very strict in one country but very limp in an other.

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