Germany Gets Peseta Fever

Last week, Izabella Kaminska at FT Alphaville drew our attention to the fact that the then recently completed 1-year ECB financing auction had drawn bids from European banks for a grand total of 75 billion euros - this figure to be compared with the 442 billion demanded in the prior edition, last June. Of the three explanations she offers for this abrupt about face, she seems to side with the version that the ECB, in light of the very marked re-animation of the covered bond market, is suggesting that banks might try looking in that direction to satisfy their funding needs instead. They seem to have taken M. Trichet's possible hint seriously, in Spain at any rate.

1). Unicaja, the most solvent of the Andalusian savings banks sold 1 billion Fitch A+ to be redeemed in five years at 52 over mid-swaps;

2). Caja Madrid, managing a triple-A from the same agency, stretched it out to a full seven years at 60 over - 1.75 billion euros in total and oversubscribed by about 60%;

3). Banesto put out 1.25 billion over 42 months at 45 over.

We could go on, but suffice it to say that investors, dominated by German institutions with little fear of being paid back in pesetas, are picking up this paper like it was the next great thing. Odd - considering that the issuers, according to some researchers who feel that heat is a suitable proxy for light, are effectively bankrupt and threatening to take Europe down with them. As to whether this development can be converted into further proof of imminent apocalypse, we ask the reader to consider the following:

Among the more influential factors that investors consider in the pricing of covered bonds is the loan-to-value ratio for the portfolio. Note that this is a ratio of two components, one being fixed and known - the loan - and the other - the value - being variable over time. No one knew what this latter was when Everything Fell Apart, and the covered bond market seized up. We don't think that it is complete wild-eyed foolishness to assume that the bond market thinks that this is once again a knowable figure.

If it is the case that some form of stability has returned to real estate prices, albeit at a considerably lower level than two years ago, the effects upon the credibility of the financial institutions' balance sheets is immediate. In the case of Spain, the large number of properties that were taken back for debt outstanding from developers (the banks rightly preferring to pay a premium over the alternative of having bankruptcy court dole out the remains) can approximately be marked to market. The covered bond market, with regards to this, also takes into account the solvency of the issuing institution as it calculates prices. Apparently, the asset side, despite the inclusion of considerable amounts of actual property within, is less of a problem than it recently was.

Possibly lastly, the banks and cajas (which were right niggardly in their willingness to dole out credit for a good, long stretch) will be able to cue their risk controls off the covered market's assessments. Simply put, if they feel confident they can fund themselves with packaged mortgages they will loosen up the terms under which the individual loans are granted up to whatever limit at which resistance is encountered, enlivening the always - at least latently - eager Spanish domestic property market in the process.

Please note that none of the above implies that we can expect widespread price increases in the foreseeable future. Real life is not binary.

Displaying his usual excellence, John Hempton wrote a piece on this issue yesterday. Of particular interest was his assessment that the brunt of the Spanish economic downturn may be being taken by groups that were not in the property and loan market in the first place. Unreflected-upon macro numbers might not be very representative of the actual state of affairs as they affect banking in Spain.

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