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Oct 05 - Spanish covered bond issuers that plan to transfer mortgages to the proposed AssetManagement Company (AMC) when it is established, will see a dip in the amount of

collateralsupporting their covered bond programme, Fitch Ratings says.

In Spain, covered bonds are secured by the whole of a bank's mortgage loan portfolio andtherefore swapping mortgages for government guaranteed debt issued by the AMC, at a price yet tobe

determined, will result in a drop in the collateral. This is similar to securitisations, inwhich mortgages are sold and therefore can no longer be used as a security for outstandingcovered

bonds.

These government guaranteed bonds are higher credit quality than the troubled mortgageassets transferred, but will in principle not be available as cover pool assets to the coveredbond

investors. The exact format of the guaranteed bonds is still being designed, but we expectthem to be used as eligible collateral for ECB repo transactions. Fitch will contact affectedbanks

to determine if they intend to amortise existing retained covered bonds with the fundsobtained via the repo transactions.

The vast majority of mortgages that will be transferred to the AMC are likely to be troubleddeveloper loans. Fitch assumes high default rates and low recovery rates for these

loans(approximately 70% default rate and a 20% recovery rate under a 'BBB' rating scenario) so thebenefit to the cover pool is limited, but it is not zero. For instance, where 30% of a

bank'smortgage portfolio consists of developer loans, this could add 7% to 10% to the net presentvalue estimation of the collateral pool.

We expect the banking authorities to develop a solution that protects covered bondholderssenior creditors if an extreme case materialises where the transfer of mortgages is so largethat the

volume of eligible mortgage cover assets dip below the legal minimum of 125% of thecovered bond liabilities.

The resulting drop in the coverage will be partly offset by the lower risk of the remainingcover pool.

((Bangalore Ratings Team, Hotline: +91 80 4135 [email protected],Group id:[email protected],Reuters Messaging:[email protected]))

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