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"We don’t want to grow this fast. We are a savings bank so we don’t have to keep shareholders happy. We prefer to have a solid institution" Carlos Stilianopoulos, Caja Madrid |
It is not often that a bank devotes management time and energy to trying to slow growth in one of its business lines but that is exactly what Caja Madrid is doing. The Spanish savings bank’s mortgage book grew by 25% last year. It is something that it is working hard not to repeat in 2007. "We don’t want to grow this fast," explains Carlos Stilianopoulos, head of capital markets at Caja Madrid. "We are a savings bank so we don’t have to keep shareholders happy. We prefer to have a solid institution." Stilianopoulos has run the origination, distribution, derivatives trading and securitization business at the bank since November 2000, having joined Caja Madrid in 1998. He explains that the bank is devoting its time to reining in both its overall mortgage growth and its high loan to value mortgage business: although 50% of the mortgages it wrote last year had LTV ratios of more than 80%, that percentage has been cut to just 10% since June 2006. The initial conclusion to draw from this is that Caja Madrid has concerns about the Spanish mortgage market – not a positive development for an institution that has a €55 billion mortgage book. But Stilianopoulos is emphatic that this is not the case. "The mortgage market is still attractive to us – we simply want to cut growth from the mid-20s to the mid-10s," he says. "But that is still huge in absolute figures. We still believe strongly in the mortgage market and want to be there."
The rapid growth in its mortgage book prompted Caja Madrid to enter the Spanish RMBS market at the end of 2006, but this is something that the bank seems similarly equivocal about. The deals were done because the mortgage book had reached such a size that there was 250% collateral for outstanding cédulas. This ‘excess’ collateral could therefore be securitized without having an impact on the covered bond programme. "The RMBS deals have been done purely for funding – to avoid oversupply in the cédulas market," explains Stilianopoulos. "The cédulas market always comes first and we will always maintain 200% collateral for our cédulas issuance." If cédulas collateral levels fall back to 200% then future RMBS issuance from the bank will cease.
Caja Madrid was a prominent sponsor at the inaugural Euromoney US covered bonds conference in March, and few would be surprised if it were to issue US dollar-denominated cedulas.
"Last year we were faced with a record increase in our funding needs to €22 billion – the year before it was €15 billion," says Stilianopoulos. "We knew that we didn’t want to use our normal senior and cédulas investor bases for the whole €22 billion." The solution was to fund in the RMBS market – something that Stilianopoulos was discounting as recently as May last year (see Is this the time to buy Spanish MBS?, Euromoney, June 2006).
Big deals
Caja Madrid has €18 billion outstanding in the cédulas market – so the €3.8 billion of RMBS that has been issued so far is a relative drop in the ocean. The bank launched its first RMBS transaction in late November last year – a €2-billion deal with an average LTV of 95.3% and average seasoning of 19.6 months. The deal, which was led by Barclays Capital and RBS, priced at 16 basis points over Euribor at the triple-A level for a 5.26-year weighted average life, just 1bp wider than regular issuer Bankinter’s 13th deal, which came at the same time. A second, €1.8-billion deal rapidly followed, this time pricing at 15bp over for a 3.8-year WAL for the triple-As. All sub-triple-A tranches in both deals were retained or sold privately. "Some banks tried to tell us that the two deals were too close together," says Stilianopoulos. "But the first transaction was three times oversubscribed and the second two times. And even though the deals had LTVs above 80% they were placed at exactly the same spread as outstanding secondary."
This is good news for Caja Madrid, but it also shows a worrying lack of discrimination among investors as regards the real risk they are taking on. The average LTV of the mortgages in the two Caja Madrid deals so far is 90%, but other lenders have gone to 110% LTV in recent years, with more lending to self-employed and second-home buyers. Some observers have long argued that spreads on Spanish RMBS deals do not accurately reflect the real risk inherent in this market (see Is this the time to buy Spanish MBS?, Euromoney, June 2006) and parallels between the Spanish mortgage market and the US sub-prime mortgage market have even been drawn in recent weeks, although they have not really been made to stick. Stilianopoulos is dismissive of the concerns that have been voiced. "There is concern over the Spanish housing market but it comes from abroad. We are not concerned – there are strong fundamentals underpinning the market. Perhaps in other countries this pace of growth would be seen as a bubble, but not in Spain." He justifies this position by pointing to the immigration that Spain has experienced from Latin America, eastern Europe and north America, explaining that demand for housing is driven by natural population growth. "People are coming to Spain to work – they have jobs," he says. Indeed, residential construction in Spain has reached 11% of GDP and last year roughly 18 houses per 1,000 people were built in Spain compared with the European average of fewer than six. But a sizeable proportion of these immigrants will be employed in the construction industry, so any slowdown in this breakneck pace of development might indeed hit their ability to service their mortgages.
| LBO boom |
| Caja Madrid’s leveraged finance underwriting |
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| Source: Caja Madrid |
Taking steps to control growth in what most would argue is an overheated market is a prudent step. And Stilianopoulos is cautious on the development of a non-conforming mortgage market in Spain. "We are very wary on sub-prime," he says. "I think that lenders trying to build a sub-prime market in Spain will be disappointed." Several firms have been doing just that (see Is this the time to buy Spanish MBS?, Euromoney, June 2006) but at least one sub-prime lender (Kensington Mortgages) has now publicly pulled back from its plans for European expansion. Mortgages slow, CLOs grow
If Caja Madrid is taking a more controlled approach to growth in its mortgage book, it has no such reservations about its CLO business. "This is a product that Caja Madrid is really betting on," enthuses Stilianopoulos. "The CLO business is a new business but it is very important for our balance sheet and for our provisions." Spanish banks have an additional incentive to rotate their balance sheets given the additional generic provision that the Bank of Spain demands for lower-rated assets. Over and above the 8% Bank for International Settlements provision the central bank requires the banks to hold a 2.25% generic provision against all credits on its balance sheet rated below single-A. Thus by rotating the balance sheet in the CLO market Caja Madrid is able to raise additional funds to meet its provision requirements. The €810 million of assets from its own balance sheet that went into the four CLOs in 2006 raised an additional €18 million generic provision.
The bank put its money where its mouth is in March this year with the launch of Neptuno CLO 1, the first CLO managed by Caja Madrid itself. "We have been involved in every big LBO worldwide – we do 70 deals a year and look at every secondary market LBO. This translates into an unrivalled knowledge and ability to manage a CLO," says Stilianopoulos.
The bank did four balance sheet CLOs in 2006 but none was self-managed.
The Neptuno CLO involves €350 million of assets from Caja Madrid’s trading book, which were ramped up in 2005. Some €73 million in mezzanine and second-lien assets have also been purchased and the bank is targeting 80% ramp-up at closure. The total pool will be 50% Caja Madrid and 50% other assets.
Stilianopoulos explains that the original plan was for Caja Madrid to keep 75% of the €50 million equity tranche but that demand was so great that it has had to drop its equity holding to 50%. "There is huge demand for exposure to the LBO market by corporates and investors," he says. "The domestic investor base is growing tremendously – just 12 months ago it was very difficult to place anything in Spain." He says that four domestic Spanish investors have bought 50% of the equity tranche. The CLO is structured with €223 million of class-A notes split into a €100 million revolver and €223 million of bonds – both of which were pre-placed. There are €48 million double-A notes, €25 million single-A notes, €28 million triple-B minus notes and €26 million double-Bs.
"The most challenging part of the whole process was selling the equity piece as a first-time manager – we were surprised that we were able to place so much equity," says Stilianopoulos. But he is emphatic that Caja Madrid has an enviable advantage over its rivals because of its LBO franchise. "A good CLO manager is one that can source assets easily," he says. "If you can get assets then you can place good assets into the CLO."
Neptuno itself is being managed by a team of six but they will be very busy if the bank’s planned programme of four managed deals and two further balance sheet CLOs takes place this year. Not surprisingly, Stilianopoulos is looking to increase the team by 10 in order to cover both managing the assets and mid-and back-office functions. The leverage credit portfolio is managed by Sergio Grasso and Alfonso Arconada is leading the CLO portfolio management team.
Stilianopoulos sees the CLO business as vital to the growth of the Caja Madrid LBO franchise. "Investors know we have experience in managing an LBO portfolio and the CLO programme frees up our LBO lines, allowing us to constantly do deals," he says. The bank has an internal LBO line of €2 billion but since the CLO programme was initiated it has never stood at more than €1 billion outstanding.
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