OREANDA-NEWS. Balance sheets of Spanish banks are becoming less encumbered because their reliance on covered bonds for funding is falling, says Fitch Ratings. The combination of banks' balance-sheet deleveraging and a shift in funding towards customer deposits since 2013 has resulted in lower wholesale funding needs, including covered bonds issuance. As a result, outstanding covered bonds averaged about 9% of Spanish banks' total liabilities and equity, based on end-June 2015 data, down from 13% at end-2013.

But Spanish banks are still more highly encumbered than the global average, as highlighted in our recent report on bank covered bond usage, available by clicking on the link below. Global cover pool encumbrance has remained fairly stable in recent years, averaging 10% for a sample of 149 Fitch-rated entities worldwide at end-June 2015. The figure is more than double this for Spanish banks rated by Fitch, at 22.5%, but lower than the 27% at end-2013. Higher encumbrance also results from high nominal over-collateralisation (OC), which averaged 182.5% at end-September 2015. This is high by international standards and offers significant protection for covered bond holders.

High encumbrance levels are partly due to Spain-specific factors, and our encumbrance calculations are higher than some other market participants'. This is because, unlike the guidelines on encumbrance reporting published by the European Banking Authority (EBA) in 2014, we include all available OC in our asset cover pool calculations, rather than only the amount that cannot be freely withdrawn by the issuer. OC is expanded further because under Spanish law every non-securitised mortgage and public sector loan on the banks' balance sheets serves as collateral, respectively for the cedulas hipotecarias (Spanish mortgage covered bonds) and cedulas territoriales (Spanish public sector covered bonds). This automatically results in higher OC levels than the legal minimum. Minimum legal OC for cedulas hipotecarias is 25% and for cedulas territoriales is 43%.

Spanish banks also retain a high proportion of their own covered bonds, using them to access the repurchase markets, like banks in other peripheral eurozone countries. Whereas the EBA disregards self-owned covered bonds for the purpose of encumbrance reporting unless they are actually pledged as part of a repo transaction, we account for them when measuring banks' reliance on covered bonds for funding, irrespective of whether they are pledged or not at a given point in time. For example, CaixaBank and Banco Mare Nostrum's covered bonds sold to investors represent 10%-20% of adjusted assets, whereas their total outstanding covered bonds - retained covered bonds and those sold to investors - reach a higher 20%-30%.

High levels of asset encumbrance are a concern to market participants because this can result in balance-sheet weakness and, by reducing the level of disposable assets available for repo, potential strains on liquidity under stress. The EBA's latest report on EU-wide asset encumbrance, published in September 2015, places covered bonds as the second-largest source of encumbrance after repos. The asset encumbrance ratio, which not only includes cover pools but also other type of collateral pledged to third parties, was about 29% for Spanish banks included in the EBA's sample.