Barclays AAA Handbook.6.2010

RESEARCH
June 2010
THE AAA HANDBOOK 2010

REBUILDING TRUST
PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ON THE LAST PAGE
Barclays Capital | AAA Handbook 2010
FOREWORD
Rebuilding trust
Larry Kantor +1 (212) 412 1458 larry.kantor@barcap.com
As we put together our eighth edition of The AAA Handbook, the market environment has deteriorated from just a few months ago. Increases in spreads and volatility, as well as a decline in liquidity, have left investors concerned that perhaps we have not seen the last of the crisis environment of 2008. In a sense, the recent environment has increased the attractiveness of the assets covered in this book. While sovereign debt concerns are greater than ever, all of the supranationals, agencies, sub-sovereigns, government guaranteed and covered bonds have continued to pay interest and principal on schedule. In addition, the rally in core European government bonds has increased the yield advantage of these instruments. One major change from 2008 is that the market is differentiating among the bonds issued by the various countries to a much greater extent, rendering the analysis of these instruments more important than ever. We see this book as a guide to facilitate a dialogue between you, our clients, and the analysts who put it together. As always, we hope that we are able to provide you with information and analysis that will lead to better investment decisions.
Larry Kantor Head of Research Barclays Capital
10 June 2010
TABLE OF CONTENTS
INTRODUCTION 4
Strategy
CENTRAL BANK COLLATERAL SCHEMES SECONDARY MARKET CONDITIONS AAA RATED BONDS AND BENCHMARK INDICES BARCLAYS CAPITAL LIVE INTERACTIVE AAA HANDBOOK RELATIVE VALUE INTERACTIVE RISK WEIGHTINGS AND LIQUIDITY RISK REGULATIONS COVERED BOND RATING METHODOLOGIES IAS AND THE APPEAL OF REGISTERED BONDS EURO AREA HOUSING MARKET SPANISH HOUSING MARKET UK HOUSING MARKET US HOUSING MARKETS 9 14 17 26 30 33 38 52 73 76 83 88 92
Market overviews
SUPRAS AND EUROPEAN AGENCIES UNITED STATES: GOVERNMENT-GUARANTEED BONDS GOVERNMENT-GUARANTEED DEBT INSTRUMENTS UNITED STATES: AGENCIES JAPANESE PUBLIC SECTOR AUSTRALIAN PUBLIC AGENCIES SPANISH AUTONOMOUS COMMUNITIES GERMAN LNDER CANADIAN MARKET DANISH MARKET PFANDBRIEF MARKET SPANISH MARKET FRENCH MARKET GREEK MARKET IRISH MARKET ITALIAN MARKET
10 June 2010
96 114 119 130 140 142 144 155 169 179 187 197 208 222 232 239
2
LUXEMBOURG MARKET DUTCH MARKET NORWEGIAN MARKET HUNGARIAN MARKET AUSTRIAN MARKET PORTUGUESE MARKET SWISS MARKET FINNISH MARKET SWEDISH MARKET UK MARKET US MARKET
248 254 262 270 276 281 288 294 301 309 318
Issuer profiles
SUPRAS AND EUROPEAN AGENCIES PROFILES OTHER SUPRAS AND AGENCIES US AGENCIES PROFILES JAPANESE PUBLIC SECTOR PROFILES AUSTRALIAN ISSUER PROFILES GERMAN LNDER PROFILES PFANDBRIEF ISSUER PROFILES SPANISH COVERED BOND PROFILES FRENCH COVERED BOND PROFILES IRISH COVERED BOND PROFILES UK COVERED BOND PROFILES SWEDISH COVERED BOND PROFILES PORTUGUESE ISSUER PROFILES ITALIAN ISSUER PROFILES OTHER COVERED BOND PROFILES 331 378 409 425 437 449 469 519 557 579 589 601 615 629 645
APPENDIX
Note: Unless otherwise stated, the sources for all table and charts in the profile section are company reports and Barclays Capital.
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10 June 2010
INTRODUCTION
Rebuilding trust
Fritz Engelhard +49 69 7161 1725 fritz.engelhard@barcap.com
Twelve months ago we published The AAA Handbook 2009: Finding a new balance. Since then, the environment for investors in supranationals, agencies, sub-sovereigns and covered bonds has generally improved. However, in recent months, it has become clear that some of the support measures established in 2008-09 have created new challenges. These are growing fiscal burdens in many countries, a more negative perception of sovereign default risk, rising supply of government debt and higher macroeconomic uncertainties, in particular with regard to inflationary expectations. The focus of all stakeholders is very much on rebuilding trust in the interplay between markets, regulation and supervision. In the introduction to this years edition of The AAA Handbook our eighth we discuss what differentiates the current market environment from the situation in H2 08 and highlight some specifics of AAA products. We also explain why the publication is still called The AAA Handbook, despite some negative rating migration and the impaired credibility of rating agencies. This Handbook consists of three sections: Strategy, Market Sector Overviews and individual Issuer Profiles. This year, we have included two sections on sovereign debt developments and the impact the substantial support packages is likely to have on the fiscal position of some countries and the broader economy. We comment on the development of secondary market liquidity and highlight the changes in covered bond rating methodologies and proposed changes to liquidity risk regulations. As usual, we also include our housing market forecasts. We have added and updated the sector overviews to account for the ever-changing and increasing covered bond universe. We describe legislation that has been amended, explain the respective frameworks and highlight strengths and weaknesses. Finally, we have enhanced the profiles section, including the new AAA debt issuers. We hope that The AAA Handbook 2010 will prove a useful tool in your investment decisions. If you have any questions please feel free to contact us our details are on the back page.
Dj-vu feelings but this time is different

Memories are still fresh from 2008-09
Pressure on equity and credit spread markets, high volatility in government debt markets, reduced secondary market liquidity and signs of stress in money markets, combined with central bank interventions, created a challenging market environment in Q2 10. This was a kind of dj-vu experience for many investors, who still had fresh memories from their experiences in Q4 08 and Q1 09. In particular, the recent rise in USD Libor fixing, which was not mirrored by a similar move in Euribor, has caused concerns about a renewed funding crunch. This seems to partly reflect a re-assessment of counterparty credit risk in light of sovereign concerns. Combined with a persistent fall in outstanding USD commercial paper, which decreased from $2.2trn in 2007 to $1.1trn currently, this has caused concerns about the ability of European banks to fund themselves in the US market. While the EUR-USD 1y basis swap moved below 50bp again, it seems unlikely that considerable demand for USD funding is emerging, or likely to emerge. In particular, the ECB could provide liquidity through longer-term (1M-3M) USD auctions if conditions deteriorate.
Concerns about USD funding of European banks
10 June 2010
Figure 1: USD Libor fixings increase

3.5 3.0 2.5 2.0
Figure 2: Moves in EURUSD basis

0 -10 -20 -30
1.5 1.0 0.5 0.0 Jan-09

-40 -50 -60 Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
EUR Euribor 3M
Source: Barclays Capital
USD LIBOR 3M (R)

Jul-09 Jan-10 EUR-USD 1yr basis
Moderate spread widening more driven by financials than corporates
Some other measures of financial stress, such as credit indices and FRA-OIS also indicate increasing pressure. 1y Spot FRAOIS in EUR and USD widened by 17bp and 36bp, respectively, between early April and end-May, leading to a conversion of both measures. Within the same period, the iTraxx 5y Europe widened from 80bp to 125bp. However, as can be seen in Figure 3, both measures are still far from the historically wide levels seen in 2008-09. Furthermore, the credit spread differential between financials and non-financials has reached a new peak, which partly reflects a higher sensitivity of financials to volatility in sovereign debt markets, but also indicates that concerns about the real economy are contained. From a AAA investors point of view, the main difference to the situation 15 months ago is the overwhelming impact of the development in (mainly European) sovereign debt markets, on the relative value across various AAA segments. This has had two important implications with regard to cross-sector allocation. First, stress in European sovereign debt markets has a more pronounced impact on the allocation between covered bonds and SSA markets. Second, other factors that used to influence swap spreads, such as supply/demand dynamics and issuer-specific risk factors have moved to the background.
Focus on sovereign debt markets
Figure 3: One-year spot FRA-OIS and 5y iTraxx Europe are far from distressed levels of 2008-09
200 180 160 140 120 100 80 60 40 20 0 Jul-08 Jan-09 Jul-09 EUR 1yr Spot FRA - OIS iTraxx 5yr Europe (RS)
Figure 4: Credit spreads of financials at their widest versus non-financials

100 50 0 -50 -100 -150 Jul-08
275 250 225 200 175 150 125 100 75 50 Jan-10 USD 1yr Spot FRA - OIS
Jan-09
Jul-09
Jan-10
iTraxx 5yr Europe: Financials - Non Financials

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Figure 5: Distribution of outstanding SSA debt by origin of the issuer (based on iBoxx), May 2010
Figure 6: Distribution of outstanding covered bond debt by origin of the issuer (based on iBoxx), May 2010
Portugal 2.3% Italy 2.0% Other 7.1%
Other 16.2% Austria 5.3% The Netherlands 7.4% Spain 7.6% Supra 15.0%
Source: Markit, Barclays Capital
Germany 33.4%
Sweden The 2.8% Netherlands 3.2% Ireland 3.2% UK 7.6%
Spain 30.7%
France 15.1%
Germany 19.7%
France 21.5%
High weight of European core countries in the SSA market
When managing exposure to sovereign risk across SSA and covered bond products, it is essential to take into account that the weight of core countries is much higher in SSA markets compared with covered bond markets. For example, European core countries and supra nationals currently make up 76% of the total outstanding SSA debt included in the iBoxx Index. At the same time, with a 31% market share, Spanish issuers are the largest contributors in the European covered bond arena, with issuers from Ireland, Portugal, Italy and Greece combined making up another 8%. The relatively strong weight of Spain in covered bond markets is reflected in the underperformance of the respective aggregate covered bond index versus the SSA Index. As Figure 7 shows, on aggregate the swap-spread differential between covered bonds and SSA markets widened from mid April to mid May. Thus, one form of expressing a view on the development of European peripheral markets is to adapt the relative weight of these two sectors, basically establishing an Overweight in SSA markets versus covered bonds, in case one expects a further swap spread widening in European peripherals and an Underweight in peripherals versus covered bonds in case one expects a swap spread tightening. The dominant influence of developments in sovereign markets on the relative value within the AAA sector is reflected in the narrow correlation between government bond spreads and agency spreads of issuers from the same country. Figure 8 highlights that spread moves in 4y Spanish government bonds reflected in similar swap spread moves of bonds issued by ICO, the Spanish government-sponsored agency. However, and this is particularly true for covered bonds, we also could observe that spread contraction in AAA products regularly lagged the respective spread tightening in sovereign markets by several days.
On aggregate, SSA markets outperformed covered bond markets between mid April and mid May
Narrow correlation between government bonds and agency debt from the same country
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Figure 7: Swap spread differential between covered bonds and SSA widens
160 140 120 100 80 60 40 20 0 Jul-09 Oct-09 Jan-10 Apr-10 ASW
Figure 8: Swap spread correlation of 4y government bonds and 4y agency bonds of the same country
180 160 140 120 100 80 60 40 20 0 -20 -40 -100
4Y Agency Swap Spread
-50
50
100
150
200
iBoxx Euro Covered 5-7 iBoxx Euro Sub-Sovereigns 5-7

4Y Sovereign Swap Spread Spain Germany France The Netherlands
Signs of resilience
Despite the substantial headwinds, there are a number of factors that are supportive for the AAA segment. First, the rally in yields and in particular in core European government bonds has made spread products more attractive again. As pricing action was very fast, many investors have missed the rally. In order to cope with target total return requirements without compromising on underlying default and loss risk, many investors focus strongly on the AAA segment when making new investments. Second, so far the kind of distressed selling pressure observed 15 months ago has not been prevalent. While investors were biased to check bids for all those sectors where the spill-over from the respective sovereign market was particularly pronounced, bid/ask spreads still remained below the levels reached in 2008-09. Third, we also note that the market differentiates much more strongly compared with the situation15 months ago. The large SSA, GGB and covered bond segments from European core countries as well as from UK and Scandinavian countries remained well bid throughout the phase of increased sovereign spread volatility.
Thinking beyond the rating letter

Yes, we still call this the The AAA Handbook
Over the past two years, we have frequently been asked whether we would consider changing the name of our AAA Handbook publication. Many debt instruments have lost their triple-A ratings and in the process, the credibility of rating agencies has suffered strongly. However, we have kept the title in the past two editions and we also keep it for this year for one very practical reason: most people still understand what we mean when saying the book covers the AAA sector. This is simply much shorter than supranationals, agencies, sub-sovereigns government-guaranteed and covered bonds. Second, although the sector has also experienced some downgrades and increased rating volatility, the respective rating actions were not only much more limited compared with other debt instruments, such as some structured credit products for example, but also rating agency default and recovery statistics underline that rating agencies were mostly on track with regard to their assessment of default and loss evaluations of more traditional debt instruments, including high investment grade securities. The debt products we covered in the 2009 edition of this book continued to pay interest and principal on schedule and most of those suffering downgrades were staying close to the AAA level.
Most ratings remained close to AAA and all products continued to make scheduled payments
10 June 2010
A rates product differs from a credit product in the way investors look at it
Third, irrespective of their actual rating, AAA products are different from traditional credit instruments. Most investors in AAA debt generally focus strongly on actively managing the exposure of their portfolios to changes in interest rates or the shape of the yield curve rather than fundamental default and loss risk. They buy and sell securities not just because they are bullish or bearish on certain credits, but mainly because they wish to express a view on interest rates and/or moves of the swap curve versus the government bond curve. Thus, compared with typical credit investors, they make stronger demands on secondary market liquidity. Their investment decisions are also driven by the specific regulatory treatment of these instruments in terms of risk-weighting and central bank repo eligibility 1. Finally, market participants increasingly refrain from applying strict rating criteria. While it appears tempting to implement strict rules because of the simplicity and clarity of such an approach, there are a number of caveats. First, the definition of ratings varies across the major agencies. Strict rules are not suited to take this aspect into account. Second, hard rating limits put asset managers under pressure to sell securities when the respective limit is breached because of a downgrade. As the market environment is generally difficult in such instances, the respective unwind could be harmful for the performance of the affected portfolio. Third, the market processes information faster than the rating agencies. Default rates and rating trends generally reach a turning point about six-to-nine months after credit spreads reach a cyclical peak. Thus, investors and regulators are at risk of being consistently behind the curve when applying strict rating criteria. Owing to these drawbacks, we recommend avoiding the use of ratings as strict investment criteria as much as possible. Avoiding ratings as strict investment criteria does not imply that one should completely ignore them. Quite the contrary is true. Generally, ratings are the result of a detailed analytical process. Rating agencies put a lot of effort into developing specific rating methodologies. Furthermore, they reacted to the financial market turmoil by adjusting their general methods, changing their assumptions and disclosing more information on their rating approaches. Following these discussions, monitoring the development of risk factors, tracking the assumptions regarding payment interruptions and recoveries, could all be beneficial in strengthening the understanding of AAA products. One interesting common characteristic of the products covered in the book is that rating agencies developed specific rating approaches for these products. They differ from the general corporate debt rating methodologies, as supranationals, agencies, sub-sovereigns government-guaranteed and covered bonds generally feature below-average default risk and above-average recovery prospects, irrespective of the actual rating level. This is why we keep the AAA Handbook title and might even continue to do so even if the rating agencies drop rating letters.
Drawbacks of using ratings as strict investment criteria
Beyond the rating letter the benefits of a qualitative approach to ratings
In this context it is worth noting that in 2007, the ECB published a working paper titled, What hides behind sovereign ratings? It concludes that across rating agencies and over various periods the respective ratings have a good overall prediction power.
10 June 2010
CENTRAL BANK COLLATERAL SCHEMES
Broadening the scope

Fritz Engelhard +49 69 7161 1725 fritz.engelhard@barcap.com Huw Worthington +44 (0) 20 7773 1307 huw.worthington@barcap.com
The eligibility of the debt instruments covered in this handbook as collateral for central bank liquidity facilities has been an important factor in bank sector demand for the asset class over the years. One of the features of central bank responses to the credit crisis has been a widening in the range of facilities through which central banks have provided funds against collateral to market participants. There are significant variations in the range of collateral accepted in the different facilities provided by the ECB, the Fed and the Bank of England. Below we provide a summary.
Collateral at the ECB

Collateral is placed with the Eurosystem to secure borrowing from it and to back the payments system
Banks deposit collateral with the Eurosystem (ie, the ECB and member central banks) as security for borrowing from the ECB and as security for intra-day credit provided in the process of the operation of the real-time payments system (TARGET). The ECB defines the criteria for determining the eligibility of assets as collateral and publishes updated lists of eligible assets daily. The same list applies to all collateral transactions within the Eurosystem. The ECB accepts a wide range of EUR-denominated assets as collateral, ranging from government bonds to asset-backed securities (ABS) and credit claims. For ABS, only true sale securitisations can be included, and bonds must be from the most senior tranche available. From 1 March 2010, the credit requirements for ABS were amended such that ABS issued after 1 March 2009 also had to have an initial rating of AAA/Aaa with at least two rating agencies. From 1 March 2011, this would be extended to all ABS in issue irrespective of issuance date. Over the lifetime of the ABS, however, the previously existing single-A minimum rating threshold would have to be retained for it to remain eligible. CDOs of ABS are not eligible as collateral. At the beginning of 2007, the ECB moved from a two-tier collateral system (in which some assets were limited to use as collateral in specific countries) to a single list, which now defines the assets eligible as collateral throughout the Eurosystem. The ECB announced further changes to its collateral policy in 2008, with the changes taking effect from 1 February 2009. The main changes, implemented were the following: A change in the categories of collateral, with ABS shifted to a new Category 5, and traditional unsecured bank bonds being shifted to a new Category 4 (Figure 9 and Figure 10). An increase of 5% in the haircut charged on unsecured bank bonds (the new Category 4) across the board. A uniform haircut for ABS securities in Category 5, of 12% (instead of the previous sliding scale, and the effective haircut for most ABS that was at 2%). In addition, for all ABS that are priced theoretically (basically, for which there is no secondary market), there is an extra surcharge of 5% (effectively 4.4%). Traditional (and jumbo) covered bonds are not included in this. The definition of close links is being extended, so as to exclude some bonds, and there are also some increased requirements related to ratings.
A wide range of EUR debt is eligible
Shift to a single list at the start of 2007
10 June 2010
Figure 9: New categories of eligible marketable collateral

Category 1 Central government Central banks Category 2 Local/regional government Jumbo covered bonds Supras/agencies
Source: ECB
Category 3 Traditional covered bonds Corporate/other
Category 4 Credit institutions
Category 5 ABS
Eligible assets include marketable and non-marketable assets
The single list is composed mainly of marketable assets, which are grouped into four categories, reflecting varying levels of liquidity. However, with the initiation of the single list at the start of 2007, non-marketable assets (mainly credit claims or bank loans) were included in the list across the whole euro area for the first time. In addition, with the move to a single list, the range of issuers has been expanded to include, for example, EURdenominated debt issued by entities established in G-10 countries outside the EEA. Marketable assets are subject to haircuts. For floating rate assets, the haircut for 0-1y fixed-rate debt in the corresponding liquidity category is applied. Therefore, for European ABS, most of which is in floating rate form, this is normally the relevant measure.
Figure 10: Haircut schedule for fixed coupon marketable assets (%)
Residual maturity (yrs) 0-1 1-3 3-5 5-7 7-10 >10 Category 1 0.5 1.5 2.5 3 4 5.5 Category 2 1 2.5 3.5 4.5 5.5 7.5 Category 3 1.5 3 4.5 5.5 6.5 9 Category 4 6.5 8 9.5 10.5 11.5 14 Category 5* 12 12 12 12 12 12
Note: Assets in category 5 that are given a theoretical value are subject to an additional valuation markdown of 5% Source: ECB
Non-marketable assets are subject to much higher haircuts than marketable assets, Figure 11.
Figure 11: Haircut schedule for fixed coupon non-marketable assets (%)
Residual maturity (yrs) 0-1 1-3 3-5 5-7 7-10 >10
Note: *NCB = National Central Bank. Source: ECB
Fixed interest payment and valuation based upon theoretical price assigned by NCB* 7 9 11 12 13 17
Fixed interest payment and valuation according to the outstanding amount assigned by NCB 9 15 20 24 29 41
There was c.EUR13.1trn of eligible collateral in 2009
The ECB estimates that in 2009, total eligible collateral averaged EUR13.1trn, of which, on average, EUR2.034trn was deposited as collateral in the Eurosystem. Of this, EUR709bn, on average, was used as collateral for borrowing from the ECB via open market operations (OMOs).
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10
Figure 12: Breakdown of assets put forward as collateral by asset type

2,500 2,000 1,500 1,000 500 0 2004 Government Corporate Other 2005 2006 Avg 2007 Avg 2008 Avg 2009 Avg Credit Institutions - uncovered ABS Credit Institutions - Covered Non -marketable assets
Note: The Government category includes debt issued by central and regional governments. Source: ECB, Barclays Capital
Fall in usage of government bonds and rise in ABS, bank bonds and credit claims
According to the ECB Annual Report, central government bonds increased as a percentage of total collateral held in the Eurosystem, from 10% to 11% between 2008 and 2009 (comparing year average data). The share of ABS went down from 28% in 2008, to 23% in 2009, due to reductions in market values and haircut increases, while the overall actual amount remained stable. The fall in ABS saw uncovered bank bonds increase their share to become the largest single class in 2009 at c.28%, thus exceeding the amount of ABS. Although it takes longer to establish eligibility for credit claims than for marketable assets and despite the higher haircuts to which they are subject, the amount of non-marketable assets used increased from 4% in 2006, to 14% on average in 2009. The new asset classes, some of which are temporarily eligible, accounted for 3.8% on average. In addition to the claims above, the ECB in October 2008 temporarily extended the range of eligible assets to include the following listed below. Initially the assets were to be eligible until end 2009, however this was subsequently extended and they will remain eligible until the end of 2010 currently. Marketable debt instruments denominated in other currencies than the euro, namely the US dollar, the British pound and the Japanese yen, and issued in the euro area. These instruments are subject to a uniform haircut add-on of 8%. Debt instruments issued by credit institutions, which are traded on the accepted nonregulated markets that are mentioned on the ECB website; this measure implies inter alia that certificates of deposits (CDs) are also eligible when traded on one of these accepted non-regulated markets. All debt instruments issued by credit institutions, which are traded on the accepted non-regulated markets, are subject to a 5% haircut add-on. Subordinated debt instruments when they are protected by an acceptable guarantee as specified in section 6.3.2 of the General Documentation on Eurosystem monetary policy instruments and procedures. These instruments are subject to a haircut add-on of 10%, with a further 5% valuation markdown in case of theoretical valuation. Furthermore, the ECB announced a lowering of the credit threshold for marketable and nonmarketable assets from A- to BBB-, with the exception of ABS, and imposed a haircut add-on of 5% on all assets rated BBB-. The measures were originally intended to remain in force until end-2009, again however this was extended until first end-2010 and then in April 2010 it was
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announced that they would be allowed permanently. As previously, these lower-rated assets are subject to an increased haircut of 5%; however, the ECB also said that in July 2010 it would replace the uniform haircut add-on with a graduated haircut schedule, which will be at least as high as the haircut currently applied, based upon the following parameters. Maturity, liquidity category and the credit quality of the asset. The lowest haircuts will apply to the most liquid assets with the shortest maturities, while the highest haircuts will apply to the least liquid assets with the longest maturities. Notably no changes were to be made to the current haircut schedule foreseen for central government debt instruments and possible debt instruments issued by central banks that are rated in the above-mentioned range. This carve-out for government debt was supplemented by a subsequent decision in early May 2010 that until further notice the minimum credit rating threshold for marketable debt instruments issued or guaranteed by the Greek government would be suspended. The new haircuts will not imply an undue decrease in the collateral available to counterparties.
Collateral at the Fed

Prior to the onset of the banking sector liquidity crisis in H2 07, the Fed made three facilities available in which it accepted specified types of USD-denominated collateral, against the provision of funds or securities, namely: OMOs with primary dealers Discount window lending to banks Securities lending through the system open market account (SOMA) With financial markets returning to more normal activity, the liquidity and credit programmes introduced in 2008 have all expired with the exception of a small part of the Term Asset-Backed Facility (TALF). The TALF supports the issuance of ABS collateralised debt by a wide variety of loans by providing non-recourse (three-year) funding to any eligible borrower owning eligible collateral. At the moment with bank reserves exceeding $1trn, and its exit strategy still several months off, the Federal Reserve is doing no open market operations and use of the discount window has ebbed to under $10bn. Securities lending through the SOMA also has been light mainly because the amount of specials activity in the repo market has been compressed by the low level of repo rates.
Collateral at the Bank of England

Range of different collateral lists eligible for different facilities
Traditionally, the Bank of England (BoE) has provided funds against collateral via: OMOs both short-term (normally one week) repos conducted weekly at the Banks official rate, and longer-term repos (with maturities from three to 12 months), conducted monthly at variable rates. Standing facilities, through which the BoE lends to eligible UK banks and building societies overnight at a penal rate. For both OMOs and standing facilities, the BoE normally accepts as collateral: UK government securities and bills in GBP and other currencies BoE foreign currency debt securities
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Certain GBP and EUR securities issued by EEA central governments, central banks and international institutions. At various stages since the start of the crisis, the BoE has provided additional longer-term funding against a wider range of collateral. However, the most notable of these came in late April 2008, when the BoE announced a Special Liquidity Scheme (SLS), affecting institutions eligible to use its standing facilities. Under this scheme, the BoE provides Treasury bills for certain assets sitting on bank balance sheets that cannot be securitised in the wholesale funding market. The key features of the facility are as follows.
Acceptable collateral
AAA UK and EEA covered bonds AAA tranches of UK and EEA RMBS AAA tranches of UK, US and EEA credit card ABS G10 sovereign debt rated Aa3 or higher G10 explicitly guaranteed Agency AAAs Conventional US GSE AAA debt
Currency
The facility is not limited to GBP-denominated securities, but can also be used for EUR, USD, AUD, CAD SEK, CHF and JPY (the last for Japanese government bonds only). However, foreign currency securities will be liable to an additional haircut.
Constraints on RMBS
For RMBS, the facility is primarily intended to provide liquidity for securities backed by collateral held on bank balance sheets at end-2007, and not to provide a source of funding new business. For RMBS master trusts that include assets originated after December 2007, their securities will be eligible on a declining scale over time, ie, 100% of the amount outstanding at 31 December 2007 is eligible in Year 1, 66% in Year 2, and 33% in Year 3.
Term and size

The SLS was introduced in April 2008, and was designed to finance part of the overhang of illiquid assets on banks balance sheets by exchanging them temporarily for more easily tradable assets. Securities formed from loans existing before 31 December 2007 had been eligible for use in the SLS. The drawdown period for the SLS closed on 30 January 2009. Use of the Scheme has been considerable, totalling 186bn of Treasury Bills against 287bn of collateral. Although the drawdown window to access the SLS has closed, the Scheme will remain in place for three years, thereby providing participating institutions with continuing liquidity support and certainty. In March 2010, the Bank of England published a consultation document that sought views on two specific issues: First, on extending the list of eligible collateral acceptable at its Discount Window Facility so as to include various classes of loan portfolios; and second, on an initiative to require greater transparency with respect to the covered bonds and ABS that it acquires via its market operations.
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SECONDARY MARKET CONDITIONS
Happiness makes up in height for what it lacks in length 2

The significant improvement of secondary market liquidity for -denominated AAA instruments, which could be observed in the course of H2, were challenged by the persistent deterioration of trading conditions in sovereign markets in the first few months of 2010. While the renewed worsening of secondary market liquidity was a kind of dj-vu experience for many investors, we would argue that the current situation differs from that the market experienced 15 months ago, as there are a number of factors which suggest that an acceptable level of secondary market liquidity could be sustained. Between Q2 09 and Q4 09, secondary market liquidity in -denominated AAA instruments improved markedly. This was the result of a whole bundle of supporting factors. First, issuance activity in SSA and GGB space decreased substantially in the course of H2 09, which helped ease concerns regarding a permanent repricing of the sector through primary market transactions. Second, the European Central Banks covered bond purchase programme led to a swing from one-sided selling to one-sided buying in covered bond markets. Third, the bond market rally, which saw the 5y swap rate decrease by 50bp between early June and early October, has created an incentive to some investors for taking profit. This in turn led to more two-way flow in AAA markets, thereby further improving secondary market liquidity. The narrowing of bid/ask spreads in -denominated benchmark AAA instruments was well reflected in covered bond markets, where swap spreads have been subject to a marked tightening since the ECB announced the implementation of the CBPP. Average bid/offer spreads persistently fell from rather wide levels of up to 75bp in Q1 09, to their lowest figure of down to 5-10bp in mid April 2010, thereby reducing significantly the liquidity gap between various market segments (Figure 13).
Significant improvement of market conditions in H2 09
Pronounced tightening of bid/ask spreads in some covered bond instruments
Figure 13: Bid/offer spreads on secondary covered bond market

80 bp 75
60
50 35 35 25 15 10 5 10 10 20 20 7 20 25 20 15 7 12
50
40 20 20
30
30 20 15 7 12 20 10 15
0 Pfandbrief early 2009

Multi-Cdulas mid 2009
Cdulas early 2010
Obl Fonc
Fr Common
UK Covered Mid May 2010
Mid April 2010
Robert Frost (American Poet)
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Pronounced tightening of bid/ask spreads in some covered bond instruments
Already in February and more pronounced from mid April onwards, increasing tensions in sovereign debt markets had significant spill-over effects in AAA markets. The pattern was rather simple. Agencies, sub-sovereigns, government guaranteed bonds and covered bonds issued out of European peripheral countries saw their swap spreads widen basically in line with swap spreads of the respective government bonds. The worsening of market conditions also reflected in bid/ask spreads, which widened back to mid 2009 levels in Cdulas for example, but in jumbo Pfandbriefe widened back towards 10bp again. Interestingly, in the early phase of the sovereign debt-related swap spread widening, some AAA instruments, including covered bonds, eventually traded tighter compared to the respective government bonds of the same country. The renewed worsening of secondary market liquidity was a kind of dj-vu experience for many investors, who still had fresh memories from their experiences in Q4 08 and Q1 09. However, in our view, the current situation differs from the situation the market experienced in the pronounced liquidity squeeze of Q4 08/Q1 09. First, pressure is not coming out of traditional credit spread markets and stress in interbank lending markets but rather from the other end of the fixed income spectrum (Figure 14). Second, the rally at the long-end of the yield curve leaves many fixed income investors with outright gains on their investments (Figure 15). Third, so far there has been no distressed selling behaviour in AAA markets characterised by price-insensitive inventory clearing operations. Fourth, screen prices have generally become more reliable, as market makers are less inclined to keep bid/ask spreads artificially tight, but are more ready to express potential buying and selling levels through the quotes shown on the screens The above differences to the stressed situation in Q4 08/Q1 09, have some important implications for trading patterns and investor behaviour. As most investors in AAA products mainly use their exposure to SSA, GGB and covered bond markets to enhance return beyond their core mandates in sovereign markets, they were forced to shift their attention strongly towards managing their exposure to sovereign debt markets. Furthermore, even investors with pure non-sovereign mandates were obliged to focus on the development in sovereign debt markets, as the situation in the respective sovereign market generally overshadowed other traditional relative value factors, such as issuer-specific risk, demand/supply trends and, for covered bonds, the quality of collateral assets. If anything, most investors became stricter in limiting their exposure to those sovereigns that have been identified as more vulnerable. However, on the positive side, we could also observe that in those periods where trading conditions in the affected sovereign debt markets improved, with a certain delay, this also had positive spill-over effects for the AAA products trading environment. Figure 15: Strong outright performance of long-dated covered bonds makes unwinds less painful
115 113 111 109 107 105 103 101 99 97 95 Jan 09
Dj-vu feelings but this time is different
Investors shift focus on exposure to sovereign risk and the management of country risk limits
Figure 14: Swap spread widening in Spanish agency and covered bonds largely a result of pressure on SPBGs
OAS 180 160 140 120 100 80 60 40 20 0 -20 Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Apr 09
Jul 09
Oct 09
Jan 10
Apr 10
ICO 3.500% Jan 14 SPGB 4.250% Jan 14

SANTAN 3.500% Feb 14
iBoxx Euro Covered 1-3 Total Return Index iBoxx Euro Covered 7-10 Total Return Index
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Bond market rally fosters twoway flow
Another aspect that differentiates the current situation from the one 15 months ago is the strong performance at the long end of the yield curve. As pricing action was very fast, many investors have simply missed the rally. In order to cope with target total return requirements without compromising on underlying default and loss risk, many investors focus strongly on the AAA segment when making new investments. Furthermore, the bond market rally reduces potential losses that outright investors may need to incur when unwinding some of their exposures to markets with above-average spread volatility. Both factors contribute to two-way flow and help improve secondary market liquidity. Between mid April and mid May, secondary market turnover in AAA markets was characterised by investors checking bids for all those sectors where the spill-over from the respective sovereign market was particularly pronounced. However, there was not the same kind of distressed selling pressure as it could be observed 15 months earlier. This is also reflected by the fact that bid/ask spreads still remained below the levels reached in early 2009, while swap spreads in some cases hit fresh highs. Given that central banks reacted quickly by signalling that they are prepared to accommodate rising demand for liquidity, for the moment there are no signs that history will repeat itself on this front. Furthermore, the large SSA, GGB and covered bond segments from European core countries as well as from UK and Scandinavian countries remained rather well bid throughout the phase of increased sovereign spread volatility. A fourth element, which differentiates the current situation from the one 15 months ago, is the more realistic approach to show prices on screens. In particular in the jumbo covered bond sector, historically market makers were generally inclined to show artificial screen prices, which gave misleading information on executable price levels and rather hampered price discovery. Many investors adapted their approach and switched from price taker into price maker mode. By communicating the prices they were prepared to accept, they kept informed about market opportunities and they could also gauge the development of liquidity over time. However, in the course of 2009 already, market makers have adapted their approach, showing screen prices which better reflect executable levels. Thus, it has become easier for investors to evaluate market conditions, although the overall market depth was limited through the fact that the respective amounts have been cut down and the number of active market makers decreased. While the above elements may help sustain an acceptable level of secondary market liquidity, we warn that liquidity conditions are unsteady. Renewed market volatility, in combination with the negative experience of many investors of being limited to fulfil their mandates in managing risk positions, makes them not only risk-averse but also sensitive to changes in market conditions.
So far no signs of distressed selling
More realistic screen prices for jumbo covered bonds
Environment remains challenging
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AAA RATED BONDS AND BENCHMARK INDICES
The Barclays Capital Euro Aggregate Bond Index

Leef H Dierks +49 (0) 69 7161 1781 leef.dierks@barcap.com
The Euro-Aggregate Index tracks fixed-rate, investment-grade euro-denominated securities. Inclusion is based on the currency of the issue, and not the domicile of the issuer. The principal sectors in the index Treasury, Corporate, Government-Related and Securitised Securities are part of the Pan-European Aggregate and the Global Aggregate indices. The Euro-Aggregate Index was launched on 1 July 1998.
Figure 16: Barclays Capital Euro Aggregate Bond Index weighting of selected sub-sectors, 2010
Baa 8% A 11%
Securitised 12%
Corporate 18% Treasury 55% Govt.Related 15%

Aa 27% Aaa 54%
Figure 17: Barclays Capital Euro Aggregate Bond Index country weightings, 2010
Greek 3% Belgian 4% Austrian Portuguese 2% 3% Other 3% German 22%
Dutch 5% Spanish 11% French 19% Non-EMU 13%
Italian 15%
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Pricing and related issues

Sources and frequency
All bonds are priced daily by Barclays Capital traders, third-party vendors or, as in the case of traditional Pfandbriefe, by an interpolated yield curve. Pricing is at 4:15pm London time. If European markets are open, but the UK is closed, then pricing will remain constant until the close of the next UK business day. If the last business day of the month is a public holiday in the major European markets, then prices from the previous business day are used. Outstanding issues are priced on the bid side, with the exception of Euro Treasury bonds, which use mid dollar prices. New issues enter the index on the offer side. T+1 settlement basis Multi-contributor verification: The primary price for each security is analysed and compared to other third-party pricing sources through both statistical routines and scrutiny by research staff. Significant discrepancies are investigated and corrected as necessary. On occasion, index users may also challenge price levels, which are subsequently reviewed by the pricing team. Prices are then updated as needed using input from the trading desk.
Timing
Bid or offer side
Settlement assumptions Verification
Rules for inclusion

Amount outstanding Quality
300mn minimum par amount outstanding. Must be rated investment grade (Baa3/BBB-/BBB- or above) using the middle rating of Moodys, S&P and Fitch, respectively. When all three agencies rate an issue, a median or two out of three rating is used to determine index eligibility by dropping the highest and the lowest rating. When a rating from only two agencies is available, the lowest (most conservative) of the two is used. When a rating from only one agency is available, that rating is used to determine index eligibility. Unrated Pfandbriefe are assigned ratings that are one full rating category above the issuers unsecured debt. This is consistent with Moodys methodology and reflects the underlying collateral.
Maturity
Maturity At least one year until final maturity, regardless of optionality. For securities with a coupon that converts from fixed to floating, at least one year until the conversion date. Perpetual securities are included in the index provided they are callable or their coupons switch from a fixed to variable rate. These are included until one year before their first call date, providing they meet all other index criteria.
Seniority of debt
Senior and subordinated issues are included. Undated securities are included provided their coupons switch from fixed to variable rate. Fixed-rate, step-up coupons and coupons that change according to a pre-determined schedule are also included. Capital securities with coupons that convert from fixed to floatingrate are index-eligible given that they are currently fixed-rate; the maturity date then equals the conversion date. Fixed-rate perpetual capital securities that remain fixed-rate following their first call date and which provide no incentives to call the bonds are excluded.
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Coupon
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Currency Market of issue Security Types
Euro. Publicly issued in the eurobond and eurozone domestic markets. Included: Fixed-rate bullet, puttable and callable Soft bullets Fixed-rate and fixed-to-floating capital securities Excluded: Bonds with equity-type features (eg, warrants, convertibility to equity) Private placements, including Schuldscheine Floating-rate issues Inflation-linked bonds German Schuldscheine and Genussscheine
Rebalancing rules
Frequency
The composition of the Returns Universe is rebalanced monthly at months end and represents the set of bonds on which index returns are calculated. The Statistics Universe changes daily to reflect issues dropping out and entering the index, but is not used for return calculation. On the last business day of the month, the composition of the latest Statistics Universe becomes the Returns Universe for the following month. During the month, indicative changes to securities (maturity, credit rating change, sector reclassification, amount outstanding) are reflected in both the Statistics and Returns universe of the index on a daily basis. These changes may cause bonds to enter or fall out of the Statistics Universe of the index on a daily basis, but will affect the composition of the Returns Universe only at month-end when the index is rebalanced. Interest and principal payments earned by the Returns Universe are held in the index without a reinvestment return until month-end when it is removed from the index. Qualifying securities issued, but not necessarily settled; on or before the month-end rebalancing date qualify for inclusion in the following months Returns Universe.
Index changes
Re-investment of cash flows
New issues
Development of AAA segment

Debt issued by supras, sub-sovereigns, agencies, and within the scope of governmentguaranteed or covered bond programmes is represented in the Government Related and Securitised sub-indices. As of mid-May 2010, these two sectors made up 1.86trn or 27% of the total volume outstanding. The Government Related Sub-Index (1,045bn) consists of Agencies (557bn), Local Authorities (284bn), Sovereigns (69bn), and Supranationals (133bn). The Securitised Sub-Index (817bn) is mostly made up of Mortgage (574bn) and Public Sector (189bn) covered bonds. Figure 18 and Figure 19 show the composition of the AAA segment, ie, the development of the total amount outstanding, and the respective swap spread developments.
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Figure 18: Barclays Capital Euro Aggregate Bond Index weightings of AAA subsectors, 2010
Public Sector Covered 10%
Agencies 31%
Mortgage Covered 32%
Supranational Sovereigns 7% 4%
Local Authorities 16%
Figure 19: Barclays Capital Euro Aggregate Bond Index AAA sector amount outstanding and spread development
bn 1200 1000 800 600 400 200 0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Dec-09 Government-Related Public Sector Covered
OAS 250 200 150 100 50 0 Jan-07 Jul-07 Jan-08 Jul-08 Government-Related Public Sector Covered
Jan-09 Jul-09 Dec-09 Mortgage Covered
Mortgage Covered
The iBoxx Index

The iBoxx Index family represents the investment grade fixed-income market for euro and euro area currency-denominated bonds 3. The iBoxx Benchmark Index comprises an overall index and four major index sub-groups. These are sovereigns, corporates, collateralised (covered and other securitised bonds) and sub-sovereigns (agencies, supranationals and government-guaranteed organisations), which fulfil the respective maturity, rating and sector index requirements. The Sovereign Index group is made up of eurodenominated sovereign debt from euro area governments. It includes an overall index and maturity indices. At the time of writing, an iBoxx Index is published for Germany, France, Italy (each with overall and maturity indices), Austria, Belgium, Finland, Greece, Ireland, Luxembourg, the Netherlands, Portugal, Slovakia and Spain (each with overall indices).
3
Note that bonds denominated in a non euro currency are included in the iBoxx indices with their amounts outstanding being redenominated into euro.
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The iBoxx Non-Sovereigns Index comprises all those bonds that do not qualify for inclusion in the iBoxx Sovereigns Index. These bonds are further classified into the Sub-sovereign, Collateralised and Corporates sub-groups. In the following, we limit ourselves to the SubSovereigns and Collateralised indices. The respective structure is outlined below (Figure 20).
Figure 20: New iBoxx Overall Benchmark Index

iBoxx Overall Benchmark Index iBoxx Non-Sovereigns Index iBoxx Sub-sovereigns Rating and Maturity indices iBoxx Supranationals iBoxx Agencies iBoxx Public Banks iBoxx Regions iBoxx Other Sovereigns iBoxx Other Sub-sovereigns iBoxx Collateralised Rating and Maturity indices iBoxx Covered iBoxx Germany Covered iBoxx Spain Covered iBoxx France Covered iBoxx Ireland Covered iBoxx UK Covered iBoxx Other Covered iBoxx Austria Covered iBoxx Netherlands Covered iBoxx Norway Covered iBoxx Portugal Covered iBoxx Sweden Covered iBoxx US Covered iBoxx Italy (new) iBoxx Securitised iBoxx Other Collateralised iBoxx Sovereigns Index
Source: Indexco, Barclays Capital
iBoxx Corporates Rating and Maturity indices iBoxx Financials Financials Rating Indices Financials Sub Indices iBoxx Non-Financials Non-Financials Rating Indices iBoxx Corporates Market Sector Corporates Market Sector Indices
Addition of further sub-indices
In 2008, the iBoxx Covered Index was enhanced by six new country sub-indices. Among these were Austria, The Netherlands, Norway, Portugal, Sweden and the US. Furthermore, the sub-index Spain Covered was split into Spain Covered 1-3, Spain Covered 3-5, Spain Covered 5-7, Spain Covered 7-10 and Spain Covered 10+. In addition, the section Covered 1-10 was created. Also, where appropriate, individual country indices were subdivided to better reflect the legal status of the covered bonds issued. For the time being, this holds true for French Obligations Foncires and French Common Law Covered Bonds. Since January 2009, however, this separation is also applicable to the Spain Covered section, which was divided into iBoxx Spain Covered Single Cdulas and iBoxx Spain Covered Pooled Cdulas. Also, in 2008, an iBoxx Other Pfandbriefe category was introduced, which at the time of writing included covered bonds collateralised by ship mortgages. Following the inaugural launch of an Italian OBG in 2008, Italy was extracted from the Other Covered bracket in 2009 and established as a proper sub-index. Following Italys departure, the Other Covered Index include Canada, Finland, Luxemburg and Hungary, at the time of writing. In order for covered bonds issued out of a single country to be grouped into an individual index, a minimum total issue of 6bn from at least two issuers is required.
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Pricing provided by 10 financial institutions
Prices for the bonds included in the indices are provided by 10 major financial institutions, among them Barclays Capital. Deutsche Brse calculates and disseminates the indices. The frequency of calculation and dissemination is once per minute between 9.00am and 5.15pm CET. End-of-day closing values are calculated and disseminated for all indices after 5:15pm CET. Operationally, the iBoxx indices have a base date of 31 December 1998.
iBoxx Index rules

Only fixed-coupon and zerocoupon bonds and step-ups are eligible for inclusion in the index
The selection criteria for the inclusion of bonds in the iBoxx indices are the bond type, the rating, the time to maturity, and the outstanding amount. Generally, only fixed-rate bonds whose cash flow can be determined in advance, such as fixed-coupon, zero-coupon or stepup bonds, are eligible for the indices. Soft-bullet bonds are considered only for the iBoxx collateralised indices. Callable bonds are only eligible if they are subordinated debt, including fixed-to-floaters. Sinking funds, amortising bonds, other callable, undated bonds, floating rate bonds, fixed-to-floater bonds, collateralised debt obligations (CDOs) and bonds collateralised by CDOs, German Kommunalanleihen and retail bonds are specifically excluded from the indices. Originally, UK covered bonds belonged to the collateralised category, but they were transferred to the covered category in 2005, where they now have their own sub-category (UK Covered) (Figure 20). Figure 21 outlines the bond types that are currently included in the iBoxx Covered Index.
Figure 21: Covered bonds qualifying for the iBoxx Covered Index
Name Fundierte Bankschuldverschreibungen Jumbo Pfandbrief Obligations Foncires Cdulas Hipotecarias Cdulas Territoriales Lettre de Gage Asset Covered Security UK Covered Bonds Obrigacaoes Hipotecarias Skerstllda Obligationer Srligt Dkkede Realkreditobligationer Dutch Covered Bonds Obbligazioni Bancarie Garantite Jelzaloglevel Obligasjonsln med portefoljepant Joukkovelkakirja Canadian Covered Bonds US Covered Bonds Country of origin Austria Germany France Spain Spain Luxemburg Ireland UK Portugal Sweden Denmark Netherlands Italy Hungary Norway Finland Canada US
Note that as at April 2010, Greek covered bonds were not included in the Markit iBoxx EUR Covered indices. Source: iBoxx, Barclays Capital
Investment grade rating required for inclusion in iBoxx Index
All bonds in the iBoxx Index family must be rated investment grade by at least one of Standard & Poors, Moodys or Fitch. In case a bond is rated by several agencies, the average rating rounded to the nearest integer will be attached to the bond. The rating determines whether the bond is eligible for the iBoxx indices and to which rating index it belongs. The minimum rating to qualify a bond as investment grade is BBB- for Fitch or S&P and Baa3
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from Moodys. Ratings are consolidated (eg, BBB+, BBB and BBB- are consolidated to BBB; A+, A and A- are consolidated to A and so on) 4. Note that bonds in the iBoxx Eurozone Index do not need to be rated; however, a rating requirement for the individual countries included in this index has been introduced. In order for their bonds to be eligible for the indices, all countries which are part of the iBoxx Eurozone indices require a long-term local currency sovereign debt rating of investment grade. The respective index rating is determined by the average rating of Fitch Ratings, Moodys Investors Service and Standard & Poors Rating Services.
Minimum amount outstanding required for inclusion in iBoxx Index
All bonds must have a minimum remaining term to maturity (TTM) of at least one year on the respective rebalancing date. Also, as outlined in Figure 22, the bonds require a specific minimum amount outstanding to be eligible for the indices.
Figure 22: Minimum amount outstanding for inclusion in iBoxx Index

Bond Sovereigns Sub-sovereigns Covered Collateralised Corporates
Source: iBoxx, Barclays Capital
Outstanding amount 2bn 1bn 1bn 500mn (1bn) (except covered bonds) 500mn (1bn for bonds issued in legacy currencies)
Figure 23 outlines the development of the historical weightings of different AAA groups within the iBoxx Index. The combined weight of the sectors outlined below (Agencies, Regions, Covered Bonds, Supranationals and Other Sub-Sovereigns) amounted to c.20.8% as at end-April 2010, decreasing around 0.8pp from 21.6% as at end-April 2009. The sudden decline in the weight of the AAA bonds in mid-2004 was attributed to a reduction in the weightings of agencies. This comes as iBoxx reclassified several institutions, among them German Landesbanks, Electricit de France, Infrastrutture SpA, and others.
Figure 23: Historical weights of agencies, regions, covered bonds, supranationals and other sub-sovereigns (%)
25 20 15 10 5 0 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Agencies Supranationals
Other sub-sovereigns Covered
Regions Total
Ford and GM were taken out of the index in the first half of 2005, which resulted in a sudden increase in credit spreads and a sudden decrease afterwards due to survivorship bias.
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Asymmetric swap spread widening from September 2008
The historical ASM development for these sub-indices is outlined in Figure 24. On a general note, we observe that between 2000 and 2007, the sectors analysed performed relatively well. Owing to the turmoil in the global money and capital markets, which became more evident in August 2007, the asset swap margin (ASM) of covered bonds started widening in a relatively stronger manner compared with other sub groups. Following the collapse of Lehman Brothers in mid-September 2008, however, spreads started widening significantly. In this context, we observe a strongly asymmetrical development of the widening momentum. Following the pronounced widening momentum observed in early 2009, swapspreads started to contract again after the ECB announced its 60bn covered bond purchase programme. Still, the once relatively homogeneous market had already started drifting apart in early 2008. Following a recovery phase of swap-spreads in late 2009, they came under renewed pressure in early 2010, as concerns regarding the fiscal position of some Mediterranean rim European Monetary Union member countries started mounting (Figure 24).
Figure 24: Historical ASM for covered bonds, agencies, regions, supranationals and other sub-sovereigns (bp)
200 150 100 50 0 -50 Jan-06 Agencies
Jan-07
Jan-08 Regions
Jan-09 Supranationals
Jan-10 Covered
Other sub-sovereigns
Figure 25 outlines the relative weights of the selected sub-covered bond sectors within the iBoxx Index. As can be seen, the ongoing modest supply of German jumbo Pfandbriefe has caused the weight of the respective sub-index to plummet to 2.3% as at end-April 2010, from 9.5% as at end-2001. Despite being fairly more modest, a comparable development can be observed in the case of Spanish Cdulas, whose relative weight has steadily declined since early 2008. Their current weight within the index amounts to 3.2% as at end-April 2010 and thus is the highest. The proportion of French issuers remained stable at a level of around 2.5% as at end-April 2010.
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Figure 25: iBoxx weighting of selected sub-covered bond sectors (%)

10 8 6 1 4 2 0 Jan-00 0 Jan-00 2
Dec-01 France
Dec-03
Dec-05 Germany
Jan-08
Jan-10 Spain
Dec-01 Ireland
Dec-03
Dec-05 UK
Jan-08
Jan-10 Others
Generally, as at end-April 2010, covered bonds had a weight of approximately 11.0% in the iBoxx Index, down about 1pp to 11.0%, from 12.0% as at end-April 2009. This, in our view, is largely due to the fact that covered bond issuance stalled between mid-2008 and mid2009, whereas the issuance of other debt instruments sharply increased. Still, the situation might be poised for a change as issuance has strongly recovered: totalling 66bn in Q1 10, from 12bn in Q1 09.
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BARCLAYS CAPITAL LIVE
One portal for all research publications & analytics

Stuart Urquhart +44 (0) 20 7773 8410 stuart.urquhart@barcap.com
Barclays Capital is committed to developing relevant and innovative solutions for the longterm success of our clients. That is why we have developed Barclays Capital Live, our research website offering online access to world class research, indices, analytical tools, reporting and electronic trading via BARX. We look forward to working in partnership with you to ensure that Barclays Capital Live is customised and developed to meet your long-term needs.
Introduction
Barclays Capital Live is accessible via https://live.barcap.com. Key features include: Award-winning global research Full spectrum of benchmark and strategy indices Comprehensive cross-asset class data Sophisticated analytical tools Prime Services cross-asset class tools Access to award-winning electronic trading services, BARX
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Frequently asked questions

Overview
What is Barclays Capital Live?
Barclays Capital Live is a web-based portal that combines the best of Barclays Capitals analytical tools, research and indices, as well as trading, risk management and reporting systems, into a single site for our clients. Barclays Capital Live offers: Award-winning research, analytical tools and prime brokerage services Barclays Capital indices Comprehensive market data Access to award-winning electronic trading services: BARX Research, data and analytical tools, including:

What does Barclays Capital Live offer?
Interactive AAA Handbook, Curve, Relative Value Interactive (RVI) Market Matrix, Options Analytics, FX Flows, FX Optimiser, Oasis and VarApp, Inflation-Linked Analytics.
Access to BARX electronic trading applications Enhanced navigation for more efficient access to content For more information on the portals offering please contact the Barclays Capital Live helpdesk at barcaplive@barclayscapital.com.
Does Barclays Capital Live offer electronic trading?
Yes, electronic trading is offered via BARX, subject to acceptance of the BARX Terms.
Accessing Barclays Capital Live

To log into Barclays Capital Live, please visit live.barcap.com and enter your login name and password. To request access to Barclays Capital Live, or if you have misplaced your username and/or password, please contact your Barclays Capital Sales Representative. He or she will contact the Barclays Capital Live Sales Group who will provide you with your own login information. If you wish to have access to additional functionality or product classes that you are not permissioned for, please contact your Barclays Capital Sales Representative.
Training and contacts

Barclays Capital Live product managers are available to assist with training. Please contact your Barclays Capital Sales Representative who will coordinate a convenient day and time. Please see the contact list on the back cover of this brochure if you have any further questions about Barclays Capital Live.
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Global research
Barclays Capital Live gives you easy access to award-winning research across commodities, credit, economics, emerging markets, equities, foreign exchange, inflation, interest rates, municipals and securitisation. Key features include: Easily accessible summaries of recent research for every asset class Ability to search by analyst, ticker, keyword or title Ability to subscribe to emails, distributing research straight to your inbox
Indices
Barclays Capital is a leading provider of fixed income benchmarks, customised indices and innovative strategy indices. You now have access to the most comprehensive fixed income and strategy-based index family on a single platform. The Barclays Capital Indices platform offers market leading benchmarks and alpha generating index products to meet the diverse needs of global investors including: Portfolio benchmarking and performance measurement Investment and market analysis of both alpha and beta sources Asset allocation Research and topical studies on indexing, market dynamics and portfolio management
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Cross-asset class data

Barclays Capital Lives market monitors, charting and statistical applications deliver a rich set of proprietary data to keep you abreast of the markets and support your investment and risk management decisions. In addition, Barclays Capital Live also makes available to you Relative Value Interactive (RVI), combining interactive pricing reports, curve builders, time series analysis and regression functionality to help users identify value, explore trades and test relationships. Key features include: Extensive charting capabilities Correlation and regression analysis Efficient data downloading Batch reports that enable you to schedule and receive your charts and data via email
Sophisticated analytical tools

Barclays Capital Lives cutting edge quantitative models and analytical tools will enable you to enhance your security, market and portfolio analysis. The platform provides access to exclusive content previously distributed through the Barclays Capital Research site. This includes: Interactive AAA Handbook Curve, Market Matrix Inflation-Linked Analytics FX Flows, FX Optimiser, Oasis Key features include: Basis tools multiple security analysis Capital structure analysis Single security analysis CDX/ABX/CMBX analysis Convertible bond market intelligence Equity trading and impact cost analysis MBS/ABS/CMBS surveillance Options and volatility analysis Rates relative value analysis
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INTERACTIVE AAA HANDBOOK
The AAA book at your fingertips

The interactive AAA handbook offers direct access to individual issuer profiles supported by the latest market valuations and credit term structures to help identify relative value opportunities and explore trade themes. The seven previous hard copy editions of the AAA handbook have been powerful tools that helped investment decisions in what proved to be challenging and turbulent market conditions. To keep pace with the constantly evolving environment, we now provide current market analysis in the form of bond pricing reports and issuer curves. The interactive AAA Handbook is the one place where clients can access all of Barclays Capitals covered bond content and analytical tools. Key features include: Issuer-specific credit term structures from our Curve analysis Current market valuations via Pricing Reports Individual issuer profiles Strategy and market overviews Archived AAA publications
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Our curve analytical platform explores value between the instruments from a specific issuer and their own fitted curve. It also compares the credit term structure of associated issuers and across various markets. Historical curves are available to highlight the evolution of trading opportunities. Key features include: Charting an issuers bonds against fitted curves to identify relative value opportunities Comparison of all issuers contained within the AAA book Flexibility to remove bonds from an issuers curve to create custom curves Examine the evolution of value by comparing historical curves Bond-specific historical performance can be analysed in our time series viewer Trade themes and curve analysis can be communicated through easy web links Curve also provides access to a vast array of Sovereign and Credit data
Historical iIssuer-specific credit term structures
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The pricing reports provide current market analysis, for all issuers, through a range of yield and spread-to-benchmark measures along with the historical performance of each instrument to identify rich/cheap performance and thus generate trade ideas. Key features include: A vast array of yield, rolldown, carry and spread to benchmark analysis Heat maps based on standard deviation movements to identify value Ability to examine the historical performance of any measure Customisable layouts allow users to design reports to their own requirements Benchmark curves include Government (AAA) and Swaps for liquidity Comparison of all issuers contained within the AAA book
Current market analysis delivered via Pricing Reports
The interactive AAA handbook can be found among the analytical tools in the interest rate section of Barclays Capital Live (BCL): https://live.barcap.com To navigate within BCL: Interest Rates > Analytic Tools > Interactive AAA Handbook or type Keyword: AAAhandbook into the search browser.
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RELATIVE VALUE INTERACTIVE
One platform, clear concise research

Relative Value Interactive (RVI) offers direct access to the performance history of all asset classes contained within this AAA Handbook, and much more. The key to accurate analysis is good quality data. RVI is sourced directly from Barclays Capitals trading platforms, ensuring clean trade-focused analysis. The analytics behind the vast majority of Barclays Capitals published research comes from our internal analytics. RVI clearly identifies how various financial sectors have performed with respect to each other. Double clicking desired data 1 sends the history of each structure into the time series window accompanied by the credit term structure 2 to identify how the relationships have developed.
RVI drives research publications
Figure 26: Research publications driven by RVI
Source: Barclays Capitals RVI
Research themes can be presented through RVI, and tailored views give the analysis a new dimension. Whether exploring raw data or complex trade structures, users have the ability to switch easily between trades, asset themes and supporting arguments. RVI is available externally; clients can customise Barclays Capitals research to their own requirements.
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Market focused
RVIs predominant theme is to offer market-focused insights into the performance of individual asset classes and to put this into a global context. 3 RVI offers a comprehensive range of instrument-specific analyses covering over 15,000 nominal and inflation-linked bonds, with extensive emerging market coverage; spot and forward swaps in 30 currencies; foreign exchange and volatility and skew data for the major currencies.
Customise RVI you have control
Researchs traditional rich/cheap bond reports are now interactive; heat maps quickly identify areas of value within each asset class, and a range of both absolute and relative attributes highlight value. Simply click on any column heading to rank data and reveal the value within chosen asset class. Alternatively use RVIs advanced filter to search for value based on mandated criteria, or tailor RVIs analysis to match portfolio holdings. Thus, RVI will only highlight user-specific trade ideas. 4
Match mandate or replicate portfolio
Figure 27: Personalise RVI
Once specific instruments have been identified, their history can be sent to the time series viewer for further investigation. 5
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The time series viewer allows users to identify and retrieve market data easily, either directly from universally recognised codes or RVIs report structure. Simple algebraic manipulation allows construction of switch trades, asset swaps and curve structures. RVI recognises there is core of regularly analysed structures, so users can take advantage of the pre-canned curve reports, 6 which also identify how various maturities have performed with respect to each other. Curve steepness and arcs are analysed in detail to identify value. Results can be transferred directly to Excel or Word.
Figure 28: Historical analysis at your fingertips
Entire reports, filters, client portfolios and trade ideas are fully transferable; users can save and share favourites. RVI provides a common language with which to communicate trade ideas. Research provides a range of market-orientated themes and trade templates.
Identify value across markets
RVI offers the ability to visualise the credit term structure of each issuer/sector. Individual bonds are plotted against a fitted curve to clearly identify specific issues that trade rich or cheap to their peers. 7 Curves can be built from any of the measures available in RVIs extensive bond reports.
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Create bespoke, generic analysis
RVIs filter function can be used to focus on asset allocation themes. In Figure 29, issuers are combined to generate generic Pfandbriefe (blue) and Cdulas (grey) curves, clearly identifying that AAA Pfandbriefe trade richer, on the whole, than their AAA Cdulas counterparts, more importantly it shows that the fitted curves fluctuate between a relatively low 70bp for 3y and 8y maturities to spreads of up to 120bp 8 for issues with 5y maturities.
Figure 29: RVIs Bond Curve Viewer
Compare over time
Users can take advantage of the reports historical calendar 9 to compare curves from the same issuer over time to see how the credit term structure has evolved. Likewise, the curves of various issuers can be analysed together to identify cross-asset relative value opportunities. Once the user has identified bonds of interest, they can double click the relevant point to send the issues history to the time series window, where they can investigate trade ideas and take advantage of the full range of RVIs analytical/regression features.
Comprehensive model testing
Regression analysis is provided to explore historical relationships, investigate causality and highlight correlation between time series. RVI provides a vast array of raw and derived instrument-specific metrics, which can be used to test the accuracy of trading models and to identify trade signals.
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Our flexible regression toolkit offers the ability to plot trend lines, select regression methodology, override intercepts and reveal value. Analysis can be cloned to match dates of previous events, 10 to highlight historical relationships, forecast fair value levels 11 and generate what-if scenarios. Multi-factor regression solves for various explanatory variables, perfect for generating regression-weighted barbells and highlighting a trades directionality. Fitted analysis can be exported to the time series viewer, to explore if the model stands the test of time.
Figure 30: RVIs regression toolkit
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11 12
The regression viewers tabs offer clarity, 12 the second plots residuals over time to demonstrate the models robustness and highlight cyclical trends, whilst the third provides statistical analysis including coefficients, fit, residuals and fair value levels.
Intuitive Research
RVI is designed to make Research accessible, intuitive and easy to use, by providing current market overviews and instrument-specific performance. Widely used by Research, Sales and Traders, RVI is an integral part of BARX, offering access to Barclays Capitals Research through our trading platforms. RVI can be accessed via the Analytical Tools section of the Barclays Capital Live website.
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RISK WEIGHTINGS AND LIQUIDITY RISK REGULATIONS
Funding market challenges from proposed regulation

Fritz Engelhard +49 (0) 6971611725 fritz.engelhard@barcap.com
This chapter provides an overview of recent proposals regarding the treatment of covered bonds, agencies, supra-nationals and sub-sovereigns under the Basel Committees recent initiative relating to liquidity risk. These were mirrored by the European Commissions proposal regarding further changes to its capital requirements directive (CRD). In our view, the respective proposals could have significant implications for the business model of many covered bond banks and, if implemented without major changes, will provide significant challenges and perhaps even threaten the existence of funding markets, which not only continued to function throughout the recent financial markets crisis but have also been in place for more than a century. As we have done previously, we also describe the calculation of risk weighting for AAA products under the CRD.
SSA and covered bonds within the proposed liquidity risk framework
Basel and Brussels address liquidity risk
In December 2009 the Basel Committee on Banking Supervision published a paper titled International framework for liquidity risk measurement, standards and monitoring 5. This document, which is also known as Basel III, addresses the adequacy of liquidity risk management rules of the banking industry. On 26 February 2010, the European Commission launched a public consultation, regarding further possible changes to the CRD, also known as CRD IV 6. Amongst others 7, CRD IV suggests the introduction of new liquidity standards, basically building on the respective Basel III proposal. The European Commission explicitly highlights that it strongly supports the work of the Basel Committee in this area and envisages publishing a legislative proposal in H2 2010. Both, the Basel Committee and the European Commission suggest the introduction of two new regulatory standards for liquidity risk, the liquidity coverage ratio (LCR) and the Net Stable Funding Ratio (NSFR). The LCR is designed to promote the short-term resiliency of the liquidity risk profile of institutions by ensuring that they have sufficient high quality liquid resources to survive an acute stress scenario lasting for one month. The NSFR is designed to promote resiliency over longer-term time horizons by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing structural basis. Supra, sub-sovereign, agency (SSA) and covered bonds play a role in both, the LCR and the NSFR. Within the calculation of the LCR, the consultative document suggests that SSA covered bonds could be part of the enumerator, as they may both qualify for the stock of high quality liquid assets. Furthermore, in the denominator of the LCR, the net cash outflows over a 30day period, the consultative paper makes exceptions for secured funding run-off, as it allows for those funding operations secured by government debt and marketable securities by certain public sector entities to be deducted from net outflows, as it is assumed that these could be rolled-over.
The Basel committee suggests the introduction of two new liquidity risk standards
Definition of the liquidity coverage ratio (LCR)
http://www.bis.org/publ/bcbs165.htm http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm 7 Besides liquidity standards, CRD IV also addresses a number of other topics, such as the definition of capital, the leverage ratio, counterparty credit risk, countercyclical measures, the role of systemically important financial institutions and a single rule book in banking.
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Definition of Liquidity Coverage Ratio (LCR):

Stock of high quality liquid assets 100% Net cash outflows over a 30 - day time period
The definition of high quality liquid assets comprises, amongst others 8, marketable securities issued or guaranteed by sovereigns, central banks, non-central government public sector entities (PSEs), the Bank for International Settlements, the International Monetary Fund, the European Commission, or multi-lateral development banks as long as they are assigned a 0% risk-weight under the Basel II standardised approach, deep repo-markets exist for the respective securities and they have not been issued by financial institutions. Covered bonds 9, could also qualify for such liquidity buffer investments. However, unlike sovereign or SSA exposures, haircuts are applied and covered bonds are subject to rating requirements (20% for covered bonds rated at least AA and 40% for covered bond rated at least A-). Furthermore, additional secondary market liquidity requirements were stipulated for covered bonds and they are actually treated similar to corporate bonds fulfilling analogical criteria. 10
Definition of the net stable funding ratio (NSFR)
Within the calculation of the NSFR, in the enumerator, covered bonds should qualify for the available amount of stable funding. To the extent they are regarded as secured borrowings and liabilities . . . with effective maturities of one year or greater they are fully acknowledged (ASF Factor = 100%). Any other covered bonds, in particular those with a term to maturity of less than one year, would not be acknowledged. On the other side, when calculating the required stable funding, the denominator, SSA and covered bonds are subject to an RSF factor, which should reflect how easy they could be monetised through sale or use as collateral in secured borrowing. The consultative document suggests assigning an RSF factor of 5% for SSA bonds and 20% to covered bonds with an effective maturity of more than one year. Definition Net Stable Funding Ratio (NSFR):
Available amount of stable funding > 100% Required amount of stable funding
Inconsistent treatment of covered bonds within the LCR
In our mind, the way covered bonds are represented in the definition of the LCR and the NSFR is inconsistent. When it comes to the LCR, we note that covered bond funding would not qualify for the exceptions made in the calculation for the "secured funding run-off". Assuming that refinancing via covered bonds would be impossible, whilst at the same time covered bonds qualify for the "stock of high quality liquid assets" is a contradiction, as the later implies that there is a bid for covered bonds even in times of stress. Although the definition of covered bond which can be held under the LCR definition excludes those issued by the respective bank itself, we note that even at the height of the recent financial market crisis, in Q4 08 and Q1 09, there was ongoing covered bond issuance activity in particular through privately placed covered bonds, whilst other unsecured funding sources dried up.
Cash, central bank reserves, government bonds. Without explicitly referring to it, the Basel III paper copied the definition of covered bonds as stipulated under the EUs UCITS 22(4) directive. 10 In this respect it is worth noting that the 730bn market of benchmark covered bonds is not only much bigger and more liquid than the 80bn market for AAA/AA rated corporate bonds, but that such treatment contradicts the initial rationale of the European Commission for introducing article 22(4) into UCITS. The EU COM (86) 315 explanatory memorandum with respect to the amendment of Directive 85/611 from 4 June 1986 states that UCITS 22(4) is designed to treat covered bonds as equivalent to bonds issued or guaranteed by the State.
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There are no rules for unwinding liquidity buffer investments under certain conditions
Furthermore, under the proposed regime, banks need to maintain the LCR at all times and no rules were stipulated, under which conditions banks would eventually be able to make use of liquidity buffer investments. Not allowing banks to sell liquidity buffer investments under certain circumstances is inconsistent with the idea of maintaining a liquidity buffer, as this means that (a) the respective investments are basically not available for sale and thus inherently illiquid and (b) banks are forced to maintain additional liquidity holdings on top of their liquidity buffer investments in order to be able to factually raise liquidity when they are under stress. As highlighted above, under the proposed rules, banks might be forced to maintain rather important holdings of (basically) government bonds and AAA instruments. Besides the negative impact this might have on net interest margins and the internal capital generation capacity of banks, we note that credit institutions would typically hedge the respective securities holdings against market risk in order to avoid any losses when eventually raising liquidity against them. This would typically be done through entering into asset swap agreements. As can be experienced in the current environment, times of increased systemic stress are generally accompanied by a significant decrease of interest rates. Thus, the gap between the current coupon payments the asset swap counterparties receive and the correspondent swap yield would increase. Consequently, the requirements for the respective banks to collateralise their asset swap off-balance sheet positions will also increase. Depending on the size and the seasoning of the underlying bond portfolio, this could lead to a further substantial increase of funding needs. When it comes to the NSFR, we note that covered bonds with a term to maturity of less than one year would not fall under the definition of "available stable funding sources". At the same time, when it comes to the definition of "required stable funding uses", under certain circumstances, covered bonds qualify for an RSF (Required Stable Funding) factor of 20%, which implies that covered bond holdings could be monetised. Thus, again, as within the definition of the LCR, disregarding completely the ability of banks to refinance via covered bonds is not only in contrast to empirical evidence but also inconsistent with the assumption that covered bonds, albeit those not issued by the bank itself, could be sold in the secondary market.
Further potentially substantial funding needs through collateralising asset swap hedges
Inconsistent treatment of covered bonds within NSFR
Market implications
The implementation of the new liquidity standards may have a significant impact on AAA markets. In particular, the preferential treatment of the SSA sector versus covered bonds could push the spread differential between SSA bonds and covered bonds from issuers of the same country persistently above the historical mean. More importantly, in those markets were specialised covered bond banks act as issuers of the covered bonds, the nonrecognition of securities with less than one year to maturity in the NSFR will make it extremely difficult to pursue their business. This is particularly important for those banks which use a matched funding strategy, such as the Danish mortgage banks. Thus, ironically, these markets, which not only continued to function throughout the recent financial markets crisis, but which have also have been in place for more than a century, are likely to shrink dramatically and potentially even disappear should the respective rules be implemented as proposed.
The banking markets that make widespread use of covered bonds will generally suffer more
From a systemic perspective, the markets where the domestic banking industry is a prolific user of the covered bond product (namely, Denmark, France, Germany, Ireland, Sweden, Spain) in general are likely to suffer more than those where the use of covered bonds is either non-existent or at a nascent stage (i.e. Belgium, Italy, and Portugal). In addition, on an
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individual level, covered bond issuance activity from those banking groups that make rather strong use of covered bond funding will generally suffer more than those who rely more on other sources of funding including deposits. For example the use of covered bond issuance might suffer more strongly with KA, BBCE, CCCI, DCL, AARB, EURHYP, LBBER, LBBW, ACHMEA, most Spanish savings banks, most Swedish banks, and NWIDE, YBS in the UK. On the other hand, covered bond issuance should hardly suffer with BAWAG, ERSTBK, BNP, CASA, CM, SOCGEN, DB, DPB, HSHN, all Italian banks, most Dutch banks, all Portugese banks, BKTSM, CAVALE, SANTAN and NORDEA. When gauging the impact on individual banking groups, we also point out that a differentiated view is needed, particularly when it comes to covered bond institutions with a strong focus on public sector lending. Most of these institutions, mainly German Pfandbriefbanks, are actively downsizing their portfolios and thus their need to roll maturing covered bonds is somewhat limited. Given that the implementation of these rules is planned for 2012 and that over the next one and half years the volume of outstanding public sector Pfandbriefe will very likely decrease by another 150bn from 470bn currently, the importance of this issue should not be overestimated. In Figure 31 below we provide an overview of the amount of outstanding covered bonds of individual banks at YE 09 and relate this to their respective debt funding and balance sheet size.
Figure 31: The weight of covered bonds within the funding profile of European banks, YE 09
Country Austria Issuer BAWAG ERSTBK KA France BNP BPCE (incl. CFF) CASA CCCI* CM DCL SOCGEN Germany AARB BYLAN DB DPB EURHYP HESLAN HSHN LBBER LBBW NDB WESTLB Ireland AIB BKIR EBSBLD* Covered bonds (bn) 2.2 6.5 7.3 19.5 115.4 4.8 18.8 14.2 102.8 6.2 10.2 37.5 1.0 6.0 109.3 19.5 13.0 42.8 63.4 23.4 10.9 10.8 9.0 1.5 Debt funding (bn) 9.3 35.8 13.3 239.2 219.4 217.9 31.4 94.8 190.9 315.0 23.5 105.4 131.8 22.2 134.8 49.9 62.0 56.6 110.7 85.1 36.2 35.2 49.2 3.9 Total assets (bn) 41.2 201.7 18.3 2057.7 1028.8 1557.3 40.0 420.5 360.3 1023.7 39.6 338.8 1500.7 226.6 256.1 148.9 174.5 143.8 411.7 238.7 242.3 174.3 181.1 21.4 Covered bonds in % of debt funding 23.7 18.3 54.9 8.2 52.6 2.2 59.9 14.9 53.8 2.0 43.3 35.6 0.8 26.9 81.1 39.0 21.0 75.6 57.2 27.5 30.2 30.5 18.4 38.5 Covered bonds in % of total assets 5.3 3.2 39.9 0.9 11.2 0.3 47.0 3.4 28.5 0.6 25.7 11.1 0.1 2.6 42.7 13.1 7.5 29.7 15.4 9.8 4.5 6.2 5.0 7.0
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Country Italy
Issuer BANCAR BPIM ISPIM PMIIM UBIIM UCGIM
Covered bonds (bn) 1.0 1.0 2.0 2.0 2.0 6.0 9.0 4.2 11.8 2.0 4.5 3.6 2.0 6.1 1.0 2.0 16.1 13.1 34.7 3.8 2.0 9.0 26.8 8.4 12.9 24.1 8.4 4.0 10.7 27.8 1.6 55.0 257.0 140.0 160.5 358.3 341.4 9.6 15.6 40.7 23.8 3.0
Debt funding (bn) 10.0 25.2 185.2 12.0 44.3 214.8 110.2 12.2 130.0 34.9 20.0 35.7 9.7 25.2 5.3 11.9 32.6 24.9 117.8 3.9 19.1 11.2 52.7 20.9 16.1 56.3 35.0 8.0 32.2 243.3 5.0 61.1 1310.9 166.6 492.4 1,025.1 741.2 52.1 177.4 268.2 39.0 5.8
Total assets (bn) 36.3 125.7 624.8 44.3 122.3 928.8 469.3 16.0 1163.6 128.9 95.6 82.2 47.5 121.0 17.2 48.4 122.3 82.8 535.1 29.8 54.5 46.3 271.9 63.7 75.5 191.9 111.5 32.3 129.3 1,110.5 34.2 157.0 4,831.8 198.1 2,308.2 2,122.8 1,794.7 288.2 2,364.5 1,027.3 191.4 22.7
Covered bonds in % of debt funding 10.0 4.0 1.1 16.7 4.5 2.8 8.2 34.5 9.1 5.7 22.6 10.2 20.5 24.2 18.9 16.8 49.3 52.7 29.5 99.2 10.5 80.0 50.7 40.4 80.1 42.8 24.1 50.1 33.3 11.4 31.4 90.0 19.6 84.0 32.6 35.0 46.1 18.4 8.8 15.2 61.1 51.7
Covered bonds in % of total assets 2.8 0.8 0.3 4.5 1.6 0.6 1.9 26.3 1.0 1.6 4.7 4.4 4.2 5.0 5.8 4.1 13.1 15.8 6.5 12.9 3.7 19.4 9.8 13.3 17.1 12.6 7.6 12.4 8.3 2.5 4.6 35.0 5.3 70.6 7.0 16.9 19.0 3.3 0.7 4.0 12.4 13.2
Netherlands
ABNANV ACHMEA INTNED SNSSNS
Portugal
BCPPL BESPL BPIPL CXGD MONTPI SANTAN
Spain
BANEST BANSAB BBVASM BILBIZ BKTSM CAGALI CAIXAB CAIXAC CAJAME CAJAMM CAVALE PASTOR POPSM SANTAN UNICAJ
Sweden (SEK bn)
LANSBK NBHSS SCBCC SEB SHBASS SPNTAB
UK (bn)
ABBEY HSBC LLOYDS NWIDE YBS
Note: YE 08 Source: Company reports
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The CRD and risk weighting of covered bonds

CRD refers to UCITS 22(4) and in addition stipulates a series of eligibility criteria for cover assets
In June 2006, the European Commission published the CRD in its Official Journal. It became effective on 1 January 200811. The special treatment of covered bonds is an important feature of the CRD as it goes beyond the Basel II framework. With regards to covered bonds, the CRD text (Annex VI, PART 1, paragraph 68-70) refers to the criteria of Article 22 (4) of the EU Directive 85/611 (Directive on Undertakings of Collective Investment in Transferable Securities or UCITS). UCITS 22(4) gives a legal definition of a covered bond along the following lines: The covered bond must be issued by an EU credit institution. The credit institution must be subject to special public supervision by virtue of legal provisions protecting the holders of the bonds. The investment of issuing proceeds may be effected in eligible assets only; the eligibility criteria are set by law. Bondholders claims on the issuer must be fully secured by eligible assets until maturity. Bondholders must have a preferential claim on a subset of the issuers assets in case of issuer default. Beyond these more formal rules, a series of eligibility criteria for cover assets were stipulated. According to these criteria, the asset pool of a covered bond may include: Exposures to or guaranteed by central governments, central banks, public sector entities, regional governments and local authorities in the EU. Exposures to or guaranteed by non-EU central governments, non-EU central banks, multilateral development banks, international organisations with a minimum rating of AA- and exposures to or guaranteed by non-EU public sector entities, non-EU regional governments and non-EU local authorities with a minimum rating of AA- and up to 20% of the nominal amount of outstanding covered bonds with a minimum rating of A-. Substitute assets from institutions with a minimum rating of AA-; the total exposure of this kind shall not exceed 15% of the nominal amount of outstanding covered bonds; exposures caused by transmission and management of payments of the obligors of, or liquidation proceeds in respect of, loans secured by real estate to the holders of covered bonds shall not be comprised by the 15% limit; exposures to institutions in the EU with a maturity not exceeding 100 days shall not be comprised by the AA- rating requirement, but those institutions must as a minimum qualify for an A- rating. Loans secured by residential real estate or shares in Finnish residential housing companies up to an LTV of 80% or by senior RMBS notes issued by securitisation entities governed by the laws of a Member State, provided that at least 90% of the assets of such securitisation entities are composed of mortgages up to an LTV of 80% and the notes are rated at least AA- and do not exceed 20% of the nominal amount of the outstanding issue. Loans secured by commercial real estate or shares in Finnish housing companies up to an LTV of 60% or by senior CMBS notes issued by securitisation entities governed by the laws of a Member State provided that at least 90% of the assets of such securitisation entities are composed of mortgages up to an LTV of 60% and the notes are at least rated AA- and do not exceed 20% of the nominal amount of the outstanding issue; national regulators may allow also for the inclusion of loans with an LTV of up to 70% in
11
Regarding the specific timetable fort he implementation of the CRD you may have a look at the respective chapter of the 2007 edition of the AAA Handbook.
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case a minimum 10% over-collateralisation is established and such overcollateralisation is protected in case the respective issuer is subject to insolvency procedures; in addition, ship mortgage loans with an LTV of up to 60% are allowed. Until 31 December 2010, the 20% limit for RMBS/CMBS notes as specified in (d) and (e) does not apply, provided that those securitisation notes are rated AAA. Before the end of this period, the derogation shall be reviewed and consequent to such review the EC may, as appropriate, extend this period. The covered bond industry, as represented by the European Covered Bond Council (ECBC), suggests converting the exception for RMBS/CMBS notes into a general rule, provided that the securitised residential or commercial real estate exposures were originated by a member of the same consolidated group. However, given that the respective exceptions will expire automatically and thus existing rules need to be explicitly amended before year end, at this stage it is not clear whether these exemptions will be put into law in a timely fashion.
Standardised and internal ratings-based options
As with other categories of risk exposures, the assessment of risk weightings is conducted within the context of either a revised standardised approach (RSA) or an internal ratings-based approach (IRBA). The latter comes in both foundation and advanced forms. Application to individual banks depends on the level of sophistication of their risk management systems. Compared with the debate about the definition of the term covered bond, the application of the general CRD/Basel II framework for corporate exposures to covered bonds was much less in the limelight. Thus, from the beginning, a rather strong link between the credit profile of an issuers senior unsecured debt and the covered bond risk weighting was made in the RSA, as well as in the IRBA. In this respect, the CRD contrasts with most central bank regulations for repo business with covered bonds. For example, in the eurozone, Denmark, Norway, Sweden and Switzerland, banks issuing covered bonds are allowed to use their own covered bonds as collateral for repo transactions with the central bank, as the respective authorities concentrate on the generally low likelihood of payment interruptions in case of the bank's insolvency, and thus focus more strongly on the default probability of underlying assets.
The revised standardised approach for covered bonds

The RSA links covered bond risk weights to those of the issuers senior debt
Under the revised standardised approach (RSA), covered bonds are assigned a risk weight on the basis of the one attributed to senior unsecured exposures to the credit institution which issues them. For banks with a senior weighting of 50%, the covered bond weighting has been reduced to 20%. In contrast, banks with a senior, unsecured risk weight of 150% will have a covered bond weight of 100%. The correspondence between senior and covered bond risk weights is as follows:
Figure 32: Risk weightings for senior debt and covered bonds
% Senior Unsecured risk weight Covered bond risk weight
Source: European Commission.
% 50 20
% 100 50
% 150 100
20 10
Two options for assigning bank senior risk weightings: sovereign-linked; and bank credit-based
The derivation of risk weightings for covered bonds is complicated by the fact that the Basel Committee has set up two ways of linking bank credit ratings to bank risk weightings, which link the banks risk weighting to the credit rating of the home country sovereign or to that of the bank itself. This approach has also been followed in the EC directive. On this basis, the correspondence of covered bond risk weightings to issuing bank credit ratings under the two calculation methods is shown in Figure 33 and Figure 34 below.
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Figure 33: Risk weights under Option 1 (%)

Credit rating of sovereign Sovereign risk weight Bank senior unsecured risk weight Covered bond risk weight AAA to AA0 20 10 A+ to A20 50 20 BBB+ to BBB50 100 50 BB+ to B100 100 50 Below B150 150 100 Unrated 100 100 50
Source: Basel Committee, European Commission, Barclays Capital
Figure 34: Risk weights under Option 2 (%)

Credit rating of bank Senior unsecured risk weight Covered bond risk weight AAA to AA20 10 A+ to A50 20 BBB+ to BBB50 20 BB+ to B100 50 Below B150 100 Unrated 50 20
Source: Basel Committee, European Commission, Barclays Capital
For banks operating under Option 1, most EU covered bonds qualify for a 10% weight
So, for example, under Option 1, if a bank is based in a country with a sovereign rating of AA- or better, its senior debt will be assigned a risk weighting of 20% and its covered bonds a weighting of 10%. For investing banks whose regulator applies Option 1, all banks within the EU, except for Greece and Malta, would attract a 20% risk weighting on senior unsecured debt because their sovereign ratings are all at least AA-/Aa3 (except for Greece and Malta, which are single-A). Hence, under this option, most EU covered bond issues would be assigned a risk weighting of 10%. In contrast, Option 2 introduces more differentiation in risk weightings as the determining factor is the credit rating of the individual issuing bank. For banks that have a credit rating of less than AA-, this leads to a senior unsecured risk weighting of 50% and a covered bond weighting of 20%. The choice between Options 1 and 2 is at the discretion of national regulators. Figure 35 gives an overview on how EU countries decided on the respective options.
Option 2 leads to 20% covered bond weightings for sub AA- issuers
The internal ratings-based approach (IRBA) for covered bonds

The IRBA specifies functions for deriving risk weights from inputs on risk components
Under the IRBA, banks that have been so authorised by their regulators can determine their capital requirements on the basis of internally generated estimates of the risk of loss on their assets. These estimates require inputs relating to the one-year probability of default (PD), the loss-given default (LGD), the exposure at default (EAD) and the effective maturity (M), which are combined to give capital requirements and risk weightings using functions specified by the Basel Committee and the EC (which in most cases are broadly comparable). Variations on the standard functions are provided to apply to different groups of assets, such as retail exposures and securitisations. Two levels of IRBA have been established, namely the foundation and advanced levels. Those banks qualifying only for the foundation IRBA are allowed to provide their own estimates only of PD; the other risk components are provided by the regulator. Banks qualifying for the advanced approach are allowed to provide their own estimates of all the risk components, subject to any constraints that may be specified by the regulator.
EC specifies constraints on key risk components for covered bonds
The Basel framework for IRBA calculations makes no separate reference to covered bonds. However, the CRD provides a specific framework for calculating internal ratings-based risk weights for covered bonds (non-EC based banks applying the Basel framework to covered bonds would have to treat them as senior bank debt.) The EC legislation specifies constraints on risk components as follows: PD (which relates to issuer rather than issue default risk) must be at least 0.03%.
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LGD should be assigned a value of 12.5% and, exceptionally until 31 December 2010, 11.25% in case all exposure to public sector entities and all substitute assets have a minimum rating of double-A minus, securitisation notes make up only up to 10% of the total nominal amount of outstanding covered bonds, no ship mortgages are included in the cover pool OR the respective covered bonds are rated triple-A. The covered bond industry, as represented by the European Covered Bond Council (ECBC) suggests converting the exception for the application of an LGD of 11.25% into a general rule, as empirical data suggest rather high recovery values for mortgage loans12. For banks applying the advanced version, a lower LGD is possible. Historical data for residential mortgage assets underline that LGD levels are basically below 10%. M, the effective maturity of the bond, is limited to a range of one to five years. For the foundation approach, regulators may specify an effective maturity of 2.5 years for all bonds. All banks using the advanced approach would have to apply this maturity range. Figure 35: National discretions regarding Options 1/2 in the RSA and the calculation of M in the IRBA across EU countries
Country Within the RSA, exposures to institutions are assigned according to Option 1 (central government risk weight based method)?* Yes No No Yes No Yes Yes Yes No Yes Yes Yes Yes No Yes No Yes Yes No No No Yes No Yes No No No Explicit maturity adjustment required under IRBA?** No Yes No Yes No No No No Yes No No No No Yes No No Yes Yes Yes Yes No No No No No No Yes
Austria Belgium Bulgaria Cyprus Czech Republic Germany Denmark Estonia Greece Spain Finland France Hungary Ireland Italy Lithuania Luxembourg Latvia Malta Netherlands Poland Portugal Romania Sweden Slovenia Slovakia United Kingdom
Note: * Within the scope of CRD Article 80 paragraph 3 and Annex VI Part 1 Paragraph 6.3; ** According to CRD Annex VII Part 2 Paragraph 12. Source: Committee of European Banking Supervisors (CEBS), Barclays Capital
12
Given that the respective exceptions will expire automatically and thus existing rules need to be explicitly amended before year end, at this stage it is not clear whether these exemptions will be put into law in a timely fashion.
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As the majority of covered bonds are rated AAA or comply with the criteria for the application of an 11.25% LGD level, our illustrations of risk weightings are based on an 11.25% LGD. Also, we illustrate figures for the range of possible effective maturities, as well as the central 2.5 yr case. The room for discretion on the part of individual banks is limited, given the constraints on the specification of LGD and M. For PD, the default probability input, one-year default probabilities published by the rating agencies provide at least a starting point.
Figure 36: Rating agency cumulative one-year default rates (%)

S&P (1981-2009) AAA/Aaa AA/Aa A/A BBB/Baa BB/Ba
Source: S&P, Moodys, Fitch
Moody's (1983-2009) 0.00 0.02 0.06 0.20 1.21
Fitch (1991-2009) 0.00 0.08 0.13 0.58 1.49
0.00 0.02 0.08 0.26 0.97
Room for debate on default probabilities
These figures reflect default history for corporates globally, so there may be reservations about their applicability to European banks. The different periods used in the agencies surveys complicate comparisons, but the divergences in their figures highlight that this is not a precise science. Standard risk management caution would counsel using the highest figure in each of these comparisons. In any event, the implication is of a very sharp rise in default probabilities for BBB and BB issuers. Default probabilities produced by risk models used by individual banks may also show some variation from these figures. Our impression is that bank risk models generally operate on the basis of slightly higher default probabilities than the rating agencies historical studies suggest and that banks apply more differentiation than is provided by the rating agencies broad alphabetic bands. Figure 37 provides an illustrative matrix of risk weightings based on plugging a range of different default probabilities and the average life figures in the EC functions.
Bank risk models probably apply higher default probabilities
Figure 37: Risk-weighted asset ratios (%) for different default probabilities and average lives (LGD = 11.25% in all cases)
Probability of default (%) Bond Life (yrs) 1 2 2.5 3 4 5 0.03% 2.01% 3.22% 3.83% 4.43% 5.65% 6.86% 0.05% 2.97% 4.46% 5.21% 5.95% 7.44% 8.93% 0.10% 4.95% 6.89% 7.86% 8.83% 10.77% 12.71% 0.20% 7.96% 10.41% 11.63% 12.86% 15.31% 17.76% 0.25% 9.19% 11.80% 13.11% 14.42% 17.03% 19.65% 0.35% 11.29% 14.14% 15.57% 17.00% 19.86% 22.71%
Note: As five years is the maximum bond life that can be input, the bottom row of the table also provides the risk weighting to be applied to all longer maturities. Source: Barclays Capital
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Low risk weightings for issuers with AA credit ratings especially for shorter maturities
The 0.03% floor for PD is likely to be applied by most risk models, at least down to banks rated at the bottom of the AA range. For covered bonds issued by banks in this top category, the risk weighting will range from 2.0% to 6.9% depending on maturity. This represents a significant capital saving relative to the risk weightings under the RSA. It also highlights that in the IRBA, the risk weighting is significantly affected by the remaining life of the bond, which is not the case in the RSA. Banks applying the IRBA have a significant incentive in terms of capital utilisation to invest in shorter maturities. The general point here is that different banks may use differing assumptions about default probabilities, and Figure 37 provides a matrix from which readers can derive or interpolate risk weightings based on their own assumptions. The matrix also highlights the importance of the assumption regarding the effective maturity requirement specified by individual regulators. In the event that all bonds are given a value of 2.5 for M, all covered bonds from issuers with senior ratings of A- or better would have a risk weighting of less than 10%. If regulators apply the range of one to five years for M, the 10% threshold moves up to A flat to A+ issuers for longer-dated covered bonds.
For M = 2.5, risk weightings will be less than 10% for A- rated issuers and better
Treatment of sub-sovereigns, public sector companies and supranationals

Key MDBs some PSEs have benefited from the introduction of the Basel II/CRD framework
For this sector, the key change provided by the Basel II/CRD framework is that, under the standard approach (RSA), the risk weighting of leading multilateral development banks (MDBs) has been reduced from 20% to zero. In addition, for AAA/AA public sector entities that used to be 100% weighted, there has been a reduction to 20%. As a general principle, risk weightings for MDBs are linked to credit ratings in the same way as for commercial banks (applying the Option 2 approach). However, the leading MDBs are subject to an exception, under which they are given a 0% risk weighting, providing that they satisfy a list of criteria (relating to ratings, ownership, capital structure and asset quality) specified by the Basel Committee. The Basel Committee specifically listed the following institutions as fulfilling these criteria: 0% applied to this standard list of MDBs World Bank Group comprising the International Bank for Reconstruction and Development (IBRD) and the International Finance Corporation (IFC), the Asian Development Bank (ADB), the African Development Bank (AfDB), the European Bank for Reconstruction and Development (EBRD), the Inter-American Development Bank (IADB), the European Investment Bank (EIB), the European Investment Fund (EIF), the Nordic Investment Bank (NIB), the Caribbean Development Bank (CDB), the Islamic Development Bank (IDB), and the Council of Europe Development Bank (CEDB).
Similar message from CRD
The CRD text follows the same approach and produces a virtually identical list of institutions that qualify for zero risk weighting. Exceptions are that the CRD list does not include the IDB. Also, unpaid capital in the EIF is assigned a 20% risk weight, while it was explicitly mentioned that a 0% risk weight should be assigned to exposures to the European Community, the International Monetary Fund and the Bank for International Settlements. Note, however, that Eurofima is not included in these lists, although it is a supranational entity. Under Basel I, it suffered a 100% risk weighting, but under Basel II/CRD, its weighting fell to 20% because of its AAA credit rating. Since publication of the Basel II/CRD documents, both the EC and Basel Committee have accepted the new entity IFFIm as being equivalent to an MDB. They have therefore assigned a zero risk weighting to its debt issues.
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Public sector entities and regional governments open to range of approaches, ultimately linked to the extent of revenueraising powers and/ or guarantees
For non-central government public sector entities (PSEs), which include sub-national governments and public sector companies, Basel III also sets them within a general framework of treatment in the same way as commercial banks. Unlike MDBs, however, there is the possibility of applying either of the two options that are applied to banks. According to Option 1, the respective public sector entities (PSEs) should be assigned a risk weight one category less favourable than that assigned to the sovereign and according to Option 2 the risk weighting for claims against the PSE should be tied to the entitys own rating. In addition, however, national regulators are allowed the discretion to apply the same risk weighting for the claims against a PSE as for the sovereign in whose country the PSE is established. This area of the Basel framework leaves scope for national discretion, but the Basel guidance highlights revenue-raising powers or the existence of specific guarantees as two main bases for allocation of risk weightings to PSEs. The final paper gives an example, in which it distinguishes between different PSEs by reference to revenue-raising capacity, as follows: Regional governments and local authorities These could qualify for the same treatment as claims on their sovereign or central government if these governments and local authorities have specific revenue raising powers and have specific institutional arrangements, the effect of which is to reduce their risks of default. Administrative bodies responsible to central governments, regional governments or to local authorities and other non-commercial undertakings owned by the governments or local authorities may not warrant the same treatment as claims on their sovereign if the entities do not have revenue raising powers or other arrangements as described above. If strict lending rules apply to these entities and a declaration of bankruptcy is not possible because of their special public status, it may be appropriate to treat these claims in the same manner as claims on banks. Commercial undertakings owned by central governments, regional governments or by local authorities may be treated as normal commercial enterprises. If these entities function as a corporate in competitive markets even though the state, a regional authority or a local authority is the major shareholder of these entities, supervisors should decide to consider them as corporates and therefore attach to them the applicable risk weights.
CRD presentation differs from Basel II, but the results are in line
The CRD provides separate treatments for regional and local governments (RLGs); and public sector entities, specifically including only administrative bodies and non-commercial undertakings. Public sector commercial undertakings are by implication treated with corporates. However, although the presentation differs superficially from the Basel II, the results are the same. In summary: Eurozone RLGs are weighted either in line with central government (0%) or as institutions (20%), at the discretion of respective national regulators. The German Lnder retain a zero risk weighting, underpinned by their strong revenue-raising powers. Given the trend towards increasing delegation of expenditure responsibilities and revenue-raising powers to lower levels of government, there may be increasing scope for applying zero risk weightings to a wider range of regional and local governments in the medium term. Administrative and non-commercial PSEs can also be treated either as central government (if the regulator takes the view that there is no difference in risk between a PSE and its respective government), or as an institution. For AAA/AA countries, this means that risk weightings are either 0% or 20%. For most cases there is no change from Basel I. One significant exception is Rentenbank, which has been assigned a 0% weighting, instead of the previous 20%, by the German regulator.
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Commercial PSEs are weighted as corporates on the basis of their credit ratings, unless they are backed by a government guarantee (eg, Network Rail), in which case they also are given a government risk weighting. For non-guaranteed AAA/AA- entities, the transition to Basel II/CRD has brought risk weightings down from 100% to 20%, given that they are determined by credit rating bands. Key beneficiaries from this change are la Poste and SNCF. (Similarly, the risk weighting for GPPS also fell from 100% to 20%, because of a similar treatment for AAA securitisations.)
Differences in exposure classes under IRBA
The IRB approach requires exposures to be allocated to a smaller number of issuer categories than are available under the RSA. In the latter, RLGs, administrative bodies and noncommercial PSEs, MDBs, and international organisations are treated as separate exposure classes from central governments/central banks, institutions, and corporates. In the IRBA, all these quasi-sovereign entities and MDBs have to be assigned to central government, institutions or corporates. However, the CRD requires that MDBs, RLGs and PSEs that are treated as central governments under the RSA, are also treated as such under the IRBA. Under the IRBA, the key benefit from being classed as a central government exposure is that the 0.03% minimum value for PD applied to all other exposure classes does not apply. For AAA governments, the one-year PD is effectively zero (cf Figure 36). In principle, this could lead to zero risk weightings under IRBA for many of the public sector issuers that are zero weighted under RSA. However, the CRD also insists on a principle of conservatism in applying the IRBA and our impression is that bank risk management functions typically apply non-zero PDs to most sovereign exposures. In these cases, risk weightings for public sector exposures suffer by comparison with those for covered bonds from the fact that the proposed LGD for senior debt (other than covered bonds) should be set at 45%, compared with 11.25% for covered bonds. Questions remain about the application of IRBA to low default portfolios. However, the effect of applying IRBA to public sector debt issues is limited because a substantial proportion of banking sector holdings of these securities are held in trading books (which use RSA-type weights to calculate specific risk) rather than banking books, and also by the use of exemptions, through which IRB banks are able to apply the RSA to part of their portfolios.
Exposures treated as central government are not subject to 0.03% PD floor, but are subject to higher LGD values than covered bonds
Implementation and national discretions

Implementation of CRD and consultation on national discretions
The final agreement on CRD was the starting signal for regulators and lawmakers in EU countries to implement the new capital adequacy regime in national regulations. The Committee of European Banking Supervisors (CEBS) provides an overview on the use of options and national discretions used by individual countries when introducing the CRD 13. Following CRD implementation within the EU, the focus has been on consistency across EU countries. This is important in order to optimise regulatory efficiency and maximise clarity for the financial services industry, which frequently operates in several jurisdictions. On this background, the EU Commission asked CEBS for technical advice on options and national discretions in the CRD 14 on 27 April 2007. Following discussions with industry experts, on 22 May 2008, CEBS published a consultation paper 15 which was setting out its preliminary views. CEBS suggests to keep as a national discretion approximately one fifth of the 152 provisions covered in its analysis. On 17 October 2008, CEBS published its response and
13 14
http://www.c-ebs.org/sd/Options.htm http://www.c-ebs.org/documents/CFA10onnationaldiscretions16052007.pdf 15 http://www.c-ebs.org/press/documents/CP18_ond.pdf
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final advice 16 in which CEBS suggested to keep as a national discretion 28% of the 152 provisions covered in its analysis.
No proposals regarding national discretions on covered bond regulations
With respect to covered bond, the final paper did not contain any specific proposals. Thus the discretion provided in CRD Annex VI Part 1 point 68 (e) regarding the recognition of commercial mortgage cover pools with a higher LTV level of 70% was kept in place. Similarly, the discretion regarding Annex VII Part 2 point 8 (2nd subparagraph) with regards to the transitional provision regarding the assignment of an 11.25% LGD to covered bonds in case certain conditions are met were maintained. With respect to public sector entities the final CEBS paper suggests to keep unchanged national discretions regarding the more permissive treatment of exposures to public sector entities stipulated in CRD Annex VI, Part 1, Point 14 and under Point 16 also proposed to add a binding mutual recognition clause, which obliges EU member states to either set criteria for the recognition of public sector entities as institutions or publish a list of public sector entities treated as institutions. A similar suggestion was made with regards to CRD Annex VI, Part 1, Point 15, which allows the treatment of public sector entities as exposures to the central government of the respective jurisdiction. When it comes to the more permissive treatment of exposures to public sector entities of third countries as it is stipulated in CRD Annex VI, Part 1, Point 17, CEBS suggests to deal with this through a non-binding joint assessment process to be carried out by all supervisors that wish to participate.
Proposals regarding national discretions on exposures to public sector entities
Refinements and amendments to the CRD

In the course of 2008, the European Commission ran a number of public consultations for a refinement of the CRD. This has been mainly in three areas: (1) large exposures, hybrid capital instruments supervisory arrangements, the waivers for cooperative banks organized in networks and adjustments to certain technical provisions, (2) an adjusted proposal for securitizations and other risk transfer products and (3) trading book requirements for incremental risk. Whilst within the consultation phase none of the initial proposals related to covered bonds or public sector entities, the final paper proposed a reduction of the 100% exemption for covered bonds for large exposures to 75% and a restriction for the issuance of covered bonds to 50% of a credit institutions assets. In the meantime, however, these proposals were withdrawn. The CRD IV proposal does not contain any additional rules or refinements regarding the risk weighting of SSA or covered bonds. However, the European Commission explicitly stated that it would not extend the exceptions made for covered bonds with regards to the application of a lower LGD of 11.25% and the inclusion of more than 20% of MBS in the cover pool.
16
http://www.c-ebs.org/getdoc/5830b511-ce4b-4705-86ed-c1b835438f7f/CEBS-technical-advice-to-theEuropean-Commission.aspx
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COVERED BOND RATING METHODOLOGIES
A mixed blessing
In this chapter we first discuss the role of covered bond ratings from an investors point of view and provide an overview on the reaction of rating agencies to the financial market crisis. We then describe the general approaches of Moodys, S&P and Fitch to covered bonds, including recent adjustments to the respective methodologies.
The role of covered bond ratings from an investors perspective

Despite being basically irrelevant for relative value, covered bond ratings attract a lot of attention
From an investors point of view, ratings give poor advice on the valuation of covered bonds. The dispersion of covered bond spreads across the term structure is significant. For example, in the 5y jumbo covered bond segment, swap spreads currently range from +5bp for triple-A rated German Pfandbriefe to +220bp for triple-A rated Portuguese covered bonds and MultiCdulas. Despite being basically irrelevant for relative value,, covered bond ratings still attract a lot of attention. Last year, this was highlighted by the strong emphasis the industry has put on the final release of the new S&P rating methodology for covered bonds The fact that covered bond ratings are unsuitable for grasping the relative value of covered bonds is in stark contrast to the attention they attract from market participants and regulators. This needs further explanation. There are a number of areas in which covered bond ratings play a distinct role. First, many investors use them as qualitative guidance for gauging the underlying credit risk of covered bonds. Rating agencies have access to material non-public information (ie, loan-by-loan data on collateral pools) and have also specialised in modelling default risk and recovery values. Second, some investors apply covered bond ratings as strictly binding investment criteria, most notably when the respective portfolio managers are benchmarked against a fixed income index. In particular, in terms of rating-based sub-indices, the triple-A and the double-A threshold play an important role when applied to covered bond portfolios. Third, a number of rules and regulations refer to covered bond ratings. Generally, regulators tend to refer to ratings because there are difficulties in defining credit quality within a fixed set of rules and because they can build on a standard that has developed over many years. The European Central Banks (ECB) repo collateral scheme and its covered bond purchase programme refer to ratings. In addition, the Capital Requirements Directive (CRD) stipulates covered bond ratings as a threshold to qualify for a Loss Given Default (LGD) of 11.25% in case certain cover pool eligibility criteria are not met. Furthermore, under the Dutch covered bond regime, covered bonds need to be at least rated AA- to qualify for registration. Finally, covered bonds ratings frequently play an important role in the securities portfolios of banks (including the cover pools of covered bonds). Regularly, the average quality of such portfolios is measured against publicly assigned ratings and banks may come under pressure to either sell the respective securities or re-calibrate their portfolios when faced with negative rating migration.
So why is the industry focusing so much on covered bond ratings?
Trust and reliance on ratings is stronger compared with traditional credit investors
On a more general level, we would also argue that trust and reliance on ratings is more important in the covered bond (rates) sector than the traditional corporate/financial debt (credit) sector. This is because most covered bond investors generally focus strongly on actively managing the exposure of their portfolios to changes in interest rates or the shape of the yield curve rather than fundamental default risk. Regularly, these investors do not build up many resources for running a detailed credit analysis, as the purpose of the covered bond is to isolate them as much as possible from credit risk.
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Another important aspect with regard to the use of covered bond ratings is that the sensitivity of investors to rating migration is not uniform. When trying to rank investor type according to their sensitivity to covered bond ratings, we would put central bank investors and credit institutions as most sensitive. Frequently we receive most enquiries on covered bond ratings from these investors. We also observe that both are rather eager to position for potential negative rating actions, which reflects that for them ratings are in many cases an important and strict investment criteria. Asset managers from the funds industry, in particular those who manage special funds, are generally much less sensitive to covered bond ratings. In our experience, they are usually more flexible in amending their investment criteria and they may also have longer grace periods for unwinding exposures, which do no longer fulfil the respective ratings threshold. In our view, insurance companies and pension funds are the least sensitive to rating migration. Their investment horizons are long term; thus, they tend to have a more fundamental view on issuers, cover pools and legal frameworks. This also allows them to position tactically and exploit market opportunities in times of distress. In Figure 38 we summarise how we would rank the various investor types according to their sensitivity to covered bond ratings. Figure 38: Rating sensitivity scale
Central Banks Credit Institutions Asset Mangers (Retail Funds) Asset Mangers (Special Funds) Insurance / Pension Funds
Sensitivity to Ratings High

Low
Drawbacks of using ratings as strict investment criteria
For many investors and rule makers, applying strict rating criteria appears tempting because of the simplicity and clarity of such an approach. However, there are a number of caveats when implementing such strict rules. First, the definition of ratings varies across the major agencies (Figure 39). Strict rules are not suited to take this aspect into account. Second, hard rating limits put asset managers under pressure to sell securities when the respective limit is breached because of a downgrade. As the market environment is generally difficult in such instances, the respective unwind could be harmful for the performance of the affected portfolio. Third, this credit cycle again proved that the market processes information faster than the rating agencies. Default rates and rating trends generally reach a turning point about six to nine months after credit spreads reach a cyclical peak. Thus, investors and regulators are at risk of being consistently behind the curve when applying strict rating criteria. Due to these drawbacks, we recommend avoiding the use of covered bond ratings as strict investment criteria as much as possible.
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Figure 39: Rating definitions

Fitch Fitch Ratings' credit ratings provide an opinion on the relative ability of an entity to meet financial commitments, such as interest, preferred dividends, repayment of principal, insurance claims or counterparty obligations. Moodys Moody's long-term obligation ratings are opinions of the relative credit risk of fixed-income obligations with an original maturity of one year or more. They address the possibility that a financial obligation will not be honoured as promised. Such ratings reflect both the likelihood of default and any financial loss suffered in the event of default. Standard & Poors Standard & Poors credit ratings are designed primarily to provide rankings among issuers and obligations of overall creditworthiness; the ratings are not measures of absolute default probability. Creditworthiness encompasses likelihood of default, and also includes (i) payment priority, (ii) recovery, and (iii) credit stability.
Source: Fitch, Moodys, S&P
The benefits of a qualitative approach to covered bond ratings
Avoiding covered bond ratings as strict investment criteria does not imply that one should completely ignore ratings. Quite the contrary is true. Covered bond ratings are the result of a complex and detailed analytical process that involves the analysis of financial institutions, the quality of asset portfolios, legal frameworks and contractual commitments. Over the past 15 years, rating agencies have put a lot of effort into developing specific covered bond rating methodologies. Furthermore, they reacted to the financial market turmoil by adjusting their general methods, changing their assumptions and disclosing more information on their rating approaches. Tracking these discussions, monitoring the development of collateral scores, following the assumptions regarding payment interruptions (including the exposure of covered bonds to liquidity risk) and looking at the rating agencies assessment of counterparty risk could all be very beneficial in strengthening the understanding of individual products.
Figure 40: The response of the rating agencies to the financial market crisis
General methodology Overhauling the basic approach to rating covered bonds (S&P) Amending approach to liquidity risk (Fitch) Amending counterparty risk criteria (Fitch, S&P) Assumptions Tightening assumptions regarding the secondary market liquidity of cover assets Tightening counterparty risk assumptions Adjusting stress scenarios for defaults and losses on cover pool assets Disclosure Clarifying rating process Disclosing refinancing assumptions Disclosing assumptions regarding payment interruptions Publishing collateral quality scores
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Figure 41: Overview of rating agency methodology changes, refinements and disclosures, 2008-10
Rating Agency S&P Fitch Moodys Fitch S&P S&P Fitch Fitch S&P Moodys Fitch Moodys Fitch Moodys Moodys Fitch Fitch Moodys S&P Moodys Moodys Moodys S&P Category* GM GM D GM/A GM/A GM GM/A GM GM/A A D A GM/A D D A GM/A A GM D A D D Date 26-Feb-08 02-Jun-08 17-Sep-08 17-Oct-08 22-Oct-08 04-Feb-09 11-Mar-09 30-Mar-09 01-Apr-09 08-Apr-09 04-Jun-09 12-Jun-09 07-Jul-09 19-Aug-09 14-Sep-09 07-Oct-09 22-Oct-09 23-Nov-09 16-Dec-09 04-Mar-10 13-Apr 13-Apr 19-Apr-10 Topic S&P publishes its new derivative counterparty framework for covered bonds. Fitch publishes an exposure draft on its criteria for swaps in covered bonds. Moodys discloses more information about its assessment of the protection provided by a swap against interest and/or currency risk in covered bonds. Fitch announces plans to revise liquidity assumptions for covered bonds. S&P updates derivative counterparty criteria and removes the eligibility of A-2 counterparties in AAA-rated transactions. S&P publishes a request for comment on a proposal to overhaul its covered bond rating methodology. Fitch publishes an exposure draft on the assessment of liquidity risks in covered bonds. Fitch publishes its exposure draft on counterparty risk in structured finance transactions. The proposed amendments in Fitchs approach will also be relevant for covered bonds. S&P announces an update of its methodology for assessing counterparty risk in AAA-rated transactions. Moodys announces an increase of the spreads it uses to model refinancing risk for European covered bonds. Fitch discusses the impact of contractual clauses in covered bonds on its ratings. Moodys concludes review of refinancing assumptions. Fitch publishes its final update on liquidity risk assumptions and revises alternative management scores. Moodys publishes report on its approach to rating financial entities specialised in issuing covered bonds. Moodys publishes report on its approach to rating Spanish Multi-Issuer covered bonds. Fitch reviews assumptions for covered bonds secured by commercial mortgage loans. Fitch releases an amended approach to counterparty risk in structured finance transactions Moody's revises approach to set-off risk for Dutch covered bond programmes. S&P presents its new covered bond rating methodology and puts 98 covered bond programmes on watch negative. Moodys presents an in-depth description on its current methodology for covered bond ratings. Moodys updates on non EEA assets in German and Austrian covered bond transactions. Moodys publishes its first monitoring overview on EMEA covered bonds. S&P updates on the roll-out of its new covered bond rating methodology, highlighting that it resolved 56 of the 98 credit watch statuses on covered bond programmes, and in 51 of these 56 cases, the respective ratings were affirmed. Fitch revises methodology on covered bonds secured by commercial mortgages.
Fitch
05-May-10
Note: * GM = General Methodology, A = Assumptions; D = Disclosure. Source: Rating Agencies, Barclays Capital
On the back of the heated debate on ratings in general, and the repeated amendments of covered bond rating approaches and assumptions in particular, we recommend investors and regulators to take a step back and eventually reconsider their approach in making use of ratings. As highlighted above, we believe that a purely quantitative approach with strict rating criteria appears inappropriate. However, the increasing disclosure of rating agencies regarding their approaches to the asset class and to individual programmes may form a good basis for defining investment criteria. On the other hand, it remains important to keep track of all the other criteria, such as the general financial market environment, investor preferences and supply trends to grasp the relative value of individual products.
Throwing out the baby with the bathwater
From a macro-economic point of view, we also warn that a strict application of rating criteria could have harmful effects on the covered bond product. Over the past two years most covered bond issuers have shown strong commitment to adjusting their programmes to the increasing requirements of rating agencies. They showed this commitment to achieve their two main objectives: 1) minimise the link between the covered bond rating and the issuer rating; and 2) employ the respective collateral in the most efficient way. Driven by investor guidelines and regulations, most issuers focused strongly on the outcome of the
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rating process, the covered bond rating, and generally made efforts to achieve and/or keep a triple-A rating. The flipside of this process is that the economics of using covered bonds have strongly deteriorated. In addition, issuers with a lower senior unsecured rating, which generally benefit the most from making use of secured funding via covered bonds, increasingly struggle to access the market. Again, focusing more on the qualitative aspects of the rating and surveillance process could help reduce the stigma of not being rated tripleA and thus improve the ability of issuers to make an efficient use of covered bond funding, which has proven to be a stabilising factor for the liquidity position of banks. In the following three sections we describe the general approaches of Moodys, S&P and Fitch to covered bonds. We also include recent refinements. The respective descriptions are based on the rating agencies publications of their covered bond approaches, as well as on reports discussing individual aspects of the relevant methodologies.
Moodys
Current rating approach published in June 2005
Moodys current rating methodology dates back to June 2005. Its approach aims to determine covered bond ratings on a quantitative basis with the inclusion of a detailed analysis of the cover pool. Following the announcement of its methodology in 2005, Moodys started to apply the revised approach to all existing covered bond ratings. As part of this, the rating agency carried out a detailed review of the legal environments affecting covered bonds. Against this background, it developed a legal checklist designed to clarify all areas of the respective jurisdiction that may affect an expected loss or timeliness of payment for a covered bond. Historically, Moodys has differentiated between a fundamental approach and a structured finance approach. The fundamental approach was applied when three criteria were met: 1) cover assets remain consolidated on the originators balance sheet; 2) bondholders have full recourse claim against the issuer, but no direct and separate claim against any specific asset subset within the cover pools; 3) there are no incremental, contractual provisions adopted by the issuer beyond the scope of legal requirements geared towards achieving a specific rating level. Given that most covered bonds fulfilled these criteria, Moodys generally applied the fundamental approach. Only when covered bonds benefited from additional structural enhancements or were issued within a jurisdiction in which no specific covered bond law was established did Moodys follow a structured finance approach. Within the fundamental approach, Moodys followed a notching policy based on a catalogue of covered bond-specific features, such as the quality of the cover portfolio, the availability of over-collateralisation, provisions against cash-flow mismatches, segregation of cover assets, protection against liquidity, non-substitution and operational risks, as well as the probability of systemic support. This analysis resulted in the definition of a maximum upward notching against the senior unsecured rating. Within the structured approach, Moodys focused on the strength of the assets and protection against cash flow interruption. Particular emphasis was placed on the enforceability of over-collateralisation and its effect on the expected loss of a covered bond. Since 2005, Moodys focuses on the expected losses for covered bond investors and employs a joint default approach, which means the final rating reflects the credit profile of the issuer and the quality of the cover pool. As a first step, the probability of default for each month during the life of the bond is calculated based on the senior unsecured rating of the issuer. Secondly, the expected loss is estimated, taking into account the net present value cover of outstanding covered bonds and any other outstanding claim against the issuer. Three factors enter the calculation of net present value cover: 1) the credit quality of the collateral; 2) the refinancing risk
Prior to 2005, Moodys differentiated between a fundamental and a structured finance approach
Focus on expected loss
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for bridging liquidity gaps; and 3) exposure to interest rate risk. To calculate the expected loss for covered bond investors, the default probability is multiplied by the expected loss.
Use of idealised default probability data
Moodys takes the probability of issuer default from its idealised probability of default data, which contain default probabilities across different rating categories over a horizon of up to ten years. According to these data, default probabilities are low between AAA and A1 rated debtors and up to a five-year horizon, but start to increase substantially from A2 onwards and for debt with a maturity of greater than five years.
Figure 42: Default probabilities increase substantially for issuer ratings below A1
7% 6% 5% 4% 3% 2% 1% 0% 1 2 Aaa A2
Source: Moodys, Barclays Capital
4 Aa1 A3
6 Aa2 Baa1
8 Aa3 Baa2
10 A1 Baa3
Structured finance approach used to assess pool quality
Assessing the quality of the cover pool is the first step in estimating the potential loss in the event of issuer default. As with its structured finance approach, Moodys analyses the portfolio on a loan-by-loan basis. Alternatively, for each asset class, Moodys has defined a catalogue of data requirements in cases where data can only be supplied on a stratified basis. Obviously, the less detailed the information provided, the more severe the potential penalties for assessing the portfolio quality. As cover pools are generally dynamic, Moodys monitors the quality of cover assets on a quarterly basis. The quality of the cover pool is measured by the so-called collateral score, which basically represents the required amount of risk-free credit enhancement to protect a triple-A rating purely against a deterioration of the credit quality of cover pool assets. Thus, the respective score does not include potential support from the sponsor bank, potential haircuts due to forced monetisation of the cover pool assets or exposure to market risk. The lower the collateral score, the better the quality of the cover pool. Collateral scores need careful interpretation, as they are subject to a number of risk factors.
Figure 43: Collateral scores statistical overview

Parameter Value
No. of programmes with published collateral scores 164 (120 mortgage/43 public sector / 1 mixed) Average collateral score Average collateral score (mortgage) Average collateral score (public sector) Minimum collateral score Maximum collateral score
11.4% 12.7% 7.7% 1.80% 66.9%
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Haircuts applied to the published collateral scores
It is important to note that Moodys applies a haircut to the collateral score as long as a covered bond programme is supported by an investment grade-rated sponsor bank. This is mainly because the respective sponsor banks generally support the quality of the cover pool. In addition, depending on the structure of the respective covered bond programme, Moodys typically assumes a probability of less than 10% for a scenario in which an issuer default would immediately be followed by a credit-stress scenario on the cover pool. Haircuts applied to the collateral score of the respective programmes are based on assumptions regarding the default correlation between the sponsor bank and the cover pool. Generally, a relatively low minimum default correlation is assumed for public sector cover pools, and a standard minimum default correlation is assumed for mortgage cover pools. Under certain conditions, haircuts of 33%, 45% and 50% are applied to public sector cover pools and a haircut of 33% is applied to mortgage covered bonds. Moodys publishes collateral scores where sufficient information on the cover pool is provided and with the issuers approval. With regard to newly rated programmes, collateral scores are generally published within the respective pre-sale reports. We understand that so far issuers have not rejected the publication of the collateral score and are generally rather eager to see the collateral scores being published. A full list of the assigned collateral scores is available in the appendix of this book. The collateral scores for individual programmes help to assess the sensitivity of achievable covered bond ratings to changes in the sponsor banks senior unsecured rating. The lower the collateral score (ie, the higher the rating assessment of the cover pool), the less sensitive is the achievable covered bond target rating to the level of the sponsor banks senior unsecured rating. Owing to the very low collateral scores of many cover pools, the cover bond rating of these programmes seems to be more restricted by the timeliness of payment considerations than by concerns about cover asset quality. However, particularly when a relatively high collateral score on a mortgage-secured programme is combined with a rather low issuer rating, the maximum achievable covered bond rating is capped by cover pool quality. So far, Moodys has published the collateral score for 164 covered bond programmes. The average collateral score across all programmes is 11.4%, with a minimum of 1.8% and a maximum of 66.9%. When comparing collateral scores across different programmes, a number of special factors need to be taken into account. In particular, small and/or highly concentrated cover pools, characterised by a number of large obligors and/or assets with high default correlation, suffer from rather high collateral scores. This is demonstrated by the fact that the collateral score for Cdulas Territoriales, issued by smaller-sized Spanish savings banks that generally focus purely on local public sector business, is rather high, while the collateral score of Cdulas Territoriales issued by BBVA and Banco Santander, which have a more diversified public sector portfolio, is rather low (6.3% and 5.0%, respectively). Another example that demonstrates the limited comparability of collateral scores refers to Cdulas programmes. Collateral scores for Spanish Cdulas reflect the total portfolio of securing assets and not just the portfolio of eligible assets. However, asset quality of the eligible portfolio is generally above average; thus, the published collateral scores are somewhat distorted to the upside. On 13 April 2010, Moodys published a report titled Moodys EMEA Covered Bond Monitoring Overview: Q3 2009. The paper gives an overview on some key risk measures Moodys assigns to covered bond programmes in the course of its rating process. Among others, it included an overview on average collateral scores of mortgage collateral scores
Correlation assumptions depend on type of cover assets
Collateral scores to be published for a growing number of covered bond programmes
Collateral scores may cap the maximum achievable covered bond rating, in particular when the sponsor bank rating is low and the pool consists of mortgages
Diversification of cover assets has a rather strong impact
Collateral scores for Cdulas are generally distorted to the upside, as they also reflect the quality of non-eligible assets
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per country. The respective figures highlight that Moodys assigned a below-average mortgage pool quality rating to programmes from Spain, Ireland and Denmark and a particularly high average mortgage pool quality rating to programmes from Finland, The Netherlands, Norway and Portugal.
Diversification of cover assets has a rather strong impact
In our view, a look at collateral scores across covered bond categories could be particularly rewarding for investors who take a more fundamental view on covered bonds despite the above limitations. In particular, the collateral scores of most mortgage-secured programmes are as low as the collateral scores of those public sector programmes backed by diversified pools. We observe that an increasing number of investors are starting to focus on pool quality to differentiate various programmes. Thus, we expect Moodys collateral score to become an important criterion in assessing relative value across different covered bonds. The quality of the cover pool has a dual effect on the assessment of the expected loss calculation within the Moodys rating approach. First, it determines the amount that has to be written off. As explained above, Moodys assumes a stronger depreciation in cases where the issuers credit profile is more narrowly correlated with the quality of cover assets. Secondly, the quality of the cover pool determines the amount of collateral that can be refinanced at different rating levels. Within the stress scenario, liquidity gaps may need to be bridged by using alternative ways of funding. To assess refinancing risk, Moodys focuses on three aspects: The refinancing margin to finance cover assets after adjustment for write-offs following issuer default. The portion of cover bonds that rely on refinancing in order to be repaid prior to their legal final maturity. The expected average life of cover assets at the time of refinance. The calculation of stressed refinancing margins is mainly based on historically observed margins for different quality pools across the respective asset categories, the time needed to complete the refinancing and the length of time between the issue date of the covered bond and the refinancing date. To estimate refinancing needs, Moodys analyses the amortisation profile of cover assets and outstanding covered bonds, as well as available over-collateralisation. Generally, exposure to refinancing risk will be lower:
Dual impact of collateral quality
Assessment of refinancing risk
Figure 44: Average collateral score by country mortgage cover pools

30% 25% 20% 15% 10% 5% 0% 3% 14% 7% 12% 12% 7% 5% 7% 4% 4% 7% 15% 24%
Fr an ce G er m an y G re ec e I re la nd
It a ly et he rl a nd s N or w ay Po rt ug al Sp ai n Sw ed en N
Average
k Fi nl an d
en m
ar
Collateral -Score
Source: Moodys
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The longer the collection period for the covered bond programme The higher the principal payment rate on cover assets The greater the amount of over-collateralisation
Changed refinancing assumptions in Q1 08
Decreasing secondary market liquidity in markets in which cover pool assets could be monetised prompted Moodys to review and update its refinancing stress assumptions in Q1 08. A respective report was published on 29 February 2008. The review process resulted in rising credit enhancement requirements for a number of programmes. The names of the respective programmes were not disclosed. Moodys confirmed that the affected issuers all agreed to add the required credit enhancement to their covered bond programmes to maintain current rating levels. Finally, Moodys methodology addresses interest rate risk by assessing the potential mismatches for the time period between the issuer default and the legal final maturity of the covered bond, as well as between the latter and the legal final maturity of the cover pool. The evaluation of mismatches is based on the analysis of the cover pool, hedge arrangements and imposed hedging rules. The potential loss to investors is then calculated by running stress scenarios based on historical data. To provide clear guidance on the criteria that have to be fulfilled to reach a particular target rating, Moodys clarifies the relationship between the issuer rating and the recovery requirement by stipulating the following formula: Issuer expected loss * (1 recovery on assets) = Aaa expected loss This means that the recovery requirement depends on the ratio between the expected loss of the target rating and the expected loss of the issuer rating. For example, on a 10y horizon, an A3-rated issuer (expected loss: 0.9900%) with an Aaa target rating (expected loss: 0.0055%) would be confronted with a minimum recovery requirement of 99.4%.
Analysis of interest risk
Link between covered bond target rating and issuer rating through minimum recovery requirement
Weak cover pool features reflected in narrower link to issuer rating
In cases of high-quality collateral, a certain amount of over-collateralisation and minimal interest rate risk, a maximum rating difference between covered bonds and issuer ratings of six notches can generally be achieved. In cases of comparatively low-quality collateral, no over-collateralisation and substantial interest rate risk, a maximum rating difference of three notches can usually be achieved. Thus, unsurprisingly, weak cover pool characteristics are reflected in a closer link between the covered bond rating and the issuer rating.
Figure 45: Recovery requirements quite strong for issuer ratings below A1
Required Recovery 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Aaa Aaa Aa1 Aa2
Aa1 Aa3 A1 A2
Aa2 A3 Baa1
Aa3 Baa2 Baa3
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Increased covered bond rating volatility in certain areas
Investors should be particularly aware that there are areas in which the rating volatility for covered bonds could exceed the rating volatility of the senior ratings of the respective sponsor bank. This is the case, for example, when senior unsecured ratings move below certain thresholds, as Moodys then no longer recognises any voluntary overcollateralisation, only the amount of additional collateral that is regarded as legally binding. This is at least the case when the senior unsecured rating moves into sub-investment grade territory, but in some cases also at an earlier stage. Another factor contributing to increased rating volatility is the assessment of timely payment. In the Moodys approach, issuers rated below A1 may only achieve an Aaa covered bond rating if the covered bonds are expected to be paid on a timely basis following issuer default. In a report entitled Timely Payment in Covered Bonds following Sponsor Bank default on 13 March, Moodys disclosed the sensitivity of its covered bond rating ceilings to changes of the sponsor banks senior ratings across individual covered bond programmes. Still, the assessment of timely payment could be quite volatile. In the case of the Icelandic covered bond programme of Kaupthing, for example, Moodys reduced its timely payment assessment from the second-best class (high) to the worst (very improbable). Within Moodys covered bond approach, the assessment of the timely payment of interest and principal in the event of a sponsor bank default is an important factor that links the covered bond ratings to the senior rating. Moodys applies a so-called Timely Payment Indicator (TPI) to individual programmes. The TPI ranges from very high or close to 100% probability of timely payment to very improbable or close to 0% probability of timely payment. Moodys also explained that it could assess a covered bond programme as delinked, although this is currently not the case with any programme. The TPI is split into six categories. Figure 46 and Figure 47 highlight the maximum ratings that can be achieved on the basis of a given timeliness of payment category and a given senior rating level. The TPI matrix defines ceilings for covered bond ratings, which are applied irrespective of the results of the expected loss assessment. For example, a covered bond programme with a TPI of Probable-High and that is sponsored by a bank with a Baa1 senior rating would not qualify for an Aaa rating even if the expected loss analysis suggested that an Aaa rating would be appropriate.
More transparency regarding the impact of timely payment concerns on covered bond ratings
Application of the so-called Timely Payment Indicator
Rating ceilings applied irrespective of the outcome of the expected loss analysis
Figure 46: Covered bond rating ceilings across Timely Payment Indicator (TPI) categories
Sponsor bank senior rating A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1
Source: Moodys
Very improbable Aaa Aa1 Aa2 Aa3 A1 A3 Baa3 Baa3 Baa3 Ba3
Improbable Aaa Aa1 Aa2 Aa3 A1 A2 Baa2 Baa2 Baa2 Ba2
Probable Aaa Aaa Aaa Aa1 Aa2 A1 Baa1 Baa1 Baa1 Ba1
Probable - High Aaa Aaa Aaa Aa1 Aa2 Aa3 A3 A3 A3 Baa3
High Aaa Aaa Aaa Aaa Aa1 Aa2 A2 A2 A2 Baa2
Very high Aaa Aaa Aaa Aaa Aaa Aa1 A1 A1 A1 Baa1
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Figure 47: Covered bond rating ceilings across TPI categories

Aaa Aa1 Aa2 Aa3 Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3
Very Improbable Improbable Probable Probable - High High Very High
Of the five factors influencing the TPI, the analysis of the legal and contractual arrangements is particularly detailed
According to Moodys, the assessment of the TPI is based on five different factors: 1) the strength of the respective legislation and/or contractual agreements; 2) the nature of hedging arrangements; 3) the type of assets; 4) the nature of liabilities; and 5) a series of Other Factors. With regards to the strength of legislation and/or contracts, Moodys focuses on general provisions concerning the commingling of cash flows, the quality of coverage tests, periodic matching of cash flows, as well as protection against short-term liquidity shortfalls. In addition, the capacity of a programme to cope with refinancing risk to operate principal payments is considered. Furthermore, the ability of an administrator to arrange timely payment is taken into account. In order to give a rough guidance about how legal and contractual arrangements influence the TPI in individual countries, Moodys has published a table listing the strengths and weaknesses across various jurisdictions. With regards to hedging arrangements, Moodys generally regards swap arrangements as negative from a timely payment perspective. Moodys argues that the respective swap contracts typically imply exposure to the sponsor bank and also may hinder the monetisation of assets and/or repurchase of liabilities. In Moodys view, this can only be mitigated by specific structural arrangements such as extended grace periods. With regards to the third factor influencing the TPI, the type of assets, Moodys assesses the depth and liquidity of those markets in which the respective cover assets can be sold and/or alternative funding can be raised against them. In terms of the type of covered bonds, Moodys regards non-bullet bonds as less exposed to refinancing risk as bonds that feature pass-through structures. There are also a number of Other Factors influencing the TPI. Among these factors are informal timely payment arrangements, such as the coverage of liquidity gaps through an appropriate matching of redemptions and/or the maintenance of suitably liquid assets. Also, a low correlation between the probability of default of the sponsor bank and the cover pool would be regarded as positive. In addition, Moodys argues that large amounts of overcollateralisation may allow covered bond ratings to exceed TPI constraints. Lastly, in cases where the sponsor bank rating would be sub-investment grade, Moodys would regard the time to the next principal payment, as well as the cash position of the sponsor bank, as important factors influencing the TPI. Figure 48 gives a summary of the respective TPI assessments by product class. Currently, the majority of programmes secured by mortgages are assessed to have a TPI that is in the Probable to Probable-High range, and the majority of programmes secured by publicsector assets are assessed to have a TPI that is in the Probable-High to High range.
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Swap arrangements negatively affect TPI
Nature of assets and liabilities is taken into account
Additional factors are considered
TPIs assigned to individual programmes
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Figure 48: Country overview of TPI assessments

Country Austria Denmark Finland France - legislative France common law Germany4 Germany (structured) Hungary Iceland Ireland Italy Latvia Netherlands Norway Poland Portugal Spain Sweden Switzerland United Kingdom United States Public sector High -1 -1 Probable-High -1 High -1 -1 -1 Probable-High Probable-High (CDEP) -1 -1 -1 Very improbable High Probable-High -1 -1 -1 -1 Mortgage Probable Very High2 Probable Probable-High3 Probable Probable-High5 Probable Improbable Very improbable Probable-High/Probable6 Probable -7 Probable Hgh8 Very improbable Probable-High Probable Probable Probable (UBS) Probable9 Improbable
Notes: 1There is either no such product category rated by Moodys, or none of the respective issuers is publicly rated by Moodys; 2except Danske Bank Global Covered Bond Programme, which is Probable; 2except GE SCF, which is Probable; 4The TPI for Ship Pfandbriefe is Probable; 5except Deutsche Bank, which is Probable; 6AIB,BKIR,EBS /ANGIRI; 7covered bonds in Latvia are currently rated one notch above the senior unsecured rating of the sponsor bank; 8except DNB Nor, which is Probable and SpareBank 1 Boligkredit, which is Probable High; 9the TPI for the HBOS Treasury Services programme backed by social housing loans is Probable-High and a number of covered bond programmes with additional safeguards and pass-through language may achieve better TPI scores (up to Very High). Source: Moodys, Barclays Capital
Only in special cases should the provision of additional collateral influence the TPI
From a systematic point of view, Moodys acknowledges that the provision of large amounts of over-collateralisation may allow covered bond ratings to exceed TPI constraints. While we understand that such a rule is currently not applied in any programme, in our view, this should be allowed in special cases where, for example, limited liquidity of cover assets is the main factor restricting the TPI. In particular, concerns regarding the legal and contractual agreements could hardly be compensated just by providing more collateral. We also note that Moodys regards maturity extension features as a rather efficient tool to overcome timely payment concerns. At the same time, the inclusion of hedge contracts can have a rather negative effect on the rating ceiling. This seems to be reflected, for example, in the fact that the Irish public sector Asset Covered Securities (ACS) has been assigned the same TPI (Probable-High) as some of the mortgage ACS, which generally benefit from maturity extension features. Regarding the TPI matrix, we find it important to highlight that a downgrade of a banks senior rating from Baa2 to Baa3 could have a materially different effect on covered bond ratings when moving from a TPI of Probable to Probable-High. If Probable was assigned, such a single-notch downgrade of the senior rating would lower the covered bond rating ceiling two notches (from Aa2 to A1), while in the case of Probable-High being assigned, the downgrade would be limited to a one-notch downgrade (from Aa2 to Aa3). Other examples where rating volatility of covered bonds may exceed rating volatility of senior bank ratings include sponsor institutions possibly losing their investment grade senior rating, as well as the senior rating dropping from Ba3 to B1. In both cases, covered bond ratings would be lowered three notches across all TPI categories.
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Maturity extension and use of hedges may have a rather strong influence on the TPI
In certain areas, the rating volatility of covered bonds may exceed rating volatility of senior bank ratings
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Standard & Poors

Historically, S&Ps covered bond ratings were de-linked from the issuer rating
When it first started to rate German Pfandbriefe in the mid-1990s, S&P used a structured finance approach. A key characteristic of S&Ps initial approach was not only the strong focus on the quality of underlying assets and the adequacy of cash flows, but also the readiness of the rating agency to replace the lack of legal supervision with its own surveillance. Consequently, there used to be ample room to apply credit enhancements, particularly through the maintenance of excess (quality) assets, to gain a AAA rating. S&P ratings were generally not linked to the senior unsecured rating of the issuer and, as such, the vast majority of covered bond issuers were rated AAA. In an attempt to add an additional layer of control beyond its internal surveillance, in 2003 S&P started to emphasise the need of issuers to be particularly transparent about liquidity risk and the commitment to over-collateralisation. Therefore, S&P expected issuers to communicate publicly the liquidity profile and the minimum level of over-collateralisation that investors could expect to be maintained over time. In this respect, it is also worth noting that S&P applied an additional penalty should an issuer not make such a public statement. In February 2006, S&P launched the Covered Bond Monitor, a tool for issuers to model covered bond asset quality and cash flow adequacy. While S&P has maintained its basic approach, it has refined the rating process and underlined the fact that it will place more emphasis on the corporate review of the issuer. When introducing the cover pool monitor, S&P also highlighted that, in addition to its quantitative analysis, qualitative aspects, such as the strength of the legal framework and the issuers commitment to the covered bond product, will play an important role in the credit committees decision-making process. On 12 May 2010, S&P released a web-based version of the covered bond monitor. Following its announcement on 4 February 2009, in which S&P outlined plans to substantially amend its existing covered bonds rating methodology, the rating agency finally presented its new methodology on 16 December 2009. Within the scope of the new methodology, S&P links the covered bond rating to the rating of the issuer provided S&P believes the respective covered bond programme has asset-liability mismatches that are not addressed structurally. The new methodology for determining a covered bond rating is based on the assessment of a number of factors including asset risk, cash flow risk, legal risk, operational and administrative risk and counterparty risk. The revision of the S&P approach was focussed on asset and cash flow risk as the most relevant determinants. More precisely, within the scope of the revised methodology, S&P developed a five-step process to evaluate the maximum potential rating uplifts for a covered bond programme. This process is based on the combined assessment of a potential asset-liability mismatch exposure and the covered bond programmes categorisation. Furthermore, determinants include the issuers rating, AALM exposure, jurisdiction, range of refinancing options, available credit enhancement and target price at which assets can be liquidated in a stress scenario (Figure 49).
Demand for self-commitments in 2003
Launch of Covered Bond Monitor in 2006
New methodology published in December 2009
Five-step approach
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Figure 49: Assessing asset-liability mismatch risk in covered bonds

Five Key Areas of Standard & Poor s Covered Bond Ratings Analysis
Asset Risk Cash Flow Risk Legal Risk Operational and Administrative Risk Counterparty Risk
See relevant criteria
Step 1: ALMM Classification
= = = = =
Zero Low Moderate High
Step 2: Program Categorization
Category 1 Category 2 Category 3

Max Potential Ratings Uplift (Notches )
Step 3: The Maximum Potential Covered Bond Rating
ALMM risk Zero Low Moderate High
Category 2 Unrestricted 7 6 6 5 5 4 1
3 5 4 3
Step 4: Cash Flow and Market Value Analysis
Determine target credit enhancement to achieve maximum potential ratings uplift
Step 5: The Covered Bond Rating
Compare target credit enhancement with available credit enhancement
Source: Standard & Poors
ALMM classification
In the first step, S&P assesses the riskiness of a programmes asset-liability mismatch by calculating the maximum cumulative asset-liability mismatch (ALMM) as a percentage of outstanding liabilities. This is then classified as low, moderate or high risk, thereby determining the maximum potential rating uplift a covered bond programme may have from the issuers rating. When determining the asset-liability mismatch, S&P applies a cash flow based approach, taking into account prepayments on mortgage portfolios, considering liabilityspecific features (ie, maturity extension, pre-maturity tests) and treating near-term exposure as more significant than mismatches occurring in the medium or long term. The latter is achieved by introducing a so-called scaling factor, through which S&P weighs net stressed cash flows occurring in up to one year at 100%; those occurring in the following years are 5pp lower weight for each year, until those occurring in 10 years and later are weighted at 50%.
Figure 50: Asset-liability mismatch classifications and maximum potential uplift ranges
ALMM risk Zero Low Moderate High
Source: S&P
ALMM percentage N/A 0 15 15 30 > 30
Max. potential number of notches uplift Unrestricted 5 to 7 4 to 6 3 to 5
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Programme categorisation
In the second step, S&P categorises covered bond programmes according to their ability to obtain third-party liquidity or monetise assets to fund potential asset-liability mismatches after an issuer fails. S&P segments the programmes into three categories depending on the covered bond programmes jurisdiction and the issuers ability to access external financing or monetise the collateral pool. The potential rating uplifts for categories one, two, and three are seven, six, and five rating notches, respectively. Note that within this measure, S&P strongly differentiates between the systemic importance of covered bonds for a market, thereby concluding how likely the covered bond programme is to access funding and how governments and regulators could likely support financial stability. Despite this rather formal approach, we understand that S&P is prepared to consider that for some public sector cover pool assets the strength of funding sources must not necessarily be a function of the systemic importance of the covered bond product or whether the respective covered bond market could be qualified as well-established, but rather a function of the breadth and depth of the market for the underlying cover assets.
Figure 51: Covered bond programme categories

Characteristic Covered Bond Category Category 1 Range of funding options A programme has the flexibility to raise funds through asset sales and borrowing from either banks or the central bank. There are no restrictions on when or how funds can be raised. The covered bond market has, in S&Ps opinion, a long and well-established history. In S&Ps view, systemic importance of the product is high. S&P considers if there is a broad range of banks that are able to lend and evaluates if there would be adequate demand among a broad range of investors for the assets backing the programme. Denmark, France (Obligations Foncires), Germany (Pfandbrief), Spain (stand-alone Cdulas) 5 to 7 Category 2 A programme is able to raise funds either through asset sales or borrowing from either banks or the central bank. There are no restrictions on when or how funds can be raised. The covered bond market has, in S&Ps opinion, a limited history. In S&Ps view, systemic importance is not as strong as Category 1. S&P considers if there is a broad range of banks that are able to lend and evaluates if there would be an adequate demand among a broad range of investors for the assets backing the programme. Canada, Finland, France (common law covered bonds), Ireland, Italy, Luxembourg, The Netherlands, Norway, Portugal, Sweden, U.K. 4 to 6 Category 3 A programme's access to funding is restricted so the sale of assets is forced.
Strength of funding sources
The covered bond product is newly established in that jurisdiction. In S&Ps view, systemic importance is low. S&P considers if banks are unable to lend to programmes and evaluates if there is uncertain demand among a broad range of investors for the assets backing the programme. Greece, US
Jurisdictions
Maximum potential rating uplift.

Source: S&P
3 to 5
Determination of maximum potential ratings uplift
In the third step, based on a combination of the asset-liability exposure and an issuers ability to cover the latter, S&P determines the maximum potential rating on a covered bond programme. In principle, the classification of the asset-liability mismatch and the categorisation of each programme are combined (Figure 51).
Figure 52: Maximum potential ratings uplift from issuers rating*

Asset-liability mismatch risk 1 Zero Low Moderate High Unrestricted 7 6 5 Category 2 Unrestricted 6 5 4 3 Unrestricted 5 4 3
Note: *By number of notches. Source: Standard & Poors
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Cash flow and market value analysis
In the fourth step, S&P analyses the cash flows to determine the periodic asset-liability mismatches of a covered bond programme before applying a stress test to the cover pool. If a programme is able to liquidate sufficient assets to meet mismatches while leaving collateral to service the remaining debt, the maximum potential rating can be achieved. In order to determine the stressed net present value of projected cash flows, S&P determines target asset spreads over the relevant funding rate (ie, Euribor). These target asset spreads are generally based on the widest historical spreads for securitizations or similar assetbased financing instruments. For mortgage collateral pools, target assets spreads range from 425bp for prime residential mortgage loans to 1000bp for commercial mortgage loans. For public sector collateral pools, target assets spreads range from 100bp for AAArated sovereign exposures to 300bp for A/BBB-rated sovereign exposures. In the fifth and final step, S&P assigns the rating to the covered bond programme by assessing whether a programmes available credit enhancement is equal to the stress tests target for the maximum potential rating determined in step three. In case the available credit enhancement covers all credit risks related to the default of the cover pool assets, S&P assigns a first notch of uplift. For any further uplift, the remaining credit enhancement should be able to cover the market value risk arising from the asset-liability mismatch. To determine the credit enhancement for each additional notch of uplift, S&P divides the credit enhancement differential by the number of additional notches. In the case of the available credit enhancement being below the stress tests target volume, the covered bond programmes rating will be lower than the potential maximum rating. S&P also applies outlooks to covered bond ratings. Whilst the outlook on covered bonds ratings is closely aligned to that on the issuer, it is also a function of S&Ps assessment of the issuers future business plans (acquisition of assets and funding operations), the expected performance of the collateral, as well as the expected asset-liability structure. Thus, in theory, a rating-positive (-negative) business plan could lead to a positive (negative) outlook on the covered bond rating, although the senior rating of the respective bank is on outlook negative (positive).
Assignment of covered bond rating
Assignment of outlooks
Fitch
Fitchs rating methodology has been refined since it started rating covered bonds in 1998
Fitchs approach to covered bonds dates back to 1998, when the agency presented a rating methodology for German Pfandbriefe. At that time, Fitch clarified that not only is the quality of cover assets vital to the credit status of Pfandbriefe, but so is the credit profile of the issuing bank. Since the late 1990s, Fitch has published a series of methodology publications for other covered bond markets. A major step in refining and explaining its general approach to covered bonds has been the introduction of the discontinuity factor (Dfactor) in 2006. In June 2009, Fitch presented its final update on liquidity risk assumptions and also revised alternative management scores. The implementation of the proposed changes resulted in a deterioration of D-factors for most covered bond programmes; as a consequence, it has become difficult for mortgage-covered bonds to reach a triple-A rating on a probability of default basis, in case the issuer is rated below AA-. Furthermore, the new recovery assumptions have led to an increase of OC requirements for maintaining a given rating uplift, as Fitch applies the respective fire-sale discounts on the full remaining pool at the time of default of the covered bond. Fitchs rating process for covered bonds contains three major steps. As a first step, Fitch determines the maximum achievable covered bond rating on a probability of default basis. This is done by combining an issuers default rating with the so-called discontinuity factor. The second step consists of stress-testing over-collateralisation to set the covered bond rating on probability of default basis. This is done by comparing stressed cash flows
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A three-stage process
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from cover assets with payments due on covered bonds in a wind-down scenario. As a third and final step, Fitch assigns a recovery uplift to reflect stressed recoveries from cover assets in case of a covered bond default.
Determination of the D-Factor

Gradual approach to reflect exposure to an issuers credit profile
Within Fitchs approach, the weight that an issuers credit profile plays in the assessment of a covered bond programme is a function of the risk of payment interruptions. An increased risk for payment interruptions is reflected in a greater weight of the issuer rating when assessing a covered bond programme. To measure the risk of payment interruptions across various covered bond systems and cover pool-specific characteristics, a D-factor is calculated. This factor ranges from 0-100%, where 0% is applied for perfect continuity of payments and 100% is applied when an issuer default automatically triggers a default of covered bonds. The calculation of the discontinuity factor is based on a scoring model that stipulates four main input factors for measuring the risk of payment interruptions: 1. The extent of asset segregation, with a 45% weight; 2. The specification of an alternative management of cover assets, with a 15% weight; 3. The assessment of liquidity gaps, with a 35% weight; and 4. The oversight of covered bonds, with a 5% weight.
Discontinuity factor is based on four input categories
The focus is on system-specific factors
Within the scoring model, system-specific drivers play a dominant role. They are included in all four categories. The importance of a proper segregation of cover assets, which, in Fitchs model, is driven purely by system-specific drivers, reflects the 45% weight the agency gives to this item. When analysing the extent of asset segregation, Fitch mainly focuses on the protection of the claims of covered bond investors against any claims of other creditors that may arise in the course of bankruptcy proceedings. This also includes the protection of overcollateralisation and derivative contracts. The second most important item in the calculation of the D-factor is the analysis of liquidity gaps, which is weighted 35%. When looking at liquidity risk, Fitch evaluates means for overcoming potential liquidity problems through passthrough amortisation agreements, liquidation of cover assets, pre-maturity tests or through accumulation or extension periods. The third element in the calculation of the D-factor refers to the specification of an alternative manager of cover assets. Within this category, Fitch emphasises the timely appointment of a back-up cover pool manager and the ability of this back-up manager to raise money against cover assets. Finally, when looking at the oversight of covered bond programmes, Fitch examines the reporting and auditing standards, as well as the importance of covered bond funding within a countrys banking system. Within the calculation of the D-factor, the scoring of the liquidity gap component is based on a three-step approach. First, Fitch allocates the respective cover assets to seven different liquidity classes, which reflect the time needed to liquidate the respective assets. These may range from class 1 (up to one week) to class 7 (more than 12 months). Fitch also indicated in which liquidity classes it would see different types of public sector and mortgage assets. On the public sector side, the main criteria refer to the respective sovereign country, the type of debtor (sovereign, region, province, municipality, other public sector entity) and the type of instrument (bonds, promissory note, loan, other). With respect to mortgage assets, Fitch suggests differentiating across countries, with established residential mortgage markets in Western Europe and Canada falling into liquidity class 5 (6-9 months), but Germany and the US falling into class 4 (3-6 months) because of the higher likelihood of asset pool transfers in the case of Germany and the depth of the RMBS market in the case of the US. Other mortgage
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Three-step approach for the scoring of the liquidity gap component
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asset types (ie, specialist residential, commercial) are assessed on a case-by-case basis. In step two, the respective liquidity risk mitigants are assessed. The following instruments are recognised in order of decreasing comfort: pass-through mechanisms, maturity extension, pre-maturity test, public liquidity guidelines, and internal liquidity guidelines. Finally, Fitch checks the extent to which the provided liquidity instruments would be sufficient to cope with the uncertainty of monetising assets in a given timeframe.
Assigning jurisdiction-specific components within the alternative management score
Within the calculation of the D-factor, the alternative management score is based on two types of sub-components: jurisdiction-specific components and issuer-specific components. To gauge the former, Fitch analyses legislative, regulatory or contractual provisions for replacing an insolvent institution in its capacity as manager of the covered bonds and servicer of the cover assets. Within its scoring, Fitch penalises programmes that involve a special purpose vehicle (SPV), as it is concerned that the underlying provisions may give rise to delay. However, in case contractual provisions detail the steps to be taken in the transition process, and the party responsible for taking decisions would be willing and able to do this without facing obstacles such as obtaining bondholder consent or finding a new partner, Fitch would give credit for such features. Fitch classifies the systemic alternative management score of covered bond programmes across the following three categories (in decreasing order): Legislative frameworks in which the regulator has an active say in the management of the cover assets and covered bonds (Ireland, Luxembourg, Germany). Integrated frameworks with a regulator involved in the appointment of a dedicated alternative manager, frameworks in which the cover pool is isolated in a special purpose financial institution, contractual programmes involving a SPV with efficient provision for the replacement of the manager (Denmark, Norway (when the issuer could not fall into insolvency estate of the parent), Portugal, France, and The Netherlands). Legislative frameworks with no dedicated covered bonds administrator, legislative frameworks involving a SPV or contractual programmes with the potential for a slower transition (Spain, Norway when the issuer could fall into insolvency estate of the parent Italy, Greece, Canada, UK and the US).
Overriding rules
There are also three rules that override the result of the scoring model. The D-factor will be set at 100% when: 1) the asset segregation score does not reach a sufficiently high level; 2) the cover pool administration is deemed inadequate; or 3) an acceleration with an automatic freeze of all cash flows is imposed during an issuer insolvency.
Step 1
The discontinuity factor and the issuer default rating determine the maximum achievable covered bond rating on a PD basis
After having determined the D-factor, Fitch calculates the highest achievable covered bond rating based purely on probability of default (PD) considerations by multiplying the five-year cumulative PD related to the issuer default rating (IDR) with the discontinuity factor. Then it selects the rating category associated with the adjusted PD level. For example, a single-A rated bank with a discontinuity factor of 40% for its covered bond programme would be exposed to a maximum AA rating on a PD basis for the covered bonds. The relationship between the IDR and the maximum covered bond rating achievable on a PD basis across different levels for the discontinuity factor is shown in Figure 53.
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Figure 53: Maximum covered bond rating achievable on a PD basis

Issuer IDR 5y PD (%) 100 AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BSource: Fitch
Discontinuity factor (%) 75 AAA AA+ AA AA AAA+ A ABBB+ BBBBBBBB+ BB BBB+ B 50 AAA AAA AA+ AA+ AAAAA+ A+ ABBB BBBBBBBB+ BB BBBB40 AAA AAA AA+ AA+ AA AA AAA+ A BBB BBB BBBBB+ BB+ BB BB30 AAA AAA AAA AA+ AA AA AAAAA+ BBB+ BBB BBB BBBBB+ BB+ BB 20 AAA AAA AAA AAA AA+ AA+ AA AA AAA BBB+ BBB BBB BBBBBBBB+ 14 AAA AAA AAA AAA AA+ AA+ AA+ AA AAA+ ABBB+ BBB BBB BBBBBB10 AAA AAA AAA AAA AAA AAA AA+ AA+ AA AAA ABBB+ BBB BBB BBB5 AAA AAA AAA AAA AAA AAA AAA AAA AA+ AA AAAAA ABBB+ BBB+ 0 AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA
0.03 0.094 0.203 0.255 0.501 0.561 0.787 1.016 1.582 3.361 5.355 7.477 11.007 15.37 19.616 25.53
AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B B-
Step 2
The final PD of the covered bonds is determined through an iterative stress testing of over-collateralisation
To determine the final PD of the covered bonds, Fitch positions the covered bond rating on a PD basis between the issuer default rating and the maximum achievable rating on a PD basis. It runs a cash-flow model under different rating scenarios, starting at the top of the range ie, with the maximum achievable covered bond rating on a PD basis. In case overcollateralisation is insufficient to avoid a default of the covered bonds, the analysis is reiterated at lower rating levels, with the IDR building a floor for the covered bond rating on a PD basis. If the PD threshold for the maximum achievable rating is passed, the PD of the covered bond is set at the respective level. When running the cash-flow models, Fitch either recognises contractual, committed or publicly-stated minimum over-collateralisation levels, or applies the lowest overcollateralisation level in the preceding 12 months if the issuers short-term rating is at least F2 and, in the case this is not feasible, the minimum mandatory over-collateralisation level. This approach helps avoid rating volatility in the background of the observed swings in over-collateralisation levels. However, Fitch clarified that a sudden drop in overcollateralisation may result in a reduction of the covered bond rating on a PD basis, which may trigger a downgrade of the respective covered bonds. When running its stress tests, Fitch assumes several timings of the issuer default. Fitchs model then compares the cash flows from the cover pool with the payments due on the covered bonds following an issuer default. Thus it is assumed that the assets are under the care of an alternative manager, no new assets enter the cover pool and further issuance of covered bonds is suspended. The simulation incorporates stressed assumptions about the credit risk of cover assets and about asset-liability mismatches in terms of maturity, interest rate and currency. Where available, Fitch applies the same assumptions and stresses as in structured finance transactions, which are backed by the same type of assets. In addition, the assumed cost of an alternative manager is factored in.
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Various types of overcollateralisation commitments recognised
Comparison of cash flows post-issuer default
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Assessing stressed sales proceeds
To capture depressed sales prices, Fitch takes into account the increased importance of access to central bank liquidity instruments. In this respect, the ability of an alternative manager to act as counterparty for central bank repo transactions, as well as the eligibility of cover assets as security for such transactions and the respective haircuts, are assessed individually. Fitch also models fire-sale discounts. Importantly, the respective principles will also apply to assess stressed recoveries in a scenario in which the covered bonds would be in default. According to Fitch, such discounts would be 3-10% for public sector assets and 10-20% for mortgage assets. The criteria for applying haircuts to various asset types resemble the criteria for allocating assets types to the different liquidity classes. On the public sector side, the main criteria refer to the respective sovereign country, the type of debtor and the type of instrument. Stressed margins may vary between Euribor +50bp and Euribor +250bp. With respect to mortgage assets, Fitch suggests differentiating across countries, LTV ratios, property types and loan features. Stressed margins may vary between Euribor +120bp and Euribor +400bp.
Step 3
Adjustments for recoveries lead to final covered bond ratings
While the discontinuity factor plays a key role in Fitchs rating approach, the rating agency has also outlined a clear approach to the role of recoveries within its rating process. After the calculation of the covered bond rating based on a PD basis, a final adjustment is made to take into account recovery prospects. Where the recovery prospects are outstanding which is assumed when recovery rates are estimated to be above 90% covered bonds will be rated two notches above the covered rating level, which was determined on a PD basis. In cases where the issuer has a sub-investment grade rating, a three-notch upgrade is applied. In Figure 54 we show Fitchs approach to recovery rates and notching. Given the secured nature of covered bond debt instruments, it is fair to assume that covered bonds would regularly achieve an RR1 recovery rating. This is highlighted by the fact that Fitch listed German Pfandbriefe and Spanish Cdulas Hipotecarias in the RR1 category when introducing recovery ratings in February 2005. Thus, we believe that achieving an AA covered bond rating on a PD basis is for most programmes the threshold for finally getting an AAA covered bond rating. Mainly in cases where over-collateralisation levels are insufficient, it is understood that a recovery rating of RR2 would be applied, which means the threshold for reaching an AAA covered bond rating would increase to AA+ when the covered bond rating is arrived at on a PD basis. Fitch publishes the D-factor for the respective covered bonds of its rating universe as well as the covered bond rating on a PD basis. Since March 2008, all assigned D-factors are made available over the newly-introduced covered bond section of its SMART (Surveillance, Metrics, Analytics, Research Tools) platform. The tool also offers information on the Figure 54: Fitchs recovery ratings
Maximum notching Recovery rating RR1 RR2 RR3 RR4 RR5 RR6
Source: Fitch
It is fair to assume that a twonotch upgrade is applied in most programmes
More transparency through the publication of key rating factors
Recovery prospects Outstanding Superior Good Average Below average Poor
Recovery bands given default (%) 91-100 71-90 51-70 31-50 Nov-30 0-10
Investment grade 2 1 1 -1 0.5
Non-investment grade 3 2 1 -1 0.6666667
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composition of cover assets, major risk factors, over-collateralisation levels and performance statistics across all covered bond programmes rated by Fitch.
Interesting difference of average d-factors across product categories
In particular, the publication of D-factors helps assess the sensitivity of the respective product to a potential downgrade of an issuers IDR. A full list of the assigned D-factors is available in the appendix of this publication. In addition, the comparison of D-factors across product categories yields interesting results. The cross-country comparison shows that the average D-factor for mortgage covered bonds is the lowest in Ireland, Portugal and the UK. These are also the only countries in which the average D-factor is equal to or below 15%. US covered bonds and Spanish Cdulas are ranked lowest, with average D-factors of 69.8% and 41.3%, respectively. When calculating the average D-factor by collateral type, the analysis reveals that the average d-factor of covered bond programmes backed by public sector assets is 10.0% much lower than the average d-factor for those programmes secured by mortgages, which is 20.9%.
Public sector-backed covered bond programmes are generally assigned a lower D-factor
Figure 55: D-factors across collateral types (min/max/avg in %)* as of mid-May 2010
Mortgage Canada Germany Denmark Spain France United Kingdom** Greece Ireland Italy Luxembourg Netherlands Norway Portugal Switzerland (UBS) US Summary 12.7 / 16.7 / 15.3 15.3 / 18.9 / 16.9 14.9 / 15.3 / 15.0 21.9 / 21.9 / 21.9 39.6 / 100 / 69.8 6.5 / 100 / 20.9 4.7 / 32.0 / 10.0 32.0 / 18.1 / 18.1 / 18.1 13.7 / 25.2 / 18.9 15.0 / 16.6 / 15.8 40.8 / 41.9 / 41.3 9.4 / 37.9 / 19.7 6.5 / 18.5 / 11.8 20.1 / 39.3 / 32.6 11.6 / 19.6 / 14.8 13.7 / 17.6 / 16.2 13.8 / 13.8 / 13.8 9.5 / 9.5 / 9.5 11.8 / 16.6 / 13.9 11.2 / 11.2 / 11.2 Public sector 21.2 / 21.2 / 21.2 4.7 / 11.9 / 7.3
Notes:*Some countries are missing because Fitch either has not assigned covered bond ratings and/or it has not yet assigned a D-factor; excluding the former Chelsea BS programme. Source: Fitch, Barclays Capital
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IAS AND THE APPEAL OF REGISTERED BONDS
Braced against the storm

The financial market disruptions exposed many investors to charges on their securities portfolios and/or the disclosure of substantial non-realised losses. This has created an increasing incentive for many publicly-traded investors in AAA debt reporting under IAS 39.9 rules to re-allocate their fixed-income holdings from benchmark bonds to registered bonds. This is because the respective debt products can be booked under the loans and receivables account. Mainly German insurance companies and pension funds make use of this feature, as it allows them to benefit from the pick-up which is offered by AAA products, without exposing them to high performance volatility.
Benchmark offerings compete increasingly with non-liquid instruments

Non-liquid fixed-income instruments no longer a purely German affair
Initially the use of registered bonds was mainly driven by the application of international accounting standards (IAS), as they allow investing in debt products that are recognised as loans and receivables in the financial assets framework of IAS 39.9. As the capital market environment became more stressful over the past three years, the incentives to use these non-liquid fixed income instruments grew substantially. The covered bonds of those issuers at the forefront of this development, namely Austria, France, Germany, Ireland and Luxembourg, as well as some Scandinavian issuers, were generally less exposed to spread volatility compared to their peers, as they were in a position to smoothly replace their funding through benchmark securities with registered bonds. According to regulation 1606/2002 of the European Parliament and of the council of 19 July 2002, since 2005, publicly-traded companies are required to apply a single set of highquality international accounting standards for the preparation of their consolidated financial statements. The regulation explicitly refers to the international accounting standards set by the International Accounting Standards Board (IASB), a private group of international accounting experts. A key part of the framework is the definition of different categories of financial assets. IAS39.9 defines four major categories of financial assets. These are: 1) financial assets at fair value through profit or loss; 2) available for sale; 3) loans and receivables; and 4) held to maturity. Figure 56 describes the decision process for the designation of different financial assets to these four categories 17. There is an important difference between loans and receivables, held to maturity and the remaining two categories. The former allow disclosure of the respective assets at amortised costs 18, while assets in the fair value through profit or loss category must be disclosed at fair value with an effect on the profit and loss statement. Assets in the available for sale category must be disclosed at fair value without an effect on the profit and loss statement. This means that if the fair value of assets that are designated to the loans and receivables or held to maturity categories move above amortised costs, the company creates unrealised gains and if it moves below amortised costs, it creates unrealised profits. By increasing the share of assets that can be designated to these two categories, companies that report under IAS are able to reduce the volatility of their income statements and more easily smooth out fluctuations in their capitalisation. It is also worth noting that the appeal of the loans and receivables category is stronger than the held to maturity category, as
Four main categories of financial assets defined in IAS 39.9
The particular appeal of the loans and receivables category
17 18
For further reading please refer to the IASB homepage: http://www.iasb.org According to IAS39.9, amortised cost is the amount at which the financial asset is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation and minus any reduction for impairment or uncollectability.
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Figure 56: Categorisation of financial assets according to IAS 39.9

Financial Instrument
Near-term sale? OR derivative? OR designated as at fair value through profit or loss"?

Yes No
Fixed or determinable payments?

No Yes
Quoted in an active market?

No Yes
Designated as available for sale"?

Yes No
No
Fixed maturity? AND positive intention and ability to hold to maturity AND not designated as available for sale"?
Yes
Financial Asset s at Fair Value Through Profit or Loss
Available for Sale
Loans and Receivables
Held to Maturity
Source: IAS 39.9, Barclays Capital
the former leaves the investor with more flexibility in terms of having the ability to sell the asset prior to maturity.
Promissory notes and registered bonds fall into the loans and receivables category
In Germany, there are two non-liquid instruments, Schuldscheindarlehen (promissory notes) and Namensschuldverschreibungen (registered bonds), which fall in the loans and receivables category under IAS 39. In other countries, namely Austria, Denmark, France, Ireland, Luxembourg, Norway, Sweden and the UK, issuers also make use of these products. An important criterion is that these assets are not listed on an exchange in order to ensure that there is no active market under the definition of IAS 39 19. The documentation of these products is straightforward. It basically contains the names of the two parties, the principal amount, the interest rate, the coupon payment dates, the maturity date, call and/or assignment terms and the governing law. This rather simple documentation is possible as these types of instruments are embedded in a rigorous legal framework. A pre-condition to selling these products to investors is the formation of an appropriate infrastructure. Documentation has to be handled, pricing requests for plain vanilla products have to be answered within a relatively short period of time (about 15 minutes) and the issuer should eventually also be prepared to handle repurchase requests for these instruments. In addition, the respective debt instruments are transferable. The issuer will be informed about a transfer of the respective loan certificate in order to ensure timely payments of cash flows. With the breakout of the financial markets crisis in mid-2007, regular issuers of AAA debt with important funding needs had a strong incentive to develop or enhance their activities with respect to their issuance in registered format. This is mainly because investors reduce potential pressure on reported mark-to-market losses, but also, from an issuers point of view, registered bonds and Schuldscheindarlehen have specific advantages: they can gain swift market access owing to limited documentation requirements while remaining very flexible in terms of market timing and the fixing of terms and conditions. In addition, issuers can raise funds with a high degree of discretion in an efficient manner owing to generally lower documentation costs and products that are more closely tailored to individual investors needs.
19
Strong incentives for investors and issuers to make more use of registered bonds
IAS39 AG71 describes what is understood under an active market. It says that a financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arms length basis.
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Increasing appetite for registered AAA debt is reflected in the Pfandbrief market
The increasing need for registered AAA debt reflects well in the Pfandbrief market. Until Q3 02, the market share of registered Pfandbriefe was stable at slightly above 25%, but since Q4 02, it is has grown consistently and currently stands at 38.3%. This reflects not only the preparation for IAS 39.9, but also the fact that in particular, many insurance companies preferred to focus on this format, as investments in registered debt were an efficient tool for stabilising income statements in an environment that has been characterised by volatile interest rate developments and widening credit spreads. The particular appetite of German insurance companies and pension funds for promissory notes and registered bonds could make a strong contribution to an issuers funding profile. According to the association of German insurance companies (GDV), the industries gross fee income amounted to 171.3bn in 2009. Life insurers, which as of YE 08 made up 686bn, or 59.2% of the total 1,160bn of investments, had total investments of 706.3bn at 30 September 2009. At this date, fixed income made up 614bn or 87% of the total. While government bonds made up only 19.1bn, or 2.7% of total investments, listed covered bonds made up 180.8bn, or 25.6%, and another 106.1bn, or 15.0%, consisted of loans to credit institutions.
Gross fee income of 171bn in 2009, suggests ongoing strong demand for registered bonds from German insurance companies
Figure 57: Market share of registered Pfandbriefe is growing consistently

40% 38% 36% 34% 32% 30% 28% 26% 24% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Market share of registered Pfandbriefe

Source: Bundesbank, Barclays Capital
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EURO AREA HOUSING MARKET
Contrasting trends
Julian Callow +44 (0) 20 7773 1369 julian.callow@barcap.com
Overall, euro area house prices look likely to continue to correct downwards, largely on account of a further significant correction that is likely in the Irish and Spanish markets, and amid a very weak outlook for household spending power. The contrasting trends in economic and financial conditions across the euro area have become ever more apparent in divergent house price trends, which increasingly are demonstrating a correction in markets where there has been an excess in valuation and housing supply. Whereas the markets in Austria, Finland, France and Germany have been showing some recovery (albeit tentative for France and Germany), other markets have generally been exhibiting weakness, consistent with very weak data for household personal disposable income and rising unemployment. The markets in Ireland and Spain have shown the most dramatic weakening, commensurate with the excess housing supply that the local booms had delivered 20. In the case of these markets, the ratio of construction investment to GDP had reached exceptionally high levels a few years previously, reaching 18% for Spain and 22% for Ireland in late 2006. It is these markets that have suffered the largest price declines, with Irish existing home prices in Q4 09 at just 63% of their peak level (in Q3 06), and consequently back to levels prevailing in early 2003, and Spanish house prices in Q1 10 at 89% of their peak level (in Q1 08), and consequently back at Q4 05 levels. In contrast, no other countries experienced such high ratios at the peak (for example, the high for this ratio hit 14% for France, 11% for Italy, 13% for Greece, and 12% for Portugal and the UK). In turn, the relative lack of excess housing supply can help to explain why these housing markets have been comparatively much less badly affected by the financial crisis. That said, the house price correction during 2008-09 was apparent in nearly all countries, with only Austria and Germany not affected.
Figure 58: House price changes and 2010 projection

% change Y/Y 2004 2005 2006 2007 2008 2009 2010 F Typical price* Austria Belgium Finland -2.7 5.9 4.0 4.1 1.3 3.6 4.2 182 12.0 16.7 11.1 9.2 5.3 -0.5 -0.6 195 5.2 6.3 6.4 5.5 0.6 -0.3 9.8 147 France 15.2 15.2 12.0 6.7 1.2 -7.2 1.7 200 German y Greece -0.8 0.0 0.6 0.8 0.8 1.3 0.3 173 2.3 10.9 12.4 5.1 1.7 -3.4 -2.4 126 Ireland 11.6 11.8 13.4 1.0 -8.8 -21.7 -14.8 238 Italy 10.4 8.1 6.7 5.5 3.1 -3.1 -5.0 181 NL 3.6 3.9 4.6 4.2 2.9 -3.3 -1.2 262 Portuga l 3.9 2.9 0.3 0.5 -4.3 -1.6 1.0 99 Spain 17.4 13.9 10.4 5.8 0.7 -7.4 -5.0 166 Euro area 8.8 9.1 7.7 4.9 1.4 -4.2 -1.4 180 UK 11.2 6.5 4.6 11.1 -1.1 -8.2 5.9 207
Note: *Q1 10 estimate, in thousands of euros (except UK: in thousands of pounds). Source: Haver Analytics and other national sources mentioned in this note, Barclays Capital
20
According to Instituto de Prctica Empresarial (IPE), a business school that specialises in property, there are now around 1,050,000 unsold new-build homes on the market in Spain with around 40% of these units in Andalucia and the Valencian Community
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Figure 59: Typical dwelling prices, euro, 000

forecast 08 400 350 300 250 200 150 100 50 0 84 88 92 96 00 04 08 Germany Italy Spain 100 50 0 84 88 92 96 00 04 Finland Portugal Greece NL FR UK 400 forecast 350 300 250 200 150 Austria Belgium euro k Ireland
euro k
Source: Barclays Capital using national data sources
Figure 60: EC consumer survey intention to purchase a home in next 12 months (diffusion balance, %)
-60 -65 -70 -75 -80 -85 -90 -95 -100 1990 -80 -85 -90 -95 1990 Euro area France Spain -70 -75 Germany Italy -60 -65 Portugal Greece Ireland UK
94
98
02
06
2010
94
98
02
06
2010
Source: European Commission, Thomson Datastream, Barclays Capital
Figure 61: Construction investment ratio to GDP (%)

Ireland Italy Portugal 16 Spain France Greece 22 E12 US UK 17 Japan Germany
forecast
21
11
12
6 80 84 88 92 96 2000 04 08
7 80 84 88 92 96 2000 04 08
Source: Haver Analytics, Barclays Capital
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forecast
77
Figure 62: Historical ratios of typical dwelling prices versus per capita personal disposable income
25 20
20 30 25 Japan (Tokyo and Osaka conurbations)
15 10 5
UK France
15 10 Ireland euro area 5 0 1975 1985 1995 2005 Spain
US
0 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: Barclays Capital using national data sources
Overall, in a fundamental sense, house price valuations depend upon a combination of the ratio of house prices to income levels, the level of interest rates, and the level of supply in relation to demand. In this note, we focus primarily on the first two factors, and in particular on the level of typical existing house prices (using a database which we have developed) in relation to per capita personal disposable income (we use per capita PDI since this is a measure which is relatively easily attainable across countries on a quarterly basis, so enabling comparisons and timely calculations). That said, the ratio of house prices to income levels is not constant. While such series may appear to be mean reverting in the long run (see charts above), there can be significant discrepancies over long periods. Moreover, presumably reflecting differences in population densities, land use and taxation, there can be substantial differences in such ratios at a country level (for example, in Japan and Britain the ratio appears to be particularly high). In the current environment, the highly accommodative policy of the European central bank has meant that mortgage rates are at extremely low levels in the euro area. That said, this may well not capture the extent of bank caution in advancing new mortgages, particularly to new borrowers. As well, per capital nominal personal disposable income has begun to fall in the case of Greece, Ireland, Portugal and Spain, and is unlikely to show much if any expansion in these countries in the next few years on account of the dramatic fiscal tightening that they will experience, accompanied by wage adjustment. In the country-level charts which follow for the euro area, we show developments in house prices (using representative series for existing home prices), per capita personal disposable income and interest rates. For most countries, the ratios of house prices to income have been correcting, but still appear to be high from a historical perspective. This indicates further downside risks, despite very low interest rates. However, for Austria and Germany the reverse has been true since the mid 1990s for Germany (and early 1990s for Austria) the ratio of house prices to income levels has been in a strong downward trend. Further, the ratio has declined significantly for Portugal, suggesting that the Portuguese market, despite a prospect of very major fiscal consolidation ahead, may not be overvalued.
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Figure 63: Austria house prices

14 house price/per capita PDI ratio, LHS forecast New borrower hypothetical interest costs*, RHS 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Note: *House price/per capita PDI ratio times 0.5x mortgage rate on new lending
30 25 20 15 10 5 0 -5 -10
House price growth, % y/y Per capita personal disposable income, % y/y Typical mortgage rate, %
13 12 11 10 9 8 7 6 5 4
84 86 88 90 92 94 96 98 00 02 04 06 08 10
Source: Haver Analytics, Eurostat, OeNB, Barclays Capital
Figure 64: Belgium house prices

20 15 10 5 0 -5 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Source: Statbel, BNB, Haver Analytics, Barclays Capital
House price growth, % y/y Per capita disposable income, % y/y Typical mortgage rate, %
12 11 10 forecast 9 8 7 6 5 4 84 86 88 90 92 94 96 98 00 02 04 06 08 10 New borrower hypothetical interest costs*, RHS house price/per capita PDI ratio, LHS
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0
Figure 65: Finland house prices

House price growth, % y/y 60 50 40 30 20 10 0 -10 -20 -30 84 86 88 90 92 94 96 98 00 02 04 06 08 10
14 13 12 11 10 9 8 7 6 5 4 84 86 88 90 92 94 96 98 00 02 04 06 08 10 New borrower hypothetical interest costs*, RHS forecast house price/per capita PDI ratio, LHS
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0
Per capita personal disposable income, % y/y Typical mortgage rate, %
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Figure 66: France house prices

20 15 10 5 0 -5 House price growth, % y/y -10 -15 Per capita personal PDI, % y/y Typical mortgage rate, % 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Source: INSEE, Thomson Datastream, Haver Analytics, Barclays Capital
12 forecast 11 10 9 8 7 6 5 84 86 88 90 92 94 96 98 00 02 04 06 08 10 house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0
Figure 67: Germany house prices

16 14 12 10 8 6 4 2 0 -2 -4 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Source: Bulwien, Thomson Datastream, Barclays Capital
House price growth, % y/y Per capita personal disposable income, % y/y Typical mortgage rate, %
14 13 12 11 10 9 8
house price/per capita PDI ratio, LHS forecast New borrower hypothetical interest costs*, RHS
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0
84 86 88 90 92 94 96 98 00 02 04 06 08 10
Figure 68: Greece house prices

25 20 15 10
forecast 97 99 01 03 05 07 09 6
House price growth, % y/y Per capita PDI (est from 08), % y/y Typical mortgage rate, %
house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS
1.0 0.9
0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1
5 0 -5 -10 97 99 01 03 05 07 09 11
4 5
0.0
Source: Central Bank of Greece, Haver Analytics, Barclays Capital
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Figure 69: Ireland house prices

40
1.5 18 house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS forecast 84 86 88 90 92 94 96 98 00 02 04 06 08 10
30
1.3 1.1 0.9 0.7 0.5 0.3 0.1 -0.1
16
20 10 0 -10 House price growth, % y/y -20 -30 Per capita PDI (est. from 08) , % y/y Typical mortgage rate, % 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Source: Dept of Environment, Thomson Datastream, Barclays Capital
14 12 10 8 6 4
Figure 70: Italy house prices

35 30 25 20 15 10 5 0 -5 -10 -15 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Source: Nomisma, Thomson Datastream, Barclays Capital
12
House price growth, % y/y Per capita PDI, % y/y Typical mortgage rate, %
11 10 9 8 7 6 5 4
house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS forecast 84 86 88 90 92 94 96 98 00 02 04 06 08 10
house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS
1.5 1.3 1.1 0.9 0.7 0.5 0.3 0.1 -0.1
Figure 71: Netherlands house prices

25 20 15 10 5 0 -5 -10 House price growth, % y/y Per capita PDI, % y/y Typical mortgage rate, % 84 86 88 90 92 94 96 98 00 02 04 06 08 10
16 15 14 13 12 11 10
1.0 0.9 0.8 0.7 0.6 0.5 0.4 forecast 0.3 0.2 0.1 0.0
9 8 7 6
84 86 88 90 92 94 96 98 00 02 04 06 08 10
Note: *House price/per capital PDI ratio times 0.5x mortgage rate on new lending
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Figure 72: Portugal house prices

24 20 16 12 8 4 0 -4 -8 88 90 92 94 96 98 00 02 04 06 08 10
9 8 88 90 92 94 96 98 00 02 04 06 08 10
House price growth, % y/y Per capita PDI , % y/y Typical mortgage rate, %
14 13 12 11 10
house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS forecast
1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0
Source: INE, Haver Analytics, Barclays Capital
Figure 73: Spain house prices

40 30 20 10 0 -10 -20 84 86 88 90 92 94 96 98 00 02 04 06 08 10
12 House price growth, % Y/Y Per capita PDI, % y/y Typical mortgage rate, % 11 10 9 8 7 6 5 4
house price/per capita PDI ratio, LHS New borrower hypothetical interest costs*, RHS forecast forecast 84 86 88 90 92 94 96 98 00 02 04 06 08 10
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0
84 86 88 90 92 94 96 98 00 02 04 06 08 10
Figure 74: Euro area house prices

15 13 11 9 7 5 3 1 -1 -3 -5 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Source: Thomson Datastream, Haver Analytics, Barclays Capital
House price growth, % y/y Per capita PDI, % y/y Typical mortgage rate, %
11 10 9 8 7 6
house price/per capita PDI ratio, LHS new borrower hypothetical interest costs*, RHS
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0
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SPANISH HOUSING MARKET
Overview
Official data imply declining house prices in Spain
After a phase of unprecedented growth in the period between 1998 and 2004, with official figures indicating a record of 18.5% y/y in Q4 03, Spanish house price growth has since continuously declined. Between Q4 04 and Q1 09, house prices as reported by the Spanish Ministry of Housing (Ministerio de Vivienda), which usually refer to valuations, have steadily fallen and actually contracted since Q4 08 for the first time since the countrys economic recession in 1993. Since Q2 09, however, the decline appears to have lost momentum with the pace gradually moderating. In Q1 10, the latest date for which data were available, house prices fell 4.7% y/y, up from a 6.3% y/y decline in Q4 09 and a 7.1% y/y fall in Q3 09 (Figure 75). In contrast to previous quarters, however, the discrepancy between the official house price series and monthly data provided by private sources such as Fotocasa or Expocasa has steadily declined and bears a relatively high level of congruence as of late. Whereas the house price series of Fotocasa indicate a 5.6% y/y decline in house prices in March 2010, the latest date for which data were available, the Expocasa series point towards a 5.0% y/y drop in house prices in May 2010. With its indication of a 4.7% y/y decline, the official series is only slightly geared to the upside, which, in our view, increases its explanatory content after previously being systematically geared to the upside (Figure 75). Considering recent macroeconomic developments, unsurprisingly, regional house price developments have developed asymmetrically over the course of the past few quarters. As a rule of thumb, economically stronger regions and/or regions which experienced strong house price growth until 2004 are currently those experiencing a more pronounced contraction in house prices. In 2008, among the regions most affected were the Balearic Islands, where prices contracted by a high 14.4% y/y (from 9.6% y/y growth in 2007) according to data complied by Expocasa. In Comunidad Valenciana, house prices fell 9.2% y/y in 2008 (-1.4% y/y in 2007), followed by Catalonia (-8.7% y/y in 2008, from -2.5% in 2007), and Madrid (-8.0% y/y in 2008, from -2.4% y/ yin 2007). In 2009, on average, house price declines were less pronounced, falling 7.4% y/y in Madrid, 6.7% y/y in Comunidad Valenciana and 6.6% y/y in Catalonia. On the Balearic Islands, house prices remained nearly stable, contracting by a moderate 1.2% y/y. The most recent Q1 10 data further support the findings of a regionally
Figure 75: Spanish housing prices

a) Annual house price inflation (%)
20 15 10
b) Annual house price inflation (%)

20 15 10 5
5 0 -5 -10 Jun-98
0 -5 -10 -15 2005 2006 Fotocasa
Jun-01
Jun-04
Jun-07
Jun-10
2007 2008 2009 Expocasa Official
2010 Idealista
Source: INE, MVIV, Expocasa, Fotocasa, Idealista, Barclays Capital
10 June 2010
83
biased development. On the Balearic Islands, house prices fell by an average of 6.3% y/y, followed by 3.3% in Catalonia. In Comunidad Valenciana and Madrid, house prices fell by 1.8% y/y and 1.7% y/y, respectively (Figure 76). Figure 76: Regional house price developments (y/y variation in %)
2007 Andalusia Aragon Asturias Cantabria Castilla and Leon Castilla-La Mancha Catalonia Valencia Extremadura Galicia Balearic Islands Canary Islands La Rioja Madrid Murcia Navarra Basque Country
Source: Expocasa, Barclays Capital
2008 -6.0 -8.3 -5.8 -2.9 -7.0 -11.0 -8.7 -9.2 -8.3 1.6 -14.3 -5.1 -2.4 -8.0 -9.2 -9.0 -7.8
2009 -5.6 -6.4 -4.4 -5.2 -7.0 -9.2 -6.6 -6.7 -8.3 -5.2 -1.2 -2.6 -1.4 -7.4 -6.1 -6.1 -2.8
2010 -2.3 -1.7 -0.1 0.2 -2.0 -2.1 -3.3 -1.8 -0.7 -2.0 -6.3 -2.8 -3.1 -1.7 1.8 -1.9 -2.0
2.9 -2.3 -0.4 2.1 2.8 0.8 -2.5 -1.4 -0.6 0.7 -1.0 3.8 -11.1 -2.4 -0.2 -4.0 -0.4
Large stock of unsold property
Taking into consideration a stock of 688,000 unsold dwellings as reported by the Ministerio de Vivienda for year-end 2009 (with estimates on behalf of the G-12 property developers association pointing towards the markedly higher figure of 1,000,000) and the currently challenging economic environment with an unemployment rate of more than 20%, we do not expect Spanish house prices to markedly recover in the near term. Despite the growth rate in the stock of unsold dwellings falling to 12% y/y in 2009 from 40% in the years before, we highlight that the better part of this stock remains on the balance sheet of property developers, which, facing mounting pressures regarding the full and timely repayment of loans as of late, have started transferring assets to Spanish commercial and savings banks. By now, most financial institutions in Spain have set up subsidiaries whose sole business purpose is to sell (residential) property. We thus believe that over the course of 2010, Spanish house prices are poised to further decline, albeit at a slightly more moderate pace than in the years before. Owing to the economic deceleration that saw both unemployment and the consumers savings rate rising sharply over the course of the past year, the Spanish construction sector has remained under pressure, with the number of new dwellings built contracting by 60% y/y for the second consecutive year. Whereas in 2007, the number of newly built dwellings still amounted to 650,427 units, figures plummeted to 264,795 units in 2008 and further to 111,140 units in 2009, the lowest number in more than 20 years. Only three years before, in 2006, the number of new dwellings built hit a record of 794,000 units, ie, more than the combined figure of dwellings built in Germany, France and Italy in the same period (Figure 77). In light of the aforementioned stock of unsold dwellings and economic situation in Spain, we do not expect this development to markedly change in 2010. In contrast, with 6,331 and 7,575 units, respectively, the number of new dwellings started in January and February 2010 is significantly lower than in the same period in 2009 (9,861 units in January and 10,253 units in
84
Ongoing decline in the number of dwellings built
10 June 2010
February) which, in our view, is a reliable indicator of a further moderating construction activity in 2010. The count of dwellings built is likely to further decline in 2010 (Figure 77). The number of property transactions, in contrast, appears to have gradually recovered as of late. Although still falling at a pace of 18% y/y to 462,747 units in 2009, from 564,464 units in 2008, already down12.4% y/y from 836,871 units in 2007, the development in Q4 09 reflected a (temporary) recovery as sales climbed to the highest number in the past six quarters (Figure 78). What is more, spurred by an 18.7% y/y (+7.2% m/m) increase to 41,033 units in the number of (new and used) urban dwellings sold, the overall number of property transactions strongly picked up in February 2010. In May 2010, overall housing transactions increased at a pace of 9% y/y.
Applicable interest rates on mortgage loans at historical lows
The current recovery in the volume of property transactions is (partly) attributable to the benign interest rate environment. Average rates applicable to mortgage loans, of which 98% are pegged to the 12-month Euribor, remained at historical lows. At the time of writing, 12month Euribor stood at 1.24%, ie, even below the 1.6% observed in June 2009 and markedly lower than the 5.4% recorded in June 2008 (Figure 78). As the principal mortgage rate in Spain usually is re-set once a year, this development has meanwhile left its mark on the average applicable mortgage rate. In March 2010, the latest date for which data were available, the average interest rate applicable to a mortgage loan stood at 2.5% in the case of commercial and 3.0% in the case of savings banks. In June 2009, the respective rates still stood at 3.0% in the case of commercial and 3.5% in the case of savings banks 21. Despite this strong decline in the applicable mortgage rates and the related drop in the Households Theoretical Affordability Index, as published by Banco de Espaa (BdE), which dropped to 34.5% in Q1 10 from 43.3% in Q1 09 and thus to its lowest level since Q4 03 22, this development has so far not caused mortgage lending to recover. According to Banco de Espaa data, mortgage lending increased at a pace of 0.8% y/y in February 2010, the latest date for which data were available. This is in line with the pace observed over the course of the past 12 months, which indicates that in principle, new mortgage lending in Spain came to a standstill in spring 2009. Adding to this development, in our view, is the fact the over the
Figure 77: Construction activity in Spain

a) Dwellings built in Spain (in 000 units) b) Dwellings started (in 000 units)
800
100
600
80
60
400
40
200
20
0 1992 1994 1996 1998 2000 2002 2004 2006 2008

Source: INE, Barclays Capital
0 Jun-92
Jun-96
Jun-00
Jun-04
Jun-08
21 22
Source: AHE, June 2010. Source: Banco de Espaa (BdE); March 2010.
10 June 2010
85
course of the past few quarters both commercial and savings banks have become increasingly hesitant with regards to mortgage lending. Three years ago, during its peak in spring 2006, mortgage lending had increased at a pace of more than 35% y/y (Figure 79). Notwithstanding the historically unprecedented interest rate environment, we do not expect mortgage lending to markedly recover in the months ahead, mostly because of the countrys challenging economic situation. Following a 3.6% y/y GDP decline in 2009, the unemployment rate in Spain stood at 20.05% at end-March 2010, with few indicators pointing towards a marked near-term improvement. As the development on the Spanish labour market is likely to continue to overshadow the demand for new (and used) housing and thus for mortgage lending, we do not expect numbers to significantly improve over the course of 2010. The recently adopted austerity measures which are set to cut the budget deficit to 9.3% of GDP in 2010 and to 6.0% of GDP in 2010, are likely to lead to more muted activity, particularly as civil servants will face a 5% salary cut in 2010 and a freeze of their pay until end-2011.
Figure 78: Property market indicators

a) Number of transactions (in 000) b) 12-month Euribor (%)
300 250 200 150 100 50 0 Q1 04
6 5 4 3 2 1 0 Jun-05
Q1 05
Q1 06
Q1 07
Q1 08
Q1 09
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Source: Ministerio de Vivienda, Barclays Capital
Figure 79: Affordability

a) Households Theoretical Affordability Indicator b) Variation in monthly mortgage lending (in % y/y)
60 50 40 30 20 10 0 Jun-98
40
30
20
10
Jun-00 Jun-02 Jun-04 excluding deductions
Jun-06 Jun-08 Jun-10 including deductions
0 Mar-99
Mar-01
Mar-03
Mar-05
Mar-07
Mar-09
Source: Banco de Espaa, Barclays Capital
10 June 2010
86
Steady increase in NPL ratios
In line with the economic downturn and the surge in the countrys unemployment rate, the ratio of NPLs has sharply increased over the past two years. Whereas in June 2008, the NPL ratio as reported by Banco de Espaa stood at a modest 1.7%, it subsequently increased to 4.6% in June 2009 and to 5.4% in February 2010. Yet, compared to 2008, the (monthly) increases in NPL appear to have gradually declined. Still, in light of the current economic situation, we expect the NPL ratio to further increase, thereby forcing banks to increase risk provisions in anticipation of higher write-offs (Figure 80). Despite being usually understood to be low-risk, mortgage lending could not decouple itself from the overall deterioration of the banks assets. Starting in late 2007, the ratio of nonperforming mortgage loans started to experience a pronounced increase, with the overall NPL ratio climbing to 5.3% in Q1 10 from 4.6% in Q2 09 and 1.7% in Q2 08. Yet whereas previously, the increase in non-performing mortgage loans was strongly driven by Spanish savings banks, which, on average, reported a 100bp higher NPL ratio than the countrys commercial banks, this development seems to have stalled in Q4 09, when the ratio of non-performing mortgage loans as reported by Spanish commercial banks (5.6%) stood in line with that of the countrys savings banks (5.6%) (Figure 80). Generally, savings banks appear to be more strongly affected by nonperforming mortgage loans as they did not reduce their mortgage lending activity as early as commercial banks and thus face weaker vintages with regards to the underlying (already elevated) house prices. Also, on average, the savings banks exposure towards property developers is higher than in the case of commercial banks. In January 2010, the latest date for which data is available, the situation had gradually shifted again, with commercial banks reporting a slightly lower NPL ratio (5.2%) than the savings banks (5.3%).
Conclusion
As a result of the high stock of unsold dwellings and the economic situation that has deteriorated compared with previous years, we do not expect the Spanish housing market to markedly recover in the near term. Despite a historically low interest environment, the countrys very high unemployment rate is likely to cause the non-performing (mortgage) loan ratio to further increase in the months ahead, thereby casting doubts over the performance of the collateral pool of Spanish covered bonds. Whereas we do not expect the legally binding over-collateralisation ratios to be breached, investors should prepare themselves to further headline news, particularly with regard to the countrys savings banks, which are on the brink of an extensive consolidation process. Furthermore, despite gradually abating at the time of writing, distortions related to the swap-spread performance of Spanish sovereign debt could continue to overshadow the market. Thus, despite the currently elevated swap-spread levels of many Spanish covered bonds, we advise investors to stay alert and to thoroughly analyse an issuers and an issues credit quality.
Figure 80: Development of non-performing loan ratios

a) Non-performing loans (%) b) Non-performing mortgage loans (%)
10
6%
8
4%
6
2%
2
0% Jun-05 Jun-06 total Jun-07 Jun-08 Jun-09 Jun-10
0 70 75 80 85 90 95 00 05 10
commercial banks
savings banks
Source: Banco de Espaa, AHE, Barclays Capital
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UK HOUSING MARKET
The mortgageless recovery

Simon Hayes +44 (0) 20 7773 4637 simon.hayes@barcap.com UK house prices have recovered strongly over the past year
House prices continue to rise in spite of weak mortgage lending. Low interest rates and a smaller-than-expected rise in unemployment have kept mortgage arrears and possessions low. The outlook is positive but subdued by pre-crisis standards. UK house prices have recovered strongly over the past year. According to the Nationwide Index, prices were up 10.6% y/y in April, leaving them 10% below their pre-crisis peak (Figure 81). The recovery has been broadly-based geographically, with every region/country seeing y/y increases except for Northern Ireland although London (15.7% y/y) and the south east (13% y/y) have been the notable outperformers. Market activity has not been buoyant, however. The number of residential property transactions in the 12 months to March was 45% down on that seen in 2007, for example. Anecdotally, rising prices have been driven by a low level of properties put up for sale rather than by particularly strong demand. However, the RICS survey does not wholly support this view, suggesting instead that there was a pronounced turnaround in new buyer enquiries last year and that the improvement in new instructions to sell, although slow to kick in, has not been particularly weak (Figure 82). If we use these two series to construct a measure of the change in net demand it tends to lag house price inflation by around nine months (Figure 83). The recent moderation in house price inflation would be consistent with the market moving closer to equilibrium during the remainder of the year.
This has been despite weak mortgage lending
The rise in house prices has occurred in spite of weak mortgage flows. Net mortgage lending for house purchase was 12.2bn in the year to March, barely 10% of the level seen in 2007 (Figure 84). UK banks are continuing to provide mortgage credit, but this is being offset significantly by ongoing retrenchment by building societies and other lenders (primarily foreign banks). The market has instead been supported by cash buyers: as we have observed before (see Households enduring desire for housing, 25 November 2009), although households purchases of housing assets has weakened, it has not weakened by as much as would have been expected given the fall in mortgage lending. The channelling of savings into housing is one of the consequences of loose monetary policy. Figure 82: RICS survey balances
Balance, 6mma 60 40 20 0 -20 -40 -60 New buyer enquiries New instructions to sell
Figure 81: Average UK house price

'000 200 180 160 140 120 100 80 60 40 20 0 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Nominal Real
01
02
03
04
05
06
07
08
09
10
10 June 2010
88
Mortgage arrears and possessions have been much lower than expected
The other notable feature of the housing market has been the fact that mortgage arrears and possessions have been much lower than might have been expected. To illustrate this point, Figure 85 shows how, in a simple linear regression (estimated up to 2007), changes in house prices, mortgage payments and unemployment account for changes in mortgage possessions. The large negative residuals in 2008 and 2009 indicate that the upward pressure on possessions coming from falling house prices and rising unemployment would have pointed to much higher possessions than were actually observed. This is so even taking into account the large drop in mortgage payments in 2009, which was helpful in cushioning the market from the effects of the recession. Given our forecasts for house prices, interest rates and unemployment, our simple model predicts possessions to fall by around 4% in 2010. However, it is worth noting that data for Q1 10 show a 16.5% fall relative to the quarterly average in 2009, so another undershoot relative to the model may be in train. Even so, there are, in our view, reasons to be cautious about the possessions outlook. There seems to be a good deal of forbearance propping up the UK economy at present. Firms cash flow is being assisted by government schemes to defer tax payments. Unemployment
Figure 83: House prices and net demand

Balance 60 40 20 0 0 -20 -40 -60 01 02 03 04 05 06 07 08 09 10
Figure 84: Net mortgage lending

% 20 15 10 5
Net new demand, lagged 9 months (lhs) House prices, 6-month change (rhs)
bn 12 10 8 6 4 2 0 -2 -4 99 00 01 02 03 04 05 06 07 08 09 10
Other UK banks Total
-5 -10 -15
Figure 85: Mortgage possessions

% y/y 200 150 100 50 0 -50 Constant Mortgage payments Residual House prices Unemployment Actual Model forecast
Figure 86: Ratio of house prices to household income

Ratio 5.5 5.0 4.5 4.0 3.5 3.0 2.5 Actual Average Trend assuming income elasticity of 1.1
-100 89 91 93 95 97 99 01 03 05 07 09
2.0 55 59 63 67 71 75 79 83 87 91 95 99 03 07
10 June 2010
89
is being held down by labour hoarding. Possessions are reportedly being dampened by forbearance by lenders. If the economy puts in a steady recovery, as we expect, this forbearance will be seen to have been helpful in cushioning the economy against the worst effects of the recession. However, were another crisis to ensue it is possible that the UK could see a surge in company insolvencies and a rise in unemployment, and arrears and possessions could rise once more. How do the recent price increases leave housing valuations? Many commentators focus on the ratio of house prices to some measure of household income. On our preferred version of this statistic the ratio of house prices to disposable income per household the market appears significantly overvalued still. The ratio stood at 4.4 in Q4 09, some way above its historical average of 3.1 (Figure 86).
The house price to income ratio remains high
The use of the historical average as a valuation benchmark is questionable, however, as the series is not obviously mean-reverting. If instead we use the historical relationship between house prices and income which produces an income elasticity of 1.1 as opposed to the 1.0 implicit in the assumption of a constant price-income ratio the degree of over-valuation appears lower but still substantial (Figure 86). Again, however, we would question the worth of such a simple, even simplistic, benchmark. In particular, this measure takes no account of factors such as impediments to the supply of new housing, which is particularly acute in the UK given strict planning laws, and changes in the user cost of housing such as mortgage rates. Housing supply is likely to be a particular problem. Prior to the credit crisis the governments housing advisory body said the UK would need to build around 240,000 new houses a year in order to stabilise affordability. Such a pace of construction had not been seen since the late 1980s (Figure 87). Moreover, house building has slumped recently, and in the four quarters to Q3 09 only 155,000 houses were completed.. The supply problem is therefore getting worse, not better, and we believe this is likely to provide a significant support to prices over the medium term. If we construct a simple long-run housing valuation model incorporating these factors, UK house prices appear to have undershot their equilibrium (Figure 88) and are around 10% below the models predicted value. Our overall assessment is that house prices will continue to rise over the course of the next year, but at a moderate pace more moderate than seen over the past year. On the
but taking mortgage rates and housing supply into account housing looks undervalued
Figure 87: Housing completions, four-quarter rolling sum

thousands 250 240 230 220 210 200 190 180 170 160 150 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09
Figure 88: UK house prices

'000 200 180 160 140 120 100 80 60 40 20 0 75 78 81 84 87 90 93 96 99 02 05 08 Actual Long-run model equilibrium
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90
supportive side, in addition to weak housing supply mortgage rates have been stable for the past year, and we expect the policy rate to stay at its current level for the rest of 2010. The outlook for mortgage lending remains subdued, however: the Bank of Englands credit conditions survey indicates that mortgage availability has stabilised but is not expected to show any material improvement in the near term (Figure 89). The outlook for real post-tax household income over the next 12 months is weak in the context of high unemployment, relatively high inflation and higher taxes. We therefore expect house price inflation to moderate from around 10% at present to around 4% at the end of the year (Figure 90). However, as the economic recovery becomes more firmly established we expect household confidence to improve which, together with a continuing shortage of supply, should put further upward pressure on prices. We see the annual rate of house price inflation back up to around 9% by the end of 2011.
Figure 89: Availability of mortgage credit, BoE credit conditions survey

20 10 0 -10 -20 -30 -40 -50 -60 Mar-08 Mar-09 Mar-10 Jun-08 Jun-09 Sep-08 Dec-08 Sep-09 Dec-09 Jun-10 Reported Expected
Figure 90: House price inflation

% y/y 30 25 20 15 10 5 0 -5 -10 -15 -20 01 03 05 07 09 11 Forecast
Source: Bank of England, Barclays Capital
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91
US HOUSING MARKETS
Recovering in fits and starts

Peter Newland +1 212 526 3153 peter.newland@barcap.com Theresa Chen +1 212 526 7195 theresa.chen@barcap.com
Housing market activity has turned higher, boosted significantly by the homebuyer tax credit. Negative payback is likely when this expires but the recovery in sales and starts, albeit from a low base, should remain intact. Foreclosures continue to pose a hurdle.
Overview
Having fallen precipitously during 2006-08 and stabilised during 2009, there has been a clear improvement in housing demand this year, as the broader economic recovery has gained traction and housing affordability has improved (average prices have been brought into line with household income, Figure 91, and mortgage rates have fallen). However, there has also been an artificial boost to demand from government policies, notably the homebuyer tax credit and Fed MBS purchase program. Looking through these temporary boosts we judge that the housing market is in the early stages of recovery and expect an upward trend in sales and starts, albeit from very low bases. However, this is unlikely to translate into significant price gains in the near term at the national level, with downward pressure from foreclosed properties entering the market offsetting upward pressure from improving demand, employment and income growth. Within our broader view of the economic outlook we look for residential construction to add positively to GDP growth over the course of this year and next, having been a drag for the previous four years. In our judgement the downside risks to this view are limited given how low activity has fallen and, in light of this, even another further leg down would only have a limited impact on top-line GDP growth. House price growth is likely to remain subdued for some time; one impact being that housing wealth will remain depressed (although this should become less negative as house prices stabilise). However, income growth and stock market wealth are more important drivers of consumer spending decisions and hence the broader economic recovery.
The housing market is no longer a drag on the US economy
A closer look at the numbers

Sales have risen, boosted by the homebuyer tax credit
Sales, particularly of existing homes, have risen strongly this year, although there has been a clear boost from the homebuyer tax credit. This initially ran to November 2009 (for signed contracts) and had the impact of pulling demand forward, boosting sales in the months prior Figure 92: Existing and new home sales
Mn, saar 7.5 7.0 6.5 Existing home sales New home sales Forecast 1600 1400 1200 1000 800 5.5 5.0 4.5 600 400 200 0 99 00 01 02 03 04 05 06 07 08 09 10 11
Source: Census Bureau, Barclays Capital
Figure 91: Home prices relative to income

index 1987 = 100 325 275 225
6.0 175 125 75 87 89 91 93 95 97 99 01 03 05 07 09 Case-Shiller HPA Median family income
4.0
Note: Barclays forecast for 1Q09; Source: Case-Shiller, BEA, Barclays Capital
10 June 2010
92
to the expiration and depressing them thereafter. The tax credit was later extended to April 2010 for signed contracts (June for closed deals) and appears to have had a similar impact again sales jumped sharply higher in March and April, but we expect this to be partly reversed in coming months (Figure 92). An additional, but smaller, boost has come from the Feds MBS purchase program, which has helped keep mortgage rates close to historical lows. Rates look unlikely to move sharply higher in the near term (with the Fed likely to maintain a loose policy stance) and while access to mortgage credit remains limited, there are signs (from the Feds Senior Loan Officers Survey, for example) that credit conditions are no longer tightening, particularly for prime borrowers.
Building permits and homebuilder sentiment have improved too
More timely indicators have improved too. Building permits have edged higher and pending home sales increased through Q1, consistent with a sustained rise in home sales over the summer. Mortgage purchase applications continue to be volatile. A recent pick-up in the NAHB Housing Index suggest that builders have grown in optimism the Headline Index has recently reached levels last seen in 2007. However, the series still remains low compared to its history. Looking ahead, once the volatility around the homebuyer tax credit has played out, we expect home sales to be on a moderate upward trend. This should translate into further gains in housing starts too. As builders have reduced inventories to such low levels, even a small gain in new home sales should spur an increase in construction. Starts reached 672,000 in April, from the record low of 488,000 in January 2009. However, this remains well below the peak of 2.27mn recorded in January 2006 and what we judge to be the neutral rate of housing starts (based on demographic factors) of around 1.5mn. This implies that homebuilders are under-building, which is appropriate as they offset the over building between 1996-2006 (Figure 93) and continue to face competition from foreclosed properties coming back on to the market.
Rising sales should lead to a pick-up in construction
Foreclosure pipeline remains a hurdle

Foreclosures continue to represent a headwind
In our summary last year, Housing to bottom in stages (AAA Handbook, June 2009), we expected that overall housing inventories would remain bloated due to rising foreclosures, and that this process would constrain new construction and put downward pressure on home prices through the second half of this year. To a large degree this view has been confirmed by the data. If anything, the pressure was a bit less severe than we anticipated due in large part to foreclosure moratoriums, loan modification programs and policies like the homebuyer tax credit.
Figure 93: Housing starts Actual versus natural rate

mn, saar 2.2 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 80 85 90 95 00 05 10 Natural rate of starts
Source: NAR, Census Bureau, Barclays Capital
Figure 94: Foreclosures pipeline

Thousands of mortgages f/c 4,500 4,000 3,500 f/c 3,000 2,500 2,000 1,500 1,000 500 0 05 06 07 08 09 10 11 12 Seriously delinquent or foreclosure Real Estate Owned (REO)
Actual starts
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That said, the foreclosure pipeline is likely to be a continued headwind in the coming year as about 4.2mn mortgages are either seriously delinquent (90+ days) or in some stage of foreclosure (Figure 94). While foreclosures started have likely peaked (Figure 95), real estate-owned (REO) inventories will remain significant as the various programs put in place to provide a boost to the housing market and forestall foreclosures fade (REO is the last stage of the foreclosure process when banks take ownership of the home).
and are likely to limit price gains this year and next
The speed at which foreclosed properties enter the market as re-sales is key to gauging the risk to the housing recovery. If foreclosures flood the market rapidly, it could drag down home prices further and slow housing starts. Working against this is our projection for continued growth in income and employment, which should continue to provide a boost to housing demand. In addition, further delaying of foreclosures from the Treasurys expansion of the Home Affordable Modification Program is likely to reduce some downside pressure on home prices, albeit at the expense of prolonging the adjustment.
A look at regional trends

Regional variations are stark
At the time of our last AAA Handbook we divided states into the following buckets based on home price movements through the first quarter of 2009: Severe bubble-to-bust: States with at least 20% y/y appreciation during the boom and 20% y/y deprecation through Q1 09. Four states fit this description at the time: Nevada, California, Arizona and Florida. Muted bubble-to-bust: 14 states with a less dramatic boom and bust swing. Bust but no bubble: Included the most distressed states, which experienced a sharp drop in home prices without a bubble. This bucket included Michigan, Ohio, Georgia and Minnesota. Mild depreciation: The majority of the states fell into this category. There was no boom, but economic weakness and tighter credit depressed prices. Home price appreciation: Texas, South Dakota, North Dakota and Wyoming were four states that largely escaped the housing downturn at the time of our last housing report.
Figure 95: Foreclosures started with forecasts

millions of homes 3.5 3.0 2.5 2.0 1.5 1.0 0.5 Forecasts
Figure 96: Home price movements

% change y/y through Q1 2010 2 0 -2 -4 -6 -8
0.0 92 94 96 98 00 02 04 06 08 10 12
Severe Muted Bust but no Mild Home price bubble-tobubble-tobubble depreciation appreciation bust bust
Note: based on FHFA purchase-only home prices. Source: Barclays Capital
Source: Mortgage Bankers Association, Barclays Capital
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The trends in home price movements at that time largely remained in place through the first quarter of 2010 (Figure 96). Severe bubble-to-bust states declined further by 7%, while those in the muted bubble-to-bust, bust but no bubble, and mild depreciation buckets experienced average declines between 2% and 4.4%. Finally, those states in the home price appreciation category continued to see slight gains in home prices. Therefore, although the national home price indices are basically flat on a y/y basis (Figure 97), those states with the most severe case of boom-bust behaviour continue to experience price weakness and the various regional markets remain in different stages of repair.
Some states still have a large degree of excess supply
To get an idea of whether these regional trends will remain in place, we examine a proxy of housing over-supply based on home-owner vacancy rates. We do this for both the US and individual states. The US vacancy rate has continued to edge down for five consecutive quarters and as of Q1 10 now stands at 2.6%. 23 Based on an estimate of the US housing stock, this translates to an oversupply of about 630,000 homes on the market, down from about 700,000 a year earlier. Yet the level of oversupply nationwide still sits well above its historical average of 1.7%. State by state results, as expected, exhibit a wide variance. Figure 98 summarizes these results in a histogram. At one end of the spectrum, are Nevada, Florida, and Michigan, three states where excess homes make up 2-3% of the housing stock. Ohio, Georgia, and Arizona are next with vacancy rates between 1.5% and 1.9%. Each of these six states fall into the first or third home price bucket, meaning prices are still falling. These states are also states with high levels of unemployment and foreclosures, which means higher numbers of transactions and downward pressure on prices. At the other end of the spectrum are those states with low over-supply (ie, undersupply) and low rates of unemployment.
which is more broadly associated with economic conditions
Bottom line
Adjustment will take time, but housing activity should continue to improve
The housing market continues to face a long period of adjustment, as foreclosures work through the system, damping starts and prices. However, demand has picked up on the back of government support and improving fundamentals. We expect the upward trend to persist.
Figure 97: National home prices

% change from respective peak -32.5 -32 -29 -23.3 -31 -13.4
Figure 98: Histogram of states by housing supply

# of states 30 25 20 15 10 5 0 2% - 3% 1% - 2% 0% - 1% <0 housing oversupply as % of housing stock 1. NV 2. FL 3. MI 4. OH 5. GA 6. AZ 7. SC 8. CO 9. MN 10. RI
latest % y/y Radar Logic RPX (Mar) Case-Shiller 20-city (Mar) National Assoc. of Realtors (Apr) Zillow.com (Q1) -0.3 2.4 4.0 -3.8 0.5 -2.3
48. 49. 50. 51.
WY WV ND NM
Source: Haver Analytics, Bloomberg, Zillow.com, Barclays Capital
Source: Barclays Capital.
23
Over-supply is based on home-owner vacancy rates (percent of the housing stock that is vacant for sale). We measure over-supply as the difference between the current and the normal vacancy rate, where the normal vacancy rate is taken as the average between 1999 and 2001. See Harvard Joint Center for Housing Studies, The State of the Nations Housing 2008.
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SUPRAS AND EUROPEAN AGENCIES
A new reality or just a breakpoint on the way?

Michaela Seimen +44 (0) 20 3134 0134 michaela.seimen@barcap.com
The supranational and European agency/sub-sovereign sector (SSA) has been subject to substantial spread volatility in late 2008 and the first half of 2009. In line with the general market recovery since summer 2009, SSA spreads seemed to have found a new basis for a while, but recent shifts in sovereign spread levels sparked by concerns over the long-term solvency of Greece also had an impact on the SSA sector. In this chapter, we provide information on spread developments and the composition of the sector.
Supra and European agency spread performance

The volatility in Supra/European agency spreads has increased substantially over the past two years, and temporarily in 2008 and early 2009, valuations moved above Libor to unprecedented highs. Major pressure on spreads coincided with the announcement of financial market stabilisation measures in Q3/Q4 08. The respective fiscal measures worsened perceptions over the credit quality of sovereigns and also triggered concerns regarding supply. In addition, issuance of government guaranteed bonds (GGBs) led to a repricing of the whole SSA segment as initially, primary market deals in this new and strongly growing area provided significant price concessions vis--vis outstanding comparable SSA debt. The gradual opening of capital markets, based on decreasing risk aversion by investors and a search for yield, resulted in the reversal of swap spread developments in summer 2009. Spreads contracted and temporarily stabilised at higher historical levels until the beginning of 2010. However, renewed concerns about sovereign risk has brought back volatility to the sector in recent months. Following the move of SSA yields above swap rates, now more than ever, monitoring and assessing swap spreads remains the starting point for assessing supra/agency trading levels. The following charts illustrate some of the key developments in swap spreads and in supranational spreads to governments and swaps, as shown by the iBoxx supranational indices (which we have used as a good indicator of core issuers in the sector).
Increased swap spread volatility and curve inversion
Figure 99 highlights not only the overall increase in swap spread volatility, but also the inversion of the swap spread curve in EUR over the past 2.5 years. Whereas pre-crisis spreads from two to 30 years traded within a 4bp range, the range reached a maximum of 140bp in Q4 08 and now after a brief phase of contraction again trade at about 110bp.
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Figure 99: EUR swap spreads (bp)

140 120 100 80 60 40 20 0 -20 -40 -60 May-07 Sep-07 Jan-08 May-08 Sep-08 EUR 2yr
Jan-09 May-09 Sep-09 EUR 10yr
Jan-10 May-10
EUR 5yr
EUR 30yr
Similar trends in EUR, USD and GBP swap spreads
As Figure 100 illustrates, a broadly similar picture has been apparent across the three key currency sectors for supranational/agency issuance (EUR, USD and GBP). The drive to higher spread levels and later the respective correction in the 2y swap spread curve has been most severe in USD. The recent surge of EUR spreads are based on concerns about developments over the European monetary union. Gaps between supranational EUR spreads to swaps have decreased, but also become quite volatile along all maturity spectrums (Figure 101): 3-5y Supras tightened within six months from a high in April 2009 of about 42bp to swap par levels around October 2009. Since then 3-5y Supra spreads fluctuate below and around swap par levels. 7-10y Supra spreads contracted from high 55bp levels as at April 2009, fluctuating between 15-22bp levels since September 2009 and at about 17bp currently.
Figure 100: Swap spreads and slopes in EUR, USD and GBP
2y swap spreads (bp) Swap spread slopes (bp)
180 160 140 120 100 80 60 40 20 0 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 EUR 2yr
50 0 -50 -100 -150 -200 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 EUR 2/30yr
GBP 2yr
USD 2yr
GBP 2/30yr
USD 2/30yr
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Over 10y issues have contracted from a high in April 2009 of about 75bp to 25bp in Q4 09. However, general market concerns have resulted in renewed spread widening relative to swaps of around 32bp. The increase in swap spread volatility has also been reflected in Supra spreads to governments. Three- to five-year spreads to governments widened about 80bp between April 2008 and Q1 09. The following contraction until April 2010 brought spread levels to governments partly back to early 2008 levels. Again, spikes in April are based on market participants recent concerns with regard to sovereign risk.
Cross currency arbitrage got a new focus in H2 09
A cross-currency comparison of three- to five-year supra spreads shows that volatility in spreads to swaps has been significantly higher in USD than in EUR (see Figure 102). GBP spread volatility has been more choppy than USD or EUR spread moves. We understand this could be partly based on dislocations with regard to variable spread measures. Prior to the financial crisis, the performance of SSA bonds was valued on a spread to government basis, whereas today performance is mainly measured on swap spreads. Due to the relative smaller size of the SSA market in GBP, and a certain time gap in adjusting to these performance measures compared to USD and EUR markets this could have caused the more extreme moves between October 08 and H1 09 in GBP compared to EUR and USD. The relationship between supra spreads to governments and to swaps has also diverged across currency sectors. For GBP, volatility in spreads to gilts has been lower than in spreads to swaps, whereas in the EUR sector, volatility in government spreads has been similar to that in spreads to swaps. For USD, volatility in spreads to Treasuries was lower compared with the volatility in spreads to swaps. Such divergences in spread behaviour across currency sectors point to opportunities and risks in primary and secondary markets. For secondary traders, such volatility can be seen as creating spread trading opportunities, but it also underlines the need to differentiate hedging approaches across currency sectors and depending on trading time horizons.
Figure 101: Supranational spreads in EUR across the maturity spectrum

Spreads to swaps (bp) Spreads to governments (bp)
80 60 40 20 0 -20 -40 Apr-06
Jan-07
Oct-07
Jul-08
Apr-09
Jan-10
100 90 80 70 60 50 40 30 20 10 0 Apr-06
Jan-07
Oct-07
Jul-08
Apr-09
Jan-10
Supranationals 10+ years Supranationals 3-5 years

Supranationals 7-10 years
Supranationals 3-5 years Supranationals 10+ years

Supranationals 7-10 years
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Figure 102: Supranational three to five-year spreads comparing EUR, USD and GBP
Spreads to swaps (bp) Spreads to governments (bp)
120 100 80 60 40 20 0 -20 -40 -60 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 GBP 3-5yrs EUR 3-5yrs USD 3-5yrs
200 180 160 140 120 100 80 60 40 20 0 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 GBP 3-5yrs
EUR 3-5yrs
USD 3-5yrs
For issuers, short-dated supra spreads to swaps have occasionally traded at tighter levels in GBP than in EUR in 2008, which was underpinned by a continuing flow of GBP issuance by MLIs and European agencies. However, decreased issuance levels in GDP in 2009 partly reversed this trend. As of H2 09, owing to a favourable base swap development, costs of USD issuance swapped to EUR looked favourable, eventually resulting in larger USD issues in primary markets. At the same time, for fixed income investors with multi-currency portfolios, cross-currency differentials of supranationals relative to governments have favoured supra investment in USD over EUR and GBP. Despite the contraction in spread levels since summer 2009 across all three currency sectors, the widening in short-dated supra spreads to governments has increased the proportionate pick-up for supra/agency bonds over governments at historically attractive levels. Figure 103 illustrates this for the GBP sector.
Figure 103: Relationship of supra spreads over governments to yield levels

GBP supranational yields (%) Ratio of spreads over gilts to yields (%)
7 6 5 4
3-5yr
40% 35% 30% 25% 20%
3-5yr
3 15% 2 1 0 Mar-03 10% 5% 0% Mar-03
Mar-05
Mar-07
Mar-09
Mar-05
Mar-07
Mar-09
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Following strong supply of SSA and GGB bonds in Q1 09, primary activity in these segments subsided in the course of Q2 09. In addition, the announcement of the ECB to purchase 60bn of covered bonds in early May helped re-open the covered bond market. This, in turn, reduced the need of banks to make use of GGBs and helped allay concerns that ongoing supply in this segment would continue to weigh on the traditional SSA segment. Thus, later in 2009, SSA spreads versus swaps and government bonds gradually tightened, despite the overall strong supply of SSAs in 2009. Owing to the contraction of government swap spreads in H2 09, SSA swap spreads partially moved sideward. Given the renewed volatility of government spreads since the beginning of the year, SSA spreads have also been affected. We expect spread volatility to continue. Nevertheless, given still high spread levels, we see potential for further spread tightening to government bonds for this segment.
Supply from supras and European agencies

SSA supply on continuously high levels in 2010
A longer-term upward trend in gross supply from MLIs and European agencies has resumed in the past few years. Funding levels in 2010 have been announced, with most issuers on similar high levels to 2009. In that year, full-year gross supply was about 350bn, compared to 265bn in 2008. For 2010, we expect a gross supply of about 375bn. The relatively high funding levels for 2009 and 2010 should be partly due to the fact that virtually all European sovereigns have established economic stimulus packages and assigned parts of the respective tasks to supra-nationals and domestic development banks. Given these reasons and the current slow recovery of the global economy, we expect the funding requirements of SSA entities to remain on relatively high levels also in 2011.
Figure 104: MLIs and European agency supply (EURbn)

250,000 200,000 150,000 100,000 50,000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 yt May
MLIs
Source: Dealogic DCM Analytics, Barclays Capital
Agencies
The overall increase in 2008 and 2009 supply has been driven by strong increases in supply from KfW, EIB and CADES. Also, 2010 supply will be strongly driven by EIBs increased planned borrowing of 70bn (60bn in 2008) and about 75bn of planned funding from KFW.
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Figure 105: Distribution of issuance by leading MLIs and European agencies, 2001-April 2009 (% of total)
30% 25% 20% 15% 10% 5% 0% 2010 yt May 2001 2002 2003 2004 2005 2006 2007 2008 2009 4% 2% 0% 2010 yt May 2001 2002 2003 2004 2005 2006 2007 2008 2009
10% 5% 0% 2010 yt May
101
10% 8% 6%
25% 20% 15%
2001
2002
2003
2004
2005
2006
2007
2008
EIB
KfW
BNG
Renten
Cades
ICO
OKB
NRW.Bank Washington MLIs Network Rail
Figure 105 illustrates the dominant position in the MLI/European agency sector occupied by EIB and KfW. Together they have averaged c.44% of the sectors issuance since the start of the decade. So far this year, they have accounted for about half of the sectors supply, and we expect their full-year share to be 45-50%. Among the second-tier of issuers, Rentenbank and BNG are relatively stable suppliers at 5-6% each of annual supply. These four issuers together normally account for 50-60% of total supply. Among the other leading issuers, there have been more significant year-to-year variations, reflecting the evolution of individual institutions. For example, CADES funding requirement first peaked in 2004-06, following the transfer of social security debt. As CADES has subsequently moved into financial surplus and started to reduce its outstanding debt, its annual funding requirement fell to more moderate levels in 2007 and 2008. However, with the assumption of new debt, in 2009, the entity raised 25.8bn in mid- and long-term issues representing about 8% of total issues in 2009. Similarly, Network Rails share of total funding peaked in 2004, with the launch and build-up of its MTN and debt-funding programmes as the company termed out its debt structure. Ongoing funding requirements are more moderate. In contrast, ICO and OKB funding needs have trended higher, reflecting increased demand for their loan facilities. The third chart highlights the significant increase of issuance from the Washington-based MLIs (IBRD, IADB, and IFC) in 2008-09, as their funding needs increased due to high demand for emergency funding from their emerging market clients. Up until May 2010, SSA issuers have issued about EUR150bn, mirroring on a 12-month basis about EUR360bn of total issues and close to our expectation for the full year. The strong issuance activities in the first months of 2010 are based on favourable market conditions and reflect a timing shift in SSA issuance patterns, rather than being evidence of a further underlying increase in funding needs. Continuing volatility in primary and secondary markets have encouraged the larger frequent issuers to front-load their issuance patterns to an even greater degree than normal.
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2009
Figure 106: Gross issuance by MLIs and European agencies 12-month totals (to mid May 2009)
All issuance (EURbn) Key currency sectors % shares
bn 390 340 290 240 190
12 month moving totals
50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 EUR GBP USD Others
140 2002 2003 2004 2005 2006 2007 2008 2009 2010
Variations in currency mix
In the past, there have been significant variations in the currency mix of funding. There are various drivers of the currency mix. Many euro transactions represent strategic benchmark transactions in the base currency for many of the component issuers in the sector. Benchmark transactions related to a strategic drive to tap dollar-based investors are also important in dollars, although dollar funding is also driven by variations in relative swapped funding costs and exchange rate prospects. The sterling sector is characterised by the importance of tap issuance by frequent borrowers, the timing of which is largely driven by cross-currency funding costs. The use of other currencies tends to reflect exploitation of currency arbitrage and also, in some cases, a strategic commitment to opening new currency sectors. The gradual increase in the share of other currency sectors had been a significant feature until 2008. However, from Q2 08 onwards, the share of the EUR and USD increased significantly. As noted earlier, in relation to Figure 102, volatility in cross-currency spreads relative to governments and swaps has been a key driver of recent issuance trends by currency sector. Over the past year, a sharp fall in the GBP sectors share has been mirrored by a strong rise in USD and other currency funding.
Figure 107: Currency distribution of MLI and European agency public debt outstanding, May 2010
MLIs European agencies
CHF 2% AUD/CAD/ NZD 10% JPY 4% GBP 11%
ZAR Others 1% 6% EUR 30%
AUD/CAD/ NZD 5% JPY 4% GBP 11%
CHF 4%
ZAR 0.2%
Others 2%
EUR 45%
USD 36%
USD 29%
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In recent years, maturity profiles slightly shifted. As of the time of writing, more than 60% of MLI and European agency debt matures within five years (67.8% for MLIs and 68.7% for agencies) and 16.5% is over 10 years (16.3% for MLIs and 17.2% for agencies). This reflects a move towards more medium term orientated structures. In the past and until 2007, the percentage of issuance in shorter maturities had been trending lower, particularly as issuers curves had extended in the EUR and USD sectors; 2005 was very much the year of the ultra-long issues, with issues of greater than 10-year initial maturity reaching 20% of the total for the first time. However, there has been a sharp change in maturity patterns of new issuance towards shorter-dated issues since the onset of the credit crisis in summer 2007, reflecting shifts in investor and issuer preferences. Investor preferences shifted toward shorter-maturity issues in response to increased uncertainty and the availability of higher spreads over government bonds in shorter dates. At the same time, the increased inversion of swap spread curves shifted issuers relative funding costs in favour of issuing toward the front end of the curve.
More balanced issuance in 2009 and expected also for 2010
The shift towards issuing shorter maturities has been reversed somewhat in the early months of 2009. This has also been due to less favourable funding conditions because of strong competition from buoyant GGB issuance. However, for 2010, we expect some further stabilisation of the issuance pattern that we observed from H2 09 until Q1 10. While overall market conditions have again become more volatile since Q1 09, we believe scattered longerdated issuance by core issuers should be realisable. Given the slow phasing out of Government Guarantee programmes, GGBs will not influence issuance structures of SSAs in 2010.
Figure 108: MLIs and European agency debt maturity distribution

Maturity distribution of outstanding debt (EURbn) Maturity distribution of new issues
250 200 150 100 50 0
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
2020-2029
>2029
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Agencies
MLIs
0 to 3
Effects of credit crisis on agency financial performance

Financial performance benefitted from improved funding conditions and valuation profits
The severe widening in credit and ABS spreads since summer 2007 has adversely affected the liquidity portfolios that some supras and agencies maintain to prevent their underlying lending business from being interrupted by primary market difficulties. Typically, these portfolios have been invested in highly-rated securities and, prior to 2007 and 2008, were generally seen as a positive credit factor. However, in so far as the investment range has included bank bonds and ABS, the sharp widening in spreads and loss in trading liquidity in these instruments, combined with IFRS mark-to-market requirements, has resulted in adverse valuation effects
103
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20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 20 10 09 yt M ay
3.01 to 5 5.01 to 7 7.01 to 10 Over
that have depressed net income in 2007 and 2008. This effect reversed in 2009 and most agencies were able to book valuation gains on their portfolios. Combined with improved funding conditions, SSAs have in general been able to improve their financial performance. We expect results to continuously be affected by mark-to-market valuations of investment and liquidity portfolios. Loan-loss provisions have been relatively capped compared to commercial banks, mirroring conservative and stringent risk measures of SSAs.
Market structure defining the sector

In our previous discussion of supply trends and our normal monitoring of debt supply from the sector, we use data from the dealogic DCM Analytics database for issues by all the issuers listed in Figure 113 and Figure 114 at the end of this section, which provide an at-aglance comparison of the variety of purposes and sectors involved, along with their ownership, types of support and risk weighting. Broadly speaking, in defining our coverage of the supranational and European agency sectors, we aim to include non-government public sector issuers of straight bonds that represent the next step along the credit curve from core eurozone government bonds. The definition of the supranational sector is relatively straightforward, being largely composed of MLIs, with a generally well-recognised composition mostly determined by the lists of entities treated as MLIs/development banks by financial regulators. One exception is Eurofima, which is set up as a supranational body and widely viewed in debt markets as such; however, it is not included in the regulators MLI list primarily because its ownership is not directly by governments but by their respective railway companies, albeit with government backing. As a result, it is treated less favourably in terms of risk weightings (20%, as opposed to zero for other MLIs). In contrast, the definition of the European agency sector is less clear cut. Varying types of public mission and types/degrees of public ownership/support can lead to public sector entities being variously described as agencies, public banks, sub-sovereign issuers, etc.
We use European agency as an inclusive term for various types of public sector entities
In the AAA Handbook and in our ongoing approach to the sector, we use European agency as an inclusive and comprehensive term and treat it as shorthand for a range of different public sector entities that are of interest to investors in high quality debt instruments. In determining the appropriateness of including any individual entity, we concentrate on: The relationship to the government or wider public sector, which is normally characterised by various combinations of:

public ownership explicit or implicit debt guarantees other forms of support for the whole entity or for asset quality and other aspects of its business public sector mission or policy role
The focus of its debt issuance. Within the agency sector, we focus on straight, unsecured debt issuers, excluding entities for which the main interest may be in covered bond issues, such as Landesbanks, which are covered separately in this book. We generally have not included GGBs because issuance is temporary; we discuss the respective instruments in a separate chapter. However, due to its specific setup, we have included the French SFEF vehicle. In addition, we do include debt issued by securitisation vehicles if the securitisation
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is of public sector receivables and the bond issues are bullet transactions of benchmark size (ie, GPPS and CDEP/ISPA). From the list of issuers in Figure 114, we can also see the range of different types of entity within the European agency sector. They may be subdivided as follows (some issuers may appear under more than one heading): Financial agencies:
Public sector promotional/development banks eg, KfW, Rentenbank, LBank, NRW Bank, BNG, Nedwbk, ICO Entities geared specifically to refinancing government or other public sector debt eg, CADES, ERAP, GPPS Entities that are channels for infrastructure funding eg, CDEP/ISPA, CNA Export finance agencies eg, SEK, Eksportfinans, OKB Local authority lenders eg, Kommunalbanken, Eksportfinans Other special purpose financial entities eg, SFEF
Non-financial entities:

Rail sector entities eg, RFF, SNCF, UKRAIL, LCR Finance Others la Poste, RTVE
Structured/securitised transactions eg, CDEP/ISPA, GPPS
Focus on more liquid issues iBoxx coverage

The iBoxx indices provide a tool for monitoring performance of the more liquid benchmark issues in the three key currency sectors: EUR, USD and GBP. Here we discuss the mapping of our coverage of the MLI and European agency sectors on to the iBoxx indices for these currencies.
Figure 109: Supranational issuance in iBoxx bond indices, mid-May 2009

Euro iBoxx (mn) Supranationals EIB EEC NIB 48,000 7,700 1,000 EIB IBRD IADB COE ASIA AFDB IFC EBRD IFFIM NIB CAF EUROF 35,750 8,600 8,500 5,100 4,000 3,000 2,500 1,500 1,000 1,000 540 500 71,990 188,119 EIB IBRD NIB EBRD COE IADB EUROF IFFIM 37,298 1,826 1,393 1,031 1,000 574 515 250 Dollar iBoxx ($mn) GBP iBoxx (mn)
Supranationals Total supras, agencies, public banks and other sub-sovs

Source: iBoxx indices, Barclays Capital
56,700 291,450
43,886 93,615
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EIB is by far the largest supranational issuer in the euro, sterling and dollar markets
The table above underlines the dominance of EIB within the supranational sector, particularly within euros. Within dollars and, to a lesser extent, sterling, there is a greater degree of diversification available to investors, although in all three cases EIB is by far the largest individual issuer.
Figure 110: European agency issue volumes in iBoxx bond indices, mid-May 2009
Euro iBoxx (bn) European agencies KFW SFEFR CADES NRWBK ICO RENTEN CNA UNEDIC FOBR LBANK HSHFF SEK OBND KOMMUN KNFP EXPT European agencies totals Other sub-sovereigns RESFER ASFING DBB* SNCF FRPTT 12,300 6,300 2,600 2,600 1,000 UKRAIL ASFING BTUN* 4,250 1,250 650 UKRAIL RESFER LCRFIN SNCVP* SNCF TRANLN* FRPTT Other sub-sovereigns totals Public banks BNG NEDWBK NDB OKB BYLAN WESTLB DEKA HSHN LBBER HAA HESLAN BYLABO Public banks totals 14,200 6,700 6,500 5,000 4,000 4,000 2,500 2,500 2,500 2,000 2,000 1,000 52,900 5,767 BNG NEDWBK OKB HESLAN LBBER 3,955 1,012 450 200 150 24,800 6,150 5,875 3,039 2,750 525 500 400 200 13,289 55,000 31,000 22,500 11,500 11,350 4,750 4,700 4,000 3,000 2,500 1,500 1,250 1,000 1,000 1,000 1,000 157,050 KFW FFCB JFCORP BNG CADES RENTEN SFEFR OKB NEDWBK KBN ICO LBANK KOMINS AGFRNC EXPT SEK CDCEPS 25,500 13,979 8,250 8,250 7,000 6,950 6,000 6,000 5,550 5,000 4,750 3,500 3,000 2,250 2,000 1,000 1,000 109,979 30,673 KFW ICO RENTEN KNFP NRWBK LBANK KBN CADES AGFRNC SEK 24,213 2,550 1,600 660 500 350 300 200 200 100 Dollar iBoxx ($bn) GBP iBoxx (bn)
Note:* We do not cover these issuers. ** GPPS was originally treated as an agency by iBoxx, but was subsequently reclassified to the Securitised Index. (Grey shaded issuers are included in our coverage of covered bonds) Source: iBoxx indices, Barclays Capital
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Figure 110 illustrates that, for European entities, the iBoxx indices allocate the names that we normally regard as agency-type issuers across several categories European agencies, other sub-sovereigns and public banks (and within the iBoxx family of indices, there are variations in the allocation of names between the sub-sectors). The public banks index also includes several issuers that we analyse as Pfandbriefe issuers elsewhere in this book, but which also have straight debt outstanding. For the issuance covered in the various iBoxx indices listed in Figure 111, almost all names (responsible for over 96% of the outstanding amounts) are covered either under our European agency section or within Pfandbriefe.
Multi-currency funding
Figure 109 and Figure 110 also illustrate the multi-currency funding orientation of the supranationals and European agencies. For most entities in this sector, EUR, USD and GBP are the main issuing currencies. Although, as illustrated in Figure 107, they also tap a widening range of other currency debt markets (which often provide more competitive funding costs); the Big Three currency sectors account for c.80% of gross supply and debt outstanding. For the issues that are included in the iBoxx indices, the EUR sector is the largest, accounting for over half of the total outstanding, while USD and GBP account for 33% and 15%, respectively (expressed in common currency).
Figure 111: Supranationals and European agencies iBoxx indices in local and common currency terms (including public banks and other sub-sovereigns)
Outstanding amounts (local currency units bn) EUR equivalents (EURbn)
500 450 400 350 300 250 200 150 100 50 0 Euro iBoxx ( bn) Dollar iBoxx ($ bn) GBP iBoxx ( bn) May 06 May 07 May 08 May 09 May 10
Local currency (% changes)
400 350 300 250 200 150 100 50 0 EUR May 06 USD May 07 May 08 GBP May 10
EUR equivalents (% changes)
40 30 20 10 0 -10 -20 -30 -40 -50 -60 Euro iBoxx ( bn) Dollar iBoxx ($ bn) GBP iBoxx ( bn) % chg 09/08 % chg 10/09
50 40 30 20 10 0 -10 -20 -30 -40 -50 EUR USD % chg 08/07 GBP % chg 09/08 Total
Note: For EUR equivalent charts, USD and GBP values are converted to EUR at exchange rates in May each year. Source: iBoxx indices, Barclays Capital
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Figure 112 compares the sector breakdowns within the three currency sectors. Supranationals are much more important within the USD and GBP indices (where they account for 44-46% of the totals) than is the case for euros (only 25%).
Figure 112: Breakdown of Supranational and European agency issuance in iBoxx bond indices, late May 2009 (% of total)
Euro iBoxx Dollar iBoxx GBP iBoxx
Supranationals 25% Public Banks 18%
Supranationals 44%
European Agencies 54%
Supranationals 46%
Other SubSovereigns 9%
Source: iBoxx indices, Barclays Capital
Public Banks 6%
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Figure 113: Multi-lateral lending institutions (MLIs) key comparisons

Sector and type of lending/investment Loans are mostly to public sector borrowers in the Asia-Pacific region, but increasing focus on nonsovereign operations. Risk weightings Basel II RSA* 0%
Full name Multilaterals ADB Asian (ASIA) Development Bank
Purpose Reduction of poverty in Asia and the Pacific region.
Ownership 67 governments, 48 within and 19 outside the region. US and Japan are the leading shareholders, each with 15.6%. 77 governments, 53 regional and 24 non-regional members. 40 governments across Western and Eastern Europe that are Council of Europe members. 60 countries, the EU and the EIB
Support More than 50% of callable capital is AAA/AA.
AfDB
African Development Bank
CEB (COE)
Council of Europe Development Bank European Bank for Reconstruction and Development European Investment Bank
EBRD
EIB
Eurofima (EUROF)
European Company for the Financing of Railroad Rolling Stock
EU / EEC
European Union Inter-American Development Bank
IADB
IBRD
IFC
International Bank for Reconstruction and Development International Finance Corporation
Promoting economic development, social progress and poverty reduction in African member countries. Loans for disaster relief and social improvement in Western and Eastern Europe. Funding the development of market economies in Central and Eastern Europe and the FSU. Loans to support EU development, especially infrastructure and SMEs. Funding the renewal and modernisation of those European railway companies that are shareholders through loans secured against rolling stock. Balance-of-paymentssupport and macrofinancial assistance Key regional development bank for Latin America and the Caribbean loans to sovereigns and sovereign-guaranteed entities. Loans to support development and reduce poverty in middle-income developing countries. Supports private enterprise in emerging markets through loans and equity finance.
Loans (and limited equity investments) to public and private sector borrowers in African member countries.
28% of callable capital is AAA.
0%
About two-thirds of the loan portfolio is advanced through other financial institutions, which take on the credit risk. The remainder is to governments and public sector institutions. Loans to and share investments in public and private sector entities and projects. Funding of the private sector is generally not covered by third-party guarantees. Loans and guarantees to public and private sector borrowers within the EU and countries with EU ties. Very strong asset quality is supported by third-party guarantees for the bulk of loans. Loans to state railway companies, secured against rolling stock and backed by government guarantees therefore, assets are effectively sovereign risk.
Over 90% of callable capital is investment grade.
0%
89% of callable capital is investment grade; 57% by EU members and institutions. 77% of capital is AAA/AA.
0%
EU member governments
0%
Railway companies in 26 European countries
Sovereign loans to EU member states
Loans are mainly to sovereigns or are sovereign-guaranteed. Private sector risk is limited to a maximum of 10% of the portfolio.
27 member states of the European Union 26 Latin American and Caribbean governments, US, Canada and 19 non-regional governments. Worldwide range of governments 185 in all.
Shareholder obligations are guaranteed by respective governments, which also guarantee repayment of loans. About 90% of callable capital is backed by AAA/AA governments. Guarantee by 27 member states via EU budget 61% of callable capital is investment grade.
20%
0%
0%
Loans to governments, agencies and private enterprises, but the latter are all government-guaranteed, so IBRD's credit risk is all sovereign risk. Loan/equity funding of private enterprise is split about 80%/20%. Wide geographic spread.
Almost 80% of callable capital is investment grade.
0%
Worldwide range of 179 governments
IIFIm
International Finance Facility for Immunisation Nordic Investment Bank
Provides funding for vaccination programmes in developing countries Provides long-term finance for investment projects that benefit the Nordic region.
All funds are transferred to finance vaccination programmes operated by the Global Alliance for Vaccines and Immunisation (GAVI). Loans to public and private sector entities in the Nordic region, the Baltic countries and emerging markets, the latter largely backed by member government guarantees.
NIB
Private company limited by guarantee and a UK registered charity The five Nordic countries and three Baltic countries
Virtually all subscribed capital is paid in to correspond to the relatively high risks attached to its private enterprise focus. Almost 80% is provided by investment-grade sovereigns. Supported by legally binding grant obligations from the governments of the UK, France, Italy, Spain, Norway, Sweden and South Africa. 96% of callable capital is AAA.
0%
0%
0%
Note: * RSA = Revised Standardised Approach. Source: Barclays Capital
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109
Figure 114: European agencies/quasi-sovereigns key comparisons

Sector and type of lending/investment Long-term development funding in areas of French interest, mostly Africa, and French overseas departments and territories. Issues debt to fund its own reserves of foreign exchange, which are held to support the implementation of its monetary policy objectives. These reserves are separate from the UKs national foreign currency reserves. Loans to Dutch munis and other public sector entities, notably housing associations and mortgage funds. Asset quality is underwritten by the municipal legal framework and by various public sector guarantee funds. Unusual balance sheet structure dominated by the net balance sheet liability: 72.9bn at end-2007. Managing funds entrusted to it from various sources, eg, tax-exempt savings accounts, legal deposits and public retirement funds. Loans are solely to public sector toll road operators, most of which were privatised during 2005-06. Lending to private sector operators will be phased out by 2009, so CNAs balance sheet will trend lower over time. 1) Long-term low margin loans to Norwegian municipalities; 2) Exportrelated loans on commercial and government-supported terms to Norwegian exporters and foreign buyers. Asset purchase scheme / wind-up entity Risk weightings Basel II RSA* 20%
Full name Financials AFD (CCCE) Agence Franaise de Dveloppement
Type French EPIC
Purpose Frances development bank
Ownership 100% French state
Support Solvency and liquidity support as a French EP.
BOE
Bank of England
UK central bank
Central banking
100% UK government
Government ownership
0%
BNG
Bank Nederlandse Gemeenten
Dutch public sector bank
Act as a bank of, and for, Dutch local authorities and other public sector institutions.
50% Dutch State 50% other Dutch public entities
Public policy role and asset quality support but no direct debt guarantee from the state.
20%
CADES
Caisse d'Amortissement de la Dette Sociale Caisse des Dpts
French EPA
Created to refinance and amortise French social security debt. Financial institution fulfilling a range of public missions
100% French state
Solvency and liquidity support as a French EP. Dedicated tax revenue. Solvency and liquidity support as a French EP.
0%
CDC (CDCEPS)
French EP
100% French state
0%
CNA
Caisse Nationale des Autoroutes
French EPA
Sole function is to act as a non-profit making financing vehicle for public sector toll motorway operators.
100% French state
Solvency and liquidity support as a French EP.
20%
Eksportfinans (EXPT)
Eksportfinans ASA
Norwegian specialised financial institution
Provision of competitive longterm funding and other financial services in the areas of export and municipal finance. Allow for an orderly run-off of nonperforming or non strategic assets of WestLB AG
15% Norwegian state; 85% banks operating in Norway.
Public policy role in provision of export finance and close interaction with various areas of government, but no direct state guarantee. Owners are obliged to compensate ERSTAA for any losses not covered by guarantees for certain debt and equity.
20%
ERSTAA
Erste Abwicklungsanstal t
Special purpose agency
48.2% State of NRW and 25% each regional savings banks associations of Westphalia and Rhineland, 1.8% two regional associations of Rhineland and Westphalia Of EUR 9bn capital, EUR6.75bn has been provided by government and EUR2.25bn by Deposit Guarantee Funds
0%
FOBR
Fondo de Reestructuracion Ordenada Bancaria
Special fund, established for assisting the restrucuturing process of Spanish banks
Temporary capital injections into banks to assist in the restructuring and consolidation of the Spanish banking system
Support for Spanish banking sector
Explicit and irrevocable guarantee from the Kingdom of Spain.
0%
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Risk weightings Basel II RSA* 20%
Full name GPPS German Postal Pension Securitisation plc
Type Dublin based securitisation vehicle
Purpose Securitisation of receivables related to pensions payable to retired civil service employees of the Deutsche Bundespost and German postal successor companies. Promotion of economic and social development in Spain.
Sector and type of lending/investment Government and government-backed receivables.
Ownership Vehicle company
Support Receivables are paid by and/or guaranteed by the German government
ICO
Instituto de Credito Oficial
State financial agency and development bank
KFW
German development bank
KOMBNK (KBN)
Kommunalbanken AS
Specialist Norwegian local authority lender
Kommuninvest (KOMINS)
Kommuninvest I Sverige AB
Specialist Swedish local authority lender
Formed to finance reconstruction, now involved in supporting a range of public policies including lending to SMEs, housing, infrastructure and environmental projects; export and project finance; and assistance to developing markets. Sole role is to lend to the local government, which is a guaranteed sector in Norway Lending to member authorities and entities owned by them. Lending to Danish local governments and entities backed by local government guarantees. To support economic development in the State of BadenWrttemberg (BW), enhancing the state's attractions as a business location. To provide competitive funding to Finnish local authorities and related entities.
Provides medium and longtem funds, mostly to SMEs, in selected sectors, such as housing, infrastructure, telecoms, energy, environment and transport, and to Spanish regions. It also provides export finance and channels public funding to alleviate effects of crises and natural disasters. Loans to support SMEs, housing finance, infrastructure and environmental projects, export and project finance, and emerging markets mainly provided through commercial banks. Much of the credit risk is transferred to intermediating banks or to public authorities.
100% owned by the Kingdom of Spain
Explicit, direct, irrevocable and unconditional debt guarantee by the Kingdom of Spain.
0%
80% German Federal Republic; 20% Lnder.
Explicit federal debt guarantee and Anstaltslast solvency support.
0%
Local government
100% Norwegian government.
Maintenance obligation from Norwegian central government Joint and several guarantees from local authority members
20%
Local government
KommuneKredit (KOMMUN)
KommuneKredit
Specialist Danish local authority lender
Local government
Kommuninvest Cooperative Society, a co-operative grouping of Swedish local authorities All the 98 Danish municipalities and 5 regions in the local government sector 100% owned by the State of BadenWurttemberg
0%
Joint and several guarantees from local authority members
0%
L-Bank (LBANK)
Landeskreditbank BadenWrttemberg Frderbank
State development bank
Municipality Finance (KUNTA)
Municipality Finance
Specialised financial institution
Provides funding for five main areas of activity: housing projects; new business start-ups and SMEs; infrastructure projects; real estate investment in technology parks; social initiatives. Long-term loans to Finnish local governments, entities guaranteed by local governments and municipal entities involved in provision of social housing.
Explicit guarantee by the State of BadenWurttemberg as well as support through Anstaltslast and Gewhrtrgerhaftung . Explicit guarantee by the Municipal Guarantee Board (which in turn is owned and guaranteed by most Finnish municipalities). Anstaltslast and Gewhrtrgerhaftung support from its owners. Explicit debt guarantee from NRW. Also NRW guarantee of its holding in WestLB AG.
0%
NRW.Bank(NR WBK)
NRW.Bank
State development bank
To support infrastructure and economic development in the state of NRW.
Provides funding to business start-ups and SMEs, public infrastructure projects, housing and urban development.
59.3% by Finnish local governments and the Finnish local government association; 40.7% by the Local Government Pension Institute. 98.6% state of NRW; 0.7% each from the regional associations of Rhineland and Westphalia-Lippe
0%
0%
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Full name NWB (NEDWBK) De Nederlandse Waterschaftsbank
Type Dutch public sector bank
Purpose Banker to Dutch water control boards, it was initially established to fund investment in sea defences.
Sector and type of lending/investment Loans to, or guaranteed by, the Dutch public sector. The main categories are loans to housing corporations and to munis, much of which is guaranteed by central or local government, so asset quality is supported by strong credit quality of these sectors. (Water boards now only take c.12% of loans.) 1) Administers export guarantees on behalf of Austrian government; 2) medium- and long-term refinancing for banks and foreign importers financing Austrian exports.
Ownership 81% Dutch waterboards; 17% Dutch state; 2% Dutch provinces.
Support Public policy role but no direct guarantee.
OKB
Oesterreichische Kontrollbank AG
Austrian banking corporation
Primary function is provision of export finance.
Wholly owned by Austrian banks
Rentenbank (RENTEN)
Landwirtschaftlich e Rentenbank
German development bank
Public policy role to support financing the agricultural, rural and food sectors.
SEK
Swedish Export Credit
Export finance agency
SFEF
Socit de Financement de lconomie Franaise
French Special Financing Company
Provision of longterm export finance to Swedish industry and commerce. More broadly, provides long-term financial solutions for Swedish business. Support the French banking system
The bulk of funding for the agricultural and rural sectors is channelled through commercial banks, which take on the credit risk of the final exposure. Although concentrated in Germany, exposure is spread across the EU. Export-related loans on commercial and government-supported terms to Swedish exporters and foreign buyers. Also long-term loans related to project and infrastructure finance. Provides funding for the French banking industry in order to encourage lending to the French economy, with a focus on helping corporates, households and local authorities.
No shareholders: capital is akin to an endowment fund for agriculture
Asset quality support provided by government guarantees of export loans. Unconditional guarantee by Republic of Austria for debt issued to finance export loans. Anstaltslast support but no direct guarantee.
0%
0%
100% by the Kingdom of Sweden
No direct guarantee, but strong implicit support based on public policy role and government ownership.
20%
34% by the French government and 66% by 7 large French banks
Bond issues benefit from a guarantee of the French government
0%
Undic
Undic
Association with a public service mission
Central organisation of the French unemployment benefit system. Construction and operation of Austrias trunk road network Financing of Italian high speed rail network Transportation 100% by the Republic of Austria
Not an EPIC, but debt issues have been explicitly guaranteed by the French state. Explicit debt guarantee, as well as solvency and liquidity support from the Austria government Debt service from project revenues and state transfers, with further Italian government backing of any shortfall. Transaction rights constitute segregated assets and so continue to back the debt after ISPAs merger into CDEP
0%
Industrials Asfinag (ASFING) Autobahnen und Schnellstrassen Finanzierungs AG Governmentowned company 0%
ISPA (CDEP)
Infrastrutture SpA
Created as limited liability company under Italian law now dissolved.
ISPAs public debt issues have all been issued under the 25bn ISPA High Speed Railway Funding Notes Programme, and were issued to fund project loan tranches related to financing the Italian high speed rail project.
Now has been merged into its former parent Cassa Depositi e Prestiti (CDEP)
0%
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Full name LCR (LCRFIN) LCR Finance plc
Type Private Corporation, wholly owned finance subsidiary of London & Continental Railways plc (LCR) Issuing entities for Network Rail Infrastructure Ltd
Purpose Building the Channel Tunnel Rail Link (CTRL) between the tunnel and central London, and the operation of Eurostar in the UK.
Sector and type of lending/investment Railway construction and operation.
Ownership Ove Arup, Bechtel, Halcrow, National Express, UBS, London Electricity and SNCF.
Support Bonds are explicitly guaranteed by the UK government.
Network Rail (UKRAIL)
Network Rail MTN Finance plc and Network Rail Infrastructure Finance plc
Network Rail Infrastructure Ltd owns and operates the UKs railway infrastructure.
Operation of rail infrastructure.
Network Rail is owned by: 1) rail industry members; 2) public interest members; 3) reps of regional and local govt; 4) a Special Member, who may be elected by the Secretary of State for Transport. 100% French state
Financial indemnity from the UK government.
0%
La Poste (FRPTT)
La Poste
French public entity (Exploitant Autonome de Droit Public) French EPIC
Provision of French postal services.
Mail, parcels, logistics and financial services.
Solvency and liquidity support as a French EP.
20%
RATP (RATPFP)
Regie Autonome des Transports Parisiens
Created to develop, maintain and operate public transport in the Greater Paris area. Owns, maintains and develops the Portuguese rail infrastructure.
Ownership and operation of metro, tramway and bus lines in the Greater Paris area; operation of urban express (RER) services jointly with SNCF. Rail infrastructure.
100% French state
Majority ownership of French Republic.
20%
REFER
Rede Ferroviria Nacional, EP.
Portuguese public entity
100% Portuguese state
Support as a public entity cannot go bankrupt. Some issues are explicitly state-guaranteed. Support as a French EP dependent on state subsidy. No direct guarantee, but closeness of support is reflected in 0% risk weighting. Funding of debt amortisation is included in the Spanish governments general budget. Solvency and liquidity support as a French EP.
Guarantee d debt: 0% Nonguarantee d debt:: 50% 20%
RFF (RESFER)
Reseau Ferre de France Ente Publico RTVE, En Liquidacion
French EPIC
Owns French railway infrastructure. Residual entity amortising debt incurred by the former RTVE.
Network and maintenance of rail infrastructure is contracted out to SNCF. Provision of national TV and radio services.
100% French state.
RTVE
Spanish public entity (ente publico)
100% Spanish state.
0%
SNCF
Socit Nationale de Chemins de Fer Francais
French EPIC
French railway operator.
Operates French railway services and manages the railway infrastructure on behalf of RFF.
100% French state
20%
Notes: 1) The Bloomberg ticker is provided in brackets if it differs from the normal short name; 2) * RSA = Revised Standardised Approach. Source: Barclays Capital
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UNITED STATES: GOVERNMENT-GUARANTEED BONDS
Temporary Liquidity Guarantee Program

Rajiv Setia +1 212 412 5507 rajiv.setia@barcap.com James Ma +1 212 526 6566 james.ma@barcap.com
Generally considered a success, the TLGP closed to primary issuance on October 31, 2009 after cumulative long-term issuance of $300bn since its initiation in November 2008 (Figure 115). Practically all of the issued long-term debt remains outstanding today, and the guarantee remains in force for these issues. Thus, as a service to secondary market investors, we reprint the relevant portions of our previous primer on the program terms below. In terms of market positioning, we note that TLGP paper generally remains a less liquid market than agency bellwethers even as the Fed has been active in the latter. As such, the liquidity premium charged by investors has caused TLGP names to trade at least 5-7bp behind agencies on a Libor basis. While this is a considerable improvement from the 5070bp margin in the programs infancy (Figure 116), we observe that TLGP paper has a lower risk weight (0% versus 20%) and an explicit government guarantee. A sister program to the TLGP, the NCUA also introduced the TCCULGP to grant a similar government guarantee to debt issued by corporate credit unions. This program expires June 30, 2010, and there have been four issues ($5.5bn) made under it. Similar to the FDICs program, the TCCULGP guarantees timely payment of interest and principal to bondholders, backed by the full faith and credit of the US government. Also like the TLGP debt, this paper is rated AAA/Aaa and bears the same index classification as TLGP paper in the Barclays Capital family of indices.
Basic terms of the program

Which entities are eligible to participate in TLGP?
TLGP is open to all FDIC-insured US banks as well as bank holding companies
All FDIC-insured depository institutions (IDI), which includes US branches of foreign banks. Also, any US bank or S&L holding company is eligible as long as it has at least one subsidiary that is an IDI. In addition, at its discretion, the FDIC can designate affiliates of IDIs (eg, GE Capital Corporation) as eligible for participation in the program.
Figure 115: Cumulative TLGP issuance history

100 90 80 70 60 50 40 30 20 10 0 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Issuance (LHS)
Figure 116: History of TLGP spreads to Libor

350 300 250 200 150 100 50 0 100 80 60 40 20 0 -20 -40 Nov-08 ASW, bp
$ bn
$ bn
Sep-09
Apr-09 2y
Sep-09 2.5y
Feb-10 3y
Cumulative (RHS)
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As the program has wound to a close, it is no surprise that the most frequent issuers of TLGP paper have generally been those with the largest funding needs and most name recognition (Figure 117). Since the structure of the TLGP retains the name of the issuing entity (in contrast to the French SFEFR model), the program is relatively more economical from a funding cost standpoint for issuer names that are better-known, despite the strength of the FDICs guarantee being uniform across all debt issued.
Figure 117: Largest TLGP issuers

C 64.6 GE 60.0 BAC 44.5 JPM 40.5 MS 23.8 GS 21.7 29 others 54.5
Which types of obligations are eligible to be guaranteed?

Senior unsecured debt with more than one month to maturity is eligible for the guarantee
The FDIC will guarantee senior unsecured debt with a maturity of more than 30 days (including commercial paper and Fed funds). Coupons may be fixed, floating, or zero. The debt may be denominated in a foreign currency (Figure 118). It explicitly excludes secured debt, structured notes, and debt with embedded options (callables, convertibles, etc), with the lone exception of mandatory convertible debt (MCD) meeting the following criteria: MCD conversion date must be on or before the maximum allowable terminal maturity; the bond itself is only guaranteed through the conversion date. MCD issuance is exempted from issuers individual caps. The FDIC must give prior written approval for any MCD issuance.
Some mandatory convertible debt is also eligible, but none has been issued yet
The FDIC stated that its intent with the MCD program was to give eligible entities additional flexibility to obtain funding from investors with longer-term investment horizons and to reduce the concentration of FDIC-guaranteed debt maturing in mid-2012. 24
How long does the program last?

The debt guarantee extended until 31 December 2012 for issuers who participated in the extended window ie, who opted to issue through 31 October 2009 (participants). Issuers who were not participants were limited to final maturities through 30 June 2012. Predictably, this limitation affected the maturity distribution of outstanding TLGP debt (Figure 119). In either case, any TLGP debt that matures on or before the corresponding termination date is fully guaranteed, but any TLGP debt with a longer maturity will only be guaranteed through the termination date. All debt issued under the program has maturities before the relevant termination date, however.
What is the fee schedule?

Fees vary by maturity and whether the issuer is a depository institution or a bank holding company
The FDIC charges a guarantee fee on a sliding scale, which also varies if the issuer is a participant in the extended window (as defined above). The annual rate is a flat 50bp for debt with a maturity of 31-180 days and 75bp for debt with a maturity of 181-364 days. For debt with 365 days or longer to maturity, the base fee is 100bp. There is an additional set of surcharges for long-term debt, which vary by date of issuance and whether the issuing name is a depository institution or a bank holding company.
24
FDIC Interim Rule, 27 February 2009.
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Figure 118: TLGP outstandings are mainly in USD

EUR 2.1% GBP 1.3% HKD 0.2% JPY 0.1%
Figure 119: TLGP maturity distribution

70 60 50 40 30 20 10 0 Dec-09 $ bn
USD 96.4%
Jun-10 Dec-10
Jun-11 Dec-11 Fixed Floating
Jun-12 Dec-12
Can participating institutions sell non-guaranteed debt as well?

By default, banks cannot pick and choose; all senior unsecured debt was guaranteed at the programs outset. However, issuing institutions could have retained the option to sell nonguaranteed debt if they paid a relatively high one-time fee. As capital markets have returned to health, many large issuers have come to market in non-guaranteed space as a show of strength and, of course, have continued to do so after the programs end.
Has FDIC considered extending the terminal maturities beyond 2012?

In October 2009, the FDIC approved an emergency extension of the TLGP debt guarantee program through April 30, 2010. Note that the previous set of program terms still ended on October 31, and any banks who want to issue beyond that date were required to reapply (none did). Under the emergency extension, issuers were obligated to demonstrate an inability to issue non-guaranteed paper, and would be assessed a 300bp guarantee fee; the maximum maturity remained at December 31, 2012 during the extension period. Ultimately, the punitive nature of the new guarantee fee precluded any actual issuance.
Top queries from investors

What are these bonds credit ratings?
TLGP bonds are rated AAA
All three rating agencies have rated TLGP debt maturing on or before December 31, 2012 with the same rating as US government debt (ie, AAA/ A-1+).
What is the risk weighting for TLGP debt?

FDIC, OTS and OCC had originally set the risk weighting at 20%, but then clandestinely lowered it to 0% in November 2009 after the programs end, citing the legislative history of the US governments full faith and credit backing of the FDIC. The risk-weighting for analogous debt guaranteed under various European programs is 0%. Notably, the FDIC decision minimises the risk of further unintended consequences in the agency debt market, where debt is 20% risk-weighted, as no new issuance can be added to the market.
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How does the guarantee differ from the GSEs effective guarantee, and how will the FDIC go about getting the money to pay claims?
FDIC guarantee is full faith and credit of the US government
The FDIC has stated that the guarantee (of timely payment of principal and interest) carries the full faith and credit of the US government. This probably reflects the FDIC Act, which states that non-deposit obligations of the FDIC are explicitly guaranteed. In contrast, FNM/FRE carry an effective guarantee, under which the Treasury has pledged to keep GAAP net assets positive by making injections of preferred equity with no limits through 2012 and up to $200bn per institution thereafter if needed. The FDICs Deposit Insurance Fund (DIF) will not be used to pay claims, as the TLGP is designed to operate on the proceeds of the guarantee fees. If the fees are not enough, the FDIC will levy a special assessment on all IDI to pay for any shortfall. Notably, one stated objective of the latest round of TLGP fee hikes was to replenish the DIF with the remaining accumulated fee income after paying any claims on TLGP. Some investors have questioned whether the FDIC is sufficiently funded to withstand a large bank failure. Others have raised the possibility that $400bn may not suffice in supporting the housing GSEs after 2012 if housing does not improve. In our view, both asset classes should be viewed as fully government guaranteed; authorities worldwide are going to be unwilling to let any large leveraged global financial institution fail.
Will the FDIC honour the timely payment schedule of principal and interest?
FDIC will honour timely payment of interest and principal through the terminal maturity
Yes, the FDIC explicitly guarantees timely payment of interest and principal through December 31, 2012 (ie, no acceleration). For TLGP debt maturing after that date, it indicates that it could accelerate (as an issuer missing payments would already be in default).
How will investors know if a particular bond is guaranteed?

All TLGP debt must state that the bond is explicitly FDIC (using the full faith and credit terminology) guaranteed on the prospectus. If an issuer retains the option to issue nonguaranteed debt, it must say that it is not guaranteed on the prospectus.
Figure 120: Components of the US Aggregate Index, $bn

Securitised $5,029 43% Gov-Guaranteed (FDIC debt, AID, KfW, etc) $228 2% Agency $1,240 11% Treasury and other Gov-related $4,587 34% Gov-Owned (FNM, FRE, TVA, etc) $768 7% Gov-Sponsored (FHLB, FFCB, etc) $286 2%
Corporate $2,424 18%
Note: As of 30 April 2010. Source: Barclays Capital
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Market structure and implications

Where is FDIC debt classified in the Barclays Index?
FDIC debt is classified in the US Aggregate within the Agency: Government Guaranteed subsector. In contrast, existing GSE debt will fall within the Government Sponsored or Government-Owned sub-sectors (Figure 120).
Who is the marginal buyer of TLGP debt?

In practice, TLGP debt is traded similar to agency paper and attracts a similar investor base
TLGP bonds are traded off the agency desks of primary dealers. The product has appeal to a broad range of traditional rate investors looking for a high yielding Treasury surrogate. Traditional agency investors have been a natural fit for FDIC debt, and since the TLGP markets early stages, both asset classes have not only converged, but also tightened substantially with the advent of QE. We believe the prototypical credit investor may not be willing to buy TLGP paper given lower yields/spreads, even as issuance from FDIC-insured entities has typically accounted for a very high proportion of overall IG corporate issuance. As a result, demand for nonFDIC corporate paper seems to have surpassed supply, leading to outperformance.
Where will TLGP debt trade in relation to GSE paper?

Fundamentals should lead to little difference between TLGP, agency debt
From a fundamental standpoint, the differences between agencies and TLGP debt are subtle. As mentioned earlier, TLGP paper trades 5-7bp behind agencies (Figure 121), most likely due to liquidity premium as the float of the average TLGP deal is smaller than even those agencies that have been heavily purchased by the Fed. However, on the other hand, from a fundamental standpoint TLGP paper has two advantages: a full faith and credit guarantee and a 0% risk weighting. Thus, in some sense the spread differential will be driven by demand dynamics. We believe the tension in the investor base will remain between spread- and liquidity-sensitive money managers (not all of whom may have approval to buy TLGP paper in their government/agency portfolios), and bank portfolios that assign more importance to yield and risk weight. Only recently has the tiering in spreads between larger issuers with a global footprint and ability to issue large deal sizes and less well-known entities reduced; some of this reflects different degrees of approval for investor mandates. In contrast, this difference is quite stark for non-US-government-guaranteed USD bonds, as the basis for this paper seems to reflect more than sovereign credit risk implies (Figure 122).
Figure 121: Asset swap levels of TLGP paper versus agencies

0 MM Libor Spread (bp) -5 -10 -15 -20 -25 -30 -35 0 FNMA
Figure 122: TLGP versus sovereign CDS, GGBs

60 50 40 30 20 10 0 -10 -20 C 2.0 3/12 0 10 20 30 40 50 60 SWEDA 2.8 2/12 INTNED 2.625 2/12 MQGAU 2.6 1/12 BACR 2.7 3/12 ASW, bp
SFEFR 2.125 1/12
1 FHLMC
2 FHLB
3 FFCB TLGP
2y Sovereign CDS
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GOVERNMENT-GUARANTEED DEBT INSTRUMENTS
The safety jacket for the financial system loses air

Michaela Seimen +44 (0) 20 3134 0134 michaela.seimen@barcap.com
After more than 1.5 years helping to rebuild confidence in financial institutions and support private funding for them, the newly and temporarily established instrument of Government Guaranteed Bonds (GGBs) seems to have edged closer to the end of its shelf life. Despite the EU Commissions indication that an extension of guarantee programmes could be possible if respective fees and structures are adjusted, we believe that GGB issue volumes will not grow again but rather gradually phase out.
A brief look at the origins of GGBs and how this market developed
GGBs created as new asset class in October 2008 wih aim of limited life span
To counteract the de-facto closure of the term-funding markets in the aftermath of the Lehman Brothers collapse in mid-September 2008, virtually all European economies started to establish government guarantee and support schemes for the financial sector. In late October 2008, after several countries decided to provide support to ailing lenders, spurred by the developments surrounding German Hypo Real Estate (HYPORE), French Dexia (DEXIA) and some of the major Irish banks, an inaugural GGB was issued. In less than a year, this previously unknown asset class experienced unprecedented growth across the US, the UK, and Europe. Within the comparatively short period between late October 2008 and early June 2009, benchmark-sized GGBs with an aggregated amount of 340bn were issued, with nearly 240bn issued in H1 09 alone. However, despite this unprecedented growth in issuance, since the ECBs announcement on 7 May 2009 that it would acquire Euro-denominated covered bonds issued in the euro area the issuance of GGBs came to a temporary halt 25 and with eventually only limited further benchmark GGBs being issued until today. The ECB announcement proved to be part of the right instruments to help re-establish confidence in financial markets. As a result financial market conditions improved considerably from June 2009, with the issuance of covered or senior unsecured bonds becoming more attractive compared with the issuance of GGBs.
Government Guarentee programmes vary from country to country
To assess GGBs, formally, a distinction needs to be made with regard to the scope of the guarantee, ie, the volumes covered. For example, the first government guarantee framework established in Ireland provided a guarantee for all new and outstanding debt. However, this was altered in late 2009 with a new guarantee framework, adopting the general European structure of guarantee schemes, with governments only guaranteeing new debt, for which the issuer purposely requested a guarantee. This enables banks to issue simultaneously guaranteed and non-guaranteed debt. Furthermore we distinguish how governments support the issuance of GGBs. In the case of France, for example, the central government established a single entity designed to tap the market, the so-called Socit de Financement de lEconomie Franaise SFEF. All GGB issuance is conducted exclusively through this entity. This approach is in sharp contrast to most other European sovereigns, which decided to let issuers tap the market on an individual basis. In our view, and this is also supported through the markedly tighter swap spread levels, the first approach is somewhat preferable. Investors have to deal with only a single issuer who is committed to issuing benchmark deals and they do not have to establish credit lines for a
25
Source: ECB Monthly Bulletin, May 2009.
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multitude of potential issuers. Retrospectively, we believe that a joint approach as in the case of France would on several occasions have been preferable for some of the countries that left the banks to their own devices with regards to the issuance of GGBs. As a result this would have added more transparency and ultimately better liquidity.
GGBs are primarily issued in USD and EUR
In terms of GGB supply, the dominating currencies are USD and EUR. Whereas the GGB market was in the beginning driven by strong issuance activity of USD-denominated debt, EUR-denominated issuance started dominating the market from February 2009 onwards, on average accounting for two-thirds of all supply. GBP-denominated issuance has always lagged (Figure 123).
Figure 123: Benchmark GGB issuance all countries; EUR, USD & GBP
90 75 60 43.0 45 30 15 7.5 0 Oct- Dec- Feb- Apr- Jun- Aug- Oct- Dec- Feb- Apr08 08 09 09 09 09 09 09 10 10 EUR
Figure 124: GGB issuance currency allocation, since Oct 08
bn
80.4 64.1 56.9
35.0
32.4 16.3 8.3 2.1
USD 44%
8.1 1.8
EUR 42%
5.0 7.15.1 0.3
GBP
USD
Other 8%
Source: Bloomberg, Barclays Capital
GBP 6%
With issuance volumes of up to 80bn in selected months, room for the issuance of other eventually comparable products was scarce. In other words, the issuance of GGBs effectively triggered a pronounced crowding-out effect which, among others, left its mark on the benchmark covered bond market where issuance volumes fell to a multi-year low, accordingly. With gross global benchmark GGB supply since October 2008 of more than EUR370bn, only about EUR17bn have been issued in 2010, which has been due to the ongoing improvement in financial market conditions and opening up of other funding channels. Originally issuance windows of most government-guarantee schemes were set to close in December 2009; however, most of the programmes extended issuance windows into 2010.
Issues under MTN programmes conceal real size of GDP market
It should be noted that issuers were to a large extent using MTN programmes for issuing GGBs. Therefore the actual funding levels via GGBs were much higher than the benchmark issuance numbers suggest. According to Bloomberg data, the overall GGB market reached an approximate size of EUR920bn as of today, with activities well into 2010 (Figure 125). As to the regional distribution of issued benchmark size GGBs, we observe that with more than a quarter (28%) of all supply the US dominates the market, followed by France (19%), due to its single issuer, Socit de Financement de lEconomie Franaise (SFEF), UK (12%) and Spain (10%). Generally, and notwithstanding the concentration on the few larger players, the GGB market appears to be relatively fragmented in terms of supply, with several European countries accounting for between 7% and 1% of all supply (Figure 127).
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Figure 125: Issuance of GGB in all countries, all currencies, incl. FRN & non-benchmark
140 120 100 80 60 40 20 0 EUR
bn 112 114 79 65 50 32 8 11 27 35 22 16 11 16 12 0 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 GBP Other USD 59 111
74 51
Redemptions crowd in 2012
Given the concentration of issuing activities in regard to GGBs, we believe that problems could well arise with regards to the maturity structure of the issued guaranteed bonds. Despite most programmes foreseeing a maximum term to maturity (TTM) of 60 months, issuers more strongly favoured the three-year maturity bracket, ie, mostly issuing GGBs that mature in 2012. This has led to a 347bn redemption hump in 2012, which in principle should cause issuers to increasingly rely on other maturities (Figure 128). For at least two reasons, though, this is not quite as straightforward as one might assume. First, from an investors perspective, bank treasuries, which are among the largest buyers of GGBs, clearly favour shorter-dated maturities and would thus probably have preferred a GGB with a 3y maturity over a GGB with a 5y maturity. Second, from an issuers perspective, issuing within the 3y sector is preferable to issuing within the 5y sector as a result of the spread differences between 3y and 5y swap rates in major funding currencies combined with additional costs in regard to longer payments of guarantee fees.
Figure 126: Top 10 issuers of GGBs (all currencies)

bn 120 100 80 60 40 20 0 56 47 38 38 35 32 29 22
Figure 127: Benchmark GGB issuance per country, since Oct 08
106 83 US 28%
AUS 4%
AUT DK 3% 1% FR 19%
NOR 0.1% UK 12% SWE 3% ESP 10% PT NED 1% 7%
GER 7% IRE 5%
DEXGRP
LLOYDS
HYPORE
SFEFR
WSTP
RBS
BAC
JPM
GE
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Figure 128: Overall GGB redemptions per country ( bn)

400 350 300 250 200 150 101 100 50 0 2009 AU 2010 DE 2011 FR 2012 GB 2013 2014 Other 2015 US 48 40 16 163 206 bn 347
Figure 129: Benchmark GGB redemptions ( bn)

200 160 120 80 40 1 0 2009 2010 EUR
bn 164
115
31 12
40 6 2014 2015
2011
2012 GBP
2013 USD
The overall improving situation on the market in line with the redemption hump, in our view, reduced issuers appetite to further (exclusively) rely on the issuance of GGBs. This trend was further driven by the ongoing swap spread tightening of alternative instruments such as covered bonds or senior debt, for example (see Figure 130). As a result of this development in Q2 09, several markets that previously were effectively shut, re-opened again and thereby gradually undermined the previous dominance of GGB issues. Figure 130: Swap spread developments
350 300 250 200 150 100 50 0 -50 -100 Jan-08 May-08 Sep-08 Jan-09 May-09 Covered Sep-09 Jan-10 May-10
Soverigns
Financial Senior
Basic terms of the programmes

Design of guarantee schemes strongly differs across Europe
Notwithstanding the common aim of the government guarantee schemes, ie, to provide financial sector entities with access to term funding, the programmes individual designs strongly differ across Europe and the UK. Among the more similar features, however, are the issuance windows and the maximum term to maturity of new issues (Figure 131). Please note that the EC is currently discussing potentially extending guarantee programmes, which might result in prolonged issuance windows in some countries.
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Figure 131: GGB issuance windows

PT NZ AT SE DK NL ES*** IE** AU FR GB* DE US Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Closing date / final issuance date
Final maturity
Note: *Following closure of the drawdown window on 28 February 2010, Eligible Institutions are able to refinance debt already guaranteed under the scheme, but they cannot issue new debt. **The Scheme, in line with all schemes approved under state aid rules, is subject to ongoing six monthly approvals by the European Commission. ***Establishment of FROB. Source: Barclays Capital
When aggregating the originally granted government guarantees (including the UK), we arrive at a total of approximately 2,900bn. Yet, this figure was of a rather hypothetical nature. As mentioned earlier, up until now approximately 920bn of GGBs has been issued, ie, little less than a third of the overall sum provided. Already in 2009, for example, selected entities, especially US-based issuers, have started to repay the guarantee funds used. Refining the analysis to country-specific figures illustrates that on average, little more than 20% of the total funds provided within the scope of government guarantee schemes have been used by the respective financial entities (see Figure 133).
Despite large GGB issues, only smaller amounts of total guarantees have been used
With regard to other characteristics, the different government guarantee schemes are far less homogeneous, particularly as pertains to details such as the respective capital injections or the fee charged by the guarantor (ie, the government), for example (see Figure 135).
Figure 132: Guarantee schemes versus amounts granted

bn 1000
Figure 133: Guarantee schemes versus amounts granted

100%
750
75%
500
50%
250
25%
0 US IRE GER FR NED ESP SWE UK AUT PT AUS* total volume granted issued until end May 2010
0% US IRE GER FR NED ESP SWE UK AUT PT total volume granted
issued until end May 2010

Note: *For AUT no maximum guarantee programme amount disclosed. Source: Barclays Capital
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Frequently asked questions

What risk weighting applies to government guaranteed bonds?
Within the EU, the risk weighting of government guaranteed debt is regulated by the Capital Requirements Directive (CRD). CRD Annex VII Part 4 2.2.4 stipulates the minimum requirements for assessing the effect of guarantees within the Internal Ratings Based (IRB) approach. According to these regulations, eligible guarantees must be, in particular, noncancellable on the part of the guarantor, in force until the obligation is satisfied in full and legally enforceable against the guarantor. In addition, generally, the respective guarantees should not be subject to any conditions. The CRD text says that guarantees prescribing conditions under which the guarantor may not be obliged to perform (conditional guarantees) may be recognised subject to the approval of competent authorities.
0% risk weighting
We have analysed some of the legal documents regarding the guarantee schemes in France, Germany, Ireland, Portugal, Spain and the UK and conclude that the respective guarantees, which protect investors within the newly created government-guaranteed bond schemes, fulfil these criteria 26.. Some investors may argue that the guarantees are effectively subject to conditions and can potentially be revoked, as the respective issuers need to fulfil specific conditions in order to make use of the guarantee schemes. However, as outlined above, this is only relevant with respect to the relationship between the guarantor and the issuing entity. For example, if the issuing entity violates a criteria that is part of its agreement with the guarantor, the guarantor may restrict further drawing capacity on the respective guarantee. But any such non-fulfilment of the relevant conditions has no influence on the guarantee, which is given unconditionally and irrevocably to the bondholders, who are the direct beneficiaries of the guarantee. Thus, objections regarding the potential cancellation of the respective guarantees are not valid, in our view. Consequently, we argue that bonds guaranteed by governments where the respective debt benefits from a 0% risk weighting, should also have a risk weighting of zero. Figure 134 outlines the concept of a generic government guarantee scheme.
Figure 134: Generic government-guarantee scheme

Guarantee (unconditional & irrevocable) Potential recovery proceeds Consideration Guarantor Issuer Fulfilment of eligibility & business criteria
Guaranteed Bond Bond Holders Holders Bond Proceeds
FDIC-guaranteed debt
US authorities have decided that insured depository institutions should apply a 20% risk weighting for FDIC-guaranteed debt, as a lower risk weighting for such debt would be inconsistent with the need to maintain strong capital bases 27. This also suggests that US banks may need to apply a 20% risk weighting for bonds guaranteed by European
26
In Ireland the guarantee may be revoked, as a whole or in part, subject to certain criteria. However, the regulation also clarifies that following such revocation, the liabilities covered by the guarantee at the date of expiry shall continue to be covered by the guarantee to their maturity date or 29 September 2010. 27 For further details please refer to the FDIC (page 14).
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governments. From a European bank investors perspective, we argue that the wording of the guarantee within the US Temporary Liquidity Guarantee Program (TLGP) suggests that the requirements of the CRD are fulfilled. In particular, we note that article 370.3 says that upon the uncured failure of a participating entity to make a timely payment of principal or interest as required under an FDIC-guaranteed debt instrument, the FDIC will pay unpaid principal and/or interest. Again, the conditions under which the respective guarantees can be used refer to the relationship between the issuing entity and the FDIC, but not to the direct legal link between the guarantor and the holder of guaranteed debt. Thus, we argue that European banks should be in a position to apply a 0% risk weighting when holding FDIC-guaranteed bonds.
What effect would non-payment of non-guaranteed senior claims by the issuer have on GGBs?
Early redemption in the event that guarantees are drawn looks unlikely
Another legal question arises about the scenario where a bank making use of the guarantee mechanism fails to make a payment on non-guaranteed senior claims. The guaranteed notes rank pari passu with all of the other unsecured and unsubordinated obligations of the relevant issuers 28. Thus, a failure to pay on non-guaranteed senior claims could lead to investors seeing their guaranteed bonds being redeemed before the scheduled maturity date, in the event that the guarantors pay the respective compensation when being drawn on the guarantee. The respective documentation of guaranteed debt instruments generally provides no clear guidance on this topic. We noted, however, that some guarantee notifications state that the respective guarantor guarantees notes according to the Terms and Conditions of these notes (eg, SOFFIN guarantee). Given that the documentation for each benchmark issue of different issuers may vary, investors need to refer to the respective bond documentation to get more clarity about the inherent and defined default scenarios and further handling. Under certain conditions, a guarantor might therefore be obliged to accelerate the bond repayment. However, in our view, an early redemption of the respective guaranteed notes is rather unlikely in most cases. First, from an economic point of view, the respective guarantors will prefer to make payments as scheduled in order to gain time and use the potential recovery proceeds for making such guarantee payments. Second, from an operational point of view, generally, the continuation of scheduled payments is much easier to manage compared with a final indemnity payment, particularly when taking into account that the covered guarantee period is limited to a well defined and rather short horizon. Consequently, we would assume that in the case of a non-payment of an issuers senior debt, the holders of guaranteed debt would receive their payments as scheduled. The similar status of guaranteed notes and non-guaranteed notes (including covered bonds) in terms of seniority also implies that the non-guaranteed notes implicitly benefit from the same ranking. As explained above, a non-payment of similarly ranking nonguaranteed debt would also be a damage event with respect to the senior debt issued under the government guarantee scheme. As the guarantee schemes are designed to avoid a wind-down scenario, resulting in a subsequent fire-sale of bank assets, we argue that government authorities would rather give further support to the respective entities than allow a payment shortfall on similarly ranking non-guaranteed debt to trigger a scenario they are trying to avoid. As a result, investors in non-guaranteed debt, such as covered bonds, which fall under the respective guarantee period, may prefer to focus on the status
28
There is no such link in those cases where the issuing entity of the guaranteed debt is a government-sponsored special purpose entity, such as the French Socit de Financement de lEconomie Francaise (SFEF) for example.
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of the respective guarantee schemes than the financial status of the issuing entity and the quality of cover pools. Importantly, within the EU, the respective guarantee schemes need to be approved by the European Commission 29.
Conclusion
Given the recent improvement in the global financial markets and the assumption that due to the changed market environment, we believe that the GGB market is nearing its end. Without doubt, over the course of Q4 08 and H1 09, the issuance of GGBs was necessary to cover the immediate funding needs and liquidity gaps of several market participants. At the same time, the issuance of GGB, which for several months was the only source of term funding, enabled these players to gain some time in order to assess their balance sheet structures and to perform the necessary adjustments. This, however, has meanwhile markedly changed. We therefore believe that in the weeks and months ahead, primary market activity related to GGBs will phase out. Some reservations remain, however. According to our observations, in 2009 the re-opening of primary markets for alternatives such as covered bonds or senior unsecured debt was limited in the beginning to larger countries and thus issuers. Thus, among the first entities to issue covered bonds after a pronounced dry spell were large German, French and Spanish issuers. Basically the same pattern can be observed in the case of senior unsecured debt, where French and UK issuers were first to tap the market again. Only later did issuers from smaller countries follow, among them Dutch, Swedish and Greek players, which issued either covered bonds or senior unsecured debt. Such a differentiation could, however, be revived should market conditions worsen again, resulting in further extensions of guarantee programmes in certain countries. Nevertheless, given the strict terms of the guarantees and applied fee structures, for most banks GGBs are a rather costly funding source and likely to become even more so. Future issues might therefore be rather concentrated on short-term funding and private placements.
29
The respective state aid cases can be found at http: ec.europa.eu/comm/competition/state_aid/what_is_new/news.html.
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Figure 135: Characteristics of government-guarantee schemes

Country Austria Guarantees 80bn Guarantee format Two types of guarantees: 1) the government guarantees Austria Clearingbank that is lending to banks on a collateralised basis to credit institutions and insurance companies; 2) the government guarantees directly or indirectly credit institutions liabilities. Two types of guarantees: 1) a guarantee by the government to the NBB extending collateralised loans to banks in need; 2) "new interbank and institutional deposits and financing, as well as new bond issuance intended for institutional investors" by a number of Dexia entities (joint with France and Luxembourg), to be extended to any 'systemic bank' if/when needed. New debt issued by banks. SFEF (French Financing Corporation) issues debt on behalf of banks (exceptionally, France can also guarantee bank debt directly). "debt and liabilities issued... by companies of the financial sector" from 20 October 2008 onwards (excluding Pfandbrief) New medium-term notes issued by banks. 2008 Scheme: All deposits (retail, commercial, institutional and interbank), asset covered securities, senior unsecured debt and dated subordinated debt (Lower Tier 2) for 11 institutions. Eligible Liabilities Guarantee (ELG) Scheme 2009: Since 9 December 2009, new debt issued by banks. Italy No specific maximum amounts. Two types of guarantees: 1) the Italian government guarantees BoI repo advances to banks ("against bonds held by banks or issued by banks after Oct13"); and 2) guarantee debt issued by Italian banks. Senior unsecured debt instrument (CDs, CP or bullet MTN) in euro, GBP or USD. New issuance of CP, CD and senior unsecured bonds and notes to refinance maturing liabilities New debt issued by banks.
Belgium
240bn in total (90bn for Dexia, rest is unallocated, ie, in May 2009, KBC got guarantees on 5.5bn of CDOs and 14.4bn of MBIA debt) Unlimited 50bn, with limits per bank 320bn (of which 55bn for Dexia) 480bn for the SoFFin fund (of which 172.5bn was drawn as of April 2010). 15bn >420bn
Denmark Finland France Germany
Greece Ireland
Netherlands Portugal Spain
200bn 20bn 100bn until end-2008, undefined for 2009 (but expectation of at least 100bn). SEK1500bn "The amount guaranteed for this purpose would depend on the specific needs of the Banking system." Asset Protection Scheme. Bank to hold first loss", after which HMT takes 90% of loss on outstanding principal amount of the asset outstanding. RBS applied for 325bn for 19.5bn; Lloyds 260bn at a cost of 15.6bn.
Sweden Switzerland
Below one year: 50bp for unsecured debt and 25bp for covered bonds. Above one year: same +CDS (Jan 07-Aug 08) "... the Federal Council is prepared to guarantee new short- and medium-term interbank liabilities and the money market transactions of Swiss banks. The aim of such a measure would be to facilitate the refinancing of the banks." New issuance of CP, CD and senior unsecured bonds and notes, to refinance debt or loans, in euro, or US dollars. Range of currencies (AUD, JPY, CAD, and CHF) was expanded on 15 December 2008.
UK
Source: Local sources, Barclays Capital
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Country Austria Belgium Denmark Finland France Asset purchase /exchange Austria Clearingbank loans are collateralised. Loans of SFEF are collateralised with non-ECB eligible collateral Capital injections 15bn (of equity capital, this amount can be exceeded to the extent that the 85bnguarantee has not been used) 4.7bn in Fortis, 1bn in Dexia, 500mn in Ethias (all equity); 3.5bn of preferred to KBC (+2bn+1.5bn from the Flemish government) First package did not include capital injection, but a second package (announced on 19 January 2009) does, for a total of DKK100bn of hybrid core capital Provisionally, 4bn in 'private equity' 40bn, of which 1bn of equity for Dexia, twice 10.5bn of Tier 1 capital for six other banks (end-2008 and 22 January 2009). Managed by the SPPE (State Shareholding Corporation). Additional 5bn to Caisse d'Epargne on 17 March 2009. 80bn (70bn +10bn top-up) for both asset purchase and capital injections. Purchases: max 5bn per financial group; injections: max 10bn per group. As of 9 April 2009, a total of 19bn of capital injections was committed. In 2009, the government decided to establish a 'bad bank' framework. The German government also prepared a specific measure to allow German Landesbanks to spin-off non-strategic assets 5bn preferred shares. Capital injection a condition for participation in the plan An initial 10bn (typically against preferred stock with an 8% dividend and 25% voting rights) was planned; new capital injections took place in 2009. Initially, no banks applied. But in Feb-March 09, a total of 9.55bn was injected following the publication of the Tremonti bonds law. 20bn (of which 10bn used by ING in quasi Tier securities, 3bn for Aegon) + 17bn Fortis equity
Germany
Greece
Ireland Italy
8bn of exchange against state bonds (2bn done in 2008) 5bn preferred shares. Capital injection a condition The NAMA (www.nama.ie) 40bn (exchange of non-ECB eligible collateral for new T-bills, with a maturity of 6 months, renewable until June 2010). Back-up facility for $35bn of Alt-A mortgages from ING (risk is 80% on the state, against a fee) announced on 26 January 2009. FAAF:30bn of non ECB eligible AA/AAA collateral (with a max volume of 50bn), favouring assets backed by loans granted after Oct 08. A combination of outright purchases and repos (www.fondoaaf.es). The scheme has been stopped at just below 20bn currently. USD54bn of illiquid UBS assets (European and US) BoE SLS: 185bn of T-Bills swapped for 287bn of assets facility closed 30 January 2009. New Asset Purchase Facility (APF) for BOE to purchase up to 50bn corporate paper, CP/CD, etc, as part of QE policy (initial amount funded by bill allowed to run off).
Netherlands
Portugal Spain
4bn of preferential share for 5 years (3 November 2008) FROB (www.frob.es)
Sweden Switzerland UK
Up to SEK50bn in exchange for preferred shares or hybrid capital (announced 3 February 2009) CHF6bn of convertible debt (UBS) Equity capital (common and preferred shares; injection into RBS and Lloyds /HBOS).
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Country Austria Guarantee fees 50bp for instruments less than 1y, median CDS (January 2007-Aug 08) +50bp for others. 55bp fee for the loans from Austria Clearing bank. 50bp for instruments less than 1y, median CDS (Jan 07-Aug 08)+50bp for others. Borne mostly by The Private Contingency Association (banks), which will contribute up to DKK35bn (above that: the Kingdom of Denmark is responsible, but there is no detail of any potential charge back on the guarantees). Cost of hybrid capital to be between 9% and 11.25%. 50bp for unsecured debt and 25bp for covered bonds+ issuer specific cost (based on rating). Cost of SFEF issuance +CDS (Jan 07-Aug 08)+20bp. 50bp for instruments less than 1y, median CDS (Jan 07-Aug 08) +50bp for others; 10bp commitment fee. Preferred shares bear a 10% dividend; Guarantee: between 25 and 50bp for less than one year, and CDS + a spread for over one year. 1bn total over two years, but the exact mechanism is at the discretion of the Minister of Finance. 50bp for less than a year, CDS based above one year (but no more details). 50bp for instruments less than 1y, median CDS (Jan 07-Aug 08) +50bp for others. 50bp for instruments less than 1y, median CDS (Jan 07-Aug 08) +50bp for others. 50bp for instruments less than 1y, median CDS (Jan 07-Aug 08) +50bp for others. Slightly different charges apply when no CDS exists. Below one year: 50bp for unsecured debt and 25bp for covered bonds. Above one year: same +CDS (January 2007 until 20 August 2008). Convertible coupon of 12.5% for UBS. Financing Regular bonds to be raised by the Austrian DMO.
Belgium Denmark
Regular bonds and bills. The winding up company will finance itself by raising loans.
Finland France Germany Greece Ireland Italy Netherlands Portugal Spain
To be administered by the State Treasury New debt issued by vehicle (first issue in week of 10 Nov) Regular bills and bonds. Regular bills and bonds. Regular bonds. Regular T-bills and bonds, as well as new CST (instruments of 6-months, deliverable into the ECB). Regular bonds and bills. Regular bonds and bills. Regular bonds and bills.
Sweden
Regular bonds and bills.
Switzerland
Budget resources for the capital injection. Loan in USD from Fed for illiquid assets (later to be refinanced in the market). Regular gilts and T-bills.
UK
12mth median CDS 5y +50bp. Reference period shifted to Jul 07-Jul 08 on 15 Dec, 2008 (a lowering of between 15bp and 30bp), applicable retrospectively.
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UNITED STATES: AGENCIES
The long and winding road

Rajiv Setia +1 212 412 5507 rajiv.setia@barcap.com James Ma +1 212 412 2563 james.ma@barcap.com
Resolving the debate on the government-sponsored enterprises (GSEs) is likely to take several years as Congress hammers out the future of US housing finance, preserving the status quo in the meantime. By raising the portfolio and debt caps at Fannie Mae/Freddie Mac, and removing the limit on equity infusions through 2012, the Treasury has taken immediate nationalization off the table. From a fundamental standpoint at the Federal Home Loan Banks (FHLB), we believe it has worked through a slim majority of losses on non-agency mortgage-backed securities (MBS) and retains a substantial capital base. Despite higher cap limits, FNM/FRE portfolio growth should remain muted in 2010 as both GSEs work through delinquency buyouts. FHLB advance activity has plummeted, and we expect this pattern to continue potentially into 2011.
Debate on housing finance reform advances glacially

We expect the administration to maintain the status quo at FNM/FRE for several years
Questions about the fate of Fannie Mae (FNM) and Freddie Mac (FRE) broadly center on two different timetables. As we have detailed in prior publications, we believe that the status quo will hold for several years: Despite lacking an explicit guarantee and likely posting quarterly losses for the next few years, FNM/FRE still have a smoothly functioning guarantee business. In the near term, there simply is no viable alternative to the GSEs for housing finance in our view. While conservatorship technically implies that FNM/FRE are being healed slowly and run for profit, it is clear that Congress will use FNM/FRE for public policy purposes in the near term, even if such a decision is not economic. In fact, Representative Barney Frank recently stated that the entities already have become kind of public utilities. 30 Longer term, regardless of what the administration outlines, it is Congress that must decide the extent of government involvement in housing policy and what role, if any, the GSEs or their successors play in fulfilling their vision. We expect the debate to be long and protracted and would not be surprised to see it stretch out over many years.
The Administrations stance: A dream deferred

President Obamas FY 11 budget made only the briefest mention of the future of the GSEs, and did not materially change the treatment of FNM/FRE from FY 10. Regarding the GSEs future forms, the Office of Management and Budget (OMB) stated only that The Administration continues to monitor the situation of the GSEs closely and will continue to provide updates on considerations for longer term reform of Fannie Mae and Freddie Mac as appropriate. 31 Shortly after the first Congressional hearing on the future of the GSEs, Assistant Treasury Secretary Barr detailed the administrations four main goals for housing finance reform in comments to the Mortgage Bankers Association:
30 31
Interview on CNBC, 5 January 2010 p.352, Credit and Insurance, Analytical Perspectives, Budget of the US Government for FY 2011
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Availability of mortgage credit to a wide range of borrowers, including those with low and moderate incomes, to support the purchase of homes they can afford. Affordable housing options, both ownership and rental, for low- and moderateincome households. Access to mortgage products that are easily understood, such as the 30-year fixed-rate mortgage and conventional variable mortgages with straightforward terms and pricing. A housing finance system that distributes credit and interest rate risk that results from mortgage lending in a way that minimizes risk to the broader financial and economic system and does not generate excess volatility or contribute to financial instability. Finally, Assistant Secretary Barr noted that the claim that Fannie and Freddies collapse was caused by the governments imposition of affordable housing goals simply is not supported by the facts and that the GSEs downfall was ultimately caused by a combination of relaxed standards and weak regulation. In our view, these remarks are consistent with Treasury Secretary Geithners previous public comments, which have emphasized retaining positive elements of the GSEs and including a role for the government. We believe that the administration is interested in preserving a GSE structure, particularly as regards housing affordability, but realizes that reducing systemic risk has become a political necessity as well.
Administration releases public questions on the future of housing finance

Finally, the administration has released the promised set of questions open for public comment, which is the culmination of previously hinted-at administration plans since 2009: The first question asks which policy goals should be prioritized, including sustainable homeownership and housing affordability. The second and third questions are related: the former asks what degree of government involvement is optimal, including the existence of GSEs and/or explicit guarantees, while the latter asks if the government approach should differ across market segments. The fourth question seeks suggestions on how to improve the existing system, including Figure 138: Sources of US mortgage credit Figure 139: Agency activity picks up the slack from PLS
70% 60% 50% 40% Conventional
Other, 581, ABS pools, 5% 1525, 14%
GSEs, 439, 4%
Other bank funds, 2396, 22% FHLB advances, 631, 6%
GSE pools, 5214, 49%
30% 20%
Subprime/ AltA/HEL Jumbo
GNMA
Total = $10,786bn
10% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: Barclays Capital, 4Q09 Federal Reserve Flow of Funds report
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the role of the GSEs; the seventh questions asks whether lessons from overseas housing markets can be applied to the US. Finally, the fifth and sixth questions ask how the housing finance should support sound market practices and protect the consumer. In our view, the fact that public comments are being solicited in the absence of an interim proposal (unlike the process with programs conceived rapidly, like the TLGP) indicates that the process of housing finance reform is still in an embryonic stage, and if GSE restructuring is truly the eventual outcome, it will not be for a considerable period. Furthermore, questions 2-3 indicated that the administration believes a government role in housing finance should be preserved, consistent with Secretary Geithners recent rhetoric. Taken together with Assistant Secretary Barrs remarks, the administrations stance seems to reflect the reality that there is no easy replacement for the existing guarantee business at FNM/FRE, particularly in terms of nationwide standardization and market share (Figure 138). The simple fact remains that the GSEs help finance about $6trn of the existing $11trn stock of mortgage debt outstanding. With banks under pressure to deleverage, it is wishful thinking to assume that the private sector can fill the financing gap that would be created if government involvement in the housing sector were switched off all at once. Meanwhile, the economics of private-label securitization still remain unattractive relative to GSE financing as the government continues to crowd out the private sector (Figure 139). In all, we continue to expect no near-term GSE restructuring, and the nearest timeline for serious proposals to be considered is 2011, in our view. Furthermore, the timeline for actual changes to the current mortgage system may well be drawn out over the rest of the decade.
Shedding light on the Preferred Stock Purchase Agreements

We summarize the status quo of the Treasurys support for FNM and FRE, namely the changes to the PSPAs made in late December 2009: 32 Limit on equity injections temporarily suspended: The maximum amount that can be drawn by either GSE increases from $200bn to the greater of that amount or $200bn plus Figure 140: PSPA cushions largely preserved through 2012
210 180 150 120 750 90 60 30 0 3Q08 4Q08 1Q09 FNM
Figure 141: Changes to portfolio caps

900 850 800 Retained portfolio, $bn
Cumulative draws, $bn
Capacity
700 650 Dec-07 2Q09 FRE 3Q09 4Q09 1Q10
Jun-08 Dec-08
Jun-09 Dec-09
Jun-10 Dec-10
Maximum
Portfolio FNM Old Limit FNM New Limit Both
Portfolio FRE Old Limit FRE
32
Treasury changes Preferred Stock Purchase Agreements, 25 December 2009.
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the cumulative total of Deficiency Amounts determined for calendar quarters in calendar years 2010, 2011, and 2012, less any Surplus amount determined as of December 31, 2012.33 Structuring the caps in this fashion is clever, as it largely preserves the size of the existing capital cushion post-2012 (Figure 140). As such, FNMs cushion has been preserved at $125bn, and FREs at $148bn, given cumulative draws through Q4 09. In our view, the higher backstops are very welcome, but only likely to be drawn on if housing suffers another dramatic decline. Our base case forecast remains that cumulative draws for FRE and FNM will ultimately total $90bn and $140bn, respectively. Portfolio caps redefined: The Treasury also changed how it defined the portfolio caps to allow FNM/FRE more flexibility. Previously, they were required to shrink by 10% per annum based on YE 09 assets; now, shrinkage is based on the YE 09 limit of $900bn. So, the portfolio cap is $810bn as of YE10, $729bn as of YE 11, and so on. Based on the current portfolio sizes of roughly $750bn each, not only do the GSEs not need to shrink in 2010, they can grow (Figure 141). While we do not anticipate large-scale growth, we expect delinquency buy-outs to keep the portfolio from shrinking. As a result, we have revised our term debt issuance forecast for 2010 to $70bn (largely due to a term-out of liabilities by all three major GSEs). Definitions of mortgage assets and indebtedness refined: As the GSEs have prospectively applied FAS 166/7 and consolidated the guarantee businesses, the Treasury has explicitly stated that it will ignore the effect of these changes in calculating the caps and draws. It will evaluate assets and liabilities without giving effect to any change that may be made hereafter in respect of Statement of Financial Accounting Standards No. 140, 166, or 167, or any similar accounting standard. 34 Periodic Commitment Fee postponed: Recall that FNM/FRE were set to begin paying a fee to Treasury for their use of the PSPAs in 2010. With the amendments, the Treasury has pushed back the start date to March 31, 2011. By allowing the GSEs to make unlimited draws in 2010-12, the Treasury has removed the primary element of doubt in the strength of its support for FNM/FRE. As a practical matter, we expect the bulk of legacy losses at the GSEs to be provisioned for by 2012. Thus, losses post-2012 are fairly unlikely unless housing suffers a double-dip. Current origination by the GSEs is likely to be very profitable and should increasingly serve as an offset to legacy expenses. Furthermore, post-YE 12, the GSEs will still have roughly $100bn+ of capacity left to support debtholders. The key takeaway is that at least for the next three years, FNM/FRE credit and Treasury credit are analogous. Furthermore, these changes indicate that immediate nationalization for FNM/FRE is not in the cards.
FNM/FRE return to losses in Q1 10 earnings releases

FNM reported an $11.5bn net loss for the three months ended March 31, 2010, before paying preferred dividends of $1.5bn to Treasury. This is the second straight improvement in quarterly results, but FNM was still unable to avoid requesting another $8.4bn in equity from the Treasury. Freddie Mac reported a net loss of $6.7bn in the quarter, excluding the $1.3bn preferred dividend. FRE also returned to making draws from the Treasury, requesting another $10.6bn.
33 34
Second Amendment to Amended and Restated Senior Preferred Stock Purchase Agreement, Financialstability.gov. Ibid.
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Revenues and credit expenses both lower

Credit loss provisions were the primary contributors to the posted losses at both FNM and FRE, totaling $11.9bn and $5.4bn in Q1 10, respectively. While FRE saw some improvement from previous quarters, FNM did not and attributed this to increased loan modifications, as well as a general deterioration of its credit book. While FNM still expects a national decline in home price appreciation (HPA) and more foreclosures in 2010, if current trends continue, our credit-related expenses could be lower in 2010 than in 2009, when they totaled $73.5bn. Cumulative provisions are now roughly $120bn at FNM and $55bn at FRE (Figure 142), or about 70% and 60% of our lifetime estimate of guarantee losses, respectively. Notably, both GSEs have begun to see a deceleration of the serious delinquency rate (Figure 143), and loss severities have moderated slightly, to 35-39%. Both GSEs expect defaults and severities to remain at elevated levels; we agree with this assessment. Reported severities of 35-40% in recent quarters at FNM have been realized on dispositions of around $40bn; the eventual pipeline that must be cleared will be closer to $400bn, and the severity on this remaining stock should be much higher.
A look at net interest income

Net interest income was $2.8bn at FNM and $4.1bn at FRE in Q1 10, down from Q4 09. However, these two figures are not directly comparable because of accounting changes. Net interest income now includes amounts previously included as guarantee fee income, as well as expenses on non-performing loans. As buyouts continue to ramp up, non-performing assets (NPA) will become an ever-larger portion of the retained portfolio that will still need to be funded. Furthermore, of late, FNM has been less nimble in liquidating its REO inventory (Figure 144). Both of these patterns should serve to depress net interest margins (NIMs). At FNM, reported non-performing loans were $223bn as of Q1 10; this amount includes 60d+ delinquent loans on the guarantee book, as well as the retained portfolio. We estimate that cumulative NPAs are closer to $280bn, given REO acquisitions and resolutions that have circumvented the foreclosure process (short sales and deeds in lieu). This is tracking ahead of our lifetime estimate of $340-400bn NPA; a similar measure for FRE is about $140bn, versus our estimate of $180-200bn.
MTM and other items were mixed

Mark-to-market (MTM) derivatives losses were substantial at both GSEs, totaling $2.8bn at Figure 142: Cumulative loss provisions versus charge-offs
120 100 80 60 40 20
1%
Figure 143: Serious delinquencies decelerate

6% 5% 4% 3% 2% Single-family serious delinquency rate, %
Cumulative, $bn
0 2005 2006 2007 2008 1Q09 2Q09 3Q09 4Q09 1Q10 FNM Provisions FRE Provisions
FNM Charge-offs FRE Charge-offs
0% Jan-06
Dec-06 FNM
Nov-07
Oct-08
Sep-09
FRE (new format 3/09)
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FNM and $4.7bn at FRE in Q1 10, despite the relatively small rally in rates. The losses were due to pay-fixed swap and payer swaption positions, a pattern similar to 3Q09, when 5y swap rates also rallied about 30bp. Other-than-temporary impairments (OTTI) was minimal at both GSEs, below $500mn at each.
Draws from Treasury continue

Although FNM posted a $13.1bn quarterly loss (after dividends), it requested just $8.4bn in equity from the Treasury. In contrast to FRE, which adjusted net assets lower because of the accounting change and requested $10.6bn, FNM actually increased net assets by $3.3bn on January 1. On top of this were mark-ups of securities taken during Q1 10: fair values of the $70bn in subprime, alt-A, and CMBS in the portfolio increased by about 2 cents on the dollar, while the roughly $60bn in agency MBS held in available for sale (AFS) were marked up by about 1pt. Cumulative draws from Treasury will total $84bn at FNM and $61bn at FRE after the Q1 10 results are included (Figure 145). In its forward-looking statements, both GSEs expect draws on the Treasury to continue, and we see little in these results that would cause us to alter our expectation that cumulative draws are likely to total about $140bn at FNM and $90bn at FRE. Notably, FNM does not expect to earn profits in excess of our annual dividend obligation to the Treasury for the indefinite future and admits that there is significant uncertainty as to our long-term financial stability as a result. Although we agree with the assessment that dividend payments to the Treasury will outstrip earnings, we reiterate our view that the unlimited PSPA capacity through 2012 will suffice to stabilize FNM and FRE.
FHLB Q1 10 results: advances shrink, net interest income steady

The Federal Home Loan Bank System recently reported its Q1 10 consolidated results, posting a $325mn profit. Although this compares somewhat less favourably with the $550mn gain in Q4 09, a wider swath of the System Banks (ie, all but one) was profitable. Advance demand is still declining, by $59bn in the quarter, as banks pay down sources of wholesale funding (Figure 146). At the same time, net interest income remained fairly robust at $1.2bn in Q1 10, from $1.3bn in Q4 09, despite the shrinking balance sheet. This is a positive for retained earnings and, by extension, capital.
Figure 144: Non-performing assets at FNM

70 60 200 50 40 30 100 20 10 1Q09 2Q09 3Q09 4Q09 1Q10 NPA (RHS) REO Added
Figure 145: Draws on Treasury resume at FRE, FNM

$ bn 250
000 properties
35 30 25 20
Capital infusion, $bn
Capital infusion, $bn
90 75 60 45
150
15 10 5 30 15 0 3Q08 4Q08 1Q09 2Q09 FNM (LHS) Cum FNM (RHS) 3Q09 4Q09 1Q10 FRE (LHS) Cum FRE (RHS)
50 REO Disposed
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Non-agency MBS and further impairments

The FHLBs non-agency MBS continue to pay down (the Q1 10 balance was $56bn), and both credit- and non-credit OTTI reduced further, to roughly $200mn each. This was about half the amount taken in Q4 09 and demonstrates a continued improvement since H1 09. However, total non-credit OTTI taken on non-agency MBS is a still-considerable $8.3bn, which would outstrip Systemwide retained earnings of $6.0bn (Figure 147). Overall, by taking $2.7bn of credit-related OTTI since Q1 09, we believe that the FHLB has worked through roughly half of the $5-6bn in lifetime losses it will experience on its nonagency MBS holdings, which its capital cushion can easily absorb.
Capital situation improves further

Notably, the FHLB System continued to grow its regulatory and risk-based capital cushions in Q1 10, despite a slight reduction in its capital balance. The regulatory capital surplus increased to $20.4bn, while the risk-based capital surplus swelled to $36.5bn. FHLB Seattles risk-based surplus remained steady at roughly $500mn, a welcome sign of health after previously negative headlines. Together with the positives in income and OTTI, the FHLB System appears relatively healthy from a capital standpoint.
Clearing the air on term supply

As we have detailed in previous publications, 35 we do not expect the $200bn in announced delinquency buyouts by FNM and FRE to lead to a commensurate surge in term debt issuance needs. This is due to a multitude of factors (Figure 148): FNM/FRE already own some of the MBS supported by the affected pools (a).
Figure 146: Advances and debt outstanding reduce further

$ bn 1,100 1,000 900 800 700 600 500 Dec-06 Sep-07 Jun-08 Mar-09 Dec-09 ` $ bn 1,400 1,300 1,200 1,100 1,000 900 800
Figure 147: AOCI versus retained earnings

% of total assets 2.0% 1.6% 1.2% 0.8% 0.4% 0.0% -0.4% Pittsburgh New York San Fran Boston Chicago Topeka Atlanta Cincinnati Indianapolis Des Moines Seattle Dallas Total
Advances (LHS)
Debt Outstanding (RHS)
Retained Earnings
Negative AOCI
*Note: Atlanta as of Q4 09, rest as of Q1 10. Source: Barclays Capital
35
Godot has arrived, and Changes in GSE delinquency buyout policy, Market Strategy Americas, 11 February 2010.
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Figure 148: Working through FNM/FRE funding needs

$ bn FNM FRE
Figure 149: Fannie Mae portfolio versus issuance, Q1 10

FNM, $bn Debt Jan Feb Mar Apr Total
Stated amount of 120d+ delinquencies, YE09 - Amount in own MBS on balance sheet (a) - Amount sold forward (b) Near-term funding needs (a subtotal) + Pipeline thru YE10, net of self-owned pools (c) - Estimated runoff thru YE10 (d) Estimated 2010 funding needs for buyouts(e) YTD net issuance, short-term debt YTD net issuance, long-term debt Total YTD net issuance (f)
127 -15 -62 50 110 -80 80 16 9 25
72 -15 NA 57 60 -80 37 -1 13 12
DN Bullet Callable Total

Portfolio
-22 -7 8 -21 3 -41 -37
7 -6 2 2 8 -17 -9
23 9 2 33 38 1 39
9 1 1 11
16 -4 13 25 49 -57 -8
Loans MBS Total
FNM can deliver roughly $62bn in MBS via forward sales contracts that were already locked in as of YE 09 (b). If the GSE does indeed exercise this option, it would have the added benefit of clearing cap room in the retained portfolio relative to the $810bn limit that is binding at YE 10. Both GSEs have a healthy pipeline of loans that will need to be bought out in 2010 under the new guidelines we estimate $110bn for FNM and $60bn for FRE. However, much of this delinquent loan pipeline can be funded from portfolio pay-downs over the course of the year (d). At the current rate, a runoff of about $80bn implies FNM will have only $30bn more in buyouts to fund, while FRE (with lower overall delinquency rates and a smaller portfolio) would recoup $20bn if it does not reinvest pay-downs (c and d). Both GSEs have funded through April at roughly the pace we would expect for the balance of 2010 (f).
Issuance in the time of buyouts

Notably, both FNM and FRE have increased loan balances in their retained portfolios by $50bn each through Q1 10 and generally reduced their holdings of MBS (agency and nonagency) by the same amount (Figure 149 and Figure 150). Not surprisingly, the need to finance buyouts with debt funding has been muted as a result. In contrast, FHLB has shrunk sharply YTD, as demand for advances continues to decline. Also year-to-date, there have been stark contrasts in the funding mix between FNM and FRE. To wit, FNM has mainly issued discount notes and callables, likely in order to retain maximum flexibility in the size of total debt outstanding. In contrast, FRE has concentrated on issuing term bullet debt, primarily floaters. FHLB has contrasted with both FNM and FRE in that it has sharply reduced long-term bullet funding (Figure 151).
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Figure 150: Freddie Mac portfolio versus issuance, 1Q10

FRE, $bn Debt Jan Feb Mar Apr Total
Figure 151: YTD net issuance has been mixed

YTD net issuance, $bn FNM FRE FHLB Total
Discount notes Bullet Callable Total
16 -4 13 25
-1 19 -6 12
-7 -68 15 -60
8 -53 22 -23
DN Bullet Callable Total

Portfolio
3 11 4 18 0 -11 -12
9 0 -1 8 -3 -9 -11
-3 5 -3 0 51 -30 21
-11 3 -6 -14
-1 19 -6 12 48 -50 -2
Loans MBS Total
Debt funding and spread implications

We have written at length about rollover risk at FHLB, as debt maturing in <1y remained high while practically all other issuers sought to term out. Although some maturity mismatch between advances and debt remains (Figure 152), FHLB has made progress YTD, reducing this ratio to below 50%. The YTD issuance pattern suggests that declining advance demand has allowed it simply to let term debt roll off. 36 We previously expected advance demand to stabilize as the Fed was to begin withdrawing excess liquidity from the system. With the Fed now indicating that asset sales will follow, not precede, its first rate hikes, this liquidity could persist for longer than expected. If so, bank demand for advances should keep declining and may not level off until well into 2011, in turn keeping FHLB funding needs light. Also, the financial regulatory reform bill poses a significant tail risk to lower advances. In our view, the lone factor that could spur advance demand is if the crisis in Europe metastasizes into a liquidity crisis in the US as in 2008, which we find unlikely.
Figure 152: Advance terms versus debt outstanding

% outstanding 70% 60% 50% 40% 30% 20% 10% 0% <1y 1-2y Advances
Figure 153: A reversal in spreads to Treasuries is possible

Adjusted Tsy Spread (bp) 50 40 30 20 10 0 -10
2-3y
3-4y
4-5y
>5y
0 FNMA
4 6 Years to Maturity FHLMC FHLB
8 FFCB
10
Debt at Maturity
Debt to Next Call
36
GSE Q1 results: No relief, Market Strategy Americas, 13 May 2010.
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Thus, we expect lower funding needs to create a positive supply technical for FHLB debt, and indeed FNM/FRE as well, to the extent that delinquency buyouts remain funded by portfolio sales. 37 On the demand side, while at some point we expect spread-sensitive investors to return to agencies, the risk-reduction trade and dealer antipathy has cheapened sister product and could push agencies wider to Treasuries in the interim. Front-end spreads to Treasuries in the low 20s may not be enough to entice investors back into the market, as spread pick-up becomes less important below a certain level of yields (Figure 153). However, we expect the advent of liquidity regulations on banks to cause demand to re-emerge. In addition, as the capital support for the GSEs from the Treasury has become unlimited through 2012, foreign investors have already shown signs of returning to the market. Along with the aforementioned positive supply technical, these factors should prevent agency-Treasury spreads from any extreme widening.
37
Ibid.
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139
JAPANESE PUBLIC SECTOR
Reinforced policy roles, with strengthened state support

Jason Rogers +65 6308 3283 jason.rogers@barcap.com Joseph Huang +65 6308 3518 joseph.huang@barcap.com
In contrast to the sector-wide organisational changes in 2008 that focused on a gradual reduction in state support, in 2009, Japanese public financial institutions increased support to corporate Japan amid the economic downturn. In return, the government strengthened the support for a range of policy-related entities, helping to offset any negative impact on stand-alone credit fundamentals. We expect this broad trend to continue in 2010. Specifically, the Development Bank of Japan Inc (DBJ) expanded its policy lending in 2009, and in turn the government injected JPY103bn of capital. The timing of DBJs full privatisation was also postponed to 2017-19 from 2013-15. Japan Expressway Holding and Debt Repayment Agency (JEHDRA) and expressway firms lowered tolls to promote the utilisation of expressways. As a result, JEHDRA made JPY2.7trn (c.USD27bn) of provisions for these toll discounts in FY 08. To offset this negative impact, JEHDRA recorded a significant one-off profit by offloading JPY3.0trn of debt to the governments general account. The Japan Finance Corporation (JFC), in the six months ended on 31 March 2009, also reported a net loss of JPY655bn, due mainly to the JPY633bn loss from its Credit Insurance Programme. This programme was enhanced in response to the governments mandate to increase support to SMEs. The losses resulted in the government injecting JPY972bn to JFC to offset the substantial policy-directed national burden. The increase in support changes also had an impact on new bond issuance volumes. Notably, net new issuance of government-guaranteed bonds turned positive for the first time since FY 05. The balance of zaito agency bonds also rose a substantial 14% y/y.
DBJ, JEHDRA and JFC have been taking expanded policy roles, with increased state support
Figure 154: Japanese public-sector bond market net new issuance (JPYtrn)
12 9 6 3 0 -3 FY 99 FY 00 FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09
Figure 155: Japanese public-sector bond market outstanding balance (JPYtrn)

120 100 80 60 40 20 0 FY 99 FY 00 FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09
Local government Zaito agency bonds
Government guranteed
Local government Zaito agency bonds
Government guranteed
Source: Japan Securities Dealers Association (JSDA)
Source: Japan Securities Dealers Association (JSDA)
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More changes afoot

Markets experienced the first administration change since the emergence of the zaito agency bond market, as a result of the general election of the House of Representatives in August 2009. The new DPJ-lead coalition party promotes some policies that imply the possibility of changing the government commitment stance towards some zaito agencies.
The results of project screening and fundamental reviews of IAIs are in focus
At the forefront of these concerns will be the outcome of the second round of project screening and fundamental reviews of Independent Administrative Institutions (IAIs). Most of the IAIs that are zaito agency bond issuers have been the subject for the screening and reviews. The latter are likely be completed in H1 10. Depending on the decisions, financial profile and funding needs of some entities may change. Not for the first time, the state of Japans public finances are likely to be under greater scrutiny in the year ahead given the global trends and in light of the policy shift. Faced with sluggish economic growth prospects and worsening government debt dynamics, we are waiting to see details of the new administration's fiscal management plan. This is planned for completion within the first half of 2010 and is expected to include a medium-term fiscal framework. This new framework looks out several years and should reveal the current administration's view of proper medium-term fiscal discipline. We are also eagerly awaiting the June release of the government's New Growth Strategy. Furthermore, the general election for the Hose of Councillors is planned in July. The focus of attention is likely to be on the extent to which the current administration is able to maintain its political power base following the election.
The pressure on Japans sovereign ratings remains
Despite some signs of stabilisation in the macroeconomic backdrop, pressure on Japans sovereign credit rating is likely to mount, in our opinion. In January 2010, S&P assigned a Negative outlook to Japans AA rating. The action reflects S&Ps view that the Japanese governments diminishing economic policy flexibility may lead to a downgrade unless measures can be taken to stem fiscal and deflationary pressures. We see little scope for meaningful fiscal consolidation in the near term, and expect Japans debt to GDP ratio to continue to rise over coming years. As Figure 156 shows, we estimate that it will take GDP growth of around 4% to stabilise Japans core debt to GDP ratio at current levels. As a result, the concern over the outlook on Japans debt position and credit ratios is likely to remain over the next few years.
Figure 156: Japans core debt to GDP ratio projections under various GDP growth assumptions
170 160 150 140 130 120 110 100 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Note: The balance of outstanding JGBs outstanding beyond 2008 is based on MOF projections as of February 2009. These projections do not include FILP bonds and thus the debt-to-GDP ratio is narrowly defined. Source: MOF, Barclays Capital.
1%
2%
3%
4%
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AUSTRALIAN PUBLIC AGENCIES
Economic recovery underpins stable outlook

Gavin Stacey +61 2 9334 6128 gavin.stacey@barcap.com
Reflecting their roles as the treasury financing arms of the Australian states, the treasury corporations credit profiles are largely dependent on the health of the states. The state governments guarantees of the issuers borrowings further underscore the importance of the state to the treasury corporations. Credit ratings of the issuers and the states are therefore linked. Overall, we expect the fundamentals of the issuers to remain intact as the improved macroeconomic backdrop will eventually help to reduce the pressure on the states finances as they continue to implement their capital spending plans. The capital spending plans of the Australian states took on increased importance during the crisis as weaker revenue trends meant that the states saw some deterioration in their financial positions. Indeed, the credit ratings on the state of Queensland and the Queensland Treasury Corporation were downgraded to AA+ and Aa1 from AAA and Aaa, respectively, in 2009 to reflect the states weakening budgetary position.
We expect the states to report improvements in forecasts for their financial positions
However, the states increased expenditure control as well as the economic recovery have since led to an improved outlook. For instance, in its FY 10-11 state budget, the government of Western Australia revised its general net operating surplus forecast for FY 10-11 to AUD286mn from AUD51mn. The non-financial public sectors net financial liabilities to revenue ratio is also expected to remain below 70% over the next four years, after previously being forecasted to reach 86% in FY 12-13. We expect the other states to announce similar trends when they release their FY 10-11 state budgets over the next few weeks.
Figure 157: Western Australia general government sectors net operating balance (AUDmn)
1000 800 600 400 200 0 -200 -400 FY 09-10 FY 10-11 FY 11-12 FY 12-13 FY 09-10 Mid -year projections FY 10-11 Budget
Figure 158: Victorias cash surplus/deficits (AUDbn)
1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0
FY 09-10 Mid -year projections FY 10-11 Budget
FY 10-11
FY 11-12
FY 12-13
FY 13-14
Source: State of Western Australia Budget 2010-11, 2009-10 Mid-Year Financial Projections
Source: State of Victoria Budget 2010-11, 2009-10 Mid-Year Financial Report
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Australias fiscal outlook

Australias current debt level is still manageable, in our view, especially in an international context
Australia has seen total debt outstanding increase considerably over the recent years. That said, because the starting point was so low, the current level of debt is still manageable, certainly when compared internationally, in our view. This, along with the fiscal outlook contained in the 2010 Federal Budget, should enhance Australias fiscal management credentials and AAA sovereign rating. The 2010 Federal Budget was framed with the labour market close to full employment, the terms of trade revisiting its 2008 peak, a resumption of a mining capex boom and households enjoying soaring house prices. Moreover, the economic backdrop was forecast to improve further with the global recovery broadening from emerging economies to advanced economies. Nominal GDP growth in 2010-11 was forecast to be about 10% stronger than expected at the time of the 2009 Budget.
Government is shifting the goal for fiscal policy to restoring the budget to surplus and mediumterm debt reduction
The Budget also highlighted the governments intent to shift the primary goal for fiscal policy from minimising the domestic consequences of a deep global recession to restoring the budget to surplus and medium-term debt reduction. To that end, the government projected a return to surplus for the underlying cash balance by 2012-13, three years earlier than forecast in the 2009 Budget. Based on the revised budget balance estimates, the government projected a peak in Commonwealth Government Securities (CGS) on issue of around AUD210bn (approximately 14% of GDP) for end-June 2012 and end-June 2013. This compared with the projection in Budget 2009 of AUD300.8bn by end-June 2013. In addition to fiscal repair, importantly, the governments fiscal strategy can be seen as assisting monetary policy manage the domestic effects of a resumption of extremely positive terms of trade shock over the projection period. Budgetary policy is forecast to be a drag on demand of 1.0-2.0% of GDP over coming years.
Figure 159: Global real GDP growth forecasts (%)

6 4 2 0 -2 -4 -6 2009 Global
Figure 160: General government net debt to GDP (%)

8
2010 US Japan Australia
2011
0 FY 09-10
FY 10-11
FY 11-12
FY 12-13
FY 13-14
Source: Australian Budget 2010
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SPANISH AUTONOMOUS COMMUNITIES
Overview
In past few years, the presence of Spanish autonomous communities (comunidades autnomas) in the global money and capital markets has been rather subdued. Attributed to sound economic growth, tax revenues made available to the autonomous communities surged to 88bn in 2008 from 15bn in 2000. Thus, literally all autonomous communities experienced a marked improvement in public finances, with the aggregate budget deficits of Spanish autonomous communities a remarkably low 1.6bn and 1.7bn in 2007 and 2008, respectively. When the end of the decade-long boom on the domestic housing market collided with the financial markets crisis in mid-2008, however, declining tax revenues met surging public expenditures. Consequently, the autonomous communities started adapting their budgeted expenditures. Despite reforms made to the financing system of the autonomous communities, the budget estimates the aggregate deficit to surge to 26.9bn in 2010 from 11.6bn in 2009 and only 1.7bn in 2008. As a result of this sharp rise in funding needs, capital market activity on behalf of the Spanish autonomous communities has markedly increased since the beginning of the year a development that we, ceteris paribus, expect to maintain its momentum over the year (Figure 161).
Figure 161: 2010 year-to-date issuance of Spanish autonomous communities

Instrument ISIN Size (mn) Launch date Spread at launch mid-swaps (bp) As at 4 June
4.950% GENCAT Feb 20 3.875% NAVARR Feb 17 4.300% NAVARR Feb 20 4.796% BALEAR Mar 20 3.609% BALEAR Mar 15 4.929% CANARY Mar 20 4.688% MADRID Mar 20 4.850% ANDAL Mar 20 4.900% VALMUN Mar 20 4.875% MANCHA Mar 20 4.805% JUNGAL Mar 20
ES00000950E9 ES0001353251 ES0001353269 ES0001348103 ES0001348095 ES0000093361 ES0000101396 ES0000090714 XS0495166141 XS0496138818
1000 200 184 300 200 620 500 900 400 400 500
2 Feb 2010 8 Feb 2010 8 Feb 2010 23 Feb 2010 23 Feb 2010 2 Mar 2010 3 Mar 2010 8 Mar 2010 10 Mar 2010 11 Mar 2010 15 Mar 2010
+160 +97 +140 +110 +155 +130 +150 +160 +155 +145
+270 +270 +275 +275 +240 +275 +270 +270 +275 +275 +275
In line with the sharp increase in the aggregate deficit of the Spanish autonomous communities, net debt issuance in 2010 is likely to amount to 27.0bn, markedly higher than the 11.9bn issued in 2009. At the time of writing, 7.6bn had already been issued (Figure 162).
The financing system

Two financing models: the common system
With regards to the financing of the Spanish autonomous communities, we distinguish between two models: the common system and the autonomous system. All autonomous communities, except for the foral regions of the Basque Country and Navarre, rely on the common system and have similar revenue structures, comprised of a share of national taxes (mostly personal income tax and VAT), regional taxes (mostly wealth and real-estate related taxes) and transfers from the central government.
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Figure 162: Spanish autonomous communities gross debt issuance (bn)

15 11.9 12 9 6 4.0 3 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010ytd
7.6
4.3 2.6 1.8
4.1 2.0 2.5
1.7
2.1 1.3 1.1
The common system is governed by Law 21/2001, which regulates the fiscal and administrative measures for the autonomous communities and the cities with a statute of autonomy 38. This system, which started in January 2002, can be characterised as integrating three blocks of jurisdiction of the autonomous communities: ie, the traditional block of common jurisdictions (including the educational service); and the new ones (health care and social services of the Spanish social security system were financed separately until 2001). To guarantee the provision of education and health services without large discrepancies between the different regional territories, the autonomous communities can apply for supplementary resources (levelling allocations). To enable the autonomous communities to finance the new tasks (ie, mainly health care), the principle of fiscal coresponsibility was extended. Thus, within the scope of the common system of financing, the autonomous communities receive: taxes on capital transfers and documented legal acts; inheritance and donations taxes; gambling taxes; capital gains taxes; taxes on certain transport means; and taxes on the retail sales of certain hydrocarbons. Furthermore, autonomous communities receive 33% of the personal income tax, as well as 35% of the revenues from the value-added tax (VAT). Revenues include 40% of those attributed to the special production taxes on beer, wine and fermented beverages, on intermediate products, on alcohol and derived beverages, as well as on tobacco products and hydrocarbons. Autonomous communities also receive 100% of the electricity tax revenues 39. Article 2 of the Spanish Constitution guarantees the principle of solidarity that sustains the state of autonomy of the Spanish autonomous communities (La Constitucin se fundamenta en la indisoluble unidad de la Nacin espaola, patria comn e indivisible de todos los espaoles, y reconoce y garantiza el derecho a la autonoma de las nacionalidades y regiones que la integran y la solidaridad entre todas ellas 40). The financing system of the Spanish autonomous communities is based on the principle of solidarity an equivalent level of services, unrelated to individual fiscal capacity, will be provided in each of the autonomous communities. To correct inter-territorial economic imbalances and implement the principle of solidarity, in December 1990, the so-called inter-territorial compensation fund (Fondo de Compensacin Interterritorial) was constituted. The
38 39
Source: Ministerio de Economa y Hacienda. Source: Ministerio de Economa y Hacienda. 40 The Constitution is based on the indissoluble unity of the Spanish nation, common and inseparable fatherland off all Spaniards, and recognises and guarantees the right of autonomy of the integrated nationalities and regions and the solidarity between them.
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compensation fund was earmarked for investment expenditures whose resources would be distributed by the central government among the autonomous communities. According to Article 4 of Law 29/1990, which was valid until January 2002, funds were distributed directly proportionally according to the following characteristics: 87.5% of the fund was assigned to the relative population, 1.6% to net migration, 1% to unemployment, 3% to the area of the autonomous community, and the remaining 6.9% to the density of the population 41. The autonomous communities that received payments from the fund were Galicia, Andalusia, Asturias, Cantabria, Extremadura, Murcia, Valencia, Castilla-La Mancha, Canary Islands and Castilla y Len 42. From an accounting perspective, the compensation fund is included within the annual aggregate national budgets, and the amount cannot be less than 35% of the investment from the central government and its autonomous bodies, weighted by the population and relative income of the beneficiary autonomous communities and cities. They are to be distributed among the autonomous communities with lower income (those considered as receivers of Objective I funds by the EU) and the cities of Ceuta and Melilla. The funds can be used exclusively for financing investment expenditures. In addition to the resources outlined above, the autonomous communities also receive other funds such as subsidies and transfers. Further supporting the solidarity principle is the so-called relative income fund, which is designed to level the relative wealth of the autonomous communities. The fund for mitigating a scarce population density was also set up to compensate those autonomous communities with a population density of less than 27 inhabitants per km and with a surface area of less than 50,000 km. At the same time, a growth modulation, which determines that autonomous communities with a per capita income of less than 70% of the national average, was introduced. Finally, inter-territorial compensation funds were established to achieve the convergence of income levels across autonomous communities.
and the autonomous system
The statute of autonomy of the Basque Country and the organic law on the reintegration and improvement of the legal system of Navarra establish that the tax and financial relationships between these legal territories (foral regions) and the central government will be regulated by the Economic Agreement or Convention system. The financing system is characterised through the Basque Country and Navarra having the authority to maintain, establish and regulate its own tax system. The levying, management, settlement, collection and inspection of most of the state taxes (except for import duties and import levies on special taxes and on the VAT) correspond to the Basque Country and the Foral Community of Navarra 43. Taxes are collected by said territories, and the autonomous community contributes to financing the general charges of the central government that are not assumed by a contribution. Within the scope of the common system, the Canary Islands (for historical and geographical reasons) also have a specific economic and tax system. The latter has been regulated in accordance with the European Unions (EU) provisions regarding the so-called ultra peripheral regions 44. Ceuta and Melilla also (partly) participate in autonomous financing in accordance with their statutes of autonomy and the local tax offices financing system. They have a special indirect tax system that allows them to collect production, services and import taxes instead of VAT. The rest of the resources these communities have are added to those the financing
Source: Ley 29/1990, 26 December 1990. Source: Ministerio de Economa y Hacienda. 43 Source: Ministerio de Economa y Hacienda. 44 The ultra peripheral regions include Guadeloupe, Guyana, Martinique, Reunion, the Azores, the Canary Islands, and Madeira. Source: European Commission.
42 41
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system provides to the autonomous communities, among others, are own taxes, transfers from the national budget and funds from the European Union. Similarly, the autonomous communities can obtain financing through indebtedness under the terms established by current law.
No bailout rule
The Spanish budgetary stability law (Ley de Estabilidad Presupuestaria LEP), which was implemented in 2007, specifically states there will not be any bailout procedures for the Spanish autonomous communities. In the Real Decreto Legislativo 2/2007 of 31 December 2007, it is explicitly stated that the Spanish central government will neither assume nor be responsible for the commitments of autonomous communities, local entities or those related or depending on these, without affecting mutual financial guarantees for the joint realisation of specific projects 45. As a result of this specific no-bailout clause, rating agencies understand the probability for timely sovereign support is relatively low 46. Still, despite limiting federal support in the case of (financial) distress, in our view, the no-bailout clause does not exclude financial help in the form of specific transfers to autonomous communities before a bankruptcy emerges. In fact, taking into consideration the legal barriers to provide (federal) help in the case of distress, we believe there is a high probability the central government (and other autonomous communities) would make the respective funds required to turn down an event of default available before any such situation arises. Furthermore, we believe that in case of distress, the Council of Financial and Fiscal Policy (CPFF) that represents Spains autonomous communities could arrange for emergency funding to weather any further adverse developments. Clearly, bearing in mind the potential spill-over effects, the default of a single autonomous community cannot be in the interest of the other autonomous communities.
Reform of the financing system

Reform foresees an additional 11bn to be channelled to autonomous regions
Attributed to the strong population growth in Spain over the past decade, surging 13.3% to 46.7456mn in 2009 from 40.264mn in 2000, the financing system of the autonomous communities started to accumulate inconsistencies. Since population growth has been concentrated in the strongest autonomous regions economically, respective expenditures have markedly increased. Still, the additional costs could mostly be covered by revenues attributed to the buoyant housing and construction sectors (ie, largely cyclical revenues). Within the scope of the new financing system, the autonomous communities proportion of central government revenues is set to increase and will likely more than compensate for the declining construction sector-related tax revenues. On 15 July 2009, the CPFF approved reforms to the financing system of the countrys autonomous communities, despite the conservative Partido Popular (PP) abstaining from the vote. The reforms are estimated to channel an additional 11bn (or 6.6% of the communities total budgeted revenues for 2009) from the central government to the autonomous communities, gradually offsetting the declining tax revenues 47. The reforms came into effect on 1 January 2010, with changes being introduced stepwise until 2012.
Reforms to consider demographic changes
According to the Ministerio de Economa y Hacienda, the new finance model has two fundamental aims: 1) from 2010 onwards, all autonomous regions will dispose of additional
45 46
Source: Boletn Oficial del Estado, 31 December 2007. Source: S&P, October 2008. 47 Whereas Asturias, Catalonia, Aragn, Extremadura, Castile-La Mancha, Andalusia, the Balearic Islands, the Canary Islands, Cantabria and Ceuta voted in favour of the reform, Galicia, Castilla y Len, La Rioja, Madrid, Comunidad Valenciana, Murcia and Melilla abstained.
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funds from the central government; 2) the equality in public services such as health, education and social services will be guaranteed across Spain, irrespective of the autonomous region in which an individual resides. The major changes within the reforms agreed upon will reflect the demographic changes in the respective autonomous communities in the past ten years. The reforms thus foresee a mechanism to update the change in population annually to better reflect the costs and benefits of the public services provided. Therefore, the reform will include variables such as an autonomous regions number of inhabitants, the number of pupils or those being older than 65 years 48. It was agreed that no autonomous community would be placed at a disadvantage as a result of the application of the new system. Also, no autonomous community can receive fewer resources for each jurisdictional block than the respective amount within the scope of the previous system. In addition to the resources outlined above, law 21/2001 stipulates the right of the autonomous communities to receive a guarantee that covered the estimated costs related to the financing of the health care services within the first three years.
Budgetary stability goals
On 17 June 2009, the CPFF and the Ministry of Finance decided to establish budgetary stability goals for 2010-12. In line with the goals set for 2008 and 2009 (which were adjusted in October 2008 in response to the economic deceleration), these are set as a percentage of the regional nominal GDP. Yet, to reflect the uncertainty related to the ongoing economic deceleration, the CPFF decided to set two limits. The first goal is set specifically for the autonomous regions that have implemented the economic and financial plan (EFP) (Figure 163). So far, the CPFF has approved adjusted EFPs for the autonomous communities of the Balearic Islands, Catalonia, Comunidad Valenciana, and La Rioja and a new EFP for Castilla y Len. Yet, note that other autonomous communities could also present EFPs in case their respective budgets deficits exceed 0.75% of their regional nominal GDP. In light of the current economic deceleration, however, the autonomous communities commitment to implement cost-cutting measures needs to be questioned, particularly as the central government recently allowed the autonomous communities to incur higher budget deficits of up to 2.5% (after investments) of their regional nominal GDP in 2010. This measure comes despite additional revenues attributed to the reform of the financing system. We thus believe there is a material risk that some autonomous communities could incur higher-than-expected deficits in the years ahead.
Figure 163: Budgetary stability goals (budget deficit, % of GDP)

Oct-08 2008 2009 2010 Jun-09 2011 2012
General objective With EFP
-0.75 -0.75
-0.75 -0.75
-0.75 -2.5
-0.75 -1.7
0 -1.3
Note: EFP = Economic and financial plan. Source: Ministerio de Finanzas, Barclays Capital
Revenues
Revenues to fall 8.3% y/y in 2010
Overall operating revenues of the autonomous communities are forecast to total 142.4bn in 2010, down 8.3% y/y from 155.3bn in 2009. This, as well as the sharp increase in the autonomous communities aggregate deficit, is largely attributed to a pronounced contraction in expected tax revenues. According to the 2010 draft budget, direct tax revenues (such as
48
Ministerio de Economa y Hacienda, 15 July 2009.
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those related to the personal income tax IRPF, for example) are estimated to drop 18.8% y/y to 30.0bn in 2010 from 26.9bn in 2009, with their relative weight declining to 16% of all revenues in 2010 from 21% in 2009. Clearly, this is attributed to the steadily increasing unemployment, which officially amounted to 3.9mn as at end-November 2009, the latest date for which data were available. Whereas in 2009, 800,000 jobs were lost, bringing the official unemployment rate to 18.9%, the European Commission (EC) cautioned that Spains unemployment rate would grow to more than 20% of the active population in 2010, which corresponds to an increase of c.500,000. Also according to the EC, in 2011, the unemployment rate will likely be 20.5%, putting further strain on public finances.
Figure 164: Spanish unemployment figures (mn)

5 4 3 2 1 0 80 83 86 89 92 95 98 01 04 07 10
INE data (nsa)

Source: INE, Eurostat, Barclays Capital
Eurostat data (sa)
Indirect tax revenues, which in 2009 accounted for 25% of the autonomous regions total revenues, are expected to fall 19.3% y/y to 36.1bn (or 20% of all revenues) in 2010 from 44.7bn in 2009. This comes despite the 2pp increase in the standard VAT rate to 18% scheduled for 1 July 2010. In late September 2009, the Spanish government announced that the VAT would be increased 2pp to 18% as at 1 July 2010. The reduced VAT rate will increase 1pp to 8%. This measure, as well as an increase in the levies on savings, comes amidst governmental financing needs of approximately 11bn in 2010. At 16% currently, the standard VAT rate in Spain is among the lowest in the EU after Luxemburg and Cyprus 49. As agreed in the 2009 reform of the financing system of the autonomous communities, transfers from the federal government increased 6.9% y/y to 70.9bn in 2010 from 66.3bn in 2009, accounting for 38% of the revenues expected in 2010. Net new borrowing, in contrast, which in 2009 amounted to 17.0bn, is forecast to nearly double to 33.1bn in 2010, which would equal 18% of all revenues ie, twice as much as in 2009 (9%) (Figure 165 and Figure 166).
49
Source: Eurostat.
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Figure 165: Development of revenues, 2000-10, (bn)*

160
Figure 166: Revenue structure, 2010*
120 56 80 40 40 49 7 8 53 21 0 8 8 16 32 18 38 20 42 22 43 46 50
60
66
66 71
transfers 38%
capital revenues 5%
48
55
56
45 36
tolls, fees, and duties 3% indirect taxes 20%
net borrowing 18%
24
27
32
38
30
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 direct taxes indirect taxes transfers
direct taxes 16%
Figure 167: Development of expenditures, 2000-10, (bn)*

120 17 29
Figure 168: Expenditure structure, 2010*
others 2%
16 80 12 15 38 44 48 52 13 9 12 32 10 13 35 22 14 25 28
16 29
transfers 39%
40
7 9 23
7 8 26
9 9 28
goods and services 20%
55
57
0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Personnel costs Goods and services Transfer payments
Note: *According to the 2010 draft budget. Source: Ministerio de Economa y Hacienda, Barclays Capital
personnel 39%
As illustrated in Figure 166, transfer payments account for c.38% of the revenues budgeted for Spanish autonomous regions in 2010. Despite a pronounced increase in absolute terms to c.71.1bn in 2010 from 68.4bn in 2009, the relative dependency on transfer payments has remained largely stable since 2003. Transfer payments relate to the Spanish sufficiency fund (fondo de suficiencia), which is the equalisation mechanism that ensures autonomous communities dispose of equivalent resources to provide basic services independent of the ability of an individual autonomous community to obtain them. The sufficiency fund thus is a locking mechanism of the autonomous communities financing system. With 1999 being defined as the base year, the sufficiency fund calculates the difference between the financing needs of each autonomous community and the assessment of the previous resources of a tax nature.
Transfer payments from central government
The sufficiency fund, which was established after Law 29/1990 (the basis of the interregional compensation fund was abolished), consists of transfer payments from the central government with the volumes related to the development of selected tax revenues that are collected by the central government 50. Furthermore, the sufficiency fund is the financing systems mechanism for adjusting to the changes that could occur in the financing needs of
50
Source: El Mundo, 2005, and Ministerio de Economa y Hacienda.
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the autonomous communities (as a result of the transfer of services) or in the resources (because of new tax transfers).
Capital revenues
Accounting for c.5% of the autonomous communities revenues, capital revenues are estimated to fall to 8.3bn in 2010 from 9.6bn in 2009. This decline, in our view, is largely expected as in the wake of the Eastern European expansion of the EU, several Spanish communities have lost the so-called Objective 1 status within the scope of the 2007-13 EU funding programme 51.
Expenditures
Expenditures to further increase in 2010
Total expenditures forecast in the 2010 draft budget will increase 1.2% y/y to 184.0bn in 2010 from 181.8bn in 2009. On an individual level, the strongest increases are related to financial expenditures, which are up 35.6% y/y to 3.7bn in 2010 from 2.7bn in 2009, and contributions into the contingency fund, which are up 26.9% y/y to 268mn in 2010 from 211.9mn in 2011. As the autonomous communities are responsible for the (relatively personnel-intensive) healthcare and educational services, personnel expenditures, which are the single largest expenditure category, will increase 2.1% y/y to 56.5bn in 2010 from 55.3bn in 2009 and (Figure 167 and Figure 168). By contrast, expenditures for investments, among them infrastructural projects, for example, are scheduled to fall 16.9% y/y to 13.3bn in 2010 from 16.0bn in 2009. Despite the economy slowing considerably as of late, the operating expenditures budgeted by the Spanish autonomous communities are set to increase further, to 154.7bn in 2009 from 136.1bn in 2008, 125.3bn in 2007 and 114.7bn in 2006. Despite the marked increase in overall volumes, with personnel expenditures accounting for 38.4% (or 52.3bn) of the total operating expenditures (136.1bn) and transfers for another 39.2% (53.3bn), the expenditure structure of Spanish autonomous communities remained relatively stable. In our view, in the medium term, this should change gradually as the personnel intensity of the educational and the healthcare sectors leave their marks on public finances. In an attempt to moderate the consequences of the ongoing economic deceleration in Spain, the central government and the autonomous communities announced counter-cyclical support measures for 2010. In our view, the potential effect of these measures is not yet fully reflected in the autonomous communities 2010 budget, which foresees a 10% y/y decline in capital expenditures to 29.7bn in 2010 from 33.0bn in 2009 and 32.0bn in 2008. Note that beyond these figures, some autonomous communities plan to raise funding for infrastructural projects with the participation of the private sector and public sector entities. Formally, the effects on the autonomous communities budgets will not be noted until the infrastructural project is used.
Personnel-intensive sectors funded by autonomous communities
Fiscal stimulus package
Financing needs
Strong regional differences
As in previous years, the gross borrowings of Spanish autonomous communities will strongly differ in 2010. Yet, with the exception of the Balearic Islands, which plan to cut the new debt made to 622mn in 2010 from 662mn in 2009, all other autonomous communities will rely on higher funding volumes. Catalonia, for example, will more than double its scheduled borrowings to 7.6bn in 2010 from 3.3bn in 2009, followed by Andalusia (+164% y/y to 4.4bn in 2010 from 1.7bn in 2009) and Comunidad Valenciana (+136% y/y to 2.1bn in 2010 from 900mn in 2009). Gross borrowings for the Basque Country, which in previous years were comparatively modest because it along with Navarre benefit from a higher level of tax autonomy than peers, are set to more than quintuple to 1.9bn in 2010 from 300mn in 2009 (Figure 169).
51
Source: European Commision, October 2006.
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Figure 169: Financial statistics net borrowings (mn)

2010* 2009 2008
Andalusia Aragon Asturias Balearic Islands Basque Country Canary Islands Cantabria Castilla Len Castilla La Mancha Catalonia Extremadura Galicia Madrid Murcia Navarre Rioja Valencia
4,388.7 728.3 615.2 622.1 1,914.4 1,208.5 400.1 1,321.8 1,121.9 7,661.4 481.9 1,531.8 1,414.7 703.7 494.8 196.5 2,127.3
1,660.4 374.1 172.2 662.0 300.0 495.9 174.0 444.6 408.9 3,280.4 187.3 604.6 1,297.5 337.9 200.5 79.7 900.3
19.6 40.1 0 371.1 25.0 0 2.5 37.0 5.5 1,394.4 0 0 -193.3 2.7 0 38.7 0
Note: *According to the 2010 draft budget. Source: Ministerio de Economa y Hacienda, Barclays Capital
Regulatory issues
Risk weighting of 0% for debt issued by Spanish autonomous communities
In Circular 5/1993 from March 1993, Banco de Espaa (BdE) provides a classification of the respective risk weightings (RW) applicable to debt issued by Spanish autonomous communities. Among other instruments, debt issued by the autonomous communities and local entities, provided the issues are authorised by the state (Deuda pblica emitida por las Comunidades Autnomas y las Entidades locales, cuando las emisiones estn autorizadas por el Estado), benefit from an RW of zero. In principle, all debt (loans and bonds) issued on behalf of the autonomous communities are authorised by the state with RW of zero. Yet, in the case of municipalities, authorisation is usually only sought for bonds. All other debt issued thus falls outside the scope of the above clause and becomes subject to an RW of 20% (Grupo con ponderacion del 20%: activos, [] que representen crditos frente a las Comunidades Autnomas y frente a las Entidades locales espaolas. Bonds issued by the Spanish autonomous communities generally fall into the ECBs liquidity class category two. Depending on the remaining term to maturity, the applicable haircut applied by the ECB ranges between 1% and 7.5% 52.
Institutional and political background

17 autonomous communities
Politically, the Kingdom of Spain is divided into 17 autonomous communities and two autonomous cities that are located in Northern Africa, Ceuta and Melilla. Geographically, with 18.6% of the total landmass, Castilla y Len is the largest autonomous community, followed by Andalusia (17.2%) and Castilla La Mancha (15.7%). In terms of population, however, with c.17.8% (8.1mn) of the total 44.1mn inhabitants, Asturias clearly is the largest autonomous community, followed by Catalonia (16.0%), Madrid (13.6%) and Valencia (10.9%).
52
For a detailed analysis of the haircuts applied, please refer to the respective chapter on risk weightings.
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Figure 170: The Spanish autonomous communities
Asturias Galicia
Cantabria Basque Country Navarre La Rioja
Castilla y Len Aragon
Catalonia
Madrid
Extremadura
Castilla La Mancha
Valencia
Balearic Islands
Murcia Andalusia
Ceuta
Canary Islands Melilla
The political power in Spain is split between the central government and 17 autonomous communities. Within the scope of the strong level of decentralisation, the regional governments are responsible for schools, universities, health and social services, culture, urban and rural development. Whereas expenditures related to the central government accounted for c.18% of public spending in 2008, regional governments accounted for 38%, local councils for 13% and the social security system for the remaining c.31%.
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Figure 171: Spanish autonomous communities

Name Population Percentage Area (in km) Percentage
Andalusia Catalonia Madrid Valencia Galicia Castile and Len Basque Country Canary Islands Castile-La Mancha Murcia Aragon Extremadura Asturias Balearic Islands Navarre Cantabria La Rioja Ceuta Melilla Total
8.202.220 7.364.078 6.271.638 5.029.601 2.784.169 2.557.330 2.157.112 2.075.968 2.043.100 1.426.109 1.326.918 1.098.744 1.080.138 1.073.844 620.377 582.138 317.501 77.389 71.448 44.108.530
17.77% 15.95% 13.59% 10.90% 6.03% 5.54% 4.67% 4.50% 4.43% 3.09% 2.87% 2.38% 2.34% 2.32% 1.34% 1.26% 0.69% 0.17% 0.15% 100%
87,268 32,114 8,028 23,255 29,574 94,223 7,243 7,447 79,463 11,313 47,719 41,634 10,604 4,992 10,391 5,321 5,045 17 16
17.2 6.3 1.6 4.6 5.8 18.6 1.4 1.5 15.7 2.2 9.4 8.2 2.1 1 2.1 1 1 -
Source: Instituto Nacional de Estadstica, Barclays Capital
Outlook
Driven by slowing economic growth with consequently falling tax revenues, we believe that the financing needs of Spanish autonomous communities are set to markedly increase in the years ahead. So far, with 7.6bn issued at the time of writing, 2010 year-to-date issuance from autonomous communities is on its way to approach the levels seen in FY 09. With the aggregated funding needs estimated to total 27.0bn in 2010, from only 11.6bn in 2009, and the overall level of indebtedness of the autonomous communities still relatively moderate, in our view, there is ample room for the further issuance of debt instruments.
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GERMAN LNDER
Overview
In the wake of the global financial markets crisis, in 2009, German GDP contracted by 4.9% y/y. With tax revenues plummeting, German lnders generated a marked budget deficit, which, at 25.5bn, brought an abrupt end to the consolidation efforts observed from 2005 onwards. In 2007 and 2008, this led German lnders to report budget surpluses of 2.9bn and 33.2bn, respectively. The backswing, which takes the deficit back to levels last seen in 2004, is largely due to a sharp increase in expenditures, which surged to 284.4bn in 2009, from 239.1bn in 2008. At the same time, tax revenues fell to 188.9bn, down from 206.8bn a year before. In light of relatively moderate economic (GDP) growth, which we do not expect to surpass 1.7% y/y in 2010, the situation is unlikely to markedly improve. This is particularly as within the scope of the mid-term funding programmes, several lnder have already announced that balanced budgets can probably not be achieved before 2013 (Figure 172). According to the latest German tax estimates, which were released in mid-May 2010, the situation is not set to markedly improve before 2012. Tax revenues of German lnders are likely to remain stable at around 203bn in 2010 and 2011, before increasing 4.8% y/y to 213bn in 2012. According to the estimates, tax revenues attributed to the federal state will follow a largely similar pattern and are to stand stable at around 217bn in 2010 and 2011. Before this phase of relative stability is reached, however, tax revenues are set to markedly decline, with the aggregate amount attributable to the lnders set to fall by 2.2% y/y to 202.5bn in 2010, from 207.1bn in 2009. The drop is even more pronounced in the case of federal taxes, which are set to fall by 5.1% y/y to 216.4bn in 2010, from 228.0bn in 2009. Also, German municipalities will remain under strong budgetary pressure as their tax revenues, before stabilising at around 66bn in 2010 and 2011, will drop by 4.2% y/y, from 68.4bn in 2009. This development might prove to be particularly challenging as their tax revenues already contracted by a sharp 11.2% y/y to 68.4bn in 2009 (Figure 173).
Tax revenues to further decline in 2010
Figure 172: State revenue/expenditure/deficits (bn)

300 250 200 150 100 50 0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 All revenues
Source: German Ministry of Finance, Barclays Capital
40 30 20 10 0 -10 -20 -30 -40 Expenditures Deficits (rhs)
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Figure 173: Estimated tax revenues, 2010-14

2009 2010 2011 2012 2013 2014
Federal government y/y variation in % Lnder y/y variation in % Municipalities y/y variation in % EU y/y variation in % Total tax revenues y/y variation in %
228.0 -4.7 207.1 -6.7 68.4 -11.2 20.5 -11.2 524.0 -6.6
216.4 -5.1 202.5 -2.2 65.5 -4.2 25.9 26.5 510.3 -2.6
217.3 0.4 202.8 -0.1 67.3 2.7 27.6 6.4 515.0 0.9
225.9 4.0 212.6 4.8 71.6 6.4 29.8 7.8 539.8 4.8
234.8 4.0 220.7 3.8 75.7 5.8 30.1 1.2 561.3 4.0
243.4 3.6 228.1 3.3 79.5 5.0 30.6 1.7 581.5 3.6
Source: German Ministry of Finance, Arbeitskreis Steuerschtzung, Barclays Capital
Rather optimistic estimates
Overall, the estimates below point towards a relatively benign image, which is based on the assumption of a sustainable economic recovery. In line with this development, the German government just revised its GDP growth forecast to 1.8% y/y in 2010, from 1.6% y/y previously. For 2011, GDP growth of 2.4% y/y is expected. Furthermore, adding to the relatively benign character of the below figures is the assumption of GDP growth of 2.9% y/y annually between 2012 and 2014. Consequently, despite lying on a gradually lower level, the May 2010 tax projections largely follow those released in May 2009. In line with the 2009 recession and the related drop in tax revenues, the correlation between the development of GDP growth and the aggregate deficit of the German states has further increased. Whereas German GDP recorded a 4.7% y/y decline in 2009, aggregate tax revenues, as reported by the German Council of Tax Surveyors, fell by 6.6% y/y to 524.0bn. This translates into an average deficit-to-GDP ratio of 1.1% in 2009, (ie, almost precisely our estimated 1.1%) with the real GDP contraction amounting to 3.5% y/y at the same time (). In terms of GDP growth, this amounts to one of the sharpest contractions in the past 20 years, abruptly bringing the deficit level back to figures last observed in 2005. Despite GDP growth ceteris paribus recovering (to 1.7% y/y) in 2010, the deficit is likely to be more permanent and actually worsen in 2010 and 2011.
Improvement in Lnder deficit/GDP ratio was reverted in 2009
Figure 174: Lnder tax projections (bn)

250
225
200
175
150 2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
May 2005 estimate May 2008 estimate
Source: German Ministry of Finance, Arbeitskreis Steuerschtzung, Barclays Capital
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Figure 175: Lnder deficit/GDP (%) and the economic cycle

1.6 1.2 0.8 0 0.4 0.0 -0.4 1993 2 -4
-2
1995
1997
1999
2001
2003
2005
2007
4 2009
Average deficit / GDP

Inverted real GDP growth (rhs)
Lnders subject to dramatically worsening financial balances
Compared to 2008, literally all German states experienced markedly worsening financial balances. Relative to the previous year, all 16 states recorded budget deficits in 2009. Despite its usually prudent budgetary policies, the most affected state was Bavaria, which saw its budget forecasts collapsing after it had to inject 10bn of equity in its ailing Landesbank BayernLB. North Rhine-Westphalia recorded a (negative) swing of 5bn in 2009, followed by Baden-Wrttemberg and Berlin (Figure 176). With regard to disaggregated data, the comparison between financial balances and revenues shows a similarly homogeneous image, with all states being subject to rapidly worsening data. Only Mecklenburg Western-Pomerania generated a minor surplus of 0.9% of revenues in 2009. In Saarland and Bavaria, in contrast, the 2009 deficits correspond to 21% and 20% of revenues, respectively (Figure 176). Taking into consideration the marked deterioration of the financial balances-to-revenues ratio over the course of 2008 and 2009, we do not believe that for the time being, despite the election promises made, any form of fiscal relaxation is likely, particularly in light of relatively high debt burdens (which in 2010 and 2011 are potentially set to further increase).
Figure 176: Comparison of changes in financial balances

Change in financial balances (bn) Change in financial balances/revenues (pp)
0 -1 -2 -3 -4 -5 -6 -7 -8 BW BY BB HE MV NI NW RP SL SN ST SH TH BE HB HH 2009 versus 2008
5 0 -5 -10 -15 -20 -25 BW BY BB HE MV NI NW RP SL SN ST SH TH BE HB HH Change in fiscal balance/revenues (percentage points)
Note: BW = Baden-Wrttemberg; BY = Bavaria; BB = Brandenburg; HE = Hessen; MV = Mecklenburg-Western Pomerania; NI = Lower Saxony; NW = North Rhine-Westphalia; RP = Rhineland-Palatinate; SL = Saarland; SN = Saxony; ST = Saxony-Anhalt; SH = Schleswig-Holstein; TH = Thuringia; BE = Berlin; HB = Bremen; HH = Hamburg. Source: German Ministry of Finance, Barclays Capital
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Figure 177: Lnder deficits/revenues the range of experience

Deficit/revenues (%) Financial balances/revenues comparison (%)
50 40 30 20 10 0
20 10 0 -10 -20 -30
2008
2009
-10 -20 1993 1995 1997 1999 2001 2003 2005 2007 2009 Min Max Average -40 -50 BW BY BB HE MV NI NW RP SL SN ST SH TH BE HB HH
Debt trends
Budget deficits to leave their marks on debt issuance
The lnders 2009 budget deficits have abruptly halted the positive development observed in 2007 and 2008 when the pace of debt issuance was relatively modest. Whereas in 2007, the aggregate amount of debt outstanding increased by only 2.1bn, it actually fell by 1.3bn in 2008. In 2009, however, the overall amount of debt outstanding sharply grew by 23.2bn to 503.6bn as at year-end 2009. The above development is also reflected in the average aggregated debt/revenues ratio, which, after falling to 176.4% in 2008, sharply increased to 194.2% in 2009, ie, close to the hitherto highest level of 198.9% which was recorded in 2005. Taking into consideration that tax revenues will likely not recover before 2012 and that so far, the lnders willingness to curb spending seems rather limited, we expect these figures to further increase in 2010 and 2011. What is more, in 2009, the Lnders debt/revenue ratios were unevenly split, whereas the Saarland featured a ratio of 422.2%, followed by Schleswig-Holstein with 307.2%, the Free State of Saxony recorded a ratio of only 49.2% at the same time (Figure 178). The average figure stood at 178.8%.
Figure 178: Lnder debt

Deficit/revenues range (%) Debt/revenues individual lnder in 2009 (%)
500 400 300 200 100
500 400 300 200 100
Debt/revenues 2009 (%)
0 1991
1994 Average
1997
2000 Minimum
2003
2006
2009
0 BW BY BB HE MV NI NW RP SL SN ST SH TH BE HB HH
Maximum
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Bonds account for 49% of Lnders aggregate capital market debt
With regards to the composition of the German states debt structure, bonds appear to play an ever increasing role and account for more than half of all funding in states such as Bavaria, Berlin, Hesse, or North Rhine Westphalia. Domestic credit instruments, among them the traditional issuance of Schuldscheine (SSD), for example, account for relatively high proportions in Saarland and Saxony, ie, in states that have so far been relatively absent from the global capital markets. As at year-end 2009, a total of 236.1bn of bonds had been issued. This compares with 253.8bn of other debt instruments and thus accounts for 49.2% of the lnders total capital market debt of 490.0bn.Note that only about two years ago, ie, as at year-end 2007, bonds represented only 46.5% of the aggregate lnder capital market debt, up from 45% at year-end 2006 and 18% in 1999 (Figure 179).
Figure 179: Debt composition and bond supply

Debt composition (bn) Gross and net bond supply (bn)
400
600
50 40
40
300 400
30
30 200 200 100 10 0 1999 2001 Bonds 2003 2005 Other 2007 2009 Total (rhs) 0 0 2000 2002 Gross supply 2004 2006 Redemptions 20 10 20
0 2008 Net Supply (rhs)
Source: dealogic DCM Analytics, Barclays Capital
Net bond supply to further increase in the years ahead
With gross supply standing above the aggregate redemption payments of German lnders, the trend in combined net supply has started pointing upwards again in 2009. This comes after a five-year phase of declining net supply between 2003 and 2008, which saw a decline to 5.5bn in 2008, from more than 35.4bn in 2003. in light of the potentially further worsening financial imbalances for German states, we expect gross (and thus net) supply to strongly increase in 2010 and 2011, particularly when taking into consideration that until 17 May 2010, the latest date for which data were available, a total of 21.4bn had already been issued.
Issuance patterns
North Rhine-Westphalia and the city state of Berlin are the largest German debt issuers
As at mid-May 2010, the latest date for which data were available, the overall amount of debt issued (in form of bonds, ie, excluding privately-placed debt such as Schuldscheindarlehen) by German lnders amounted to 424bn. Among the largest issuers are North Rhine-Westphalia (NRW) and the city state of Berlin (BERGER) which, as at year-end 2009, had debt outstanding in the overall amount of 120.5bn and 58.8bn, respectively, according to data from Deutsche Bundesbank. In the case of NRW, the relatively high amount of debt outstanding correlates with its economic weight as the largest state in Germany in terms of GDP. It ranks 18th on a global scale if measured on a stand-alone basis. Still, in the early years of the decade, public finances sharply deteriorated which, in turn, led to an increase in debt funding and eventually put pressure on its credit ratings. In the case of Berlin, things are different. The high amount of debt outstanding reflects the sharp increase in the states fiscal deficit and debt-to-GDP ratios during the citys financial crisis in recent years. At 51.1bn, the thirdlargest borrower was Lower Saxony, followed by Rhineland Palatinate and Baden Wrttemberg (Figure 180).
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Figure 180: Key German state issuers (bn) ranked by cumulative issuance since 2002* 53
2002 2003 2004 2005 2006 2007 2008 2009 2010* Total
NRW Berlin Lower Saxony Joint Lander Rhineland-Palatinate Baden-Wrttemberg Hesse Brandenburg Others Saxony-Anhalt Schleswig-Holstein Bavaria Thuringia Total
9.5 7.6 4.6 3.2 1.1 1.9 2.8 1.4 1.7 1.5 1.5 0.9 0.5 38.2
10.7 8.5 3.5 4.6 1.9 2.2 2.7 3.1 1.4 1.4 1.7 1.0 0.5 43.3
8.4 8.2 3.7 4.0 2.9 1.5 3.1 1.3 0.6 1.1 0.7 1.3 0.5 37.3
10.8 8.5 3.8 3.6 2.6 2.0 3.1 0.8 1.9 1.2 0.4 1.0 0.5 40.2
12.2 5.5 3.9 4.8 2.7 2.1 0.9 2.2 0.5 1.2 0.0 1.0 0.0 37.0
10.2 3.2 4.6 4.2 3.4 1.0 2.2 1.5 1.8 1.1 1.2 1.0 0.6 36.2
10.0 3.7 4.9 3.0 5.5 4.5 2.2 2.0 2.8 1.3 1.5 0.6 0.0 41.9
13.4 6.9 5.8 2.7 5.9 5.0 4.5 1.8 0.2 0.1 2.4 2.2 0.2 51.1
6.0 3.1 1.2 1.2 1.0 0.0 3.0 1.1 0.2 0.4 0.7 1.0 0.0 18.9
91.2 55.2 36.0 31.3 27.0 20.2 24.5 15.2 11.1 9.3 10.1 10.0 2.8 343.9
*Note: To 17 May 2010. Source: dealogic DCM Analytics, Barclays Capital
Over the course of the past few years, the proportion of lnder funding based on the issuance of bonds (as opposed to traditional domestic sources such as Schuldscheindarlehen or SSD) has steadily increased. Still, disaggregated data point towards substantially differing levels: whereas the proportion of bond financing accounts for less than 20% of all capital market funding in the case of Saxony, the respective proportion stands above 70% in Bavaria (Figure 181).
Figure 181: Composition of funding for German states

100% 75% 50% 25% 0%
Lower Saxony
Saxony
MecklenburgWestern North RhineWestphalia RheinlandPalatinate
BadenWrttemberg
Brandenburg
SaxonyAnhalt SchleswigHolstein
Berlin
Hamburg
Saarland
Bremen
Hessen
Bonds
Domestic credit (incl Schuldscheine)
Other Capital makets
Intra Govt debt
53
Our inclusion of profiles on individual Lnder is determined by considering not only total issuance but also the trading liquidity of their issues, as well as economic comparisons. We thus have not produced individual profiles on some of the smaller bond issuers among the Lnder. However, all 16 states are covered in the comparative material in this overview.
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Bavaria
The European supply context

Gross issuance volumes reach record highs in 2009
In 2009 (as in the years before), German lnders were the largest (sub-sovereign) issuers of debt. With 54.3bn being issued in 2009, up almost 12.5bn y/y from 41.9bn in2008, the issuance volume was almost five times as large as those of Spanish autonomous communities (11.9bn). What is more, except for Central and Eastern European (CEE) economies and Italy, issuance volumes of all sub-sovereigns have markedly increased in 2009. The sharpest increase was recorded in the case of Spanish borrowers, whose funding volumes increased to 11.9bn in 2009, from 2.5bn in 2008. Also, on an aggregate basis, funding volumes soared to new highs, climbing to 76.1bn in 2009, from 49.0bn in 2008. As at 17 May 2010, the latest date for which data were available, aggregate issuance stood at 31.2bn, largely driven by German Lnders, which had so far issued 21.4bn and the Spanish autonomous communities, whose aggregate issuance stood at 7.6bn at the same time (Figure 182).
Figure 182: Bond issues by European regional and local governments (mn)*
80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 1999 2000 2001 2002 2003 2004 Germany Italy Spain 2005 2006 2007 2008 2009 2010* Other West Europe C&E Europe
*Note: As at 17 May 2010. Source: dealogic DCM Analytics, Barclays Capital
Institutional and political background

The Federal Republic of Germany consists of a federation of regional states, or lnder. There are three levels of government: the central federal government, the states, and the municipalities. There are 16 German states 13 are regional states, and three (Berlin, Hamburg, and Bremen) are city states. In total, there are 10 states in the territory of the former West Germany (including Bremen and Hamburg), while the former GDR is divided into five federal states. The 16th state is Berlin, which comprises the former West and East Berlin (Figure 183).
Constitutional independence of German lnder
According to Article 109, 1 of the German Constitution (Grundgesetz), the 16 Lnder have equal status with the German federal government. The federal republic and each of the Lnder have autonomy in exercising the powers and responsibilities assigned by the federal constitution. Each state has its own constitution and is responsible for determining and administering its own budget. Therefore, and in contrast to most other European countries, the individual states budgets are not subject to approval by the German federal government. Still, there are significant constraints on both the political independence and the fiscal flexibility of the lnder governments. The constitution, in effect, creates a division of functions between the federal and regional levels. Key areas of legislation are delegated by the constitution to the federal government, whereas the states have a wider range of administrative and judicial
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powers. Certain specific expenditure responsibilities are assigned to the states, the most important of which relate to education, culture, the judiciary and public security. In addition, even in areas where responsibility is delegated to the central government, regional governments also have an important influence through their nomination of members to the upper house of the federal parliament (the Bundesrat). Elections to state parliaments follow five-year cycles.
Figure 183: The German lnder
CDU/CSU-FDP coalition government has no majority in upper house of parliament
As well as changing the government at state level, state election results also determine state representation in the Bundesrat. Currently, all states governed by the CDU, CSU or FDP can be regarded as supportive of the federal government. Coalitions of conservatives or FDP with the social-democrats (SPD) are generally not regarded as supportive because they usually abstain from voting, which is counted as a no vote in the Bundesrat. So, following the most recent elections held in North Rhine-Westphalia in May 2010, the CDU/CSU-FDP coalition government has support from only 31 out of the total 69 seats.
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Constitutional developments
The Federalism reform
First stages of federalism reform
After several years of debate on reforming the relationship between the federal government and the states, the grand coalition government of the CDU and SPD passed a federal reform bill (Federalism Reform I) through the Bundestag (lower house) and Bundesrat (upper house) with the required two-thirds majorities in June and July 2006. This corresponded to a radical adjustment of the German Constitution (Grundgesetz) with the amendments deemed crucial in streamlining political decision-making in Germany. Figure 184: Current distribution of seats in the upper house of parliament (Bundesrat)
State Ruling parties Seats Next election due
Schleswig-Holstein Baden-Wrttemberg Bavaria Lower Saxony Saxony Hesse

Votes held by CDU/CSU-FDP coalition government
CDU/FDP CDU/FDP CSU/FDP CDU/FDP CDU/FDP CDU/FDP CDU/Greens CDU/FDP/Greens SPD/CDU CDU/SPD CDU/SPD CDU/SPD SPD SPD/Left party SPD/Left party SPD/Green
4 6 6 6 4 5
31
Q3 2014 March 2011 Q3 2013 Q1 2013 Q3 2014 Q1 2014 Q1 2012 Q3 2014 Q3 2011 Q3 2014 March 2011 Q2 2015 March 2011 Q3 2011 Q3 2014 Q2 2011
Hamburg Saarland Mecklenburg-Western Pomerania Thuringia Saxony-Anhalt North Rhine-Westphalia*

Potentially abstaining votes
3 3 3 4 4 6
23
Rhineland-Palatinate Berlin Brandenburg Bremen

Votes held by opposition Total seats
4 4 4 3
15 69
Note: * Assuming a so-called grand coalition government as at the time of writing, no government had yet been formed. The Bundesrat has a total of 69 seats. Each regional state has a minimum of three seats. States with a population of more than 2mn have four seats; those with more than 6mn five seats and those with more than 7mn six seats. The absolute majority is 35 seats, the two-thirds majority 46 seats. Source: Bundesrat, Landeswahlleiter
Before the respective amendments came into force, approximately 60% of the German laws had to be approved by both the Bundestag and the Bundesrat, the latter representing the Lnder. This system was inherently prone to blockades of important legislation should the lower and upper house be controlled by different parties and thus proved to be a considerable obstacle to all coalition governments not headed by a grand coalition. The new law, which became effective on 1 September 2006, redefines the relationship between the central government and the state states, and reduced the number of laws the Bundesrat can veto to c. 35%. However, laws that affect Lnders expenditures still are subject to approval by the Bundesrat. In exchange for the (part) concession of powers by the states (among them the control of nuclear energy, for example), the central government relinquished powers in areas such as education, environment, the penal system and the civil service. In addition, the responsibility for the salary law covering lnder and municipal employees has been transferred to the lnder.
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Federalism Reform II lies ahead
Furthermore, the federalism reform introduces an element of budgetary discipline for both the central and lnder governments. In the case of any EU sanction payments against Germany attributed to a breach of the stability pact, the central government will cover 65% and the lnder will cover the remaining 35%. However, there has not yet been an agreement on a National Stability Pact, which would be necessary to allocate any necessary budget cutbacks and bear the responsibility for meeting any EU sanction payments. This area, together with modernisation and reform of the prevailing system of financial relations between different government levels, including Germanys financial equalisation system, have been delayed until a second stage (Federalism Reform II). There so far is no timetable for completion.
Lnder economic background

Strong regional differences
As illustrated below, the German lnder strongly differ with respect to their economic weights, prosperity and performance. Whereas lnder such as NRW, Bavaria, and BadenWrttemberg account for 50.2% of the German population and 53.9% of GDP in 2009, lnder such as Brandenburg, Bremen, Mecklenburg Western-Pomerania, Saarland, SaxonyAnhalt and Thuringia each account for less than 2.5% of German GDP. At the same time, living standards (measured as per capita GDP) strongly vary. Whereas the per capita GDP amounts to almost 50,000 in Hamburg, it stands at less than half, ie, 21,300 in neighbouring Mecklenburg-Western Pomerania (Figure 185).
Figure 185: Key figures of German lnder, 2009

In % of total size of Germany Population in % of 2009 total Share in Total GDP (%) GDP per GDP per capita rel to German Real GDP capita (000) average growth (%)
Population (mn)
Nominal GDP (bn)
Baden-Wrttemberg Bavaria Berlin Brandenburg Bremen Hamburg Hessen Mecklenburg-Western Pomerania Lower Saxony North Rhine-Westphalia Rhineland-Palatinate Saarland Saxony Saxony-Anhalt Schleswig-Holstein Thuringia Germany
Source: National sources, Barclays Capital
10.0 19.8 0.2 8.3 0.1 0.2 5.9 6.5 13.3 9.5 5.6 0.7 5.2 5.7 4.4 4.5 100
10.8 12.5 3.4 2.5 0.7 1.8 6.1 1.7 8.0 18.0 4.0 1.0 4.2 2.4 2.8 2.3 82.1
13.1% 15.2% 4.2% 3.1% 0.8% 2.2% 7.4% 2.0% 9.7% 21.9% 4.9% 1.3% 5.1% 2.9% 3.5% 2.8% 100.0%
343.7 429.9 90.1 53.9 26.8 85.8 216.5 35.2 205.6 521.8 102.5 28.9 92.9 51.5 73.4 48.9 2407.2
14.3% 17.9% 3.7% 2.2% 1.1% 3.6% 9.0% 1.5% 8.5% 21.7% 4.3% 1.2% 3.9% 2.1% 3.0% 2.0%
31.9 34.4 26.3 21.4 40.5 48.2 35.7 21.3 25.8 29.2 25.5 28.1 22.2 21.7 25.9 21.7 29.4
108.8% 117.0% 89.3% 72.8% 137.8% 164.0% 121.5% 72.3% 88.0% 99.2% 86.8% 95.7% 75.6% 73.9% 88.2% 73.6% 100.0%
-5.8 -3.4 1.7 -0.9 -2.5 -2.0 -2.2 -1.3 -3.5 -4.7 -3.6 -7.1 -2.2 -4.2 -0.7 -3.0 -3.5
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State finances background

Practical constraints on fiscal flexibility
Under the German constitution, the 16 states have budgetary autonomy, in principle. However, as with political autonomy, fiscal flexibility also has its limits. First, tax revenues are determined largely by the relatively rigid structure under which the central government sets rates (albeit with state influence via the Bundesrat) and the apportionment of revenues (except for the VAT) is set by the constitution. Second, the operation of the Financial Equalisation System is intended to minimise the differences in resources available to different states, although amendments introduced in 2005 have widened the range of outcomes for individual states. Third, short-term discretionary control of expenditure has also been limited, given the extent to which expenditure obligations have been determined by nationally dictated standards of service provision and wage agreements, although the implementation of Federalism Reform I has increased lnder autonomy, notably with respect to wages and salaries.
The German Financial Equalisation Scheme

Taxes account for about three quarters of lnder revenues
Tax revenues usually account for 70-75% of the lnders total revenues. The other main sources of revenues include current and capital transfers from the federal budget and various other own revenues, such as fees. The lnder are responsible for the collection of both federal and state taxes, which fall into four categories: Shared taxes, which are apportioned among federal, state and municipal governments, according to various pre-determined percentage allocations (notably income and sales taxes). Taxes allocated solely to the federal government (notably duties on mineral oil and tobacco). Taxes allocated entirely to the lnder (notably motor vehicle and inheritance taxes). Taxes allocated solely to municipalities.
Shared taxes account for c.70% of all tax revenues
In 2009, shared taxes (for which rates are centrally set) represented the largest portion of the tax system, accounting for c.70% of the total. The lnders own taxes represented a low c.3% of total tax revenues in 2009 and, on our projections, are unlikely to change over the course of the years ahead. Instead, the council of German tax surveyors (Arbeitskreis Steuerschtzung) expects their weight to decline to c.2.25% in 2010. Shared revenues are distributed between the levels of government and among the lnder through a four-stage sequence of vertical and horizontal apportionment and equalisation, which can be summarised as follows: Vertical apportionment or distribution. Rates for all shared taxes and their apportionment among the different levels of government are largely pre-determined or decided centrally. For income taxes, the shares allocated to the various levels of government are laid down in the constitution. The apportionment of sales taxes is subject to federal legislation and has varied over the past few years as part of a negotiation between the central and state governments on the overall mix of burden sharing. Horizontal distribution of lnder share of revenues. In part, this is related to population and/or shares of revenue actually collected in each state, but there is also an element of redistribution (or equalisation) of VAT revenues, which increases the tax revenue received by the states that are weaker economically.
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Financial equalisation. This is a horizontal redistribution in which richer lnder contribute funds and weaker lnder receive funds in order to reduce (but not eliminate) imbalances in the financial resources available per inhabitant. Supplementary federal grants. There is a further stage of vertical equalisation in which the federal government makes additional grants to poorer lnder. These may be general grants, designed to further reduce the extent to which a states financial capacity per inhabitant falls short of the national average, or special grants, designed to compensate poorer lnder for special burdens. For example, Eastern lnder and the city-state of Berlin still receive special supplementary grants to assist in building up their comparatively under-developed infrastructure.
Largely equal division of taxes between federal and lnder governments
Following the apportionment of taxes and taking into consideration the use of federal funds to make payments to the EU and the vertical equalisation payments to the lnder, the federal and lnder governments end up with largely comparable shares of tax revenues from which to fund their expenditures. Tax estimates published in May 2010 indicate that c.43% (2009: 44%) of the taxes should be available to the federal government and c.39.5% (2009: 39.5%) to the lnder, in aggregate. In our view, due to this split, lnder generally have a rather limited short-term flexibility with regard to their revenues. The extent to which the cumulative stages of equalisation achieve convergence in the financial resources available to individual states is illustrated below. The advantage of lnder with above-average financial capacity is reduced by the horizontal redistribution, eg, a state that starts with a capacity of 130% of the average will find that reduced to 109%. For all lnder with capacity of less than 99.5% of the average, the process lifts them towards the average. For example, for a state that starts with 80% of the average capacity, horizontal equalisation is designed to increase it to 93.5%, and general supplementary grants increase it further to 98% (Figure 188).
Figure 186: Tax type (bn) (lhs) and distribution of revenues after apportionment and vertical equalisation payments (bn) (rhs)
450 400 350 300 250 200 150 100 50 0 Shared Taxes 2005 Purely federal* 2006 Purely Lnder Municipalities 2007 2008 2009 (f)
0 Federal 2005 Laender 2006 Municipalities 2007 2008 EU 2009 (f) 100 50 150 250 200 300
Note: Based on May 2010 tax estimates. Source: German Ministry of Finance, Arbeitskreis Steuerschtzung, Barclays Capital
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Figure 187: Effect of financial equalisation on financial capacity per inhabitant (as % of the average financial capacity per inhabitant)
Financial capacity per inhabitant before Financial Equalisation Financial capacity Financial capacity per per inhabitant inhabitant after Financial after Financial Equalisation Equalisation among the lnder and among the lnder general supplementary grants
70 80 90 100 110 120 130

Source: German Ministry of Finance
91 95 98 100 104.5 106.5 109
97.5 98 98.5
Notwithstanding the redistribution of revenues according to the German Financial Equalisation Scheme, the diversity in economic resources across German lnder is strongly reflected in substantial divergences with respect to the individual public finances. This becomes particularly evident when comparing public sector expenditure of east (c. 20% of GDP) and west German (10%) lnder.
The German Financial Equalisation System
The German Financial Equalisation Scheme is geared toward achieving a convergence in the financial resources available to the states. Specifically, it seeks to reduce the differentials in financial strength, defined with respect to total revenues per capita available to regional governments. It does not take into account the differing expenditure needs that can go along with varying starting levels in terms of regional living standards. The scheme was never designed to ensure equality in terms of public finances. This is underpinned by the continuing divergence in public finance and debt indicators. Still, the scheme is generally understood to be a major source of credit protection for the regional governments of the economically weaker parts of the country, although rating agencies take differing views as to just how much support this entails). The flipside to this, however, has been to limit the potential upside revenue for stronger economic regions, which, in turn, has limited their incentive to optimise revenue generation. The amendments introduced in 2005 leave the system continuing to provide a large part of the redistribution and, hence, credit support of the existing scheme, although there has been a shift in the balance towards limiting the redistributive effect and increasing the incentive to optimise revenues.
Credit ratings
Only Bavaria is rated Aaa/AAA/AAA
In contrast to Moodys and S&P, Fitch applies an AAA rating to all German lnder, thereby reflecting the pre-eminence it assigns to the credit support provided by the Financial Equalisation Scheme and the concept of the solidarity principle, under which all 16 members of the German federation are deemed to be jointly responsible for supporting a state in financial distress. S&P and Moodys take the view that the equalisation scheme and solidarity principle provide substantial credit support, but still allow for some differentiation with regards to the credit quality. In the case of Moodys, the introduction of Joint-Default Analysis (JDA) to European regional and local governments in December 2006, resulted in an upward convergence in its ratings of the lnder, with all sub-Aaa ratings being upgraded to Aa1. Whereas NRW and Brandenburg were upgraded from Aa2, Berlin and Saxony-Anhalt were upgraded from Aa3. These changes do not reflect any change in the stand-alone assessments of the individual
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states, but rather the more explicit, and thus heavier weighting given to the probability of support from the Federal Republic. Moodys assigns a probability of 95% to this support being given. In effect, this is the highest probability Moodys can apply within its framework, unless the provision of support is enshrined in a legal statute.
Apparent floor of AA- for states rated by S&P
S&P, in contrast, continues to maintain a slightly wider range of credit assessments. Still, the importance of the mutual support obligations between the lnder and the federal government are recognised in the apparent floor of AA- for the states rated by S&P. The latter has further indicated that it believes that the increasing flexibility for lnder governments as a result of Federalism Reform could lead to greater differentiation in rating levels in the long term.
Figure 188: Issuer ratings

Moody's West German states S&P Fitch
Baden-Wrttemberg Bavaria Berlin Bremen Hamburg Hesse Lower-Saxony North Rhine-Westphalia Rhineland-Palatinate Saarland Schleswig-Holstein
East German states
Aaa Aaa Aa1 Aa1 -
AA+ AAA AAAA AA-
AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA
Brandenburg Mecklenburg-Western Pomerania Saxony Saxony-Anhalt Thuringia Federal government

Source: Rating agencies
Aa1 Aa1 Aaa
AA+ AAAAA
AAA AAA AAA AAA AAA AAA
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CANADIAN MARKET
Overview
Latest new issuance dates back to September 2008
Despite the marked improvement in the primary and secondary covered bonds market over the course of 2009, the issuance of Canadian EUR-denominated benchmark covered bonds stalled. At the time of writing, the nominal amount outstanding totalled a modest 6.25bn from four covered bonds by three different issuers. Irrespective of the sound growth recorded in 2008, when three benchmark deals with an aggregate amount of 4.25bn were issued, in terms of volume, the Canadian benchmark covered bond market still ranks among the smaller ones as a result of the current absence of any new issuance. Yet, whereas the last EUR-denominated benchmark covered bond was issued in September 2009, as of late, issuance has resumed in the USD and CAD space with both the Canadian Imperial Bank of Commerce (CM)54, the Royal Bank of Canada (RY), and the Bank of Montreal (BMO) tapping the respective markets.
Figure 189: EUR-denominated benchmark Canadian covered bonds outstanding

Issuance date Issuer Maturity ISIN Coupon (%) Size (bn) Mid-swap spread (bp) At launch As at 28 May 2010
2 Sep 2008 23 Oct 2007 16 Jan 2008 9 Jan 2008
CM RY BMO RY
Sep 2010 May 2012 Jan 2013 Jan 2018
XS0386792286 XS0328142715 XS0341749116 XS0340256147
5.250 4.500 4.250 4.625
2.00 2.00 1.00 1.25
+52 +10 +24 +20
0 +27 +36 +58
With an aggregate EUR-denominated benchmark covered bond issuance of 3.25bn at the time of writing, which corresponds to slightly more than half the entire markets volume, the Royal Bank of Canada (RY) is the largest player in the Canadian market, followed by the Canadian Imperial Bank of Commerce (CM) with 2bn, and the Bank of Montreal (BMO) with 1bn. Whereas the Royal Bank of Canada (RY) set up a 15bn programme, the Bank of Montreal established a 7bn covered bond programme. With the Bank of Nova Scotia (BNS) and Toronto-Dominion Bank (TD), Canadas second-largest bank, we believe two more well-suited candidates for issuing covered bonds could tap the market. Figure 190: Swap spread development
200 150 100 50 1 0 -50 Mar-08 ASW (bp)
Figure 191: Redemption profile

EUR bn 2
Mar-09 CM 5.250% Sep 10 BMO 4.250% Jan 13
Mar-10 RY 4.500% Nov 12 RY 4.625% Jan 18 0 10 11 12 13 14 15 16 17 18
Source Barclays Capital
Source Barclays Capital
54
For more detailed information on the respective issuers, please refer to the Profiles section of this publication.
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Outstanding covered bonds not to exceed 4% of total assets
As a Canadian particularity, the Office of the Superintendent of Financial Institutions (OSFI) on 27 June 2007, decided to limit the issuance of covered bonds to a maximum of 4% of a Deposit Taking Institutions (DTI) total assets to balance the benefits and concerns associated with the issuance of covered bonds. In case of the 4% limit being breached, the DTI must immediately notify the OSFI and provide a plan showing how the excess will be eliminated. Note that this came after the OSFI had announced that it expected all Canadian DTIs to refrain from issuing covered bonds until regulatory and policy concerns had been resolved on 27 February 2007. The reason then stated was that a preferred class of depositors would be created. However, on 27 June 2007, OSFI retracted this request 55. An initial review had concluded that debt obligations issued by a DTI and secured by assets of the institution presented both benefits and potential concerns. On 4 March 2010, the Canadian government said it would introduce legislation setting out a framework for covered bonds in a bid to provide financial institutions with a wider variety of funding sources, claiming that "The legislation will increase legal certainty for investors in these debt instruments, thereby making it easier for Canadian financial institutions to access this low-cost source of funding 56".
Canadian covered bond structure

True sale structure
Within the scope of a generic Canadian covered bond structure (Figure 192), investors have a direct recourse to the issuer, while being protected by a pool of (residential) mortgages that has been segregated and would be managed exclusively for their benefit in the event of distress. The proceeds raised through the issuance of covered bonds are on-lent through an inter-company loan to a so-called guarantor LP, a limited partnership that is legally independent from the issuer. The guarantor LP uses these proceeds to purchase portfolios of mortgages through a true sale transfer from the issuer. The guarantor LP could also sell the mortgage loans. By the time this happens, however, borrowers should have been notified and legal title will have passed to the guarantor LP. It is also worth noting that the programmes can be increased in size by transferring more mortgages to the guarantor LP and issuing more bonds against them subject to meeting stringent tests.
Figure 192: Generic Canadian covered bond transaction structure

Mortgage Loans and Related Securities
Seller
Consideration
Covered Bond Guarantor LP Guarantor LP

Loan Repayment Covered Bond Guarantee and Security Agreements
Interest Rate Swap Provider Covered Bond Swap Provider
Intercompany Loan
Covered Bond Issuer

Covered Bond Proceeds Covered Bonds
Security Trustee
Security under Security Agreements
Covered Bond Holders

55 56
Source: http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/notices/osfi/cvbnds_e.pdf Canada, Budget Report 2010.
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Inter-company loan consists of
The inter-company loan agreement outlined above, which the covered bond issuer will make available to the guarantor LP on an unsecured basis, consists of a revolving demand loan and a guarantee loan in a combined amount that equals the total credit commitment. Consequently, the balance of the demand and guarantee (ie, the inter-company) loan will fluctuate with the issuance and redemption of covered bonds. The size of the guarantee (or term) loan corresponds to an amount equal to the balance of the outstanding covered bonds plus the over-collateralisation (OC) as determined by the asset coverage test at any relevant time. According to the Canadian covered bond structures established so far, the amount of overcollateralisation that protects covered bond holders is limited to the asset percentage only. Any excess collateral (ie, any implied over-collateralisation) is merely deposited with the guarantor LP and can be returned to the issuer at any given time. It will also automatically be returned to the issuer in the case of an issuers default. This is accomplished through the demand loan, basically a revolving credit facility, which obliges the guarantor to return the respective funds to the issuer. The volume of the demand loan corresponds to the difference between the balance of the inter-company loan and the guarantee loan and is likely to be exercised by the issuer in conjunction with the issuer pulling its pre-emptive right to purchase the mortgages, effectively transferring the mortgage loans serving as collateral back to the issuer. Among the relative strengths of the Canadian covered bond programmes, in our opinion, are: The collateral assets are separated from the balance sheet at inception of the programme/issuance through a true sale to the guarantor LP. A cash flow adequacy is secured through an asset coverage test and the obligation to neutralise any exposure to interest rate and currency risk. Investors are well protected against liquidity risk, as there is a clear escalation process in the case of a deterioration of the credit profile of participating parties.
a guarantee loan
and a demand loan feature
Strengths
Weaknesses
Among the relative weaknesses of the Canadian covered bond programmes, in our view, are: Compared with other covered bond products and with only three active issuers, there is a lower level of standardisation, yet the basic structure is similar in all programmes. With the inaugural covered bond issue dating back to October 2007 and only four EURdenominated benchmark issues outstanding, the record of banking regulators with regards to the surveillance of Canadian covered bonds is limited. This, however, is mitigated by the fact that the OSFI controls covered bond issuance and volumes and conducts a review process. In the Canadian covered bond programmes hitherto established, the issuer (ie, the bank) also operates as the interest rate swap provider. In the event of deterioration of the credit profile, there is some uncertainty regarding the execution of mitigants.
Qualifying collateral for Canadian covered bonds

Collateral pools contain Canadian residential mortgage loans
Within the scope of the Canadian covered bond programmes established so far, the collateral consists of residential mortgages located in Canada. These can be divided into uninsured and insured mortgage loans. Generally, all mortgage loans with a loan-to-value (LTV) ratio greater than 75% before April 2007 and 80% thereafter are insured. As the
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banks still issue their covered bonds off a structured programme at the time of writing (as opposed to a specific law), geographical restrictions on cover pool assets have been self imposed. However, so far, all covered bond programmes have focused on Canadian mortgage assets exclusively. As outlined in Figure 194, the programmes LTV limits stand at 80%. It is important to note that higher LTV loans can be included in the pool, but loan amounts exceeding the respective cap are not taken into account when calculating the appropriate loan balance within the asset coverage test. Consequently, from an economic point from view, their inclusion in the collateral pool is not feasible. Loans that are in arrears cannot be accounted for. Substitution (non-mortgage) assets can be included in the cover pool up to an aggregate value of 10% of the cover assets.
The ACT ensures an OC level compliant with the issuers target rating
To reduce the risk of a potential shortfall, the Canadian covered bond programmes include a dynamic asset coverage test (ACT) that requires the balance of the mortgages in the collateral pool to significantly exceed the balance of the outstanding covered bonds. Apart from the results of this calculation, a minimum OC level has to be maintained. The level indicated in Figure 194 may be increased if the credit quality of the mortgages in the collateral pool decreases, as determined by quarterly loss severity indicators. Noncompliance with the ACT on a calculation date will prevent the issuer from further issuing covered bonds as long as it is not remedied. If compliance is not re-established by the end of the next calculation period, an issuer event of default would occur and an enforcement notice would be delivered to the guarantor LP. In addition, the asset coverage test imposes minimum OC requirements to mitigate potential negative carry. In the case of a breach, the issuer is obliged to restore the balance by transferring additional loans or providing cash to the guarantor LP. If the breach is not rectified until the following calculation date, the trustee will serve a notice to pay on the guarantor LP. In an issuers event of default, a court might allow depositors with the DTI to set off any losses suffered on their deposits against the amounts they owe to the bank under their residential mortgage loan. Potentially, this creates a risk for covered bond holders regardless of the contractual elements of the deposits and the loans. Yet, according to the rating agencies, most of the loans include clauses that require borrowers to waive their right to set-off for sums owed to them by the DTI, a provision which also holds in the issuers event of default. This set-off risk, however, is further mitigated by the borrowers benefiting from the Canadian deposit insurance scheme, which guarantees up to CAD100k of deposits. Unlike other jurisdictions, the asset coverage test does not incorporate a revaluation of the underlying mortgage loans using indices. This would account for the risk of a house price decline that could negatively affect the value of the underlying mortgages. However, the asset coverage test will give credit only to 80% of the latest valuation of the properties for uninsured mortgages and 90% for insured mortgages 57. Yet, any house price decline will be captured in the assessment of stressed recovery values, which is one of the drivers of the asset percentage. Still, the current Canadian programmes do not include contractual provisions aimed at increasing the amount of assets in the collateral pool following house price decline. This stems from the issuers concerns that there is no widely recognised housing price index in Canada.
Possible set-off risks
Amortisation test
An amortisation test is designed to ensure that the assets will be sufficient to enable the guarantor LP to repay the outstanding covered bonds. It applies only after an issuer event of
RY announced that it will use only uninsured mortgages ie, mortgage loans with an LTV of 80% or less. The BNS collateral pool will comprise only uninsured mortgages. Since Canadian law requires mortgage loans with an LTV of more than 80% to be insured, it can thus be assumed that BNSs collateral pool will consist only of first-lien residential mortgage loans with an LTV of less than 80%.
57
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default has occurred, at which time covered bond holders will be relying on the guarantee. The test will be failed if the amortisation test aggregate loan amount falls below the outstanding notional balance of all the covered bonds.
Regional concentration
As outlined below, the respective collateral pools backing the established Canadian covered bond programmes are biased towards Ontario ie, towards one of the more densely populated regions of Canada, where about 39% (13.1mn) of the countrys entire population of approximately 33.9mn live.
Figure 193: Canadian covered bond programmes regional collateral concentration

% of population Royal Bank Bank of Montreal CIBC Bank of Nova Scotia*
Alberta British Columbia Ontario Quebec
10.9% 13.3% 38.6% 23.2%
13.7% 17.8% 39.6% 15.2%
15.2% 15.5% 43.8% 17.0%
16.1% 23.4% 42.3% 6.9%
13.7% 16.1% 53.6% 6.6%
Note: *Expected. Source: Statistics Canada, investor reports, transaction documents
Note that the regional composition of collateral pools always is subject to adjustments, particularly in the case of the cover pools being increased in preparation of potential further covered bond issues.
Regulatory oversight of assets and asset/liability risk management

Absence of a dedicated legal framework
So far, Canadian covered bond issuers have been DTIs regulated by the OSFI. The covered bond issuer is responsible for the monthly pool monitoring, with the asset coverage test calculation being checked by an independent auditor on an annual basis 58. So far, rating agencies are strongly involved in the individual covered bond programmes and need to reaffirm the ratings of the programme upon each issuance. Based on their respective risk models, the rating agencies also monitor the amount of over-collateralisation required to minimise default and loss exposure. This should provide investors with comfort regarding the credit risk exposure in the case of the mortgage market weakening. The Canadian covered bond programmes established so far feature contractual provisions stipulating that exposure to interest rate and currency risk must be neutralised. Furthermore, downgrade triggers for swap counterparties, maturity extension rules, and the amortisation test all ensure cash flow adequacy. The two current Canadian covered bond programmes feature a soft-bullet maturity. Following the serving of a notice to pay, the guarantor LP may not have sufficient proceeds for a timely repayment of those covered bonds that mature soon after such an event. In this case, the legal final maturity will be extended by 12 months to allow for a realisation of cover assets. Moreover, the programmes include a number of other safeguards. In particular, there are minimum rating requirements for third parties supporting the transaction, including the currency and interest rate swap counterparties as well as the cash manager. Also, independent audits of the asset coverage test calculations are undertaken on a regular basis. If the issuers short-term ratings are downgraded below A-1+ (S&P), Prime-1 (Moodys) or F1 (Fitch), the guarantor LP will be required to establish a reserve fund. The reserve fund is
Strong protection against potential cash-flow mismatches
Maturity extension
Other safeguards
Reserve fund
58
As long as covered bonds remain outstanding, the guarantor LP must ensure that monthly, on each calculation date, the adjusted aggregate loan amount will be at least equal to the aggregate outstanding of the covered bonds.
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established to trap available revenue receipts from the cover pool up to an amount sufficient to cover one months interest plus all senior expenses, servicing fees, and swap payments due on the next payment date. The respective amount will be retained in a GIC account. If there is a subsequent issuer event of default, the contents of the reserve fund will form part of available revenue receipts to be used by the guarantor LP to meet its obligations under the covered bond guarantee.
Bankruptcy remoteness and payment in case of insolvency

The payments under the covered bonds are further guaranteed by the guarantor LP following an issuer event of default. The guarantor LP is reliant on the proceeds derived from the assets it holds to make these payments. If these proceeds were insufficient to meet the obligations to bondholders in full, investors would still have an unsecured claim against the issuer and group guarantors for the shortfall. There are a number of trigger events in the covered bond structure, the first being an issuer event of default. This can occur in a number of situations, including: An issuers failure to pay any interest or principal due on the covered bonds of any series for more than 30 days An issuers failure on any other obligation under the covered bonds for more than 30 days Bankruptcy, appointment of a liquidator or the OSFI taking control of the issuer or its assets; or Failure to rectify any breach of the asset coverage test
No acceleration until guarantor LP defaults
An issuer event of default would not accelerate payments by the guarantor LP to covered bondholders, but would allow the security trustee to serve an issuer acceleration notice, which would result in a notice to pay being served on the guarantor LP. The second event of default is the guarantor LP event of default which comprises: The guarantor LPs default for a period of seven days or more on any guaranteed amounts due The guarantor LPs default for a period of 30 days or more on any other covered bond obligation Liquidation or insolvency of the guarantor LP; or Failure to satisfy the amortisation test on any calculation date Any such event would cause the acceleration of payments by the guarantor LP to covered bond holders and their redemption at the early redemption amount relevant to that particular covered bond. Cover assets need to be sold as quickly as practicable to meet covered bond payments.
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Figure 194: Overview Canadian covered bond programmes

Royal Bank of Canada Bank of Montreal CIBC Bank of Nova Scotia*
Programme volume LTV cap (uninsured/insured)** House Price Index Asset percentage applied in ACT Minimum over-collateralisation Maximum substitute assets In arrears accounting Hard bullet Asset monitor
EUR15bn 80%/tbd Not applicable 93.0% 107.5% 10% No recognition No, 12 months maturity extension Deloitte & Touche
EUR7bn 80%/90% Not applicable 94.5% 105.8% 10% No recognition No, 12 months maturity extension KPMG
EUR8bn Not applicable 94.0% 106.4% No recognition No, 12 months maturity extension
USD15bn 80% Not applicable 94.5% 105.8% 10% No recognition No, 12 months maturity extension tbd
Note: *Expected; ** Generally, the cut-off rate for uninsured loans is 80%. In the case on insured loans, the cut-off rate amounts to 90% in the case of BMO and still needs to be determined in the case of RY. Source: Transaction documents
The Canadian housing and mortgage market

Housing starts to recover in 2010
Following a phase of pronounced growth between 1996 and 2006, the number of housing starts in Canada experienced a sharp contraction in 2009. Whereas in 2007, a total of 228,242 units were built, the respective volumes declined to 211,056 units in 2008, before plummeting to 160,250 units in 2009. In light of the since improved economic situation with our GDP forecasts pointing towards a recovery of 3.4% y/y in 2010 from a 2.6% y/y contraction in 2009 and the currently benign interest rate environment, we expect housing starts to increase to 171,250 units in 2010 and to 175,150 units in 2011 59. More precisely, in light of a high degree of economic uncertainty, estimates on behalf of the Canadian Housing and Mortgage Corporation (CHMC) indicate a range in the number of housing starts from 152,000 to 189,300 units in 2010 and from 156,400 to 205,600 units in 2011. Despite this (moderate) recovery, the number of housing starts remains markedly below those observed in between 2002 and 2006 and currently is on the levels last observed in 2001 (Figure 195). Among the factors that we expect to be supportive for the (modest) increase in housing starts in the years ahead is the currently benign interest rate environment in Canada, where the applicable mortgage rates have fallen to a multi-year low in 2009. Whereas the applicable oneyear mortgage rate, for example, stood at 3.7% in 2009, down from 6.7% in 2008, the threeyear mortgage rate had fallen to 4.4% from 7.1%. The applicable five-year mortgage rate stood at 5.6% in 2009, from 7.1% in 2008. Despite this development, estimates on behalf of the CHMC point towards a steady increase in the years ahead consistent with a gradual removal of the monetary stimulus by the Bank of Canada. Following a series of rate cuts, by early 2009, the Bank of Canadas target for the overnight rate stood at 0.25%, a level it has since stood stable on. In light of the current economic situation, the Bank of Canada has committed itself to keeping this rate at 0.25% through mid-2010 unless inflationary pressures justify an increase. According to the CMCH, the posted one-year mortgage rate is expected to be in a range between 3.7% and 4.3%, while three- and five-year posted mortgage rates are forecasted to be in the 4.4-6.0% range, respectively. For 2011, estimates for the posted oneyear mortgage rate point towards a range of 4.7-5.5%, with the three- and five-year posted mortgage rates forecast to be in the 5.1-6.7% range, respectively. Further adding to the better affordability of housing in Canada of late is the increasing number of mortgage products, as well as the price competitiveness attributed to the greater weight of other than the classical mortgage lenders (ie, chartered banks).
Benign interest rate environment
59
Source: CMHC, Housing Market Outlook Q1 2010.
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Figure 195: Canadian housing indicators

Housing starts and completions Average mortgage lending rates
250 225
tsd
15
12 200 175 150 6 125 100 1990 1993 1996 1999 2002 2005 2008 2011 Housing starts Completed dwellings 3 1990 1994 1yr
Source: Bank of Canada, Barclays Capital
1998
2002 3yr
2006
2010 5yr
2014
Note: From 2010 onwards: expected. Source: Canadian Mortgage and Housing Corporation (CMHC), Canadian Real Estate Association (CREA), Statistics Canada, Barclays Capital
Housing and Consumer Price Index
Canadian interest rate environment

5 4 3 %
12
2 1 0 Jan-07
-4 1992 1996 2000 2004 2008 Housing price index (y/y change in %) Consumer price index (y/y change in %)
Source: CMHC, Statistics Canada, Barclays Capital
Jan-08
Jan-09
Jan-10
Overnight repo rate (CORRA) Bankers' acceptances - 1mth

Structure of mortgage lending
Growth in mortgage lending
1,000
1,000 900 800
15
800
600 700 400 600
10
200 Jan-04 Jan-05 Jan-06
Jan-07 Jan-08 Jan-09 Jan-10
5 500 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Residential mortgage lending (CAD bn) y/y change (%, RHS)
Total residential mortgage lending (CAD bn) Residential mortgage credit (chartered banks)
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Mortgage lending gradually slows
Overall, residential mortgage lending in Canada amounted to an aggregate CAD966.4bn as at end-January 2010, the latest date for which date were available. This corresponds to a 6.8% y/y increase from CAD905.0bn a year before. Of the total residential mortgage lending, CAD468.3bn (or 49%) corresponded to mortgage loans granted by chartered banks whose lending was up 3.8% y/y. Since early 2009, residential mortgage lending on behalf of chartered banks has developed more modestly than the overall market, thereby implying the increasing importance of other lenders in the Canadian mortgage market. Overall, with a share of approximately two-thirds (of which roughly half have a mortgage loan), Canada features a comparatively high home-ownership ratio. Among the peculiarities of the Canadian residential mortgage market is the so-called mortgage insurance, which is available for Canadian residential mortgage lenders. There are several mortgage providers in the Canadian market, the largest being CMHC, which, as an agent of the Canadian government, benefits from a long-term issuer rating of Aaa. Mortgage insurance generally covers the entire balance of the mortgage until it matures or is fully repaid. Residential mortgage insurance policies also cover foreclosure costs (subject to a limit) and in most cases up to 18 months of interest on the mortgage 60. Another factor that traditionally is supportive for the Canadian housing market is (net) immigration, which amounted to 278,000 in 2009. The CMHC expects this figure to gradually increase to 280,150 in 2010 and to 290,900 in 2011 and this is likely to have a positive impact on the (rental) market.
Conclusion
Following a phase of weakness in 2009, the Canadian housing and mortgage market seems poised for a recovery in 2010, with housing starts pointing upwards given a benign interest rate environment. Despite falling to an average annual growth rate of c. 6% y/y in early 2009 and not recovering since, the growth in mortgage lending remains intact, thereby providing Canadian banks with a potentially large collateral pool for the issuance of covered bonds. Regardless of the current rather favourable conditions in the market, issuance of EURdenominated, benchmark Canadian covered bonds might be postponed until a dedicated covered bond legislation is set out as envisaged in Canadas Budget Report 2010.
60
Source : CMHC, 2010.
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Canada
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching
Canadian structured covered bonds. Private legal structure based on Canadian common and contract law. No; any Canadian bank. Not applicable. Cover assets are segregated through the transfer to a separate entity (Guarantor LP). Under the currently established covered bond programmes, this is a limited partnership or LP. Hedge positions are part of the structural enhancements intended to protect bondholders. Up to 10% in the existing covered bond programmes. In the current programmes, the collateral consists of first lien residential uninsured Canadian mortgage loans. Subject to contractual prescriptions. Subject to contractual prescriptions (under current programmes, only Canadian mortgages are included in the respective collateral pools). Subject to contractual prescriptions. Not applicable. No. Basis = market value. Subject to bank-internal procedures. Yes; Office of the Superintendent of Financial Institutions (OSFI) and an independent trustee. Within all Canadian covered bond programmes, there are contractual provisions stipulating that exposure to interest rate and currency risk has to be neutralised. In addition, downgrade triggers for swap counterparties, maturity extension rules and the amortisation test ensure cash flow adequacy. Yes; defined by asset coverage test. Yes; stipulated through contractual rules. Yes; subject to the asset percentage applied in the asset coverage test. No. The technically implied over-collateralisation is not protected. No, but all assets are ring-fenced within a specially separated entity. The nominal amount of covered bonds outstanding cannot exceed 4% of the deposit taking institutions total assets. all the payments received from the special entity's assets. These payments are collected in a GIC account. Investors continue to receive scheduled payments, as if the issuer had not defaulted. In the event of insufficient pool assets proceeds to cover their claim, investors rank pari passu with senior debt holders. There is a simultaneous unsecured dual claim against the issuer and secured against the portfolio held by the specially separated entity. No. No.
Protection against credit risk Protection against operative risk Mandatory over-collateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms
Compliance with UCITS 22(4) Compliance with CRD

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DANISH MARKET
Overview
With only one issuer being active and five EUR-denominated benchmark covered bonds or Srligt Dkkede Obligationer (SDO) in the aggregate amount of 6.25bn issued at the time of writing, the Danish market, in terms of EUR-denominated papers, ranks among the smaller ones in Europe. Potential covered bond issuers therefore have ample room to move towards the issuance of EUR-denominated covered bonds, particularly as Denmark has the worlds largest per-capita mortgage market. Still, in our view, issuers are only inclined to tap the EUR market if they seek to diversify their funding basis or can realise marked funding advantages. It is therefore of little surprise that the collateral pool backing the hitherto issued EUR-denominated benchmark covered bonds are backed by residential property located in Norway and Sweden, exclusively. Mortgage loans granted on Danish property are nearly exclusively being refinanced through the issuance of a new, or the tapping of an existing, domestic mortgage-backed bond, the socalled Realkreditobligationer (RO). As the RO, in its current form, does not satisfy the CRD requirements, Finanstilsynet, the Danish Financial Supervisory Authority, in December 2006 introduced a law for the implementation of the EU capital requirements directive (CRD) into the Danish covered bond legislation. On 29 May 2007, Folketinget, the Danish Parliament, adopted the respective covered bond legislation. The new law came into effect as of 1 July 2007, thereby giving Denmark one of the more recent covered bond legislations.
Figure 196: Outstanding Danish jumbo covered bonds

Name Size (bn) Launch date Spread at launch asat 28 May
mid swaps (bp)
4.875% DANBNK Jun 2013 3.250% DANBNK Oct 2015 4.500% DANBNK Jul 2016 3.500% DANBNK Apr 2018 4.125% DANBNK Nov 2019
XS0369059216 XS0456413847 XS0437056954 XS0501663099 XS0469000144
1.25 1.25 1.25 1.25 1.25
3 Jun 2008 30 Sep 2009 24 Jun 2009 7 Apr 2010 18 Nov 2009
+20 +45 +120 +56 +63
+30 +35 +51 +49 +59
Note: Covered bonds originally issued by Finnish SAMPO (ticker: DANBNK) are covered in this publications section on Finland. Source: Barclays Capital
Dedicated covered bond legislation

Three different covered bond types
Until 1 July 2007, only specialised Danish mortgage banks could issue mortgage bonds, ie, the so-called ROs. As a result of the new covered bond legislation, however, both mortgage and commercial banks can now issue bonds backed by real estate, provided they have a licence from Finanstilsynet. Whereas commercial banks can issue Srligt Dkkede Obligationer (SDO), ie, covered bonds, Danish mortgage banks can issue ROs and Srligt Dkkede Realkreditobligationer (SDROs), ie, covered mortgage bonds and covered bonds (SDOs). The collateral backing Danish covered bonds has to be issued in line with the asset types listed in the capital requirements directive (CRD). Mortgage banks, however, cannot issue covered bonds backed by collateral from loans granted for the financing of ships. Within the scope of the Danish covered bond legislation, the loan limits and demands for maturity and the repayment profiles of the current mortgage credit legislation need to be maintained. In connection with loans for homes, commercial and mortgage banks can avoid limitations regarding the maturity and repayment profile, provided the loan granted is within a loan limit of 75%.
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The Danish balance principle
Danish mortgage banks traditionally had to comply with the so-called balance sheet principle. When the new SDO legislation was adopted, however, the balance principle was revised. Whereas the specific balance principle typically limits the liquidity risk with the issuer, this is not necessarily the case with a more flexible general balance principle, which does not foresee a strict demand on the permitted variation between the terms of the loans and the bonds. Also, the refinance risk is not necessarily regulated under the general balance principle. So far, Nykredit, Danske Bank, and BRFkredit have decided to follow the general balance principle.
Figure 197: Danish mortgage bond types

SDO SDRO RO
Type CDR-compliant Risk weighting Assets eligible Continuous compliance with LTV requirements
Source: Realkreditraadet, Barclays Capital
Covered bond Yes 10% Loans secured by real estate, exposure to public authorities and exposure to credit institutions Yes
Covered mortgage bond Yes 10% Loans secured by real estate and exposure to public authorities Yes
Mortgage bond No 20% Loans secured by real estate and exposure to public authorities No
Cover pool register
Any commercial bank with a licence to issue covered bonds had to establish and maintain a cover pool register that backs the outstanding covered bonds. In addition to the assets, these registers can include financial instruments. Although mortgage banks do not have to set up a register, they must have a capital centre for issues, as is required for mortgage bonds. The Danish covered bond legislation foresees the continuous compliance with the loan-to-value (LTV) limits on a loan-by-loan basis. If a mortgage bank has to establish an over-collateralisation, it may raise loans to meet the respective limits. Financial instruments linked to the assets also benefit from the preferential status. It is also possible to raise supplementary loans (senior debt) to the continuous LTV compliance, in which senior debt creditors get a secondary secured position in the capital centres (after the bond owners and certain counterparties on financial instruments). Note that the Danish covered bond legislation includes the possibility of joint funding, ie, of several institutions pooling together in order to issue covered bonds in a larger nominal amount.
Regulatory oversight
Regulatory oversight by Finanstilsynet
Oversight of the Danish mortgage banking system is strictly regulated by the Danish banking regulator, Finanstilsynet. The supervision is formally enshrined in both the Danish Financial Services Act and the Danish Mortgage Credit Act (DMCA). According to these regulations, mortgage bonds can be issued exclusively by mortgage banks. These entities are required to maintain a solvency ratio of at least 8% of their risk-weighted assets. Note that in case of a mortgage bank entering into bankruptcy, mortgage bondholders will benefit from a preferential claim. We highlight, however, that since inception of the DMCA in 1850 no such bankruptcy has taken place. Note that Danish mortgage banks need to report to Finanstilsynet on a quarterly basis.

Covered bond holders rank senior to unsecured debtors
In the case of insolvency, there is no acceleration of payments. Operationally, Finanstilsynet will appoint three liquidators (a mortgage bank specialist, a lawyer, and an accountant) to ensure that payments from mortgagors are adequately passed onto the bondholders. If the
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mortgage loans outstanding are insufficient to meet the bondholders claims, they rank senior to all other assets of the bank. Compared with other covered bond legislation, this is a clear improvement because bondholders often rank pari passu with the unsecured debtors should the mortgage pool prove insufficient. Liquidators are also entitled to raise new funds in an attempt to maintain the integrity of the business while insolvency proceedings are being followed.
Historical background
Largest per capita mortgage market
The first Danish mortgage bank, Husejernes Kreditkasse i Kobenhavn, was founded in 1797 to help rebuild Copenhagen after the Great Fire of 1795. In general, the approach followed the manner in which the German mortgage market was created after the Prussian war (1756-1763). Since the 1850s, mortgage banks have taken up a predominant position in the financing of real estate property. Denmark is the largest per capita mortgage market in the world. The Danish Mortgage Credit Act (DMCA) was originally adopted in 1850, in line with the founding of several mortgage associations. Similar to the German Mortgage Bank Act adopted in 1900, the DMCA originally foresaw a maximum LTV of 60%. Under the 1989 DMCA, maximum LTVs nowadays are 80% for owner-occupied homes and 60% for commercial loans. Furthermore, since 1989, several changes have been made to the DMCA in order to make it compliant with EU directives. Also, in August 2000 and June 2003, significant changes were made in an attempt to increase flexibility for the so-called balance principle, the cornerstone of the Danish mortgage market.
A Danish peculiarity: the special balance principle
The Danish special balance principle, which is enshrined in the 1989 DMCA, stipulates that mortgages taken on by a bank have to be passed onto the investor in essentially the same form. This has led to both callable and non-callable mortgage bonds being listed on the Copenhagen Stock Exchange. Market participants planning to borrow (eg, a residential mortgage) tap the existing bonds through the issuing bank, while market participants wishing to redeem their mortgage loans either do so at par (if callable) or buy the loan back below par on the exchange with at least two months notice. Therefore, the mortgage banks predominant revenue stream is a servicing fee of about 50bp of the mortgages nominal amount.
The Danish housing and mortgage banking market

First signs of stabilisation after sharp price correction
Following a steady increase in Danish real estate prices with average prices doubling since 1998, the market became subject to a sharp correction in Q4 06 when prices for owneroccupied flats started falling. With a time lag of approximately three quarters, prices of single family houses and weekend cottages followed this development, albeit at a considerably more muted pace. In light of the number of dwellings completed (and started) as well as the number of building permits sharply contracting in recent months (Figure 201 and Figure 202), the average interest rate for (shorter and longer-dated) mortgage loans declining throughout 2009 (Figure 203), and the average disposable income slightly increasing, we observed the first signs of a stabilisation in housing prices in Q2 and Q3 09 (Figure 198). Again, this development was led by owner-occupied flats where cash prices slightly increased. In the case of single family houses and weekend cottages, cash prices stopped falling. On average, Danish house prices had contracted by 10.8% y/y in Q3 09, the latest date for which data were available. Prices for owner-occupied flats had contracted by 12.4% y/y over the course of the same period.
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Figure 198: Danish house price growth (2006 = 100) (in 000)
125 100 75 50 25 0 Mar-92 Mar-95 Mar-98 Mar-01 Mar-04 Mar-07 Mar-10 One-family houses Owner-occupied flats
Source: Statistics Denmark, Barclays Capital
Figure 199: Net Danish mortgage lending (monthly in DKKbn)

25
15
Weekend cottages
-5 Jan-94
Jan-98
Jan-02
Jan-06
Jan-10
Source: Realkreditrdet, Statistics Denmark, Barclays Capital
Figure 200: Property transactions (quarterly in 000)

40
Figure 201: Building permits (monthly in 000, nsa)

5
30
3 20 2 10
0 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09

0 Jan-94
Jan-98
Jan-02
Jan-06
Jan-10
Figure 202: New buildings (monthly in 000 sa)

5 4 3
Figure 203: Interest rates on DKK mortgage loans (%)

8
4 2 2 1 0 Jan-94 0 Jan-03 Jan-98 Started Jan-02 Jan-06 Jan-10 Completed < 1yr
Jan-05 1yr - 5yrs
Jan-07
Jan-09 > 10yrs
5yrs - 10yrs
Source: Danmarks Nationalbank, Statistics Denmark, Barclays Capital
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Recovery still lacks sustainable momentum
As the volumes of monthly net mortgage lending still are declining, however, we remain cautious as to whether the stabilisation in house price growth already signals a broad-based recovery (Figure 199). Adding to this uncertainty is macroeconomic data, which point towards an ongoing rise in unemployment figures and the potential risk of increasing interest rates once Danmarks Nationalbank swings into a hiking cycle. The concerns are also supported by more recent data, which show that the number of property transactions in Denmark remain on relatively low levels despite a light recovery in Q2 09, the latest date for which data were available. In Q2 09, the number of property transactions increased to 18,552 units from 14,189 units in Q1 09. Still, in Q2 08, the respective figure amounted to 26,491 units (Figure 202). According to data from the Association of Danish Mortgage Banks, this upward trend continued in Q3 09, when turnover in single-family houses was down c.13% y/y, whereas the number of transactions in owner-occupied flats had increased by nearly 15% y/y 61. Nonetheless, the time that flats which have been put up for sale remain on the market is high, despite a stabilisation at just under eight months for both house and owner-occupied flats. Demand thus seems to be the crucial factor for a sustainable recovery of the Danish housing market. As at end-January 2010, the latest date for which data were available, total domestic lending (excluding loans to MFIs by Danish mortgage institutions amounted to DKK2,285bn, up 4.9% y/y from DKK2,178bn a year before 62. Approximately 60% of the loans granted were raised on owner-occupied flats and second homes, which together account for circa 75% of the total loan volume. Whereas roughly 55% of all mortgage loans granted are subject to a fixed interest rate, floating rate products, which have become increasingly less popular as of late, account for the remaining 45%. The Danish mortgage market is controlled by five players. All of these entities are specialpurpose banks whose assets exclusively consist of mortgage loans and reserves and which need to be funded through the issuance of mortgage bonds and equity. At least 60% of the reserves have to be invested in alternative instruments of higher quality and liquidity than mortgage bonds. As in the years before, the market is dominated by Nykredit Realkredit whose market share increased to 55.9% of net new lending in 2009, from 40.7% in 2008 63. The institutions gross new residential lending amounted to DKK164bn in 2009, up from DKK112bn in 2008, thereby corresponding to a market share of Danish residential mortgage lending of 48.9%, ie, slightly up from 47.4% in 2008 64. The second-largest lender, Realkredit Danmark, which is the Danske Bank Group's mortgage finance specialist, benefited from a market share (including repo loans) of 28.2% as at year-end 2009, slightly down from 30.5% a year before 65. Market shares of domestic rivals such as Nordea Kredit, which slightly increased to 12.9% in Q4 09 from 12.6% in Q4 08, BRFkredit, which fell to 8.5% in 2009, from 9.3% in 2008, or DLR Kredit, which stood largely stable at 5.7% in 2009, from 5.8% in 2008, were at markedly lower levels (Figure 204).
Modest increase in mortgage lending
Market controlled by five mortgage institutions
61 62
Source: Danmarks Nationalbank, Monetary Review, Q4 2009. Source: Statistics Denmark. 63 Following the acquisition of Totalkredit in 2003, Nykredit Realkredit became the largest Danish mortgage lender. 64 Source: Nykredit, Annual Report 2009. 65 Source: Danske Bank, Annual Report 2009.
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Figure 204: Danish mortgage lenders

Name Market share* Rating Lending activities
Nykredit Realkredit
55.9%
Aaa**
After the acquisition of Totalkredit, a Danish mortgage bank, Nykredit became the largest mortgage bank in Denmark, being active in all lending activities Realkredit Danmark specialises in mortgage lending secured by residential, commercial, agricultural or industrial properties. The entity, which dates back to 1851, is part of the Danske Bank Group. All property categories except for some types of publicly-subsidised building projects. Nordea Kredit, which was formed in 1993, is part of the Nordea Group. BRFkredit offers mortgage loans against a mortgage on owner-occupied homes, commercial properties, and subsidised housing. In the corporate lending segment, BRFkredit focuses on loans for office and business properties and for private rental and cooperative housing. Loans for owneroccupied homes accounted for 44% of all lending as at year-end 2009. BRFkredit dates back to 1797. DLR Kredit focuses on mortgage loans for the financing of commercial properties (agricultural properties and urban trade properties private rental housing, co-operative housing, office and business premises, manufacturing and manual industries and social housing).
Realkredit Danmark
28.2%
Aaa
Nordea Kredit
12.9%
Aaa
BRFkredit
8.5%
Aa1***
DLR Kredit
5.7%
Aa1
Note: * Company information, **Aa1 for older series, ***Aa2 for older series. Source: Company information, Barclays Capital
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Denmark (Realkreditobligationer)
Realkreditobligationer Law enshrined in 1850, modified in 1970, 1989, 2001, and 2003 Yes. new mortgage institutions All types of mortgage lending as well as some ancillary activities Cover assets remain on the balance sheet and can be allocated to a specific series, which serves as coverage for outstanding bonds, either mutually or on a stand-alone basis Hedge positions cannot be included in the asset pool, but the so-called balance sheet principle provides a protection against mismatching Up to 2% substitute collateral may be used temporarily No
Not applicable No legal limitations, but the issuers strategy is focused on domestic business 80% (60% for secondary residences; 84% for subsidised housing facilities with a public sector guarantee for 65-84%) 60% for industrial and commercial real estate; 70% for agricultural mortgage loans and 40% for other types of real estate, including greenfield land No. The "amount that a professional purchaser is assumed to be prepared to pay". Annual examination Yes. Finanstilsynet the Danish banking regulator We believe the protection against mismatching is rather strict. The so-called special balance principle strongly restricts market and liquidity risk. Also, borrowers must compensate bondholders for early asset repayment. No. Neither a back-up servicer nor a cover pool administrator is stipulated No Yes No, but the assets within the cover pool are exempt from bankruptcy proceedings All mortgages In the event of insufficient pool assets proceeds to cover their claim, mortgage bond investors rank ahead of senior debt holders. In addition, shareholders may extend some other form of support (eg, guaranteeing the top slice of the mortgage loans) No No. As no preferential treatment as defined by CRD
Protection against credit risk Protection against operative risk Mandatory over-collateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on: External support mechanisms
UCITS Art. 22 par. 4 compliant? CRD Annex VI, Part 1, 65 compliant?

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Denmark (Srligt Dkkede Realkreditobligationer, Srligt Dkkede Obligationer)
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities Asset allocation
Srligt Dkkede Realkreditobligationer (SDRO), Srligt Dkkede Obligationer (SDO) Law enshrined in 1850, modified in 1970, 1989, 2001, 2003, and 2006/07 SDRO: mortgage banks. SDO: universal and mortgage banks as well as ship financing institutions after being licensed by Finanstilsynet the Danish banking regulator SDRO: All types of mortgage lending as well as some ancillary activities. SDO: no Universal banks are required to register assets that serve as collateral for covered bonds in a separate cover pool. In the case of mortgage banks, cover assets remain on the balance sheet and have to be allocated to a specific series. Hedge positions cannot be included in the asset pool, but the so-called balance sheet principle provides a protection against mismatching Up to 2% substitute collateral may be used temporarily No
Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential
Not applicable No legal limitations, but the issuers strategy is focused on domestic business 80% for residential mortgages with maximum maturity of 30 years and maximum interest-only period of 10 years; 70% (75% from 2009) for residential mortgage loans with longer maturity and/or interest only periods; 60% for secondary residences; 84% for subsidised housing facilities with a public sector guarantee for 65-84%) 60% for industrial and commercial real estate (may be raised to 70% under certain conditions); 70% for agricultural mortgage loans and 40% for other types of real estate, including undeveloped land Market value Annual examination Yes. Finanstilsynet the Danish banking regulator We believe the protection against mismatching is very strict. The so-called general balance principle restricts market and liquidity risk No. Neither a back-up servicer nor a cover pool administrator is stipulated No Yes No, but the assets within the cover pool are exempt from bankruptcy proceedings All mortgages In the event of insufficient pool assets proceeds to cover their claim, mortgage bond investors rank ahead of senior debt holders. In addition, shareholders may extend some other form of support (eg, guaranteeing the top slice of the mortgage loans) Yes Yes
LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk Mandatory over-collateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on: External support mechanisms

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PFANDBRIEF MARKET
Jumbo market structure and spread development

Issuance of jumbo Pfandbriefe began in June 1995. Initially, the market grew exponentially and in 2003, a peak of 413bn of outstanding jumbo Pfandbriefe was reached. However, since mid-2004, volumes have decreased persistently. In mid-May 2010, the total volume of outstanding jumbo Pfandbriefe stood at 208bn. At that time, the market consisted of 25 issuers, with a total of 144 issues. The current average size of jumbo Pfandbriefe is 1.5bn. From mid-2007 onwards, swap spreads of jumbo Pfandbriefe started to widen. On the back of low secondary market turnover, the widening trend was relatively constrained until Q3 08. The events surrounding Hypo Real Estate Group in early October led to a significant swap widening and swap spreads reached a peak around mid swaps +100bp in Q1 09. Over the past 12 months the significant tightening move has led swap spreads back down to 20bp. While average spreads between mortgage and public sector Pfandbriefe diverged and widened from 1bp in mid-2007 to a peak of 10bp in September 2008, the trend reversed and in Q1 09 mortgage Pfandbriefe were quoted on average about 5bp tighter. Currently, the spread differential between both types of Pfandbriefe is negligible. Figure 206: Market share, May 2010
MUNHYP 4% BYLAN 5% DGHYP 6% HVB 7% LBBW 8% EURHYP 23% HYPORE 14% WLBANK 4% DEXGRP 4% BHH 5%
Spill-over from the financial market crisis
Figure 205: Development of outstanding volume and avg size

bn 450 400 350 300 250 200 150 100 50 0 95 97 99 01 03 05 07 09 Jumbo Mortgage Pfandbriefe Jumbo Public Pfandbriefe Average size of Jumbo Pfandbriefe (RS) bn 3.6 3.0 2.4 1.8 1.2 0.6 0.0
Other 20%
Figure 207: Spread development

120 100 80 60 40 20 0 -20 99 00 01 02 03 04 05 06 07 08 09 iBoxx Euro Oeffentliche Pfandbriefe ASM iBoxx Euro Hypothekenpfandbriefe ASM
Figure 208: Credit term structure of major issuers, May 2010

Barcap OAS 140 120 100 80 60 40 20 10 0 2009 EURHYP
2012 BHH
2014
2017 HYPORE
2020 HVB
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Background
Four types of Pfandbriefe
Pfandbriefe bonds are German debt instruments backed by either public sector loans (ffentliche Pfandbriefe = Public Sector Pfandbriefe), claims secured by mortgages on real estate (Hypothekenpfandbriefe = Mortgage Pfandbriefe), ship mortgages (Schiffspfandbriefe = Ship Mortgage Pfandbriefe) or aircraft mortgages (Flugzeugpfandbriefe = Aircraft Mortgage Pfandbriefe). Issuance is based on the German Pfandbrief Act, which came into force on 19 July 2005. As of February 2010, there was a total of 705bn of outstanding Pfandbriefe across all four categories, although the vast majority, 472bn, or 67%, consisted of public sector Pfandbriefe. The first Pfandbriefe bonds were issued in 1769 in areas such as Silesia, where Frederick II sought to relieve poverty after the devastating 1756-63 Prussian War. The bonds were backed by landlords property. By 1770, Landschaften were established as public law associations of landowners who, in turn, refinanced these through Hypothekenpfandbriefe bearer bonds. A revival of the collateralised idea took place in the mid-19th century, with the majority of Pfandbriefe bonds issued by public law credit institutions. Soon after this, the direct claims of a bondholder to the mortgaged property were abandoned in favour of the asset pool concept. In 1900, the Mortgage Banking Act (MBA) came into effect. It was the first explicit legal framework for the issuance of Pfandbriefe and it contained a number of important features, such as the protection of cover assets against an insolvency of the issuing bank, the stipulation of eligibility criteria and a special regulatory oversight. Under the MBA, the business activities of Pfandbrief banks were limited to mortgage and public sector lending and the banks were allowed to issue both public sector and mortgage Pfandbriefe. Only socalled mixed mortgage banks had the privilege to follow other business activities as well. In 1927, the Pfandbrief Law (PL) for public sector banks became effective. It gave public sector credit institutions the right to issue public sector and mortgage Pfandbriefe. Compared with the MBA, the provisions of the PL were somewhat less stringent. This was particularly apparent with respect to the lack of supervisory control, the absence of a 60% LTV limit and the lack of strict rules for the application of mortgage lending value principles. The Ship Banking Act (SBA) became effective in 1933. Ship mortgage banks were limited to ship mortgage and public sector lending, and the banks were allowed to issue both public sector and ship mortgage Pfandbriefe. There has been remarkably little change in the different frameworks for Pfandbrief banks. However, with the introduction of the euro and the general opening up of international capital markets in the 1990s, Pfandbrief banks reacted by introducing the jumbo model in 1995. The broadening of the investor base helped Pfandbrief banks to grow their businesses. At the same time, the safety mechanism of the Pfandbrief framework came under scrutiny. This resulted in a series of amendments, which related mainly to the protection of the claims of Pfandbrief investors in an insolvency scenario and stricter rules for asset liability matching. In 2005, the German Pfandbrief legislation was harmonised and the German Pfandbrief Act was introduced. This was driven mainly by two factors. First, the quality of Pfandbriefe had been threatened by the withdrawal of the state guarantees from German Landesbanks and savings banks issued under the PL, due to the legislations weak provisions. The second important factor in the creation of the Pfandbrief Act was the problem of maintaining a different level playing field for mortgage and public sector lending business between pure mortgage banks, mixed mortgage banks, public sector banks and commercial banks
188
Pfandbriefe can be traced back to the 1800s
Mortgage Banking Act became effective in 1900
Pfandbrief Law and Ship Banking Act became effective in 1927 and 1933, respectively
Internationalisation of the Pfandbrief leads to a refinement of the legal framework
Introduction of the German Pfandbrief Act in 2005
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without Pfandbrief privileges. There was no compelling reason to expose the various types of credit institutions to different business restrictions for entering and doing mortgage and public sector business.
Pfandbrief Act triggers a series of strategic decisions
The introduction of the Pfandbrief Act sparked a series of interesting strategic decisions from several issuers. The most obvious of these developments was the integration of specialised mortgage banks into the operations of their parent companies. Elsewhere, WestLB AG announced that it would resume public sector Pfandbrief issuance out of Germany and also Deutsche Kreditbank AG, a member of Bayern LB Group, started issuing public sector Pfandbriefe. More recently, Deutsche Postbank (in 2007), Deutsche Apotheker and rtztebank (in 2008) and Deutsche Bank (2009), all received Pfandbriefbank licences, but with a focus on mortgage Pfandbrief business. The failure of Hypo Real Estate Group in Q3 08 highlighted the limitations of running aggressive liquidity and credit spread risk positions within public sector covered bond programmes. Figure 209 highlights that the non-realised losses of the securities holdings of some German Pfandbriefbanks exceeded the reported equity at YE 09.
Fallout from financial market crisis
Figure 209: 2009 balance sheet data of German Pfandbriefbanks

Reported nonrealised net losses (mn) Tot. Securities holdings (mn) Reported nonSecurities realised net classified as fixed Tot. equity losses in % of assets in % of tot. (mn) tot. equity securities
Name
Tot. assets (mn)
Aareal Bank AG Bayerische Hypo- und Vereisbank AG Berlin Hannoversche Hypothekenbank AG Deutsche Hypothekenbank Hannover AG Deutsche Pfandbriefbank AG Dexia Kommunalbank AG DG Hyp AG Dsseldorfer Hypothekenbank AG Eurohypo AG Muenchener Hypothekenbank eG WL-Bank AG
298 934 82 161 2,461 472 1,280 382 1,858 175 362
14,136 92,022 12,776 12,303 40,921 18,343 26,046 13,425 60,750 6,831 14,603
39,569 309,076 41,291 34,050 272,944 47,291 68,075 24,170 216,312 35,733 43,380
2,077 23,638 789 655 2,491 331 1,426 307 5,654 763 330
14% 4% 10% 25% 99% 143% 90% 124% 33% 23% 110%
53% 24% 44% 95% 92% 76% 100% 98% 71% 94% 89%
Source: 2009 Annual Reports according to German GAAP, Barclays Capital
While in Q4 08/Q1 09 the exposure of Pfandriefbanks to financials was the main factor that led to an increase of non-realised losses, recent spread volatility in sovereign debt markets leads to new concerns. According to the latest available data from the German association of Pfandbriefbanks (vdp), as of 31 December 2009, German Pfandbriefbanks had a combined 87.5bn of exposures to Italy (37.6bn), Spain (25.1bn), Greece (14.1bn), Portugal (7.6bn), and Ireland (3.0bn). These exposures are held inside as well as outside the cover pools of the respective public sector Pfandbriefe and may consist not only of government bonds, but also of exposures to sub-sovereigns. As a breakdown of these data by company is generally not available, we have taken a closer look at the data for the public sector cover pools of selected Pfandbriefbanks. (Figure 210).
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Figure 210: Public sector cover pool exposures of selected German Pfandbriefbanks to Italy, Spain, Greece, Portugal and Ireland (in mn)
Total cover pool GR, PT, IR, SP, IT in % of GR, PT, IR, SP, Reporting total cover IT in % of total date pool equity
Ticker
IT
SP
GR
PT
IR
AARB BHH BYLAN DHH DEXGRP DGHYP DUSHYP EURHYP HVB HYPORE LBW MUNHYP WESTLB WLBANK Total
3,179 12,874 49,368 16,648 36,336 33,468 10,466 66,825 9,762 59,024 72,706 11,664 11,032 25,804
0 228 27 65 637 880 152 35 136 3,718 823 68 100 362
55 250 0 30 334 900 230 131 0 1,980 0 95 170 155 4,330
25 0 0 20 30 50 13 0 0 0 0 23 35 0 196
184 137 424 670 750
89 0 105
31 Dec 09 31 Dec 09 31 Dec 09
11% 5% 1% 13% 10% 26% 13% 5% 2% 26% 3% 4% 6% 8% 10%
17% 78% 3% 321% 1105% 601% 429% 64% 1% 618% 17% 61% 16% 608% 57%
1,319 31 Dec 09 1,909 31 Dec 09
4,883 1,853 31 Dec 09 639 285 30 Sep 09
2,179 1,285 31 Dec 09 50 0 31 Dec 09
2,496 7,194 31 Dec 09 271 164 351 967 832 120 0 589 31 Dec 09 31 Dec 09 31 Dec 09 31 Dec 09 -
419,155 7,231
14,165 15,580
Source: Company data, Barclays Capital
Downturn in public sector Pfandbrief business accelerates
Most public sector Pfandbrief portfolios are basically in a wind-down mode. As a result, the downturn in public sector Pfandbrief business accelerated in the course of 2008. Bundesbank data indicate that the y/y change of listed public sector Pfandbriefe decreased from around -4.5% in mid-2007, to a new historical low of -22.5% in September 2009. In February 2010, the total volume stood at 284bn, down 422bn, or 59.8%, from its peak in August 2000. Figure 212: Listed Pfandbriefe y/y change
y/y change 40% 30% 20% 10% 0% -10% -20% -30%
Figure 211: Listed Pfandbriefe outstanding volume

bn 900 800 700 600 500 400 300 200 100 0 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 Mortgage Pfandbriefe
60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 Mortgage Pfandbriefe
Public Sector Pfandbriefe
Public Sector Pfandbriefe
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Incentives of funding commercial mortgage portfolios with Pfandbrief issuance
In contrast to the public sector Pfandbrief business, issuance of mortgage Pfandbrief business improved over the past two years. This has been partly the result of the ongoing freeze in securitisation markets and the challenging funding conditions in non-secured debt markets. In addition, pressure on Pfandbrief spreads has been particularly low, due to the traditionally strong faith in the product, the broad domestic investor base, the issuers ability to place bonds in registered format and the persistent decrease of outstanding public sector Pfandbriefe. Consequently, from an issuers point of view, the relative economics of using the Pfandbrief market for funding commercial real estate portfolios have been rather good. This is reflected by the fact that many Pfandbriefbanks, which focus on commercial mortgage lending, since mid 2007 concentrated on making this business eligible for Pfandbrief funding. However, rating agencies are in an ongoing process of adjusting their valuation models and an increase of haircuts on cover assets could potentially be significant on commercial real estate portfolios. Such amendments may have a negative impact on the economics of using commercial mortgage collateral. Finally, the fact that new Pfandbrief programmes with a focus on residential mortgages have been launched highlights the fact that funding has also become more attractive in this space, albeit competition from funding via deposits remains severe. On 24 March 2010, the German government presented amendments to the Pfandbrief Act to the German parliament. The draft bill has the objective of adapting to market developments and maintaining the Pfandbriefs attractiveness for issuers and investors. Importantly, the proposed amendments contain rules that are designed to clarify the status of the Pfandbriefbank in a stress scenario. The new rules stipulate that the non-insolvent part of the Pfandbriefbank should be able to continue to operate under the existing legal entity and banking licence. The special administrator would be enabled to continue all banking operations, which help ensure the proper management of the Pfandbrief business. These rules were designed to facilitate the liquidity management of the Pfandbriefbank in a stressed environment. In particular, they may allow a Pfandbriefbank to have continued access to central bank liquidity facilities. Furthermore, a number of other amendments have been made in order to clarify liabilities of the Pfandbrief trustee and set minimum standards for the reporting dates with regards to the information that needs to be published under transparency rules. From an investors point of view, the new regulations, in particular the rules addressing the legal status of the Pfandbriefbank may help improve the liquidity position of a Pfandbriefbank in a stress scenario and thus could be a positive for the quality of the Pfandbrief. Furthermore, to the extent that rating agencies give credit to these new rules, they may also help further reduce rating volatility.
Proposals to amend the Pfandbrief Act
Reduced spread volatility in jumbo Pfandbriefe
Within the European covered bond sector, jumbo Pfandbriefe were the first sector were swap spreads decreased close to those levels observed prior to the acceleration of the financial market crisis in Q4 08. Figure 213 below indicates that spread volatility has been less pronounced in the jumbo Pfandbrief market compared to other jumbo covered bonds and for the moment, Pfandbriefe did not suffer at all from renewed volatility in sovereign bond markets of European peripheral countries.
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Figure 213: iBoxx Covered and iBoxx Germany Covered

200 180 160 140 120 100 80 60 40 20 0 -20 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
iBoxx Euro Covered 5-7 ASM

iBoxx Euro Germany Covered 5-7 ASM
Strengths
The key strengths of the Pfandbrief framework are: Cover assets are separated from the balance sheet through registration. In the case of issuer insolvency, cover assets are not subject to insolvency proceedings. Cash flow adequacy is secured through the stipulation of net present value cover, which also has to be tested against stress scenarios. In addition, through specific rules, liquidity over at least 180 days following the take over of the Pfandbrief business by the Cover Pool Administrator is ensured through specific regulations. Rigorous surveillance as well as detailed rules regarding transparency. In addition, there is strong institutional support for the Pfandbrief product.
Weaknesses
The relative weaknesses of the Pfandbrief framework are outlined below: Pfandbriefs quality depends, in many cases, on the maintenance of voluntary overcollateralisation, which can be subject to change, particularly in a stress scenario. Through the mortgage-lending value approach, there is typically a delay before property price developments are reflected in the valuations of mortgage cover assets. This can become problematic if there is a pronounced downturn in the property market.
Overview
Under the Pfandbrief Act, the ability to issue Pfandbriefe is subject to the fulfilment of operational, regulatory and asset-quality requirements
The issuance of Pfandbriefe is subject to the fulfilment of specific requirements. These requirements refer to regulatory approval, the operational set-up and the quality of cover assets. The regulatory prerequisites consist of the requirement that issuers must possess a general banking licence and that BaFin, the German banking regulator, assigns a specific Pfandbrief licence separately for each type of Pfandbrief. According to article 2(1) of the Pfandbrief Act, the Pfandbrief issuance is permitted in the following scenarios. When the bank has a minimum core capital of 25mn. If it has permission to carry out lending business. When it has appropriate risk management rules and instruments for running and controlling the cover business and the Pfandbrief issuance in place.
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If the companys business plan and organisational set-up reflect the commitment to do Pfandbrief business on a regular basis. If it maintains adequate operational structures and resources for the respective types of cover business.
BaFin is empowered to assign and to withdraw the Pfandbrief licence Operational requirements also include transparency rules
According to article 2 (2) of the Pfandbrief Act, BaFin is empowered to withdraw the licence if the pre-requisites listed above are no longer fulfilled or if no Pfandbrief has been issued for two years and none can be expected to be issued within six months. Article 2(1) reveals that, beyond the formal requirements for issuing Pfandbriefe, the legal framework also stipulates a series of operational requirements. These mainly include rules about risk management capacities, professional expertise and the overall operational set-up. In addition, Article 28 stipulates specific reporting standards, which oblige Pfandbrief issuers to publish data on collateral quality and market risk indicators on a regular basis. The transparency rules stipulate the reporting of the following data on a quarterly basis. The nominal and the present value of cover assets and outstanding Pfandbriefe, as well as the calculated net present value. Term to maturity and fixed interest periods of assets and liabilities broken down into annual brackets for the next five years, as well as from five to 10 years and over 10 years. The share of derivates in the cover pool. The stratification of cover assets across loan size brackets geographical origin and loan type. The volume of payments that are 90 days in arrears across different regions. Article 28 of the Pfandbrief Act also stipulates the reporting of collateral information on an annual basis. According to these rules, the annual report has to contain information about the number of foreclosures and forced administrations, the number of properties which were taken over to avoid losses, the volume of in-arrears for which no provisions were made and the total amount of repaid mortgages.
Non-guaranteed debt of public sector credit institutions is not eligible for public sector Pfandbriefe
There are additional safety measures that refer to the asset quality of the underlying portfolio. In particular, non-guaranteed debt issued by public sector credit institutions is not eligible for the cover pool of a public sector Pfandbrief. With respect to mortgage Pfandbriefe, the application of mortgage lending value principles is stipulated. An additional feature of the Pfandbrief Act is the stipulation of a specific control of the Pfandbrief business and, in particular, of the evaluation of cover assets by the German banking regulator, at least every two years.
Qualifying collateral
Public sector cover assets
Public sector loans that are refinanced through Pfandbriefe may only be granted to public authorities within the European Union (EU), the European Economic Area (EEA), Canada, Japan, Switzerland and the US, where the risk weighting of the public authority is 20% or less. However, as mentioned above, business with non-EU countries, in which the preferential claim of the Pfandbrief holder is not recognised, is limited to 10% of all EU business, and business where the preferential claim is recognised. In addition, public sector exposures to member states outside the EEA are restricted to assets of credit quality step 1 (with a minimum AA- rating). In the case of mortgage Pfandbriefe, only mortgage loans (or a portion thereof) with a loanto-value ratio not exceeding 60% qualify for inclusion in the asset pool. In addition, the respective mortgages have to be evaluated according to mortgage lending value principles.
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Mortgage cover assets
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The geographical scope of eligible mortgage business contains the following areas: EEA countries Switzerland, the US, Canada and Japan. Mortgage loans to non-EU countries, in which the preferential claim of the Pfandbrief holder is not recognised, are only allowed up to an amount of 10% of the sum of total EU mortgage loans and mortgage loans in countries with a preferential claim. In case of ship mortgages, this limit is raised to 20%. In addition, the Pfandbrief Act stipulates that Pfandbrief banks, which want to enter new business areas, such as the Japanese property lending market, have to prove that they have operated in this business successfully on a non-cover basis for two years before they may get approval for making it eligible for Pfandbrief cover.
Substitute cover assets
The Pfandbrief Act also allows for the inclusion of substitute assets. Up to 10% of the nominal volume of Pfandbriefe outstanding may consist of money claims against the European Central Bank or central banks in the European Union, or against adequate (geeignete) credit institutions. In the case of mortgage Pfandbriefe, the part of those 10% not being exhausted by these asset types and then up to 20% may consist of cover assets eligible for public sector Pfandbriefe (Article 19 (3) Pfandbrief Act). In addition, substitute exposures, including claims against financial institutions, are restricted to assets of credit quality step 1 (with a minimum AA- rating) in case they are against issuers outside the EEA. Long positions in derivatives such as swaps and options are eligible to be used as collateral for Pfandbriefe issued under the Pfanbrief Act, on condition that they do not exceed 12% of the NPV of the collateral pool. They have to be marked to market on a daily basis.
Derivatives allowed up to 12%
Regulatory oversight of assets

Compliance monitored by BaFin, which also appoints a trustee who supervises and controls cover pool assets
Compliance with the Pfandbrief Act is monitored by BaFin. The registration of assets is supervised and controlled by a trustee who is appointed by the BaFin after consultation with the mortgage bank. In addition, the trustee monitors the compliance with other provisions of the Pfandbrief Act. Together with the Pfandbrief bank, the trustee has joint custody of the assets included in the cover pools and of any documents evidencing such assets. The trustee may release such assets to the Pfandbrief bank only under circumstances expressly provided for by statute. Moreover, the Pfandbrief bank may remove any assets from the pool only with the permission of the trustee. Any issuance of Pfandbriefe may take place only upon prior certification by the trustee that the Pfandbriefe to be issued meet all statutory requirements. In addition to the monitoring conducted by the trustee, BaFin should conduct audits at least every two years, which focus particularly on assets that were newly added to the pools. BaFin also supervises compliance of Pfandbrief banks within the provisions of the Pfandbrief Act, including approval of valuation guidelines for mortgaged property, approval of the principal characteristics of the provisions of the loans, the resolution of disputes between the bank and the trustee, and the enforcement of the limitations on the issuance of Pfandbriefe.
BaFin regularly audits compliance to Pfandbrief Act
Asset/liability risk management

Net present value cover stipulated
The nominal value of the cover assets must permanently be higher than the total value of the Pfandbriefe and the interest income must at least be the same. This is stipulated in 4(1) Pfandbrief Act. Moreover, 4(2) Pfandbrief Act requires that Pfandbriefe are covered on a net present value basis and also stipulates a 2% over-collateralisation. This 2% applies equally to mortgage and public sector Pfandbriefe pools and is designed so that maintenance and one-off costs could be paid for in case the issuer becomes insolvent. Details with respect to the net present cover are regulated in secondary legislation. In July 2005, the Bafin issued the Present Value Rules for Pfandbrief Banks (Barwertverordnung fr Pfandbriefbanken), which stipulated that at no point in time over the next six months
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without any new injections should there be a cover ratio below 100% between the collateral assets (incl. derivatives) and the Pfandbriefe bonds used to finance the collateral loans.
Specific liquidity management requirements
Furthermore, Pfandbriefbanks are obliged to ensure that over the next 180 days, payments which are due on the Pfandbriefe are always covered by sufficient liquidity on the asset side. For this matter, Pfandbriefbanks need to calculate the cumulative sum of the daily net liquidity position for the next 180 days. The largest negative sum (liquidity shortfall) over the 180 day period needs to be fully covered with ECB eligible substitute assets.

Pfandbriefe creditors enjoy preferential claim in case of insolvency
In the event of a Pfandbrief bank's insolvency something that has never occurred the provisions of Pfandbrief Act stipulate that the claims of holders of Pfandbriefe will be satisfied out of the asset pools (accordingly, the assets therein are "ring-fenced"), thereby taking priority over all other creditors in bankruptcy. In the event of the opening of insolvency proceedings with respect to a mortgage bank, the outstanding Pfandbriefe, unlike the other debt obligations of the mortgage bank, will not be accelerated. The cover pools will be treated as separate assets and will not be part of insolvency proceedings. Only if a pool becomes insolvent will a separate insolvency proceeding be opened. To the extent that the assets in the cover pools are then not enough to meet the liabilities, the Pfandbriefe investors rank pari passu with other creditors for the issuers remaining assets. In an insolvency scenario, an additional person, called the Cover Pool Administrator (CPA), would be appointed by the local court upon the authorisation of the Bafin. The CPA is entitled to arrange bridge financing but is not able to issue new Pfandbriefe. However, Article 30(2) contains wording that would allow the CPA to represent the Pfandbriefbank vis--vis third parties. This helps improve the ability to raise liquidity in a stress scenario. The CPA would also be able to transfer the collateral pool, or parts of the collateral pool to a sound Pfandbrief bank. The liquidator will also not have access to any of the over-collateralisation unless the liquidator can expressly prove that the collateral is obviously not needed for the Pfandbriefe holders. This also holds true with respect to the interest from collateral assets.
Pfandbriefe not subject to acceleration in case of insolvency
Banking regulator may request the appointment of a Cover Pool Administrator
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Pfandbrief Act
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities Asset allocation Inclusion of Hedge Positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets
Hypothekenpfandbriefe, ffentliche Pfandbriefe, Schiffspfandbriefe, Flugzeugpfandbriefe. German Pfandbrief Act effective since 19 July 2005. No, the use of each of the respective Pfandbrief types is subject to a licence. Not applicable. Cover assets remain on the balance sheet, but are maintained in a separate cover registers. Hedge positions can be included in the cover register, but the volume is limited to 12% of the pool's value at that time. Up to 10%. No.
Central governments and sub-sovereigns with a maximum 20% risk weighting in EEA countries, Switzerland, the US, Canada and Japan; public loans to non-EU countries in which the preferential claim of the Pfandbrief holder is not recognised are only allowed to an amount of 10% of the sum of total public loans with EU countries and countries with a preferential claim. EEA countries Switzerland, the US, Canada and Japan. Mortgage loans to non-EU countries, in which the preferential claim of the Pfandbrief holder is not recognised, are only allowed to an amount of 10% of the sum of total EU mortgage loans and mortgage loans in countries with a preferential claim. 60%. 60%. Yes; "durch sorgfltige Ermittlung festgestellter Verkaufswert" (prudently assessed market value). Regular (every two years) examination of the cover register stipulated by law. Yes; Bundesanstalt fr Finanzdienstleistungsaufsicht (BaFin), the German banking regulator and an independent trustee. Coverage by nominal value and by net-present value required by law. Specific coverage of liquidity risk over a 180-day period. The issuer may replace non-performing loans. Further protection may stem from voluntary overcollateralisation. The regulator is able to request the court appoint up to two cover pool administrator, in addition, there are detailed rules for the transfer of assets and liabilities. 102%. Yes. No, but assets within the cover register are exempt from bankruptcy proceedings. All assets earmarked for the respective asset pool. In addition, investors may benefit from positive market values of derivatives. In the event of insufficient proceeds from the pool assets to cover their claim, Pfandbriefe investors rank pari passu with senior debt holders. In addition, shareholder(s) may extend some other form of support. Yes. Yes.
Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms UCITS Art. 22 par. 4 compliant? CRD Annex VI, Part 1, 65 compliant?
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SPANISH MARKET
Overview
Spurred by the marked recovery in primary covered bond market activity in mid-2009, Spanish benchmark supply doubled to 17.3bn in 2009, from 8.8bn in 2008. Part of this development was due to the fact that as several smaller savings banks (cajas de ahorro) could access the market at relatively lower funding levels, they opted for an independent issuance of plain vanilla covered bonds instead of participating in pooled issues as before. In 2010, year-to-date issuance stood at 12bn at the time of writing. As a result of the recovery which, however, has come to an abrupt halt of late because of spill-over effects arising from a pronounced volatility phase of government bonds swap spreads the Spanish benchmark covered bond marked could defend its position as the worlds largest covered bond market in terms of volume. At the time of writing, the aggregate amount outstanding of mortgage and public sector backed Spanish benchmark covered bonds amounted to 263.5bn from 151 deals by 22 different issuers (Figure 214). In mid-May 2009, the market volume still stood at 251bn from 139 benchmark deals. The overall amount outstanding of the historically dominant jumbo Pfandbrief market, in comparison, further declined and stood at 215.6bn from 146 deals at the time of writing, down from 247bn from 159 issues in mid-May 2009. Despite doubling from 2008 when issuance, overshadowed by the global financial crisis, had plummeted to 8.8bn and thus its lowest levels since 2001, the recovery to an issuance of 17.3bn in 2009 is still markedly lower than the average annual volumes in between 2003 and 2007, which oscillated between 32bn and 65bn. In 2010, we estimate issuance to increase to 25bn versus redemption payments of 23bn at the same time. In light of the high correlation between Spanish government and covered bonds and the recent weeks rollercoaster ride with regards to swap spread development, however, we expect issuance to remain subdued in the remainder of 2010. Overall, new issuance was strongly geared towards mortgage-backed covered bonds, which dominated 2009 supply. Following the sharp increase in debt issuance on behalf of Spanish Autonomous Communities, which, for some investors, provided a well suited alternative, it was not until March 2010 that the issuance of public sector backed covered-bond was revived.
Figure 214: Outstanding Spanish covered bonds

a) Outstanding Spanish covered bonds
300 2.0 POPSM 4% BANSAB 3% IMCEDI 5% BANEST 6% CEDTDA 8% CAJAMM 9%
b) Issuers market share, as at June 2010

Others 10%
AYTCED 18%
1.5 200 1.0 100 0.5
BBVASM 15%
0 Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
0.0 Jan-10
Jumbo Covered Bonds outstanding ( bn) (LS) Average size ( bn) (RS)
SANTAN 11%
CAIXAB 11%
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Swap spreads: Back to where we stood a year ago
Overall, neither the pick-up in issuance nor the steadily increasing redemption payments have had a material impact on the market shares of Spanish covered bond issuers. As in the years before, the five largest players accounted for a combined 64% of the outstanding volume. Multi-Cdulas issuer AYTCED, Europes third-largest issuer with 48.2bn of covered bonds outstanding at the time of writing, accounted for 18% of all volume outstanding, up from 17% in mid-May 2009, followed by BBVASM (15%, up from 14% in mid-May 2009), CAIXAB 11% (down from 12% in mid-May 2009), CAJAMM (unchanged at 9%), and SANTAN (11%, up from 10% in mid-May 2009) (Figure 214). In other words, the (opportunistic) covered bond issuance on behalf of several smaller savings banks that joined the market in 2009, among them BILBIZ, UNICAJ and CAZAR, has so far failed to leave its mark on the market which, as before, remains dominated by the five major players previously outlined. Following the ECBs May 2009 announcement that it would acquire 60bn of denominated covered bonds issued in the euro area in the period between July 2009 and June 2010, swap spreads of covered bonds started markedly tightening. Owing to their relatively high sensitivity, Spanish covered bonds were among the papers that strongly benefitted from this development. By early October 2009, the iBoxx Euro Spain Covered Index had fallen to 90bp, from 200bp in early May 2009, and thus stood at the same levels as in September 2008. Given mounting concerns regarding the fiscal position of some Mediterranean rim sovereigns, however, by November 2009 the situation started to change again. Following the sharp and abrupt widening of Spanish government bonds swapspreads in Q1 10, the swap spreads of respective covered bonds came under renewed pressure and sharply widened (Figure 215). In particular, longer-dated Spanish covered bonds were affected and traded at their historically widest levels (mid-swaps plus 225bp) in the days before the EU announced its 750bn rescue package.
High correlation with spread development of sovereign debt
Taking into consideration the marked swap-spread contraction of bonds issued by Mediterranean rim sovereigns in the aftermath of the EUs announcement (Figure 216), swap spreads of Spanish covered bonds are likely to recover in the short term but, in our view, are unlikely to return to pre-crisis levels for the foreseeable future, particularly as the situation in the Spanish housing market so far has shown little signs of a broad-based recovery. In addition, the economic situation in Spain with an unemployment rate of 20%,
Figure 215: Swap spread development on the Spanish covered bond markeT
a) Swap spread development
250 200 150 100
b) iBoxx Euro Spain Covered
250
200
150
100
50 0 May-04 May-05 May-06 May-07 May-08 May-09 May-10 iBoxx Euro Spain Covered (Swap spread in bp)
50 Oct-08
Feb-09
Jun-09
Oct-09
Feb-10
Jun-10
Spain Covered 5 to 7 years
1 to 3 years 7 to 10 years
3 to 5 years >10 years
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the steady increase in non-performing loans (NPLs), and the impact of the governments recently announced austerity measures, as well as the consolidation of the countrys savings banks sector are adding to investors perception of a phase of elevated uncertainty.
Market is steadily drifting apart
In light of the developments portrayed above, the once relative homogeneity of the Spanish covered bond market has dissipated. Whereas the swap-spread difference between plain vanilla and pooled covered bonds amounted to little more than 20bp in early 2008, it has since increased and amounted to 70bp at the time of writing. Pooled covered bonds, ie, the so-called Multi-Cdulas, have been particularly sensitive to the recent market distortions; a development which, in our view, is due to the fact that as many as 26 different savings banks can participate in selected Multi-Cdulas issues. These often are smaller-sized entities with a strong regional focus. Also, these lenders, among them many we expect to be affected by the consolidation process, often are geared towards (residential) mortgage lending and on several occasions feature sizeable exposures towards property developers. As of late, this strategic alignment has been reflected in steadily rising ratios of NPLs. Thus, irrespective of Multi-Cdulas per se being less exposed to potential risks regarding the geographical concentration of the collateral pool (as a result of the diversification across different non-benchmark covered bond issuers) and the additional protection provided by a liquidity facility, which helps bridge any possible delays in payments related to an issuer event of default, investors have remained distant. Plain vanilla covered bonds issued by larger commercial banks trade at markedly tighter levels (130bp) than those of savings banks (165bp), for example. What is more, plain vanilla covered bonds from larger savings banks, with established (liquid) benchmark curves have on average, over the past few years, traded at significantly tighter levels than covered bonds issued by smaller savings banks which previously limited themselves to an issuance within the scope of pooled covered bonds. Also, the swap-spread difference between Spanish government debt and plain vanilla single-name covered bonds issued by major commercial banks has markedly contracted. On several occasions over the past year, investors could switch out of covered bonds and into sovereign debt with literally no give-up (Figure 217).
Figure 216: Correlation between Spanish sovereign debt and covered bonds
a) Swap spread development
250 200 150 100 50 0 -50 May-08
b) Correlation analysis, May 2008-May 2010

Bonos swap spreads (bp)
200 150 100 50 0 -50
y = 71.085Ln(x) - 302.31 R = 0.6321

2
Nov-08
May-09
Nov-09
May-10
50
100
150
200
250
iBoxx Euro Spain Covered

iBoxx Euro Spain

(Note: light blue mark = 14 May 2010)
Covered bond swap spreads (bp)
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Figure 217: Market environment

a) Swap spread development (in bp) b) Credit term structure
ASW (bp) 250
250 200 150
200
100 50
150
0 -50 Jan-08
TTM (yrs)
Jul-08
Jan-09
Jul-09
Jan-10
100 0 SANTAN 5 10 AYTCED 15 CAJAMM 20
SANTAN 3.500% Feb 14 CAJAMM 5.000% Oct 14

AYTCED 4.000% Apr 14 SPGB 4.750% Jul 14
Impact on covered bonds
The above developments have meanwhile left their mark on Spanish covered bonds which, as outlined above, have been subject to an asymmetrical swap-spread development. With concerns regarding the fiscal position of several Mediterranean rim countries overshadowing the swap spread development of the respective sovereign bonds, covered bonds generally trade on a wider note. Still, the once homogeneous Spanish market has steadily drifted apart over the course of the past few years, affecting Multi-Cdulas in particular, where as many as 26 different savings banks, among them many smaller and regionally active entities, have pooled their (non-benchmark) covered bond issuance. Following the steady increase in the NPL ratio to 5.3% at the time of writing, we believe that the smaller savings banks could come under further pressure, particularly as they generally are less diversified, but more exposed to residential mortgage lending and often have a relatively high exposure to real-estate developers. Property developers, of which many have by now filed for bankruptcy, are among the most affected entities, as their business models rely on intact demand for new dwellings and relatively cheap refunding methods. Despite these conditions being fulfilled until mid-2006, the situation deteriorated afterwards and has affected virtually all Spanish property developers. Following the development observed over the course of the past year, we thus expect the respective coverage and collateralisation ratios to further decline. In light of the above, we highlight that despite this increasingly challenging situation, Spanish savings banks benefit from the support mechanism of the CECA. This body not only provides technological and advisory services that are of particular relevance for smaller savings banks, but it also has its own banking licence and is able to provide liquidity and arrange support for distressed savings banks. Furthermore, savings banks benefit from the Spanish Fondo de Garanta de Depsitos FDG (the Spanish depositor guarantee fund). As no Spanish savings bank has ever defaulted on its obligations since the inception of the sector in 1837, the FDG has accumulated sufficient reserves, which it is authorised to use to rescue or manage the liquidation of a troubled savings bank. As of late, merger activity among Spanish savings banks (cajas) has started to gain considerable momentum. On 22 May, news emerged that the regulator Banco de Espaa (BdE) had seized control of CajaSur after merger talks with domestic peer Unicaja had failed. As in the case of Caja Castilla La Mancha (CCM), which was seized in March 2008, Banco de Espaa assigned the so-called Orderly Bank Restructuring Fund Fondo de Reestructuracin
Support mechanisms protect Spanish savings banks
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Ordenada Bancaria (FROB) as provisional administrator. For the time being, Banco de Espaa, ie, the regulator, and thus not the cajas, seem to be the driving force behind the mergers. This perception could likely be fuelled over the course of the summer if Banco de Espaa believes the consolidation efforts of the cajas are insufficient. With the availability of new loans granted within the scope of the FROB expiring by 30 June, Banco de Espaa has ratcheted up its rhetoric of late, and, in the case of CajaSur, acted decisively. The pressure on the cajas has increased further with Banco de Espaa hinting that it would not seek to extend the 30 June deadline for its banks to apply for aid from the FROB.
Figure 218: The changing landscape of the Spanish savings banks sector
Under FROB administration New Caja Catalana New Unnim Merging Merging Likely merging Likely merging
Caja Castilla La Mancha CajaSur
Caixa Catalunya Caixa Manresa Caixa Tarragona
Caixa Sabadell Caixa Terrassa Caixa Manlleu
CAM Cajastur Caja Santander y Cantabria Caja Extremadura
Caja Duero Caja Espana
Caja Murcia Caja Granada Sa Nostra Caixa Peneds
Caja Madrid Caja Canarias Caixa Laietana Caja de Avila Caja Segovia Caja Rioja
FROB involvement 1.250bn
500mn
1.600bn
562mn
Source: Company statements, press reports, Barclays Capital
Two different types of covered bonds
Spanish legislation distinguishes between two different types of covered bonds. Whereas CH are covered bonds backed by Spanish mortgage loans, Cdulas Territoriales (CT) are covered bonds backed by loans granted to the public sector. Yet, Cdulas can also be issued in quasi-structured finance forms, the so-called Multi-Cdulas, backed by smaller regional (savings) banks, which pool resources to issue large liquid jumbos. So far, Multi-Cdulas have been issued by AYTCED, CEDTDA, IMCEDI, and PITCH. Given the pass-through format of any such Multi-Cdulas, investors are not only protected by the same legislative framework as for stand-alone Cdulas Hipotecarias or Territoriales, but they potentially benefit from the diversification offered from the pool of banks participating in these transactions, as well as the provided liquidity back-up. The structure of CH issues is regulated by the 1981 Ley del Mercado Hipotecario and the Mortgage Market Act (MMA), which was amended in 1991 and in 2003. Given that historically, the Spanish mortgage market has largely been based on variable interest rates, which accounted for 98% of all mortgage lending as at end-May 2010, most mortgages have also been financed via floating retail deposits. The CH bonds that existed before 1999 were mostly small domestic issues with limited liquidity. In 1999, the Spanish government made several legal changes, such as exempting EU institutions from the withholding tax on listed bonds and eliminating the need for CH issuers to place insurance deposits at the Bank of Spain for each CH issue. In February 2005, the exemption from withholding tax was broadened to include any global investor that is not incorporated in a country regarded as a tax haven. The widened exemption from withholding tax refers to all bonds issued after 7 July 2003 by a credit institution, and thus includes pooled Cdulas that are listed on an exchange and are not purchased by a Spanish investor or investors from tax havens. To help investors benefit from tax exemptions, the credit entity needs to disclose the identity
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and country of residence of the respective bondholders. It also needs to disclose the amount of income paid in each period and identify the respective notes. On 23 April 2008, the exemption from withholding tax was extended to beneficial owners resident in a country or territory considered by Spanish legislation to be a tax haven. These are now eligible for exemption from withholding tax on interest paid from all public debt securities and those private debt securities that are subject to Laws 19/2003, 23/2005 and 36/2007. 66
Little effort in claiming exemption from withholding tax
There generally is little effort required in claiming exemption from Spanish withholding tax. More precisely, a form needs to be filled out once, confirming the name of the beneficiary of the interest payments. Only in the case of a change of details, eg, a change of name, does a form with the new information have to be updated and resubmitted. Moreover, a certificate of residence, which should come from local tax authorities, needs to be submitted to the respective clearing houses Euroclear and Clearstream on an annual basis. If these two documents are on hand at the clearing house, interest payments on any Spanish covered bond are automatically exempt from the withholding tax at source. Thus, there is generally no need either to report any changes in the volume of holdings or to fill out a form for each bond. In the case of more than one beneficial owner, an additional form must be completed each time a payment is expected. However, as this process is generally automated by the clearing institutions, investors will receive a notification and are asked to reconfirm the respective amounts and the list of beneficial owners two to three days prior to a coupon payment. Overall, we regard the operational effort in receiving a tax exemption on Spanish covered bonds as little different to the procedures for other covered bonds. Among the particular strengths of the Spanish Cdulas framework, in our view, are: CH benefit from a mandatory over-collateralisation, which states that they can only be issued up to 80% of the total registered mortgage book, thus implying an over-collateralisation level of 125%. In case of CTs, this amounts to 143%. In the case of an issuers insolvency, however, the entire pool of (non-securitised) mortgage loans supports the CH. The pool of eligible assets needs to be registered in a separate register and thus is operationally segregated from other assets on an issuers balance sheet. This facilitates the execution of the legally embedded explicit duty of the insolvency administrator to ensure an uninterrupted servicing of Cdulas. As the amended regime has introduced the possibility of making use of substitute collateral, investors may benefit from protection against liquidity risk. In addition, when it comes to the issue of Multi-Cdulas, the liquidity enhancement, mostly provided by larger banks, as well as maturity extension language, serve as additional liquidity buffers for the holders of Multi-Cdulas.
Strengths
Weaknesses
Among the relative weaknesses of the Spanish Cdulas framework, in our view, are: Both CH and CT are backed by the individual issuers total pool of mortgage and public sector loans, respectively. This creates a concern for unsecured investors and depositors with respect to subordination, which could lead to a situation where the respective claims of Cdulas holders are legally challenged. The above is further magnified by the fact that the administration of the cover pool and the issuers insolvency would be executed by a single party, which could potentially impede the immediate availability of cash flows in the case of issuer insolvency,
66
Source: Clearstream, 23 April 2008.
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although the amended legislation now explicitly obliges the insolvency administrator to sustain interest and amortisation payments related to Cdulas throughout the insolvency procedure. There is a lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. However, this can be mitigated by detailed and regular reporting on cover pool characteristics and risk management indicators on a voluntary basis.
Collateral for Cdulas Hipotecarias

Eligible assets
CH are mortgage certificates, collateralised by first-lien mortgage loans. Eligible assets include residential and commercial mortgage loans registered in Spain and other member states of the European Union. Spanish banking regulations stipulate that the loan-to-value ratio (LTV) for residential mortgage loans must not exceed 80%; ie, the total volume of CH is limited to 80% of the registered loans. In the case of commercial real estate loans, the LTV ratio must not exceed 60% 67. If the level of over-collateralisation drops below the mandatory level then the same amount of underfund has to be deposited in cash with the Banco de Espaa. The issuer then has up to three months to restore the overcollateralisation through adding new eligible loans, buying CH from the market, or by redeeming a sufficient level of outstanding CH to re-establish a minimum mandatory level of over-collateralisation. Meanwhile, the bank would have to cover any deficit through depositing cash or government bonds with the Banco de Espaa within 10 days 68. As a result of legal changes that became effective in December 2007, a special register comprising the mortgage loans, public debt and substitute cover assets used to back the CH and CT was introduced. As in other European legislations, such as Germany and Ireland, the register will have to be maintained by the issuers (Article 13). Furthermore, as another consequence of the new legislation, the substitute collateral for CH can account for up to 5% of the total outstanding cover pool (Article 16). 69 Substitute assets can be: Fixed-rate assets (securities) issued by the Spanish government, the Instituto de Crdito Oficial (ICO), or other member states of the EU., Fixed-rate assets (securities) quoted on a regulated or an official secondary market with a credit rating comparable to that of the Kingdom of Spain and provided that these securities are not issued by the covered bond issuer or related entities, and that these securities are not backed by any mortgage loans conceded by related entities (ie, including CH, AAA-rated ABS or RMBS) Other assets of low-risk and high-liquidity that will be determined on a regular basis (Article 17).
Introduction of cover pool register
Inclusion of real estate guarantees from EU member states
Furthermore, also owing to the legal changes, the geographical limits for mortgages pooled in the asset cover pool (previously only Spain) were extended to real estate guarantees from other European Union member states. However, the method by which the mortgage lending value of the non-domestic real estate will be assessed has not yet been determined (Article
These LTV barriers, however, were revised within the scope of legal changes which became effective in late 2007: the LTV ratio of mortgage loans not granted for the purpose of constructing, renovating, or acquiring residential real estate was lowered from 70% previously to 60% now. The LTV ratio of mortgage loans granted for the construction, renovation, or purchase of residential real estate remained contained at 80%. Besides, loans with an LTV ratio above 80% but below 95% will also be eligible as a cover asset in case an additional bank guarantee or credit loan insurance is provided (Article 5). 68 At the time of writing this was of subordinated relevance as Spanish issuers were over-funded by an average of c.130% to 140%. This, however, is sharply down from the 250% observed until 2007. 69 The capital requirements directive (CRD), in contrast, allows for a 15% limit for substitute cover.
67
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5). Even though we do not expect any significant changes in the compositions of the respective cover pools in the medium term, the amendment paves the way for an improvement in the geographical diversification in the long term.
Public-sector loans and bonds do not yet constitute substitute eligible assets
In contrast to other European legislations, public sector loans and bonds do not constitute eligible substitute assets for CH yet. Similarly, Bonos Hipotecarios, which are mortgage bonds that require individual registration, or mortgage loans that are registered as collateral for Participationes Hipotecarias, do not qualify as eligible assets.
Collateral for Cdulas Territoriales

Eligible assets
CT were first issued in April 2003 and are currently regulated by Article 13 of the Ley de Medidas de Reforma del Sistema Financiero, the Financial System Reform Law (FSRL). Eligible assets include loans to states, autonomous communities, local authorities and public sector companies within the EU and EEA (European Economic Area). The range of eligible loans to the public sector is not limited by a rating or a risk weighting, yet, there is no scope to lend outside the EEA. The law pertaining to CT was further strengthened in July 2003 with a new Spanish Insolvency Law, which became effective in September 2004. This law classifies CT holders as special privileged creditors, giving them the same seniority as CH holders over and above those of unsecured creditors. CT are not backed by an explicitly defined collateral pool or a special purpose vehicle, but in fact have seniority on the proceeds of the entire EEA public loan portfolio. Holders of CT potentially benefit from a minimum mandatory over-collateralisation level of 143%; ie, the total volume of CT is limited to 70% of registered loans, giving an exceptionally high level of security in comparison with other public sector covered bond markets. The amount of CT a bank can issue is limited by Spanish law and is tied to the volume of available eligible assets. This pool of eligible assets is dynamic, reflecting redemptions and newly originated public sector loans. Given the possibility of issuance of additional CT, the level of over-collateralisation may vary over time. If this 70% limit were breached, the issuer would need to restore the minimum level of over-collateralisation within three months through adding new eligible loans, buying CT from the market, or by redeeming a sufficient level of outstanding CT to re-establish a minimum mandatory level of over-collateralisation. Meanwhile, the bank would have to cover any deficit through depositing cash or government bonds with the Banco de Espaa within 10 days.
Minimum mandatory overcollateralisation of 143%

Regulatory oversight by Banco de Espaa
Oversight is enacted by Banco de Espaa. In the case of Multi-Cdulas issued by AYTCED, CEDTDA, IMCEDI, or PITCH, where a pool of smaller mortgage banks pool together (in fixed percentages) to issue jumbo Cdulas by means of a Spanish special purpose vehicle (Fondo de Titulizacion de Activos FTA) and the appointment of a trustee (Sociedad Gestora), there is an additional layer of control. The trustee is supervised by the Comisin Nacional del Mercado de Valores (CNMV), the Spanish Commission of Securities, and is authorised to act on behalf of the holders of the Cdulas bonds. The trustees job is to manage the cash flows even though it does not guarantee the cash flows from the FTA.

Few prepayments
The matching of interest payments is not required by law. Pre-payments on mortgages are legally possible, but rarely occur because the mortgagor has to cover all administration costs, as well as potential penalty payments. According to a law passed in April 2003, all
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mortgagors taking out floating-rate mortgages must be offered interest rate caps by the mortgage bank; however, the mortgagors awareness of this facility and their take-up has so far been nearly non-existent 70. Law 41/2007 71, which was adopted on 7 December 2007 and makes amendments to Law 2/1981 regarding the Mortgage Market Regulation, stipulates a significant reduction of legal costs 72. Also, the maturity of mortgage loans granted after 7 December 2007 can be extended without the need to cancel and reconstitute the respective loan. Overall, we do not expect these changes to the Spanish mortgage law such as the extension of the repayment period in selected cases, for example to have an effect on CH.
Additional cash pool in case of Multi-Cdulas
In the case of Multi-Cdulas, there is an additional cash pool to back the Cdulas. The participating banks exact contributions into this cash pool are determined by the rating agencies, which determine the amount required to attain the required AAA rating. The size of the pool is generally set to meet a sudden fall in the coupon from a certain percentage of the collateral over a two-year period. The cash is deposited with an arms-length institution (eg, a state-owned Instituto de Credito Oficial (ICO) to ensure punctual payment for the Cdulas. Alternatively, a back-up liquidity line has been set up. This institution in turn pays a guaranteed minimum rate of interest on the cash back to the participating banks.
Bankruptcy remoteness and payment in the event of insolvency

Cdulas senior to all creditors
CT and CH rank senior to all other creditors. The introduction of new legislation in 2003 meant that this also holds true for Spanish tax authorities and employees claims. Should loans fail to cover the Cdulas claims in the event of a liquidation, Cdulas would have a senior unsecured claim on all other remaining assets, ranking pari passu with other senior unsecured creditors. CT and CH are an issuers direct liabilities (ie, they do not require the use of a special-purpose vehicle) with the underlying cover assets being segregated from other assets on the issuers balance sheet. As the cover pool register principle was not introduced until late 2007 however, the timeliness of repayment could previously have been affected. In order to avoid any such delays in payments, the legal basis for an uninterrupted servicing of interest and principal had already been created through the insolvency regime, which became effective in September 2004. Despite the privileged position of Cdulas holders, their claims would immediately be repaid. This is stated in article 146 of the Ley Concursal, the Insolvency Act, which stipulates the "in advance maturity (vencimiento anticipado) of the respective credits once the liquidation process has started. Nevertheless, articles 14(2) MMA (Mortgage Market Act; Ley del Mercado Hipotecario) and 13(7) FSRL (Financial System Reform Law; Ley de Medidas de Reforma del Sistema Financiero) state that the claims of Cdulas holders should be treated equally as claims against the insolvency estate on the basis of article 84(2.7) Ley Concursal. This means that their claims are subject to article 154(2) and article 59(1) Ley Concursal, which stipulate uninterrupted servicing of interest and principal.
New framework as legal basis for uninterrupted repayment of Cdulas in case of issuer insolvency
Article 154(2) states that "los crditos contra la masa, cualquiera que sea su naturaleza, habrn de satisfacerse a sus respectivos vencimientos, cualquiera que sea el estado del concurso" (credits against the insolvency estate have to be serviced at their respective maturities, irrespective of their origin and irrespective of the state of insolvency). The
As at end-May 2010, 98% of all Spanish mortgage loans granted were subject to a variable interest rate. This ratio is largely unchanged from the years before. 71 Source: Boletin Oficial del Estado, 8 December 2007. 72 Average legal costs for the modification of the conditions of a 120,000 mortgage, for example, now are 67 instead of 351 previously.
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limitations of article 56 Ley Concursal, which implies an acceleration of the claims of creditors with a special privilege after a period of 12 months, should be irrelevant for Cdulas holders, as they can refer to articles 14(2) MMA and 13(7) FSRL.
Implementation of insolvency law
In co-operation with the Spanish Ministry of Justice (Ministerio de Justicia), selected elements of the Spanish insolvency law (Ley Concursal) were also implemented into the new law. The respective amendments lead to an improved segregation of the collateral pool in the case of insolvency of the issuer (Article 14). The law states that Cdulas holders have a preferential claim over all other creditors with regard to the total amount of mortgage loans serving as collateral for the Cdulas and other substitute assets. Besides, in the case of an insolvency of the issuer, Cdulas holders benefit from a special privilege outlined in section 1, number 1 of Article 90 of the Ley Concursal. Notwithstanding section 2, number 7 of Article 84 of the Ley Concursal, it is stated that interest and amortisation payments related to Cdulas have to be sustained throughout the insolvency procedure. If these payments do not occur, the insolvency administrator has to ensure the respective payments by selling substitute assets. Should these prove insufficient, the insolvency administrator has to conduct other financial operations in order to guarantee the respective payments to the Cdulas holders. In the case of Multi-Cdulas, bondholders have direct recourse to the FTA, which in turn has recourse to the individual banks portfolios. An independent third party acts as a paying agent. This independent paying agent also manages the cash pool, which acts as a buffer against payment delays if one of the individual banks goes bankrupt. If one of the participating banks cannot maintain over-collateralisation of 125% in the case of CH, there may be an early redemption. In this event, proportional interest and amortisation payments would be made. Multi-Cdulas programmes stipulate that redemptions should also include accrued interest. Should any remaining claims be made on the structured Cdulas transaction, the legal maturity of the FTA would be extended by a further three years until all liabilities are met.
Structured Cdulas bondholders have direct recourse to the FTA
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Spain
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk Mandatory overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency 1st claim is on External support mechanisms UCITS Art. 22 par. 4 compliant? CRD Annex VI, Part 1, 65 compliant?
Cdulas Hipotecarias (CH), Cdulas Territoriales (CT). Law enshrined on 25 March 1981 (CH) and 22 November 2002 (CT). Amendments on 22 November 2007. No; any Spanish bank with eligible assets. Not applicable. Cover assets remain on the balance sheet, but are maintained in separate coverpool registers. Hedge positions can be included in the cover register. Up to 5%. No.
Any country is allowed, but only public loans from EEA countries (including sub-sovereigns and publicsector companies) are eligible for collateral. Properties located in the EU. 80%. 60%. No; "valor de tasacin" ("estimated value" = market value). The examination of property valuations is part of the specific surveillance. Yes; Banco de Espana (Spanish Central Bank). Coverage by nominal value. No back-up servicer or cover pool administrator is stipulated. Investors may derive comfort from the fact that there are a broad number of Cdulas issuers. 125% (CH) / 143% (CT). Yes. No; only Multi Cdulas provide independence from parents through a reserve fund or a liquidity line and by issuer diversification. All mortgages (CH)/public loans and credits (CT) are in favour of the issuer (since September 2004, claims of CT investors rank at a similar level of seniority as those of CH investors). In the event of insufficient proceeds from the pool assets to cover their claim, Cdulas investors rank pari passu with senior debt holders. Yes. Yes.
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FRENCH MARKET

Since its inception in 1999, the French jumbo market has expanded persistently. As at mid May 2010, the total volume of outstanding -denominated jumbo French covered bonds was 187bn. The jumbo market consisted of five issuers of Obligations Foncires (OFs), BNPSCF, CFF, CIFEUR, DEXMA, GESCF and SG, and six issuers of French common law covered bonds (FCLCBs), ACAFP, BNPPCB, BPCOV, CDEE, CMCICB and HSBC 73. Furthermore, Caisse de Refinancement Hypothecaire (CRH) has 13 benchmark French covered bonds, with a total volume of 40bn outstanding. Thus, including CRH, currently, there are 100 jumbo French covered bonds outstanding with an average size of 1.9bn. From mid-2007 onwards, swap spreads started to widen. Until Q3 08, the trend was somewhat limited in the OF market, more pronounced for CRH bonds and substantial for FCLCBs. The spread differential between 5y OFs and 5y FCLCBs diverged, widening from an initial 2bp to a peak at 20bp in July 2008. The further escalation of the crisis in H2 08 led to substantial further widening in OF spreads. In Q1 09, the 5y FCLCBs was quoted about 35bp tighter compared with 5y OFs. In the course of 2009 however, the spread differential contracted again and since YE 09 is close to zero again.
Figure 219: Outstanding volume and average size

bn 200 150 2.0 100 50 0.5 0 99 00 01 02 03 04 05 06 07 08 09 10 Jumbo French Common Law Covered Bonds Jumbo Obligations Foncires & CRH Average size of Jumbo Covered Bonds (RHS)
Figure 220: Market share, May 2010

bn 3.0 2.5 GESCF 1% DEXMA 18% HSBC ACACB SOCSCF BNPPCB BNPSCF 1% 4% 8% 3% 1% BPCOV 2% CDEE 1% CFF 26% CRH 21% CMCICB 5% CIFEUR 9%
1.5 1.0
0.0
73
Note that since 1 July 2008 onwards, the iBoxx France Covered Index has been further split into an iBoxx France Covered Legal (incl. CRH) and an iBoxx France Covered Structured component.
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160 140 120 100 80 60 40 20 0 -20 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 iBoxx Euro France Covered ASM 5Y France (OF) 5Y France (SCF)
Figure 222: Sector credit term structures

Barcap OAS 80 70 60 50 40 30 20 10 0 -10 -20 2009
2012
2014 OF
2017 FCLCB
2020 CRH
2023
2025
Background
French Mortgage Bank Act 1999 ensured prior claims of mortgage bondholders in the event of insolvency
Legislation on the mortgage markets in France dates back to 1852, although until recently, it was cumbersome. Furthermore, the French Bankruptcy Act of 1985 failed to recognise the senior claims of mortgage bondholders, making their issuance rather unattractive. Given this background, most secured debt issuance prior to 1999 was executed through MBS or ABS-type vehicles or the CRH. The introduction of the French Mortgage Bank Act in 1999 finally paved the way for a jumbo covered bond approach. The resulting Socits de Crdit Foncires (SCFs), which are allowed to issue Obligations Foncires (OFs), are exempt from the 1985 Bankruptcy Act. As in other European countries, the implementation of CRD into French law triggered changes to the regulations for SCFs. This was basically made through Ordonnance 2007571 from 19 April 2007 and Decree 2007-745 from 9 May 2007. The respective changes in the legislative and regulatory parts of the French Banking Act primarily were made to ensure compliance of OFs with CRD rules. In particular, the limit for substitution assets was lowered to 15% from 20%. In addition, several amendments were made to modernise the legal framework and make it more flexible to respond to the changing needs of the French industry. Importantly, in Article R515-6 of the Banking Code, the limit on the inclusion of guaranteed housing loans was raised to 35% from 20%. On 31 October 2006, the French banking regulator (Commission Bancaire) attributed a 10% risk weighting to the debt of CRH. This reflected an amendment to the French Banking Act, which clarified the privileged access of debt investors to its assets. 74 The decisions regarding CRH helped the respective debt product to more strongly resemble other traditional covered bond products, which are equally based on a statutory regime. Issuance through the jumbo model generally is handicapped by CRHs lack of operational flexibility. Yet, since early 2008 efforts have been made to introduce a smoother approach when it comes to new offerings. A more detailed explanation of CRH can be found in the Profiles section of this book, and at the end of this chapter there is an overview in table form.
Implementation of CRD into French law triggers amendments to the OF framework
CRH more strongly resembles other statutory covered bond products
74
The amendment was made through law Nr. 2006-872 from 16 July 2006.
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Development of common law covered bond products
In November 2006, BNP Paribas presented the first French common law covered bond programme. Basically, the bank chose this route because it could use its collateral more efficiently than with the established legal framework for OFs. In the course of the past two years, other major French banking groups followed this example and set up FCLCB programmes: Groupe Crdit Mutuel, which set up the CM-CIC Covered Bonds programme; Groupe Banques Populaires, which launched the Banques Populaires Covered Bonds programme; Caisse Nationale des Caisses dpargne et de Prvoyance, which set up the GCE Covered Bonds programme; Crdit Agricole, which set up the Crdit Agricole Covered Bonds programme; Caisse Interfdrale de Crdit Mutuel (CICM), which set up the Crdit Mutuel Arkea covered bond programme and HSBC France, which set up the HSBC Covered Bonds (France) programme. On 16 December 2009, the French government presented a number of new banking regulations 75, which also included the introduction of a legal framework for Socits de Financement de lHabitat (SFHs), which will have the right to issue Obligations lHabitat (OHs). For these entities there will be no limit on the inclusion of guaranteed loans in their cover pools. We would expect the majority of those banks who so far issue French common law covered bonds to either convert their existing funding entities into SFHs, or create a new SFH. Furthermore, the draft law includes rules that would enable SCFs and SFHs to retain own-bonds for short periods in order to use these as collateral for central bank repo transactions. This would help facilitate liquidity management in a stress scenario. The technical part of this section of the AAA Handbook is split into two. In the first part, we describe the OF framework. In the second part we describe French common law covered bonds. At the end of the section, there are separate summary tables for both instruments and also a summary table for CRH covered bonds.
Introduction of legal framework for Obligations lHabitat and ability to retain own covered bonds
Separate discussion of OFs and common law covered bonds
Part 1: Obligations Foncires

OF issuers with quite different approaches to the covered bond business
OFs are backed by a dynamic pool of public sector assets, mortgage assets or a combination of both. To issue OFs, the respective SCFs must apply to become a specialised credit institution. As described below, Dexia Municipal Agency (DEXMA) and BNP Paribas Public Sector SCF focus on the issuance of OFs with pure public sector collateral, Compagnie de Financement Foncier (CFF) and Socit Gnrale SCF combine public sector and mortgage assets within their OF businesses. CIF Euromortgage (CIFEUR) as well as GE SCF (GESCF) concentrate purely on funding mortgage assets through OFs. BNP Paribas Public Sector SCF is a wholly owned subsidiary of BNP Paribas. Its main purpose is to help finance BNP Paribas 17bn public sector loan portfolio through OF issuance. Compagnie de Financement Foncier (CFF) is a wholly-owned subsidiary of Credit Foncier de France, which, in turn, is a member of the Caisses dEpargne Group, with Caisse Nationale des Caisses dpargne et de Prvoyance (CNCE) holding 75% of CFF. CFFs main purpose is to acquire public sector assets, mortgage loans and RMBS tranches that were originated through the groups network, and refinance these assets predominantly through OF issuance. CIF Euromortgage (CIFEUR) is a wholly-owned subsidiary of Caisse Central du Credit Immobilier de France (3CIF). Its main purpose is to acquire French RMBS tranches with loans that were originated through the groups network and mix these with RMBS
75
http://www.assemblee-nationale.fr/13/dossiers/regulation_bancaire.asp
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tranches that are backed by mortgage assets from other countries of the European Economic Area (EEA). The respective cover assets are then refinanced predominantly through OF issuance. Dexia Municipal Agency (DEXMA) is owned by Dexia Credit Local. The main purpose of DEXMA is to acquire public sector assets that were originated through its parent and refinance these assets predominantly through OF issuance. GE SCF (GESCF) is 99.9% owned by GE Money Bank. The sole purpose of GESCCF is to acquire mortgages and home loans that were originated through its parent and refinance these assets predominantly through OF issuance. Socit Gnrale SCF (SGSCF) is owned by Socit Gnrale. The sole purpose of SGSCF is to provide funding for its parent. This is reflected by the fact that the proceeds of the issuance of OFs are made available by the issuer to Socit Gnrale through secured loans that rank pari passu and without priority among themselves. The respective payment obligations of Socit Gnrale will be secured by a portfolio of collateral assets, which may contain exposures to public sector entities, property loans or RMBS notes.
Strengths
A detailed analysis of all three issuers is provided in the profiles section of this book. The particular strengths of the French OF framework include: Strict segregation of all cover assets from the balance sheet of the originating entity. The limitation of liquidity and market risk, as well as the commitment to a minimum level of over-collateralisation, all can be regulated on a contractual basis and, thus, be tailored to the individual profiles of the respective issuers. In the case of the cover pool containing a mix of public sector and mortgage assets, investors may benefit from enhanced diversification, as the default probability of both asset types is generally not strongly correlated, and recovery prospects are usually rather different.
Weaknesses
The particular weaknesses of the French OF framework include: Lack of strict asset/liability matching requirements and restrictions with regards to liquidity risk and any mandatory over-collateralisation. However, in France, this is mitigated by liquidity and market risk being generally limited rather strictly on a contractual basis, and any additional risks can be offset by voluntary overcollateralisation, which is protected in an insolvency scenario and regularly subject to rating agency surveillance. Potential support from the industry is regarded as weaker compared with some other frameworks, as OF issuers specialized legal entities with no staff, but service level agreements in place. This is mitigated by an increasing volume of domestic mortgage and public sector business being funded through OFs, which, as such, favours structural support. Lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. This is mitigated by the fact that, to date, all OF issuers have reported cover pool characteristics on a regular basis.
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Collateral for Obligations Foncires

No separation of public sector assets from mortgage assets in cover pools
There is no segregation of public sector lending from mortgage lending within the SCF. The law restricts the assets that are eligible for inclusion as collateral for Obligation Foncires to: Loans to public sector entities (central, local and regional) within the EU, EEA, French overseas territories, Switzerland, Canada, Japan and the US. Normal non-guaranteed mortgages up to a maximum LTV of 60% and residential mortgages to individual mortgagors up to a maximum LTV of 80%. Guaranteed loans, which are exclusively used for the financing of real estate property. As with traditional mortgages, the LTV barrier is set at 60% for all types of property financing loans and at 80% for residential housing loans for individual borrowers. The guarantor has to be a credit institution or an insurance company with a minimum capital of 12mn and should not be consolidated to the same corporate group as the SCF. Housing loans that have a Fonds de Garantie LAccesion Sociale a French state guarantee may have an LTV of up to 100%. Guaranteed loans should not exceed 35% of all assets within the SCF. Units of residential mortgage-backed securities must have 90% or more of their assets in the eligible assets listed above. In addition, the respective securities can only make up 20% of the nominal amount of outstanding OFs in case they are not rated triple A. Otherwise, they can make up to 100% of the nominal amount of outstanding OFs. R515-4 of the Banking Act, which stipulates regulatory requirements for the inclusion of securitisation notes, explicitly states that eligibility rules will be re-examined before 31 December 2010.
Substitution assets allowed, but subject to a maximum 15%
A special supervisor (Controleur Specifique) must assess the market value of the properties financed using evaluation principles laid down in legislation (L.515-30 and Rglement n 9910). Commercial property values have to be assessed once a year if the purchase price (or the last estimated price) is above 450,000, and every three years if the price (or the last estimated price) is below 450,000, or in case of housing loans. Substitute collateral is permissible in the form of eligible assets, according to Annex VI, Part 1 point 68(c) of the EU Capital Requirements Directive. The limit on substitute collateral within the SCF is 15%.

Independent trustee appointed by Commission Bancaire, responsible for monitoring SCF activities
The Controleur Specifique is responsible for monitoring the SCFs activities. He must have accountancy qualifications and be nominated by the Commission Bancaire. He determines the eligibility of collateral with reference to legislation, the required over-collateralisation at all times, and is obliged to notify the Commission Bancaire in the case of a shortfall of collateral or a general deterioration in terms of ability to pay coupons.

French legislation limits SCF activities individual contractual clauses assure a positive net present value
To minimise risks to holders of Obligation Foncires, French law limits the activities in which SCFs can participate and prohibits them from holding equity stakes, providing traditional banking facilities or from undertaking derivative transactions, unless for hedging purposes. Bondholders enjoy the benefit of over-collateralisation, which is subject to contractual agreements. In addition, the law stipulates that while there is no legal limit on the mismatching of assets versus liabilities, at all times the SCF must prove it can repay all its liabilities with no delays. All three SCFs adopted individual contractual clauses designed to ensure a positive net present value throughout specific stress scenarios. This means that, in practice, there is little regulatory capital at risk. The loan collateral can only be financed through the issuance of OFs or unsecured borrowing.
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Bankruptcy remoteness and payment in the case of insolvency

OF holders have prior claims against all assets of the SCF
SCFs are protected by law from bankruptcy proceedings that affect their parent companies. The same legislation stipulates that all proceeds generated by a specialised mortgage credit institution must be used to pay, with priority, interest and principal to holders of Obligation Foncires. Given that SCFs can borrow funds on an unsecured basis, the law stipulates that they can also be declared bankrupt. In this instance, however, all unsecured creditors, including the fiscal authorities and employees, are subordinate to the priority claims of OF holders and have no claims on any of the assets of the SCF, until the holders of the Obligation Foncires have been paid in full. The implication of this provision is that unsecured creditors have no interest in attempting to stop SCFs from paying amounts due to OF holders.
Part 2: French common law covered bonds

Application of structured finance techniques
As mentioned above, BNP Paribas introduced the first French common law covered bond programme in November 2006. Its main aim was to make more efficient use of the banks collateral than with the established legal framework for Obligations Foncires. BNP Paribas has more than 50% of its housing loan business and about two-thirds of its current originations secured by guarantees. As such, one major obstacle that it was particularly keen to overcome was the 20% cap on guaranteed housing loans, which was increased to 35% only in May 2007. With BNP Paribas position reflecting overall trends within the French banking industry, unsurprisingly, six more issuers launched similar programmes since 2006. French common law covered bonds make full use of the implementation of the EU Collateral Directive 76 in the French Banking Act. Among other things, the respective rules protect the enforcement of financial collateral arrangements between credit institutions. French common law covered bonds are issued through a multi-stage structure. A dedicated covered bond funding entity is the issuer and is a regulated French credit institution with limited purpose. The covered bonds are limited recourse obligations of the issuer. The proceeds from the sale of the covered bonds are used to finance advances to the respective sponsoring banks (BNP Paribas, BFCM, BFBP, CNCE, CASA, CICM, HSBC France) 77. The covered bonds are secured by a pledge of the issuers assets, and the advances are, in turn, secured by a pledge over cover assets, which remain either on the sponsoring banks balance sheet and/or on the balance sheets of the respective subsidiaries, affiliates and Figure 224: Other common law covered bond structure
Cover Pool Affiliates / Subsidiaries Interest & Principal
Audit Firm Hedging Counterparties Hedging Counterparties (Hedge entered upon breach of rating trigger)
Multi-stage structure
Figure 223: BNP Paribas covered bond structure

Cover Pool Collateral Security Affiliates / Subsidiaries Interest & Principal Borrower Facility
Borrower Facility* Facility Audit Firm
Cover Pool ) XXX (Borrower) (Borrower) Collateral Security Issuer Security Agent Issuer Security Agent Interest & Principal Borrower Facility
Collateral Security
XXX (Borrower) Interest & Principal Borrower Facility
Hedging Counterparties Hedging Counterparties (Hedge entered upon breach of rating trigger)
Covered Bonds SA (Issuer) Pledge of Issuer s Interest & Assets Principal Covered Bond Proceeds
Issuer Security Agent Issuer Security Agent
Covered Bonds SA (Issuer) Pledge of Issuers Interest & Assets Principal Covered Bond Proceeds
Covered Bond Investors
Note: In case of the BFBP programme, the advances are made directly to the individual group member banks. Source: Transaction documents, Barclays Capital
76 77
Directive 2002/47 In case of the BFBP programme the advances are made directly to the individual group member banks.
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group member banks. Upon a borrower enforcement notice or in case of default of the sponsoring bank and/or the participating group member banks, the respective cover assets, including underlying securities, will be transferred to the covered bond issuer.
Covered bonds rank pari passu
The covered bonds are limited recourse obligations of the issuer backed by related secured advances. Under the terms of a borrower facility agreement, the issuers grant advances to the sponsoring bank. The terms and conditions of these advances are designed to match those of the covered bonds. The covered bonds are either fungible with an existing series or constitute a new series with different terms. All covered bonds issued under the respective programme rank pari passu with each other and share equally in the security. Subject to certain rating triggers, swaps with suitable counterparties will have to be entered to ensure that exposure to market risk, which may occur upon an enforcement of the collateral, is properly hedged. The particular strengths of French common law covered bond programmes are: Cover assets are separated from the balance sheet at the inception of the programme/issuance through the transfer of receivables to the dedicated covered bond funding entity. Cash flow adequacy is secured through the asset-coverage test and the contractual obligation to neutralise any exposure to interest rate and currency risk. Investors are well protected against liquidity risk because there is a clear escalation process in case of a credit profile deterioration of participating parties.
Strengths
Weaknesses
The relative weaknesses of French covered bond programmes are: Compared with traditional covered bond products, the programme contains a rather complex set of structural features. So far, the record of French banking regulators with regards to the surveillance of French common law covered bonds is rather limited. Within the French common law covered bond programme, regularly a substantial percentage of the cover pool assets are secured by a guarantee provided by specialist insurance companies, which partly also belong to the same financial services group as the respective sponsor bank. Thus, the cover pool is exposed to additional default risk. However, this is mitigated by the fact that upon a downgrade of the sponsor bank below a certain trigger level (generally A-), the respective programmes foresee that the sponsor bank will pay and maintain the registration cost of the mortgages or similar legal privileges securing the payment of the home loans granted by the counterparties belonging to the group.
Initial focus on French housing loans
The collateral securing the advances, which from an economic point of view is the ultimate collateral of the covered bonds, initially consisted of French housing loans, which are secured either by a mortgage or a guarantee from a third party. Being a structured programme, geographical restrictions to date have been self imposed. All common law covered bond programmes have an 80% LTV limit. When calculating the appropriate loan balance within the asset-coverage test, higher LTV loans (up to 100%) are included in the pool, but loan amounts exceeding the respective cap are not taken into account when calculating the appropriate loan balance within the asset-coverage test (see explanation below). Loans in arrears are not eligible. A maximum single-loan amount is set at 1mn in all existing common law covered bond programmes. The properties are valued using the
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French mortgage market accepted practice. The property values are indexed to the French INSEE 78 house price index or PERVAL 79 house price index on a quarterly basis. Price decreases are fully reflected in the revaluation, while in the case of price increases, a 20% haircut is applied. Substitution assets can be included in the cover pool. Their aggregate value can make up as much as 20% of cover assets and may consist of exposures that are subject to relatively high quality criteria. They consist of short-term (<1y) investments, namely bank deposits, at least rated A-1+, AA-, F1+ 80, or debt securities, RMBS notes and government debt, which all must be rated at least triple A.
Asset-coverage test ensures a level of over-collateralisation that is compliant with the target rating
To reduce the risk of a shortfall, the programme includes a dynamic asset-coverage test that requires the balance of the housing loans in the collateral pool to significantly exceed the balance of the related advances. Every month, the sponsoring bank must ensure that the adjusted aggregate asset amount will be equal to, or greater than, the aggregate principal amount of the outstanding covered bonds. Apart from the results of this calculation, a minimum over-collateralisation (108.1%) has to be maintained. The asset-coverage test comprises a number of valuation rules that are applied to the underlying assets. In the case of a breach of the asset cover test, no further covered bonds can be issued, and the issuer is obliged to restore the balance. If the breach is not rectified until the following calculation date, a borrower event of default would occur and the existing borrower advances would become immediately due and payable.

Regulated French financial institutions
The respective sponsoring banks are regulated French financial institutions, which are subject to the regulation, supervision and examination of the Commission Bancaire (French banking regulator). In their role as sponsor banks, they are responsible for the monthly pool monitoring, with the asset-coverage test calculation being checked by an independent asset monitor. Under the terms of an asset monitoring agreement, an asset monitor tests the calculation of the asset-coverage test annually. In case of noncompliance with the asset-coverage test, or if the senior unsecured rating of the sponsor bank drops below a trigger rating level 81, the test has to be checked on a monthly basis. In addition, rating agencies are heavily involved in the programme and re-affirm the ratings of the programme upon a pre-defined issuance volume. They also monitor the amount of over-collateralisation required to maintain the AAA ratings, which should comfort investors should the mortgage market weaken. Similar to other countries structured covered bond programmes, there are contractual provisions in place that stipulate that potential exposure to interest rate and currency risk has to be neutralised. At inception of the programme, the respective issuing entities are not exposed to market risks, as the payments of the sponsor bank under the respective borrower facility agreements match the cash flows for the covered bonds. Still, in case collateral assets have to be enforced, the covered bond issuers can be exposed to market risk, due to a potential mismatching between the reference rate used for the asset pool and the one used on the covered bond hedge. Thus, upon a downgrade of the sponsoring banks below A1/A-1+/F-1+, a pre-defined hedging strategy has to be implemented. A pre-maturity test has been designed for the respective programmes to ensure that sufficient cash is available to repay the covered bonds, in full, on the original maturity date
78 79
Strong protection against potential cash flow mismatches
Pre-maturity test
Institut National de la Statistique et des tudes conomiques (INSEE) The PERVAL index is calculated based on information from French solicitors. PERVAL is owned by the Conseil Suprieur du Notariat (CSN). 80 Only BNP Paribas and CM CIC. 81 The minimum ratings are generally set at Baa2/BBB/BBB with Moodys/S&P/Fitch, respectively.
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in the event of the sponsoring banks insolvency. If the sponsor banks short-term ratings fall below A-1+ (S&P), F1+ (Fitch) or P-1 (Moodys), the pre-maturity test requires the sponsor bank to cash-collateralise the payments due under the covered bonds in the six months before the final maturity date of each series. It is worth noting that the BPCOV, GCE and HSBC programmes also include the option to issue covered bonds with extendable maturity in order to mitigate exposure to liquidity risk.
Amortisation test
An amortisation test has been created that is designed to ensure that the assets will be sufficient to enable the issuer to repay the covered bonds. It only applies after a borrower enforcement notice has been delivered and, therefore, covered bond holders will be relying on the proceeds from cover assets. The amortisation test will fail if the aggregate loan amount falls below the outstanding balance of all the covered bonds. Within the amortisation test, for any loans that may fall in arrears, a 30% haircut is applied. Similar to other countries structured covered bond programmes, French programmes include a number of other safeguards. In particular, there are minimum rating requirements in place for the various third parties that support the transaction, including the swap counterparties. There are also regular independent audits of the calculations. If the borrowers short-term ratings are downgraded below A-1 (S&P), P-1 (Moodys) or F1 (Fitch), the borrower will be required to establish a reserve fund to retain an amount sufficient to meet interest and principal payments over two months on each series of covered bonds.
Other safeguards
Reserve fund

Borrower event of default
There are a number of trigger events for default in the covered bond structure, the first being a borrower event of default. This can occur in a number of situations, including: Failure by borrower to pay any interest or principal amount when due; Bankruptcy or legal proceedings being taken by the borrower; Failure to rectify any breach of the asset-coverage test; Failure to rectify any breach of the pre-maturity test; Failure to rectify any breach of reserve funding requirement; or Failure to enter into hedging agreements following a hedging rating trigger event.
No acceleration unless the issuer defaults
A borrower event of default would not accelerate payments to covered bondholders, but would allow the issuers security agent to start proceedings against the borrower and enforce security over covered assets in an orderly fashion. A second important trigger event would be a covered bond issuer event of default. This would arise after the covered bond issuer failed to make any payments when due, legal proceedings were started against the issuer, the failure of the amortisation test, or the failure to enter into hedging agreements following a hedging rating trigger event. In this case, the issuers security agent shall be entitled to enforce its rights. Payments to covered bondholders would be accelerated, and the covered bonds would be redeemed at the early redemption amount including accrued and unpaid interest relevant to that particular covered bond.
Covered bond issuer event of default
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Figure 225: Overview French common law covered bond programmes

BNP Paribas covered bonds CM CIC covered bonds Banques Populaires covered bonds
Legal form of the issuer Share capital Programme volume (bn) LTV cap Max. single-loan amount (mn) House price index Haircut for indexed valuation Maximum asset percentage applied in the ACT Minimum over-collateralisation In arrears accounting in the ACT In arrears accounting in the amortisation test Hard bullet Ratings Asset monitor
Socit anonyme directoire et conseil de surveillance 35mn 25 80% 1 INSEE 20% 92.50% 108.10% No recognition Max. 70% Yes; pre-maturity test Aaa/AAA/AAA KPMG
Socit anonyme conseil d'administration 120mn 15 80% 1 PERVAL 20% 92.50% 108.10% No recognition Max. 70% Yes; pre-maturity test Aaa/AAA/AAA Ernst & Young and PricewaterhouseCoopers Audit
Crdit Agricole covered bonds
Socit anonyme conseil de surveillance et directoire 40mn 25 80% 1 INSEE 20% 92.50% 108.10% Substitution Max. 70% Generally Yes; pre-maturity test* Aaa/AAA/Deloitte & Touche
GCE covered bonds
HSBCcovered bonds
Legal form of the issuer Share capital Programme volume (bn) LTV cap Max. single-loan amount (mn) House price index Haircut for indexed valuation Maximum asset percentage applied in the ACT Minimum over-collateralisation In arrears accounting in the ACT In arrears accounting in the amortisation test Hard bullet Ratings Asset monitor
Socit anonyme conseil d'administration 65mn 25 80% 1 INSEE 20% 92.50% 108.10% No recognition Max. 70% Generally Yes; pre-maturity test* Aaa/AAA/PricewaterhouseCoopers Audit
Socit anonyme conseil d'administration 70mn 35 80% 1 PERVAL 20% 92.50% 108.10% No recognition Max. 70% Generally Yes; pre-maturity test* Aaa/AAA/AAA KPMG
Socit anonyme conseil d'administration 28mn 8 80% 1 INSEE 20% 92.50% 108.10% No recognition Max. 70% Generally Yes; pre-maturity test* Aaa/AAA/KPMG
Note: *The programme also includes the option to issue covered bonds with extendable maturity. Source: Transaction documents
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Figure 226: Reporting overview of common law covered bond programmes (latest available data mostly Q1 10)
BNPPCB CMCIB PCOV GCE CA HSBC
Total loan balance Adjusted loan balance Outstanding mortgage bonds Credit support Current asset percentage Current over-collateralisation WA seasoning WA LTV LTV>80% (in % of tot.) Buy to let (in % of tot.) Owner occupied (in % of tot.) Vacation/second home (in % of tot.)
Source: Programme reports, Barclays Capital
27,186,852 26,185,473 19,934,708 658,078 78.10% 128.04% 48 68 38.1 15.9 79.5 4.6
25,399,170 25,001,007 16,655,000 2,966,909 78.90% 126.74% 48 68 33.8 13.6 83.8 2.6
17,156,948 16,675,839 14,205,000 969,161 92.50% 108.11% 44 69 39.9 7.6 89.9 2.5
26,975,346 26,305,386 19,250,000 1,368,154 78.40% 127.55% 52 66 34.0 4.3 93.5 2.2
8,581,904 8,502,393 4,750,000 2,632,453 88.90% 112.49% 56 64 25.6 10.9 86.5 2.3
3,817,189 3,695,057 1,774,254 1,529,214 87.00% 114.94% 45 69 37.0 15.6 75.9 8.5
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France Obligations Foncires
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential
Obligations Foncires. Law enacted on 25 June 1999, amended in Q2 01, Q2 02 and Q2 07 Yes; mortgage credit institutions: Socits de Crdit Foncier (SCF). Only public sector, residential and commercial mortgages, guaranteed loans, units of eligible ABS issues and bonds, issued or guaranteed by public entities. Eligible assets are transferred to the SCF, which, in turn, are fully consolidated within the parent companys balance sheet. The same SCF may acquire both public sector and mortgage loans. Hedge positions can be included in the cover register. Up to 15%. No.
Central governments and sub-sovereigns in EEA countries, Switzerland, the US, Canada and Japan. EEA countries, Switzerland, the US, Canada and Japan. Up to 60% of the value of the financed asset is eligible for the loan. This amount may be increased to 80% if the entire loan portfolio consists of loans to individuals and is intended to finance home purchases. It may be raised to 100% for loans guaranteed by the FGAS (Fonds de Garantie de l'Accession Sociale la proprit). 60%. Yes; valeur hypothcaire (market value = upper limit). Annual examination. Yes; Commission Bancaire (French banking regulator) and a special supervisor. Not compulsory, though the law requires the special supervisor to inform both the SCFs management and the Commission Bancaire if an SCF mismatching risk appears too high. OFs issued from all three issuers benefit from additional protection through contractual features. Not compulsory, but common law covered bonds may include contractual rules that stipulate that overcollateralisation adjusts to cover pool characteristics. Not compulsory, but could be included through contractual rules. No. Yes. No, but status of the issuer as a separate legal entity provides bankruptcy remoteness from the parent. all assets of the SCF. In addition, investors may have a claim on derivative counterparties. No formal recourse to assets outside the SCF, but we expect the Commission Bancaire to exert some pressure over the shareholder(s) to support the SCF. Yes. Yes.
LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching
Protection against credit risk Protection against operative risk Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms Compliance with UCITS 22(4) Compliance with CRD
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France Caisse de Refinancement de lHabitat (CRH)
CRH Covered Bond. Law enacted on 11 June 1985, amended in Q2 01, Q2 02 and Q2 07 Yes; specialised credit institution: tablissement de crdit agr en qualit de socit financire. Only mortgage notes (billets de mobilisation). CRH debt obligations are collateralised by a portfolio of mortgage notes issued by the stakeholders of CRH. The mortgage notes in turn are backed by portfolios of home loans, which are secured by mortgages or guarantees. No. Not needed in the normal course of business, due to narrow matching of assets and liabilities. Still, according to CRHs statutes, its shareholders have to make liquidity advances to CRH of up to 5% of the respective outstanding mortgage notes and capital contributions in relation to their use of the CRH scheme. Not eligible single loan amount capped at 1mn
Inclusion of hedge positions Substitute collateral
Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential
France Up to 60% of the value of the financed asset is eligible for the loan. This amount may be increased to 80% if the entire loan portfolio consists of loans to individuals and is intended to finance home purchases. The limit may be raised to 90%, if the amount of the collateralised loans exceeds that of the bonds by at least 25%. It may be raised to 100% for loans guaranteed by the FGAS (Fonds de Garantie de l'Accession Sociale la proprit). Yes; valeur hypothcaire (market value = upper limit). Monthly coverage calculation. Yes; Commission Bancaire (French banking regulator); in addition, CRH regularly audits the portfolio pledged by borrowing banks. Cash flows from mortgage notes are generally matched with payments on CRH bonds. Through high mandatory over-collateralisation. CRH has neither the capacity to manage home loans nor is it prepared to actively manage interest rate risk. Thus, investors would be exposed to operational, liquidity and market risk. However, this is mitigated by the fact that CRH would very likely seek to assign the loan portfolio to a third party and buy back outstanding CRH bonds with the respective proceeds. 125%. Yes. No, but status of the issuer as a separate legal entity provides bankruptcy remoteness from the mortgage note issuers. all assets of CRH. We would regard it as very likely that CRH may benefit from additional solvency commitments as well as operational support in case of need. Yes. Yes.
LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk
Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms Compliance with UCITS 22(4) Compliance with CRD
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France Common Law Covered bonds
French Common Law Covered bond Private legal structure based on French banking and contract law. Yes; the issuer is a special purpose credit institution. Not applicable. Covered bonds are issued by a dedicated covered bond funding entity, which grants advances to the sponsor bank. The respective advances are secured by cover assets, which are on the balance sheet of the sponsor bank. Upon a borrower enforcement notice or in case of default of the sponsoring bank, the respective cover assets, including underlying securities, will be transferred to the dedicated covered bond funding entity. Hedge positions are part of the structural enhancements intended to protect bondholders. Up to 10%. Subject to contractual prescriptions. Only performing French residential housing loans, which are secured either through a mortgage or through a guarantee agreement. Subject to contractual prescriptions. Subject to contractual prescriptions. Subject to contractual prescriptions; generally 80%. Subject to contractual prescriptions; irrelevant until now. No. Basis = market value. Indexed to house price index. Price decreases are fully reflected in the revaluation, while in the case of price increases, a haircut (20%) is applied. Yes; the French banking regulator (Commission Bancaire) and an independent asset monitor. There are contractual provisions that stipulate that exposure to interest rate and currency risk has to be neutralised. In addition, downgrade triggers for swap counterparties, the asset-coverage test, the amortisation test and the pre-maturity test are designed to ensure cash flow adequacy. Yes; defined by asset-coverage test. Yes; stipulated through contractual rules. Yes, with regards to the borrower advances; subject to the asset percentage applied in the assetcoverage test. Yes. Yes, all assets are owned by the covered bond funding entity; covered bondholders benefit from the automatic segregation of assets upon a borrower enforcement notice or an insolvency of the sponsor bank. all the payments received from the covered bond funding entity's assets. Investors continue to receive scheduled payments, as if the sponsor bank had not defaulted. Bondholders rights exclusively refer to segregated assets; there is no recourse to the sponsor bank. tbd tbd
Inclusion of hedge positions Substitute collateral Restrictions on inclusion of certain types of mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching
Protection against credit risk Protection against operative risk Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms Compliance with UCITS 22(4) Compliance with CRD
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GREEK MARKET
Overview
With only one benchmark covered bond outstanding at the time of writing, the Greek covered bond market is among Europes smallest, with a total volume of 1.5bn. The first (and hitherto only) Greek benchmark covered bond was publicly issued on the primary market in September 2009. Yet, despite the rather modest primary market appearance of Greek covered bonds so far, we emphasise that since summer 2008, Greek covered bond issuers have increasingly relied upon the issuance of covered bonds designed for liquidity operations of the European Central Bank (ECB). From July 2008 to May 2010, six benchmark deals totalling 6.5bn were issued, taking the aggregate volume of Greek covered bonds to 8bn at the time of writing (Figure 227).
Figure 227: Outstanding Greek covered bonds

Instrument Coupon ISIN Size ( bn) Launch date Spread at launch at 28 May 2010 Mid-swaps (bp) Public issuance
ETEGA Oct 2016

Likely retained issuance
3.875% ECB +110bp ECB +70bp ECB +65bp 1mth EURIBOR +35bp 1mth EURIBOR +45bp ECB +190bp
XS0438753294 XS0400240262 XS0402183940 XS0398841782 XS0378006604 XS0378340847 XS0496641761
1.50 1.00 1.00 1.00 1.00 1.00 1.50
30 Sep 2009 17 Nov 2008 27 Nov 2008 28 Nov 2008 16 Jul 2008 16 Jul 2008 17 Mar 2010
+90
+450 NA NA NA NA NA
EGNATI Nov 2010 ETEGA Dec 2014 ETEGA Dec 2013 ALPCB Jul 2011 ALPCB Jul 2013 ETEGA Aug 2018
+190
NA
At the time of writing, almost all major Greek banks were active on the covered bond market. As the amounts issued so far are markedly lower than the respective programme sizes, gross issuance might well increase in the medium to long term (Figure 228). Overshadowed by the current macroeconomic situation, however, we do not expect Greek covered bonds to be publicly issued on the primary market in the near future because the new issuance premium would likely need to be in excess of the swap spread levels of Greek government bonds, making the refinancing through covered bonds relatively unattractive. Instead, unless the overall situation improves significantly and swap spreads contract markedly again, we expect potential Greek covered bond issues to rely on the issuance of covered bonds that are tailor-made for the ECB.
Figure 228: Greek covered bond programmes

Issuer Ticker Programme size Amount issued Collateral pool OC
National Bank of Greece* Marfin Egnatia Bank** Alpha Bank
ETEGA EGNATI ALPCB
10.0bn 3.0bn 8.0bn
3.5bn 1.0bn 2.0bn
5.1bn 1.3bn
147% 132%
Note: * As at end-February 2010; ** As at end-January 2010. Source: Company information, Barclays Capital
Greek legislation allows for issuance in two ways

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The issuance of Greek covered bonds is governed by primary and secondary legislation. The principal laws that cover the issuance of covered bonds in Greece are Article 91 of Law
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3601/2007, which came into effect on 1 August 2007, and Governors Act No. 2598/2.11.2007 issued by the Bank of Greece (BoG) in November 2007 under the authority conferred on it by the primary covered bond law. In contrast to other covered bond frameworks, the Greek legislation allows for the issuance of covered bonds in two different ways: a so-called direct issuance in which cover assets remain ring-fenced on the issuers balance sheet; and an indirect issuance in which cover assets are transferred to a special purpose vehicle (SPV), which then acts as the issuer of covered bonds.
Figure 229: Generic Greek (indirect) covered bond transaction structure

Repayment of Intercompany Loan Intercompany Loan Interest Rate Swap Provider(s) Covered Bond plc (Issuer) Purchase Price Sale of Mortgage Loans and Related Securities Covered Bond Proceeds Covered Bonds Bank (Seller and Guarantor)
Covered Bond Swap Provider(s)
Covered Bond Holders/Trustee
Covered Bond Guarantee
Indirect issuance through SPV
Within the scope of the indirect issuance (Figure 229), cover assets are transferred to a SPV, which then acts as the issuer of covered bonds. The debt issued by the SPV is guaranteed by a credit institution as if it were the principal obligor. Technically, within the scope of the indirect issuance, the bank sells the cover assets to the issuer (SPV). The purchase is funded through a subordinated inter-company loan, which will be redeemed with proceeds from the sale of covered bonds. The inter-company loan will furthermore fund a reserve account that is set up on establishment of the covered bond programmes to cover interest payments due on the liability side and senior expenses for one month. The indirect issuance structure is formally allowed under 10 of the Primary Greek Covered Bond Law, which allows the issue of covered bonds by a Greek credit institution directly or by a SPV with its registered office either in Greece or in a member state of the European Economic Area (EEA). The SPV needs to be solely consolidated with the relevant sponsor bank. Greek provisions on solo consolidation enable the Bank of Greece to allow sponsor banks to take into account subsidiaries with material obligations existing vis--vis the credit institution when determining their capital adequacy on an unconsolidated basis. In economic terms, we believe that for Greek entities, the indirect issuance of covered bonds is more relevant because it enables investors to circumvent the Greek withholding tax that applies in the case of a direct issuance. Also, the indirect approach is the standard method of Greek banks when issuing senior debt.
Issuance through SPVs incorporated under UK law
Within the scope of the Greek indirect covered bond programmes established so far, the covered bond issuers are SPVs incorporated under UK law. The SPV will issue the covered bonds as direct, unconditional and subordinated obligations. At the same time, the sponsor bank (ie, the guarantor) grants an unconditional, first-demand guarantee on the covered bond, which is drafted under UK law. According to the rating agencies, this choice will be
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recognised and applied by the Greek courts, and the guarantee ensures the dual recourse against the cover assets and a financial institution, thereby constituting an essential feature of covered bond issuance.
Covered bond holders benefit from preferential claim
According to 10 of the primary Greek covered bond legislation in combination with Article 10, 18 of the Greek securitisation law, if insolvency proceedings are commenced against a sponsor bank or SPV that has previously issued covered bonds, the holders of those covered bonds and the secured creditors will have a preferential claim on the cover assets located in Greece as a result of a statutory pledge. According to Article 451 of the Greek Civil Code and 8 and 10 of the primary Greek covered bond legislation, the statutory pledge created in favour of the trustee, for the benefit of, among others, the covered bond investors, enjoys priority over all other rights, including potential rights arising from set-offs. The Greek covered bond legislation in combination with the Greek securitisation law provides for a true sale of the assets to the issuer (ie, the SPV). The legal effect of the true sale is to segregate the assets over which the covered bond investors will have special creditor privilege in the event of an issuers winding down or dissolution. The special creditor privilege foresees that no other creditor of the covered bond issuer will be able to claim any rights over the collateral pool until all amounts due to the covered bond investors have been fully repaid. In this context, the inter-company loan to the SPV from the issuing bank is also subordinated. In order to issue covered bonds pursuant to the Greek covered bond legislation, institutions must have a regulatory capital of at least 500mn and a capital adequacy ratio of at least 9% at the time of issuance. Furthermore, in the case of total assets comprising the collateral pool exceeding 20% of the available assets of the institution (as issuer or guarantor), the Bank of Greece may impose further capital requirements. When determining whether to impose additional capital requirements, the Bank of Greece will take several factors into consideration, among them the possibility of any significant deterioration of the average quality of the available assets for the institution following the issuance of covered bonds. Available assets in this context refer to the issuers or guarantors assets on an individual basis, thereby excluding any receivables transferred to a SPV under Article 10 of the Greek Securitisation Law, assets that are the underlying instruments of reverse repos and assets charged in favour of third parties. In our view, among the strengths of the Greek covered bond programmes are: In case of an indirect issuance, cover assets are separated from the balance sheet of the guarantor at inception of the programme through a true sale to the covered bond issuer. Cash flow adequacy is secured through a nominal value test, a net present value (NPV) test and an interest cover test. Furthermore, any exposure to interest rate and currency risks has to be neutralised. Investors are protected against liquidity risk because there is a clear escalation process in the case of a deterioration of the credit profile of participating parties.
True sale structure
Legal requirements
Strengths
Weaknesses
Among the weaknesses of the Greek covered bond programmes, in our opinion, are: Compared with other covered bond legislations, the issuers choice between a direct or indirect covered bond issuance adds to a lower level of standardisation. As the issuer of indirectly issued Greek covered bonds is an SPV and thus not a regulated financial institution, indirectly issued Greek covered bonds do not comply with the definition of covered bonds as applied in Article 22 (4) of the Undertakings for
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Collective Investment in Transferable Securities Directive (UCITS), or the European Capital Requirements Directive (CRD). This does not apply for directly issued Greek covered bonds, however. In the issuers event of default, there is a potential risk that depositors with the sponsor bank will try to offset losses suffered on their deposits against amounts they owe to the bank under their residential mortgage loan. In our view, this is mitigated by the fact that exercising set-off rights can only occur after all covered bonds (and privileged creditors) have been repaid in full.
Qualifying collateral for Greek covered bonds

Collateral of covered bond programmes consists of residential mortgage loans
According to the Greek covered bond legislation, the eligible assets for the collateral pool backing covered bonds issued include loans secured by mortgages on residential and commercial property (provided that the security over such real estate is governed by Greek law), loans secured by ship mortgages, loans granted to or guaranteed by certain governmental bodies, government-issued securities and other highly rated securities, among others ( 8(b), Section B, Bank of Greece Act No. 2588/20.8.2007). Within the scope of the existing Greek covered bond programmes, however, the collateral consists of residential mortgages located in Greece. Substitution assets can be included in the cover pool up to an aggregate value of 15% of the cover assets. Among these are euro-gilt edged securities, high-quality deposits and debt obligations, as well as high-quality government securities with a maturity of up to one year and RMBS securities satisfying certain minimum rating criteria with maturities of up to one year. There is no restriction with regard to the proportion of residential or commercial mortgages or other eligible assets in the collateral pool. In order to include assets governed by foreign law in the collateral pool, a legal opinion needs to be submitted to the Bank of Greece confirming that the security created over these assets is valid, binding and enforceable under the provisions of the applicable foreign law. To be eligible for inclusion in the collateral pool of Greek covered bonds, mortgage loans need to comply with a maximum loan-to-value (LTV) ratio of 80% in the case of residential and 60% in the case of commercial loans. Loans with higher LTV ratios can also be included in the collateral pool, but those parts of the loan with an LTV higher than 80% cannot be taken into consideration when testing for compliance with the mandatory tests. Generally, loans being in arrears are not eligible and need to be replaced.
Three mandatory tests
The Greek covered bond legislation prescribes a total of three mandatory tests to determine the relationship between the collateral provided and the covered bonds issued. Nominal value test: The covered bond issuer and the respective guarantor have to ensure that on each calculation date the nominal value of the covered bonds outstanding does not exceed 95% of the nominal value of the collateral pool. In order to assess compliance with this nominal value test, the assets comprising the collateral pool shall be evaluated at their nominal value plus accrued interest. NPV test: The covered bond issuer and the respective guarantor have to ensure that on each calculation date, the NPV of the collateral assets (including swaps) is at least equal to the NPV of the covered bonds outstanding. The Bank of Greece (BoG) furthermore requires compliance with this test under a stress-test scenario, comprising a 200bp parallel shift of the interest yield curve. Interest cover test: The covered bond issuer and the respective guarantor have to ensure that on each calculation date, the amount of interest payments expected on the cover
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assets needs to be at least equal to the interest payable on the covered bonds issued 12 months from the calculation date.
Breach of asset coverage test triggers issuers event of default
The breach of any one of these three mandatory tests triggers the guarantors event of default. In consequence, the issuer will have to perform an asset coverage test, which is met if the aggregate loan amount is at least equal to the principal outstanding of the covered bonds. The breach of the asset covered test triggers an issuers event of default and leads to an acceleration of the covered bonds issued. In accordance with the Greek covered bond legislation, the statutory pledge created in favour of the trustee (Figure 229) has priority to all other rights, including those arising from a potential offset when loans are held by the covered bond issuer. Yet, in the issuers event of default, we believe there is a potential risk that depositors with the sponsor bank try to offset losses suffered on their deposits against amounts they owe to the bank under their residential mortgage loan. Evidently, this creates a potential risk for covered bond holders regardless of the contractual elements of the deposits and loans. However, in our view, exercising offset rights can only occur after all covered bonds (and privileged creditors) have been repaid in full, as this would otherwise contradict the statutory pledge created in favour of the covered bond investors over the cover pool, as outlined in the Greek covered bond legislation. Following a guarantor event of default and the service of a guarantor acceleration notice (but prior to service of an issuer acceleration notice) and as long as covered bonds remain outstanding, the issuer has to ensure that on each calculation date the aggregate loan amount determined by the amortisation test is at least equal to the aggregate principal amount outstanding of the covered bonds. The amortisation test will be carried out by the servicer on each calculation date following the guarantor event of default and service of a guarantor acceleration notice. A breach of the amortisation test constitutes an issuers event of default, upon which the trustee can accelerate the obligations of the issuer and the guarantor under the covered bonds and require all amounts (within the scope of the covered bonds and the covered bond guarantee) to become immediately due and payable. Following the acceleration, the trustee can enforce the security over the charged property (including the loans and their related security) after having been indemnified and/or secured to its satisfaction.
Potential offset risk
Breach of amortisation test triggers issuers event of default

The hitherto established Greek covered bond programmes feature contractual provisions that stipulate interest rate exposure has to be neutralised. In addition, downgrade triggers for swap counterparties, maturity extension rules and the amortisation test all ensure cash flow adequacy.
Soft-bullet maturity
The Greek covered bond programmes feature a soft-bullet maturity. Following the serving of a notice to pay, the guarantor may not have sufficient proceeds for a timely repayment of the covered bonds that mature soon after such an event. In this case, the legal final maturity will be extended by 12 months to allow for a realisation of cover assets. The current Greek covered bond programmes include a number of further safeguards. In particular, there are minimum rating requirements for third parties supporting the transaction, including the currency and interest rate swap counterparties, as well as the cash manager. Under the terms of the covered bond swaps, in the event that the relevant rating of the swap provider or any guarantor of the swap providers obligations is downgraded below a rating previously specified in the swap agreement, the swap provider
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Additional safeguards
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will be required to take certain remedial measures, among them the provision of collateral for its obligations under the swap, arranging for its obligations under the swap to be transferred to an entity with the ratings required, or any other action agreed upon with the relevant rating agencies. In addition, if the net exposure of the covered bond issuer against the swap provider under the relevant swap exceeds the threshold specified in the relevant swap agreement, the swap provider may be required to provide collateral for its obligations. A failure to take such steps will, subject to certain conditions, allow the covered bond issuer to terminate the swap. Furthermore, as an additional safeguard, independent audits of the asset coverage test calculations are undertaken on each quarterly calculation date.
Reserve fund
The reserve fund is set up to cover up to one month of interest due on the covered bonds issued as well as senior expenses. The respective amount will be retained in a so-called reserve fund GIC account. If subsequently there is an issuer event of default, the contents of the reserve fund will form part of available revenue receipts to be used by the guarantor to meet its obligations under the covered bond guarantee.

Bankruptcy proceedings against sponsor bank do not result in acceleration of covered bonds
10 of the secondary Greek covered bond legislation stipulates that the initiation of bankruptcy proceedings against the sponsor bank does not necessarily have to result in the acceleration of the covered bonds issued. Accordingly, the insolvency or other event of default of the guarantor will result in the guarantee given on the covered bonds accelerating against the guarantor, but will not result in an acceleration of the covered bonds issued. The issuer event of default, however, will result in the acceleration of the covered bonds issued. Upon the latter, all amounts due on the covered bonds issued and thus (provided it had not accelerated previously) the guarantee pledged on the covered bonds will accelerate and become due and payable immediately. Covered bond investors will in that case not continue to receive payments as outlined in the original terms of the covered bond programmes. According to the covered bond programmes established so far, issuer events of default occur: If default is made on behalf of the covered bond issuer for a period of at least seven days in the payment of any amounts due under the covered bonds; Through failure by the issuer to pay any interest or principal due on the covered bonds of any series for more than 30 days; Through failure by the issuer on any other obligation under the covered bonds for more than 30 days; Through bankruptcy or appointment of a liquidator taking control of the issuer or its assets; By failure to rectify any breach of the asset coverage test. In summary, the indirect issuance of Greek covered bonds bears some resemblance to the structure of UK covered bonds, with the covered bond issuers in fact being SPVs incorporated under English law. This setup is required to circumvent the otherwise applicable Greek withholding tax.
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The Greek housing and mortgage market

House prices started falling in Q3 08
As most other European countries, Greece was also subject to a market deceleration in house price growth over the past two years. This is particularly obvious in the case of the larger Athens area where prices for residential property fell 5.4% y/y in Q3 09, the latest date for which data were available. Weakening house prices started gaining momentum in late 2008 when the house price index started contracting after four years of positive price growth. Similar developments can be observed in other urban areas in which the decline in house prices started slightly later and was not as pronounced as in the case of Athens. In Q3 09, the latest date for which data were available, house prices in the urban areas of Greece had fallen 0.7% y/y ie, more modestly than in Q1 09 (-2.5% y/y) and Q2 09 (-1.9% y/y), respectively (Figure 230). In light of the current economic difficulties in Greece, we do not expect house price growth to recover markedly in the near term. For historical reasons, Greece has one of the highest home-ownership ratios in the EU, amounting to approximately 84% as of year-end 2007. This is clearly above the euro area average of roughly 60%. Still, reflecting the aftermath of the regulation of the Greek mortgage market, per capita mortgage debt stood at a modest 5,100 less than half of the EU-27 average of 11,600 as at year-end 2006, the latest date for which data were available. In terms of residential debt-to-GDP ratio, the respective level stood at a moderate 29.3% (ie, clearly below the EU-27 average of 49.0%) 82.
Pace of residential mortgage lending declining
The decline in Greek house prices will likely not be offset by the pronounced fall in mortgage rates. Whereas the average applicable interest rate for floating rate mortgage loans, which accounted for roughly 80% of all new mortgage lending volumes at the time of writing, stood at 5.5% in September 2008, it had fallen to 3.1% by January 2010, the latest date for which data were available (Figure 231). Despite mortgage financing thus being historically cheap, we do not expect Greek house prices to benefit markedly from this development, as demand will likely remain muted because of the countrys macroeconomic situation. In line with this development and overshadowed by the ongoing economic deceleration, aggregate Greek mortgage lending increased at a modest 3.7% y/y from December 2008 to December 2009, the latest date for which data were available (Figure 235). As the Greek mortgage market is heavily geared towards mortgage loans with a rate fixation of less than one year or floating, we furthermore expect a high proportion of this growth to be attributed to mortgage borrowers rolling their debt. Note that since early 2009, roughly 80% of all newly granted mortgage loans had a floating interest rate or a rate fixed for a period of up to one year, strongly up from c.30% observed in 2007 and 2008. The weight of other instruments, among them longer dated, fixed rate mortgage loans, fell markedly (Figure 234). Following a decade of strong growth in residential mortgage lending from 1996 to 2006, the pace of lending showed the first signs of slowing in 2007. As a result of the 1994 deregulation of the Greek mortgage market, interest rates, which had previously been administratively set, increasingly became subject to competition among the banks. Furthermore, in the run-up to Greeces membership in the European Monetary Union (EMU), interest rates generally came under pressure, thereby exerting additional downward pressures on interest rates in mortgage loans. The consequent fall in interest rates, both in nominal and real terms, with a floating interest rate or a rate fixed for a period of up to one year falling to 4.4% as at year-end 2006 from 20% as at year-end 1993, clearly fuelled demand for mortgage loans. According to data provided by the Bank of Greece, housing
82
Source: European Mortgage Federation.
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loans (excluding securitised loans) amounted to 80.6bn as at year-end 2009, the latest date for which data were available. As at year-end 2003, the Greek residential mortgage market had a size of only 26.5bn (Figure 232).
Deregulation of mortgage market in 1994
Prior to 1994, only specialised credit institutions such as the Deposits and Loans Fund, the National Mortgage Bank of Greece, the National Housing Bank of Greece, the Postal Savings Bank and Aspis Bank were permitted to engage in mortgage lending in Greece. In 1994, commercial banks were then allowed to enter the relatively modestly developed market. As a result of the previous regulation, Greek households were rather credit constrained, with housing purchases often made in cash obtained through savings or intra-family transfers, or through financing provided by property developers. However, with property developers financing themselves through bank loans, this corresponded to indirect bank lending to those acquiring residential property. Still, the previous credit constraints of Greek households led to significant pent-up demand for mortgage loans, which, following the 1994 deregulation, was increasingly met by commercial banks 83. Furthermore, as a result of the deregulation process, mortgage loans for residential properties became an increasingly important constituent of bank portfolios, with the share of mortgage loans in total bank loans doubling from 14% as at year-end 1995, to 29% as at year-end 2005.
83
Source: The interaction between mortgage financing and housing prices in Greece. Sophocles N. Brissimis and Thomas Vlassopoulos, Bank of Greece Working Paper Nr. 58, March 2007.
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Figure 230: Annual house price variation (% y/y)

20 15 10 5 0 -5 -10 Dec-01
Figure 231: Interest rate for housing loans (%)

8
2 Sep-02
Dec-03 Urban areas Dec-05 Dec-07 Dec-09 Athens
Mar-04
Sep-05
Mar-07
Sep-08
Mar-10
Floating or < 1yr fixation >5 and <10yr fixation

Source: Bank of Greece, Barclays Capital
>1 and <5yr fixation >10 yr fixation
Source: Bank of Greece, Haver Analytics, Barclays Capital
Figure 232: Residential mortgage lending in Greece (bn)

90 80 70 60 50 40 30 20 Oct-03
Figure 233: Volume of new residential mortgage lending (nsa)

3 bn
0 Jan-04
Jul-05
Jan-07
Jul-08
Jan-10
Oct-04
Oct-05 Oct-06
Oct-07
Oct-08
Oct-09
Floating or <1yr fixation >5 and <10yr fixation

>1 and <5yr fixation >10 yr fixation
Figure 234: Type of new mortgage loans granted (%)

100%
Figure 235: Mortgage lending (annual variation, %)

40
80%
30
60%
20
40%
20% Floating or <1yr fixation >5 and <10yr fixation 0% Jan-04 Jan-06
10
>1 and <5yr fixation >10 yr fixation Jan-08 Jan-10
0 Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
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Greece
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities Asset allocation Inclusion of Hedge Positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets
Greek Covered Bonds Greek covered bond law and a secondary regulation No; any Greek Bank Not applicable In the case of the so far established Greek covered bond programmes based upon the indirect issuance scheme, cover assets are segregated through a transfer to a separate entity (SPV). Hedge positions are part of the structural enhancements intended to protect bondholders. Up to 15% in the currently established covered bond programmes. In the currently established covered bond programmes, the collateral consists of prime residential loans secured by first-lien mortgages. Not applicable. Republic of Greece. (The Greek Covered Bond Law provides that in order for any assets governed by foreign law to be included in the Cover Pool, a legal opinion must be submitted to the Bank of Greece confirming that the security created over such foreign assets is valid, binding and enforceable under the provisions of the applicable foreign law.) 80% Not applicable No. Basis = market value Subject to bank-internal procedures Bank of Greece and an independent trustee Within the Greek covered bond programmes established so far, there are contractual provisions that stipulate that exposure to interest rate and currency risk has to be neutralised. In addition, downgrade triggers for swap counterparties, maturity extension rules and the amortisation test all ensure cash-flow adequacy. Yes; defined by asset coverage test Yes; stipulated through contractual rules Yes; subject to the asset percentage applied in the asset coverage test. Yes. No, but within the scope of an indirect covered bond issuance, all assets are ring-fenced within a specially separated entity all the payments received from the special entity's assets. These payments are collected in a GIC account. Investors continue to receive scheduled payments, as if the issuer had not defaulted. In the event of insufficient pool assets proceeds to cover their claim, investors rank pari passu with senior debt holders. There is a simultaneous unsecured dual claim against the guarantor and secured against the portfolio held by the specially separated entity. Yes. (In the case of a direct issuance.) Yes. (In the case of a direct issuance.)
LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching

Source: Barclays Capital.
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IRISH MARKET

Issuance of jumbo Asset Covered Securities (ACS) started in 2003. Shortly after inception, the market grew strongly, then stabilised at 35bn and then decreased slightly below 30bn. As of mid-May 2010, the total volume of outstanding jumbo ACS was 25bn. The market consisted of five issuers with a total 13 issues. DEPFA ACS is the largest, with a market share of 57%, followed by Bank of Ireland Mortgage Bank (22%) and Allied Irish Mortgage Bank (11%). The average size of jumbo ACS is currently 1.9bn. Over a long period, spreads tightened consistently and reached historical lows in early 2007, but they have been under pressure since mid-2007. Initially spread widening was more pronounced in mortgage ACS because of a general supply overhang of mortgage-secured debt instruments, combined with a more negative market perception. However, the break out of the crisis surrounding Depfa Bank plc pushed the spreads of its public sector ACS above those for mortgage ACS. The significant overall spread tightening in Q2 09 was followed by a phase of spread stability, until spreads started to re-widen in Q2 10. Figure 237: Market share, May 2010
EBSBLD 4% WESTLB 6% AIB 11%
Strong swings between public sector and mortgage ACS since mid-2007

bn 40 35 30 25 20 15 10 5 0 2003 2004 2005 2006 2007 2008 2009 2010 bn 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jumbo Asset Covered Securities Averge size of Jumbo Asset Covered Securities (RS)
BKIR 22%
DEPFA 57%

600 500 400 300 200 100 0 -100 03 04 05 06 07 08 09 10 Euro Irish Covered ASM 5Y Irish Mortgage ACS 5Y Irish Public ACS (Depfa)
Figure 239: Credit term structure of major issuers

Barcap OAS 250 200 150 100 50 0 2008
2011
2013 DEPFA
2016 BKIR
2019 AIB
2021
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Covered bond legislation enacted in 2001
In 1995, when German mortgage banks began to issue jumbo Pfandbriefe, the financial authorities were considering establishing a covered bond framework in Ireland. With the introduction of the euro in 1999, the initiative gained momentum. The Irish mortgage lending industry was keen on developing a more efficient and competitive instrument to fund the rapidly expanding mortgage business. In addition, the project was regarded by financial authorities as important for strengthening the Irish capital markets position versus its European peers. The initiative proved successful and, on 18 December 2001, the Asset Covered Securities Bill was enacted. Shortly after, the first designated credit institutions (DCIs) were established. Pursuant to the Irish Law, cover assets have to be transferred to a DCI, but can also be originated by it. The DCI is obliged to keep public sector and/or mortgage loans in separate cover registers. These segregated assets then serve as cover for Asset Covered Securities (ACS), which are either backed by public sector assets, residential mortgage assets or, since the introduction of new legislation in April 2007, commercial mortgage assets. To issue ACS, the respective DCIs must apply to become a designated mortgage credit institution, a designated public sector credit institution or both. As described below, DEPFA ACS BANK and WestLB Covered Bond Bank focus on the issuance of public sector ACS, while Allied Irish Mortgage Bank, Anglo Irish Mortgage Bank, Bank of Ireland Mortgage Bank and EBS Mortgage Finance concentrate on issuing mortgage ACS: Allied Irish Mortgage Bank is part of Allied Irish Banks (AIB) mortgage business and is 100%-owned by AIB. Its main purpose is to acquire mortgage loans originated by AIB and refinance them predominantly through the issuance of mortgage ACS. Anglo Irish Mortgage Bank is a wholly-owned subsidiary of Anglo Irish Bank (ANGIRI). Its main purpose is to acquire commercial mortgage portfolios originated by its parent and refinance them predominantly through the issuance of mortgage ACS. It is the first issuer of commercial mortgage ACS. Bank of Ireland Mortgage Bank is part of Bank of Irelands Retail Financial Services Ireland Mortgage business and is 100% owned by Bank of Ireland. Its main purpose is to acquire mortgage loans originated by Bank of Ireland and refinance these loans predominantly through the issuance of mortgage ACS. DEPFA ACS BANK is 100%-owned by DEPFA Bank plc. Its main purpose is to carry out the wholesale funding activities for DEPFA Bank plcs public sector business, largely through the issuance of public sector ACS. In 2007, DEPFA Bank plc became part of Hypo Real Estate Group, assuming responsibility for the groups public sector finance business. Following the groups nationalisation in 2009, DEPFA Bank plc is subject to the groups restructuring. EBS Mortgage Finance is part of EBS Building Societys (EBSBLD) mortgage business and is 100% owned by EBSBLD. Its main purpose is to acquire residential mortgage loans originated by EBSBLD and refinance them predominantly through the issuance of mortgage ACS. WestLB Covered Bond Bank plc is a wholly-owned subsidiary of WestLB AG. Initially, WestLB Covered Bond Bank plc enjoyed a key strategic role within the WestLB AG group in refinancing public sector operations, mainly through the issuance of public sector ACS. On 22 July 2005, WestLB AG announced it would resume Pfandbrief issuance out of Germany, scale back the activities of WestLB Covered Bond Bank plc and consider strategic options for its Irish funding arm. In May 2010, 100% of the ownership of WestLB Covered Bond Bank was transferred to Erste Abwicklungsanstalt (EAA), the work-out entity of WestLB supported by the state of North-Rhine Westphalia. In the course of the transfer, EAA
Existing issuers focus on either the mortgage or the public sector business
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irrevocably and unconditionally became the principal obligor of WestLB Covered Bond Bank plcs obligations. At the time of writing, West LB Covered Bond Bank plc had only one jumbo public sector ACS outstanding, the 1.5bn 4.0% WESTLB March 2014.
Amendment passed in April 2007
On 9 April 2007, an amendment of the Asset Covered Securities Act was passed, and on 31 August 2007, secondary legislation was signed. The bill was put in place in response to the developing nature of the business and to anticipate the effect of new EU provisions. Some of the key amendments include the introduction of mandatory minimum over-collateralisation (residential: 3%; commercial: 10%), the use of commercial mortgages as 100% backing for ACS, a reduction in the limit for the inclusion of substitution assets to 15% from 20%, the use of securitised mortgage loans as backing for the bonds, and the addition of New Zealand and Australia to the list of category A countries. Within the past 12 months, due to the challenging conditions in jumbo covered bond markets, opportunities to tap the jumbo market have been very limited and only two new benchmark deals were launched. At the same time, the focus has shifted more towards private placements. Strict segregation of all cover assets from the balance sheet of the originating entity. Particularly firm matching requirements, which stipulate: that the duration of the assets must not be less than that of the securities; that over a rolling 12 months, interest receivable on the assets is not less than interest payable on the ACS; and that the currency of the assets matches that of the ACS after hedging. The ability of the Irish National Management Treasury Agency (NTMA) to execute management functions in case an ACS issuer runs into an insolvency scenario, as well as the real-time monitoring through the cover asset monitor.
Recent developments
Strengths
Weaknesses
Lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. This is mitigated by the fact that, to date, all ACS issuers have reported cover pool characteristics and risk management indicators on a regular basis. Potential support from the industry is regarded as weaker compared with some other frameworks, as there are only a few ACS issuers, and some of them have a non-Irish background. This is mitigated by the fact that reliance on potential support generally makes issuers reluctant to strive for a valid business model and gives investors an excuse for having a sloppy attitude with respect to surveillance. In addition, the importance of the financial services industry to the Irish economy and the increasing volume of domestic mortgage business, which is funded through ACS, are strong arguments in favour of strict surveillance and structural support.
Qualifying collateral for ACS

LTV of 75% for residential mortgages
Assets eligible for inclusion in the cover asset pool are mortgage credit assets, cover asset hedge contracts and substitution assets. Only mortgages with loan-to-value (LTV) ratios not exceeding 75% for residential properties and 60% for commercial real estate are eligible for inclusion in the cover asset pool (mortgages with an LTV greater than the maximum may also be included, but the amount by which the principal amount of the assets exceeds the LTV has to be disregarded). Mortgage credit assets and substitution assets located in EEA countries can be included in the asset pool without restrictions, as well as exposure to A countries (eg, Australia, Canada, Japan, New Zealand, Switzerland and the US). Mortgage loans to B countries (eg, OECD countries that
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EEA with restrictions, and some OECD countries with a 10% limit
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have not rescheduled their external debt in the preceding five years) cannot be included in the cover asset pool. Commercial properties can be included in the asset pool of a mortgage covered security, provided that they account for less than 10% of the prudent market value of the mortgage credits in the asset pool. Geographical restrictions for commercial mortgage covered securities are similar to those for residential mortgage covered securities. Substitution assets (essentially deposits with eligible financial institutions, as well as assets approved by the IFSRA) cannot exceed 15% of the prudent market value of the asset pool.
Inclusion of MBS is subject to a list of criteria and only up to 20%
Following the amendment in April 2007, both types of mortgage covered securities may also include securitised mortgage credit assets. This is subject to a list of criteria. For example, the securitisation entity, which is the issuer of the securitised mortgage credit assets, has to be established under and subject to the laws of an EEA country; at least 90% of the assets held by the securitisation entity have to comprise of one or more mortgage credits, which, if held by a designated mortgage credit institution, would qualify as mortgage credit assets; and the securitised mortgage credit assets must constitute senior claims of the securitisation entity. In addition, the inclusion of MBS should not exceed a certain percentage of the cover asset pool. This percentage may be specified by the IFSRA by regulatory notice. The percentage has been set at 20%, to be in line with the CRD regime. For public loan-backed ACS issuers (eg, DEPFA ACS), assets that are eligible for inclusion in the cover asset pool are public credit assets (these include financial obligations to public sector entities as defined by the CRD), cover asset hedge contracts and substitution assets. Public credit assets and substitution assets located in EEA countries are eligible for inclusion in the asset pool with no limitations, as well as exposure to A countries. Exposure to B countries is subject to the upper limit of 10% of the prudent market value of all the public credit assets and substitution assets held, but lending to these countries cannot be included in the asset pool cover. Substitution assets cannot exceed 15% of the prudent market value of the asset pool. Pursuant to the Asset Covered Securities Act, designated credit institutions must keep a register for the assets (including substitution assets) included in the asset cover pool. Details of the asset hedge contracts entered into also have to be kept in the register. Institutions that are designated mortgage credit institutions, designated commercial mortgage institutions and public credit institutions are required to keep separate registers for their mortgage, commercial mortgage and public credit covered securities businesses. The registration is supervised by a cover asset monitor effectively, a trustee appointed by the institution, subject to approval from the IFSRA. To ensure adequate levels of liquidity without diverting too many resources away from the designated credit institutions core activity of providing mortgages or public sector loans, the Asset Covered Securities Act allows designated credit institutions to hold 10% of their assets in the form of credit transaction assets (eg, deposits with eligible financial institutions, financial assets and other transactions designated as a credit transaction by the Minister of Finance).
Rather broad geographical scope for the asset pool of public sector ACS
Derivatives within the pool
Use of credit transaction assets

Trustee concept
To ensure that the pools provide adequate coverage for covered securities outstanding, inclusion (or removal) of assets in (from) the relevant asset pool is possible only after approval by the cover-asset monitor (ie, a trustee), whose role is to monitor ongoing compliance with existing legislation/regulations for the benefit of preferred bondholders. Importantly, the cover asset pools are managed dynamically, with eligible assets used to replace assets that no longer qualify for inclusion in the pool.
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The aggregate principal amount of the outstanding ACS issued by a designated credit institution must be covered by assets that qualify for use as cover under the provisions of the Asset Covered Securities Act, (cover asset hedges are included in the calculations). To ensure this matching principle and to minimise the adverse effects that unexpected market movements may have on P&L and the balance sheet, the Asset Covered Securities Act, specifies that:
Limitations on yield curve risk, interest cover and FX risk, as well as a stress test
The duration of the asset cover pool has to be equal to or greater than that of the covered securities issued. To limit the potential mismatch, a regulatory notice, which became effective on 13 August 2002, clarified that the weighted-average duration of the public cover asset pool must not be more than three years greater than the weightedaverage duration of the public ACS issued. The prudential market value of the asset pool has to be greater than that of the covered securities issued. The interest generated in any given 12-month period by the asset pool has to be greater than the interest payable on the covered securities issued. The currency of denomination of the assets in the pool has to be the same as the covered securities issued. The issuing entity has to manage its interest rate position to ensure that a 1% shift and twist in the yield curve does not exceed, in net present value terms, 10% of own funds.
Mandatory over-collateralisation on a net present value basis
The ACS Act also stipulates a 3% mandatory over-collateralisation for mortgage and public sector ACS, and a 10% mandatory over-collateralisation for commercial mortgage ACS on a net present value basis. It is also worth noting that the level of mandatory overcollateralisation does not affect any higher existing contractual minimum overcollateralisation levels. If asset covered securities provisions, including the matching requirements mentioned above, are breached, the institution will not be able to issue any further ACS until the violation(s) is (are) rectified.

No acceleration as long as cover pools integrity is not breached
In the event of a designated credit institution becoming insolvent, potentially insolvent, having difficulties that threaten the position of creditors or having its licence revoked, the IFSRA may request that the National Treasury Management Agency (NTMA) appoint a new manager to assume control of the asset cover pools and manage them in the commercial interest of the holders of asset covered securities issued by the institution and persons with whom the institution has entered into cover asset hedge contracts. If the NTMA is unsuccessful in finding a qualified manager for this role, the IFSRA may appoint the NTMA to manage the asset covered securities activities of a designated or formerly designated credit institution. Given this, it is important to note that the NTMA is prepared to perform back office functions. In case of insolvency of a designated credit institution (or its parent), the asset cover pools and associated cover asset hedges are excluded from the estate of the insolvent institution, and neither outstanding ACS nor cover asset hedge contracts are accelerated as long as the cover asset pool continues to perform. Managers and cover-asset monitors (defined in the current legislation as super-preferred creditors) rank ahead of any preferred creditor. Preferred creditors (ie, holders of ACS and persons with whom the institution has entered
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In the worst-case scenario, ACS investors rank pari passu among themselves
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into cover asset hedge contracts), in turn, rank pari passu among themselves, and have preferential claims with respect to the covered asset pools. The two pools of assets will be treated as separate pools, meaning that holders of mortgage covered securities have preferential claim only over the mortgage cover asset pool, and holders of public credit covered securities have preferential claim only over the public cover asset pool. If the claims of a preferred creditor are not fully satisfied from the proceeds from the disposal of covered assets, these creditors become unsecured creditors for the unsatisfied portion of their claims and rank equally not only among themselves but also with other unsecured creditors of the designated ACS issuer.
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Ireland
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets
Mortgage, commercial mortgage and public Asset Covered Securities (ACS). Asset Covered Securities Act from 18 December 2001, amended 9 April 2007. Yes; Designated Credit Institution (DCI) mortgage, commercial mortgage and/or public. Mainly public sector, residential and commercial mortgage lending in OECD countries and some secondary activities. Eligible assets are transferred to the DCI. The DCI could acquire public sector, mortgage and commercial mortgage loans, but is obliged to maintain separate cover registers for each asset class. Hedge positions can be included in the asset pool and have to be documented in the cover asset hedge contract register. Up to 15%. Yes, with respect to Mortgage ACS, commercial mortgage loans should not exceed 10% of the total cover assets. Commercial Mortgage ACS may consist purely of commercial mortgage assets. Central governments and sub-sovereigns in EEA countries, the US, Australia, Canada, Japan, New Zealand and Switzerland are allowed. Loans to other OECD countries are permitted, but are not eligible for cover. The total amount of these public sector loans should not exceed 10% of total assets. In addition, exposures to AAA-rated multilateral development banks and international organisations are allowed. Every EEA country, the US, Australia, Canada, Japan, New Zealand and Switzerland are allowed. 75%; loans above the legal LTV limit must be refinanced on an unsecured basis, and the average LTV for all mortgages should not exceed 80%. Maximum 60%; loans above the legal LTV limit are permitted to be refinanced on an unsecured basis, and the average LTV for all mortgages must not exceed 80%. Yes; prudent market value (market value = upper limit). The examination of property valuations is part of the specific surveillance. Yes; Central Bank and Financial Services Authority of Ireland and a special supervisor (cover asset monitor). Coverage by nominal value and by net present value required by law. The law also stipulates that the duration of public sector assets must be at least as high, but not in excess of three years, of the public sector ACS. Exchange rate risk is prohibited, and in addition, the total amount of interest receivable in any given 12-month period on the collateral assets must exceed the total amount of interest payable on such bonds in the same period. The issuer may replace non-performing loans. No back-up servicer is stipulated. In the case of issuer insolvency, the National Treasury Management Agency (NTMA) can appoint a cover pool administrator or fulfil this role itself. 103% for mortgage and public sector ACS; 110% for Commercial Mortgage ACS. Any minimum overcollateralisation held on a contractual basis may exceed these levels and should be controlled by the cover asset monitor. Yes. No, but status of the issuer as a separate legal entity provides bankruptcy remoteness from the parent company. all assets earmarked for the respective asset pools. In addition, investors may benefit from positive market values of derivatives. No formal recourse to assets outside the DCI, but the regulator is expected to exert some pressure over the shareholder(s) to support the DCI. Yes. Yes.
Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching
Protection against credit risk Protection against operative risk Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency, first claim is on External support mechanisms UCITS Art. 22 par. 4 compliant? CRD Annex VI, Part 1, 65 compliant?
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ITALIAN MARKET
Overview
With an aggregate amount outstanding of 11bn from nine deals issued between the inception of the market in July 2008 and the time of writing, the issuance of Italian benchmark covered bonds has so far not lived up to expectations and still ranks among the smaller ones in Europe, despite the countrys 282bn mortgage market. With funding conditions having become increasingly more benign as of late in the light of the ongoing normalisation on the global financial markets, and covered bonds ranking among the cheapest refinancing instruments for most European banks, we expect issuance to increase in the months ahead. Ceteris paribus, gross full-year supply, which we believe will be exclusively attributed to the issuance of so-called obbligazione bancarie garantite (OBG), could then amount to 10bn in 2010 ie, markedly up from the 6bn issued in 2009 (Figure 240). Technically, the Italian covered bond market allows for the issuance of two different products, which themselves are backed by two different legal frameworks: the aforementioned OBG and covered bonds issued by Cassa Depositi e Prestiti (CDEP). The latter benefits from an exclusive regulation Article 5/18 of Law No. 296 dated 30 September 2003 which stipulates that CDEP may secure its assets, rights and obligations to the repayment of the amounts owed to holders of notes issued by it and other lenders. In November 2004, CDEP announced the launch of a 20bn covered bond program, issuing its first benchmark covered bond in March 2005. At the time of writing, CDEP had three benchmark transactions in the aggregate amount of 6bn outstanding. In light of the negligible supply activity in recent years (CDEP issued its last benchmark covered bond in September 2006), we believe issuance to gradually phase out in the years ahead.
Two different legal frameworks
The issuance of OBG is governed by amendments to the so-called Legge 130 that were approved by the Italian parliament in May 2005. Article 7 was enhanced by specific rules
Figure 240: Outstanding Italian jumbo covered bonds

Instrument CDEP ISIN Size (bn) Launch date Spread at launch at 28 May 2010
Mid swaps (bp)
CDEP 3.250% Jul 10 CDEP 3.750% Jan 12 CDEP 3.000% Jan 13

OBG
IT0003829105 IT0004103492 IT0003933717
1.00 2.00 3.00
17 Mar 2005 1 Sep 2006 13 Oct 2005
+1 +1 +3
+2 +55 +71
5.500% PMIIM Jul 11 4.250% UCGIM Jul 16 3.625% UBIIM Sep 16 3.500% PMIIM Oct 16 4.375% UCGIM Jan 22 4.000% UBIIM Dec 19 3.625% BANCAR Nov 16 3.625% BPIM Mar 17 3.250% ISPIM Apr 17
IT0004391626 IT0004511959 IT0004533896 IT0004540289 IT0004547409 IT0004558794 IT0004548464 IT0004587363 IT0004603434 Total
1.00 2.00 1.00 1.00 1.00 1.00 1.00 1.00 2.00 11.00bn
Jul 2008 Jun 2009 Sep 2009 Oct 2009 Oct 2009 Mar 2009 Oct 2009 Feb 2010 Apr 2010
+50 +103 +60 +50 +60 +67 +60 +80 +50
+58 +85 +85 +86 +70 +89 +105 +95 +67
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that allow Italian banks to use mortgage and public sector loans (including securitisation notes backed by this type of assets) that have been segregated from other assets on their balance sheet as securing assets for OBG.
Obbligazioni bancarie garantite

Structure strongly resembles design of UK covered bonds
The issuance of Italian OBG is governed by Article 7 of Legge 130, which permits a special purpose company (SPV) to issue a guarantee backed by the assets that the SPV has bought from the originating bank. As outlined in Figure 241, OBGs issued on the basis of Legge 130 strongly resemble the design of UK covered bonds.
Figure 241: Structure of obbligazioni bancarie garantite

Mortgage Loans and Related Securities Banca XYZ (Seller) Consideration Intercompany loan Banca XYZ Issuer Banca XYZ Covered Bond SPV Banca Loan repayment
Banca XYZ Interest rate swap provider Covered Bond swap provider
Covered Bond Guarantee and Deed of Charge Covered Bonds
Covered Bond Proceeds Covered Bond Holders Bond Trustees Security Trustee Swap Providers
Direct recourse to bank as issuer of the bonds
Technically, OBGs are issued by a bank (issuer) with a SPV purchasing the coverage assets from a bank (seller), which presumably but not necessarily is the issuing bank. To finance the acquisition, the SPV will enter into an advance loan agreement again, potentially, but not necessarily with the issuing bank. The coverage assets allow the SPV to provide a guarantee in favour of the holders of the covered bonds. Article 7 of Legge 130 also envisages the possibility of segregating assets within the issuing bank to guarantee payments on the covered bonds. However, so far, Italian authorities have not promulgated the secondary legislation required to make use of this second option. Within the structure outlined in Figure 241, holders of OBG will have direct recourse to the bank as the issuer of the bonds, while at the same time they are protected by a pool of mortgages. The latter has been segregated and will be managed exclusively for their benefit in the event of difficulties. We understand the following points to be important features when analysing OBG. Covered bonds are issued as direct, unsecured and unconditional obligations that will rank pari passu among themselves and with all other present and future unsecured and unsubordinated obligations of the respective issuer.
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Proceeds raised through the issuance of covered bonds are on-lent through an intercompany loan to the covered bond SPV. The latter is legally independent from the issuer, but consolidated in its accounts. The SPV uses these proceeds, together with a capital contribution from the issuer, to purchase portfolios of residential mortgage loans from the seller. Additionally, substitution assets can be acquired. The inter-company loan fully mirrors the covered bond.
Qualifying collateral for Italian OBG

Investors benefit from two types of guarantees
Article 7-bis of Legge 130 explicitly defines the type of assets that can be purchased by the SPV and that are eligible to act as collateral for the issuance of covered bonds. Specifically, these are monetary claims arising from mortgage loans, monetary claims against public sector entities (or those guaranteed by public sector entities) and/or asset-backed securities (ABS) that are backed by a collateral portfolio comprising the previous two types of claims. Covered bond holders technically thus benefit from two types of guarantees: a general one provided by the banks assets and a specific one provided by cover assets. By law, the repayment of the advance loan is subordinated to payments to the covered bondholders, the hedging counterparties and the other service providers/costs in the context of the transaction. With regard to the eligibility of mortgage assets, loan-to-value (LTV) ratios are limited to 80% for residential property and 60% for commercial property located in the European Economic Area (EEA) and Switzerland. According to the Basel II Revised Standardised Approach (RSA), the definition of public sector lending also includes assets from the EEA and Switzerland, with a risk weighting (RW) of not more than 20% and up to 10% of cover assets outside the EEA and Switzerland, provided that such exposures qualify under the RSA for a risk weighting of 0% for central governments and 20% for public sector entities, regional governments or local authorities. The decree furthermore foresees the use of senior tranches of securitisation transactions such as ABS and/or RMBS, provided that at least 95% of the collateral portfolio complies with eligibility criteria for mortgage and/or public sector lending, and the risk weighting is no more than 20% under the Basel II RSA. In addition, substitute assets of up to 15% of cover assets are allowed. They should consist of exposures to banks with a double-A rating from the EEA and Switzerland, or from a central government with a 0% risk weighting under the Basel II RSA. The Italian covered bond regulation stipulates that the guarantee provided by the SPV to OBG holders has to fulfil the following requirements: the guarantee needs to be irrevocable, unconditional, immediately available, and independent from the issuing banks obligations on the covered bond. Upon bankruptcy of the issuing bank, the guarantee will be callable by the holders of OBG. There will be no cross-acceleration with the banks debt to fulfil the rating agencies de-linking requirement. The guarantee will be limited to cover pool assets to ensure the bankruptcy remoteness of the SPV. The OBG holders will have the right to file a claim against the issuing bank for a full repayment. In this case, the holder will be represented exclusively through the SPV. Moreover, in the case of a liquidation of the issuing bank, the SPV will be entirely responsible for executing payments to the OBG holder and other counterparties and will represent the holders of the respective OBG in any proceedings against the issuing bank. Any amount obtained as a result of the liquidation procedure will become part of the cover pool and can therefore be used to satisfy the rights of the OBG holders.
Assets eligible for cover pool
Characteristics of the guarantee
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Regulatory oversight
Banca dltalia in charge of special surveillance
Within the OBG framework, Banca dItalia, the Italian central bank, assumes specific regulatory functions. It controls whether an issuing bank fulfils certain prerequisites, in particular with respect to regulatory capital. In addition, it will monitor the compliance of OBG with the regulations. On 15 May 2007, Banca dItalia enacted its supervisory regulation (istruzioni di vigilanza) on OBG. According to this regulation, OBG issuers must have a minimum consolidated regulatory capital of 500mn, a minimum regulatory capital ratio of 9.0% and a minimum Tier 1 ratio of 6%. In addition to this policy, limits for allocating assets to covered bonds were stipulated and are listed in Figure 242.
Limits for capital ratios
Figure 242: Barriers for the allocation of assets (%)

Total capital ratio 11.0 10.0 and <11.0 9.0 and <10.0 Tier 1 ratio 7.0 6.5 6.0 Cover assets/eligible assets
No limit Up to 60% Up to 25% No transfer is allowed
<9.0
<6.0
Note: In the case of a bank not belonging to a banking group, the total capital ratio and Tier 1 ratio are calculated on an individual basis. Source: Banca dItalia, Barclays Capital
Limitation of eligible assets used as cover assets
As illustrated above, banks with a Tier 1 ratio of 7% or more have no limits with regard to the proportion of eligible assets used as cover assets. However, we assume, on average, that the proportion of assets used does not exceed 50%. Banks with a Tier 1 ratio of 6.5-7.0% may issue up to 60% of their eligible assets as cover assets. On average, we do not expect the ratio to be significantly above 40%. If the Tier 1 ratio lies at 6.0-6.5%, the respective banks may issue up to 25% of their eligible assets as cover assets. We expect the ratio to average about 20%. In light of the current situation on the markets, we estimate that about one-third of Italian banks could be subject to issuance limits. Among the relative strengths of Italian covered bond programmes are, in our view: Cover assets are separated from the balance sheet at inception of the programme/ issuance through a true sale to the SPV. Cash-flow adequacy will be secured through the obligation to neutralise any exposure to interest rate and currency risk. Investors are well protected against liquidity risk as there is a clear escalation process in the case of a deterioration of the credit profile of participating parties.
Strengths
Weaknesses
Among the relative weaknesses of Italian covered bond programmes, in our view, are: Compared with other covered bond products, there is a lower level of standardisation. However, the basic structure is similar in all programmes. With the first issue of an OBG dating back to only 2008 and only 8bn outstanding at the time of writing, the record of banking regulators with regards to the surveillance of Italian covered bonds is limited. This, however, is somewhat mitigated by the fact that regulators were involved in designing the regulatory framework for the product and, thus, there should be a rather high awareness of the relevant risk factors.
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The structure of Italian covered bond programmes implies some involvement of the sponsoring bank, particularly with regards to the neutralisation of exposures to market and liquidity risk. In the event of a deterioration of the counterparty credit profile, there is some uncertainty regarding the execution of mitigating factors. At the time of writing, OBG were issued out of five different covered bond programmes whose characteristics we depict in Figure 243.
Figure 243: Italian OBG programmes

Issuer Ticker Programme size Amount issued Collateral pool OC OC required to maintain current rating Moodys Fitch S&P
UBI Banca Banca Popolare di Milano UniCredit Group Banca Carige Banca Popolare
UBIIM PMIIM UCGIM BANCAR BPIM
10.0bn 10.0bn 20.0bn 5.0bn 5.0bn
1.0bn 2.0bn 3.0bn 1.0bn 1.0bn
3.7bn 2.3bn 10.9bn 2.3bn 1.4bn
370% 115% 363% 230% 140%
15.5% 15.0% 8.5% 18.5% 19.5%
27.55% 18.06% 23.46% 24.07% 25.79%
9.89% NR 13.97% NR NR
Source: Company information, rating agencies, Barclays Capital

No mandatory overcollateralisation
Banca dItalia stipulates that the nominal value of the cover pool assets must at all times be at least equal to the nominal value of the covered bonds outstanding. The net present value (NPV) of the cover pool, net the SPVs general and administrative expenses and taking into consideration any hedging instrument that might be in place, must be at least equal to the NPV of the covered bonds issued. Furthermore, the cover pool assets need to accrue sufficient interest to cover interest payments on the covered bonds outstanding. Figure 245: Redemption profile
bn 6 5
Figure 244: Outstanding jumbo OBG

bn 10 8
4 6 4 2 2 0 Jun-08 0 Dec-08 Jun-09 Dec-09 Jun-10 201120122013201420152016 201720182019202020212022


Statutory framework requires asset segregation
The Italian covered bond legislation, as well as contractual arrangements in future OBG programmes, protect the claims of covered bond investors since they give first ranking access to the respective collateral assets. This prior access to cover assets cannot be negatively
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affected by other creditors, such as tax authorities, employees or unsecured debt holders. In particular, any payment to covered bond holders, as well as involved swap counterparties, must be effected before payments to service the subordinated loan to the SPV. As in the case of UK covered bonds, interest and principal payments arising from the issuance of OBGs will be guaranteed by the SPV after an issuer event of default. The SPV is reliant on the proceeds derived from the assets it holds to make these payments. If proceeds are insufficient to meet the obligations to bondholders in full, investors still have an unsecured claim against the OBG issuer. The Italian covered bond legislation does not stipulate that cash flows paid to the benefit of OBG holders will be operationally separated in a specific account. In addition, the law does not foresee the appointment of a dedicated manager for the SPV who would be in charge of enforcing the guarantee and arranging liquidity management. There is no explicit rule regarding the mitigation of liquidity gaps. We thus expect these risks to largely be covered by contractual arrangements.
Cassa Depositi e Prestiti covered bonds

Exclusive regulation for CDEP
As a result of an exclusive regulation, the collateral of covered bonds issued by CDEP mainly consists of loans to Italian regions and local entities or loans guaranteed by these entities, respectively. Cover assets, which can also include debt of central and local government entities from EEA countries, remain on the balance sheet and can be replaced on an ongoing basis. More precisely, CDEP is obliged to substitute any non-performing assets (dynamic collateral pool). Quality and diversity within the portfolio are maintained through eligibility criteria and rules for asset substitution. Additionally, the cover portfolio benefits from a 115% mandatory over-collateralisation, which is referenced to every future payment date. Investors in covered bonds issued by CDEP are protected against mismatches and market risk, as their respective exposure is monitored through an asset and cash-flow coverage test, which ensures cash-flow adequacy. The cover assets backing the respective issues are entered into a specific register and are thus ring-fenced and protected against a potential insolvency of CDEP. Article 5/18 of Law No. 296 stipulates that covered bond investors stand senior to any other lenders. Furthermore, investors are protected against operational risk, as a back-up servicer is stipulated in case CDEP is downgraded to a rating below BBB-/Baa3/BBB- and/or fails to perform its servicing obligation. Upon an insolvency of CDEP, investors receive all payments from the assets. Cash flows are collected in a segregated collection account, with investors continuing to receive their scheduled payments as if CDEP had not defaulted. A peculiarity of covered bonds issued by CDEP is that the rights of bondholders refer to the segregated assets, exclusively. There will be no recourse to the issuer.
Rights of bondholders refer to segregated assets, exclusively
The Italian housing and mortgage market

Correction in house prices in 2009
According to data provided by the Osservatorio sul Mercato Immobiliare di Nomisma, house prices in the 13 main metropolitan areas of Italy had contracted 4.1% y/y in H2 09, the latest date for which data were available. In H1 09, prices had already fallen 3.4% y/y, taking the annualised house price decline to 4.1% y/y in 2009 (Figure 246). In 2008, house prices had still increased at a pace of 1.1% y/y, markedly down, however, from 5.1% y/y in 2007. At the same time, the number of property transactions had sharply contracted, with home sales falling 11.3% y/y in Q3 09, the latest date for which data were available. As of late, however, data provided by Banca dItalia indicated that the downward trend of property
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sales started to moderate, thereby eventually reducing the downward pressure on house prices. Consequently, the negative balance between expectations of rising versus falling house prices as measured in the Banca dItalia-Tecnoborsa Italian Housing Market Survey recorded its first decline since January 2009 84. As the survey also found that the discount sellers were willing to accept with respect to the original asking price (11.3% in Q3 09, versus 12.2% in Q2 09) had declined slightly and that the share of sellers willing to postpone a sale until conditions improve again had increased, we expect the situation on the Italian housing market to gradually stabilise in the months ahead, particularly as we observe first signs of recovery on the Italian mortgage lending market (Figure 247).
Residential mortgage lending regaining momentum
Spurred by a historically low interest rate environment, with the average mortgage lending rate standing at 3.8% for loans with a term to maturity of more than five years in January 2010 (Figure 248), the latest date for which data were available, residential mortgage
Figure 246: Type of mortgage loans in Italy

100% 17% 75% 16% 16% 15% 8%
Figure 247: Average mortgage lending rate (%)

15 13
41%
11 9 7
50%
64%
64% 77% 74%
25% 19% 0% 2003 fixed rate

Source: ASSOFIN, Barclays Capital
51%
5
7% 2004 10% 2005 21% 2006 2007
3 Jan-95
Jan-98 1 to 5 years
Jan-01
Jan-04
Jan-07
Jan-10
floating rate
mixed rate
over 5 years maturity
Source: Haver Analytics, Banca dItalia, Barclays Capital
Figure 248: Lending for house purchases (annual variation)
Figure 249: Italian house price development (annual variation in 13 main metropolitan areas)
25 20 15 10 %
25 20 15 10
5
5 0 -5 Jan-02
0 -5 -10 Jun-90
Jan-04
Jan-06
Jan-08
Jan-10
Jun-94
Jun-98
Jun-02
Jun-06
Jun-10
Source: Banca dItalia, Haver Analytics, Barclays Capital
Source: Haver Analytics, Banca dItalia, Barclays Capital
84
Source: Banca dItalia, Economic Bulletin, January 2010.
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lending started regaining momentum earlier this year. Note that as a result of the benign interest rate environment, the proportion of fixed-rate mortgage loans has steadily increased over the course of the past years. After the volume of bank lending to Italian households for house purchases effectively fell between July 2008 and February 2009, lending recovered and grew 6.8% y/y in January 2010, the latest date for which data were available (Figure 249). At the time of writing, the overall volume of bank lending to Italian households for house purchases amounted to 282bn, up from 264bn in January 2009, making the Italian mortgage market one of the smaller ones in Western Europe. Nonetheless, with a total of 282bn granted to Italian households for the purpose of purchasing houses at the time of writing and OBG outstanding in the nominal value of only 8bn, in principle, there should be ample room for the further issuance of OBG.
Modestly sized mortgage market
The markets modest size, in our view, reflects the relatively low tendency of Italys 24.8mn households to incur debt. Although this reluctance appears to be decreasing gradually, overall indebtedness levels remain relatively low by international standards. As at year-end 2009, the latest date for which data were available, the residential mortgage lending to GDP ratio stood at approximately 17.4%, considerably lower than the EU-27 average of roughly 50% 85. This, in combination with the relatively high home-ownership-ratio of about 80%, which is among the highest in Europe according to data provided by Banca dItalia, in our view, currently limits growth prospects for the mortgage market. Note that approximately 10% of the Italian households own a second home. In 2008, changes were made to the Italian mortgage law. Among the most relevant one was Law 40/2007, which removed eventual expenses or penalties to be paid in the case of a total or partial advance repayment of a residential housing mortgage loan. The law also foresees that a mortgage loan granted on a property can be redeemed without the involvement of a public notary and, thus, without related expenses. Also, the new law allows for the possibility of mortgage loan portability ie, a creditor substitution at no cost for the debtor who may not be charged expenses or commissions regarding the granting of a new loan, for judicial inquiry or for real estate records ascertainment. In addition, Law 244/2007, which came into force with the Finanziaria Budget Act 2008, specifies that the refinancing plans agreed between banks and customers must be at no cost to the customer. Finally, the maximum amount of the taxes to be deducted for interest paid was raised to 4,000.
Legal changes
85
Source: Banca dItalia, EMF, Barclays Capital.
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Italy
Obbligazione Bancarie Garantite. Legge 130 Article 7 in combination with bylaws published by the Ministry of Finance and the Bank of Italy. No; any Italian bank fulfilling specific issuance criteria. Not applicable. Cover assets are segregated through the transfer to a separate entity. Hedge positions are part of the structural enhancements intended to protect bondholders. Up to 15%. No we expect the collateral of the covered bond programmes to consist mainly of first-lien mortgage loans. EEA states and Switzerland, subject to a maximum risk weighting of 20% and up to 10% of the cover pool non EEA states or local authorities subject to a maximum risk weighting of 20%. EEA states and Switzerland. 80% 60% No Basis for valuation = market value. The approach needs approval from Bank of Italy and is verified by an independent auditor Semi-annual review and annual reporting to Bank of Italy. Yes; Banco dItalia. The nominal value of the cover pool assets must at all times be at least equal to the nominal value of the covered bonds outstanding. The net present value (NPV) of the cover pool must be at least equal to the net present value of the covered bonds issued. Furthermore, the cover pool assets need to accrue sufficient interest to cover interest payments on the covered bonds outstanding. Sponsor banks may replace non-performing loans. Stipulated through contractual rules. Expected to be subject to an asset coverage test. Yes. No, but all assets are ring-fenced within a specially separated entity. Depending on Tier 1 and total capital ratios. There is no limit, as long as the respective bank maintains a total capital ratio above 11% and a Tier 1 ratio above 7%. all the payments received from the special entity's assets. These payments are expected to be collected in a separate account. Investors continue to receive scheduled payments, as if the issuer had not defaulted. In the event of insufficient pool assets proceeds to cover their claim, investors rank pari passu with senior debt holders. There is a simultaneous unsecured dual claim against the issuer and secured against the portfolio held by the specially separated entity. Yes. Yes.

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LUXEMBOURG MARKET
Overview
Lettres de gage (LDGs) are issued by specialised banks (Banques dmission de Lettres de Gage) located in Luxembourg. They are backed by loans to the public sector or mortgages originating from within the EU, EEA and the OECD. Therefore, they have the largest geographical reach of all the European covered bonds issued on the back of a legal framework. The Luxembourg Mortgage Bank Act (MBA) came into force in November 1997. It was amended in June 2000 and in October 2008. Unlike the German Pfandbrief Act, the Luxembourg framework contains the special banking principle. Only specialised banks, socalled Banques dEmission de Lettres de Gage (BELDGs) are allowed to issue LDGs. Currently there are five BELDGs, namely, Dexia LdG Banque S.A. (DEXGRP), Erste Europische Pfandbrief- und Kommunalkreditbank (EEPK), Eurohypo Luxembourg SA (EUROHYP LUX), Hypo Pfandbriefbank International (PBINTL) and Nord/LB Covered Finance Bank S.A. (NORD/LB CFB). Until early 2006, issuance had only been in the form of Lettres de Gage Publiques (public sector covered bonds). However, following EEPK obtaining approval in November 2005 to issue Lettres de Gage Hypothcaire (mortgage covered bonds), it issued the first Luxembourg mortgage covered bond in January 2006. At end-2009, there was a total outstanding volume of 31.1bn of Lettres de Gage (YE 08: 34.1bn). In 2000, shortly after the first Luxembourg mortgage banks started their businesses, the focus was on the issuance of jumbo Lettres de Gage. After growing consistently until mid2003, the market peaked at slightly above 5bn of outstanding jumbos. From 2003 onwards, after having reached a certain level of name recognition through an appearance in the jumbo market, the focus shifted towards either non-benchmark issuance or the noneuro market. Consequently, there has been no transaction in jumbo format since May 2003. The particular strengths of the Luxembourg LDG framework are as follows: All cover assets from the balance sheet of the originating entity are strictly segregated. Cash-flow adequacy is secured through the stipulation of net present value cover, which also has to be tested against stress scenarios. In addition, LDG cover pools generally benefit from a high geographical diversification. In case of issuer bankruptcy, the Commission de Surveillance de Sector Financier (CSSF) acts as the administrator for the pools and the existing LDGs.
Focus on non-jumbo issuance
Strengths
Weaknesses
The relative weaknesses of the Luxembourg LDG framework consist of the following: LDG quality depends on the maintenance of voluntary over-collateralisation, which can be subject to change, particularly in a stress scenario. This is particularly important, as compared with other covered bond frameworks, the Luxembourg legislation offers a broader range of eligible assets with potentially weaker fundamental credit profiles (eg, the non-guaranteed debt of public sector banking institutions, exposure to all OECD countries). This is mitigated by the generally large geographical diversification of the respective pools. Liquidity protection is incomplete in an insolvency scenario. While the cover pool administrator is entitled to arrange bridge financing, liquidity support is not pre-defined and has to be organised on an ad-hoc basis.
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There is a lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. This is mitigated by the fact that to date, all LDG issuers report coverpool characteristics and risk-management indicators on a regular basis.
Modernisation of Lettres de Gage framework
On 24 October 2008, amendments to the LDG framework became effective. The key changes are summarised below. A new category of Lettres de Gage, secured against movable objects such as ships or airplanes, as well as other classes of movable assets, were introduced. According to the new law, a separate cover pool register needs to be created for each category of Lettres de Gage Mobilire. In order to be eligible as a cover asset, the respective assets and the respective charges on ownership need to be recorded in a public register within the European Union (EU), European Economic Area (EEA), or the OECD. The different forms of bonds secured by such movable assets need to be approved by the CSSF. ABS/MBS notes are now allowed in the respective cover pools. The securitisation notes should have a minimum rating of AA-/Aa3/AA- with S&P/Moodys/Fitch. In addition, at least 90% of the securitised portfolio should directly qualify as regular cover in the respective category. Alternatively, this percentage can be as low as 50%, in case the total weight of ABS/MBS notes in terms of outstanding Lettres de Gage of the respective category it remains below 20%. The cross-border transfer of cover assets should be facilitated, as the new legislation contains a provision that allows the inclusion of these assets, where the respective security is held indirectly, ie, by a third-party bank, which should be established in a member state of the EU, the EEA or the OECD. A 102% mandatory minimum over-collateralisation on a nominal, as well as on an NPV basis, was introduced. The percentage can eventually be modified by the banking regulator. In particular, the CSSF may decide to tailor the percentage to the perceived risk profile of the underlying cover asset category. The LTV ratio for mortgage credits that serve to finance retail property (prts qui financent des immeubles dhabitation) was increased to 80% from 60%.
More business opportunities should lead to more detailed disclosure
With the amendment of the Lettres de Gage framework, the Luxembourg authorities followed their traditional approach to have a broader definition of eligible assets compared with most other covered bond regimes. In addition, the transfer of cover assets has been eased by allowing the use of ABS/MBS, as well as securities held by non-domestic banks. Thus, on the positive side, we note that Lettres de Gage issuers will have easier access to a broader pool of cover assets, which could help to strengthen their business profile and also reflect in profitability. However, so far no Lettre de Gage backed by movable objects has been introduced. At the same time, some traditional standards were affirmed. In this, we not only note that the respective covered bond categories will be secured by separate cover pools, but also recognise that the specialised banking principle remained in place. However, with respect to the quality of the respective cover pools, it will be important to closely monitor the banks enhanced ability to include assets, which potentially were neither originated in-house nor benefit from the sponsorship of another banking institution. In addition, the rating floor on ABS/MBS could potentially become problematic, in case the respective notes have a high share in the cover pool and would suffer from downgrades. Finally, when it comes to Lettres de Gage Hypothcaires, the increased LTV level of 80% could be regarded as too ambitious, as the wording of the law does not exclude multifamily real estate projects to benefit from the increased LTV level. Clearly, we would expect Lettres de Gage issuers to enhance disclosure in order to address these concerns.
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CRD compliance
From a bank investors point of view, it is important to note that LDGs are generally not compliant with CRD regulations on covered bonds as defined in CRD Annex VI Part 1 paragraph 68-70 and thus are treated the same way as unsecured bank debt. This basically results from the fact that the LDG legislation allows a broader use of collateral assets compared with the CRD, and thus, management focus is largely geared towards making use of the broader range of eligible assets.
Qualifying collateral for LDG Publiques

Loans within the EU, EEA and the OECD
Eligible collateral consists of all public sector loans within the EU, EEA and OECD, and all other public sector covered bonds issued by other banks within the EU. These must be recorded in a separate public sector register within the bank. There are no limits on risk weighting for public sector loans. In addition, it is important to note that cover assets of LDG Publiques may consist of non-guaranteed debt issued by public sector credit institutions. This is in contrast to German public sector Pfandbriefe, where this type of debt is not eligible for the cover pool. Finally, since October 2008, it is allowed to put ABS notes in to the cover pool. The notes should have a minimum rating of AA-/Aa3/AA- with S&P/Moodys/Fitch. In addition, at least 90% of the securitised portfolio should directly qualify as regular cover. Alternatively, this percentage can be as low as 50%, in case the total weight of ABS/MBS notes in terms of outstanding Lettres de Gage of the respective category remains below 20%. The amount of substitute collateral can be as high as 20%. Collateral eligible for substitution consists of cash or deposits with a central bank within the OECD. In addition, all bonds that comply with Article 22(4) of the EU UCITS Directive also qualify as substitute collateral. Derivatives are allowed within the pool, as hedges and cover must be maintained on a net present value basis. All FX risks must be hedged out.
Substitution up to 20%
Qualifying collateral for LDG Hypothcaire

LTV limit of 80% for mortgage secured on residential property and 60% for all other mortgages
Eligible collateral consists of all mortgages originating within the EU, EEA and OECD, and all other mortgage sector covered bonds issued by other banks within the EU. These must be entered in a separate mortgage sector register within the bank. The LTV limit for mortgages secured by residential property is 80% and for all other mortgages the LTV limit is 60%. In addition, all mortgage covered bonds that comply with Article 22(4) of the EU UCITS Directive also qualify as substitute collateral. Thus, the cover for LDG Hypothcaires may fully consist of mortgage covered bonds from other legislations. Furthermore, since October 2008 it is allowed to put MBS notes in to the cover pool. The notes should have a minimum rating of AA-/Aa3/AA- with S&P/Moodys/Fitch. In addition, at least 90% of the securitised portfolio should directly qualify as regular cover. Alternatively, this percentage can be as low as 50%, in case the total weight of ABS/MBS notes in terms of outstanding Lettres de Gage of the respective category remains below 20%. As with LDG Publiques, the amount of substitute collateral for LDG Hypothecaire can be as high as 20%. Eligible collateral for substitution consists of cash or deposits with a central bank within the OECD. Derivatives are allowed within the pool, as hedges and cover must be maintained on a net present value basis. All FX risks must be hedged out.
Regulatory oversight of assets and asset liability management

Trustee concept with supervision by authorities
Each bank appoints a trustee (reviseur spcial) with the approval of the supervisory authority, the Commission de Surveillance de Sector Financier. The trustee must be independent from the issuer and must be a licensed professional auditor. The trustees responsibilities include monitoring and registering both the collateral and the derivatives,
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making sure LDG programmes fulfil regulatory requirements. In particular, the trustee verifies that the programmes comply with minimum overcollareralisation requirements and that the interest income from the collateral pool is higher than that being paid out on the LDGs. In addition, a rviseur dentreprise supervises the principle of integral matching (congruence of currency, interest rates and cover), which ensures that little regulatory capital is at risk.

Ring-fenced with no acceleration
In the event of bankruptcy of the issuer, the collateral pools are immediately separated from the balance sheet and the CSSF acts as the administrator for the pools and the existing LDGs. The bondholders claims on the pools rank pari passu with derivative counterparties that are also listed within the collateral pool. There will be no acceleration of payments as long as the collateral pool is solvent. Should these assets prove to be insufficient, then the LDG bondholders rank pari passu with unsecured creditors of the bank.
Figure 250: Overview LDG programmes

Dexia LdG Banque Erste Europische Pfandbrief- und Kommunalkreditbank Eurohypo Luxembourg Hypo Pfandbriefbank International Nord/LB Covered Finance Bank
Ticker Ownership
DEXGRP Dexia Banque Internationale Luxembourg 100% 25 3.7 4.7 27.3% France 32% US 18% Spain 16%
EEPK Commerzbank 100%
EURHYP Eurohypo AG 100%
PBINTL DEPFA Bank plc 100% 15 4.6 5.1 9.3% US 21% Germany 18% Austria 11%
NDB NORD/LB Luxembourg 100% 5 3.9 4.4 13.5% Germany 27% US 24% Luxembourg 9%
Programme volume in bn Outstanding bonds in bn as of YE 09 Cover pool assets in bn as of YE 09 Over-collateralisation Geographical concentration
7.5 5.0 5.2 4.9% US 36% Canada 10% Italy 7%
13.9 15.5 11.1% US 29% Canada 14% UK 14%
Note: *Fitch/S&P Source: Transaction documents, monthly pool reports
Dexia LdG Banque
Dexia LdG Banque is a specialised credit institution authorised by the Luxembourg Ministry of Finance to refinance its public sector loan portfolios through the issuance of LDGs. It was set up in mid-2007 and is fully owned by Dexia Banque Internationale Luxembourg. Within Dexia Group, Dexia LdG Banque has a dedicated role as a secured funding vehicle. As of YE09, the banks total assets amounted to 5.1bn, and the company had 3.7bn in LDG outstanding. Management generally does not focus on ensuring CRD compliance of the LDG product. Erste Europische Pfandbriefe- und Kommunalkreditbank (EEPK) is a specialised credit institution authorised by the Luxembourg Ministry of Finance to refinance its public sector and mortgage loan portfolios through the issuance of LDGs. Its main focus is the provision of loans to central and regional governments, as well as municipalities and other public sector entities in the EU and OECD countries, although its inaugural issue of mortgage-backed Lettres de Gages in January 2006 signalled an increased strategic focus on this area. EEPK was established in 1999 and has been growing rapidly. As of YE 08, the banks total assets amounted to 6.3bn, and the company had 5.0bn in LDG outstanding. Since 2009, EEPK has been 100%-owned by Commerzbank. Management generally does not focus on ensuring CRD compliance of the LDG product.
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Erste Europische Pfandbriefeund Kommunalkreditbank
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Eurohypo Luxembourg
Established in 1989 as a limited liability company to conduct general banking business, Eurohypo Luxembourg changed its banking licence in 1999 to limit its activities to mortgage and public sector financing and to allow refinancing through the issuance of LDGs. The vast bulk of its activities relate to the refinancing of public sector loans granted to borrowers in the EU, EEA, the US, Switzerland, Canada and Japan. While the bank initially was excluded from lending in Turkey, Mexico and South Korea by its articles of association, the respective rules were rescinded in 2007. The bank is a wholly-owned subsidiary of EUROHYPO AG, which itself is fully owned by Commerzbank AG. However, it is important to note that in May 2009, the European Commission asked Commerzbank AG to dispose of Eurohypo AG over a five-year time horizon as a condition for state aid approval. With total assets of 23.5bn and a total amount of 13.9bn of outstanding LDG as of YE 09, Eurohypo Luxembourg was the largest issuer in this asset class. While management generally does not focus on ensuring CRD compliance of the LDG product, for the time being LDGs issued by Eurohypo Luxembourg do fulfil the CRD requirements and thus qualify for beneficial treatment. Hypo Pfandbrief Bank International (PBINTL) is a specialised credit institution authorised by the Luxembourg Ministry of Finance to refinance exclusively its public sector loan portfolios through the issuance of LDGs. Its main focus is the provision of public sector lending activities in Europe and other OECD countries as a specialised credit institution. PBINTL was established in 1999 by the HypoVereinsbank Group. Since December 2007, it has been 100%-owned by DEPFA BANK plc, which, in turn, is part of Hypo Real Estate Group. As at YE 09, it had total assets of 8.1bn and 4.6bn in LDG outstanding. Management generally does not focus on ensuring CRD compliance of the LDG product. Nord/LB Covered Finance Bank (NORD/LB CFB) was established in May 2006 as a Banque dEmission de Lettres de Gage. It is a wholly owned subsidiary of Nord/LB Luxembourg, which in turn is fully owned by Nord/LB Girozentrale the latter has provided a letter of support for NORD/LB CFB. Within Nord/LB Group, NORD/LB CFB is the centre of competence for international public finance. As of YE 09, total assets amounted to 5.9bn and outstanding LDGs amounted to 3.9bn. Its business is complementary to the activities of Nord/LB Girozentrale and the associated public savings banks in Germany. Outside Germany, NORD/LB CFB engages directly in lending to the public sector in the developed countries of the European Community, the European Economic Area and the OECD. Within Germany, NORD/LB CFB takes on part of the public finance business generated by Nord/LB Girozentrale and provides funding for the public savings banks. NORD/LB CFB is the first, and so far the only, institution within the German Landesbank sector to provide refinancing via LDGs to its savings banks. In order to help broaden NORD/LB Groups investor base internationally, NORD/LB CFBs LDG issuance focuses on long-term debt. Management generally does not focus on ensuring CRD compliance of the LDG product.
Hypo Pfandbrief Bank International
Nord/LB Covered Finance Bank
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Luxembourg
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities
Lettres de gage hypothcaire/publique. Law enacted on 21 November 1997, amended in June 2000 and October 2008. Yes; mortgage banks (Banques d'mission de Lettres de Gage). Mainly public sector, mortgage and other forms of secured lending in OECD countries, though some secondary activities are permitted. Cover assets remain on the balance sheet but are maintained in separate asset pools. Hedge positions can be included in the cover register. Up to 20%. No. Any OECD country. Any OECD country. Any OECD country. 80%. 60%. Yes. Valeur estime de realisation (estimated realisable value). The examination of property valuations is part of the specific surveillance. Yes; Commission de Surveillance du Secteur Financier (CSSF; Luxembourg banking regulator) and an independent trustee. Coverage by nominal value and by net-present value required by law. The issuer may replace non-performing loans. The regulator could oblige another mortgage bank to act as a backup servicer and could also nominate a cover pool administrator. 102%. No. No, but the assets within the cover register are exempt from bankruptcy proceedings. 60x. all assets earmarked for the respective asset pools. In addition, investors may benefit from the positive market values of derivatives. In the event of insufficient pool asset proceeds to cover their claim, lettres de gage, investors rank pari passu with senior debt holders. In addition, the shareholder may also extend some other form of support. Yes.
Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets Geographical scope for movable assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk Mandatory minimum over-collateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency, first claim is on External support mechanisms
UCITS Art. 22 par. 4 compliant?

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DUTCH MARKET

The issuance of jumbo Dutch structured covered bonds started in 2005. Since its inception, the market has grown consistently. In mid-May 2010, the total volume of outstanding jumbo covered bonds was 23bn 86. The Dutch jumbo market consists of four issuers ABN AMRO, Achmea Hypotheekbank, ING Bank NV and SNS Bank NV with a total of 15 issues. The average size of jumbo covered bonds is currently 1.5bn. Figure 252: Market share, May 2010
bn 3.5 3.0 2.5 SNSSNS 9%
Figure 251: Development of outstanding volume and avg

bn 25 20 15 10 5 0 2005
2.0 1.5 1.0 0.5 0.0 2006 2007 2008 2009 2010 ACHMEA 12%
AAB 39%
INTNED 40%
Jumbo Covered Bonds Average size of Jumbo Covered Bonds (RS)

Spillover from the financial market crisis
Following their inception, Dutch covered bonds spreads tightened consistently and reached historical lows in early 2007. However, from mid-2007 onwards, swap spreads widened substantially in a series of waves. With the ECB announcement that it would purchase covered bonds in May 2009, spreads of AAB and INTNED in particular tightened substantially. In Q2 10, the market hardly suffered from volatility in sovereign debt markets as swap spreads widened only by about 5-10bp. Figure 254: Credit term structure of major issuers
Barcap OAS 160 140 120 100 80 60 40 20

180 160 140 120 100 80 60 40 20 0 -20 Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
AAB 3.250% Sep 15 INTNED 4.250% Mar 13

ACHMEA 4.250% Feb 14 SNSBNK 3.500% Oct 15
0 2009 AAB
2012
2014 INTNED
2017 SNSSNS
2020
ACHMEA

86
As total issuance of 23bn (from four issuers) to date exceeds the imposed minimum of 6bn, The Netherlands is among the countries that benefited from the addition of a country index (iBoxx Netherlands Covered) to the iBoxx Covered Index in 2008. For additional information, please refer to the chapter on AAA rated bonds and the iBoxx Index within this publication.
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Background
Jumbo market started in 2005
Two Dutch banks Achmea Hypotheekbank and Bouwfonds started to offer structured covered bonds as early as the mid-1990s. However, investors were strongly exposed to the credit profile of the issuing bank because covering assets were not exempt from insolvency proceedings. The assets were pledged to an independent trust, which guaranteed prior access to them in the event of issuer insolvency. To offer stronger credit standards and a higher degree of liquidity to investors, ABN AMRO Bank NV, the parent of Bouwfonds, decided to develop a covered bond programme. Consequently, in September 2005, the first jumbo covered bond was launched. Achmea Hypotheekbank NV followed with its inaugural jumbo covered bond in early 2007, and ING Bank NV was the third issuer in early 2008. In February 2008, SNS Bank NV announced its debut in the covered bond market, and in May 2008, NIBC Bank NV announced a 7bn covered bond programme. On 6 September 2006, the Dutch Finance Ministry (Ministerie van Financin) announced it would start preparations for dedicated Dutch covered bond legislation. In November 2007, the concept was publicly presented. On 1 July 2008, the Dutch Registered Covered Bond Regime came into force, allowing covered bonds to be issued in line with UCITS 22(4), as they are issued on the basis of a legal structure. It also allows for the issuance of CRD-compliant covered bonds in case the additional set of rules of the CRD with regards to the limitations on eligible assets are met. Thus, following the introduction of the new law, there are three possible types of Dutch covered bonds: registered covered bonds compliant with CRD; registered covered bonds compliant with UCITS 22(4) but not with the CRD; and non-registered covered bonds. Under the Dutch law, the fulfilment of the respective rules needs to be demonstrated to the Dutch central bank (DNB). The DNB has a public register, in which it lists all programmes that comply with UCITS 22(4). The list also indicates whether the additional set of rules of the CRD with regards to the limitations on eligible assets are met. The register is accessible via the DNB website 87. As of mid May 2010, the covered bond programmes of ABN Amro Bank Bank NV, ING Bank NV, NIBC Bank NV and SNS Bank NV were registered. For all programmes except NIBC Bank NV it was stated that they would fulfil the CRD. Within the scope of the Dutch covered bond law, two potential set-ups are outlined. The framework foresees the possibility of issuing Dutch covered bonds that either meet only the UCITS 22(4) criteria or those that meet the UCTIS 22(4) and CRD requirements. The purpose of this dichotomy is to allow Dutch banks to partly avoid the stricter CRD criteria, which foresee a maximum loan-to-value ratio (LTV) of 80% for residential mortgages, a barrier that appears too restrictive in the context of the Dutch mortgage market. Evidently, the family of Dutch covered bonds that are not CRD-compliant will not be able to benefit from a 10% risk weighting under the RSA but have a 20% risk weighting. According to the Dutch covered bond law, the Dutch Authority for the Financial Markets (Autoriteit Financile Markten) reviews the prospectus of the covered bond for the purpose of a Dutch listing. As a second step, the Dutch central bank (De Nederlandsche Bank) assesses whether the covered bond prospectus submitted meets the mandatory conditions with respect to a registered covered bond. The assessment is submitted to the potential covered bond issuer. In addition to the regular supervision on behalf of the Dutch Authority for the Financial Markets and the Dutch central bank, the Dutch covered bond decree also foresees a special (government) supervision of registered covered bond programmes. This also lies within the responsibility of the Dutch central bank. In case a registered covered bond is listed as being compliant with the CRD, supervision also includes controls with regards to fulfilling the CRD.
87
Specific covered bond legislation since 1 July 2008
Public register
Two legal categories
Supervision
http://www.dnb.nl/openboek/extern/id/en/all/41-186085.html
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Registration
Within the scope of the Dutch covered bond decree, there are two lists for the registration of covered bonds that are in line with the UCITS criteria: a Dutch list that is subject to supervision by the regulator (ie, the Dutch central bank); and a list of the European Union (EU). In accordance with the provision relating to the UCITS, a covered bond programme is subject to mandatory notification of the European Commission. Whereas the regulator (ie, the Dutch central bank) gives notification of the covered bond, the European Commission makes the notification public. To be characterised as a covered bond, the latter needs to be submitted to and approved by the Dutch central bank to be included in the Dutch register. In the case of certain conditions no longer being met, the supervisor (ie, the Dutch central bank) and the covered bond issuer will agree on a specific period in which the issuer is required to meet the specific obligations. Should the breach of the mandatory conditions not be reversed within that period, the regulatory institution will remove the respective covered bond from the register, thereby disabling the covered bonds issuer from any further issuance. Furthermore, the regulatory institution will also remove the covered bond from the EU register.
Exclusion from register
Transaction structure
Direct recourse to the issuing bank and a pool of Dutch mortgage receivables
As explained above, Dutch authorities decided to follow a principle-based approach to covered bonds. Unlike most other countries, it is not designed to pre-determine the structural details of individual covered bond programmes, but rather focus on a proper public supervision and the maintenance of minimum standards. Consequently, the well-established structure of all existing covered bond programmes will basically qualify to be registered under the planned legislation (Figure 255). The respective contractual structure has been designed to produce the same benefits normally available to covered bond investors in instruments from those countries with more traditional covered bond legislation. More specifically, covered bond investors will have direct recourse to the respective bank as the issuer. In addition, investors are also protected by a pool of Dutch mortgage receivables that have been segregated and will be managed exclusively for their benefit in case of problems.
Figure 255: Generic Dutch covered bond transaction structure
Service Administrator Swap providers Transfer of receivables Mortgage originators XXX Covered Bond Company (CBC) Asset Monitor Parallel debt pledge of transferred receivables Security Trustee
Transfer of receivables
Security
XXX Bank N.V.
Covered Bond Investors Covered Bond Proceeds Covered Bonds
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CBC provides a guarantee to covered bondholders
The respective bank is the issuer of the covered bonds, which are its own direct, unsecured and unconditional obligations. These obligations rank pari passu among themselves and equally with all other present and future unsecured and unsubordinated obligations of the issuer. The respective Covered Bond Company (CBC) a private company created specifically for the covered bond debt programme provides a guarantee to covered bondholders for the payment of interest and principal, which becomes enforceable if the issuer defaults or if the CBC defaults and the security trustee serves an acceleration notice. To allow the CBC to meet its obligations, the originating entities transfer receivables through a silent assignment to the CBC. Through this transfer, which is based on a guarantee support agreement, the CBC becomes the legal owner of the respective mortgage receivables, which will not participate in any potential insolvency estate of the respective originators. As long as there is no notification event and neither the respective originator nor the CBC is defaulted, the originating entities may use the cash flows from cover assets at their own discretion. The guarantee is backed through a pledge of the secured property to the security trustee. To ensure that covered bondholders benefit from the pledged security, a parallel debt has been implemented. This debt agreement enables the trustee to issue a notice to pay against the CBC, which, in turn, would require the CBC to make payments to covered bond investors. The particular strengths of Dutch covered bond programmes are: Cover assets are separated from the balance sheet at inception of the programme/ issuance through the transfer of receivables to the CBC. Cash flow adequacy is secured through the asset coverage test and the obligation to neutralise any exposure to interest rate and currency risk. Investors are well protected against liquidity risk because there is a clear escalation process in case of a credit profile deterioration of participating parties.
Originators transfer receivables to the CBC
Parallel debt agreement between CBC and trustee
Strengths
Weaknesses
The relative weaknesses of Dutch covered bond programmes are: Compared with traditional covered bond products, the programme contains a rather complex set of structural features. So far, the Dutch banking regulators record with regards to the surveillance of Dutch covered bonds is rather limited.
Qualifying collateral for Dutch covered bonds

Dutch prime residential mortgages
The cover portfolio consists of Dutch residential prime mortgage loans on owner-occupied properties. Generally, the single loan amount shall not exceed 1.5mn, which is reduced to 250,000 in the case of loans that benefit from a Nationale Hypotheek Garantie (NHG). Appropriate real estate insurance must be in place. With regards to pool eligibility, there is a general LTV limit of 125%, which is defined as loan-to-foreclosure value (LTFV). Foreclosure values are about 85% of the market value. Within the asset coverage text (see below), specifically defined haircuts are applied in the respective programmes 88. In this context, it is also important to note that LTV levels in the Dutch mortgage market are generally above those observed in other countries, as interest payments are fully deductible from tax, increasing mortgage affordability significantly. In cases of mortgage loans
88
We provide an overview of the LTV haircuts applied in the various programmes at the end of this chapter.
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guaranteed by NHG, there is neither a cap with regards to eligibility criteria nor a cap within the asset coverage test (see below). Property values are indexed to the Dutch Kadaster House Price Index on a quarterly basis. Price decreases are fully reflected in the revaluation, and, in the event of a price increase, a haircut is generally applied 89. Substitution assets can be included in the cover pool. Their aggregate value can account for up to 10% of the cover assets and may consist of exposures to, or which are guaranteed by: governments or other public sector entities that qualify for a 0% risk weighting under the standard approach according to the EU capital requirements directive; exposures to institutions that are up to 20% risk weighted (standard approach); and triple-A rated RMBS tranches.
Asset cover test and minimum over-collateralisation
To ensure that over-collateralisation is compatible with the target rating level, a quarterly asset cover test is in place. Along with the results of this calculation, a minimum overcollateralisation must be maintained, which may vary across programmes. The asset cover test comprises a number of valuation rules that are applied to the underlying assets. For example, it stipulates that loans more than 90 days in arrears have to be deducted to a predefined degree (100% ABN AMRO, 70% all other programmes) from the current balance when running the test. In the case of a breach of the asset cover test, no further covered bonds can be issued. If the breach is not rectified until the following calculation date, the trustee will serve a notice to the CBC to pay. The amortisation test is designed to ensure that the assets will be sufficient to enable the CBC to repay the covered bonds. It only applies after an issuer default has occurred, so covered bond holders will be relying on the guarantee. The test will fail if the amortisation test aggregate loan amount falls below the outstanding balance of all the covered bonds.
Amortisation test

Surveillance through independent trustee, Dutch banking regulators and rating agencies
The issuer/originator is responsible for the regular pool monitoring, with the asset coverage test calculation being checked by an independent auditor on an annual basis. In addition, in case of registered covered bonds, the Dutch covered bond regime stipulates minimum requirements for the registration of covered bonds and regulatory surveillance. Finally, rating agencies are heavily involved in the programme and need to re-affirm the ratings upon each issuance. They also monitor the amount of over-collateralisation required to maintain the triple-A ratings, which should provide investor comfort with respect to rating stability, should the mortgage market weaken. Similar to UK covered bonds, within Dutch covered bond programmes, certain contractual provisions stipulate that exposure to interest rate and currency risk must be neutralised. In addition, downgrade triggers for swap counterparties, the pre-maturity test, maturityextension rules and the amortisation test all are designed to ensure cash flow adequacy. Most Dutch programmes foresee the issuance of covered bonds with a soft-bullet maturity. Following the serving of a notice to pay, the CBC may not have sufficient proceeds for a timely repayment of covered bonds. In this case, the legal final maturity will be extended 12 months to allow for a realisation of cover assets. Some programmes also feature a pre-maturity test. This is the case with the ABN AMRO programme and, optionally, with the ING Bank programme as well. The pre-maturity test is designed to ensure that there will be sufficient cash available to make redemption payments for the respective covered bonds. If in the six months before a hard bullet final maturity payment is due the issuers short-term ratings fall to below A-1+ (S&P), or F1+ (Fitch), or P89
Maturity extension
Pre-maturity test
An overview of these valuation haircuts is provided in the table at the end of this chapter.
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1 (Moodys), the pre-maturity test will trigger the CBC to raise cash by either receiving funds from the originators, selling randomly selected loans, or entering into appropriate liquidity facility agreements. The failure to cure a breach of the pre-maturity test would authorise the trustee to serve a notice to pay against the CBC, which then would be obliged to sell receivables and credit the respective proceeds to a separate account.
Other safeguards
Dutch covered bond programmes include a number of other safeguards. In particular, there are minimum rating requirements for the various third parties that support this transaction, including the swap counterparties and cash manager. There are also regular independent audits of the calculations.

The payments under the covered bonds are further guaranteed by the CBC following an issuer default. The CBC will rely on the proceeds derived from the assets on which it has a claim to make these payments. If these proceeds are insufficient to meet obligations to bondholders in full, they will still have an unsecured claim against the issuer for the shortfall.
Asset segregation safeguards
There are a number of safeguards to protect the claims of bondholders in an insolvency scenario. Residual set-off risk, which can arise where mortgage borrowers seek to set-off mortgage payments with their deposits and/or insurance claims, is consistently captured in the asset coverage test. Claw-back risk, which would occur, for example, in case asset transfers to the guarantor or the redemption of covered bonds are challenged by the insolvency administrator, has been addressed within the legal structure. Commingling risk is addressed through provisions which stipulate that upon a downgrade of an issuers short-term rating below a certain threshold (generally P-1/A-1+/F1), the borrowers of the underlying mortgage loans will be notified to redirect their payments to an account in the name of the guarantor. There are a number of trigger events in the covered bond structure, the first being issuer default. This can occur in a number of situations, including the following: Failure to pay any interest or principal amount when due by the issuer for more than 7 or 15 days, respectively; Bankruptcy or legal proceedings being taken against the issuer; Issuer default on any obligation relating to the covered bond programme.
No acceleration unless the CBC defaults
An issuer default will not accelerate payments to covered bondholders but will allow the security trustee to start proceeding against the issuer and group guarantors while the asset pool is wound up in an orderly fashion. The second is the CBC event of default, which would arise if the CBC failed to make any payments under the guarantee when due, if legal proceedings were started against it, if the amortisation test failed or if there was a default on any other obligation. This would cause the acceleration of payments to covered bondholders and the redemption at the early redemption amount relevant to that particular covered bond.
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Figure 256: Overview Dutch covered bond programmes

ABN AMRO Achmea ING Bank NV SNS Bank NV NIBC Bank NV
Programme volume in bn Ratings: (S&P/Moodys/Fitch) LTV cap pool eligibility LTV cap in ACT
25 AAA/Aaa/AAA 125%*/ No cap NHG ** 80%**/ 100% NHG *** Kadaster 85% 92.50% 108% No recognition Yes Yes; pre-maturity test Yes Yes Yes
10 AAA/Aa2/125%*/ No cap NHG ** 125%*/ No cap NHG *** Kadaster 85% 86.2% 116% Max. 30% or repurchase Yes No; 12-month maturity extension No No No
30 AAA/Aaa/AAA 125%*/ No cap NHG ** 80%**/ As notified NHG *** Kadaster 90% 90.40%**** 111% Max. 30% or repurchase Yes Subject to individual bond issue Yes Yes Yes
15 -/Aaa/AAA 125%*/ No cap NHG ** 80%**/ 100% NHG *** Kadaster 100% 72.5% 138% Max. 30% or repurchase Yes No; 12-month maturity extension Yes Yes Yes
7 -/-/AAA 125%*/ No cap NHG ** 125%*/ As notified NHG *** Kadaster 100% 90.5% 110.50% Max. 30% or repurchase Yes No; 12-month maturity extension Yes Yes No
House Price Index Indexation haircut for price increases Asset percentage applied in the ACT Applied overcollateralisation In arrears accounting in the ACT Set-off risk accounted for in the ACT Hard bullet
Registered with the DNB Fulfills UCITS 22(4) Fulfills CRD
Note: *Loan-to-foreclosure value (LTFV). **For loans with a Nationale Hypotheek Garantie (NHG). ***Indexed loan-to-market value (LTMV). ****Programme maximum set at 97%. Source: Transaction documents
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Netherlands
Dutch Covered Bonds Private legal structure based on Dutch civil law and contract law. Legislation came into force on 1 July 2008. No; any Dutch bank. Not applicable. Cover assets are segregated through the transfer to a separate entity. Under both covered bond programmes, this is the Covered Bond Company, an insolvency remote private company that is wholly owned by a foundation. Hedge positions are part of the structural enhancements intended to protect bondholders. Up to 10%. So far, only residential mortgages are allowed.
Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching
Not relevant. Subject to contractual prescriptions; under both existing programmes, only Dutch mortgages are allowed. Subject to contractual prescriptions generally either 80%, based on the loan-to-market-value, or 125%, based on the loan-to-foreclosure-value Subject to contractual prescriptions; irrelevant until now. Subject to individual programme generally either foreclosure value (~ 85% of the market value) or market value (market value = fair value/85-90%). Indexed to house price index (Kadaster House Price Index). Yes; Dutch Central Bank (De Nederlandsche Bank), Dutch Authority for the Financial Markets (Autoriteit Financile Markten) and an independent auditor. By contractual provisions, exposure to interest rate and currency risk is neutralised. In addition, downgrade triggers for swap counterparties, the asset cover test, the amortisation test and a prematurity test/maturity extension are designed to ensure cash flow adequacy. Yes; defined by asset cover test. Yes; stipulated through contractual rules. Yes; subject to the asset percentage applied in the asset coverage test, which is to be adjusted on the upside if portfolio performance worsens. Yes. No, but all assets are ring-fenced within a specially created entity. all the payments received from the special entity's assets are collected in a special account. Investors continue to receive scheduled payments as if the issuer had not defaulted. In the event of insufficient pool asset proceeds to cover their claim, investors rank pari passu with senior debt holders. There is a simultaneous unsecured dual claim against the issuer and secured against the portfolio held by the specially separated entity. Yes (only registered covered bonds). Only in case the cover pool eligibility criteria of the respective programme are compliant with the CRD. In particular an 80% LTV cap needs to be stipulated in the ACT.
Protection against credit risk Protection against operative risk Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms

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NORWEGIAN MARKET
Overview
Dr Leef H Dierks +49 (0) 69 7161 1781 leef.dierks@barcap.com
With an aggregate volume of 14.25bn from 10 benchmark covered bonds (Obligasjonslan med portefoljepant) issued, the Norwegian market is the second largest in the region (after Sweden) at the time of writing, recording considerable growth since the Norwegian Covered Bond Act and the respective supplementary legislation came into force on 1 June 2007. The first and hitherto largest entity to issue benchmark covered bonds within the scope of the Norwegian Covered Bond Act was DnB NOR (DNBNOR), which, in June 2007, issued its inaugural Norwegian covered bond. In autumn 2007, SpareBank 1 Boligkreditt (SPABOL) followed with its inaugural benchmark Norwegian covered bond. Also active on the Norwegian covered bond market is Terra Boligkreditt (TERBOL), which, however, has so far only issued covered bonds in non-benchmark size. These are not included in this publication 90. Despite likely not in benchmark format in a first step, Storebrand Kreditforetak (STORE) and Sparbanken Vest (SVEG) could also be issuers of Norwegian covered bonds soon. Attributed to spill-over effects from the crisis on the global financial markets, the issuance of benchmark Norwegian covered bonds experienced a pronounced slow-down over the course of 2009. With swap spreads of covered bonds coming under pressure in the first half of the year and widening by as much as 80bp between September 2008 and May 2009, EUR-denominated covered bonds were no longer an attractive refinancing instrument. Consequently, issuance dropped to only one benchmark deal in 2009; the latter being issued in late November. Among the factors for the muted primary market activity observed in 2009 was the exchange of Norwegian government securities for covered bonds. This was authorised by the Norwegian parliament (Storting) on 7 January 2009 and foresaw that the government will exchange Treasury bills for the following covered bonds denominated in NOK Covered bonds backed by Norwegian residential mortgage loans (Section 2-28, first paragraph, a) of the Financial Institutions Act). Covered bonds backed by Norwegian commercial mortgage loans, Section 2-28, first paragraph, b) of the Financial Institutions
Second-largest Nordic market
Figure 257: Outstanding Norwegian jumbo covered bonds

Instrument ISIN Size ( bn) Launch date Spread at launch As at 28 May 2010
mid-swaps (bp)
4.500% SPABOL Oct 10 4.375% DNBNOR Nov 10 4.500% DNBNOR May 11 4.000% SPABOL Jun 11 4.625% DNBNOR Jul 12 2.375% SPABOL Dec 12 4.125% DNBNOR Feb 13 5.000% SPABOL Sep 13 3.375% DNBNOR Jan 17 3.250% SPABOL Mar 17
Total
XS0323446665 XS0330848622 XS0363732701 XS0350301668 XS0308736023 XS0470740969 XS0342241295 XS0386753031 XS0478979551 XS0495145657
1.50 1.50 2.00 1.00 1.50 1.00 2.00 1.00 1.50 1.25
14.25bn
25 Sep 2007 8 Nov 2007 7 Apr 2008 26 Feb 2008 26 Jun 2007 24 Nov 2009 18 Jan 2008 3 Sep 2008 11 Jan 2010 10 Mar 2010
+4 +2 + 15 + 13 -4 +32 + 11 +48 +39 +45
-10 -23 -6 +2 +21 +27 +19 +27 +46 +51
90
Please refer to the Association of German Pfandbriefbanks (vdp) for the minimum standards for the issuance of Jumbo Pfandbriefe.
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Act, if a plan for obtaining a credit rating is submitted and a high rating is expected. Covered bonds backed by Norwegian loans to, or guaranteed by, central or local government, Section 2-28, first paragraph, d) of the Financial Institutions Act, if a plan for obtaining a credit rating is submitted and a high rating is expected. Similar securities (covered bonds) issued under the rules of other EU/EEA states backed by Norwegian residential or commercial mortgage loans. Covered bonds backed by Norwegian commercial mortgage loans are eligible, provided a plan for obtaining a credit is submitted and a high rating is expected 91. This measure, which ended by year-end 2009 when Norges Bank announced that auctions are cancelled until further notice, enabled Norwegian entities to secure longterm funding without relying on the (EUR-denominated) capital market 92. At the time of writing, two benchmark deals worth 2.75bn had been issued in 2010. Taking into consideration the rather benign funding environment and redemptions of 3bn, we expect gross issuance to total c. 4bn in 2010, thus markedly up from 1bn in 2009 but still lagging the 2008 supply (6bn) (Figure 258). In light of relative stable redemptions of 2.5-3bn annually from 2010 to 2013, we expect gross benchmark covered bond supply out of Norway to largely follow the pattern observed before the crisis (Figure 259). Figure 258: Gross benchmark covered bond issuance (bn)
8 6.0 6 4.5 4.0 4 2 3 2.5
Figure 259: Benchmark covered bond redemptions (bn)

4 3.0 3.0 3.0 2.8
2 1.0 0 2007 2008 2009 2010e
0 2010 2011 2012 2013 2014 2015 2016 2017
Note: * Expected. Source: Barclays Capital
Covered bond issuance limited to so-called Kreditforetaks
The Norwegian covered bond framework was originally enacted in December 2002, when the Norwegian Parliament adopted amendments to the Law on the Financing Business of Financial Institutions. These amendments stipulated the conditions of funding covered bonds. As in the case of other European covered bond legislations, the framework for Norwegian covered bonds was primarily designed to provide Norwegian mortgage lenders with a more efficient instrument for funding their mortgage businesses. According to Norwegian law, only mortgage credit institutions, ie, the so-called Kreditforetaks, whose business activities are restricted to residential and commercial mortgage lending, as well as public-sector lending, are allowed to issue covered bonds. Within the scope of the previous legal framework, bonds issued by mortgage credit institutions did not benefit from a bondholders preferential claim. This shortcoming was adjusted through respective
91 92
Source: Norges Bank, Circular 1, 7 January 2009. Source: Norges Bank, 17 December 2009.
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amendments that now assure that derivative counterparties rank pari passu with covered bond investors in the event of issuer insolvency. In June 2004, the Norwegian Parliament passed amendments to the Financial Institutions Act, thereby allowing domestic financial institutions to issue covered bonds. In June 2005, the parliament approved further changes, among them the inclusion of derivative contracts in the cover pool to hedge market risk between eligible assets and covered bonds. Since then, the Norwegian Parliament worked on new amendments to reinforce and ensure the priority pledge of covered bond investors on the cover pool in the event of insolvency of the issuer. In parallel, Kredittilsynet, the Banking, Insurance and Securities Commission of Norway, and the Ministry of Finance (MoF) revised the secondary legislation. The latter provides further criteria on asset and liability management, mortgage loan evaluation, and timely payment of covered bonds under bankruptcy proceedings. The final supplementary legislation was adopted by the Ministry of Finance on 25 May 2007. Both the Norwegian Covered Bond Act and the supplementary legislation came into effect on 1 June 2007.
Strengths and weaknesses
In our opinion, among the strengths of the Norwegian covered bond framework are: Strict segregation of all covered assets from the balance sheet of the originating entity. Sound asset liability matching requirements in place. A single exposure ceiling of 5% of the total cover pool limits concentration risk. Among the relative weaknesses of the Norwegian covered bond framework are: The quality of Norwegian covered bonds depends largely on the maintenance of voluntary over-collateralisation, which can be subject to change, particularly in a stress scenario. Still, this weakness can usually be mitigated through contractual obligations to maintain a sufficiently high level of over-collateralisation to be awarded an AAA rating. As Norwegian covered bonds are still relatively new products that have so far only been used by two institutions, neither market participants nor Kredittilsynet have so far gained much experience. There is a lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. However, this can be mitigated by detailed and regular reporting on cover pool characteristics and risk management indicators on a voluntary basis.
Collateral pool requirements
Upon inclusion of the loans in the collateral pool for Norwegian covered bonds, a prudent value shall be established for the assets serving as collateral for the respective mortgage loan. The prudent market value may not exceed the market value resulting from a cautious assessment and shall generally be fixed by an individual assessment of the respective assets registered. As stated in section 2-29 of the Norwegian Financial Institutions Act, the valuation shall be conducted by a competent and independent person in accordance with recognised principles. Nevertheless, the valuation of residential properties may be based on general price levels, provided this is considered prudent based on market conditions. Also, the respective mortgage credit institution has to establish a system for the subsequent monitoring of asset values. In the case of the market value indicating that a significant impairment of the value has occurred, the mortgage credit institution has to ensure that a new prudent value is established. As stated in section 2-30 of the Norwegian Financial Institutions Act, assets included in the cover pool may not be pledged or subject to execution or other enforcement
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procedures in favour of particular creditors of the mortgage credit institution. Section 2-31 of the Act stipulates that the value of the collateral pool must, at all times, exceed the value of the covered bonds issued with a preferential claim over the pool, accounting for the mortgage credits derivative agreements.
Strict liquidity requirements
As outlined in section 2-32 of the Norwegian Financial Institutions Act, the mortgage credit institution has to ensure that payments from the collateral pool enable the mortgage credit institution to honour its payment obligations towards covered bond holders and counterparties to derivative agreements at all times. To meet this requirement, mortgage credit institutions can enter into interest and foreign exchange contracts. Mortgage credit institutions furthermore need to establish a liquidity reserve, which is included in the cover pool as substitute collateral. Section 2-33 of the Norwegian Financial Institutions Act states that every mortgage credit institution needs to maintain a register of the covered bonds it issues, and of the cover assets assigned thereto, including derivative agreements. Cover assets can be maintained in either separate asset pools (utlnsregister) for commercial mortgage loans, residential mortgage loans and public sector loans, or in a single asset pool. As outlined in the supplementary legislation, loans will be eligible for inclusion in the collateral pool provided they are secured on residential property up to a maximum loan to value (LTV) of 75%. The respective property must be located in the EEA or in an OECD country. It is also worth noting that the strategy of potential Norwegian issuers is clearly biased towards the domestic business. With regards to commercial mortgage loans, mortgage credit institutions are not allowed to grant mortgage loans with a LTV above 60%. Substitute cover assets can ordinarily be included to up to a maximum of 20% of the collateral pool. Substitute assets must have a similar quality than other cover assets. In addition, derivative contracts entered into with the purpose of meeting matching requirements can be included in the cover pool. The volume of hedge contracts including substitute collateral is limited to 20% of the pool. If this limit is exceeded, the mortgage credit institution needs to immediately notify Kredittilsynet. The latter will then set a time limit for rectifying the share of substitute assets. Finally, section 2-31 of the Norwegian Financial Institutions Act limits exposure to a singlemortgage borrower to 5% of the nominal amount of all cover assets. This feature is typical for previous structured covered bond programmes in the UK and the Netherlands. Yet, in these cases, the limit is defined on an absolute basis and, therefore, represents a much higher degree of granularity. However, such a single-exposure ceiling limits concentration risk and, therefore, in our view, is credit positive.
Maximum loan to value ratio (LTV) of 75% for residential property
Single exposure ceiling of 5%

Supervision through Kredittilsynet
Norwegian mortgage credit companies have to comply with the rules of the Norwegian Financial Institutions Act. This is regulated by Kredittilsynet. Mortgage credit institutions are obliged to report information on cover assets on a regular basis to an independent inspector who particularly controls the cash flow adequacy, the market risk exposure and the evaluation of cover assets. Before mortgage credit institutions issue covered bonds, Kredittilsynet appoints an independent inspector. This appointment can be withdrawn at any time and in favour of a new inspector. According to section 2-34 of the Norwegian Covered Bond Act, the inspector shall oversee that the (cover asset) register is correctly maintained and regularly reviewed. The mortgage credit institution is obliged to provide the inspector with all relevant information, with the latter having full access to the credit mortgage institutions register.
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The Norwegian Financial Institutions Act requires the current nominal value of assets within the collateral pool to be in excess of the current nominal value of the covered bonds issued at all times. Derivatives must be included within the scope of the calculation. Furthermore, the Norwegian Financial Institutions Act stipulates that cash flows have to be matched narrowly. Also, there should be no exposure to foreign exchange risks.

The provisions of the Norwegian Covered Bond Legislation stipulate that in the event of an issuers insolvency, the collateral pool, any derivative contracts and the covered bonds themselves, will be separated from any of the issuers other assets and liabilities. In a second step, timely payments can then be made to covered bondholders. Should their priority claim prove to be inadequate, additional claims by covered bond holders and derivative counterparties will rank pari passu to those of unsecured unsubordinated creditors.
Covered bond holders benefit from preferential claim
In the event of bankruptcy or the wind-down of a mortgage credit institution, holders of covered bonds shall have an exclusive, equal and proportional preferential claim over the collateral pool assigned to them. Any such preferential claim over the cover pool shall rank ahead of priority. Furthermore, according to section 2-35 of the Norwegian Covered Bond Law, covered bondholders shall be entitled to timely payment from assets encompassed by their preferential claim for the duration of the bankruptcies proceedings, provided the cover pool is essentially in compliance with statutory requirements. In case it is not possible to make contractual payments to the covered bondholders using funds from the collateral pool, and an imminent change in the liquidity situation is unlikely, the bankruptcy estate shall set a date on which payments shall then be halted.
The Norwegian housing and mortgage market

Market fully recovered from the 2008 dip in house prices
In contrast to several other European countries, the Norwegian housing market remained relatively unaffected from falling property prices in 2009, thereby dispelling concerns which were based on the marked contraction of housing investments in late 2008. Following a dip in house prices in Q3 and Q4 08 with the house price index falling from 131.5 in Q2 08 to 127 in Q3 08 and to 118.1 in Q4 08, the market had fully recovered by Q3 09 when the house price index stood at 131.8 again. Despite all regions recording a recovery in property prices in 2009, the above development was mostly driven by the Stavanger region where, compared to 2005, house prices had increased by 53%. In Oslo, house prices were up 26.7% since 2005, followed by Trondheim and Bergen with 18.0% and 18.4%, respectively. On a seasonally-adjusted basis, Norwegian house prices in fact rose by an average of 11.6% between Q4 08 and Q4 09 93. Driving the ongoing recovery of the Norwegian housing market is the moderation in the decline in housing investments, which markedly slowed over the course of H2 09. According to Norges Bank, the increase in spending on home refurbishment likely restrains a further fall in housing investment 94. Housing starts, which had markedly declined in Q2 and Q3 09, started gradually recovering in Q4 09. This however, in our view, is at least partly attributed to seasonal factors, as, historically, the number of housing starts is seen to increase as at year-end. Despite this moderate recovery, we note that new housing
93 94
Source: Statistics Norway. Source: Norges Bank, Monetary Policy Report 3/09.
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construction is primarily concentrated on detached and small dwellings. The new construction of major residential flat buildings still leaks momentum.
Further recovery lies ahead
With the number of new housing starts totalling 19,698 in 2009, ie, strongly down from 25,791 units in 2008, Norges Bank highlights that the underlying demand, which was fuelled by the drop fall in interest rates and the improved access to residential mortgage lending, was not satisfied. This, in combination with the new order index for residential dwellings which has been pointing sharply upwards since Q2 09, makes us believe that housing starts will further increase over the course of 2010. Generally, with a population of 4.86mn and a total of 2.3mn residential dwellings of which 1.2mn are detached houses, the Norwegian housing market is among Europes smallest. Yet, the market benefits from a comparatively high ownership ratio of c.80% and from a comparatively low unemployment rate of 3.5% at the time of writing. As in the years before, the Norwegian mortgage market remains dominated by domestic commercial and savings banks, which provide c.75% of all residential mortgage lending. The remaining 25% of all mortgage lending is accounted for by federal lending institutions, mortgage lending institutions, as well as insurance and finance companies. According to the Norwegian central bank, approximately two-thirds of the banks gross lending was secured by residential and commercial mortgage loans as at year-end 2009. Note that in light of a benign mortgage funding environment with the key interest rate standing at 1.75% at the time of writing and an average mortgage rate of 3.32% in Q4 09, down from 6.45% in Q4 08, mortgage lending volumes will likely further increase. Note, however, that figures might appear biased as the sharp increase in industry loans from Norwegian mortgage companies and the decrease in the growth for banks, may be connected with the swap agreement of covered bonds and treasury bills that the Norwegian government issued in October 2008 in an effort to reduce the negative effects of the financial crisis. Large portfolios of both housing loans and industry loans are moved from banks to mortgage companies in order to be used as collateral when issuing covered bonds, which in turn are used in the swap agreement with the government to acquire treasury bills 95. Overall, we thus believe that the Norwegian housing market seems poised to further recover over the course of 2010.
Figure 260: House Price Index (2000 = 100)

140 120 100 80
Figure 261: Price Index (new detached houses, 2000=100)

200
150
100 60 40 20 0 1992 0 Mar-89 50
1996
2000
2004
2008
Mar-93
Mar-97
Mar-01
Mar-05
Mar-09
Source: Statistics Norway, Barclays Capital
95
Source: Statistics Norway
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Figure 262: New Order Index: residential buildings (2005=100)

125
Figure 263: New dwellings started (SA, units in 000)

5 4
100 3 2 75 1 50 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 0 Jan-85
Jan-90
Jan-95
Jan-00
Jan-05
Jan-10
Figure 264: Change in prices of new dwellings (in % y/y)

15
Figure 265: Mortgage lending in Norway (% y/y)

30 25
10
20
5
15 10
5
-5 Mar-89
Mar-93
Mar-97
Mar-01
Mar-05
Mar-09
0 Mar 96 Mar 98 Mar 00 Mar 02 Mar 04 Mar 06 Mar 08
Source: Ecowin, Barclays Capital
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Norway
Obligasjonslan med portefoljepant, obligasjonslan sikret ved pant Law enshrined on 22 December 2002, amendments in 2006 and 2007 Yes; mortgage credit institutions: Kreditforetaks (KFs) Only public sector, residential and commercial mortgage lending Cover assets remain on the balance sheet but are maintained in either separate asset pools (utlnsregister) for commercial mortgage loans, residential mortgage loans, public sector loans or in a single-asset pool Hedge positions can be included in the cover register Limited to 20% of the cover pool; regulator can temporarily raise limit to 30%, not including hedge contracts, with the approval of Kredittilsynet It is stipulated that designated residential cover pools shall not include any commercial mortgage loans. There will be separate pools for residential mortgages, commercial mortgages and public sector assets EEA and OECD countries with a satisfactory rating Limitations are subject to more detailed regulations, which have yet to be adopted. The potential issuers current strategies are focused on domestic business 75% 60% No. Basis = market value Regular surveillance through independent inspector Yes. Kredittilsynet (Norwegian banking and financial markets regulator) and an independent trustee The law stipulates that cash flows should be matched narrowly and that there should be no exposure to foreign exchange risk The issuer may replace non-performing loans Servicing can generally be transferred to a third party. In the case of bankruptcy, a bankruptcy administration committee has to ensure the fulfilment of bondholder claims No Yes No. But assets within the cover pool are exempt from bankruptcy proceedings All assets earmarked for the respective asset pool. In addition, investors may benefit from the positive market values of derivatives In the event of insufficient proceeds from the pool assets to cover their claim, covered bond investors rank pari passu with senior debt holders Yes Yes
Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk Mandatory overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms UCITS Art. 22 par. 4 compliant? CRD Annex VI, Part 1, 65 compliant?
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HUNGARIAN MARKET
Overview
With a single deal in the nominal amount of 1.05bn, the Hungarian EUR-denominated, benchmark covered bond market remains among Europes smallest in terms of size. In benchmark format, the only active issuer so far is OTP Mortgage Bank (OTP), which in February 2008 tapped the market with its inaugural jumbo issue that matured in March 2010 96. A second benchmark transaction within the lenders 3bn covered bond programme followed in December 2009. Whereas the overall amount of EUR-denominated benchmark covered bonds outstanding thus was comparatively modest at the time of writing, the countrys overall covered bond market had grown to 3.7bn. Further growth in the near to medium term might arise from the recently announced HUF100bn covered bond purchase programme whose target appears to largely resemble that of the Eurosystems 60bn covered bond purchase programme. In early February 2010, the Monetary Council of the Hungarian National Bank (Magyar Nemzeti Bank, or MNB) announced a programme to support the development of the domestic forint mortgage lending and mortgage bond markets. The overall objective of the programme is to remove obstacles to the autonomous development of the mortgage bond market, and thereby to enhance financial stability and the efficiency of the interest rate transmission mechanism. This may facilitate forint mortgage lending through a reduction in the interest differential against foreign currency loans. More precisely, under the scheme, the (Magyar Nemzeti) Bank will offer to make primary and secondary market purchases of domestically issued HUF mortgage bonds listed as eligible collateral up to a total amount of HUF100bn. All domestic credit institutions will be eligible to participate in the programme, subject to meeting the relevant technical criteria. The Bank will stand ready to make primary market purchases of mortgage bonds with original maturity of three years or more. The Bank will buy up to 20% of bonds issued outside the issuers group as part of an issue, which is a clear indication of the Banks commitment to reinvigorating the market. The Bank requires those institutions participating in the programme to ensure the provision of continuous and firm two-way price quotes in the mortgage bonds it will purchase. That is expected to enhance the transparency of the secondary market of mortgage bonds. The first mortgage bond auctions in the secondary market took take place on 10 March 2010. 97 As at end-January 2010, the latest date for which data were available, residential mortgage lending to individuals in Hungary, which traditionally is not limited to borrowing in the local currency, amounted to HUF2,974bn, down slightly from the HUF3,076bn observed a year before. In January 2008, residential mortgage lending still amounted to HUF3,338bn. At the
Magyar Nemzeti Bank: HUF100bn covered bond purchase scheme
Sharp increase in foreign currency mortgage lending
Figure 266: Outstanding Hungarian covered bonds

Instrument ISIN Size ( bn) Launch date Spread at launch As at 28 May 2010
mid-swaps (bp)
4.125% OTP Dec 2011

XS0471918077
1.050
1 Dec 2009
+220
+198
96
Previous issues such as the 4.25% OTP November 2011, strictly speaking are no benchmark covered bonds as they do not fulfill the minimum standards for the issuance of jumbo covered bonds. 97 Source: Magyar Nemzeti Bank.
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Figure 267: Structure of Hungarian mortgage market (%)

100%
Figure 268: Monthly residential mortgage lending

100 HUF bn
80%
75
60%
50
40%
25
20% local currency 0% Jan-00 Jan-02 Jan-04 foreign currency Jan-06 Jan-08 Jan-10
0 Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Source: Magyar Nemzeti Bank, Barclays Capital
Source: Magyar Nemzeti Bank, Barclays Capital
same time, EUR-denominated mortgage lending had strongly picked up, growing from HUF73bn in January 2008 to HUF151bn in January 2009 to HUF435bn in January 2010. At the time of writing, the foreign currency mortgage market, which is dominated by CHF and EUR-denominated products, thus exceed the domestic currency market in terms of volume; a development that could be observed for the first time in February/March 2008 and that has since stabilised itself on a high level (Figure 267) 98. The development outlined in Figure 267 is attributed to the gradual decline in the demand for mortgage loans denominated in HUF (Figure 268). Particularly in the case of longerdated maturities, borrowers featured a preference for mortgage loans denominated in foreign currencies, effectively making CHF-denominated loans with variable interest rate the most popular mortgage product at the time of writing. The Hungarian mortgage market is dominated by three banks: the Land Credit and Mortgage Bank (FHB), Unicredit Jelzlogbank, and OTP Mortgage Bank. Having tapped the EUR-denominated benchmark covered bond market, the latter institution is extensively covered in the profiles section of this publication.
Figure 269: Hungarian mortgage banks (as at year-end 2008)

Fldhtel- s Jelzlogbank Rt. (FHB) Unicredit Jelzlogbank Zrt. OTP Jelzlogbank*
Total assets (HUF bn) Mortgages (HUF bn) Average LTV Proportion of NPL
690 (+11.8% y/y) 516 (+16.4% y/y) 39.9% 5.4%
144 (+42% y/y) NA NA NA
9,376 (+10.8% y/y) 2,061 (+16.7% y/y) 43.6% 4.0%
Note: *Figures refer to OTP Bank Group. Source: Company data, Barclays Capital
Fldhtel- s Jelzlogbank
The Land Credit and Mortgage Bank (FHB), which is headquartered in Budapest, was established in 1997 as the first Hungarian mortgage credit institution through the Ministry of Finance and four Hungarian banks the Magyar Befektetsi s Fejlesztsi Bank Rt., the Mezobank Rt., the Postabank s Takarkpnztr Rt, and the Pnzintzeti Kzpont Bank Rt. It operates as a special banking institution under the Hungarian Act on Mortgage Banks and Mortgage Bonds. On 29 August 2007, the Hungarian Privatization and State Holding
98
At the time of writing, the most typical mortgage loan in Hungary was a variable interest rate loan denominated in CHF.
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Company (PV Zrt.), which formerly held a 54.11% stake in FHB, reduced its participation to 4.11%. As at end-June 2009, a 44.8% stake in FHBs shares was held by Hungarian institutional investors with foreign institutional investors holding a 46% stake. The Hungarian government held 4.1%.
Unicredit Jelzlogbank
Founded on 8 June 1998 as Vereinsbank Hungria Jelzlogbank, HVB Jelzlogbank was the first privately-owned mortgage bank in Hungary. It received its operating licence in June 1999. Following the merger between Bayerische Vereinsbank and Bayerische Hypothekenund Wechselbank in September 1998, the mortgage bank continued operating under the name of HVB Jelzlogbank and was unchanged after HVB was acquired by UniCredit in late 2005. On 1 February 2007, HVB Jelzlogbank Rt changed its name to Unicredit Jelzlogbank Rt with its sole owner being UniCredit Bank Hungary. OTP Mortgage Bank (OTP) is a fully-owned (100%) subsidiary of OTP Bank, the largest financial services provider in Hungary, and is set up as a special banking institution operating under the Hungarian Act on Mortgage Banks and Mortgage Bonds. Established in February 2002, its role is to provide subsidised and non-subsidised mortgage loans, land mortgage loans and home equity loans, relying on OTP Banks network of more than 250 branch offices and intermediaries. OTP Mortgage Bank is fully integrated into OTP Bank and relies on its parent with regard to credit origination, treasury activities and financial reporting. As at year-end 2009, the latest date for which data were available, 73.5% of OTP Banks share capital was held by foreign investors, among them Groupama (9.16%). Domestic investors, among them the Hungarian Oil and Gas Company MOL (8.57%) or the countrys government (0.5%), held the remaining 26.5%.
OTP Jelzlogbank
Issuance of mortgage bonds restricted to mortgage banks
Act No. XXX of 1997 on Hungarian Mortgage Banks and Mortgage Bonds stipulates the specific rules applicable to the countrys mortgage banks bonds. According to section 2(1), mortgage banks are specialised credit institutions. Their foundation, operation, supervision, and liquidation are subject to the provisions of Act CXII of 1996 on Credit Institutions and Financial Enterprises. Legally, in Hungary, only mortgage banks are allowed to issue mortgage bonds (jelzloglevl). As outlined in the Hungarian Mortgage Bank Act (1997/2004), mortgage banks are specialised credit institutions whose business activity is basically restricted to providing mortgage lending and auxiliary financial services. Mortgage banks grant loans secured by mortgages including independent mortgage liens on real estate property located in the Republic of Hungary. Funds will be raised by issuing mortgage bonds. Amendments to the Hungarian Mortgage Bank Act came into effect on 1 January 2007 when lending limits were extended to all EEA countries and up to 15% of the total loan portfolio. At the same time, the general rule limiting ordinary collateral to a maximum of 60% was eased towards 70% for claims covered by residential property.
Cover assets remain on issuers balance sheet
The Hungarian Act on Mortgage Banks and Mortgage Bonds (1997/2004) provides that mortgage banks always possess cover assets in excess of the principal of the mortgage bonds outstanding and the respective interest thereon both on a nominal basis and based on present value calculation. Cover assets remain on the balance sheet of the issuer, and all mortgage bonds issued by a mortgage bank are covered by the same collateral pool. The composition of the collateral pool can only be changed with the prior permission of the Coverage Supervisor who acts in the interest of mortgage bond holders.
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The Hungarian Act on Mortgage Banks and Mortgage Bonds (1997/2004) stipulates that the value of principal claims from mortgage loans cannot exceed 70% of the mortgage lending value. Also, only the portion of a mortgage loan that does not exceed 60% of the mortgage lending value of the property is eligible for inclusion in the collateral pool of the mortgage bonds. Consequently, on an aggregated (or portfolio) level and as prescribed by law, the loan-to-value ratio (LTV) of mortgage loans cannot exceed 70%. The proportion of mortgage loans exceeding 60% cannot be refinanced by mortgage bonds. Hungarian mortgage bonds may be covered exclusively by mortgages and independent mortgage liens entered into the coverage register (fedezet-nyilvntarts). The availability and quality need to be permanently monitored. Supplementary coverage may only consist of liquid assets listed in the Hungarian Mortgage Bank Act and cannot exceed 20% of the collateral pool.
Calculation methods specified by decree laws
Specific regulations with regards to the determination of the mortgage lending value (hitelbiztostki rtk) are set out in Decrees 25/1997 (Ministry of Finance) and 54/1997 (Ministry of Agriculture). The decrees specify the calculation methods of the mortgage lending value of real estate that does not qualify as agricultural land. Both decrees bindingly prescribe the use of comparative methods, as well as the application of the principle of prudence in the valuation process. The decrees also determine the validity of the valuation report. Regulations regarding the determination of the mortgage lending value usually refer to the sustainable aspects of the property. The mortgage banks internal systems used to determine the mortgage lending value refer to methodological principles defined in the decrees. Internal regulations are subject to prior approval by the Hungarian Financial Supervisory Authority.

Surveillance rules
The Hungarian Financial Supervisory Authority is responsible for verifying that the countrys credit institutions (and thus its mortgage banks) comply with the Credit Institutions Act, as well as other acts and other applicable banking regulations. As outlined in the Hungarian Act on Mortgage Banks and Mortgage Bonds (1997/2004), the Hungarian Financial Supervisory Authority exercises special supervision over mortgage banks in addition to the provisions foreseen in the Credit Institutions Act and the Capital Markets Act. The Hungarian Act on Mortgage Banks and Mortgage Bonds requires the mortgage bank to appoint a cover pool monitor that has to be approved by the Hungarian Financial Supervisory Authority. Even though an independent auditor can be appointed, the latter cannot be identical to the mortgage banks regular auditor. Formally, the cover pool monitor is responsible for monitoring and certifying the existence and registration of eligible security in the cover register on a permanent basis. A certificate from the collateral pool monitor regarding the existence of the cover assets is attached to each mortgage bond. The cover pool monitor may be appointed for a fixed period, not exceeding five years, however. The cover pool monitor may be re-appointed following the termination of the appointment period. Although the contract of appointment between the mortgage bank and the cover pool monitor is subject to civil law, it cannot be lawfully terminated without the approval of the Hungarian Financial Supervisory Authority. Within the scope of coverage supervision activities, the cover pool monitor may not be subject to influence by the respective mortgage bank.
Publication of data
Hungarian mortgage banks are legally required to publish the nominal value and the accrued interest of the mortgage bonds outstanding. Also, on a quarterly basis, the cover asset value needs to be published. Figures have to be certified by the collateral pool monitor and are then disclosed to the Hungarian Financial Services Authority.
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Cover ratio of at least 100%
The Hungarian Act on Mortgage Banks and Mortgage Bonds stipulates that mortgage banks shall always possess sufficient cover to surpass the principal of the mortgage bonds outstanding and the respective interest thereon. Formally, the combined volume of the (value-adjusted) outstanding principal claims considered as collateral have to be in excess of 100% of the nominal value of the mortgage bonds outstanding. Also, the aggregate amount of interest accrued on the (value-adjusted) outstanding principal claims serving as collateral must exceed 100% of the interest accrued on the nominal value of the outstanding mortgage bonds. Section 14 (4) of the Hungarian Act on Mortgage Banks and Mortgage Bonds stipulates that the amount of coverage backing the mortgage bonds must also be calculated and published at its net present value (NPV). Cash-flow mismatches between collateral assets and cover bonds are reduced by the prepayment rules of the Hungarian Act on Mortgage Banks and Mortgage Bonds. The Act also states that mortgage banks can formally stipulate (eg, in the mortgage loan contract) that the respective loan cannot be prepaid prior to its original maturity. If prepayment is allowed, the mortgage bank is entitled to charge a fee for any related profit losses.

Investors benefit from preferential claims in case of insolvency
According to the Hungarian Act on Mortgage Banks and Mortgage Bonds, the collateral pool consists of the assets recorded in the cover register. In the event of liquidation of a mortgage bank, and following the settlement of liquidation expenses, ordinary and supplementary cover assets registered in the collateral register and other, particularly liquid assets of the mortgage bank can be used only for the satisfaction of obligations towards mortgage bonds holders. In case of default in paying the principal or interest of any mortgage bond, bondholders exclusively can initiate an enforcement procedure against the collateral pool. In the case of an issuer default (ie, a liquidation procedure against the mortgage bank) or upon a decision of Hungarian Financial Services Authority, even prior to any liquidation procedure being initiated, the portfolio and its corresponding collateral assets shall be transferred to another mortgage bank or a commercial bank. The bank in turn will maintain the payments to the mortgage bondholders in accordance with the original terms and conditions of the bond. The Hungarian legal framework also allows for measures to be taken by the Hungarian Financial Services Authority in the case of insolvency. Among these is that the regulator is entitled to delegate a supervisory commissioner to a mortgage bank, even before the formal commencement of an insolvency procedure. In that case, however, the rights of the owners and the management of the mortgage bank will be restricted to guarantee the satisfaction of the claims of the mortgage banks creditors (ie, the bondholders).
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Hungary
Name of debt instrument(s) Legislation Special banking principle Restrictions on business activities Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk
Jelzloglevl Law enshrined on 7 June 1997 and modified in 2004 Yes; mortgage credit institution: jelzlog-hitelintzet Mainly residential and commercial mortgage lending Cover assets remain on the balance sheet, but are maintained in a mortgage credit register. No Up to 20% No
Not applicable Hungary 70% 60% Yes; the assessment of the credit protection value is part of the legislation. The examination of property valuations is part of the specific surveillance through the asset monitor. Yes; Hungarian banking regulator and an independent asset controller (vagyonellenr) Coverage by nominal value The issuer may replace non-performing loans. The regulator could nominate another mortgage bank to take over the servicing and administration of a weakly capitalised or insolvent issuer. If that is impossible, covered bond investors have a prior claim on cover assets. No No No, but investors have a prior claim on cover assets All assets earmarked for the respective asset pool In the event of insufficient pool assets proceeds to cover their claim, covered bond investors rank pari passu with senior debt holders. Yes Yes
Mandatory overcollateralisation Voluntary overcollateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms UCITS Art. 22 par. 4 compliant? CRD Annex VI, Part 1, 65 compliant?
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AUSTRIAN MARKET

Issuance of jumbo Austrian covered bonds started in 2003. Since their inception, the market has grown to 8bn. At end-May 2010, the total volume of outstanding jumbo covered bonds was 8bn, consisting of three issuers with a total of eight issues 99. The average size of jumbo covered bonds is currently 1bn. In H2 08, Austrian covered bonds suffered from the stress in the financial system and swap spreads widened towards mid swaps +100bp. However, since Q2 09, in particular following the ECBs announcement to purchase covered bonds, swaps spreads tightened back towards 3040bp. The 7y covered bond issued by Erste Bank in May 2009 at mid swaps +117bp, mirrored this development and tightened towards mid-swaps +35bp. Figure 271: Market share, May 2010
ERSTBK 13%
Fallout from the financial market crisis

bn 10 9 8 7 6 5 4 3 2 1 0 2003 bn 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2004 2005 2006 2007 2008 2009 2010 Jumbo Austrian Covered Bonds Securities Average size of Jumbo Austrian Covered Bonds (RS)
BAWAG 25%
KA 62%

100 80 60 40 20 0 -20 Jan-04 Jan-05

Barcap OAS 45 40 35 30 25 20 15 10 5 0 2009 2010 2012 BAWAG
Jan-06 Jan-07 Jan-08
Jan-09 Jan-10
Euro Austrian Covered ASM KA ASM BAWAG ASM

2013 KA
2014 ERSTBK
2016
2017
99
In 2008, Austria was among the countries that benefited from the addition of a new country index (iBoxx Austria Covered) to the iBoxx Covered Index. For additional information, please refer to the chapter on AAA-rated bonds and the iBoxx Index within this publication.
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Background
Currently, Austrian jumbo covered bonds are mainly issued as FBS
Austrian jumbo covered bonds were mainly issued as Fundierte Bankschuldverschreibungen (FBS). FBS are issued by Austrian banks and are regulated by: The Law on the Protection of the Rights of the Owners of Pfandbriefe, dated 24 April 1874, RGBI No 48, which is complemented by; The Law on Secured Bank Bonds (Law on FBS), dated 27 December 1905, RGBI No 213. There are two other types of covered bonds namely, public sector and mortgage Pfandbriefe that are regulated by legislation similar to that which governed the German Pfandbrief prior to the introduction of the German Pfandbrief Act in 2005. Austrian Pfandbriefe, on the other hand, are subject to the requirements of the Austrian Pfandbrief Law of 1927, while joint stock companies refinancing their mortgage portfolio through the issuance of Pfandbriefe are subject to the requirements of the 1938 revision of the Austrian Mortgage Banking Act. In May 2009, Erste Group Bank AG was the first Austrian bank to issue a jumbo mortgage Pfandbrief under the Mortgage Banking Act. In March 2010, Erste Group Bank AG also issued the first benchmark public sector Pfandbrief with a total size of 750mn.
Modernisation of Austrian covered bond framework in 2005
On 21 January 2005, the Austrian Ministry of Finance presented new legislation on Austrian FBS and Pfandbriefe. This legislation was passed by parliament on 11 May 2005 and became effective on 1 June 2005. It contains substantial amendments to all three legal frameworks: the Mortgage Banking Act, the Pfandbrief Law, and the Law on Secured Bank Bonds (Law on FBS). The main objective of the amendments was to increase the appeal of Austrian covered bonds by bringing them into line with other covered bond frameworks. This also led to harmonisation of domestic covered bond legislation. In addition, innovations with respect to the protection against credit risk, such as the inclusion of credit derivatives in the cover pool, were introduced. The particular strengths of the Austrian FBS framework are: The strict segregation of all cover assets from the balance sheet of the originating entity. FBS from both jumbo covered bond issuers benefit from credit enhancements, which are stipulated in the issuers articles of association. Sound asset liability matching requirements in place.
Strengths
Weaknesses
The relative weaknesses of the Austrian FBS framework are: FBS quality depends largely on the commitment of the respective issuers to the quality of cover assets and the maintenance of voluntary over-collateralisation, which both can be subject to change, particularly in a stress scenario. Liquidity protection is incomplete in an insolvency scenario. While the cover pool administrator is entitled to arrange bridge financing, liquidity support is not pre-defined and has to be organised on an ad-hoc basis. Lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. This is mitigated by the fact that all FBS issuers report cover pool characteristics and risk management indicators on a regular basis.
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Qualifying collateral for FBS

Registration of cover assets
According to 1 (3) of the Law on FBS, cover assets have to be entered into a cover register. Through registration, the respective cover assets are protected against a scenario in which bankruptcy proceedings are opened against the issuer ( 3 (1)). Consequently, investors are legally protected against an acceleration of FBS. FBS are debt securities issued under Austrian Law by licensed institutions and secured by the following eligible assets: credits to central governments and sub-sovereigns in EEA countries and Switzerland, as long as the debtors enjoy a maximum risk weight of 20%. The law also allows the use of other covered bonds as eligible assets. In addition, substitute assets of up to 15% of total cover assets can be used. Issuers of FBS may restrict themselves to include only Austrian assets (ie, BAWAG) or exclude the use of other covered bonds (ie, BAWAG and Kommunalkredit). Since mid-2005, assets held by a trustee can be included in the cover pool. This supports the creation of larger cover pools, eases access to this market, and facilitates the issuance of benchmark mortgage covered bonds. A particular feature of the Austrian framework is the inclusion of credit derivative contracts in the cover register. This helps mitigate potential credit quality concerns and makes it easier for covered bond issuers to reach target ratings. The use of credit derivative contracts is particularly interesting for issuers with a high correlation between the issuers default probability and the default probability of cover assets, given that, when using this method, it is generally more efficient to mitigate credit quality concerns compared with the alternative route of over-collateralisation.
Individual issuers may use a narrower definition of eligible assets
Inclusion of credit-derivative contracts in the cover register

Supervision through a government trustee
The issuing bank will be obliged to keep a register of its outstanding FBS, in which the assets included in the cover pool are listed. To ensure that the pool provides adequate coverage for the outstanding FBS, the registration is supervised and controlled by a government trustee (Regierungskommissr), who is appointed by the Federal Finance Ministry of the Republic of Austria. Any issuance of FBS may take place only upon prior certification by the trustee that the covered bonds to be issued meet all statutory requirements, while the issuing bank may remove assets from the cover pool only with the permission of the trustee.

Improvements with the 2005 amendments
Until end-May 2005, the matching principle required the nominal value of FBS in circulation to be covered at all times by an equal amount of cover assets. Thus, there was no net present value cover stipulated. However, amendments made in April 2004 introduced the ability to use derivative contracts for hedging purposes. In the past, FBS issuers overcame the lack of net present value cover regulations by stipulating self restrictions in their articles of association (see below). In 2005, net present value cover and a mandatory overcollateralisation of 102% were introduced. In addition, the protection of voluntary overcollateralisation was established.

Protection against acceleration
Issuers of FBS are not subject by law to restrictions concerning the nature of the activities that they can undertake. As a result, the special bank principle does not apply. In case insolvency proceedings are initiated against the issuer or the issuer goes into liquidation, cover assets benefit from special protection because they are exempt from the insolvency
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estate. Last, but not least, all three laws stipulate that the insolvency court has to nominate a cover pool administrator who is mandated to organise liquidity management and identify a bank that is ready to take up cover assets and outstanding secured debt. Should the assets in the cover pool not be sufficient to satisfy the interest of covered bond investors, they would rank pari passu with other senior unsecured creditors of the bank.
Structural enhancement features

BAWAG and KA use credit enhancements
To enhance the quality of their covered bonds, BAWAG and Kommunalkredit have amended their articles of association to provide covered bond investors with a greater degree of protection than would otherwise be attainable. More specifically: They have limited the range of assets eligible for inclusion in the cover pool to cash and claims (bonds and loans) and, in the case of BAWAG, the geographical scope is also limited to claims against, or guaranteed by, the Republic of Austria, its provinces and municipalities; They ensure that the assets in the cover pool match, on a risk-adjusted basis, the outstanding principal plus interest accrued on FBS issued. More precisely, the cover pool includes the market value of the collateral plus a margin to cover any additional risk (using a value-at-risk methodology) that may occur while insolvency proceedings take place. Given that the asset pool generates a return, the interest accrued over the period creates implicit over-collateralisation.
Monthly review of cover pool
The value of the cover pool is subject to monthly revision unless a new issue is brought to market or an existing FBS tapped, in which case, the market value coverage has to be verified before issuance. Finally, the results are audited by an independent auditor, must be sent to the authorities and rating agencies monthly, and are published on the issuers web page.
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Austria
Name of debt instrument(s) Legislation
Hypothekenpfandbriefe, ffentliche Pfandbriefe, Fundierte Bankschuldverschreibungen (FBS). Law of 13 July 1899 (Mortgage Banking Act), Law of 27 December 1905 (Law on Secured Bank Bonds), and Law of 21 December 1927 (Pfandbrief Law); changed modestly in 1998 and 2004; substantial amendments became effective on 1 June 2005. No, as in practice, only commercial banks, mixed mortgage banks, or public sector banks appear as issuers. All types of commercial banking activities. Covered assets remain on the balance sheet, but are entered in a separate register. Hedge positions can be included in the cover register. Up to 15%. No.
Special banking principle Restrictions on business activities Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk
Credits to central governments and sub-sovereigns in EEA countries and Switzerland, as long as the debtors enjoy a maximum risk weight of 20%. Austria without restrictions, EEA countries with a maximum 20% BIS weighting and where the preferential claim of the Pfandbrief holder is recognised. The volume of loans in countries without a preferential claim is limited to 10% of all domestic mortgage loans. 60%; no legal limit for Pfandbriefe issued under the Pfandbrief Law and for FBS. 60%; no legal limit for Pfandbriefe issued under the Pfandbrief Law and for FBS. Yes, not stipulated for Pfandbriefe issued under the Pfandbrief Law and for FBS. Regular examination of cover register; not legally anchored for Pfandbriefe issued under the Pfandbrief Law and for FBS. Yes; Finanzmarktaufsicht (Austrian banking regulator), Ministry of Finance and trustee. Coverage by nominal valuation. Net present value cover can be stipulated in the company act. The issuer may replace non-performing loans. In addition, the inclusion of credit derivative contracts and/or comparable guarantee agreements in the cover pool is allowed. The insolvency court has to nominate instantaneously (unverzglich) a cover pool administrator who is mandated to organise liquidity management, and identify a bank which is ready to take-up cover assets and outstanding secured debt. Yes; 102% or higher levels specified in the company act. Yes. No, but assets within the cover register are exempt from bankruptcy proceedings. All assets earmarked for the respective pool. In addition, investors may have a claim on derivative counterparties. In the event of insufficient proceeds from the pool assets to cover their claim, Pfandbriefe investors rank pari passu with senior debt holders. Furthermore, shareholder(s) may extend some other form of support. Yes. Yes.
Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency, first claim is on External support mechanisms

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PORTUGUESE MARKET
Overview
Following a marked pick-up in issuance over the course of mid-2009 and early 2010, the Portuguese benchmark covered bond market had a size of 20.15bn from 17 deals at the time of writing. As issuance did not commence until the dedicated covered bond legislation was adopted in 2006, the market has since recorded sound growth. All the major banks have set up covered bond programmes and are among the regular issuers of so-called obrigaes hipotecarias. Annual issuance volumes have steadily increased since early 2006, thereby illustrating the growing importance of covered bonds as a refinancing instrument for the Portuguese banking sector. This is supported by the observation that in July 2009, the scope of the Portuguese covered bond market was enlarged through the market entry of a new player and the issuance of the inaugural public sector covered bond, a so-called obrigaes sobre o sector pblico (Figure 274). Overshadowed by the global financial markets crisis, issuance of Portuguese covered bonds came to a standstill in between mid-2008 and mid-2009, as in light of the funding costs, potential covered bond issuers turned to government-guaranteed debt instruments instead. Following the Eurosystems May 2009 announcement to acquire 60bn of covered bonds within the scope of its covered bond purchase programme (CBPP), swap spreads of covered bonds markedly tightened. In response, new covered bond issuance restarted, with a combined 9.0bn from nine benchmark deals being supplied since (Figure 275). As the first redemption is not due until May 2010, the volume outstanding so far has not been subject to any decline. With gross issuance estimates of up to 8bn in 2010, of which 3.0bn had been
Figure 274: Outstanding Portuguese covered bonds

Instrument ISIN Size (bn) Launch date Spread at launch at 28 May 2010
Mid swaps (bp)
5.500% BESPL Jul 2010 5.750% BPIPL Aug 2010 4.375% BESPL Jan 2011 4.750% SANTAN May 2011 4.625% CXGD Jun 2012 3.000% BPIPL Jul 2012 3.250% MONTPI Jul 2012 2.625% SANTAN Apr 2013 3.625% CXGD Jul 2014* 3.250% SANTAN Oct 2014 4.750% BCPPL Oct 2014 3.250% BPIPL Jan 2015 3.375% BESPL Feb 2015 3.875% CXGD Dec 2016 3.750% BCPPL Oct 2016 4.750% BCPPL Jun 2017 4.250% CXGD Jan 2020
PTBEMB1E0016 PTBBQO1E0024 PTBERU1E0015 PTBSPK1E0010 PTCGFC1E0029 PTBB24OE0000 PTCMKROE0009 PTCPP7OE0020 PTCGGFOM0015 PTCPP7OE0020 PTBCU31E0002 PTBB5JOE0000 PTBLMVOE0011 PTCGF11E0000 PTBCSSOE0011 PTBCUB1E0005 PTCG2YOE0001
Total
1.25 1.00 1.25 1.00 2.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 2.15 1.00 1.50 1.00
20.15bn
9 Jul 2008 22 Jul 2008 14 Jan 2008 14 May 2008 20 Jun 2007 8 Jul 2009 17 Jul 2009 Mar 2010 9 Jul 2009 14 Oct 2009 17 Oct 2007 7 Jan 2010 10 Nov 2009 22 Nov 2006 23 Sep 2009 5 Jun 2007 14 Jan 2010
+45 +50 +20 +41 -2 +98 +105 +85 +85 +55 +11 +62 +60 +4 +60 +3.5 +80
+16 +74 +162 +53 +180 +220 +222 +215 +195 +227 +220 +224 +212 +194 +240 +240 +153
Note: * Portuguese public sector covered bond (obrigaes sobre o sector pblico). Source: Barclays Capital.
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Figure 275: Covered bonds outstanding

bn 25 20 15 10 5 0 Jan-07 Jul-07
Figure 276: Redemptions

bn 5 4.0 4 3.3 3 2.3 2 1.0 1 0 2.0 1.5 1.0 3.0 3.2
Jan-08 Jul-08
Jan-09 Jul-09 Jan-10
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
issued at the time of writing and aggregate redemption payments of 3.25bn, we believe that notwithstanding any potential macroeconomic concerns, the Portuguese benchmark covered bond marked is probably poised for further growth in the months ahead (Figure 276). At the time of writing, six issuers, and thus all major Portuguese banks, were active on the benchmark covered bond market. In terms of papers outstanding, with four deals totalling 6.2bn out of two programmes, the largest player was state-owned Caixa Geral de Depsitos (CXGD), which held a market share of roughly 31%. Banco Esprito Santo (BESPL) and Banco Comercial Portugus (BCPPL), which each had three deals outstanding in a combined amount of 3.5bn, accounted for market shares of c.17% each, followed by Banco Santander Totta (SANTAN) and Banco BPI (BPIPL), each with 3bn outstanding, which corresponds to a market share of approximately 15%. With 1bn of covered bonds outstanding, newcomer Montepio Geral (MONTPI) had a market share of 5% (Figure 277).
Figure 277: Portuguese covered bond programmes

Issuer Ticker Programme size Amount issued
Banco Comercial Portugus Banco Esprito Santo Banco BPI Caixa Geral de Depsitos Montepio Geral Banco Santander Totta
BCPPL BESPL BPIPL CXGD CXGD MONTPI SANTAN
10bn 10bn 10bn 15bn* 5bn** 5bn 5bn
3.50bn 3.50bn 3.00bn 5.15bn 1.00bn 1.00bn 3.00bn
Note: * backed by mortgage loans; ** backed by loans to the public sector. Source: Company information, Barclays Capital
Covered bond law replicates international practice
The Portuguese covered bond framework, which was formally enacted in March 2006 when the Portuguese government approved a new legislation on mortgage bonds, ranks among the younger European legislations. Technically, decree-law 59/2006 amended decree-law 125/90, which had been in effect since April 1990. This measure set the regulatory
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framework for obrigaes hipotecrias (covered bonds backed by mortgage loans) and obrigaes sobre o sector pblico (covered bonds backed by loans to the public sector). In October 2006, Banco de Portugal published the so-called avisos 5 through 8 and the regulatory instrument 13/2006, which set out the details of the secondary legislation and are understood as a complement to decree-law 59/2006. Overall, the Portuguese covered bond framework, which has been adjusted to replicate international practice in the covered bond markets, was designed to facilitate domestic mortgage lenders access to cheaper funding for their mortgage and public sector businesses. Within the scope of the Portuguese decree-law, covered bonds can either be issued by credit institutions, which are duly authorised to grant credit secured by mortgages and have own funds of at least 7.5mn, or by a new type of credit institution, instituies de crdito hipotecrio, whose sole purpose is to grant, acquire and sell mortgage receivables in order to issue covered bonds.
Strengths
In our view, among the strengths of the Portuguese covered bond framework are: As in other European covered bond legislations, covered bond issuers have to register the receivables and other underlying assets in separate accounts. As a result of the markets age and relatively moderate issuance forecasts, Portuguese covered bond issuers benefit from a certain scarcity value.
Weaknesses
Among the weaknesses of the Portuguese covered bond framework, in our view, are: A lack of transparency rules, which are stipulated, for example, in the German Pfandbrief Act. However, this can be mitigated by detailed and regular reporting on cover pool characteristics and risk management indicators on a voluntary basis. The quality of Portuguese covered bonds depends on the maintenance of a voluntary over-collateralisation. The latter can be subject to change, particularly in case of distress. This, however, in our view is somewhat mitigated through a comparatively high mandatory over-collateralisation (OC) of 5%. The collateral pool for Portuguese covered bonds, as stated in decree-law 59/2006, consists of mortgage loans for residential or commercial assets, public sector loans, and supplemental cover assets. Issuers have to register the receivables and other underlying assets in separate accounts in order to ensure adequate segregation.
Collateral pool characteristics
Mortgages qualify for inclusion in the cover pool as eligible collateral provided they are secured on properties used for residential or commercial purposes and are located within a member state of the European Union (EU). The maximum loan-to-value (LTV) ratio of the mortgage loans included in the respective cover pool is 80% in the case of residential property and 60% in the case of commercial property. As in other European covered bond markets, public sector loans and bonds may also be included in the cover pools as collateral. Similar to the qualifying collateral for mortgage covered bonds, the scope for public sector assets is restricted to receivables owed or guaranteed by Portugals central government, as well as by the regional or local authorities of an EU member state. Also eligible to be allocated to covered bond issues are supplemental cover assets, such as cash and time deposits at the Banco de Portugal or at credit institutions with a rating of at least A- or equivalent, provided the value of these assets does not exceed 20% of the aggregate value of all relevant assets. Market characteristics thus largely resemble the international practice in covered bond markets.
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Notwithstanding the responsibilities of the Comisso do Mercado de Valores Mobilirios (CMVM), the Portuguese securities commission, Banco de Portugal ensures that the issuers of covered bonds comply with the formal requirements as stated in decree-law 59/2006. In addition, an independent auditor registered at the CMVM will be in charge of protecting the bondholders interests by ensuring the issuers meet the applicable legal and regulatory requisites, on which it presents an annual report. Decree-law 59/2006 stipulates that the rules of the Portuguese Commercial Code on the issuance of bonds do not apply to covered bonds except for rules governing the bondholders general meetings.

Minimum mandatory coverage ratio of 105%
Portuguese covered bonds cannot be issued with a maturity term of less than two years or in excess of 50 years. Their aggregate nominal amount outstanding cannot exceed 95% of the aggregate nominal amount of the assets allocated to such issues at all times, thereby ensuring a mandatory coverage ratio of approximately 105%. Moreover, the average maturity of covered bonds issued by an entity cannot exceed that of the underlying assets at any moment. In addition, the aggregate amount of interest instalments on covered bonds cannot exceed the interest due on the underlying assets at any time. Should any of the limits imposed be breached, the issuer has to rectify the situation immediately, either by allocating new assets or by purchasing covered bonds in the secondary market.

Preferential claim
In case of an issuers insolvency, holders of Portuguese covered bonds benefit from the socalled privilgio creditrio especial. The latter corresponds to a preferential claim over the underlying assets with precedence over any other creditors of the issuer until the principal and interest corresponding to the respective covered bond are fully redeemed. Mortgage loans that guarantee the aforementioned credits prevail over any other real estate preferential claims. Furthermore, in the event of an issuers dissolution and liquidation, decree-law 59/2006 requires that mortgage receivables and other underlying assets are separated from the insolvency pool and form a segregated pool that shall be managed independently in accordance with the conditions set by Banco de Portugal.
The Portuguese housing and mortgage market

House prices declined in 2008 and 2009
In line with the developments observed in several other European markets, house prices in Portugal have been subject to a pronounced decline since mid-2008. After growing at a pace of almost 2% y/y in Q2 07, prices started slipping in Q4 07 and fell by more than 6% y/y in Q4 08. Despite the trend reversing in Q1 09, the Portuguese housing market remains under pressure and recorded a price decline of 1.5% y/y in Q2 09, the latest date for which data were available (Figure 278). Despite a relatively benign financing environment with the average interest rate for loans for house purchases standing at 2.1% in January 2010, the latest date for which data were available, and the number of completed dwellings steadily falling, we do not believe that demand for housing will be sufficiently large to offset a potential phase of weakness ahead in the Portuguese housing market. Typically, nearly all (98.4% in Q2 09) Portuguese mortgage borrowers apply for a floating-rate mortgage loan. As the latter is usually pegged to 12-month Euribor, average mortgage rates have fallen to historical lows (Figure 280).
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This becomes particularly evident when considering that the Portuguese mortgage lending sector was not opened to competition until the early 1990s, when average mortgage rates stood at roughly 20%.
Slowdown in residential mortgage lending
Overshadowed by macroeconomic developments, with real GDP contracting by 2.7% y/y in 2009, residential mortgage lending in Portugal experienced a marked slowdown and increased at an average pace of only 2.5% y/y over the course of the past year (Figure 281). This corresponds to the lowest level observed in the past decade, and despite residential mortgages growing at a pace of more than 5% y/y in January 2010, we do not expect annual lending volumes (5.4bn in 2009) to surge in the months ahead. In Q2 09, the latest date for which data were available, gross residential mortgage lending had fallen by 36.1% y/y, up from a 53.1% y/y slump observed in Q1 09. Net figures even point towards a stronger contraction as in Q2 09, the latest date for which data were available, net residential mortgage lending had dropped by 40.8% y/y, up from a 64.8% y/y decline observed in Q1 09. At the time of writing, the overall size of the Portuguese mortgage market amounted to approximately 110bn, which translates into per capita housing loans of c.9,662. Thereof, according to the Bank of Portugal, roughly 1.9bn and thus 1.7% were non-performing mortgage loans (NPL). Although this is a modest number, particularly when compared with other European mortgage markets, it is noteworthy that the NPL rate sharply increased from a level of 1.2% observed in early 2008 (Figure 282). Attributed to an average annual growth rate of almost 19% over the course of 2009, we believe that the amount of non-performing Portuguese mortgage loans is set to further increase in the months ahead, thereby potentially diluting the quality of selected collateral pools. Partially offsetting this development, however, is the combination of historically low interest rates and very low inflation rate which should support households disposable income and purchasing power, thereby supporting the households ability to increase savings and to thus comply with their debt service payments. Despite the overall improving availability of mortgage loans across Portugal, which only experienced a dip in early 2009, when the Bank of Portugal bank lending survey pointed towards an increase in the restrictiveness of credit standards of the five major Portuguese banking groups 100, the number of completed dwellings has followed a downward trend over the course of the past few years, falling to approximately 31,500 units in 2009 from around 63,000 units in 2002 (Figure 279). As this development is largely in line with the very modest population growth, we do not expect a steep increase in residential building activity in the near to medium term future. This, in our view, is rather supportive for the market as in contrast to several other European countries, Portugal did not experience a housing boom in recent years. As supply has gradually adjusted as a result of fewer housing starts, a potential overhang of unsold homes has been avoided. Despite the macroeconomic challenges ahead, adjustments to the Portuguese housing market could therefore be less painful than in the case of many other European countries.
Number of completed dwellings has steadily declined
100
Source: Banco de Portugal, Statistical Bulletin, February 2009.
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Figure 278: House price development (y/y variation in %)

2 0 -2 -4 -6 -8 Dec-05
Figure 279: Completed dwellings (in 000)

70 60 50 40 30 20 1995
Sep-06
Jun-07
Mar-08
Dec-08
Sep-09
1997
1999
2001
2003
2005
2007
2009
Source: Source: EMF, Barclays Capital
Source: Source: INE, Barclays Capital
Figure 280: Implicit interest rates on housing credit (%)

6.0
Figure 281: Mortgage lending growth (y/y variation in %)

20
5.0
15
4.0 10 3.0 5
2.0
1.0 Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
0 Mar 02
Mar 04
Mar 06
Mar 08
Mar 10
Source: Banco de Portugal, Barclays Capital
Figure 282: Non-performing mortgage loans (in % of all)

1.8
Figure 283: Gross residential mortgage lending (in bn)

14 12 10 10 9 7 7 5 4 4 8 9 12
1.6
1.4
8 6 4
1.2
1.0 2 0.8 Jan-00 0 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
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Portugal
Obrigaes Hipotecrias (mortgage-secured bonds) and Obrigaes sector pblico (public sector secured bonds). Laws enshrined on 16 April 1990 and 27 January 1995. Decree-Law no. 59/2006, which sets out a new legal framework for covered bonds and public sector bonds, was enacted on 20 March 2006. Optional. Optional ie, restrictions apply to Institues de Crdito Hipotecrio but not to commercial banks, which only need to fulfil minimum criteria (authorisation to grant credit secured by mortgages, own funds of at least 7.5mn). Cover assets remain on the balance sheet but are maintained in a mortgage credit register (Registo dos Crditos Hipotecrios). Hedge positions constitute an integral part of the cover pool. Up to 20%. No.
Central Administration of a member state of the European Union and qualifying regional and local authorities. Mortgage loans from any EU member state. 80%. 60%. No. Basis = market value. The law stipulates that the issuer has to produce a specific valuation report. Yes, Bank of Portugal. Coverage by nominal value required by law: outstanding bonds cannot exceed 95% of the overall value of mortgages assigned to such bonds. In addition, the average maturity of the covered bonds in the issue cannot exceed the average maturity of the mortgage receivables. Also, the overall amount of interest payable for the covered bonds cannot exceed the amount of interest payable by the debtors of the covered mortgage receivables. The issuer may replace non-performing loans. Minimum over-collateralisation (95%). No, neither a back-up servicer nor a cover pool administrator is stipulated. 105% of the mortgage pool. Yes. No, but investors have a prior claim on assets within the mortgage register (Registo dos Crditos Hipotecrios). All assets earmarked for the respective asset pools. Not defined. Yes. Yes.
Protection against credit risk Protection against operative risk Mandatory over-collateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency 1st claim is on External support mechanisms UCITS Art. 22 par. 4 compliant? CRD Annex VI, Part 1, 65 compliant?
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SWISS MARKET
Overview
The issuance of jumbo Swiss structured covered bonds started in September 2009, with the inaugural issuance of a 5y transaction by UBS AG. The bond had a volume of 2bn. While the two specialised Swiss covered bond institutions, Pfandbriefzentrale der schweizerischen Kantonalbanken AG (PFZENT) and Pfandbriefbank schweizerischer Hypothekarinstitute AG (PSHYPO), have a long tradition of issuing covered bonds, the respective transactions were purely in local currency. For the moment UBS AG, is the only Swiss bank to have tapped the jumbo market. In mid-May 2010, the total volume of outstanding jumbo covered bonds was 5.75bn. The average size of these jumbo covered bonds is currently 1.4bn.
Background
Pfandbrief Law from 1930 assigns exclusive right to issue Pfandbriefe only to two specialised institutions
Switzerlands two specialised Pfandbrief institutions, Pfandbriefzentrale der schweizerischen Kantonalbanken AG (PFZENT) and Pfandbriefbank schweizerischer Hypothekarinstitute AG (PSHYPO), were designed to provide mortgage-secured financing to their respective member banks. With a total balance sheet of CHF24.2bn as of 31 March 2009, PFZENT exclusively services the Swiss cantonal banks. The second issuer, PSHYPO, with a total balance sheet of CHF43.5bn as of YE 09, services all non-cantonal banks, including the two large commercial banks, UBS AG and Crdit Suisse. Pfandbrief issuance of PFZENT and PSHYPO is based on the Swiss Pfandbrief Act from 25 June 1930, which exclusively grants the right to issue Pfandbriefe to these two institutions. Issuance of PFZENT and PSHYPO is purely in the domestic Swiss franc market. With a total volume of CHF55bn of publiclyissued Pfandbriefe, the local Pfandbrief market is the second largest behind the Swiss government bond market, which has a total size of about CHF90bn. In late 2008 and in 2009, PFZENT issued Pfandbriefe under the so-called Limmat project. Within this project, it provided up to CHF11bn of loans to its members. These loans were refinanced through issuance of privately placed Pfandbriefe with a similar amount, which in turn could be used as collateral for repo transactions with the Swiss central bank. In order to diversify its funding towards the covered bond investor base, lengthen the duration of its liabilities and also cope with the significant drain (-CHF 55bn in FY 09) of deposits in its home market, in September 2009, UBS AG launched its inaugural jumbo covered bond. The common law programme allows UBS to issue directly under its own name and also helps avoid the volume constraints of the domestic Pfandbrief market. Below we describe the main features of the UBS common law covered bond programme.
The Limmat project
Inaugural UBS covered bond issued in 2009
Direct recourse to the issuing bank and a pool of Swiss mortgage receivables
In order to be able to issue covered bonds backed by Swiss mortgages under its own name, UBS AG decided to establish a programme based on Swiss and UK law (Figure 255). The respective contractual structure has been designed to produce the same benefits normally available to covered bond investors in instruments from those countries with more traditional covered bond legislation. More specifically, covered bond investors have direct recourse to the respective bank as the issuer. In the case of UBS covered bonds, this is UBS AG acting through its London branch. In addition, investors are also protected by a pool of Swiss residential mortgage receivables that have been segregated and will be managed exclusively for their benefit in case of problems.
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Figure 284: UBS common law covered bond transaction structure

Security Assignment / Transfer of Cover Pool Collateral Differential Swap Cashflows
Seller: UBS AG acting through its head office
Guarantor: UBS Hypotheken AG
Swap Providers
Secured Prefunding Obligations
Guarantee Fee
Covered Bond Issuer: UBS AG acting through its London Branch Covered Bond Proceeds Covered Bonds Trustee
Guaranteed Amount
Covered Bond Holders
Source: Transaction documents, Barclays Capital
UBS Hypotheken AG provides a guarantee to covered bondholders
UBS AG, acting though its London branch, is the issuer of the covered bonds, which are its own direct, unsecured and unconditional obligations. These obligations rank pari passu among themselves and equally with all other present and future unsecured and unsubordinated obligations of the issuer. The respective guarantor, UBS Hypotheken AG a private Swiss corporation 98% held by UBS AG and created specifically for the covered bond debt programme provides a guarantee to covered bondholders for the payment of interest and principal, which becomes enforceable if the issuer defaults. In order to allow UBS Hypotheken AG to meet its obligations, UBS AG acting through its head office as originator transfers eligible mortgage claims denominated in CHF by way of a security assignment of mortgage claims 101 and onward security transfer of the title in the related mortgage certificates 102 to UBS Hypotheken AG. Through this transfer, which is based on a guarantee mandate agreement, the UBS Hypotheken AG becomes the legal owner of the respective mortgage receivables and the title owner of transferred mortgage certificates, which will not participate in any potential insolvency estate of the respective originators. As long as there is no notification event and neither UBS AG nor UBS Hypotheken AG is defaulted, UBS AG may use the cash flows from cover assets at its own discretion. The residential mortgage claims in the entire pool secure the pre-funding obligations of the issuer in relation to the guarantee, but not the guarantee itself. Thus, covered bond holders do not benefit from direct security over cover pool assets. This is mainly for regulatory and tax reasons. The obligations of the guarantor are subject to limited recourse to its available assets. While the guarantee mandate, the security over the cover pool, as well as collateral management and servicing, are all regulated under Swiss law, covered bond issuance, the guarantee, the trust and the hedges are all regulated under UK law. The particular strengths of the Swiss contractual covered bond programme are: Cover assets are separated from the balance sheet at inception of the programme/ issuance through the transfer of receivables to UBS Hypotheken AG. Cash flow adequacy is secured through the asset coverage test and the obligation to neutralise any exposure to interest rate and currency risk.
101 102
UBS AG, acting through its head office, transfers receivables to UBS Hypotheken AG
Cover pool assets secure the pre-funding obligations of UBS AG
Governed by Swiss and UK law
Strengths
In German: Sicherungszession von Hypothekarforderungen In German: Weiterbereignung der zugehrigen sicherungsbereigneten Schuldbriefe
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Investors are well protected against liquidity risk because there is a clear escalation process in case of a credit profile deterioration of participating parties.
Weaknesses
The relative weaknesses of Swiss contractual covered bond programme are: Compared with traditional covered bond products, the programme contains a rather complex set of structural features. Timely payment of covered bonds is strongly reliant on UBS in connection with the servicing, the administration and the funding of the cover pool assets and other involved third parties, such as the cash manager, the account bank, the corporate service provider to the guarantor, the swap provider and the calculation agent. So far, the Swiss banking regulators record with regards to the surveillance of Swiss covered bonds is rather limited.
Swiss residential mortgages
The cover portfolio needs to comply with a number of eligibility criteria. It shall consist of Swiss CHF-denominated residential mortgage loans originated by an entity of UBS group. Each mortgage debtor is one or more private persons. The aggregate current principal balance of all mortgage claims secured by the same property does not exceed CHF5,000,000. The relevant property shall be located in Switzerland. At the time of the transfer, the aggregate of all relevant mortgage loans relating to a particular property has a maximum current LTV of 80%. Each mortgage claim is secured by a mortgage certificate encumbering an eligible property, it is not past due as of the cut-off date prior to its assignment, it is not a construction loan and it does not permit any further advances or redrawing of any repaid portion of the principal amount at the sole discretion of the mortgage debtor. Up to 15% of the total cover pool may consist of substitute assets. Eligible substitute assets are CHF cash, CHF- or EUR-denominated demand or time deposits, certificates of deposit and short-term debt obligations at least rated F-1/AA- by Fitch and P-1/Aa by Moodys, triple-A rated CHF- or EUR-denominated government bonds with a term to maturity of less than one year, triple-A rated CHF- or EUR-denominated RMBS notes with a term to maturity of less than one year, or securities issued by the Pfandbriefbank Schweizerischer Hypothekarinstitute AG provided that such investments are rated at least Aaa by Moody's. To ensure that over-collateralisation is compatible with the target rating level, a monthly asset coverage test is in place. Along with the results of this calculation, a minimum overcollateralisation of 111% (= asset percentage of 90%) must be maintained. The asset cover test comprises a number of valuation rules that are applied to the underlying assets. For example, it stipulates that loans more than three months in arrears have to be deducted to a pre-defined degree (40% if more than three months, 25% if more than three months and LTV >80%) from the current balance when running the test. The test also foresees dynamic adjustments for property valuations on a loan-by-loan basis. In the case of a breach of the asset cover test, no further covered bonds can be issued. If the breach is not rectified until the following calculation date, the trustee will serve a notice to pay to the guarantor. The amortisation test is designed to ensure that the assets will be sufficient to enable the guarantor to repay the covered bonds. It only applies after an issuer default has occurred, so covered bond holders will be relying on the guarantee. The test will fail if the amortisation test aggregate loan amount falls below the outstanding balance of all the covered bonds.
290
Substitute assets
Asset cover test and minimum over-collateralisation
Amortisation test
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Surveillance through independent trustee and rating agencies
The issuer/originator is responsible for the regular pool monitoring, with the asset coverage test calculation being checked by an independent auditor on an annual basis. Furthermore, rating agencies are heavily involved in the programme and need to re-affirm the ratings upon each issuance. They also monitor the amount of over-collateralisation required to maintain the target rating level. Within the UBS covered bond programme, certain contractual provisions stipulate that exposure to interest rate and currency risk must be neutralised. This is ensured through a monthly interest coverage test and the pool interest rate exposure test. The former is designed to ensure that interests from the cover pool, after hedges, are always in excess of payments due under the covered bonds. The latter was set up to limit exposure to CHF interest rate volatility. In addition, downgrade triggers for swap counterparties, the pre-maturity test, maturity-extension rules and the amortisation test, are all designed to ensure cash-flow adequacy. The UBS programme foresees the issuance of covered bonds with a soft and hard-bullet maturity. Under the soft-bullet format, following an issuer event of default, the guarantor may not have sufficient proceeds for a timely repayment of covered bonds. In this case, the legal final maturity will be extended for 12 months to allow for a realisation of cover assets. As maturity extension is subject to an issuer event of default, it is not an option of the issuer. For bonds issued under the hard-bullet format, a so-called pre-maturity test is in place. The prematurity test is designed to ensure that there will be sufficient cash available to make redemption payments for the respective covered bonds. If at least 180 days before a hard bullet final maturity payment is due the issuers short-term ratings fall to below F1+ (Fitch) or P-1 (Moodys), the pre-maturity test will trigger the guarantor to raise cash by either receiving funds from the originators, selling randomly selected loans, or entering into appropriate liquidity facility agreements. The failure to cure a breach of the pre-maturity test would authorise the trustee to serve a notice to pay against the guarantor, which then would be obliged to sell receivables and credit the respective proceeds to a separate account. The UBS covered bond programmes includes a number of other safeguards. In particular, there are minimum rating requirements for the various third parties that support the transaction, including the swap counterparties and cash manager. There are also regular independent audits of the calculations.
Maturity extension/ pre-maturity test
Other safeguards

The payments under the covered bonds are further guaranteed by UBS Hypotheken AG following an issuer default. UBS Hypotheken AG will rely on the proceeds derived from the assets on which it has a claim to make these payments. If these proceeds are insufficient to meet obligations to bondholders in full, they will still have an unsecured claim against the issuer for the shortfall.
Asset segregation safeguards
There are a number of safeguards to protect the claims of bondholders in an insolvency scenario. Set-off risk, which can arise in case the waiver of deposit set-off rights would not be recognised, is captured in the asset coverage test. Claw-back risk, which would occur, for example, in case asset transfers to the guarantor or the redemption of covered bonds are challenged by the insolvency administrator, has been addressed within the legal structure. According to Swiss law, claw-back is basically limited to dispositions made six months prior to insolvency. Commingling risk is addressed through provisions which stipulate that upon a downgrade of the issuers shortterm rating below F1/P-2, the borrowers of the underlying mortgage loans will be notified to redirect their payments to an account in the name of the guarantor.
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There are a number of trigger events in the covered bond structure, the first being issuer default. This can occur in a number of situations, including the following: Default is made by the issuer for a period of seven days or more in the payment of any principal or redemption amount on the covered bonds of any series when due, or for a period of 14 days or more in the payment of interest on the covered bonds of any series when due; A default is made in the performance or observance by the issuer of any obligation under the transaction documents, or any related representation or warranty or undertaking; If the issuer failed to revoke a breach of the asset coverage test and/or the interest coverage test. Any order by a competent court or other authority or resolution passed by the Issuer for the dissolution or winding-up of the issuer or for the appointment of an administrator over the Issuer or of all or a substantial part of its assets, other than in connection with a solvent reorganisation, reconstruction amalgamation or merger; If the issuer shall stop payment or shall be unable to, or admit to its creditors generally its inability to, pay its debts as they fall due, or shall be adjudicated or declared bankrupt or insolvent or shall enter into any composition or other arrangements with its creditors generally.
No acceleration unless the guarantor defaults
An issuer default will not accelerate payments to covered bondholders but will allow the security trustee to start proceeding against the issuer and group guarantors while the asset pool is wound up in an orderly fashion. In particular, the guarantor will issue a corresponding pre-funding notice on UBS AG. Claims under the pre-funding obligations are structured not to be subject to early acceleration or discounting in an insolvency of UBS AG. They become due in advance compared to the scheduled guaranteed payments to which they relate. The second is the guarantor event of default, which would arise if the UBS Hypotheken AG failed to make any payments for a period of seven days or more under the guarantee when due, if legal proceedings were started against it, if an administrator shall be appointed, if the amortisation test failed or if there was a default on any other obligation. This would cause the acceleration of payments to covered bondholders and the redemption at the early redemption amount relevant to that particular covered bond.
Figure 285: Overview UBS Swiss covered bond programme

UBS AG
Volume of loans eligible under the programme (in CHFbn) Ratings: (S&P/Moodys/Fitch) Issuer Originator Guarantor Asset monitor Maximum asset percentage applied in the ACT Minimum over-collateralisation In arrears accounting in the ACT Set-off risk accounted for in the ACT Hard bullet
Source: Transaction documents
20 -/Aaa/AAA UBS AG, acting through its London branch UBS AG, Zurich UBS Hypotheken AG KPMG 90% 111% 40% if more than 3 months, 25% if more than 3 months and LTV >80% Yes Depending on final terms
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Switzerland (UBS common law covered bonds)
Swiss Common Law Covered Bonds Private legal structure based on Swiss and UK civil law and contract law. No; any Swiss bank. Not applicable. Cover assets are segregated through the transfer to a separate entity, which is an insolvency remote private company, 98% owned by the issuer. Hedge positions are part of the structural enhancements intended to protect bondholders. Up to 15%. Only residential mortgages are allowed.
Not relevant. Subject to contractual prescriptions; only Swiss mortgages are allowed in the UBS programme. Subject to contractual prescriptions currently 80% within the UBS programme Subject to contractual prescriptions; irrelevant until now. No. Valuation is based on the hedonic valuation model of Wuest & Partner Back-testings of the valuation model are conducted quarterly. No specific public supervision, but control through an independent auditor. By contractual provisions, exposure to interest rate and currency risk is neutralised. In addition, downgrade triggers for swap counterparties, the asset cover test, the amortisation test, the interest coverage test and a pre-maturity test/maturity extension are designed to ensure cash flow adequacy. Yes; defined by asset cover test. Yes; stipulated through contractual rules. Yes; subject to the asset percentage applied in the asset coverage test, which is to be adjusted on the upside if portfolio performance worsens. Yes. No, but all assets are ring-fenced within a specially created entity. all the payments received from the special entity's assets, which are collected in a special account. Investors continue to receive scheduled payments as if the issuer had not defaulted. In the event of insufficient pool asset proceeds to cover their claim, investors rank pari passu with senior debt holders. There is a simultaneous unsecured dual claim against the issuer and secured against the portfolio held by the specially separated entity. No. No.
Protection against credit risk Protection against operative risk Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms

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FINNISH MARKET
Overview
With an aggregate volume of 4.25bn from four benchmark covered bonds issued to date, the Finnish covered bond market is among the smallest in Europe. At the time of writing, Sampo Housing Loan Bank (DANBNK) and OP Mortgage Bank (OPMBK) were the only issuers of benchmark covered bonds on the market. Whereas Sampo Housing Loan Bank, which was fully acquired by its Danish rival Danske Bank (DANBNK) in March 2007, currently has 2bn from two deals outstanding, OP Mortgage Bank has so far issued three benchmark covered bonds within the combined amount of 3.25bn. One 1bn transaction matured in early June 2010. Sampo Housing Loan Bank became the first entity to issue a benchmark Finnish covered bond in September 2005, followed by OP Mortgage Banks inaugural transaction in May 2007. Also active in the Finnish covered bond market is Aktia Real Estate Mortgage Bank (AKTIA); however so far it has only issued covered bonds in non-benchmark size. These are not included in this publication 103.
Figure 286: Outstanding benchmark Finnish covered bonds

Name Size (bn) Launch date Spread at launch Spread as at 28 May 2010
Mid-swaps (in bp)
DANBNK 2.500% Sep 10 DANBNK 3.750% Sep 11 OPMBK 4.500% Jun 12 OPMBK 3.125% Nov 14
1.00 1.00 1.00 1.25
13 Sep 2005 12 Sep 2006 30 May 2007 12 Nov 2009
-1 -3 -4 45
-12 -7 +25 +29
In 2010, redemption payments on the Finnish benchmark covered bond market will amount to 2bn, due in June and September. As we expect this volume to be largely offset by potential new issuance ahead, the overall market volume will likely remain stable 104. Finnish covered bonds should therefore continue to benefit from a relative scarcity value.
Relatively young and small covered bond market
The Finnish covered bond framework was formally enacted in December 1999, when the Finnish Parliament passed the Act on Mortgage Credit Banks (AMCB). The AMCB is principally designed to enable Finnish mortgage lenders to make use of a more efficient instrument for funding their mortgage business. Within the previous framework, the Finnish banking regulator (Rahoitustarkastus) took mortgage loans originated by Finnish mortgage credit institutions into custody before issuing secured debt. This function, however, became obsolete with the adoption of the AMCB, which states that only specialised credit institutions, ie, the socalled mortgage credit banks are allowed to issue covered bonds. The mortgage credit banks business activities are restricted to mortgage and public-sector lending. Sampo Housing Loan Bank is a wholly-owned subsidiary of Sampo Bank, which was taken over by Danske Bank in March 2007. In principle, Sampo Housing Loan Bank was established as a non-deposit funding vehicle for Sampo Bank, issuing covered bonds, which were in turn secured by mortgages regulated by Finlands Mortgage Bank Act. Sampo
Sampo Housing Loan Bank
103
Please refer to the Association of German Pfandbrief Banks (vdp) for the minimum standards for the issuance of Jumbo Pfandbriefe. 104 For a detailed 2010 issuance forecast, please refer to the AAA Investor, 19 November 2009.
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Figure 287: Issuance profile

bn 2.0
Figure 288: Redemption profile

bn 2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0 2005 2006 2007 2008 2009 2010*
0.0 2010 2011 2012 2013 2014 2015
Note: * estimated. Source: Barclays Capital
Housing Loan Bank purchases the mortgages securing these bond issues from its parent company and does not grant loans to customers. In September 2005, Sampo Housing Loan Bank announced that it would establish a 5bn Euro Medium-Term Covered Note Programme, under which it issued the first Finnish -denominated mortgage-backed covered bond in September 2005. Note that being a regular jumbo covered bond issuer, Danske Bank (DANBNK) is extensively featured in the profiles section of this publication.
OP Mortgage Bank
OP Mortgage Bank is a subsidiary of OP Pohjola Group, Finlands largest financial services group. OP Mortgage Bank operates through the co-operative banks of the OP Bank Group and grants long-term home mortgages against full collateral. Funding is obtained by issuing mortgage-backed bonds. Its parent, OP Pohjola Group, is made up of independent member co-operative banks as well as a central institution, OP Bank Group Central Co-operative and its subsidiaries, the largest of which is listed company OKO Bank, which was renamed as Pohjola Bank on 1 March 2008. The OP Pohjola Group offers a comprehensive range of banking, investment and insurance services for both private and corporate customers. Note that being a regular jumbo covered bond issuer, OP Mortgage Bank (OPMBK) is extensively featured in the profiles section of this publication. As at year-end 2009, the latest date for which data were available, OP Pohjola Group had a mortgage market share of c.35%.
Figure 289: Finnish covered bond issuers

Sampo Housing Loan Bank* OP Mortgage Bank* Aktia Real Estate Mortgage Bank
Parent company Total assets (bn) Mortgage loans granted (bn) Tier 1 ratio
Dankse Bank 415.9bn (2008: 475.1bn) 93.0bn (2008: 89.7bn) 14.1% (2008: 9.2%)
OP-Pohjola Group 80.4bn (2008: 75.7bn) 26.0bn (2008: 24.2bn 12.6% (2008: 12.6%)*
Aktia Group 10.6bn (2008: 9.5bn)* 2.7bn (2008: 2.1bn) 7.4% (2008: 7.1%)
Note: All figures refer to year-end 2009. * Figures refer to parent company (EUR/DKK = 7.44 as at 18 May 2010). Source: company reports, Barclays Capital
Aktia Real Estate Mortgage Bank
Aktia Real Estate Mortgage Bank is a Finnish credit institution subject to the Act on Mortgage Credit Bank (AMCB). It is part of the Aktia Group and commenced operations in 2001, specialising in granting housing loans to private individuals and households secured by real estate or shares in housing co-operatives. The mortgage loans are sold through Aktia Savings Bank as well as other savings and co-operative banks. As 39 local co-operative banks acquired a minority interest in Aktia Real Estate Mortgage Bank in April 2006 (11.5% of the equity, or
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10% of the voting rights), Aktia Bank plc (previously Aktia Savings Bank) currently holds a 52.3% proportion of the equity, or a 70% proportion of the voting rights. Furthermore, 32 different savings banks held 36.2% of the equity, or 20% of the voting rights, at the time of writing. Aktia Real Estate Mortgage Bank does not take deposits. Instead, it is financed by equity, short-term borrowing and the issuance of covered bonds on the domestic and foreign capital markets. As at year-end 2008, the latest date for which data were available, Aktia Real Estate Mortgage Bank had a mortgage market share of c.12%.
Strength
We outline what we think are Finnish AMCBs core strengths below. The underlying cover assets are segregated from other assets on the issuers balance sheets, as separate cover registers have to be maintained for each portfolio. Finnish mortgage credit banks are required to report information about their cover assets on a monthly basis to the Finnish banking supervisor, Rahoitustarkastus. As a result of the markets comparatively small size, Finnish covered bonds benefit from a certain scarcity value. At the time of writing, the total volume outstanding of Finnish covered bonds amounted to only 5.25bn from five issues.
Weaknesses
We outline what we perceive to be Finnish AMCBs relative weaknesses below. With only two issuers actively issuing benchmark covered bonds under the Finnish legislation so far, market participants have not been able to garner much experience within the respective framework. The law does not explicitly require a mandatory over-collateralisation, which could serve as compensation for liquidity risk, credit risk and additional costs in a stress scenario. Still, we feel that this weakness is somewhat mitigated, as in the programmes established so far, a minimum level of over-collateralisation is explicitly stipulated on a contractual basis. Liquidity protection is incomplete in an insolvency scenario. While the cover pool administrator is entitled to arrange bridge financing, liquidity support is not pre-defined and would thus need to be organised on an ad-hoc basis.
Collateral pools backing Finnish covered bonds can consist of public-sector or mortgage loans. Separate cover registers need to be maintained for each portfolio.
Maximum LTV of 60%
Mortgage loans are eligible for inclusion in the cover pool as eligible collateral provided they are located within the European Economic Area (EEA) and are secured on property intended for residential purposes. A loan-to-value (LTV) ratio of 60% cannot be surpassed. Thus, whereas mortgage credit banks in principle can grant mortgage loans with a LTV of up to 100%, these loans are not eligible for inclusion in the cover portfolio. In addition, the total amount of these loans cannot exceed one-sixth of the mortgage credit banks entire mortgage book. Also, loans to the public sector and bonds are eligible for inclusion as collateral in the cover pool. As in the case of the qualifying collateral for mortgage-covered bonds, the geographical scope for public sector assets is restricted to countries within the EEA. Provided they belong to the list of Tier 1 ECB eligible assets, substitute cover assets can ordinarily be included up to a maximum of 20% of the collateral pool. In addition, derivative contracts entered into with the purpose of meeting matching requirements can also be included in the cover pool.
Substitute assets of up to 20% of collateral pool
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Surveillance through Finnish banking regulator, Rahoitustarkastus
Rahoitustarkastus, the Finnish banking regulator, ensures that the mortgage credit banks comply with the rules of the Act on Mortgage Credit Banks, 1999. Finnish mortgage credit banks are obliged to report their cover assets on a monthly basis to the Finnish banking regulator, which, in turn, controls the adequacy of cash flows, monitors the market risk exposure and examines the evaluation of cover assets.

NPV regulation stipulates cover ratio of at least 100%
The current nominal value of assets within the cover pool must at all times exceed the current nominal value of the covered bonds outstanding. Derivatives are included in the calculation. Furthermore, in February 2004, the regulation of net present value (NPV) cover became effective, stipulating that the cover pools NPV must exceed the NPV of covered bonds, which are collateralised by the cover pool, also considering the value of any derivative contracts entered into. In addition, the total amount of interest receivable in any 12-month period on the covered mortgage bonds collateral assets should exceed the total amount of interest payable on such bonds in the same period. Also, the NPV of the cover pool must be in excess of the covered bonds collateralised by the collateral pool following a 100bp shift up or down the swap curve. The Finnish Act on Mortgage Credit Banking does not prescribe any mandatory level of overcollateralisation. Yet, a minimum level can be stipulated on a contractual basis. In the case of Sampo Housing Loan Bank (DANBNK) and OP Mortgage Bank (OPMB), for example, a 5% mandatory over-collateralisation was explicitly stipulated in the base prospectuses. In the case of Aktia Real Estate Mortgage Bank, the committed over-collateralisation stands at 8.5%.
No mandatory overcollateralisation

Covered bond holders are not subject to acceleration in the event of insolvency
In the event of an issuers insolvency, the provisions of the Finnish Act on Mortgage Credit Banks stipulate that the collateral pool, any derivative contracts and the covered bonds themselves will be separated from any of the issuers other assets and liabilities provided the conditions of the act, including the matching requirement, have been met. Timely payments can then be made by the receiver to covered bond holders. Should the priority claim prove to be inadequate, additional claims by covered bond holders will rank equally with those of unsecured unsubordinated creditors. Yet, the Act on Mortgage Credit Banks does not contain any specific regulation on the management of cover assets upon issuer default, including provisions that may enable the insolvency administrator to raise money for liquidity management purposes.
The Finnish housing market

Further stabilisation in house price growth ahead
Overshadowed by a pronounced contraction in economic growth with the GDP slumping by 7.8% y/y in 2009, the Finnish housing market, in line with several of its European peers, was subject to a moderation in price growth in late 2008 and 2009. According to the Bank of Finland (Suomen Pankki), prices of existing homes fell by 2.8% y/y in Q2 09;, however, this corresponds to a 3.9% q/q increase across the country. Price growth started gaining further momentum in the quarters after (+7.9% y/y in Q4 09), thereby partially offsetting the decline. On average, prices of dwellings in Finland (the whole country) fell by 0.3% y/y in 2009 105 (Figure 290). According to the Bank of Finland, the slight recovery in the housing
105
Source: Bank of Finland, Main Indicators for the Finnish Economy, 2/2010.
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market in recent months is a response to demand. Investors have been particularly interested in small apartments as a consequence of the rapid rise in rents and especially the low level of interest rates 106. With a population of 5.2mn and a total of 2.7mn dwellings as at year-end 2008, the latest date for which data were available, the Finnish housing market is among Europes smallest. Attributed to the regional structure of Finland, the housing market is characterised by geographical and housing-type related differences in price trends. Generally, average house prices in the Helsinki metropolitan area are markedly higher than in other parts of the country. Whereas the average m price for a used property amounted to 2,932 in Helsinki in 2009, up from 2,893 in 2008, the average price in other (rural) areas climbed to 1,469 in 2009 from 1,445 in 2008.
Recovery in housing market driven by demand
Following the pronounced rate cuts on behalf of the European Central Bank (ECB), average Finnish mortgage rates continued their decline throughout 2009 and fell to below 2% in
Figure 290: Finnish housing market indicators

Average annual house price growth (change in /m y/y in %) Completed dwellings (in 000)
30 20
40
30 10 0 -10 -20 0 -30 1990 1995 Helsinki region

Typical mortgage loan rates
20
10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2000 2005 2010 Rest of Finland Detached houses Blocks of flats
Structure of the property market, %
Attached houses All dwellings
6 5
100
Owner-occupied
Rented
Other
75 4 50 3 2 1 Jan-04 25
Jan-05 Total
Jan-06
Jan-07 Jan-08 up to 1 year
Jan-09 Jan-10 over 1 year
0 2000
2002
2004
2006
2008
Source: Bank of Finland, Statistics Finland, Barclays Capital
106
Source: Bank of Finland, Economic Outlook 2/2009.
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January 2010 from an average of 3.2% a year before. Currently, average Finnish mortgage loans are on the lowest levels observed in recent years (Figure 290). In line with this development, the consumer confidence indicator complied by Statistics Finland, signalled that there was a discernible increase in households house-purchase intentions in early 2009 107. Nonetheless, according to Statistics Finland, the number of housing units sold in Q1 09 fell by over 26% y/y, while new construction in Q2 09 slumped by 23% y/y 108, the latest date for which data were available. Later that year, however, the stock of unsold new housing units, which in April 2009 still stood at circa 26 months of sales across Finland, had fallen to circa nine months by mid-June 2009. Thus, the over-supply of housing appears to have been cleared in H1 09. The marked decline in housing starts of detached and terraced houses, ie, the reduction in supply in combination with a low interest rate environment ensure, in our view, that (nominal) house prices will probably not decline in 2010. Instead, ceteris paribus, we expect Finnish house prices to remain on the recovery path which started in mid-2009 and believe that the short-term outlook will largely be dominated by demand considerations.
107 108
Source: Bank of Finland, Economic Outlook 2/2008 Source: Statistics Finland.
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Finland
Kiinteistvakuudellinen joukkovelkakirja (mortgage-secured bonds) and Julkisyhteisvakuudellinen joukkovelkakirja (public sector-secured bonds). Law enshrined on 23 December 1999. Yes; mortgage credit banks. Mainly public sector and/or residential and commercial mortgage lending within the EEA, as well as "operations closely related to such business". Cover assets remain on the balance sheet, but are maintained in separate cover registers. Hedge positions can be included in the cover register. Up to 20%. No.
Any EEA country. Any EEA country. 60% and maximum one-sixth of the total mortgage pool, up to 100%. Maximum 60% and maximum one-sixth of the total mortgage pool, up to 100%. Yes; valuation principles are fixed by finance ministry. Regular examination of cover registers. Yes; Rahoitustarkastus, the Finnish banking regulator. Coverage by nominal value and by net-present value required by law. In addition, the total amount of interest receivable in any 12-month period on covered mortgage bonds collateral assets should exceed the total amount of interest payable on such bonds in the same period. The issuer may replace non-performing loans. No, neither a back-up servicer nor a cover pool administrator is stipulated. No, however, a minimum level of over-collateralisation may be stipulated on a contractual basis. Yes. No, but assets within the cover pool are exempt from bankruptcy proceedings. All assets earmarked for the respective asset pool. In addition, investors may benefit from positive market values of derivatives. In the event of insufficient pool assets proceeds to cover their claim, mortgage or public bond investors rank pari passu with senior debt holders. In addition, shareholder(s) may extend some other form of support. Yes. Yes.

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SWEDISH MARKET
Overview
Following the marked recovery in gross issuance volumes of EUR-denominated benchmark covered bonds over the course of the past year, Sweden remains the Nordic regions largest market by far. After a modest decline in mid-2009, the aggregate volume outstanding recovered to 26.5bn from 22 deals at the time of writing. This corresponds to the highest level since the inception of the market in October 2006. In light of the redemption profile of the Swedish market, we believe that ceteris paribus, benchmark covered bond issuance will likely increase over 2010 and 2011 when a combined 13.2bn will mature. As this amount corresponds to roughly half the total amount outstanding and as average swap spread levels and, therefore, refinancing costs of covered bonds have sharply declined since early 2009, primary market activity is poised to markedly pick up. So far, four EUR-denominated benchmark deals have been issued in 2010. Issuers are likely to tap the medium- to longterm maturity brackets, particularly as the Swedish market so far appears to be geared towards shorter-dated papers (Figure 291).
Figure 291: Outstanding benchmark Swedish covered bonds

Instrument ISIN Size (bn) Launch date Spread at launch As at 28 May 2010
mid-swaps (bp)
3.750% NBHSS Oct 11 3.875% SCBCC Oct 11 3.750% SHBASS Dec 13 4.250% NBHSS Feb 14 4.250% NBHSS Nov 10 4.250% SEB Jan 11 4.250% NBHSS Apr 11 4.500% SEB Apr 13 4.625% SPNTAB May 11 4.750% SEB Aug 11 5.000% SPNTAB Sep 10 5.125% SCBCC Sep 10 4.000% SEB Mar 14 4.125% SPNTAB Jun 14 3.000% SHBASS Oct 14 3.625% SPNTAB Oct 16 3.500% NBHSS Jan 17 2.500% SPNTAB Jan 13 3.000% SCBCC Feb 15 3.375% SPNTAB Mar 17 3.250% SCBCC Mar 17 2.750% SHBASS Apr 15 Total
XS0272191791 XS0273264712 XS0278556286 XS0285686738 XS0332343762 XS0340137131 XS0359403168 XS0360829419 XS0365158996 XS0384896584 XS0385104442 XS0387410631 XS0420248568 XS0432619087 XS0455319029 XS0455687920 XS0478492415 XS0479630013 XS0483829320 XS0496542787 XS0498316255 XS0501715311
1.25 1.00 2.00 1.25 1.25 1.50 1.25 1.00 1.00 1.00 1.00 1.25 1.00 1.25 1.50 1.25 1.50 1.00 1.00 1.00 1.00 1.25 26.50bn
17 Oct 2006 24 Oct 2006 5 Dec 2006 30 Jan 2007 15 Nov 2007 8 Jan 2008 15 Apr 2008 22 Apr 2008 15 May 2008 20 Aug 2008 22 Aug 2008 4 Sep 2008 23 Mar 2009 29 May 2009 24 Sep 2009 28 Sep 2009 7 Jan 2010 12 Jan 2010 27 Jan 2010 Mar 2010 Mar 2010 Mar 2010
-4 -4 -1 -2 +2 +3 +11 +17 +15 +20 +22 +38 +130 +130 +35 +58 +39 +39 +47 +57 +48 +35
-7 -3 +18 +27 -15 -8 -7 +34 +14 +1 +59 -16 +30 +47 +27 +56 +45 +24 +36 +60 +53 +35
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At the time of writing, five issuers were active on the Swedish market for EUR-denominated, benchmark covered bonds. With market shares (in terms of volume outstanding) of around 27% each, Nordea Hypotek (NORDEA) and Swedbank (SPNTAB), respectively, dominate the market, followed by Skandinaviska Enskilda Banken (SEB) (19%), Stadshypotek (SHBASS) (14%), and by the Swedish Covered Bond Corporation SCBCC (13%). As in the case of other Nordic markets, however, (potential) issuers of Swedish EUR-denominated (benchmark) covered bonds benefit from a liquid domestic market which limits their dependence on the global capital markets.
Figure 292: Swedish covered bonds Market characteristics

a) Outstanding Swedish covered bonds (bn) b) Redemption profile (bn)
25
8 6.0 6
7.2
20
5.0 15 4 10 2 1.0 0 Jan-07 Jan-08 Jan-09 Jan-10 2010 2011 2012 2013 2014 2015 2016 2017 1.3 1.5 4.0
0 Jan-06
The Swedish Covered Bond Act

Swedish Covered Bond Act came into effect in July 2004
To adopt a state-of-the-art framework for the issuance of covered bonds and to transform the previous legislation into a CRD-compliant framework, the Swedish Covered Bond Act was reformed in 2003 and 2004. As the Swedish Covered Bonds Act (Lag 2003:1322 om utgivning av skerstllda obligationer), which governs the issuance of covered bonds (Skerstllda Obligationer), did not come into effect until 1 July 2004, the Swedish covered bond framework still ranks among the relatively new legislations. Within the scope of regulations (Finansinspektionens freskrifter och allmnna rad om skerstllda obligationer) that were enacted on 21 September 2004, but did not come into effect until 15 October 2004, further regulatory provisions were established by the Swedish Financial Supervisory Authority (Finansinspektionen). The first Swedish EUR-denominated jumboformat covered bonds followed the conversion of all existing mortgage bonds and comparable debt securities. Although the Swedish Covered Bonds Act does not embrace the specialist banking principle explicitly, we observe a de facto specialisation of the issuing institutions. The current legislation is comparable with long-established covered bond frameworks such as the German Pfandbrief Act, for example. Among the strengths of the Swedish covered bond framework, in our opinion, are: Cover assets are separated from the balance sheet through registration. In case of an issuers insolvency, cover assets are not subject to insolvency proceedings.
Strengths
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Cash flow adequacy is secured through the stipulation of a net present value (NPV) cover, which also has to be tested against stress scenarios.
Weaknesses
Weaknesses of the framework, in our view, include the following: Lack of transparency. As no minimum over-collateralisation is legally prescribed, investors rely upon contractual features, which vary between the different covered bond programmes. The quality of Swedish covered bonds is strongly related to the maintenance of a voluntary over-collateralisation, which, however, can be subject to change, particularly in the case of a stress scenario. We believe that this weakness can be mitigated through contractual obligations to maintain a sufficiently high level of over-collateralisation to secure an AAA rating.
Qualifying collateral for Swedish covered bonds

Cover pool characteristics
As in several other European covered bond legislations, the collateral pool for Swedish covered bonds can consist of mortgage loans, public sector loans, and supplemental cover assets. Mortgage loans are eligible for inclusion in the collateral pool as eligible cover assets, provided they are located within the European Economic Area (EEA), and are secured on property intended for residential purposes. The maximum LTV stands at 75% for residential dwellings, 70% for agricultural property, and 60% for commercial property. There is a limit of 10% on the proportion of the cover pool secured by commercial mortgages. Collateral intended for a variety of uses will only be included within the highest LTV category if the collateral is predominantly for residential use. Loans granted to the public sector, which are generally defined to be subject to a 0% risk weighting (RW), can be included in the cover pool as collateral. While exposures guaranteed by public sector entities are eligible for inclusion in the collateral pools, bonds secured by collateral made up of this type of exposure are not. The Swedish covered bond legislation also foresees the potential inclusion of supplemental cover assets into the collateral pool. Whereas their relative weight ordinarily cannot exceed 20% of the cover pool, the barrier can, subject to regulatory approval, be increased to up to 30%. Supplemental cover assets, which can include cash, cheques, postal acceptance bills, securities and claims against the Swedish government and sub-sovereigns, securities and claims against other governments, securities and claims against EU sub-sovereigns, and securities and claims with a comparable risk, have to comply with chapter 3, 1, A of Lag 1994:2004 om kapitaltckning och stora exponeringar fr kreditinstitut och vrdepappersbolag, 20 December 2004. Also, derivative contracts entered into with the purpose of meeting matching requirements can be included in the collateral pool.
Inclusion of supplemental assets in collateral pool

Supervision by Finansinspektionen
Swedish covered bond issuers are supervised and authorised by the Swedish Financial Supervisory Authority, Finansinspektionen, and must either be Swedish banks or Swedish credit market companies. As a requisite for the issuance of covered bonds, the aforementioned institutions need to apply for a specific covered bond licence, which is subject to fulfilling the following criteria: the articles of association must comply with the Swedish Covered Bond Act; it can be assumed that the planned business will be executed according to the Swedish Covered Bond Act; mortgage bonds issued under the previous legislation will be transformed according to a specific plan, which is subject to approval by Finansinspektionen; the issuer presents a financial plan, which underlines that the financial situation is solid, and the interests of other creditors are respected. Once granted, the licence can still be withdrawn if an issuer does not
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fulfil its duties, or if no covered bond is issued within 12 months after receiving the licence. In the event of Finansinspektionen withdrawing the licence, it can also stipulate how the respective business will be phased out.
Cover register
The details of cover assets and the respective covered bonds collateralised, along with any derivative agreements entered into, have to be entered into a cover register. The latter needs to be maintained by the issuer and is monitored by an independent inspector (oberoende granskare), which is appointed by Finansinspektionen for each discrete issuer. The inspector will further monitor whether covered bonds and derivatives in the cover pool are registered correctly, whether the cover pool consists of only eligible cover and supplemental assets, and whether the valuation of collateral held within the pool is fair. The inspector will furthermore ensure that only the eligible part of mortgage assets in which the value of the collateral has declined is included in the cover pool. Finansinspektionen will receive an annual report from the inspector which outlines his activities and the respective payments received.

Covered Bond Act stipulates cover ratio of above 100%
As stipulated in the Swedish Covered Bond Act, the current nominal value of assets in the collateral pool must, at all times, be in excess of the current nominal value of the covered bonds issued. Derivatives have to be included in the calculation. Also, the NPV of the cover pool has to be in excess of that of covered bonds collateralised by the respective collateral pool, taking the value of any derivative contracts into consideration. Note that, within the scope of a stress test, the NPV of the collateral pool has to exceed the NPV of covered bonds collateralised by the cover pool following a 100bp shift up or down the swap curve. Issuers furthermore have to calculate the effect of more severe interest rate movements in terms of curve twists. Unhedged currency positions must be able to withstand permanent changes in the exchange rate of up to 10% without the NPV of the covered bonds issued exceeding the NPV of the collateral pool. Cash flows attributed to the collateral pool and derivative contracts have to be held in a bespoke account and need to be able to meet the obligations of the covered bonds issued and any derivative contracts entered into. The volume of derivative instruments has to be deducted from substitute collateral. Also, derivative contracts may only be entered into with institutions with a RW of 20% or less. Derivative contracts do not form part of the collateral pool unless there is an act of insolvency. In that case, however, cash inflows and the derivative contracts themselves are understood to be part of the collateral pool. Cash outflows to counterparties are treated with the same priority as those owed to a covered bondholder. There should be no early termination language on any derivative contract.
Derivative contracts not part of collateral pool unless act of insolvency

Separation in case of issuers insolvency
In the event of an issuers insolvency, the provisions of the Swedish Covered Bond Act stipulate that, subject to the conditions of the act having been met and including the matching requirement, the cover pool, any derivative contracts and the covered bonds themselves will be separated from any other of the issuers assets and liabilities. Timely payments can then be made by the receiver to the covered bondholders. In the case of this not occurring, covered bond holders will enjoy a priority claim over the disposal proceeds of the cover pool after any claims due to debt incurred by the receiver are met. Should the priority claim prove inadequate, additional claims by covered bondholders will rank pari passu to those of unsecured unsubordinated creditors.
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No specific regulation on management of cover assets upon issuer default
In April 2010, the Swedish parliament approved the governments proposal to amend the Swedish Covered Bonds Issuance Act to permit receivers in bankruptcy to raise loans in order to maintain liquidity matching. This amendment came into effect on 1 June 2010. For further information please refer to the Association of Swedish Covered Bond Issuers.
The Swedish housing and mortgage market

Signs of recovery: house price growth of 5.8% y/y in Q4 09
As several other (European) countries, Sweden was subject to a pronounced slowdown in house price growth in 2008 and early 2009. Following average annual house price increases of around 9% between 2000 and late 2007, price growth markedly slowed from Q1 08 onwards, in fact contracting by 4.1% in Q1 09, ie, the sharpest contraction since 1993. This development, which could be observed across all Swedish regions, was led by the larger Stockholm area where prices for residential dwellings, as reflected in the house price index, contracted by 0.7% y/y in 2009 after increasing by 2.3% y/y in 2008 and 14.5% y/y in 2007. At the time of writing, average house price growth in Sweden had started recovering again and in terms of quarterly data, increased at a pace of 5.8% y/y in Q4 09, the latest date for which data were available. According to Sveriges Riksbank, the recovery in house prices is attributed to the decline in interest rates for mortgage loans and the improved economic outlook 109. At the same time, we expect supply and demand imbalances to leave their mark on the Swedish housing market, as the number of housing starts has gradually decreased since early 2007. Traditionally, housing investment has been low in Sweden, making housing shortages prevalent in many municipalities. Meanwhile, however, we observe that the so-called ROT programme, which foresees tax deductions for repair and renovation work on dwellings, has caused overall housing construction to stabilise and the latest data indicate that the number of building permits granted for residential buildings (1,740 units in Q4 09 after 1,417 units in Q3 09) is recovering again. As demand has remained largely stable, however, with the purchase price coefficient, ie, the relation between purchase price and taxation value pointing upwards, Swedish house price growth will likely further recover over the course of the year. Supporting this view is the 8% y/y increase of the purchase price coefficient in Q4 09. Consequently, we expect housing investment to slightly increase in 2010. As the large construction companies seem to have sold nearly all of their stocks of apartments, which had started piling up during the global financial crisis, they have now started embarking on new projects. According to Sveriges Riksbank, the situation will further improve in 2010, as funding an investment in housing has become cheaper with the situation on the financial markets improving. At the same time, the demand for new apartments is growing. Yet, as highlighted by Sveriges Riksbank, the house price growth could likely become subject to a weakening as soon as the central bank engages in a rate hiking cycle 110. This comes as, since 2004, the proportion of mortgage loans with a variable interest rate has steadily increased and amounted to more than 45% of all mortgage loans granted at the time of writing. Whereas mortgage loans with a fixed term of less than five years accounted for 40% of the entire market, the relative weight of mortgage loans with a fixed term of more than five years has plummeted to less than 15% at the time of writing from 30% in 2004 and 60% in 1997.
Potentially further growth ahead
Interest rate hikes likely to dampen house price growth
109 110
Source: Sveriges Riksbank, Monetary Policy Report, February 2010. Source: Sveriges Riksbank, Monetary Policy Report, February 2010.
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Mortgage market dominated by two institutions
With the aggregate amount of Swedish housing institutions lending to households amounting to SEK1,485bn (or approximately 153bn) as at end-January 2010, the latest date for which data were available, the Swedish mortgage market, in terms of volume, clearly is the Nordic regions largest 111. According to data compiled by the Swedish Bankers Association (Bankenfreningen), the countrys mortgage market is dominated by two players which, together, had a market share of 58% in Q3 09, the latest date for which data were available. Swedbank Hypotek had a market share of roughly 31%, followed by Stadshypotek (27%) and Nordea Hypotek (17%). Among the medium- to smaller-sized players in terms of market share were SEB (13%), SCBC (8%), LF Hypotek (3%), and Landshypotek (2%) (Figure 293). In terms of outstanding mortgage loans, 70.9% were granted to finance single-family homes, followed by tenant-owned apartments (22.3%) (Figure 294). As illustrated above, EUR-denominated benchmark covered bonds are only one refinancing source for Swedish mortgage credit institutions which secure the better part of their funding on the domestic market112. As at year-end 2009, the latest date for which data were available, the overall volume outstanding of Swedish mortgage covered bonds amounted to 144.1bn, up from 126.4bn as at year-end 2008. Therefore, the volume of non-benchmark deals amounted to 94.6bn, up from 83.2bn as at year-end 2008. The average term-to-maturity was 2.6 years, up from 2.2 years in 2008. Yet, notwithstanding these large volumes in absolute terms, only 28.3bn or 19.6% were denominated in EUR, up from 23.4bn or 18.5% of all mortgage covered bonds as at year-end 2008. Note that on the Swedish market, private placements have so far only played a minor role. In 2009, private placements backed by Swedish mortgage loans amounted to only 4.0bn and, thus, a negligible 2.7% of the entire amount of covered bonds outstanding. Ceteris paribus, we do not expect the composition of the Swedish covered bond market to drastically change in the year(s) ahead. As a result of the very liquid and large domestic market which is backed by a sound investor base, the issuance of EUR-denominated benchmark covered bonds will likely not surpass a level of 25% for the time being.
Figure 293: Mortgage lending in Sweden market shares

100% 18% 15% 12% 12% 12% 14% 13% 13% 12% 29% 28% 28% 27% 27% 29% 27% 28% 29% 32% 32% 32% 31% 32% 32% 31% 29% 30% 10% 11% 11% 12% 12% 12% 12% 11% 13% 15% 15% 16% 16% 16% 16% 16% 15% 17% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Nordea Hypothek SEB Swedbank Hypothek Stadshypotek Others
Source: Swedish Bankers Association; Barclays Capital
Figure 294: Mortgage lending in Sweden collateral structure

100% 90% 20% 19% 17% 80% 70% 9% 10% 11% 60% 50% 40% 30% 61% 60% 61% 20% 10% 0% 2001 2002 2003 14% 13% 13% 13% 12% 11% 13% 14% 15% 17% 18% 19%
75%
50%
62% 62% 62% 62% 61% 61%
25%
2004 2005 2006 2007 2008 2009 Tenant-owner apartments Farm properties
Single-family dwellings Apartment buildings Other

Source: Statistics Sweden, Barclays Capital
111 112
At the time of writing, the EURSEK exchange rate stood at 1:9.0783. Source: ASCB - Association of Swedish Covered Bond Issuers.
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Figure 295: Property Price Index (y/y variation in %)

15
Figure 296: Purchase price coefficient*

2.5
10 2.0 5 1.5 0
-5 Mar-00
Mar-02
Mar-04
Mar-06
Mar-08
Mar-10
1.0 Mar-00
Mar-02
Mar-04
Mar-06
Mar-08
Mar-10
Figure 297: House Price Index (1981=100)

750
Figure 298: Building permits granted in Sweden (nsa, in 000)

4 3
500 2 1 0 Mar-99 1980 1985 Stockholm 1990 1995 2000 2005 2010 Malm
250
0 Gothenburg
Mar-01
Mar-03
Mar-05
Mar-07
Mar-09
residential buildings buildings for seasonal and secondary use non-residential buildings
Figure 299: Housing starts (quarterly, nsa, in 000)

6 5
Figure 300: Completed dwellings (quarterly, nsa, in 000)

8
6 4 3 2 2 1 0 Mar-00 0 Mar-00 4
Mar-02
Mar-04
Mar-06
Mar-08
Mar-10
Mar-02
Mar-04
Mar-06
Mar-08
Mar-10
one or two-dwelling buildings multi-dwelling buildings
one or two-dwelling buildings multi-dwelling buildings
*Note. The purchase price coefficient is determined as purchase price / taxation value. Source: Statistics Sweden, Haver Analytics, Barclays Capital
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Sweden
Name of debt instrument(s) Legislation
Skerstllda Obligationer (before July 2004: Bostads Obligationer) Law enshrined on 17 December 1992 was replaced by a new law (Lag om utgivning av skerstllda obligationer) on 15 May 2003, coming into effect on 1 July 2004; side regulation (Finansinspektionens freskrifter och allmnna rad om skerstllda obligationer) was enacted on 21 September 2004 and came into force on 15 October 2004 No; the issuance of covered bonds is subject to fulfilling specific criteria Not applicable Cover assets remain on the balance sheet. Mortgage and public sector collateral have to be registered in a single register Hedge positions can be included in the cover register Up to 20% Commercial mortgage loans should not exceed 10% of total cover assets
Special banking principle Restrictions on business activities Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check Special supervision Protection against mismatching Protection against credit risk Protection against operative risk
Public sector borrowers can include the Kingdom of Sweden, Swedish municipalities, and certain sovereign borrowers, central banks, and municipalities within the EEA and the OECD Eligible property of mortgage borrowers should be located in the EEA 75% (70% agricultural) 60% No. Market value, under the assumption of a voluntary sale and "normal" sales procedures, should be taken into account Regular monitoring of property values Supervision through Finansinspektionen (Swedish financial supervisory authority) and an independent inspector (oberoende granskare) Coverage by nominal value, net present value, duration, and currency The issuer may replace non-performing loans and is obliged to monitor the value of its assets on a regular basis Post-bankruptcy regulations do not include specific regulation on the management of cover assets; in particular, it is assumed that the insolvency administrator cannot raise money for liquidity management purposes. No Yes No, but assets within the cover register are exempt from bankruptcy proceedings All loans are earmarked for the asset pools. In addition, investors may benefit from positive market values of derivatives In the event of insufficient proceeds from the pool assets, creditors rank pari passu with senior debt holders Yes Yes
Mandatory over-collateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency first claim is on External support mechanisms UCITS Art. 22 par. 4 compliant? CRD Annex VI, Part 1, 65 compliant?
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UK MARKET

Fritz Engelhard +49 69 7161 1725 fritz.engelhard@barcap.com Michaela Seimen +44 (0) 20 3134 0134 michaela.seimen@barcap.com
The first jumbo UK covered bond was issued in 2003. The market followed a steep growth path from Q4 05 until Q3 07 and stabilised around 60bn since October 2007. In mid-May 2010, the total volume of outstanding -denominated jumbo asset covered securities was 64bn, with the market consisting of 39 issues from nine issuers. The average size of jumbo asset covered securities is 1.6bn. Following their inception, UK covered bonds spreads tightened consistently and reached historical lows in early 2007. However, between mid-2007 and Q1 09, swap spreads widened substantially in a series of waves and the average swap spread reached a historical high at 250bp. Since Q2 09, swap spreads tightened by about 150bp. Figure 302: Market share, May 2010
YBS 2.3% ABBEY 9.7% BACR 7.0% NRKLN 14.4% LLOYDS 2.3% HSBC 2.3% BRADBI 11.5%

bn 70 60 50 40 30 20 10 0 2003 2004 2005 2006 2007 2008 2009 2010 bn 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jumbo UK Covered Bonds Securities Average size of Jumbo UK Covered Bonds in bn EUR (RS)
NWIDE 14.0%
HBOS 36.3%

300 250 200 150 100 50 0 -50 2003
Figure 304: Credit term structure of major issuers, May 2010

Barcap OAS 140 120 100 80 60 40 20 0 2008 HBOS
2004
2005
2006
2007
2008
2009
2010
2010
2013 BACR
2016
2018 ABBEY
2021
2024
Euro UK Covered ASM

NWIDE
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The UK market overview

UK Regulated Covered Bonds Regulations introduced on 6 March 2008
On 6 March 2008, the UK Regulated Covered Bonds Regulations (RCBR), the legislative framework governing the issuance of covered bonds in the UK, came into force. Initially, its main purpose was to provide the necessary underpinning for Undertakings for Collective Investment in Transferable Securities (UCITS) 22(4) compliance of UK covered bonds. However, during the course of the consultation period (23 July 2007-15 October 2007), a series of amendments, designed to focus on quality rather than flexibility, were made. In particular, the programme structure was restricted, a high-quality marker was introduced and the list of eligible assets was refined. The RCBR also contains a specific section which stipulates the priority of payments and clearly outlines that in a winding-up scenario, the claims of regulated covered bondholders with regards to the relevant asset pool rank in priority to all other creditors. 113 The UK initially chose not to implement Article 22(4) of the ECs UCITS Directive, which is the key to the provision of an EU-compliant framework for covered bonds. This has encouraged UK issuers to develop general law-based covered bonds. In August 2003, HBOS launched the first UK covered bond. This was followed by issues from a number of other financial institutions, including building societies. 114 The objective in all cases was to reduce funding costs by attracting a new investor base and term out the liability profile of the balance sheet. In this context, it is also worth noting that UK covered bond issuers made concerted efforts to raise the profile of covered bonds to US investors with a series of dollardenominated benchmark transactions launched between Q4 06 and mid-2007. UK authorities started to regulate covered bond issuance on 17 August 2004, when the FSA introduced an interim soft limit of 4% of total assets on the issuance of covered bonds. A further step was made in August 2005, when the FSA published a paper in which it outlined an amended prudential approach to covered bonds. This intimated that the FSAs previous interim soft limit on covered bond issuance would be relaxed, in effect opening the way for UK financial institutions to use covered bonds to fund an increasing proportion of their assets. Furthermore, on 7 February 2006, it published a letter to the British Bankers Association and other industry groups announcing a formal consultation period on implementing a covered bond regime. The joint consultation by HM Treasury and the FSA resulted in proposals for the legislative framework and FSA guidance on its implementation of the regime. This was presented on 23 July 2007. Following further consultation, the RBCR was finally published on 14 February 2008 and came into force on 6 March 2008. The statutory regime is not geared to prescribe the complete design and contractual arrangements for the product. The legislation provides a principles-based framework with the necessary legal requirements for the regime and its special public supervision. It thus provides flexibility to permit product development, along with clarity in respect of bondholder protection. The model which foresees the transfer of assets to a special purpose vehicle (SPV), and which is used in the existing UK covered bond programmes, basically complies with the RCBR and, thus, benefits from the additional supervisory protection and legal clarity. UK authorities also discussed the so-called integrated approach, which involves a ringfencing of cover assets directly on the balance sheet of the issuing bank, as is the case in most other EU countries. However, the authorities decided not to include this option at the initial stage, but to review this possibility after implementation of the regime. The main reason for putting this option on hold was the concern that clarifying the technical issues to make this model sufficiently robust would take too much time.
113 114
UK market commenced in 2003
FSA started to regulate covered bond issuance in August 2004
Model of existing UK covered bonds benefits from additional supervisory protection and legal clarity
Integrated approach may be introduced at a later stage
RCBR Part 6 Article 27 (1). Nationwide was the first building society to tap the covered bond market in November 2005.
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Definition of application criteria
To ensure special public supervision, the FSA regulates issuers and covered bonds. It also enforces the regime and provides guidance on the related operations. It maintains a register of UK Regulated Covered Bond issuers and their UK Regulated Covered Bonds programmes, which can be found on the FSAs website. 115 An applicant must be a credit institution authorised in the UK 116 to carry out regulated activities and must document the key features of its respective programmes, such as the participants in the transaction, details of the asset pool, the programme structure, and coverage rules. An applicant also has to clarify whether the respective programme is compliant with the EU Capital Requirements Directive (CRD). As of 25 May 2009, there were eight regulated covered bond issuers: Abbey National Treasury Services plc, Alliance & Leicester plc, Barclays Bank plc, Bank of Scotland plc 117, HSBC Bank plc, Leeds Building Society, Nationwide Building Society and Yorkshire Building Society. Within the RCBR, the FSA has specific supervisory and enforcement powers. It can halt covered bond issuance by removing a covered bond issuer from the list of UK Regulated Covered Bond issuers. It also has the power to require issuers to top up the asset pool if it is not satisfied that the assets contained within the pool are sufficient to cover all claims attaching during the lifetime of the bond. To ensure minimum quality standards for covered bond programmes, the FSA was given the power to refuse an application for registration of a Regulated Covered Bond or an issuer if the FSA considers that granting it would be detrimental to the interests of investors in Regulated Covered Bonds or to the maintenance of the good reputation of the Regulated Covered Bond sector in the UK. The FSA will also control whether the respective programmes are appropriately designed to ensure that cover assets will be of sufficiently high quality. While UK authorities preferred not to be prescriptive about the eligibility of cover assets, as these are mainly subject to the contractual commitments of the individual covered bond programmes, there is a definition of eligible property that is designed to ensure a level of control over the minimum quality of assets in the pool. According to this definition, eligible assets are those that comply with CRD Annex VI Part1 paragraph 68-70, social housing and public private partnership loans (because these are secured by a repayment stream from public monies) and any other asset held in relation to a body which has a credit assessment equivalent to a AAA or AA rating. The geographical scope comprises exposures to EEA states, as well as the US, Japan, Canada, Switzerland, Australia, New Zealand, the Channel Islands and the Isle of Man. In addition, issuers need to get confirmation that the law of the respective jurisdiction would not adversely affect the claims on non-UK assets. Following consultation on the initial draft, it was also decided to define eligibility criteria more narrowly. The original proposal allowed the use of any asset rated credit quality step 2 (A+ to A-) under CRD rules or better. This kind of catch-all provision was removed in the final regime. Eligible assets are now restricted to exposures to entities rated credit quality step 1 (AAA to AA-). In addition, the inclusion of RMBS and CMBS notes is now restricted to those which are backed by assets that the issuer or affiliate has originated or acquired, and rated AAA. Since mid-2007, UK covered bonds have experienced significantly higher spread volatility than their peers. In our view, this is largely the result of a bundle of particular factors, eg, pronounced negative perceptions of the UK housing market; name-specific pressure in particular on Northern Rock and Bradford & Bingley, as two of the seven existing jumbo covered bond issuers, and the fact that the product design is largely geared towards distribution to non-domestic investors. The introduction of the statutory regime in March
Supervision and enforcement
Eligible property
Eligibility criteria tightened
Persistent spread widening in the jumbo market
115 116
http://www.fsa.gov.uk/Pages/Register/rcb_register/index.shtml. Whether UK branches of EEA issuers should be allowed to issue UK covered bonds will be reconsidered. 117 Not with respect to the HBOS Social Housing Covered Bond programme.
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2008 failed to ease spread widening momentum and the primary jumbo market remained closed for a prolonged period. In the course of 2009, market conditions improved significantly and in September 2009, the jumbo market was re-opened.
Persistent spread widening in the Jumbo market
During the period in which the Jumbo UK covered bond market was basically closed, most issuers could benefit from private placements and from being able to use their covered bonds as collateral for the Special Liquidity Scheme (SLS) established in April 2008 by the Bank of England (BoE) 118. In the course of 2008, mid- to smaller sized banks and building societies set up a number of new covered bond programmes, which were rather designed to benefit from the SLS. The respective covered bonds needed to have a current triple-A rating to be eligible for the SLS. We estimate that an amount of about 110bn of covered bonds was retained by the respective issuers and used as collateral for the SLS scheme.
Generic UK covered bond programme structure

Generic UK covered bond set-up
When buying a UK covered bond, investors typically have a direct recourse to the issuer, but are also protected by a pool of mortgages that has been segregated and would be managed exclusively for their benefit in the event of problems. The proceeds raised through the issue of covered bonds are on-lent through an inter-company loan to an LLP (limited liability partnership), which is legally independent from the issuer. In turn, the LLP uses these proceeds to purchase from the issuer portfolios of mortgages through a true-sale transfer by equitable assignment. The LLP is able to sell the mortgage loans. By the time this happens, borrowers should have been notified and legal title will have passed to the LLP. It is also worth noting that these programmes can be increased in size by transferring more mortgages to the LLP and issuing more bonds against them subject to meeting stringent tests. The typical structure of a UK covered bond programme is shown below in Figure 305. The particular strengths of UK covered bond programmes are: Cover assets are separated from the balance sheet at inception of the programme/ issuance through a sale to the LLP. The Regulated Covered Bonds Regulations clearly outline that in a winding up scenario, the claims of regulated covered bondholders with regards to the relevant asset pool rank in priority to all other creditors. Cash flow adequacy is secured through the asset coverage test and the obligation to neutralise any exposure to interest rate and currency risk. In addition, the FSA is obliged to monitor whether cash flows from the asset pool are sufficient to cover all claims of covered bond investors during the lifetime of the bonds. It also controls whether the respective programmes are appropriately designed to ensure that cover assets will be of sufficiently high quality. Investors are well protected against liquidity risk, as there is a clear escalation process in the case of a deterioration of the credit profile of participating parties.
Strengths
Weaknesses
The relative weaknesses of UK covered bond programmes are: Compared with other covered bond products, there is a lower level of standardisation. Yet the basic structure is similar in all programmes and the FSA was given the mandate to ensure the maintenance of minimum quality standards for covered bond programmes. Thus far, banking regulators track record on the surveillance of UK covered bonds is somewhat limited. However, following the introduction of the UK Regulated Covered Bonds Regulations, experience is deepening quickly.
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http://www.bankofengland.co.uk/publications/news/2008/029.htm
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The contingency measures built in the programmes foresee the replacement of involved parties in case certain minimum requirements are breached. The execution of such schemes may become difficult in a stressed environment.
Figure 305: Generic UK covered bond programme structure

Mortgage Loans and Related Securities Seller Covered Bond LLP Consideration Intercompany Loan Loan Repayment Covered Bond Guarantee and Deed of Charge Covered Bond swap providers Interest rate swap providers
Covered Bond Issuer
Covered Bond Proceeds
Covered Bonds
Covered Bond Holders Bond Trustees Security Trustee Swap Providers
Qualifying collateral for UK covered bonds

Focus on UK mortgages
In all but two UK programmes, the collateral consists of residential mortgages. There is one programme (HBOS) where the collateral consists of loans to housing associations and another (Anglo Irish Bank Corporation/UK branch) where the collateral consists of a portfolio of UK commercial mortgage loans. As UK banks issued off a contractual covered bond programme, geographical restrictions on cover pool assets so far have been self imposed. To date, all covered bond programmes have focused on UK assets. Within the new statutory regime, the geographical scope for eligible property comprises exposures to EEA states, as well as the US, Japan, Canada, Switzerland, Australia, New Zealand, the Channel Islands and the Isle of Man. Issuers need to get confirmation that the law of the respective jurisdiction would not adversely affect the claims on non-UK assets. The LTV limit varies across the different programmes (Figure 306), but in all existing programmes, it is below the 80% level for residential mortgages stipulated by the CRD and the RCBR. It is important to note that higher LTV loans are included in the pool, but loan amounts exceeding the respective cap are not taken into account when calculating the appropriate loan balance within the asset coverage test (see explanation below). In all but one programme, the maximum single loan exposure was limited to 1mn. Loans which are in arrears are either repurchased by the originator or subject to specific haircuts (Figure 306). Substitution assets can be included in the cover pool. In most programmes, their aggregate value can make up to 10% of cover assets, although HSBC has explicitly linked its substitution asset limits to those set out in the Capital Requirements Directive (currently 15%). In all programmes, substitution assets are limited to short-term investments in sterling, namely bank deposits and debt securities with a minimum rating of double-A minus or P-1/A-1+/F1+ , triple-A rated RMBS notes and government debt.
Application of valuation rules
The properties are valued using UK mortgage market accepted practice. Normally, this is carried out by a UK surveyor prior to granting the loan. Residential property values are
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indexed to a reputable real estate price index on a monthly basis. Price decreases are fully reflected in the revaluation, while in the event of price increases, a haircut (15% in all programmes) is applied.
Asset coverage test ensures a level of over-collateralisation that is compliant with the issuers target rating
To reduce the risk of shortfall, the programmes include a dynamic asset coverage test that requires the balance of the mortgages in the collateral pool to significantly exceed the balance of the outstanding covered bonds. Apart from the results of this calculation, a minimum over-collateralisation level (OC) has to be maintained (Figure 306). This minimum may be increased from time to time if the credit quality of the mortgages in the collateral pool decreases, as determined by a quarterly WAFF/WALS test. In addition, the asset coverage test imposes additional minimum OC requirements to mitigate set-off risk, redraw risk on flexible mortgages and potential negative carry. In the case of a breach of the asset cover test, the issuer is obliged to restore the balance by transferring additional loans or by providing cash to the LLP. If the breach is not rectified until the following calculation date, the trustee will serve a notice to pay on the LLP. An amortisation test is designed to ensure that the assets will be sufficient to enable the LLP to repay the covered bonds. It applies only after an issuer event of default has occurred, at which time covered bondholders will be relying on the guarantee. The test will fail if the amortisation test aggregate loan amount falls below the outstanding balance of all the covered bonds.
Amortisation test

HM Treasury and FSA have prepared a specific covered bond regime
An applicant must be a credit institution authorised in the UK to carry out regulated activities and must document the key features of their respective programmes, such as the participants in the transaction, details of the asset pool, the programme structure, and coverage rules. An applicant also has to clarify whether the respective programme is compliant with the EU CRD. The issuer/originator is responsible for the monthly pool monitoring, with the asset coverage test calculation being checked by an independent auditor on an annual basis. In addition, as explained above, the FSA is obliged to monitor whether cash flows from the asset pool are sufficient to cover all claims of covered bond investors during the whole period of the validity of the bonds. It also controls whether the respective programmes are appropriately designed to ensure that cover assets will be of sufficiently high quality. Finally, rating agencies are heavily involved in the programme and need to re-affirm the ratings of the programme upon each issuance. They also monitor the amount of over-collateralisation required to maintain minimum target rating levels. Within all UK covered bond programmes, there are contractual provisions stipulating that exposure to interest rate and currency risk has to be neutralised. In addition, downgrade triggers for swap counterparties, the pre-maturity test, maturity extension rules and the amortisation test all ensure cash flow adequacy. Most UK covered bond transactions have a soft-bullet maturity. Following the serving of a notice to pay, the LLP may not have sufficient proceeds for a timely repayment of covered bonds. In this case, the legal final maturity will be extended by 12 months to allow for a realisation of cover assets. Some of the programmes launched in the course of 2008-09 have introduced partial pass-through features, which have very long extendable maturities that allow principal to be paid on a pass-through basis following an issuer event of default. Such programmes provide rather high protection against liquidity gap risk, as no assets would need to be monetised to pay covered bonds following an issuer event of default.
Maturity extension
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Pre-maturity test
For HBOS and HSBCs 119 programmes, a pre-maturity test is designed to ensure the LLP will have sufficient cash available to repay the bonds in full on the original maturity date in the event of the issuers insolvency. If, in the past six months before a maturity date, the issuers short-term ratings fall below A-1+ (S&P), F1+ (Fitch) or P-2 (Moodys) (or, in HBOSs case, the issuers long-term Moodys rating falls to A2 or below), the pre-maturity test requires the LLP to cash-collateralise its potential obligations under the guarantee. The LLP can raise this cash through contributions from the issuer or by selling randomly selected loans. All UK covered bond programmes include a number of other safeguards. In particular, there are minimum rating requirements for the various third parties that support the transaction, including the swap counterparties and cash manager, and independent audits of the asset coverage test calculations are undertaken on a regular basis. If the issuers short-term ratings are downgraded below A-1+ (S&P), P-1 (Moodys) or F1+ (Fitch), the LLP will be required to establish a Reserve Fund to retain an amount sufficient to meet the next interest payment on each series of covered bonds from available revenue receipts. This amount will be retained in a GIC account. If subsequently there is an issuer event of default, the contents of the reserve fund will form part of available revenue receipts to be used by the LLP to meet its obligations under the covered bond guarantee.
Other safeguards
Reserve fund

The payments under the covered bonds are further guaranteed by the LLP following an issuer event of default. The LLP is reliant on the proceeds derived from the assets it holds to make these payments. The RCBR clearly outlines that in a winding up scenario, the claims of regulated covered bondholders with regards to the relevant asset pool rank in priority to all other creditors. If the proceeds from the cover pool were insufficient to meet the obligations to bondholders in full, investors would still have an unsecured claim against the issuer and, in certain programmes, group guarantors for the shortfall. There are a number of trigger events in the covered bond structure, the first being an issuer event of default. This can occur in a number of situations, including the following: Failure to pay any interest or principal amount when due by the issuer and the group guarantors; Bankruptcy or legal proceedings being taken against any of these parties; Failure to rectify any breach of the asset coverage test; or Failure to rectify any breach of the pre-maturity test.
No acceleration unless the LLP defaults
An issuer event of default would not accelerate payments by the LLP to the covered bondholders, but would allow the security trustee to start proceeding against the issuer and, in certain programmes, group guarantors while the asset pool is wound up in an orderly fashion. The second event of default is that of the LLP. This would arise after an issuer event of default if the LLP failed to make any payments on the guarantee when due, if insolvency proceedings were started against it, or the failure of the amortisation test. This would cause the acceleration of payments by the LLP to covered bondholders and their redemption at the early redemption amount relevant to that particular covered bond.
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Within the HSBC programme, only covered bonds which are issued as hard bullet covered bonds are subject to the pre-maturity test. The programme also allows for the specification of an extended final maturity.
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Figure 306: Overview UK covered bond programmes*

HBOS Northern Rock Bradford & Bingley Abbey National Nationwide Yorkshire HSBC
Programme volume in bn LTV cap House Price Index Maximum asset percentage applied in ACT Minimum overcollateralisation Current asset percentage applied in ACT Current overcollateralisation In arrears accounting
60 60% Halifax 92.50% 108.10% 92.50% 108.10% No recognition
10 75% Halifax 90.00% 111.10% 84.50% 118.30% Max. 40% or repurchase
15 75% Halifax 91.00% 109.90% 83.00% 120.40% Max. 40% or repurchase
25 75% Halifax 91.00% 109.90% 90.70% 110.30% Max. 40% if LTV 75%, max 25% if LTV >75% or repurchase No; 12-month maturity extension D&T
35 75% Nationwide 93.00% 107.50% 93.00% 107.50% Max. 40% if LTV 75%, max 25% if LTV >75% or repurchase No; 12-month maturity extension PWC
7.5 75% Avg. of Halifax & Nationwide 93.50% 107.00% 91.00% 109.60% Max. 40% if LTV 75%, max 25% if LTV >75% or repurchase
15 75% Halifax 92.50% 108.10% 91.90% 108.80% Max. 40% if LTV 75%, max 25% if LTV >75% or repurchase
Hard bullet
Yes; prematurity test KPMG
No; 12-month maturity extension PWC
No; 12-month maturity extension KPMG
No; 12-month Yes; prematurity maturity test** extension PWC KPMG
Asset monitor
Note: *Issuers of jumbo covered bonds **For designated series only. Source: Transaction documents
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United Kingdom
Name of debt instrument(s) Legislation Special banking principle Asset allocation Inclusion of hedge positions Substitute collateral Restrictions on inclusion of commercial mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial
UK Covered Bonds. UK Regulated Covered Bonds Regulations effective since 6 March 2008. In addition, investors are protected by a private legal structure based on UK common and contract law. No; any credit institution authorised in the UK to carry out regulated activities. Cover assets are segregated through the transfer to a separate entity. Under all current covered bond programmes, this is a limited liability partnership or LLP. Hedge positions are part of the structural enhancements intended to protect bondholders. Up to 10% in all existing covered bond programmes, except for the covered bond programme of Anglo Irish Bank Corporation plc, where it is up to 15%. In all but two UK programmes, the collateral consists of residential mortgages. There is one programme (HBOS) where the collateral consists of loans to housing associations and another (Anglo Irish Bank Corporation/UK branch) where the collateral consists of a portfolio of UK commercial mortgage loans. Subject to contractual prescriptions. Subject to contractual prescriptions. The geographical scope for eligible property comprises exposures to EEA states as well as the US, Japan, Canada, Switzerland, Australia, New Zealand, the Channel Islands and the Isle of Man. Under current covered bond programmes, only UK mortgages are allowed. Subject to regulatory and contractual prescriptions (Figure 306). In all existing programmes, it is below the 80% level for residential mortgages stipulated by the CRD and the RCBR. Subject to regulatory and contractual prescriptions (Figure 306). In case of the Anglo Irish programme, the LTV cap is in line with 60% LTV barrier on commercial mortgages and well below 70% LTV cap for programmes with a minimum over-collateralisation of 10%. No. Basis = market value. Indexed to house price index. Price decreases are fully reflected in the revaluation, while in the case of price increases, a haircut (15% in all programmes) is applied. In case of the covered bond programme of Anglo Irish Bank Corporation plc, the values of the respective commercial properties have to be updated annually, and in case the originator is rated below triple-B plus, on a semi-annual basis. Yes; Financial Services Authority (FSA) and an independent trustee.
Restrictions on business activities Not applicable.
Basis for valuation = mortgage lending value Valuation check
Special supervision
Protection against mismatching Within all UK covered bond programmes, there are contractual provisions stipulating that that exposure to interest rate and currency risk has to be neutralised. In addition, downgrade triggers for swap counterparties, the prematurity test, maturity extension rules and the amortisation test all ensure cash flow adequacy. Furthermore, the FSA controls whether the respective programmes are appropriately designed to ensure sufficient coverage. Protection against credit risk Yes; defined by asset coverage test. Furthermore, the FSA controls whether the respective programmes are appropriately designed to ensure sufficient coverage.
Protection against operative risk Yes; stipulated through contractual rules. Furthermore, the FSA controls whether the respective programmes are appropriately designed to ensure ongoing servicing of the covered bonds. Mandatory overcollateralisation Yes; subject to the asset percentage applied in the asset coverage test (Figure 306). Furthermore, the FSA has the power to require issuers to top up the asset pool if it is not satisfied that the assets contained within it are sufficient to cover all claims attaching during the whole period of the validity of the bonds.
Voluntary over-collateralisation Yes. is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency, first claim is on External support mechanisms No, but all assets are ring-fenced within a specially separated entity. all the payments received from the special entity's assets. These payments are collected in a GIC account. Investors continue to receive scheduled payments, as if the issuer had not defaulted. In the event of insufficient pool assets proceeds to cover their claim, investors rank pari passu with senior debtholders. There is a simultaneous unsecured dual claim against the issuer and secured against the portfolio held by the specially separated entity. Yes. Generally Yes; CRD compliance is subject to individual programme features.

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US MARKET
Jumbo market and spread development

Following its inception in 2006, the US covered bond market grew sharply, with the total volume of outstanding -denominated Jumbo covered bonds reaching 11.5bn in mid2007. However, since then, the market has stagnated and consists of only two issuers with a total of six issues 120. The two existing programmes are sponsored by Bank of America (BAC) and JP Morgan Chase Bank (JPM) 121. From mid-2007 onwards, swap spreads have widened in a series of waves. Spreads between JPM and BAC diverged significantly and widened from an initial 2-3bp to a maximum of 630bp in September 2008, shortly before JPM took over the programme from Washington Mutual. From Q2 09 onwards, swap spread tightened significantly and at the time of writing, JPM is quoted about 5-10bp tighter compared with BAC. Figure 308: Market share, May 2009

bn 16 14 12 10 8 6 4 2 0 2006 2007 2008 Jumbo Covered Bonds 2009 2010 bn 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
JPM 52%
BAC 48%
Average size of Jumbo Covered Bonds (RS)

Source: Barclays Capital Source: Barclays Capital

950 750 550 350 150 -50 Aug-06

Barcap OAS 140 120 100 80 60 40 20
May-07
Feb-08
Nov-08
Aug-09
JPM 3.875 27 Sep 11 BAC 4.125 5 Apr 12

JPM 4 27 Sep 16 BAC 4.25 5 Apr 17
0 Jul-09
Nov-10 Apr-12 Aug-13 Dec-14 May-16 Sep-17 BAC JPM
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The US is among the countries that benefited from the addition of a specific country index (iBoxx US Covered) to the iBoxx Covered Index in 2008.
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Background
Washington Mutual introduced US covered bonds in 2006
In September 2006, Washington Mutual (at that point, the sixth-largest US banking institution) introduced the first US covered bond programme. Its main objective was to diversify the refinancing of the mortgage business. Having previously set up an assetbacked commercial programme and a senior unsecured global MTN programme, this was a further step towards diversifying the funding of its significant mortgage business. In March 2007, Bank of America launched two issues in its covered bond programme. Again, the diversification of the banks funding sources through a cost-efficient instrument was the main objective. The significantly higher spread volatility of US covered bonds compared with peers products, which has been observed since mid-2007, is largely the result of a number of negative factors: eg, negative perceptions of the US housing market; name-specific pressure on Washington Mutual as one of the two initial covered bond issuers; a somewhat higher product complexity; and the fact that the product design is largely geared towards distribution to non-domestic investors. However, there is also the exposure to legal risk, which is repeatedly quoted as a negative.
Significant spread volatility
The best practices regime

Launch of Final Policy Statement on the Treatment Covered Bonds by the FDIC and and Best Practices Regime by the US Treasury in July 2008
After comments from Federal Deposit Insurance Corporation (FDIC) chairman Sheila Bair in February 2008 and US Treasury Secretary Paulson in mid-March 2008, both underlining the need to clarify the status of covered bonds in the event of insolvency, on 8 April 2008 the FDIC published the Interim Final Covered Bond Policy Statement 122, followed on 15 July 2008 by the Final Policy Statement on the Treatment of Covered Bonds 123. This statement provides guidance on the availability of collateral pledged to the benefit of covered bondholders in a receivership or a conservatorship and, thus, was intended to facilitate the development of the US covered bond market. Furthermore, on 28 July 2008, the US Treasury published a best practice regime for residential covered bonds. With this measure, US authorities aimed to increase clarity and homogeneity to the US covered bond model. As the best practice regime refers to the FDIC policy statement, we first describe the rules of the FDIC policy statement and then explain the US Treasurys best practice regulations, which exceed the scope of the FDIC rules, with a clear focus on surveillance. The FDIC statement consists of an introductory paragraph and eight articles ((a) to (h)). It basically prescribes the circumstances and areas in which the FDIC would renounce the specific rights it is entitled to in case a credit institution falls under receivership. Most important, the articles concern definitions of the used terms (article (a): Definitions), the scope of the respective regulation (article (b): Coverage) and the approval of the FDIC to allow a covered bond creditor to exercise certain rights, as well as the FDICs renouncement to assert the rights to repudiate contracts and request a stay as a conservator or a receiver (article (c): Consent to certain actions). Furthermore, it is stipulated that the parties requesting the FDICs renouncement to its specific powers should provide a respective statement, as well as copies of the relevant documents (article (d)). Finally, there are a number of more technical clarifications regarding the effectiveness of the new regulation. In the first section on definitions, a number of areas are quite interesting. First, the statement defines a covered bond as:
The new rules provide a framework under which the FDIC will renounce its specific powers for the benefit of covered bondholders
Covered bond definition
121 122
In September 2008, the programme was taken over from Washington Mutual Bank. http://www.fdic.gov/news/board/08Apr15SOPinterim.pdf 123 http://www.fdic.gov/news/news/press/2008/pr08060a.html
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A non-deposit, recourse debt obligation of an Insured Depository Institution (IDI) with a term greater than one year and no more than thirty years, that is secured directly or indirectly by perfected security interests under applicable state and federal law on assets held and owned by the IDI consisting of eligible mortgages, or AAA-rated mortgage-backed securities secured by eligible mortgages if for no more than ten percent of the collateral for any covered bond issuance or series.
Recourse to issuer stipulated
This clarifies that any covered bond benefiting from the new regulation would need to offer full recourse to the issuer, as is the case in both existing covered bond programmes. The covered bond definition also differentiates between direct and indirect issuance of debt obligations issued by an IDI, which implies that covered bonds could be issued directly by the respective credit institutions, thereby potentially overcoming concerns regarding certain legal risks related to the possibility of voluntary bankruptcy of a special purpose company and/or substantive consolidation. Furthermore, under the FDIC definition, covered bonds could contain up to 10% of mortgage-backed securities (MBS) that are secured by eligible mortgages. This could be an interesting feature to allow the smooth transfer of assets and help mitigate exposure to liquidity risk. The covered bond definition contains the term eligible mortgages, which is defined as: Performing first-lien mortgages on one-to-four family residential properties, underwritten at the fully indexed rate 124 and relying on documented income, and complying with existing supervisory guidance governing the underwriting of residential mortgages, including the Interagency Guidance on Non-Traditional Mortgage Products, October 5, 2006, and the Interagency Statement on Subprime Mortgage Lending, July 10, 2007, and such additional guidance applicable at the time of loan origination.
Definition of eligible mortgages
Explicit exclusion of subprime mortgages
While the definition does not contain any specific LTV limit, as is the case in many European regulations concerning mortgage-secured covered bonds, the eligibility criteria stipulate that mortgages must be secured by residential properties, that the income of the respective mortgage debtors must be documented and that a covered bond should not contain any Non-Traditional (ie, subprime) mortgages. Article (b) of the policy statement clarifies the scope of the respective rules. In particular, it stipulates that an IDIs total covered bond obligation should not comprise more than 4% of its total liabilities. It also limits the scope of substitution assets to cash, Treasury and agency securities. The core part of the FDICs Covered Bond Policy Statement is stipulated in article (c), in which the FDIC basically allows a covered bond obligee to exercise certain rights while possibly requesting the FDIC to not assert the rights to repudiate contracts and to request a stay as conservator or as receiver. In both relevant cases, if the appointed conservator or receiver fails to make payments on the respective covered bond obligations over 10 business days (or in case of repudiation, if the FDIC fails to pay the respective damages within 10 business days), the FDIC authorises the respective covered bond obligee to exercise the respective contractual rights. On 28 July 2008, shortly after the publication of the FDICs policy statement, the US Treasury published its best-practice regime for residential covered bonds. With this measure, US authorities aim to increase clarity and homogeneity to the US covered bond model by
124
4% cap on covered bond issuance
A covered bond obligee is allowed to exercise his rights in case payments on his claims are delayed by more than 10 business days
US Treasury announces best practice for residential covered bonds
According to the FDIC, the fully indexed rate equals the index rate prevailing at origination plus the margin to be added to it after the expiration of an introductory interest rate.
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encouraging issuers to use a common and simplified structure with high-quality collateral, thus facilitating the growth of the covered bond market. The US Treasury emphasises that the best practice is building on the Federal Deposit Insurance Corporations final covered bond policy statement issued on 15 July 2008. This best practice mirrors the rules of the FDIC policy statement: covered bonds could be issued directly or indirectly by a depository institution; covered bonds are limited to 4% of an institutions total liabilities; and all criteria for eligible cover assets are listed, including the use of substitution collateral, and confirms the particular treatment of covered bonds in an insolvency scenario. However, a number of rules clearly exceed the scope of the FDIC statement and include regulatory surveillance. These rules comprise the following items. More detailed guidance is given with respect to the two models of direct and indirect issuance of covered bonds. Eligible mortgages have been further restricted to incorporate performing mortgages only, including first lien mortgages, mortgages with a maximum 80% LTV at the time of pool inclusion only but limiting geographical concentration in a single metro statistical area to 20%, and excluding negative amortisation mortgages. A minimum over-collateralisation of 5% within the asset coverage test. Monthly cover pool disclosure rules, including specific information requirements when a certain amount of cover assets was substituted within a certain timeframe. Issuance was made subject to regulatory approval. Only well-capitalised institutions will be allowed to issue covered bonds under the new regime. Specific supervision regarding an issuers controls and risk management process were stipulated.
The Covered Bond Act

Introducing a legal framework
Already on 30 July 2008, US Representative Scott Garrett proposed a legal framework for US covered bonds. Following further discussions and a number of significant amendments, on 18 March 2010, Rep. Garrett proposed the United States Covered Bond Act (USCA). The USCA addresses securities regulations issues, provides an improved framework for liquidity safeguards in a stress scenario and additional certainty with respect to the rights of covered bondholders. Under the bill, a covered bond is defined as senior recourse debt obligation of an eligible issuer that:
has an original term to maturity of not less than one year is secured directly or indirectly by a perfected security interest in a cover pool that is owned directly or indirectly by the issuer of the obligation; is issued under a covered bond programme that has been approved by the covered bond regulator and is identified in a register of covered bonds maintained by the covered bond regulator is not a deposit (as defined in section 3 of the Federal Deposit Insurance Act).
Enabling credit institutions to become covered bond issuers
Eligible issuers are insured depository institutions or their subsidiaries, bank holding companies, savings and loan holding companies, or issuing entities sponsored by one or more of the foregoing for the sole purpose of issuing covered bonds. The cover pool must be a pool
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of assets owned directly or indirectly by the issuer and comprised of eligible assets from a single eligible asset class, as well as substitute assets, which may include cash and some other high quality highly liquid assets. The following eligible asset classes were defined: (A) residential mortgage asset class: first-lien mortgage loans secured by one- to four-family residential property mortgage loans insured under the National Housing Act and loans guaranteed, insured, or made under chapter 37 of title 38, United States Code residential mortgage-backed securities backed by first-lien mortgage loans. (B) home equity asset class: home equity loans secured by one- to four-family residential property; and asset-backed securities backed by home equity loans. (C) commercial mortgage asset class: commercial mortgage loans (including multifamily mortgage loans); and commercial mortgage-backed securities backed by commercial mortgage loans (including multifamily mortgage loans). (D) public sector asset class: investment-grade securities issued by, and loans made to, one or more states or municipalities; and loans, securities, or other obligations that are insured or guaranteed, in full or substantially in full, by the full faith and credit of the United States (whether or not these loans, securities, or other obligations are also part of another eligible asset class). (E) auto asset class: auto loans or leases; and asset-backed securities backed by auto loans or leases. (F) student loan asset class: student loans (whether guaranteed or nonguaranteed); and asset-backed securities backed by student loans (G) credit or charge card asset class: credit or charge card loans; and asset-backed securities backed by credit or charge card loans (H) small business asset class: loans made under a program established by the Small Business Administration (whether guaranteed or non-guaranteed); and asset-backed securities backed by loans made under one or more programs established by the Small Business Administration.
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Defining and monitoring credit enhancement levels
The USCA also stipulates that each cover pool would need to satisfy an asset-coverage test at all times. The asset-coverage test is designed to ensure the assets in a cover pool satisfy the minimum over-collateralisation requirements established by the covered bond regulator for the applicable asset class. Each issuer would be required to perform the asset-coverage test monthly on each of its cover pools. In addition, the indenture trustee for the covered bonds, or another independent third party, would be required to be appointed by the issuer as asset monitor. In a resolution scenario, the FDIC would be appointed as conservator or receiver for a covered bond issuer. In this case, and if no uncured default with respect to the related covered bonds otherwise existed, the FDIC could transfer the cover pool, and the covered bonds and related obligations secured by the cover pool, to an eligible transferee for 15 days from the date of the FDICs appointment. Before the completion of this transfer, the FDIC would be required to satisfy all monetary and non-monetary obligations of the issuer under the covered bonds. After this 15-day period, the transferee would be fully liable on all covered bonds and related obligations of the issuer that were secured by the cover pool. If no such transfer to an eligible transferee would be possible within the 15-day period and/or in case a breach of the asset-coverage test will not be cured, an estate on the respective cover pool would automatically be created. This estate would have a separate legal existence from the issuer and its affiliates and would hold the cover pool free from any claims that might be made by the issuer or its conservator, receiver, liquidating agent or trustee in bankruptcy. In case the assets in the cover pool were insufficient to satisfy the obligations secured by the cover pool, covered bondholders would retain a claim against the issuer for the deficiency. In our view, it is good that US authorities have taken steps towards encouraging the development of the US covered bond market. It remains to be seen, whether covered bonds could become instruments for helping refinance the US mortgage industry, diversify funding sources, improve duration matching for refinancing long-term mortgage assets and create the appropriate incentives with which to manage credit risk.
Transferring cover assets and attached liabilities
Creating an estate over the cover pool
Strengths
The particular strengths of US covered bond programmes are: Cash flow adequacy is secured through the asset coverage test and the obligation to neutralise any exposure to interest rate and currency risk. Investors are protected against liquidity risk since there is a clear escalation process in case the credit profile of participating parties deteriorates. In addition, the FDICs policy statement is designed to clarify the treatment of covered bonds in a wind-down scenario, thus helping to improve the efficient use of contingency measures.
Weaknesses
The relative weaknesses of US covered bond programmes are: Compared with other covered bond products, there is a lower level of standardisation. However, the basic structure is similar in the two existing programmes. So far, the record of banking regulators with regards to the surveillance of US covered bonds is rather limited.
Application of structured finance techniques
In the US, there is no explicit legal framework for covered bonds. Thus, to achieve a similar economic result as those issued in countries with dedicated covered bond legislation, JPM and BAC make use of structured finance techniques. The generic structure of US covered bonds is shown in Figure 311.
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Figure 311: Generic US covered bond transaction structure

Mortgage Bond Indenture Trustee Pledge of Cover Pool Cover Pool XX Bank (Mortgage Bond XX Bank(Mortgage Issuer) Floating Rate Mortgage Bonds Pledge of Floating Rate Mortgage Bonds Floating Rate Mortgage Bond Proceeds Mortgage Bond receipts A1 / P1 / F1+ rated counterparty (Covered Bond Swap Provider)
Covered Bond Indenture Trustee
XX Covered Bond XX Covered Bond (Covered Bond Issuer) (Covered Bond Issuer)
Covered Bonds
Specified Currency Swap Payments Covered Bond Proceeds
Two-stage structure
US covered bonds are issued through a two-stage structure. A dedicated covered bond funding entity 125 is the issuer for which the bonds are limited recourse obligations. The proceeds from their sale are used to purchase mortgage bonds issued by the respective sponsoring bank, which is the mortgage bond issuer (MBI). The mortgage bonds are direct and unconditional obligations of the MBI, secured by a pool of US residential mortgages and substitution assets, which form the cover pool ultimately backing the covered bonds. The mortgage bonds are senior secured obligations of the MBI, ranking pari passu and without priority among themselves. The MBI is obliged to pay the interest and principal and does not rely on cash flows from the cover pool to meet these obligations. The cover pool comprises residential mortgage loans that are pledged in favour of the covered bond issuer through the creation of a perfected security interest via the Uniform Commercial Code (UCC). The MBI grants a first-priority perfected security interest in the cover pool to the mortgage bond indenture trustee for the benefit of the covered bond issuer. Under the terms of a mortgage bond purchase agreement, the MBI sells and the covered bond issuer purchases each series of mortgage bonds. As the mortgage bonds are secured pari passu and without priority to the assets of the cover pool, the covered bond investors share pro rata in any proceeds of the cover pool in case of an MBI event of default. Swaps with suitable counterparts ensure there are sufficient cash flows out of the floating rate USD mortgage bonds for a timely payment of interest and principal on the respective covered bonds.
Mortgage bonds rank pari passu among themselves and benefit from the pledge of cover assets
Pass-through structure
Qualifying collateral for US covered bonds

Focus on US residential mortgages
The collateral for the mortgage bonds, which from an economic point of view is the ultimate collateral of US covered bonds, consists of US residential mortgages. Being a structured programme, geographical restrictions have been self imposed. The programmes have LTV limits. It is important to note that higher LTV loans can be included in the pool, but loan amounts exceeding the respective cap are not when calculating the appropriate loan balance within the asset coverage test (see explanation below). Delinquent loans are not eligible. A maximum single loan amount is set at $3mn and $5mn in the JPM and BAC programmes, respectively. The properties are denominated in USD and valued using US mortgage market accepted practice. The property values are indexed to the Office of Federal Housing Enterprise Oversight (OFHEO) House Price Index on a monthly basis. Price decreases are fully reflected in
125
WM Covered Bond Program for JPM and BA Covered Bond Issuer for BAC.
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the revaluation, while in the case of increases, a haircut (15% in both programmes) is applied. Substitution assets can be included in the cover pool. Their aggregate value can be up to 10% of cover assets and may consist of exposures that are subject to rather high quality criteria. They consist of short-term investments, namely bank deposits and debt securities, AAA rated RMBS notes and government debt, which all must be defined as eligible assets for covered bonds according to Annex VI, Part 1 point 68(c) of the EU Capital Requirements Directive 126.
Asset coverage test ensures a level of over-collateralisation that is compliant with the target rating
To reduce the risk of a shortfall, the programmes include a dynamic asset coverage test that requires the balance of the mortgages in the collateral pool to exceed the balance of the outstanding mortgage bonds significantly. The MBI must ensure that on the fifth business day of each month (the determination date), the adjusted aggregate loan amount will be greater than or equal to the aggregate principal amount of the outstanding mortgage bonds. Apart from the results of this calculation, a minimum over-collateralisation has to be maintained. The asset coverage test comprises a number of valuation rules that are applied to the underlying assets. In the case of a breach of the test, the issuer is obliged to restore the balance. If the breach is not rectified until the following calculation date, the mortgage bond indenture trustee is entitled to declare the mortgage bonds immediately due and payable and enforce its security over the cover pool.

Regulated US financial institutions
JPM and BAC are subject to the regulation, supervision and examination of the Office of the Comptroller of the Currency (OCC), the general US banking regulator. In their role as MBI, the respective sponsor banks are responsible for the monthly pool monitoring, with the asset coverage test calculation being checked by an independent monitor, which tests the calculation of the asset coverage test annually or, in case the senior unsecured rating of the sponsor bank drops below investment grade 127, monthly. In addition, rating agencies are heavily involved in the programme and need to re-affirm the ratings of the programme upon each issuance. They also monitor the amount of over-collateralisation required to maintain the AAA ratings, which should provide investor comfort with respect to rating stability should the mortgage market weaken. Similar to other structured covered bond programmes, in US versions there are contractual provisions that stipulate that exposure to interest rate and currency risk has to be neutralised. The covered bond issuer receives floating-rate USD payments of interest and principal as holder of the mortgage bonds. To match these cash flows with fixed (or other rate) specified currency denominated payments in the amounts required to make timely payments of interest and principal due on the covered bonds, the covered bond issuer makes use of swaps. The mortgage bonds securing the respective covered bonds are expected to produce sufficient funds to make payments under the particular covered bond swaps, such that payments received by the issuer from the swap providers will be sufficient to make payments due under the respective series of covered bonds. In addition, maturity extension, the proceeds compliance test and downgrade triggers for swap counterparties all ensure cash flow adequacy. Similar to the UK, US covered bonds have a soft-bullet maturity. However, the extension period is much shorter 120 days versus 12 months. This is due mainly to the fact that the mortgage bonds and not the related residential mortgages are the direct collateral of the covered bond. Following a MBI event of default, the covered bond issuer may not have
Maturity extension
126 127
Directive 2006/48 of the European Parliament and the Council from 14 June 2006. Below Baa3/BBB-/BBB- with any of the three major rating agencies (Moodys/S&P/Fitch).
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sufficient proceeds for timely repayment, as the enforcement of the security interest against the MBI and its receiver or conservator, notwithstanding the insolvency of the bank, may cause payment delays. In this case, the legal final maturity will be extended to allow for a realisation of cover assets.
Proceeds compliance test
The covered bond indenture trustee performs a proceeds compliance test on each determination date following a mortgage bond acceleration and prior to a covered bond issuers event of default. On each such determination date, the covered bond indenture trustee will determine whether the sum of the aggregate amount on deposit in the GIC account for each series of covered bonds and the nominal amount of all outstanding mortgage bonds will be equal to or greater than the aggregate principal amount of outstanding covered bonds on such date. A breach of the test will constitute a covered bond issuer event of default, entitling the trustee to declare the covered bonds immediately due and payable. In the unlikely event that the cover pool needs to be monetised, covered bond investors would be exposed to liquidity and interest rate risk. In the worst-case scenario, the liquidity gap could amount to up to 120 days because the stay period requested by the FDIC can be up to three months, and the time needed to sell the respective high-quality loans in the market could last up to one month. To mitigate the exposure to liquidity risk, the covered bonds benefit from a liquidity facility that covers up to four months of interest payments on the mortgage bonds. This facility is provided by the swap counterparty. With regard to the principal payment, the covered bonds benefit from an automatic monthly maturity extension for up to four months to compensate for the potential maturity mismatch. Exposure to interest rate risk results from the fact that the market value of the pledged loans, which form the cover pool, is exposed to changes in interest rates in the period between the last satisfied calculation of over-collateralisation (asset percentage) and the point at which the loans have been sold. This period can be up to eight months. The rating agency stress tests take into account such a worst-case scenario 128, and the respective exposure is mitigated by the provision of over-collateralisation. Figure 312 gives a schematic overview of the exposure to liquidity and interest rate risk. Figure 312: Exposure to liquidity and interest rate risk 0 Time in months 3M stay period 3M period between two 1M Breach of OC calculation dates ACT
Exposure to liquidity risk covered by swap counterparty and maturity extension; exposure to interest rate risk covered by over-collateralisation
1M to monetize
Other safeguards
Similar to other structured covered bond programmes, US versions include a number of other safeguards. In particular, there are minimum rating requirements for the various third parties that support the transaction, including the swap counterparties, and independent audits of the calculations are made on a regular basis.
128
For example, interest rate stress scenarios include a 200-300bp upward shift of the yield curve over the respective eight-month period.
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Segregation of cash flows upon a downgrade of the sponsor bank below certain trigger levels
There are a number of trigger events in the covered bond structure, the first being a downgrade of the senior unsecured rating of the sponsor bank below a certain trigger level. Following such an event, cash flows from the mortgage loans will have to be segregated. Within 28 days, the respective sponsor bank is obliged to deposit on a daily basis; within two business days of receipt, all collections it receives on the eligible mortgage loans included in the cover pool to a segregated account maintained by the bank itself (the mortgage bond account). The sponsor bank will not commingle any of its own funds and general assets with amounts on deposit in the mortgage bond account, which is established for the benefit of the holders of mortgage bonds. As long as the senior unsecured rating of the sponsor bank remains investment grade with all three rating agencies, the bank will retain possession of the mortgage loan files related to the mortgage loans included in the cover pool and all other records relating thereto. However, following a downgrade of the senior unsecured rating below investment grade by Moodys, S&P or Fitch, the mortgage loan files will have to be transferred to the mortgage bond indenture trustee or a third-party custodian within a 60-day period. If new mortgage loans are added to the cover pool, the respective mortgage loan files will have to be transferred to the mortgage bond indenture trustee or the third-party custodian no later than 10 business days following such an addition. Furthermore, the sponsor bank will, within 60 days, transfer the mortgage bond account to the mortgage bond indenture trustee. Last, but not least, as described above, the monitoring of the asset coverage test will change from annually to monthly. The fourth trigger event is an MBI event of default. This can occur in a number of situations, including: Failure by the MBI to pay any interest or principal amount when due; Bankruptcy or legal proceedings taken against the MBI; Failure to rectify any breach of the asset coverage test.
Transfer of mortgage loan files and the mortgage bond account upon a downgrade below investment grade
Clear rules with regards to the claims of mortgage bondholders in case the MBI falls under receivership
An MBI event of default would not automatically accelerate payments to covered bondholders. The sponsor bank, the MBI, is a US credit institution and, as explained above, is subject to supervision and regulation by US banking regulators. In the event the MBI becomes insolvent, the respective banking regulator is authorised to appoint the Federal Deposit Insurance Corporation (FDIC) as conservator or receiver of the MBI. In certain circumstances, the FDIC can also appoint itself conservator or receiver of the MBI. Under the Federal Deposit Insurance Act (FDIA), the FDIC has the ability to stay any judicial action or proceedings involving the insolvent institution. During this time, the FDIC would authorise the MBI to continue to meet its contractual obligations under the mortgage bonds by making timely payments of interest and principal and complying with the asset coverage test. The FDIC has three possible approaches to resolving the MBIs obligations to bondholders: Affirmation It can cause the MBI to continue making payments of interest and principal on the mortgage bonds as they come due. Repudiation It can cancel the mortgage bond contract and pay actual direct compensatory damages equal to par plus accrued interest up to the date of the FDICs appointment as receiver. Acceleration It can allow the mortgage bonds to default and permit the MBI trustee to enforce its security interest over the cover pool.
Proceeds from MBI event of default collected in GIC accounts

10 June 2010
All proceeds from an MBI event of default will be collected in GIC accounts for the benefit of covered bond investors. This includes: 1) cash received through an FDIC repudiation; 2)
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cash generated by the mortgages or substitution assets; 3) proceeds from the monetisation of the cover pool; and 4) proceeds from the liquidation of the MBI, if any. The covered bond issuer will exchange the investment income from such GIC accounts with the relevant covered bond swap provider in return for payments equal to the interest payable on the covered bonds. The GIC provider will have the highest A-1+/P-1/F1+ short-term ratings.
Liquidity support
It is also worth noting that under the terms of the covered bond swap, the swap counterparty will cover any potential interruptions or shortfalls of interest on the mortgage bonds after an MBI event of default. In addition, monthly net settlement under the covered bond swap ensures that funds paying interest on the covered bonds will be held with an A1+/P-1/F1+ rated counterparty. A third important trigger event would be a covered bond issuer event of default. This would arise after the covered bond issuer failed to make any payments when due, legal proceedings were started against it, or it failed the proceeds compliance test. In this case, the covered bond indenture trustee would be entitled to enforce its rights, payments to covered bondholders would be accelerated and the covered bonds would be redeemed at the early redemption amount, including accrued and unpaid interest relevant to that particular covered bond.
Covered bond issuer event of default
Figure 313: Overview US covered bond programmes

JPM BAC
Programme volume (bn) LTV cap First lien only House Price Index Haircut for indexed valuation Maximum asset percentage applied in the ACT Minimum over-collateralisation In arrears accounting in the ACT Hard bullet
Source: Transaction documents
20 75% Yes OFHEO 15% 86.6% 115.5% No recognition No; 120-day maturity extension
20 75% No OFHEO 15% 93% 107.5% No recognition No; 120-day maturity extension
Figure 314: Overview cover pool characteristics , March 2010

JPM BAC
Total loan balance ($mn) Adjusted loan balance ($mn) Outstanding mortgage bonds ($mn) Excess collateral ($mn) Excess credit support by asset coverage test Excess credit support by total loan balance Asset percentage LTV >75% WA seasoning (months) 30d in arrears FICO <700 or not available Income documentation Stated or Unknown (JPM); Reduced (BAC) Exposure to California
Note: *0.0% above 80%. Source: Monthly Investor Reports, Barclays Capital
13,068 10,473 9,359 1,114 11.9% 39.6% 80.7% 26.3% 37 1.21% 14.8% 43.1%
11,797 7,957 7,784 172 2.2% 51.5% 67.0% 23.7% 51 3.10% 22.6% 8.3% 58.5%
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US
US covered bonds. Private legal structure based on US banking and contract law. No; any US bank. Not applicable. Covered bonds are issued by a covered bond funding entity, which buys series of mortgage bonds. The respective mortgage bonds are secured by first lien mortgages and substitute assets, which are on the balance sheet of the originating bank. They are segregated from other assets by a pledge through a perfected security interest via the UCC. Hedge positions are part of the structural enhancements intended to protect bondholders. Up to 10%. For JPM, only first lien residential mortgages are included in the cover pool. The BAC programme also allows for the use of second lien mortgage loans set up as lines of credit. Subject to contractual prescriptions. Subject to contractual prescriptions (under the JPM covered bond program, only US mortgages are allowed). Subject to contractual prescriptions; 75% in both existing programmes. Subject to contractual prescriptions; irrelevant until now. No. Basis = Market value. Indexed to House Price Index. For both existing programmes, this is the OFHEO House Price Index. Price decreases are fully reflected in the revaluation, while in the case of price increases, a haircut (15% in both existing programmes) is applied. Yes; the OCC, the FDIC and an independent asset monitor. Contractual provisions stipulate that exposure to interest rate and currency risk has to be neutralised. In addition, downgrade triggers for swap counterparties, the asset coverage test, the proceeds compliance test and maturity extension rules all ensure cash-flow adequacy. Yes; defined by asset coverage test. Yes; stipulated through contractual rules. Yes, with regards to the mortgage bonds; subject to the asset percentage applied in the asset coverage test. Yes. All assets are owned by the covered bond funding entity; covered bondholders benefit from the segregation of cash flows upon certain trigger events. all the payments received from the covered bond funding entity's assets. These are collected in a GIC account. Investors continue to receive scheduled payments, as if the issuer of mortgage bonds had not defaulted. The final maturity date may be extended to give the MBI trustee sufficient time to liquidate the cover pool to provide the issuer with sufficient funds to pay the principal on the covered bonds. The rights of bondholders exclusively refer to segregated assets; there is no recourse to the bank issuing mortgage bonds. No. No.
Inclusion of hedge positions Substitute collateral Restrictions on inclusion of certain types of mortgage loans in the cover pool Geographical scope for public assets Geographical scope for mortgage assets LTV barrier residential LTV barrier commercial Basis for valuation = mortgage lending value Valuation check
Special supervision Protection against mismatching
Protection against credit risk Protection against operative risk Mandatory minimum overcollateralisation Voluntary over-collateralisation is protected Bankruptcy remoteness of the issuer Outstanding covered bonds to regulatory capital In the event of insolvency, first claim is on
External support mechanisms Compliance with UCITS 22(4) Compliance with CRD
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SUPRAS AND EUROPEAN AGENCIES
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Asian Development Bank (ASIA)

Description
% $ Index 0.177 % Index NA Total assets $86bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
Moodys Aaa P-1 Stable S&P AAA A-1 + Stable Fitch AAA F1+ Stable
The Asian Development Bank (ADB) is the key multi-lateral development bank of the Asia-Pacific region. ADB lends to promote economic and social development in member countries, with the ultimate aim of eliminating poverty in the region. The long-term policy framework emphasises inclusion, environmental sustainability and a regional/global focus for projects. Although most loans are to public sector borrowers, there is an increasing focus on non-sovereign operations. Its asset quality track record is very good.
Risk weighting
Basel II RSA: 0%
Key features of the credit

Purpose: ADB was established in 1966 to foster economic development and co-operation in the Asia-Pacific region. Since 1999, reducing regional poverty has been its key objective. The long-term strategy review published in 2007 (for the period 2008-20), emphasised inclusion, environmental sustainability and a shift from a national to regional/global focus. Ownership and capital structure: Initially established by 31 members, it now has 67 members: 48 are located within the Asia-Pacific region and the remaining 19 are developed economies outside the region. The US and Japan are the leading shareholders, each accounting for 15.6% of subscribed capital. After the last general capital increase in 1994, ADB reviewed its capital levels in 2009 and adopted a resolution by the Board of Governors for the fifth general capital increase to $165bn. As of year-end 2009, $4.1bn of the subscribed capital was paid-in and $56.6bn was callable. No call has ever been made on ADBs callable capital. Asset structure and quality: Lending is predominantly to public sector borrowers, however, with increasing proportions in nonsovereign operations. At end-2009, non-sovereign exposures amounted to c.5.6%. There is a high level of country concentration in the overall loan portfolio, with Indonesia and China absorbing 47% and the leading five countries accounting for c.81% of the portfolio. About 33% of the exposure is to subinvestment grade or non-rated countries. We understand that ADB benefits from preferred creditor status. By sector, loans are concentrated in transport and communications, social infrastructure and energy. Asset quality is good despite a strong increase of expected losses in the non-sovereign portfolio as of year end 2009. The increase is mainly based on provisions on loans to and guarantees for defaulted financial institutions. Financials: Debt leverage and gearing In 2008, ADB revised its policy on lending limitation, which limits the total amount of outstanding loans and guarantees as well as outstanding equity investments including undisbursed commitments, to the total amount of ADBs unimpaired subscribed capital, reserves, and surplus. The gross outstanding borrowing shall not exceed the sum of callable capital from non-borrowing members, paid-in capital and reserves. As of 31 December 2009, headroom for lending was $29.5bn and for borrowings $5.8bn. Funding: Financial performance New loan approvals and disbursements expanded strongly again in 2009 compared with previous years and the volume of loans outstanding increased 15.2% to $41.7bn. As the bank expected increasing demand for loans, in June 2009 it established a Countercyclical Support Facility in response to the global economic crisis to provide timebound assistance to crisis affected countries of up to $3.0bn. For 2009, ADB posted net unrealised losses of $466.2mn, primarily due to fair value adjustments on swapped borrowings and derivatives used for hedging transactions. Funding: ADB accesses a range of markets to optimise funding costs, but the USD remains the dominant funding currency. In 2009, gross medium- and long-term funding increased to $10.4bn from $9.4bn, with an average maturity of 5.2yrs. Of total borrowings, $7.7bn was raised via nine public offerings, including two global benchmark bonds in US$ and the remaining $2.7bn were raised via 35 private placements. In addition, ADB raised $340mn (2008: $2.9bn) via its ECP programme. New borrowings were raised in seven currencies (AUD, MXN, CNY, ZAR, CHF, TRY, USD); 86.6% of the 2009 borrowings were swapped into US$ and the remaining 13.2% and 1.4% in Japanese Yen and Yuan, respectively.
Strengths
Strong track record on asset quality Strong capitalisation and support from members Preferred creditor status
Weaknesses
Substantial geographic concentration in loans. Loans predominantly to sub-investment grade countries, although strengthening sovereign credit performance in the region has been reflected in an increase in the proportion of borrowing countries with investment-grade ratings.
Key points for 2010

Asian economic conditions capacity to weather global economic and financial turbulence. Embarking on the new long-term strategic framework for 2008-20. 10 June 2010 Increasing lending to infrastructure projects.
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Public sector
Financial summary YE Dec
USD Balance sheet summary ($ bn) Total assets Net disbursed loans Net equity investments Gross liquid assets Total borrowings Paid in capital and reserves Net interest revenue Operating expenses Write-downs & LLPs Net income Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int rev/Op inc 0.2 0.9 24.5 93.6 1.1 4.5 16.2 81.9 1.2 5.6 1.5 7.7 0.0 0.1 51.4 23.7 0.5 11.2 24.7 12.3 521 137 -4 109 56.8 26.4 0.8 13.0 27.9 13.1 658 130 -33 570 69.5 78.7 85.7 30.6 36.2 41.9 1.0 0.8 1.0 13.4 15.6 14.3 32.0 36.0 42.5 14.3 15.4 15.6 736 131 -1 856 156 -3 730 199 16 8.8 15.7 29.1 -8.4 18.0 1.3 -15 28 -99 2005 2006 2007 2008 2009 % chg
Asian Development Bank (ASIA)

Credit term structure
150 100 50 0 -50 0 5 10 15
Income statement summary ($ mn)
OAS swap spread evolution

50 25 0 -25 Jun-09 Sep-09 Dec-09 AFDB 1.875% Jan 12 AFDB 3.000% May 14
116 -3439
765 1147
15.5 18.3 25.0 87.4 100.9 91.7
Gearing, debt leverage & capital ratios (%) Loans & invest/Paid in cap & res 197.6 207.5 221.5 240.7 276.2 Net loans & invest/Total cap Total capital/Debt Paid in and res/Total assets Asset quality($ mn) Non-accrual loans Cum loss reserves Loss res/Disbursed loans(%) 52 80 0.33 36 28 0.11 19 15 2 9 38 2158.8 103 1025.4 41.1 23.9 43.5 23.1 47.6 55.7 59.4 20.5 19.5 18.2 239.0 224.2 207.4 184.3 169.9
Mar-10 AFDB 3.000% May 14 $ AFDB 1.625% Feb 13
Public debt issuance ($bn)

8 6 4 2 0 2003 2004 2005 2006 2007 2008 2009 2010 yt May 1.7 1.2 2.4 2.7 4.5 4.8 7.1 4.7
0.05 0.03 0.25 870.3
Note: ADBs accounts are drawn up in accordance with US GAAP. Debt maturity and currency structure charts are based on dealogic DCM Analytics data.
Public debt maturity structure, May 2010 ($bn)

5 4 3 2 1 0 3.2 4.1 3.8 2.1 3.9 3.0 1.4 1.1 0.2 0.1 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 1.5 1.0
Currency distribution, YE 09
Others CHF 16% 1% JPY 4% AUD/CAD/ NZD 20.8%
USD 55%
Capital structure, YE 09
Loan distribution, YE 09
India 20.6% Philippines Pakistan 7.9% 12.8% Uzbekistan 1.6% Bangladesh 2.6% Others 8.6% Indonesia 19.6%
Reserves 13.9% Callable 80.3% Paid-in 5.8%
China 26.3%
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Bank Nederlandse Gemeenten (BNG)

Description
% Index 0.307 % Index 0.355 Total assets 105bn LT senior unsecured Covered bond rating Outlook
Note: As at 7 June 2010.
Michaela Seimen
Ratings table
Moodys Aaa Aaa Stable S&P AAA AAA Stable Fitch AAA AAA Stable
Founded in 1914 and headquartered in The Hague, Bank Nederlandse Gemeenten (BNG) is the leading bank to Dutch local authorities and public sector institutions in the areas of housing, healthcare, education and public utilities. It is the most important single source of external funds for Dutch municipalities and the public housing sector. BNGs bylaws stipulate that its ownership is restricted to the Dutch public sector. Half of its share capital is held by the State of the Netherlands and the other half by municipal authorities, provincial authorities and a water board. With total assets of 104.5bn (a 12% increase from 93bn in 2007), BNG is among the Netherlands largest banks. Its ownership structure has been stable since 1925 and it does not envisage this changing.
Risk weighting
Basel II RSA: 20%.
Key features
Sound market position: In 2009, BNG was able to stabilise its high market share in the Dutch municipal sector lending (c.60% in previous years), followed by a strong position in lending to housing associations (47%), healthcare entities (40%), educational institutions and public utilities. Previously, as a result of the improving fiscal position of Dutch local and regional authorities in past years, BNG started extending its strategy to other public sectors. This particularly applies to the healthcare sector, where loans are guaranteed by Waarborgfonds voor de Zorgsector, a government-owned entity set up to support the sectors funding. This also underlines BNGs high asset quality. High asset quality: In past years BNG has not suffered a loan loss. However, as a result of the turmoil in the international money and capital markets, two debtors defaulted, which resulted in a 3mn charge to credit losses. According to BNGs statutes, it can only lend to public sector entities. Local governments or a combination of both. We understand that a large proportion of BNGs loans are granted to Dutch housing associations (c.52%), which are guaranteed by Stichting Waarborgfonds Sociale Woningbouw (WSW). As of year end 2009, lending to Dutch local governments accounted for one-third of all lending, with another 9% attributed to Dutch healthcare authorities. Potential governmental support: Despite its ownership being exclusively limited to the Dutch public sector, BNG is not explicitly guaranteed by the Dutch state. Still, as Dutch local governments are responsible for a large proportion of total government spending (c.35%), rating agencies believe that in the event of distress, the government is highly likely to provide support to BNG, particularly in light of its large market share. Funding strategy: BNGs long-term funding is almost entirely based on the issuance of bonds under the lenders standardised debt issuance programme, whose size was increased to a maximum of 80bn, from 70bn already in mid-2008. During 2009, BNG attracted long-term funding of 14.1bn, up from 13.1bn in 2008, with the number of issues increasing to 81 from 67 and the average weighted term to maturity of the issues increasing by 0.5 years to 4.7 years (after an initial falling by 1.1 years, to 4.2 years in 2008). BNG issued in 10 different currencies in 2008 and 2009, down from 14 in 2007. While the proportion of USD-denominated debt accounted for 44% in 2008 and EURdenominated debt accounted for 35%, in 2009 BNGs funding was more concentrated in EUR, with the share of eurodenominated issues amounting to 45% and USD-denominated debt accounting for 29% of BNGs funding. In 2008 and 2009, BNG issued seven benchmark bonds in EUR and USD, up from four in 2007. The euro equivalent of the total amount of issued benchmark loans was 8.4bn, up from 6.3bn in 2008. Owing to the situation in the capital markets, over the course of Q4 08 and the beginning of 2009, BNG increasingly relied on its ECP programme, the size of which was increased by 5bn to a new maximum of 15bn. As at year-end 2008, BNG had mainly relied on the capital markets for its funding (86%). Retail deposits from local governments, in contrast, accounted for only 8%, followed by interbank funding, which accounted for c.5%. However, in the second half of 2009 and in line with the general recovery of confidence in capital markets, BNG was able to reduce the use of the short-term ECP programme.
Strengths
Sound capitalisation: With its Tier 1 ratio standing at 19% as at year-end 2009 and, thus, markedly above the regulatory minimum of 4%, BNG benefits from sound capitalisation. High asset quality: BNG has only suffered limited loan loss as according to its statutes, it can only lend to public sector entities. We do not expect this to change markedly.
Weaknesses
Profitability: BNGs net profit increased to 278mn in 2009, from 158mn in 2008, based on favourable funding conditions. Yet, we note that profit maximisation is not a key objective for the bank.
Key points for 2010

As more than 80% of BNGs operating revenues are related to its interest income, the declining net interest margin needs to be monitored carefully.
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Financials and spreads

Total assets Loans Interbank and liquid assets Debt security holdings Financial assets under IFRS Own funds Total capital Debt funding Net interest revenue Operating expenses Pre-tax income Net income Profitability (%) Return on assets Return on equity Cost/Income ratio Net int rev/Op inc Capital adequacy (%) Tier 1 ratio Total capital ratio Total capital/Total assets 24.0 26.0 3.0 24.0 26.0 3.0 18.0 20.0 2.4 18.0 20.0 2.1 19.0 20.0 2.3 0.3 7.0 18.3 95.5 0.3 7.0 20.1 94.0 0.3 8.4 21.7 0.2 7.8 25.1 0.3 13.1 14.8 82.0 2006 2006 2007 2008 2009 % chg 90.1 65.0 9.1 0.0 15.7 2.6 2.7 72.2 90.1 65.0 9.1 0.0 15.7 2.6 2.7 72.2 92.6 101.4 104.5 66.0 10.6 0.0 15.4 2.1 2.2 70.0 75.7 9.5 0.0 15.9 2.0 2.1 79.2 16.5 2.3 2.4 79.9 4.0 13.8 12.9 1.0 % 21.7 0.0 92.3 75.9 64.0 66.0 61.0 61.0 79.3 3.1 4.8 Balance sheet summary ( bn)
Bank Nederlandse Gemeenten (BNG)

40 20 0 -20 -40 0 2 4 6 8 10 12
8.3 -11.8

80 60 40 20 0 -20 -40 May-09 Aug-09 Nov-09 BNG 4.000% Feb 12 (L) BNG 4.125% Jun 16 (L)
Income statement summary ( mn) 298.0 300.0 265.0 277.0 337.0 57.0 255.0 255.0 238.0 182.0 350.0 199.0 199.0 195.0 158.0 278.0
Feb-10 BNG 3.750% Mar 14 (L)
87.2 114.0
Public debt issuance (bn)

16 12 8 4 0 12.4 13.8 9.6 12.4 10.0 11.1 13.7 7.6
Public debt maturity structure, May 2010 (bn)

16 12 8 4 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 3.4 12.0 9.9 11.9 5.5 6.3 4.2 4.9 0.9 2.2 0.6
Currency distribution, May 2010

Others 6.8% EUR 41.5%
2.7
AUD/CAD/ NZD 8.3% JPY 1.9%
GBP 7.2%
USD 33.9%
Post tax profit 7.4% Subordinated Debt 5.0% Share capital 6.5%
Health care 9.2% Other 5.7% Public sector 33.6%
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Reserves 78.3%
Housing & mortgage funds 51.5%
10 June 2010
2010 yt May
Note: BNG introduced IFRS presentation of its accounts in 2005. Debt issuance, maturity and currency structures are based on Dealogic DCM Analytics data.
2003
2004
2005
2006
2007
2008
2009
Caisse dAmortissement de la Dette Sociale (CADES)

Description
% Index 0.741 % $ Index 0.149 Net liability 97.1bn LT senior unsecured ST Outlook
Michaela Seimen
Moodys Aaa P-1 Stable S&P AAA A-1+ Stable Fitch AAA F1+ Stable
Ratings table
CADES is the French public entity created to refinance and amortise the accumulated debt of the French social security system. It uses the proceeds of a dedicated tax to amortise the debt. Originally created with a limited lifespan, legislation in 2004 and 2009 widened its remit, by making further substantial transfers of debt from the social security system to CADES and abolishing the existing 2014 deadline for completing its mission. Its EPA status and dedicated tax revenues underpin its credit status as very close to the French state, and are reflected in its zero-risk weighting by leading central banks.
Risk weighting
Basel II RSA: 0%

Purpose: CADES was established in 1996 to provide a vehicle for consolidating and servicing the debts of the French social security funds accumulated since the early 1990s. The law establishing it also provided that CADES should make annual contributions to the general budget of the French government. It also created a specially dedicated tax, the Social Debt Reimbursement Contribution (CRDS), a broad-based 0.5% tax levied on a wide range of incomes, as the principal source of revenue from which the debt is to be repaid. In 2009, an additional tax claim was introduced, which makes up 0.2% of general social contributions. Its role had been modified on various occasions, to take on further tranches of debt and/or obligations to make payments to the government budget. Legislation to implement health insurance reform enacted in August 2004 introduced a more radical change, by transferring substantial further obligations, abolishing the existing 2014 planned end date, and providing for CADES to continue receiving CRDS proceeds until its mission is complete. Ownership and support: CADES was created as an administrative public agency (tablissement Public Caractre Administratif EPA). It is fully owned by the French government, which is ultimately responsible for its solvency and liquidity. It is the only public administrative body in France that benefits from the revenue of a specially dedicated tax the Social Debt Reimbursement Contribution (CRDS). Of all the French public entities, CADES is generally regarded as the one closest to the French government, due to the nature of funding part of public debt. This is underlined by the assignment of zero risk weightings to its debt by leading central banks (even though the government does not guarantee its debt explicitly) and the fact that its debt is consolidated with that of the government. Following the 2004 legislation, CADES assumed 35bn of accumulated deficits for 2002-04 from the health insurance fund. In addition, up to a further 15bn in deficits for 2005 and 2006 could be transferred to CADES. In fact, 6.6bn was transferred in 2005, and a further 5.8bn in 2006. CADES obligation to make annual payments to the French general budget was completed in 2005, following which it moved into operating surplus in 2006, enabling it to start amortising the debt. In 2007, it amortised 2.6bn in debt and in 2008 2.9bn. At the end of 2008, the net liability stood at 97.0bn and at year end 2009, the residual deficit was 91.9bn. Funding: The widening in CADES remit produced a bulge in its funding requirements during 2004-06, with a first peak in 2005, when it raised about 21bn in medium- and long-term debt. In 2007 and 2008, funding needs have been lower as its operating surplus reduced the need to refinance some of each years maturities. Following the transfer of 26.9bn of new debt in Q1 09, funding needs have significantly increased again. In 2009, CADES raised in total 35.7bn, via benchmarks in EUR and USD, French inflation-linked issues and MTNs/private placements in various currencies. Euro benchmark bonds form the largest component of CADES funding with 25.8bn in mid- and longterm issues; however, an overall curve expands out to 2021. Other funding is spread across public issues in other currencies, private placements in AUD and NZD and inflation-linked issues in EUR. For 2010, CADES presented a 15bn funding programme, compromising about 6bn of EUR-denominated benchmark bonds, 2bn of re-opening of existing bonds and about 2bn equivalent in USD benchmark bond issues. At the end of December 2005, new French legislation authorised the French Trsor (AFT) to conduct funding on behalf of CADES. No plans have been announced for the AFT actually to take on this role and CADES is continuing to fund in its own name.
Strengths
French public entity (EP) status and complete absence of privatisation risk means that CADES credit risk is ultimately that of the French government. Broad-based dedicated tax revenue ensures that debt will be paid down on schedule, even under relatively pessimistic economic assumptions.
Weaknesses
Life span, debt profile, and funding policy is at the mercy of political decisions, as illustrated by the large increase in its mandate in 2004 and 2009. For 2010, the French government decided not to raise social taxes nor to transfer any debt to CADES, however, an overdraft ceiling for ACOSS (L'Agence Centrale des Organismes de Scurit Sociale) has been increased to 65bn.
Key points for 2010

Cades has a target to reduce its net liability through further debt amortisation, by a further 5.0bn in 2010.
10 June 2010
336

mn 2005 Income and cash flow summary CRDS revenues 5,241 Property sales 0.1 Financial charges 2,546 (net interest payable, etc) Operating Costs 62 Operating surplus 2,633 Payments to the government 3,000 and social security funds Net surplus -367 Balance sheet summary Total assets Debt transferred to Cades during year Gross liabilities of which Debt securities outstanding Net balance sheet liability 2006 2007 2008
Caisse dAmortissement de la Dette Sociale (CADES)

2009 % chg 4.2 NM -0.3 -38.5 11.9 0.0 NM
5,542 5,815 6,060 8,254 0.0 0.0 0.0 0.0 2,661 3,101 3,093 2,819 65 133 82 174 2,815 2,578 2,885 5,260 0 0 0 0 2,815 2,578 2,885 5,260
30 20 10 0 -10 -20 -30 -40 -50 0
OAS
10
12

3,078 1,643 3,710 6,247 6,967 6,610 5,800 2,690 0 17,000 75,791 77,241 76,665 86,312 98,777 71,283 73,652 72,092 82,676 96,954 72,713 75,598 74,203 84,286 97,106 0 17,000 0 0 68.4 -100 12.6 14.7 13.6
80 60 40 20 0
OAS
Off balance sheet commitments Obligations taken over by 0 0 CADES during year Outstanding commitment to 8,390 2,690 make payments to the State and social security funds
-20 Dec-08
Mar-09
Jun-09
Sep-09
Dec-09 Mar-10 CADES 3.625% Apr 15 CADES 4.250% Apr 20
0 17,000
CADES 4.500% Sep 13 CADES 4.125% Apr 17
Note: CADES annual statements are prepared in accordance with accounting regulations applicable to financial institutions and French GAAP, adjusted to take account of the particular nature of the fund. Debt maturity and currency structure charts are based on dealogic DCM Analytics data

30 25 20 15 10 5 0 25.7 19.6 15.0 2.6 2003 2004 2005 2006 14.2 5.3 2007 6.9 1.4 2008 2009 2010 yt May

15 10 5 0 5.8 10.3 7.7 10.0 7.0 7.0 5.7 5.7 0.3 7.3 13.6

USD 22.1% AUD/CAD/ NZD 1.9%
2020-2029
>2029
EUR 73.8%
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
AUD/CAD/ NZD 1.9%
Debt composition, YE 09
MTNs 19.9% Inflation Linked Bonds 13 3% Private placements 17.1% CP (Euro & US) 15.6%
10 June 2010
Debt instrument structure (bn)

60 50 40 30 20 10 0 Bonds MTNs Private Inflation Linked placements Bonds Dec-08 Dec-09 CP (Euro & US)
Bonds 50.5%
337
Council of Europe Development Bank (COE)

Description
% $ Index 0.14 % Index 0.087 Total assets 22.7bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
Moodys Aaa P-1 Stable S&P AAA A-1 + Stable Fitch AAA F1+ Stable
The Council of Europe Development Bank (CEB) is a multi-lateral development bank formed by the Council of Europe, initially for the purpose of channelling funds to ease refugee problems, but now with a broader social orientation, encompassing both funding for disaster relief and longer-term projects for social improvement. With total assets at year-end 2009 of 22.7bn, CEB is one of the smaller and more slowly growing multi-lateral lending institutions (MLIs). Improved credit controls and a re-orientation of the loan portfolio over the past few years have improved asset quality.
Risk weighting
Basel II RSA: 0%

Purpose: The Council of Europe (COE) established the CEB in 1956 as its sole financially autonomous institution. The Council was created in 1949 with the aim of strengthening democracy, human rights and the rule of law throughout its member states. The CEBs functions have evolved to include funding disaster relief and a wider range of social projects that are linked to three main focus areas: namely social integration, environmental management and support for human capital. The COEs 201014 Development Plan is governed by the prospect of a fragile economic recovery on a global scale, a significant increase in unemployment and a greater vulnerability of the emerging countries in central and south-eastern Europe. The plan foresees an increased mobilisation of the institutions resources, encompassing increased lending and strengthened collaboration with the EU and donor countries to optimise project implementation conditions. Ownership and capital structure: Ownership is spread across over 40 governments in western and eastern Europe. The most recent members are Serbia and Ireland (2004), Georgia (January 2007) and Montenegro (November 2007). The top five shareholders account for c.68% of the total capital subscription, and investment-grade countries provide more than 90% of callable capital, with the majority being provided by AAA sovereigns. The most recent general capital increase was in 2001. Asset structure and quality: Over the past few years, CEB has diversified the geographical distribution of its loan portfolio, and in the process, has addressed earlier credit concerns. Loans outstanding slightly declined 1.7% in 2009 to 12.2bn. Between 2005 and 2009, the majority of loans were distributed as follows: Germany (in favour of target group countries) 15.3%, Portugal 11.3%, Poland 10.3%, Turkey 10.1%, Spain 7.5% and Lithuania 4.9%. Overall exposures are well diversified geographically. Increasing priority is being given to lending to a target group of 21 new EU members and transition countries of central and south-eastern Europe. Some 52% of the total amount approved during 2009 was to target group countries. Financials: Debt leverage and gearing In past years CEB developed a new prudential framework, which aligns the banks risk framework with the principles of Basel II by shifting to more risk-based measures. It is mainly organised around three ratios: a risk-weighted capital adequacy ratio (maximum 100%); a risk asset coverage ratio (limiting the ratio of below investment-grade exposure to available own funds and AAA/AA callable capital to 66%); and a liquidity ratio (such that the cash position should be at least 50% of net treasury needs over the following three years). At year-end 2009, the capital adequacy ratio was 20.3% (20.4% in 2008), the risk asset coverage ratio was 40.5% (33.1%), and the liquidity ratio stood at 102.2% (103.7%). Financial performance despite erosion in net margins on loans in 2008 and 2009, net income rose by 11.2mn, or 11.7% to 107mn in 2009, compared with 95.8mn in 2008. This was mainly due to favourable interest differential in refinancing conditions. Funding: New borrowing decreased to 2.5bn in 2009 (3.3bn in 2008), reflecting refinancing debt and to cover lending needs. In 2009, the CEB executed transactions in various currencies to diversify its funding and to broaden its investor base. In 2009, 31% of the funds raised by CEB were denominated in Australian dollars, 28% in GBP, 17% in CHF, 16% in Hong Kong dollars, 5% in US dollars and 3% in New Zealand dollars. This is in contrast to past years activities, when debt outstanding and new issuances were dominated by the dollar sector, which provided 66.5% (87% in 2007) of 2008 funding. CEB hedges all financing operations with swaps to eliminate both interest rate and foreign-exchange risks. After swaps, the total amount of funds borrowed was converted into euro. In 2008 and 2009, the average maturity of issues was five years. As of 31 December 2009, debt outstanding of CEB amounts to 16.5bn, up from 14.6bn as of year end 2008. The majority of redemptions of CEBs debt are due until 2014, with c.3.5bn maturing debt in 2011.
Strengths
Asset quality is protected by preferred creditor status. High-quality callable capital base. Geographically diversified loan portfolio.
Weaknesses
Highly leveraged relative to paid-in capital and reserves.
Key points for 2010

Continuing focus on loans to central and southeastern Europe. 10 June 2010 338
Public sector
Balance sheet summary ( bn) Total assets Net disbursed loans Internbank & securities holdings Total borrowings Subscribed capital Paid-in capital and reserves Net interest income Operating expenses Net income Profitability (%) Return on average assets Return on capital Cost/Income ratio Net int rev/Op inc Disbursed loans/ Paid in capital & reserves Disbursed loans/ Subscribed capital & reserves Callable capital/Debt Paid-in res/Total assets 0.74 7.5 24.1 100.0 0.52 5.4 23.6 98.4 0.50 5.2 25.0 98.2 0.52 5.3 24.1 95.4 0.48 5.4 23.7 0.52 5.7 22.3 2004 2005 2006 2007 2008 2009 % chg 16.40 17.67 18.23 18.51 21.40 22.73 10.84 11.71 12.10 12.11 12.60 12.33 4.89 3.29 1.61 5.04 3.29 1.69 5.26 3.29 1.77 5.35 3.30 1.83 5.09 3.30 1.78 7.79 3.30 1.96 11.78 13.72 13.62 13.26 16.17 17.68 15.6 4.0 -4.8 21.9 0.0 -2.2 0.7 1.4 2.7
Council of Europe Development Bank (COE)

40 30 20 10 0 -10 0
27.4 88.5 29.4 88.1 29.6 93.3 30.0 30.9
Income statement summary ( mn) 116.9 114.1 115.4 117.2 118.0 141.5 28.2 121.0 95.8 107.0

100 80 60 40 20 0 -20 May-09
93.1 101.9
Gearing, debt leverage & capital ratios (%) 671.2 691.8 682.6 663.5 706.1 629.3 238.7 253.6 257.6 254.5 267.1 251.9 24.8 9.8 21.3 9.6 21.5 9.7 22.1 9.9 18.1 8.3 16.6 8.6
Aug-09 Nov-09 COE 5.500% Jun 12 COE 5.125% Apr 17
Feb-10 COE 4.500% Jun 14

4 3 2 1 0 2.3 2.0 2.6 2.8 2.1 3.3 2.4 1.4

5 4 3 2 1 0 2020-2029 >2029 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 0.4 0.0 4.4 3.4 2.4 3.3 2.3 0.8 0.1 0.2 0.1
EUR 1.5% USD 77.5% AUD/CAD/ NZD 10.6% Others 10.2%
General Reserves 32.4% Callable & unpaid 60.0% Other Reserves & Retained Earnings Paid-in 0.1% 7.6%
Outstanding loan country distribution, YE 09

Greece 3% Portugal 4% Turkey 6% Hungary 9% Finland 6% Poland Germany 6% 5% Others 24% Spain 17% Italy 10% France 10%
339
10 June 2010
2010 yt May
2003
2004
2005
2006
2007
2008
2009
Description
% $ Index 0.072 % Index NA Total assets NOK225bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
Moodys Aa1 P-1 Negative S&P AA+ A-1 + Stable Fitch AA F1+ Stable
The Eksportfinans Group (EXPT) provides long-term funding and other financial services in the areas of export and municipal finance. Ownership is spread across the Norwegian banking system and the Norwegian government (15%). EXPT is the sole specialised export lender in Norway. Effective March 2009, EXPT sold its subsidiary Kommunekreditt Norge AS, one of the main lenders to the Norwegian municipality sector. EXPTs areas of activity are characterised by strong asset quality and narrow lending margins. EXPT is Norways leading international borrower.
Risk weighting
Basel II RSA: 20%

Purpose: EXPT was established in 1962 to provide long-term financing to Norwegian exporters. The institution is the sole specialised export lender in Norway, provides commercial export funding (on behalf of shareholder banks) and acts as an agent for government-supported finance. In 1999, it acquired local authority lender Kommunekreditt Norge AS, the secondlargest municipal lender in Norway. In 2009, Kommunekreditt Norge AS was sold to Kommunal Landspensjonskasse (KLP). Ownership and capital structure: The Norwegian government has a 15% direct stake and a further indirect stake via DnB NOR Bank (40%). At the end of 2009, 26 Norwegian banks and foreign banks operating in Norway shared the other 45%. The largest shareholder is DnB NOR Bank ASA with 40%. There is no explicit guarantee of EXPTs debt, but government participation, together with the companys public policy role in providing export finance and close interaction with various areas of government, provides a strong expectation of government support. It is regulated as a specialised financial institution by Kredittilsynet (the Norwegian equivalent of the FSA). Asset structure and quality: EXPTs traditional export-related business areas were in lending for capital goods, ships built at Norwegian shipyards and more general export-related and international lending. During its ownership of Kommunekreditt, loan growth was concentrated in municipal lending. Kommunekreditt was sold in 2009, however, with a portfolio of NOK11bn of loans to Norwegian municipalities transferred to EXPT. EXPT expects to hold these loans to maturity. Over the past few years, export lending has grown, as demand has been boosted by strong growth in the shipping industry and the oil and gas sector, which has been driven by high oil prices. Asset quality of the loan book is inherently robust: All export-related lending is backed by guarantees provided by governments (of Norway and other OECD countries) and banks (currently mainly Norwegian). It has never suffered a loan loss on export finance. Asset structure and quality: EXPT has traditionally carried a high level of liquid assets as a hedge against interruptions to funding. As of year-end, liquidity placed in commercial paper and bonds amounted to NOK76.1bn, down from NOK108.1bn in 2008. The share invested in ABS with an average AAA rating has risen in recent years. As of year-end 2009, the ABS portfolio made up about 42% of the liquidity portfolio (covered by a Portfolio Hedge Agreement). Financial performance: The balance sheet decreased 24% in 2009 due to the sale of its subsidiary, reduction of its liquidity portfolio and foreign exchange rate effects. In the past, assets more than doubled. Net interest income increased strongly (+78%) due to effects related to beneficial borrowing conditions by EXPT in 2009. The Norwegian government agreed in 2008 to provide EXPT market-based funding on specified terms in 2009 and 2010. However, EXPT was able to raise sufficient funding volume in 2009 and has not utilised the agreement with the government. EXPTs total capital ratio increased from 11.6% to 13.3% as of Q4 09. In 2008, shareholder banks agreed to provide NOK5bn credit protection against further unrealised losses in the liquidity portfolio under a so-called Portfolio Hedge Agreement. Funding: EXPT is one of Norways largest international borrowers. In 2009, total borrowing amounted to NOK69.3bn, versus NOK93.7bn in 2008. It is active in MTN issuance across a range of currencies, particularly in structured MTNs, many of which are not captured in public databases, depressing the public volumes in our issuance chart. In 2009, a total of 1023 bonds were issued in nine currencies. EXPT normally issues one or two dollar benchmarks each year, in part to provide a benchmark for its MTN funding. In 2009, it issued three benchmark bonds: two bonds were issued in CHF with tenors of 7.5 and 9.5 years and a USD 5-year global benchmark issue targeted investors in the US, Europe, Middle East and Asia.
Strengths
Strong asset quality and high levels of liquidity. Public policy role in the provision of export finance. Government shareholding and stakes held by a wide range of banks, which underpin expectations that its export finance franchise will remain unchallenged.
Weaknesses
No explicit government debt or solvency guarantee. Narrow operating margins. Dependency on single business line of export lending.
Key points for 2010

Performance of liquidity portfolio and implications for net income and credit ratings. Growth prospects: Can EXPT continue to sustain strong growth in its loan portfolios in the face of potential capital constraints in the event of further valuation pressure on the liquidity portfolio? 340
10 June 2010
Public sector
NOK Balance sheet summary (NOK bn) Total assets Customer loans Security holdings Shareholders' equity Total capital Debt security funding Net interest revenue Operating income Operating expenses Pre tax income Net income Profitability (%) Return on assets Return on equity Return on total capital Cost/Income ratio Net interest revenue/Op. income Asset quality Non-accrual loans (NOKmn) Non-accrual/total loans (%) Loans/Total capital Capital/Debt securities Total capital ratio Total capital/Total assets 3.6 0.0 357.4 0.4 372.5 1967.5 0.3 1.3 137.3 0.1 0.2 9.8 5.9 34.8 94.7 0.1 5.7 3.4 44.9 -0.1 -5.2 -3.0 -804.7 1.3 69.6 48.5 4.1 21.6 -0.7 -28.6 -21.3 -8.1 -63.5 165.2 90.3 63.4 2.4 4.2 157.3 484.1 511.0 177.7 333.3 242.6 172.4 79.0 63.9 3.0 5.3 160.6 459.1 394.3 177.2 217.1 159.3 218.7 98.8 80.1 2.7 4.6 206.3 296.9 112.8 108.1 7.2 9.6 259.0 225.3 -24.1 66.7 -40.9 76.1 -29.6 5.4 -25.0 7.3 -23.4 197.6 -23.7 1,470.0 187.3 37.6 NM -8.4 NM NM 2006 2006 IFRS 2007 2008 2009 %chg
150 100 50 0 0.0
561.0 1,068.2 186.7 204.5 -23.2 4,945.3 -2,313.6 -209.9 4,740.8 -2,500.9 -148.8 3,435.6 -1,801.8
Income statement summary (NOK mn)
1.0
2.0
3.0
4.0
5.0

150 125 100 75 50 25 0 -25 May-09 Aug-09 Nov-09 EXPT 1.875% Apr 13 EXPT 5.500% Jun 17
116.4 -2418.1
Feb-10 EXPT 3.000% Nov 14
Gearing, debt leverage and capital adequacy 2356.8 1911.4 2741.5 1557.6 2.7 12.2 2.6 3.3 12.2 3.0 2.2 9.6 2.1 3.7 11.6 3.2 1784.9 3.7 13.3 3.3

6 5 4 3 2 1 0 4.3 3.1 2.9 2.8 5.0 3.6 3.0 1.5

4 3 2 1 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 2.9 2.5 1.5 2.7 1.5 0.6 1.1 0.8 0.9 3.3
AUD/CAD/ NZD 12.3% EUR 15.9% JPY 19.9% Others 14.1%
0.2 0.4
USD 38.0%
Sub debt 20.5%
Government supported Loans 31.8% Commercial Loans 68.2%
Share capital 37.8%
Preferred cap secs 5.7%
Other equity 36.0%
10 June 2010
2010 yt May
341
2003
2004
2005
2006
2007
2008
2009
Eurofima (EUROF)
Description
% $ Index 0.062 % Index 0.048 Total assets CHF35bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
Moodys Aaa P-1 Stable S&P AAA A-1+ Negative Fitch NR NR NR
Eurofima (The European Company for the Financing of Railroad Rolling Stock) is well defined by its long name. It was formed as a supranational organisation for this purpose in 1956. It is owned by the railway companies of 26 European countries and backed by sovereign guarantees on both its callable capital and its loans.
Risk weighting
Basel II RSA: 20%

Purpose: Eurofima was established in 1956 as a supranational organisation under the terms of a convention signed in 1955, initially by 14 European governments (now 26), with the purpose of financing the acquisition of railway rolling stock and, more generally, supporting the development of rail transportation in Europe. Originally established for 50 years (to 2006), a subsequent agreement in 1984 extended its life a further 50 years to 2056. Ownership and capital structure: It was set up as a joint-stock company, based in Basel and operating under its founding treaty and then under Swiss law. The shareholders are the national railways of the signatory countries. In 2007, the state railways of Portugal and Greece increased their participation in Eurofimas share capital from 1% to 2% through a re-allocation of shares from the German, French and Italian railways, which are the three largest shareholders. Banking regulators treat Eurofima as a commercial public entity rather than a multilateral development bank. Under the Revised Standardised Approach of Basel II, which weights AAA to AA- corporates at 20%, Eurofimas risk weighting reduces to this level, from 100%, which had applied under Basel I. Asset structure and quality: Its main activity is lending through equipment-financing contracts, which are secured against the purchased rolling stock and guaranteed by the respective national governments of the borrowing railway companies. Its asset quality is protected further through a combination of provisioning, a special guarantee reserve and a general reserve. As well as guaranteeing Eurofimas loans to their respective railways, signatory governments provide a joint guarantee of the loans up to the value of their shareholdings. They also guarantee their national railways obligations as shareholders, specifically the joint obligation to provide callable capital. Debt leverage and gearing: At year-end 2009, total assets amounted to CHF37.4bn, slightly down 7.6% from 2008 levels. The ratio of subscribed capital and reserves to total loans, increased to 10.8% (10% in 2008); however, it is lower compared with other multi-lateral institutions. Nevertheless, the combination of guarantee support for Eurofimas loans and the high-quality sovereign guarantees underpinning its callable capital are viewed by the rating agencies as sustaining its Aaa/AAA ratings. Until year-end 2009, Eurofima has never written off any loans or had to call on government guarantees. Financial performance: New loan disbursements amounted to CHF1.8bn in 2009, down from CHF3.9bn in 2008. This was due to a continuing challenging economic environment, combined with five years of strong balance sheet growth, which resulted in more cautious lending activities. Net income rose a slight 4.8% to CHF50.8mn, mainly as a result of better net interest income due to favourable borrowing costs. Funding: Total borrowing decreased to CHF2.3bn in 2009, from CHF4bn in 2008, and was made up of three currencies in total. For the first time since 2004, Eurofima re-entered the euro market with a new 500mn bond due in 2021. This issue was targeted at investors in its member states and to further broaden Eurofimas investor base. After six benchmark bonds have been issued between 2004 and 2008 in the US$ market, there were no benchmark issues in 2009. US$ issues focused on the short to medium-term maturities, whereas Eurofima looked for duration in the euro and CHF markets.
Strengths
Strong asset quality secured against rolling stock, backed by sovereign guarantees and further supported by a conservative provisioning policy.
Weaknesses
High balance sheet leverage. Risk-weighting treatment puts it at a disadvantage to other Multi-lateral Lending Institutions (MLIs).
Key points for 2010

No major developments expected. In light of the crises, Eurofima intends to strengthen its liquidity and equity base.
10 June 2010
342
Public sector
CHF 2005 2006 2007 2008 2009 % chg Balance sheet summary (CHF bn) Total assets (net of unpaid capital) Disbursed loans Cash and investments Total borrowings Subscribed capital Paid in capital + reserves Net interest revenue Operating expenses Net income Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int rev/Op inc Loans/Paid in cap. & res. Loans/Subscribed cap. & res. Callable capital/Debt Paid in + res/Total assets 0.16 0.14 0.14 0.13 0.14 4.9 4.6 4.4 4.4 4.8 14.1 15.1 15.4 13.8 13.2 57.6 56.7 56.1 66.1 69.1 2,920 2,884 2,909 3,381 3,007 931 7.1 3.1 935 6.9 3.1 958 1,133 1,027 6.7 3.1 6.1 2.7 6.5 3.1 31.4 32.3 33.3 38.4 35.3 28.4 28.8 29.7 35.5 32.4 2.1 2.6 1.0 2.6 2.6 1.0 2.8 2.6 1.0 2.5 2.6 1.0 2.7 2.6 1.1 29.3 30.1 31.2 33.9 32.2 -8.0 -8.6 7.6 -4.9 0.0 2.8 6.8 -1.9 11.9
Eurofima (EUROF)
60 50 40 30 20 10 0 0 2 4 6 8
Income statement summary (CHF mn) 33.2 31.0 29.6 37.9 40.4 8.1 8.3 8.1 7.9 7.8 47.2 45.4 44.5 45.4 50.8

150 100 50 0 Jun-09 Sep-09 Dec-09 EUROF 5.125% Aug 12 EUROF 5.250% Apr 16
Gearing, debt leverage & capital ratios (%)
Mar-10 EUROF 4.250% Feb 14

3.0 2.5 2.0 1.5 1.0 0.5 0.0 2.7 1.8 2.7 1.7 2.5 2.2 1.3 0.4 2010 yt May
343
2003
2004
2005
2006
2007
2008
CHF 27%

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 3.2 1.5 1.3 1.6 1.9 1.0 1.4 1.4 0.9 1.2
EUR 5%
0.5 2020-2029 >2029
0.7 2019
AUD/CAD/ NZD 27.3% GBP 3% Others 2%
2010
2011
2012
2013
2014
2015
2016
2017
General Reserves 16.0% Callable 66.5% Other Reserves & Retained Earnings Paid-in 0.9% 16.6%
10 June 2010
2018
USD 33%
Switzerland 10.7% Belgium 13.9% Italy 13.9% France 16.9% Spain 9.6% Austria 8.0% Germany 7.2% Portugal 4.4% Greece Others 4.3% 11.2%
2009
European Bank for Reconstruction & Development (EBRD)

Description
% $Index 0.038 % Index 0.088 Total assets 33bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
The European Bank for Reconstruction and Development (EBRD) is the key regional development bank for the transition economies of Central and Eastern Europe (CEE) and the countries of the former Soviet Union. As new countries have progressed towards EU membership, the focus has increasingly been on those countries that are still outside the EU. This is inherently an area of higher credit risk, and EBRDs credit quality is heavily dependent upon the strength of capital support and conservative financial policies.
Risk weighting
Basel II RSA: 0%

Purpose: The EBRD started operations in 1991. Its objective is to encourage the development of market economies in the CEE countries, as well as those of the former Soviet Union, stretching into central Asia. Ownership and capital structure: The EBRD is owned by 61 countries, the EC and the EIB. Membership is not restricted to European nations the US, Japan and Canada are among the leading shareholders. Borrowing members account for 12.8% of subscribed capital. The US is the largest individual shareholder with 10.1%. Members and institutions of the EU provide 57%, and investment grade shareholders provide almost 90%. Paid-in capital is 26% of the total, which is a relatively high proportion compared with other MLIs, but the percentage has declined over the past two years, reflecting growth in reserves and retained earnings. Asset structure and quality: The bank operates in 30 countries, where it helps to finance public and private sector projects through loans, equity finance and the provision of guarantees. Financial institutions, infrastructure/energy projects as well as industry and commerce. Asset quality has been on an improving trend since a low point in 2000, and although impaired loans have increased sharply since 2007, they remain a relatively low proportion of total loans (2.3%) and are well covered by loan provisions. As the countries of CEE move into the EU, these countries have been de-emphasised in the EBRDs portfolio. For example, in 2007, the Czech Republic became the first of the eight new EU members to graduate to an economic level at which the EBRD no longer makes new loans or investments in it. Debt leverage and gearing: Given the relatively higher risk of EBRDs assets, its financial policies are relatively conservative. It applies gearing ratios that limit outstanding loans, equities and guarantees to the total unimpaired subscribed capital, reserves and surpluses. Also, equity investments are limited to the paid-in capital, reserves and surpluses. Observed gearing and debt leverage ratios to capital (including and excluding callable capital) are therefore at the lower end of the MLI scale. Financial performance: A declined net interest income combined with a continuing decline in valuations on equity investments for the second year in a row caused a net loss for the EBRD of -746bn. Business volumes continued to expand strongly in 2009, with new commitments amounting to 7.9bn (in 311 projects), compared with 5.1bn (302 projects) in 2008. The balance sheet size decreased slightly by 518mn to 32.5bn. Outstanding loans increased c.19% over the year, while reserves and retained earnings, paid-in capital remained at stable levels. Funding: EBRD focuses most of its funding efforts on MTN structures to minimise funding costs, rather than benchmark transactions. The currency mix of its outstanding debt is, therefore, particularly diverse.
Strengths
Conservative financial policies. Strong capital base. Preferred creditor status.
Weaknesses
Concentration in countries with low credit ratings. Substantial amount of equity exposure, which is inherently high risk and subject to mark-to-market volatility.
Key points for 2010

Impact of global economic pressures on the economies of the transition region. Trends in asset quality further scope for improvement? Increased volatility in income, assets and capital as a result of the application of fair valuation techniques Will request for 50% capital increase be realisable?
10 June 2010
344
Public sector
2006 2007
European Bank for Reconstruction & Development (EBRD)

2008 2009 % chg -1.5 15.9 8.7 -11.6 7.6 0.0 -2.0 -12.7 -2.5 NM 50.3

3 2 1 0 2020-2029 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 >2029 1.9 1.0 1.1 2.5 1.7 1.5 0.1 0.3 0.3 0.0 0.6 2.0
AUD/CAD/ NZD 16% JPY 14% GBP 2% ZAR 7% Others 17% EUR 5% USD 39%
Reserves & Retained Earnings 24.2%
Poland 5.3% Russian Federation 30.5% Others 16.8% RomaniaRegional Serbia 9.6% 4.7% 3.7% Croatia 4.7% Kazakhstan 4.5%
Callable 55.9%
Paid-in 19.9%
Ukraine 13.4% Bulgaria Hungary 2.3% 4.6%
10 June 2010
2010 yt May
345
2003
2004
2005
2006
2007
2008
2009
Balance sheet summary ( bn) Total assets 30.7 33.2 33.0 32.5 Net disbursed loans 8.0 8.9 10.7 12.4 Net share investments 5.1 6.6 4.4 4.8 Liquid assets 14.3 14.7 13.8 12.2 Total borrowings 16.8 17.7 18.4 19.8 Subscribed capital 19.8 19.8 19.8 19.8 Paid in capital and reserves 12.2 13.9 11.8 11.5 Income statement summary ( mn) Net interest revenue 462 576 667 582 Operating expenses 225 251 243 237 Write-downs & provisions -53 201 -105 -535 Net income 2389 1884 -475 -714 Profitability (%) Return on average assets 8.1 5.9 -1.4 -2.2 Return on average equity 21.7 14.5 -3.7 -6.1 Cost/income ratio 8.4 13.0 -191.3 408.6 Net int rev/Op inc 17.3 29.8 -525.2 1003.4 Gearing, debt leverage & capital ratios (%) Loans & shares/Paid cap & res 107.0 111.7 128.6 149.3 Loans & shares/Total cap 48.7 54.4 57.3 65.9 Callable capital/debt 86.8 82.6 79.2 73.6 Paid in + res/Total assets 39.7 41.8 35.6 35.4 Asset quality (%) Non-accrual loans ( mn) 19.0 37.0 127.0 305.0 Non-accrual/Total loans 0.2 0.4 1.2 2.3 Cum LLPs ( mn) 341.0 124.0 227.0 719.0 Cum LLPs/Non-accrual loans 1,794.7 335.1 178.7 235.7
14 12 10 8 6 4 2 0 0 1 2 3 4 5 6

60 40 20 0 -20 May-09 Aug-09 Nov-09 Feb-10 EBRD 3.625% Jun 13
EBRD 5.000% May 14 EBRD 2.750% Apr 15

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2.0 2.4 1.6 0.7 0.7 1.5 3.2 2.0
European Investment Bank (EIB)

Description
% Index 1.526 % Index 3.383 Total assets EUR352bn LT Senior Unsecured ST Outlook
Michaela Seimen
Ratings table
The EIB is the worlds largest multi-lateral lending institution (MLI) in terms of total assets. Its key objective is to provide long-term finance to support EU development. Historically, the bulk of its loans have been within EU member states, with a key focus on financing infrastructure projects, particularly relating to the development of trans-European networks. In recent years, increasing emphasis has been given to lending to new and potential EU member countries and, within the EU, to providing support for small and medium-sized enterprises (SMEs).
Risk weighting
Basel II RSA: 0%

Purpose: The EIB was established in 1958. Its particular focus has been on financing projects that promote regional development and social and economic cohesion, especially in Europes less prosperous regions, notably in recent years via funding of investment in trans-European communication networks (TENs) and implementing initiatives seeking to build a competitive and innovative economy. The current Corporate Operational Plan (COP), covering 2010-12, also reflects the EIBs fast-track answer to the effect of the financial crisis on the real economy with increased and/or innovative lending to priority and/or particularly vulnerable sectors and regions, the development of new financial instruments. At the Economic and Financial Affairs Council (ECOFIN) meeting in early December 2008, an additional lending of at least 15bn per annum was envisaged for 2009 and 2010 as a response to the present crisis in the banking industry. Ownership and capital structure: The EIB is owned by the members of the EU. The EIB Statute was amended to include the new EU members as owners, with effect from 1 May 2004. Following the increase in capital subscriptions, the four largest members account for a majority of subscribed capital. The credit quality of EIBs owners remains higher than most MLIs: 62% of its capital is provided by countries with AAA sovereign foreign currency ratings; 77% by AAA/AA countries. Asset structure and quality: As of year-end 2009, the EIB had a loan book of 406bn. The bank lends to public and private sector borrowers within the EU and to other countries with ties to the EU. Loan growth within the EU-15 is limited to 2% pa, to make room for more rapid growth in new members and accession and candidate countries. EIB loan quality is very high and gains substantial support from security related to underlying projects and in the form of thirdparty guarantees: between 2003 and 2009, about 90% of lending was provided to member states or guaranteed by member governments or their public institutions. Debt leverage, gearing and financial performance: EIB is a highly leveraged entity among leading MLIs. The gearing policy limits loans outstanding (including undisbursed loans) and guarantees to 250% of subscribed capital + reserves. Following a capital increase at the start of 2003, the next capital increase was planned for 2010. However, following the higher lending activity foreseen in the COP 2009-11, in April 2009 subscribed capital has been increased from 164bn to 232bn. This resulted in a capital adequacy ratio of about 30% as of year-end 2009. Financial performance: Although full results for year-end 2009 have not yet been published at the time of writing, initial indications from the bank are that loan approvals and disbursements accelerated strongly in 2009, continuing the trend from 2008. After total assets held steady at slightly above 300bn in 2006 and 2007, EIBs total assets increased to 352bn as of year-end 2008. Income has increased strongly in recent years with profits of 1.9bn and 1.7bn as of year end 2009 and 2008, respectively. Funding: In 2009, EIB raised 79.4bn (2008: 59.5bn) via 262 transactions (247 in 2008). EUR funding accounted for 54.4% of amounts raised. However, the EIB is a frequent non-USD issuer in the USD market and in 2009 raised USD27.9bn (25.9% of total funding). Also in 2009, the EIB issued its largest USD issue to date, a USD5bn three-year bond. Sterling funding accounted for 8.2% of total funds raised. Issuance of EIB in other currencies included 16 currencies. In the past EUR, USD and GBP have usually accounted for about 85-90% of funding. The choice of the funding currency is strongly influenced by market conditions. The EIB swaps some, but not all, of its non-EUR issues back to EUR. In 2009, the bank extended the maturity profile of its funding to 7.4 years, up from five years in 2008. In 2009, the Governing Council of the European Central Bank (ECB) decided that the EIB will be an eligible counterparty in the Eurosystems monetary policy operations. As of July 2009, the EIB has access to the Eurosystems open market operations and standing facilities under the same conditions as any other counterparty. The access to ECB liquidity allows the EIB to accommodate additional demand for its lending programme. For 2010 and 2011, it has indicated an expected funding range of 65-70bn.
Strengths
High-quality callable capital, provided entirely by EU member states. Key public policy role in implementing EU policy objectives. Asset quality is underpinned by stringent credit criteria and third-party guarantees, which ensure that the level of risk is much lower than suggested by raw leverage ratios.
Weaknesses
Highly leveraged compared with other MLIs, especially relative to paid-in capital and reserves. Some dilution of capital and asset quality resulting from support of new EU members, lowered ratings and SMEs.
Key points for 2010

A period of pronounced EIB balance sheet growth? Increasing focus on responding to the financial markets crisis. 10 June 2010 Continued EIB contribution to EU cohesion objectives.
346
Public sector
Balance sheet summary ( bn) Total assets Disbursed loans Liquid assets Total borrowings Subscribed capital Paid in capital + reserves Net interest revenue Operating expenses Net income Profitability (%) Return on average assets Return on average equity Cost/income ratio Net int rev/Op inc Loans/Paid in cap. & res. Loans/Subscribed cap. & res. Callable capital/debt Paid in + res/total assets Liquidity (%) Liquid assets/Debt 13.4 15.1 11.4 11.2 12.0 0.39 0.43 0.73 0.27 1.92 3.8 4.5 7.7 2.9 19.8 6.1 22.4 19.0 15.3 28.3 273.2 311.6 304.4 310.8 352.0 225.2 248.1 257.6 268.7 291.9 30.4 39.6 28.8 29.1 35.0 226.0 261.6 253.1 260.5 290.5 163.7 163.7 163.7 164.8 164.8 27.1 28.6 30.3 28.1 36.3 1695 1676 1690 1863 2141 362 308 391 386 425 1044 1247 2260 13.2 8.6 20.1 11.5 0.0 29.2 14.9 10.2 2004 2005 2006 2007 2008 % ch
European Investment Bank (EIB)

100 80 60 40 20 0 -20 0 5 10 15 20 25 30 OAS
Income statement summary ( mn)

80 60 40 20 0 -20 May-09 Aug-09 Nov-09 EIB 1.125% Apr 12 EIB 2.750% Mar 15 Feb-10 EIB 1.625% Mar 13 EIB 5.125% May 17 OAS
843 6356 653.8
105.0 103.5 66.2 136.5 30.7 831.2 868.3 850.4 957.1 804.6 123.4 134.8 138.7 145.5 151.4 68.8 59.4 61.4 60.1 53.9 9.9 9.2 10.0 9.0 10.3
Gearing, debt leverage & capital ratios (%)

80 60 40 20 0 47.4 50.0 53.5 56.5 74.5 36.5
37.4
44.4
Note: EIBs accounts are drawn up in accordance with IFRS. Debt maturity and currency structure charts are based on dealogic DCM Analytics data, which may not include all MTNs and private placements.

50 42.1 39.0 36.1 34.7 35.0 34.3 40 25.0 22.4 18.8 22.1 30 20 8.5 3.6 10 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029
Others 5.9% AUD/CAD/ NZD 4.2% JPY 2.7% GBP 15.7% EUR 45.9%
USD 25.6%
General Reserves 8.55% Other Reserves & Retained Earnings 5.99%
Hungary Poland 2.6% 4.7% Greece 2.3% Portugal 3.8% United Kingdom France 8.0% 9.2% Others EU 17.8% Others nonEU 7.8% Germany 14.4% Spain 16.1% Italy 13.4%
347
Callable (incl unpaid) 81.19%
Paid-in 4.27%
10 June 2010
2010 yt May
2003
2004
2005
2006
2007
2008
2009
Instituto de Credito Oficial (ICO)

Description
% Index 0.201 % Index 0.224 Total assets 53bn LT senior unsecured ST Outlook
Note: As at 7 June 2010
Michaela Seimen
Ratings table
Moodys Aaa P-1 Stable S&P AA A-1+ Negative Fitch AA+ F1+ Stable
Established in 1971, Instituto de Crdito Oficial (ICO) was originally responsible for the co-ordination and control of state-owned banks in Spain. In 1988, ICO became a state-owned enterprise and started tapping capital markets to raise resources. It also assumed the ownership of the capital of Spains state-owned banks. ICO has the legal nature of a credit institution and is classified as the Kingdom of Spains financial agency, with its own legal status, equity and cash assets. The Kingdom of Spain explicitly guarantees ICOs debt.
Risk weighting
0% risk-weighted. Under the Basel II standard approach, the risk weighting of the Kingdom of Spain is applied to ICO.
Key features
General: ICO is the Kingdom of Spains financial agency whose principal objective is to promote economic and social development by means of allocating medium- and long-term funds to selected domestic sectors such as housing construction, infrastructure, telecommunications, energy, environment and transport. Its legal status as a state-owned corporate entity rules out any privatisation. In light of ICOs strategic importance as a provider of public services, we do not expect this to change any time soon. Ownership and support: ICO is wholly owned by the Spanish state and reports to the Ministry of Economy and Finance through the Secretariat of State for the Economy. The former is in charge of approving ICOs annual budget. ICOs borrowing limits are included in the governments general budget, and the Council of Ministers appoints the chairperson of the Board. ICO is required to maintain the same level of regulatory capital as other credit institutions, with the exceptions stipulated in applicable regulations. At year-end 2009, regulatory capital stood at 3.1bn, or 5.2% of total assets. The 2009 National Budget Law included a capital increase of 140mn. The Spanish government provides a timely unlimited, explicit, direct, irrevocable and unconditional guarantee for ICOs debt securities. Asset structure: In 2009, ICO granted loans with a total volume of 19.3, up from 16.2bn in 2008. Over 2009, ICO recorded a 14% y/y increase in its total assets to 60.4bn, largely as a result of increased lending, which was up in terms of direct loans (5.9%) and second-floor loans, mainly via the ICO-SME Facility (58.9%). Within the scope of its financing programmes, in 2009, ICO had arranged c.365,000 loans to the self-employed and enterprises and private individuals. ICO brokered 25% of loans granted in the Spanish financial system in 2009. Funding: In order to refinance the loans granted whose volume grew strongly in recent years, ICO similarly increased its funding resources. The funding programme estimated for 2010 stands at 16-18bn compared with a funding volume of 17.4bn in 2009. ICOs funding is diversified over 11 currencies, among them NOK, GBP, USD, AUD, NZD, BRL, JPY, CHF, EUR, SEK and TRY. 58% of funding is EUR denominated and 23.6% is in US$. ICO accesses the US investor base under 144-rule. In 2009, 14bn of funding was concentrated in medium- and long-term issues and 3.4bn in short-term deals. For 2010, ICO plans two to three benchmark transactions. As of April 2010, ICO had issued a total of about 3bn in three different currencies, among them USD, EUR and GBP. First issues comprised a 5-year euro benchmark bond and a 3-year US$ benchmark issue.
Strengths
The Spanish government provides an explicit, direct, irrevocable and unconditional guarantee for debt securities issued by ICO. Furthermore, ICO benefits from its public ownership and given its strategic importance as a provider of public services, we do not expect this to change any time soon.
Weaknesses
ICOs rating depends on those of the sovereign, thus, the further rating migration of the Kingdom of Spain could trigger further downgrades. S&P downgraded its rating to AA from AA+ in April 2010 with a negative outlook on the rating.
Key points for 2010

The ongoing economic deceleration led ICO to markedly increase its lending over 2008 and 2009. As it seems that the economic downturn in Spain has not yet bottomed, any further development of ICOs overall funding needs should be monitored closely. As ICO is directly involved in several of the measures related to the economic stimulus packages adopted on behalf of the Kingdom of Spain, business volumes are likely to increase also over the course of 2010, in our view.
10 June 2010
348

Balance sheet summary ( mn) Total assets Net loans (via banks and direct) Net direct loans Borrowing through securities Equity and reserves Net interest revenues Operating expenses Net operating income Write-offs and provisions Tax Net income Profitability (%) Return on assets Return on equity & reserves Cost/Income ratio Asset quality Non-performing assets ( mn) % of total gross loans Provisions ( mn) Provisions/NPA (%) Provisions/Gross loans (%) Leverage and capital ratios (%) Loans/Equity and reserves (times) Equity & reserves/Total assets (% 18.9 4.9 22.1 4.4 15.8 5.6 15.7 5.2 602.4 2.5 650.7 108.0 2.6 452.2 1.5 475.2 105.1 1.5 331.7 0.9 343.2 103.5 1.0 372.4 0.9 539.7 144.9 1.2 0.2 3.9 25.2 0.4 7.9 17.5 0.2 4.5 53.7 0.2 3.6 65.3 26,691 32,298 39,883 52,970 24,473 31,084 35,200 42,849 8,497 10,740 13,550 17,784 19,483 23,897 29,054 39,345 1,295 90.4 33.2 57.2 39.6 13.5 51.1 1,407 196.2 36.4 159.8 16.7 52.3 106.1 2,226 207.4 121.6 85.9 -83.0 25.8 79.2 2,736 295.2 229.4 65.7 33.7 88.4 23.5 13.2 26.2 21.6 58.2 2005 2006 2007 2008 %ch
Instituto de Credito Oficial (ICO)

200 150 100 50 0
5.7 234.0 -46.3 -50.7 -25.4
10

200 150 100 50 0 Jun-09 Sep-09 Dec-09 ICO 4.375% May 12 ICO 4.375% May 19 Mar-10 ICO 3.500% Jan 14
45.0 -597.0

15 10 5 0 2003 2004 2005 2006 2007 2008 2009 2010 yt May 4.3 2.3 6.1 8.3 10.1 3.8 13.2 12.7
Note: ICO introduced IFRS reporting in its 2006 accounts and 2005 accounts were adjusted accordingly. The 2004 statements were prepared in accordance with the Bank of Spains Circular 4/2004, which replaced the earlier Circular 4/1991 as a transitional step towards IFRS.

15 10 5 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 3.2 12.0 10.4 5.2 2.4 2.1 1.5 1.0 0.0 2.1 0.4 -
USD 33% GBP 8% AUD/CAD/NZD 8% Others 9%
EUR 43%
Reserves (net of value adjustments) 21.8%
Ordinary loans, 42%
Paid-in capital 75.0%
Income for the year 3.2%
Second-floor loans w/securitisation, 58%
Special and exceptional operations, 0.3%
10 June 2010
349
Inter-American Development Bank (IADB)

Description
% $ Index 0.234 % Index 0.052 Total assets $84bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
IADB is the key regional development bank, providing financing to Latin America and the Caribbean. It aims to promote environmentally sustainable growth, poverty reduction and social equity. Most loans are to sovereign borrowers or are sovereignguaranteed, although in 2006 the bank introduced a new initiative to encourage widening its client base. Despite the poor credit quality of the region over the years, IADB has maintained a very strong track record for asset quality. Moreover, capital cover ultimately continues to give bondholders very strong protection.
Risk weighting
Basel II RSA: 0%

Purpose: The IADB was established in 1959 by the Organisation of American States to help accelerate economic and social development in Latin America and the Caribbean. Ownership and capital structure: The IADB has 48 member countries: 26 Latin American and Caribbean members provide just over 50% of its callable capital (which accounts for c. 96% of total capital); the US 30%; Canada 4%; and 19 non-regional countries approximately 16%. In 2009, Canada offered to increase IADBs callable capital by US$4bn on a temporary basis; accordingly, the authorised ordinary capital of the bank was increased to US$104.98bn. The paid-in capital stock of the bank remained unchanged. This subscription will continuously decrease after five years. Given the relatively low sovereign ratings in Latin America, IADBs callable capital is of relatively lower quality, with 39% being provided by sub-investment grade or unrated sovereigns. Asset structure and quality: The vast majority (c.95%) of loans are to sovereign borrowers or are sovereign-guaranteed. Loans to the private sector without government guarantee are limited to 10% of the loan portfolio (excluding emergency lending). The bank has three main loan categories: investment loans, policy-based loans and emergency loans. The first, related to individual projects, is the key priority and largest element. In 2006, the bank approved new guidelines to encourage lending to sub-national entities without a sovereign guarantee. (At end2009, 9% of loans and guarantees were non-guaranteed.) Given its regional focus, geographical concentration is inevitably very high. Nevertheless, preferred creditor status has been effective in maintaining debt service, even in times of stress. Nonaccruing loans had fallen sharply in recent years; however, they stepped up sharply at end-2008 as a result of a non-sovereign guaranteed loan being declared impaired at the end of the year. In 2009, loan losses decreased slightly. The Banks investment portfolio ($20.1bn at end-2009) consists amongst others of bank and ABS securities, which are more strongly exposed to credit spread risk.
Weaknesses
Debt leverage and gearing: In recognition of the risks attached to IADBs Latin American lending focus, its financial policies are relatively conservative compared with other MLIs. Gearing limits constrain disbursed loans and guarantees to the sum of paid-in capital, general reserves and callable capital of non-borrowing members. Also, the total equity-to-loans ratio (TELR) was 34.2% at end-2009 (35.3% in 2008), below its medium-term target of 38%. Net borrowing is also limited to the callable capital of nonborrowing members. (In 2009, the ratio was 74.1% and in 2008 it was 69.3%.) Gearing and debt leverage ratios based on total capital are therefore at the lower end of the scale for MLIs. Financial performance: A further increase in loan disbursements in 2009, together with reduced loan maturities, produced another increase in outstanding loans in 2009 and a continuation of balance sheet growth. Net operating income increased sharply after a loss in 2008. The income increase was mainly due to higher net interest income, resulting from an increase in net investment income in the banks trading investment portfolio. Funding: The bank uses a combination of USD benchmark and MTN issues across a range of currencies, with a majority of its funding in USD. In 2009, IADB executed five benchmark global bond issues in US$ with two-, three-, five- and 10-year maturities for a combined US$9.5bn (US$11.1bn in 2008). In 2008 and 2009, all non-US$ borrowings are swapped into US$. Assets and .liabilities, after swaps, are held primarily in US$, but also in euro, JPY and CHF.
Strengths
Conservative financial polices. Preferred creditor status. Strong capital base, with borrowing well covered by investment grade callable capital.
Weaknesses
Strength of demand for IADB loans. Innovations to widen IADBs effect on the region. Exchange rate moves affect asset-liability matching.
Key points for 2010

Latin American economic prospects and its inter-linkages with the US. 10 June 2010 Trends in asset quality: further scope for improvement?
350
Public sector
$ 2005 2006 2007 Balance sheet summary ($ bn) Total assets 65.4 66.5 69.9 Disbursed loans 48.0 45.8 47.9 Cash and investments 13.8 16.1 16.4 Total borrowings 45.1 44.7 47.0 Subscribed capital 101.0 101.0 101.0 Paid in capital + reserves 18.7 19.8 20.4 Income statement summary ($ mn) Net interest revenue 1,038 984 756 Operating expenses 399 448 537 Write-downs & LLPs -14 -48 -13 Net inc bef Acc. Adjust 712 627 283 Net income 762 243 134 Profitability (%) Return on average assets 1.1 0.4 0.2 Return on average equity 4.1 1.3 0.7 Cost/Income ratio 36.4 43.6 66.5 Net int rev/Op inc 94.6 95.8 93.7 Gearing, debt leverage & capital ratios (%) Loans/Paid in cap & res 257.0 231.9 235.6 Loans/Subscribed cap & res 41.7 39.5 41.0 Callable capital/Debt 214.3 216.2 205.3 Paid in + res/Total assets 28.6 29.8 29.1 Asset quality (%) Non-accrual loans ( mn) 196.0 66.0 2.0 Non-accrual/Total loans 0.4 0.1 0.0 Cum LLPs ( mn) 175 90 70 Cum LLPs/Total loans 0.36 0.20 0.15 2008 72.5 51.0 16.4 49.4 100.9 22.1 2009 84.0 57.9 20.4 60.3 105.0 23.3 % chg 15.9 13.5 24.4 22.1 4.0 5.6
Inter-American Development Bank (IADB)

25 20 15 10 5 0 -5 -10 0
(436) 1,814 -516.1 508 624 22.8 93 -21 NM -972 1,294 -233.1 (22) 794 -3,709.1 0.0 -0.1 -136.9 117.5 231.5 43.1 195.6 30.5 288.0 0.6 169 0.33 1.0 3.5 32.9 95.6 248.7 46.8 166.9 27.8
10
12

100 50 0 -50 Jun-09
Sep-09 Dec-09 IADB 4.375% Sep 12 IADB 3.875% Feb 20
Mar-10 IADB 4.250% Sep 15

12 10 8 6 4 2 0 9.8 6.5 4.7 3.3 3.7 3.4 4.5 2.9
148 0.25
2003
2004
2005
2006
2007
2008
2009
2010 yt May

7 6 5 4 3 2 1 0 5.0 1.5 6.2 3.1 1.7 1.9 0.4 2020-2029 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 6.1 1.7 2.2 3.1 0.4 >2029
JPY 4.6% AUD/NZD/ CAD 21.2% GBP 4.4% EUR Others 4.7% 7.9%
USD 57.3%
General Reserves 12.5% Callable 81.2% Paid-in 3.5%
Guyana Haiti 10.4% Ecuador 3% 5.8% Uruguay Nicaragua 4.0% 13.3% Peru 6% Ecuador 10.1% Others 13%
Other Reserves & Retained Earnings 2.9%
Dominican Other 8.3% Rep. 6.9% Brazil 4.5% Bolivia 9%

351
10 June 2010
International Bank for Reconstruction & Development (IBRD)

Description
% $ Index 0.215 % Index 0.178 Total assets $275bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
IBRD is the major institution in the World Bank Group. Its key focus is funding projects geared to reducing poverty in middle-income developing countries. Its activities are global, although the loan book is concentrated in Asia, Latin America and central and eastern Europe. Despite high levels of country risk, its asset quality track record has been fairly sound. Overall, credit quality remains underpinned by its preferred creditor status, capital strength and conservative financial policies.
Risk weighting
Basel II RSA: 0%

Purpose: IBRD was established in 1945 to promote sustainable economic development and reduce poverty in developing countries. An increasing proportion of World Bank funding has been channelled through the groups concessional financing arm, the IDA, while new loans by the IBRD (at market rates) have been relatively static. With gross disbursements running substantially below repayments, the total loan book has been contracting. IBRD has also promoted the Heavily Indebted Poor Countries (HIPC) Initiative. Ownership and capital structure: The US is the largest shareholder (with 16.36% of callable capital), but ownership is spread across a wide range of governments, 186 in all. Member governments cover a broad range of sovereign ratings, but investment grade sovereigns provide almost 80% of the capital. In April 2010, a capital increase was announced after its last general increase in capital subscriptions in 1988. In recent years, capital growth has come from net income. At 30 June 2009, the authorised capital of IBRD was US$190.8bn. The announced capital increase has a total size of US$86bn and includes US$5bn in paid-in capital. In line with the capital increase a shift in voting power has been agreed, shifting voting power to developing countries. Asset structure and quality: Loans are advanced to governments, agencies and private enterprises (guaranteed by their respective governments). IBRDs credit risk is, therefore, all sovereign risk. Although the bank lends to inherently high-risk areas, IBRD is treated as a preferred creditor and has never written off any outstanding loans. Eventually all contractual principal and interest on its loans are collected; however, IBRD suffers losses resulting from the difference between the discounted present value of payments for interest and charges according to the related loans contractual terms and actual cash flow. In FY 09, non-accrual loans remained on a low level of about $0.5bn (c.0.5% of disbursed loans). Accumulated provisions for loan and guarantee losses increased from $1.4bn to $1.6bn as of end of June 2009. Debt leverage and gearing: The banks articles limit net loans and guarantees to the sum of subscribed capital, reserves and surplus; this ratio is currently 48%. The related equity/loans ratio has been trending upwards in the past few years, but decreased during FY 09 to 34.53% from 37.62% in 2008. IBRD set a specified prudential minimum for liquid assets, with the minimum being equal to the highest consecutive six months of expected debt service obligations plus one-half of approved net loan disbursements as projected for the relevant fiscal year. The FY 10 level has been set at $20bn ($19bn in the previous year). At 30 June 2009, the aggregated size of IBRDs liquid asset portfolio was US$36.8bn ($23bn in June 2008). During FY 09, new loans, guarantee commitments and facilities to member countries were US$32.9bn (US$13.5bn in FY 08). Lending to any individual country is limited by measures relating to the capital base. For FY 10, this limit has been set at US$16.5bn (an increase of US$1bn to FY 09). The largest exposure was to China, which had US$12.7bn of loans and guarantees outstanding at end-June 2009. Financial performance: The bank is not a profit-maximiser, but needs to generate sufficient net income to grow the capital base. Financial statements are prepared according to US GAAP principles. Mark-to-market effects of derivative positions have increased volatility in reported net income in recent years. IBRD reported US$3.1bn of net income in June 2009, up from US$1.5bn in 2008. On a fair value basis, IBRD reported a net loss of US$225mn as of 30 June 2009 after a strong net profit of US$1.1bn in FY 08. Funding: IBRD diversifies its funding via global offerings and private bond placements, designed to meet the needs of specific markets or types of investors. In FY 09, medium- and long-term debt (average maturity: 3.16 years) raised in financial markets amounted to US$44.3bn (US$19.1bn in 2008), via 374 transactions in 19 currencies (2008: 750 transactions). New funding is initially swapped to floating rate USD. Funding in FY 09 was increased to meet larger loan commitments due to the global financial crisis.
Strengths
Wide range of membership enhances international political support. The equity/loan ratio is high and a large proportion of callable capital is from high-grade countries and recent capital increase. Long-standing track record of good risk management. Conservative debt leverage and liquidity policies.
Weaknesses
Loans are concentrated in low-rated countries. Nevertheless, the asset quality track record is good, and there has been some diversification away from key Latin American borrowers. The loans are protected by a preferred creditor status.
Key points for 2010

Global economic conditions will IBRDs emerging market borrowers be affected by the global credit crunch? Focus on improving the effectiveness of international aid through supporting good governance
10 June 2010
352
Public sector
$ 2006 Balance sheet summary ($ bn) Total assets 212.3 Net disbursed loans 100.2 Liquid assets 24.7 Total borrowings 95.8 Subscribed capital 189.7 Paid in capital and reserves 36.5 Income statement summary ($ mn) Net interest revenue 2,012 Operating expenses 1,055 Write-downs & LLPs -724 Underlying net income 1,740 Net income (after adjustments -2,389 for FAS 133 etc)
International Bank for Reconstruction & Development (IBRD)

2007 2008 2009 % chg 207.9 233.6 275.4 95.4 97.3 103.7 22.0 22.7 36.8 87.8 87.7 110.0 189.8 189.8 189.9 39.9 41.4 39.7 2,240 1,065 -405 1,659 -140 17.9 6.6 61.7 25.5 0.1 -4.2
60 40 20 0 -20 0 5 10 15 20 25 30
2,632 1,728 -34.3 1,082 1,244 15.0 -684 284 -141.5 2,356 572 -75.7 1,491 3,114 108.9

150 100 50
Profitability (%) Return on average assets -1.1 -0.1 Return on average equity -6.4 -0.4 Cost/Income ratio 47.0 42.7 Net int rev/Op inc 89.5 89.9 Gearing, debt leverage & capital ratios (%) Loans/Paid in cap & res 282.4 245.0 Loans/Subscribed cap & res 48.0 44.8 Callable capital/Debt 186.0 203.2 Paid in + res/Total assets 17.2 19.2 Asset quality (%) Non-accrual loans ($ mn) 1,038 1,070 Non-accrual/Total loans 1.0 1.1 Cum LLPs ($ mn) 2,296 1,932 Cum LLPs/Non-accrual loans 221.2 180.6 Cum LLPs/Total loans 2.2 2.0
0.7 3.7 36.9 89.9
1.2 7.7 54.1 75.2
0 -50 Jun-09 Sep-09 Dec-09 Mar-10 IBRD 2.000% Apr 12 IBRD 2.375% May 15 IBRD 3.625% May 13 IBRD 9.750% Jan 16 IBRD 7.625% Jan 23
239.2 266.4 45.1 48.5 203.3 162.1 17.7 14.4 464 460 0.5 0.4 1,370 1,632 295.3 354.8 1.4 1.5

25 20 15 10 5 0 20.4 8.4
5.9
5.9
7.4 3.2
7.2
7.1
2003
2004
2005
2006
2007
2008
2009
2010 yt May

12 10 8 6 4 2 0 9.6 5.0 6.1 6.6 2.9 2.5 1.8
2010 2011 2012 2013 2014 2015 2016
7.5 JPY 18% ZAR 4% AUD/NZD/ CAD 15% EUR 5% Others 10%
4.4 0.9 0.1
2.8
2020-2029
>2029
2017
2018
2019
USD 48%
General Reserves 11.8% Callable 81.8% Other Reserves & adjustments 2.3% Paid-in 5.3%
China Brazil 12.0% 9.9% Argentina 5.7% Others 26.3% Colombia India Indonesia Mexico 5.4% 4.7% 8.1% 6.7% Philippines 2.2% Poland 3.0% Romania Russian Federation 2.3% Turkey 8.3% 2.7%
353
Peru 2.6%
10 June 2010
International Finance Corp (IFC)

Description
%$ Index 0.096 % Index NA Total assets 51.5bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
Moodys Aaa P-1 Stable S&P AAA A-1+ Stable Fitch NR NR NR
The IFC is the arm of the World Bank Group that focuses on supporting sustainable private enterprise in emerging markets through loan and equity finance without any direct government guarantees on its assets. Much smaller than its sister organisation, the IBRD, the high-risk nature of IFCs business is reflected in a much weaker asset quality than most MLIs. However, IFCs overall credit quality remains supported by a combination of high provisions, high levels of liquid assets, and conservative gearing and debt leverage.
Risk weighting
Basel II RSA: 0%

Purpose: The IFC was established in 1956 to support economic growth in developing countries by promoting private enterprise through the provision of both loan and equity finance. The IFC is the largest and only global multi-lateral source of debt and equity financing for private enterprises in developing countries. Ownership and capital structure: The IFC is a member of the World Bank Group. It is a separate legal entity, but membership is limited to member countries of the World Bank. Similar to the IBRD, it is noteworthy for its wide spread of ownership across 182 countries. Unlike other MLIs, IFC does not have callable capital virtually all of its capital is paid-in or represents accumulated earnings and other reserves. 51% of its capital is held by G7 countries, 24% of which is concentrated with the US as largest shareholder, 6% with Japan and 21% by Germany, the UK, France, Canada and Italy. Asset structure and quality: The IFC makes loans to and equity investments in private enterprises. Loans account for about 74% (2008: 70%) of IFC financing. The investment portfolio is widely diversified geographically. Among borrowing sectors, the finance and insurance sector represented 38% of the disbursed portfolio as of June 2009. The investment portfolio of loans, equities and debt securities has strongly increased over the past four years. Commitments and disbursements increased in FY 09, underpinning an increase in gross disbursed loans outstanding to USD16.8bn. Unlike most MLIs, IFCs exposure is not covered by sovereign guarantees, although, historically, it has been accorded preferred creditor status by its members, so that transfer risk is effectively very low. Credit risk is inherently relatively high, but asset quality has improved sharply in the past four years, though it increased again as of June 2009 to 2.7% from 2.4% in 2008. Total reserves against losses increased in FY 09 to USD1.2bn, compared with USD848mn in FY 08. This is equivalent to 7.4% of the disbursed loan portfolio. Debt leverage and gearing: To compensate for the higher risk profile of its asset portfolio, the IFC has conservative leverage and liquidity policies. The IFC aims to keep net liquidity of at least 65% of expected net cash requirements. On 30 June 2009, net liquidity was US$17.9bn (2008: US$14.6bn), representing 163% of liquid assets according to the guidelines. Liquid assets also include mortgage- and asset-backed securities. Financial performance: The overall market environment has a significant influence on IFCs financial performance. A strong upward trend in net income, after the FY 02 low (when emerging market financial pressures were at their worst), changed again in FY08, with heightened uncertainty replacing a rather stable environment of recent years. As an immediate result, income dropped in FY08 to US$500mn and in FY 09, IFC reported an overall net loss of US$151mn. IFC does not distribute dividends, so all net income in the past has boosted IFCs own capital. Funding: IFC executes a matched-funding policy, with virtually all of the funds for its lending activities being raised through the issuance of debt obligations in international capital markets. IFCs funding structure is built on three pillars: 1) issue of liquid USD-denominated global benchmark bond; 2) access public and private bond markets; and 3) promote development of emerging capital markets by borrowing in local currencies. In FY 09, IFC borrowed US$8bn equivalent (FY 08: US$6.3bn) in seven different currencies (AUD, BRL, CAD, JPY, ZAR, TYR and USD). 76% of issues in FY 09 were in USD. Since 2000, IFC issued each year a 5-year USD global benchmark bond. All borrowings are swapped into variable-rate US$. (Approximately 70% of all IFC loans are denominated in USD) As of June 2009, IFC maintained US$25.7bn in outstanding debt in 16 currencies.
Strengths
Conservative financial policies and aggressive provisioning policy. Strong capital base and membership support. High levels of liquidity on the balance sheet. Transfer risk is limited by preferred creditor status.
Weaknesses
Relatively high-risk investments. Substantial exposure to emerging market private sector entities, though its investment portfolio being well diversified on a sector basis.
Key points for 2010

Size of the ABS portfolio and valuation effects. Effect of global financial crises on asset quality. 10 June 2010 Continuing growth in the loan and equity portfolios
354
Public sector
$ 2006 2007 Balance sheet summary ($ bn) Total assets 38.5 40.6 Net disbursed loans 9.8 11.8 2.7 3.2 Net equity investments 23.3 21.7 Gross liquid assets 12.7 13.3 Net liquidity 15.0 15.9 Total borrowings 11.1 14.0 Paid in capital + reserves Income statement summary ($ mn) Net interest revenue 877 948 1107 2350 Other operating income 477 500 Operating expenses Write-downs & LLPs 15 -43 Net income 1263 2491 Profitability (%) Return on average assets 3.2 6.3 12.1 19.8 Return on average equity Cost/Income ratio 24.0 15.2 44.2 28.7 Net int rev/Op inc Gearing, debt leverage & capital ratios (%) Net loans & invest/Total cap 112.4 107.5 74.4 88.3 Total capital/Debt Paid in + res/Total assets 28.9 34.5 Asset quality ($ mn) Non-accrual loans 447 378 Accum LLPs 898 832 8.4 6.6 LLPs/gross disbursed loans (%) 2008 2009 49.5 14.1 7.3 22.6 14.6 20.3 18.3 945 1801 555 38 1612 3.6 10.0 20.2 34.4 51.5 14.9 5.3 25.1 17.9 25.7 16.1 893 111 629 438 -196 -0.4 -1.1 62.6 88.9 %ch 4.1 5.7 -27.0 10.9 22.2 26.9 -11.7 -6 -94 13 1053 -112
International Finance Corp (IFC)

10 5 0 -5 -10 -15 0 1 2 3 4 5 6

60 40 20 0 -20 -40 Jun-09
117.5 125.8 90.1 62.7 36.9 31.3 369 457 848 1238 5.7 7.7 23.8 46.0
Sep-09 Dec-09 IFC 4.750% Apr 12 IFC 3.000% Apr 14
Mar-10 IFC 3.500% May 13 IFC 2.750% Apr 15

6 5 4 3 2 1 0 5.6 3.3 1.7 2.3 1.3 1.1 1.1 2.6
2003
2004
2005
2006
2007
2008
2009
2010 yt May

4 3 2 1 0 2010 2011 2012 2013 2014 2015 1.9 1.8 2.0 2.1 3.7 2.8 1.6 0.3 0.1 0.1 0.2 2016 2017 2018 2019 0.7 2020-2029 >2029
Others 32.0% EUR 0.03%
JPY 10.3% GBP 1.0% USD 56.7%
Other Reserves & Retained Earnings 85.3%
Asset composition, YE 09
Sub-Sahara Other Africa 1.9% 8.0% North Africa & Middle East 9.4% Europe and Central Asia 27.0% Latin America and Caribbean 28.2%
Asia 25.5%
Paid-in 14.7%
10 June 2010
355
KFW Bankengruppe (KFW)

Description
Michaela Seimen
Ratings table
KfW (Kreditanstalt fr Wiederaufbau) was established in 1948 as a public law institution. It is the promotional bank of the Federal Republic of Germany, which owns 80% of the lender, while German states own the remaining 20%. KfW engages in lending to small and medium-sized enterprises (SME), entrepreneurship, environmental protection, housing, infrastructure, education finance, project and export finance, and development cooperation. Debt issued by KfW is explicitly guaranteed by the Federal Republic of Germany. With total assets of 400bn as at year-end 2009, slightly increased from 395bn in 2008, and more than 4,200 employees, KfW ranks among the 10 largest German banks.
Risk weighting
0% risk weighted. According to 28 of the Solvency Regulation, funding raised by KfW will be treated equal to issues of the Federal Republic of Germany for risk-weighting purposes (0%).
Key features
Explicit guarantee from the German state: The Federal Republic of Germany guarantees all existing and future obligations of KfW in respect of money borrowed, bonds issued and derivative transactions entered into by KfW, as well as third-party obligations that are expressly guaranteed by KfW. Further, following an understanding between the European Commission and the German Federal Ministry of Finance in 2002, the co-called Anstaltslast (maintenance obligation) and Gewhrtrgerhaftung (statutory guarantee) of the Federal Republic of Germany will continue to be available to KfW in respect of the promotional activities for which it is responsible. Whereas the maintenance obligation requires the public institution responsible for the lenders creation to safeguard the banks economic basis and enable it to maintain operations and meet its obligations as they fall due, the statutory guarantee is an unlimited guarantee, in which the owner is responsible for all the entitys liabilities. These forms of support render the explicit guarantee of secondary importance, except that it provides the basis for KfWs debt to be zero risk-weighted. According to the 2002 EU Consensus, KfW will keep its unconditional and explicit guarantee, as well as the maintenance obligation and deficiency guarantee in the future. Structure: KfW is organised in six main component business areas: Promotional activities are concentrated in KfW Mittelstandsbank for SMEs and in KfW Privatkundenbank for housing, environment and education. KfW Kommunalbank focuses on financing for public clients. Development activities related to emerging markets are handled by KfW Entwicklungsbank/DEG. In 2004, KfW IPEX-Bank was established as a bank within the main bank to cover export and project finance. Treasury and funding, securitisation and other capital market-related activities are centralised in the banks Financial Markets business area. Profitability: After KfW reported consolidated losses in 2007 and 2008, the institution returned to profitability in 2009, with a consolidated profit of 1.1bn as of year-end. The result was strongly driven by positive effects from the securities portfolio, as well as by higher risk provisions for lending business made in the worsening economic and financial market crisis. Highly favourable refinancing conditions also contributed to the improved performance of the lender. Funding: KfWs volume of business increased noticeably to 474.8bn and lending increased by 5% to 383.5bn. To refinance the increased business activities, KfW raised over the course of 2009, 74.7bn (2008: 75.3bn). About 47% of the funding volume has been raised via benchmark issues, split into 19bn and US$21bn issues respectively. As of December 2009 KfW had placed 412 transactions in 19 different currencies. Despite this wide diversification, the EUR remains the most important currency for KfWs issues with a share of 44%, followed by USD with 35%, GBP with 7%, JPY with 4% and AUD 4%. For 2010 KfW has announced a planned funding volume of 70-75bn. KfW intends to issues more large-volume benchmark bonds in the core currencies EUR and USD and in all maturities. Furthermore, other public bonds in EUR and other currencies as well as private placements usually round off the entities funding mix. As of 21 April 2010, KfW had raised approximately 35bn (46.7%) of its intended funding volume for 2010. Still, in our view, the 75bn total funding needs envisaged for 2010 could be subject to an upward revision as continuing economic stimulus packages and emergency funding in Europe might well influence the banks funding target.
Strengths
KfW benefits from being state owned and its explicit and unconditional guarantee, ie, the so-called Anstaltslast and Gewhrtrgerhaftung. Furthermore, KfWs liabilities benefit from an explicit state guarantee, which underlines the banks distinct role in German public policy.
Weaknesses
From 6.2bn in 2007, KfW again reported a consolidated loss of 2.1bn in 2008, mostly due to developments surrounding IKB and Lehman Brothers, as well as Iceland. Consequently, the Tier 1 ratio fell from 9.4% in 2007, to 7.8% in 2008.
Key points for 2010

Monitor KfWs profitability after the lender generated a second consecutive loss in 2008. Monitor any potentially higher-than-expected funding needs in 2010. 10 June 2010 KfWs involvement in the European emergency plan on behalf of the German government.
356

Balance sheet summary ( bn) Total assets Net Loans Share-holdings Debt securities Capital (own funds) Total borrowings of which debt securities Net interest revenue Operating income Operating expenses Pre-provision income Net write-downs & LLPs Net income Profitability (%) Return on assets Return on equity Cost/Income ratio Net int rev/Op inc Leverage and capital ratios Loans/Total capital (times) Total capital/Total assets (%) 18.3 4.4 16.6 5.1 19.9 4.3 26.7 3.1 25.1 3.4 0.28 6.7 30.4 79.3 0.46 10.3 28.9 88.3 -1.79 -39.0 30.9 89.3 -0.71 -19.9 29.0 90.2 0.28 9.0 25.2 90.3 359.6 289.0 19.5 38.3 15.3 323.5 246.0 1,568 1,979 601 1,378 332 973 334.4 282.5 2.9 38.9 16.7 300.0 240.1 1,754 1,986 573 1,413 -162 354.0 298.3 2.7 42.8 14.9 310.8 260.3 1,755 1,965 607 1,358 7,521 394.8 320.3 1.7 42.6 11.8 345.7 302.6 2,006 2,224 646 1,578 4,324 400.1 334.0 1.4 35.3 13.1 353.3 321.4 2,654 2,940 742 2,198 1,014 1,127 1.3 4.3 -15.8 -17.1 11.0 2.2 6.2 32 32 15 39 Nn -142 2006 2006* 2007* 2008* 2009* % Chg
KFW Bankengruppe (KFW)

40 20 0 -20 -40 -60 -80 0 5 10 15

75 50 25 0 -25 -50 -75 May-09
1,565 -6,167 -2,657
Aug-09 Nov-09 Feb-10 KFW 3.375% Jan 12 KFW 3.500% Jul 15 KFW 4.375% Jul 18 KFW 3.500% Jul 21
Debt maturity issuance (bn)

80 60 40 20 0 43.2 47.5 58.2 67.6 67.2 33.3
Note: KfWs accounts are drawn up in accordance with the requirements of the German Commercial Code, the Ordinance regarding the Accounting System for Banks, and the Law Concerning KfW. *IFRS was introduced for consolidated accounts in 2007. Debt maturity and currency structures are based on dealogic DCM Analytics data.
36.0
41.7
Debt maturity structure, May 2010 (bn)

75 50 24.8 25 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 48.2 53.5 35.7 29.6 20.9 30.4 12.4 10.5 10.6 13.3 8.2

USD 30% GBP 15% JPY 3% AUD/CAD/ NZD 5% Others 5%
EUR 42%
Capital structure, May 2009

Retained Earnings Fund for 36.0% General Banking Risks 0.4% Paid-in Capital 25.1%
10 June 2010
Loan distribution, May 2009

KfW Mittelstand sbank 20.3% KfW IPEXBank 24.9% KfW Entwicklung sbank 5.2% DEG 1.7%
Other Reserves 38.5%
KfW Foerderbank 47.9%
2010 yt May
357
2003
2004
2005
2006
2007
2008
2009
Kommunalbanken AS (KBN)
Description
% $ Index 0.076 % Index 0.027 Total assets NOK232bn LT senior unsecured ST Outlook
Michaela Seimen
Ratings table
Kommunalbanken (KBN) is the leading funding agency for the local government sector in Norway. It is 100% owned by the Kingdom of Norway. KBNs lending is restricted to Norwegian local government entities, and it benefits from strong central government support, control and supervision. KBNs asset quality is extremely robust, reflecting the credit quality of the local government sector, and it has never suffered loan losses. Strong growth in its loans reflects not only market share gains, but also local authority demand, driven by increased public service commitments. This is likely to continue to be reflected in a trend growth in funding through international markets.
Risk weighting
Basel II RSA: 20%

Purpose: Originally created as a government agency in 1926 and converted into its current form (as a limited company) in 1999, Kommunalbankens sole role is to provide low-cost funding to the local government and the local governmentguaranteed sector in Norway. As such, it is regarded as fulfilling an important public policy function. KBN has a market share of nearly 50% and is the largest lender to the Norwegian local government sector with more than 95% of Norways municipalities and counties having loans with KBN. Ownership and capital structure: Effective 24 June 2009, the ownership structure of KBN changed, whereby the government took 100% ownership of KBN by acquiring the 20% share held by the National Local Government Pension Fund (KLP, a mutual pension and life assurance company for Norwegian local governments). KBNs debt is not explicitly guaranteed, but the entity is supported by the central government in the form of a maintenance obligation, which affirms that the government is required to meet its financial obligations in a timely manner. The Ministry of Local Government and Regional Development appoints and controls all of KBNs governing bodies, and it is supervised by the Norwegian Financial Supervisory Authority (Kredittillsynet). Asset structure and quality: KBN lends over a wide range of maturities at very fine margins, but only to the local authority sector ie, local governments, inter-government entities and entities guaranteed by local or central government. The Norwegian local government sector is very robust in credit terms. Composed of 19 counties and 430 municipalities, it provides about two-thirds of public services, representing about 20% of GDP. Norwegian local authorities are tightly supervised and controlled by central government. Under the Local Government Act, a local authority cannot go bankrupt and the authorities are backed by an implicit government guarantee, which underpins expectations of timely payment. KBN has never experienced loan losses. Debt leverage and gearing: KBN has experienced strong growth in lending in recent years. In part, this reflects increased demand from local authorities to finance capital investment (the only purpose for which they are allowed to borrow), related to a widening range of responsibilities delegated to the authorities. Lending growth has also been driven by structural change in the local authority market, as direct competition from commercial banks has diminished, leaving KBN to compete primarily with Kommunekredit (the local authority subsidiary of KLP). As a result, KBNs market share has been growing: its share of lending to the local government sector reached 46.7% in 2009, from 38.5% in 2007. There is now less scope to increase market share, but local authorities investment should support growth in their underlying demand for funds. Net income grew strongly from NOK390mn as of year-end 2008, to NOK1.399mn in 2009, due to strongly increased net interest, as well as net gains on repurchases of issued securities and valuation of financial instruments. Capital adequacy: In recent years, capital increased through re-investment of the dividend and partly retained profits. In 2008, NOK500mn was injected via reinvestment of a previously declared dividend and share capital increases. The total capital ratio slightly decreased to 11.05% as of year-end 2009 compared to 11.6% at end-2008. Funding: KBN pursues a diversified funding strategy. In 2009, more than 95% of funding was raised outside Norway, through 508 transactions, across 15 different currencies. KBN targets both institutional (via 15-25% benchmark issues, 30-40% private placements and 10-20% institutional niche markets) and retail investors (20-50%). Outside NOK, the principal currency components of the debt structure are JPY, USD, AUD, GBP and CHF. Issuance has increased from NOK67.9bn in 2008, to NOK116bn in 2009. Liquid benchmark transactions are becoming more important: Two US$1bn benchmark bonds have been issued in 2009, with 3y and 5y maturities. KBN envisages a continuing programme of two to three benchmark transactions per year. For 2010, total issues of US$15bn of long-term debt are planned.
Strengths
Public sector ownership and maintenance obligation support from the central government. Robust credit quality of the Norwegian local government sector.
Weaknesses
Market share growth is approaching a limit, but with prospects of some continuous growth in local authority loan demand.
Key points for 2010

Will growth in financing needs for investment by the municipal sector continue? 10 June 2010 Risk weighting on loans to local authorities. The Norwegian banking regulator applies 20%. 358
Public sector
NOK 2006 Balance sheet summary (NOK bn) Total assets Loans Debt securities outstanding Capital (own funds) Sub debt and Hybrid Tier 1 Total reg capital Debt securities outstanding Net interest revenue Operating revenues Operating expenses Pre-tax operating income Tax Net income Profitability (%) Return on assets Return on equity Cost/Income ratio Net int rev/Op rev Capital adequacy (%) Tier 1 ratio Total capital ratio Total capital/Total assets 6.0 10.9 1.8 6.0 10.6 1.8 7.5 11.6 1.6 9.2 11.0 1.9 0.1 10.4 28.1 0.0 0.1 11.0 25.0 0.0 0.2 17.7 12.6 0.0 0.6 39.3 4.5 0.0 126.6 87.5 118.4 1.1 1.2 2.3 118.4 231.7 222.0 62.3 159.7 44.9 114.8 2007 142.4 101.7 136.3 1.3 1.3 2.6 136.3 281.7 266.5 66.7 199.8 56.3 143.5 2008 216.2 120.9 200.1 2.2 1.3 3.5 200.1 2009 % chg 231.9 153.0 223.6 3.6 1.0 4.0 223.6 7.3 26.5 11.7 61.5 -24.1 13.4 11.7 100.5 227.9 16.1 258.5 257.3 259.0
Kommunalbanken AS (KBN)
30 25 20 15 10 5 0 0 1 2 3 4 5 6
Income statement summary (NOK mn) 525.2 1053.0 621.2 2037.0 78.4 153.1 91.0 547.0 542.8 1946.0 389.7 1399.0

30 20 10 0 Jul-09 Oct-09 KOMBNK 5.125% May 12 KOMBNK 2.750% May 15
Jan-10 Apr-10 KOMBNK 2.875% Oct 14 KOMBNK 2.000% Jan 13

6 5 4 3 2 1 0 4.9 3.5 1.3 1.8 2.4 2.7 3.8 4.5
2003
2004
2005
2006
2007
2008
2009
2010 yt May

5 4 3 2 1 0 4.0 1.8 3.3 3.3 2.2 2.0 0.2 0.5 0.1 0.2
2020-2029 >2029 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
3.2 1.3 AUD/CAD/ EUR 1.2% NZD 16.9% CHF 3.8% GBP 5.7% JPY 23.6% Others 8.4%
USD 43.2%
Sub debt and Hybrid Tier 1 21.1%
Sovereigns an central banks, 6% Securitisation 0.2% Financial institutions Multilateral 5% development banks Public sector 7% entities, 8%
359
Retained profits, etc 51.9%
Regional authorities 74%
Share capital 27.1%

10 June 2010
Landeskreditbank Baden-Wuerttemberg Frderbank (LBANK)

Description
Michaela Seimen
Moodys Aaa Aaa Stable S&P AA+ AA+ Stable Fitch AAA AAA Stable
Ratings table
Landeskreditbank Baden Wrttemberg Frderbank (LBANK) is the state development bank of the German State of Baden Wrttemberg. It is fully owned by the state and benefits from an explicit and unconditional guarantee (ie, the so-called Anstaltslast and Gewhrtrgerhaftung). According to the 2002 EU Consensus, LBANK will keep its unconditional and explicit guarantee, as well as guarantor and maintenance obligation in the future. Since its foundation in 1998, LBANK funds itself through the issuance of registered bonds and notes (Schuldscheine), as well as German domestic notes (Inhaberschuldverschreibungen) on a stand-alone basis. In 2001, this was extended by a debt issuance programme, followed by an Australian MTN programme in 2004. LBANKs liabilities benefit from an explicit state guarantee.
Risk weighting
0% risk weighted. As a result of an explicit and irrevocable guarantee by the State of Baden-Wrttemberg, LBANK is 0%-risk-weighted. Under the Basel II standard approach, the risk weighting of the Federal Republic of Germany is applied to LBANK.
Key features
Explicit guarantees from regional state: LBANK is wholly owned by the German State of Baden-Wuerttemberg, which has provided an explicit and unconditional guarantee for all debt issued by LBANK. Further, Baden-Wuerttemberg has provided the so-called Anstaltslast (maintenance obligation) and Gewhrtrgerhaftung (statutory guarantee). Whereas the maintenance obligation requires the public institution responsible for the lenders creation (ie, Baden-Wuerttemberg) to safeguard the banks economic basis and enable it to maintain operations and meet its obligations as they fall due, the statutory guarantee is unlimited, as the owner is responsible for all the entitys liabilities. These forms of support render the explicit guarantee of secondary importance, except that it provides the basis for LBANK debt to be zero risk-weighted. According to the 2002 EU Consensus, LBANK will keep its unconditional and explicit guarantee, as well as the maintenance obligation and deficiency guarantee in the future. Sound asset quality: In 2009, LBANKs total assets decreased slightly by 2.6% to 59.7bn from 61.3bn in 2008, mainly based on decreased lending volume. Due to the global recession and businesses in Baden-Wuerttemberg being largely export focused, new financing volume to SMEs and business, the banks largest business segment, decreased by c.21% to 2.3bn in 2009, whereas the volume for loans related to the banks housing business slightly increased by 4.6% to 1.12bn. Due to lower tax income, local governments are currently somewhat financially constrained and business volume in this business segment therefore only slightly increased. As of year-end 2009, LBANK declared a portfolio of 2.4bn loans as problematic, which accounts for c.3.4% of the banks total loan portfolio, with part of these loans related to exposure in Saxony. Strategic alignment: LBANK mainly focuses on three segments: economic development, housing and infrastructure within Baden-Wuerttemberg. LBANK furthermore operates as a conduit for the states development and social programmes and promotes the building of new homes and the modernisation of existing ones by housing companies and individuals. In an attempt to provide public funds for the above purposes, LBANK has launched several programmes for families who receive funds at attractive interest rates. Also, LBANK provides financial support to small- and medium-sized enterprises in BadenWuerttemberg. Owing to a reduction in the banks balance sheet, its business volume decreased by 1.66bn to 70.6bn as of yearend 2009. Profitability: Driven by an increased interest rate income, LBANKs most important source of income, the bank was able to slightly increase its profit in 2009 to 50.31mn, up from 21.71mn in 2008. In 2008, LBANKs net profit slumped by 79% y/y from 102mn in 2007; however, profit maximisation is not a key objective for the bank. Due to the slow economic recovery, LBANK assigned 57mn to its fund for general bank risks, which currently stands at 304mn. Funding: As in previous years, LBANK still heavily relied on interbank funding in 2009, which stood at 19.2bn, slightly down from 25.5bn in 2008. However, this decrease has been partly offset by increased Commercial Paper issues. As of yearend 2009, the banks 30bn Debt Issuance Programme and 5bn Commercial Paper Programmes have been utilised with 16bn and 4.1bn, respectively. LBANK does not plan to issue Pfandbriefe. The bank issued two US$ and one EUR benchmark bonds in 2009, albeit the focus for the bank lies in private placements in EUR. From 10.8bn in 2009, LBANK plans funding of 7-10bn in 2010.
Strengths
LBANK benefits from being wholly owned by the State of BadenWrttemberg and its explicit and unconditional guarantee, which underlines the lenders distinct role in public policy.
Weaknesses
LBANK continues to hold a sizable portfolio of residential property loans in the State of Saxony, which continues to drain on loan-loss provisions.
Key points for 2010

LBANKs funding structure needs to be monitored. Performance of ABS and CLN portfolio. Performance of export-oriented business in BadenWuerttemberg and resulting impact on credit risk in the banks corporate portfolio. 360
10 June 2010

Balance sheet summary ( bn) Total assets Loans of which mortgages public sector loans Debt security holdings Capital (own funds) Total borrowings Net interest revenue Operating income Operating expenses Pre-provision income Write-downs & LLPs Net income Profitability (%) Return on avg assets Return on avg equity Cost/Income ratio Net int rev/Op inc Leverage and capital ratios Loans/Total capital (times) Total capital/Total assets (%) 0.3 7.2
Landeskreditbank Baden-Wuerttemberg Frderbank (LBANK)

60 50 40 30 20 10 0 0 2 4 6 8
2006 2007 2008 2009 % chg 52.0 59.5 61.3 59.7 40.9 43.2 41.7 41.1 16.1 10.2 5.9 1.9 5.5 1.9 9.5 5.1 2.0 9.0 5.5 2.1 -2.6 -1.4 -5.3 7.6 0.3 4.2 -3.2 12.0 11.0 32.1 2.1 na 135.9
9.6 14.2 16.9 17.0 46.0 52.7 56.3 54.5 373 443 179 264 42 139 328 395 114 281 1 152 0.3 7.8 346 398 118 280 148 21 0.0 1.1 387 442 156 286 124 50 0.1 2.5

60 40 20 0 May-09
Aug-09
Nov-09
Feb-10 LBANK 2.000% Oct 12
LBANK 4.125% Jul 11 LBANK 2.750% May 15
40.4 28.9 29.7 35.4 84.1 83.0 86.8 87.6 21.0 22.2 21.0 19.9 3.7 3.3 3.2 3.5

8 5 3 0 2010 yt May
361
5.4 3.1 3.5 3.8 4.0
6.0
6.2 2.9
2003
2004
2005
2006
2007
2008
EUR 57%
Note: L-Bank accounts are drawn up in accordance with the German Commercial Code and the Regulation on the Accounting Principles applied to credit institutions. Debt maturity and currency structures are based on dealogic DCM Analytics data.

8 4.9 4 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 3.6 3.9 3.1 2.3 0.3
1.7 0.1 0.0 0.0 0.1 0.1
Others 9%
USD 34%
Paid-in capital 12% Fund for general banking risks Unapprop 15% profit 2%
10 June 2010
Capital surplus 46% Retained profit and reserves 25%
Loans to banks 54% SME loans 21% Private customer loans 12% Public sector loans 13%
2009
Landwirtschaftliche Rentenbank (RENTEN)

Description
% Index 0.103 % $ Index 0.249 Total assets 78bn LT senior unsecured Bonds Outlook
Michaela Seimen
Ratings table
Landwirtschaftliche Rentenbank (RENTEN), is a specialised development bank ie, the central public refinancing agency for the German agricultural sector (including forestry and fishing), as well as for rural areas. It is headquartered in Frankfurt. RENTEN raises financial resources that are then on-lent to the domestic banking sector. The banks involved bear the credit risk and earn a spread for channelling the funds to the final beneficiaries. For its promotional activities, RENTEN does not receive funds from the German federal or regional governments (Bundeslnder). The bank does not accept deposits, nor does it provide direct credit lines.
Note: As at 26 May 2010. The issuer credit ratings on RENTEN are based on the support of the government of the Federal Republic of Germany under the legal concept of the so-called Anstaltslast (maintenance obligation).
Risk weighting
0% According to 28 of the Solvency Regulation, funding raised by RENTEN will be treated equal to issues of the Federal Republic of Germany for risk weighting purposes (0%).

Ownership structure: RENTEN was established by the Federal Republic of Germany as a public law institution through the socalled Rentenbank Law in 1949. Its roots, however, date back to Deutsche Rentenbank, which was founded in 1923 in an attempt to combat hyperinflationary problems. Being transformed into Deutsche Rentenbank-Kreditanstalt in 1925, the entity became the central refinancing institution for the German agricultural sector. Despite having built up RENTENs capital, neither the German agricultural sector nor any natural or legal entity, including the federal and Lnder governments, holds any property rights over the entity. In the unlikely scenario of RENTEN being dissolved (which would require new legislation), its net assets after payment of all outstanding obligations could only be applied to support the agricultural sector as a whole. Nowadays, RENTENs capital comprises mostly accumulated reserves and issues of subordinated debt. Governmental support: Being the central public refinancing agency for the German agricultural sector, RENTEN benefits from the so-called Anstaltslast (ie, an appropriate guarantee from the Federal Republic of Germany in the meaning of the Consolidated EU Banking Directive) being obliged by law to capitalise Rentenbank adequately and ensure the banks ability to do business operations. Its liabilities, thus, are effectively backed by the full faith and credit of the Federal Republic of Germany. Note that unlike KFW, however, RENTEN does not benefit from a statutory federal guarantee. However, following the ECs agreement in 2002 that the federal support for RENTEN is compatible with EU competition law, revisions to the Rentenbank Law reinforced its role as a federal development bank, and there is no prospect of a change in status. High asset quality: In 2009, RENTENs total assets fell to 75.8bn, from 87.9bn in 2008, as loans and advances to banks fell further to 46.4bn in 2009, from 61bn in 2007 and loans to customers decreased from 6.7bn to 1bn. RENTEN generally extends its loans via the borrowers principal banks, instead of directly via loans and advances to customers. As of year-end 2009, provisions for loan losses decreased from 58.2mn in 2008, to 40.4mn. RENTENs aggregated lending volume comprised 17.6bn in 2009. Funding strategy: RENTEN is funded through borrowings or the issuance of securities on domestic and international capital markets. The bank has two funding programmes for its international funding activities a 60bn EMTN programme and a 20bn ECP programme. As of year-end 2009, securitised liabilities amounted to 61.6bn, down from 68.9bn in 2008). The bank raised 10bn in 2009 (2008: 11.2bn); half of this volume was placed with domestic investors. For 2010, RENTEN advised of its medium and long-term funding plans of about 10bn. The bank intends to issue up to four EUR and USD benchmark bonds with maturities of up to 10 years, but focusing on maturities of five years and shorter. Benchmark issues typically account for 40% of RENTENs funding. Complementary, liquid issues in other currencies (non-core USD, Scandi currencies, GBP and JPY) and private placements are planned for 2010. As of 26 April 2010, RENTEN has raised about 5.4bn in medium and long-term funding. In the US, RENTEN is registered with the SEC under the Schedule B exemption for a foreign government, or political subdivision thereof.
Strengths
Sound capitalisation: As at year-end 2009, RENTENs total capital stood at 3.1bn, up from 3bn in 2008, including subordinated liabilities of 1.1bn (2008: 1.1bn). Reserves and the fund for general banking risks stood at 2bn (2008: 1.9bn). At 15.3% (2008: 12.3%), RENTENs Tier 1 ratio stood well above the regulatory requirements.
Weaknesses
Owing to its promotional policy mandate, RENTEN operates its special loans window at the expense of overall profitability. As a result of its non-profit mandate, RENTENs profitability has remained modest but stable over the course of the past years. Net profit stood at 11.3mn in 2009, from 10.8mn in 2008.
Key points for 2010

Further development of RENTENs refinancing costs.
10 June 2010
362

Financial summary
2007* 2008* 90.1 27.5 52.8 6.5 66.6 14.8 2.1 2.9 350.7 -47.0 42.4 261.3 202.9 464.2 0.5 22.9 14.0 115.5 12.4 19.3 3.3 2009* 77.8 27.9 45.8 0.6 60.3 9.4 2.2 3.0 381.0 -1.7 47.1 332.2 -409.1 -76.9 -0.1 -3.6 12.4 100.4 15.3 23.9 3.9 % chg -13.6 1.6 -13.2 -90.5 -9.5 -36.1 8.7 3.7 8.6 -96.4 11.1 27.1 NM -116.6 Balance sheet summary ( bn) Total assets 88.7 Securities portfolio 26.0 Amounts due from banks 60.2 Amounts due from customers 1.3 Funding - bond issues 64.9 Other borrowing 14.8 Equity 2.0 Liable capital 2.8 Income statement summary ( mn) Net interest income 199.8 Other operating income 2.5 Operating expenses 39.0 Net operating income 163.3 Provisions, FGBR, etc -112.3 Net income 51.0 Profitability (%) Return on assets 0.1 Return on own funds 2.5 Cost/Income ratio 19.3 Net int rev/Op inc 98.8 Leverage and capital ratios (%) Core capital ratio 10.4 Total capital ratio 16.7 Total capital/Total assets 3.2
Landwirtschaftliche Rentenbank (RENTEN)

80 60 40 20 0 -20 -40 0 2 4 6 8 10

75 50 25 0 -25 -50 May-09 Aug-09 Nov-09 Feb-10 RENTEN 3.875% Mar 12 RENTEN 3.250% Mar 14 RENTEN 4.375% Nov 17

16 12 8 4 0 2003 2004 2005 2006 2007 2008 2009 2010 yt May 8.7 15.1 12.3 14.5 14.1 10.6 7.8 5.2
Note: * Rentenbank implemented IFRS in 2007, and published comparative figures for 2006. Previous accounts are drawn up in accordance with the requirements of German banking regulations and the German Commercial Code. Debt maturity and currency structures are based on dealogic DCM Analytics data.

12 8 4 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 4.6 7.5 8.2 9.2 6.3 5.5 4.1 3.3 0.4 0.1 0.9 0.2

USD 49% GBP 4% EUR 25% Others 6% JPY 3% AUS/CAD/ NZD 13%
Subscribed capital 6% Principal and g'tee reserves 34%
Loans and advances to banks 59.9% Loans and advances to customers 0.8% Derivatives 3.7% Financial Investments 35.6%
Other ret earnings, reval reserve and net profit 58%
10 June 2010
363
Nederlandse Waterschapsbank N.V. (NEDWBK)

Description
% Index 0.185 % Index 0.083 Total assets 52bn LT Senior Unsecured Bonds Outlook
Michaela Seimen
Moodys Aaa Aaa Stable S&P AAA AAA Stable Fitch NR NR NR
Ratings table
De Nederlandse Waterschapsbank (NEDWBK) was founded in 1954 by the Dutch water boards (26 as of 2010) to provide them with funding for the substantial investments needed to attempt to better protect the country from potential floods. NEDWBK arranges short- and long-term loans for municipal authorities, provinces, public housing, healthcare, educational institutions and activities in the field of water and the environment. Since its founding, all shares in NEDWBK have been held by public authorities. With total assets of 52.4bn as at year-end 2009, up 8% y/y from 48.4bn in 2008, NEDWBK is one of the Netherlands largest banks in terms of assets. It refinances its activities on the international money and capital markets.
Risk weighting
Basel II RSA: 20%.
Key features
Sound market position: As the principal banker to the Dutch water boards (waterschappen), NEDWBK benefits from its undisputed market leader position in this segment with a market share of c.90% in 2009. Further, with lending to the Dutch housing corporation sector, NEDWBK is among the largest providers of funding guaranteed by Waarborgfonds Sociale Woningbouw (WSW a special, independent Social Housing Guarantee Fund secured via a backstop position of the central government and the municipalities), whose total guaranteed debt amounts to c.72bn, of which c.9bn needs to be refinanced on an annual basis. Potential governmental support: At the time of writing, all shares in NEDWBK (which, as at year-end 2009, had 33 employees) were held by Dutch public authorities. The water boards, which, in light of the Netherlands geographical location, play a crucial role in the country, are the dominant group of shareholders (81%). A further 17% is owned by the Dutch government and 2% by Dutch provinces. As the Dutch local governments are responsible for a large proportion of total government spending, NEDWBK, as one of the main funding sources, plays an important role in Dutch government finances. Rating agencies therefore believe that in the case of distress, the government would provide support to NEDWBK. Furthermore, there is widespread agreement that the Dutch government would not take any steps that would compromise the bank's ability to continue performing its role. In this context, we are not aware that the Dutch Ministry of Finance has indicated any plans to divest its participation in NEDWBK. Strengths Capital adequacy: As the majority of NEDWBKs lending benefits from a 0% risk weighting, at 51.4% (2008: 56%), NEDWBKs BIS solvency ratio is very high and markedly above the legal requirement of 8%. High asset quality: NEDWBKs loan book consists exclusively of loans granted to Dutch public sector entities, and/or loans guaranteed by public sector bodies. In 2009, NEDWBKs longterm loan portfolio increased to 40.2bn (2008: 35.9bn), with lending to the water boards accounting for 10% of all lending, lending to Dutch housing corporations accounting for a strong 60% , up from 56% in 2008, municipal and provincial authorities accounting for 17% and Healthcare institutions for 9%. Owing to a very high asset quality, NEDWBK has so far never suffered a loan loss with as a result of limited credit risk no losses being expected. NEDWBK therefore has made no loan-loss provisions. Funding: For its funding purposes, NEDWBK has established three different programmes: a 50bn debt issuance programme, a 15bn Euro-CP and CD programme and an AUD5bn Kauri Bond programme. In January 2009, NEDWBKs ECP programme was increased to a maximum of 15bn from 10bn previously and NEDWBK further increased its reliance on the CP market by issuing a large proportion in short-term securities. NWB issued in 2009 over 25bn in CPs with terms averaging four months. In 2009, NEDWBK raised 7.6bn in long-term funding, up from 6.3bn in 2008. Long-term funding is focused in EUR (57%), USD(15%) and CHF (15%). NEDWBK also issues in JPY, GBP and HKD.
Weaknesses Profitability: After NEDWBKs annual profit fell to 9mn in 2008, from 71mn in 2007, the bank reported an increased profit of 57mn in 2009, mostly owing to recovered market value results, which were driven by a fall in risk spreads. However, profit maximisation is in general not an objective for the bank.
Key points for 2010 Closely monitor the further development of NEDWBK profitability, particularly with regard to potentially further (un)realised losses in its fair value portfolio. Funding structure with high reliability on short-term funding.
10 June 2010
364

Total assets Loans & advances of which, Long term Liquid and Other assets Total capital Total borrowings Net interest revenue Operating expenses Pre-tax income Net income Profitability (%) Return on assets Return on equity Cost/Income ratio Net int rev/Op inc LT Loans/Total capital Capital/Debt securities Capital adequacy (%) Tier 1 / BIS Solvency Ratio Total capital/Total assets 110.0 115.0 96.0 53.2 51.4 3.8 3.7 2.8 2.2 2.0 Gearing and debt leverage (%) 2080 2199 2932 3432 3833 4.5 4.3 3.3 2.5 2.3 0.6 16.6 6.2 0.3 7.6 0.2 5.9 0.0 0.8 0.1 5.4
Nederlandse Waterschapsbank N.V. (NEDWBK)

30 20
8.3 8.1 11.8 9.6 0.1 11.5 -28.1 0.0
2005 2006 2007 2008 2009 %chg 33.2 35.2 38.8 48.4 52.4 31.0 32.6 35.0 42.1 45.5 26.3 28.8 32.0 35.9 40.2 2.2 1.3 2.6 1.3 3.8 1.1 6.3 1.0 6.9 1.0
Balance sheet summary (bn)
10 0 -10 -20 -30 0 2 4 6 8 10
28.2 30.1 33.2 41.5 46.2 126.0 125.0 114.0 128.0 92.0 9.0 15.0 13.0 13.0 13.0 197.0 98.0 71.0
Income statement summary (mn)

100 50 0 -50 May-09 Aug-09 Nov-09 Feb-10 NEDWBK 3.750% Jan 12 NEDWBK 4.250% Nov 13 NEDWBK 3.375% Jan 16 NEDWBK 4.375% Jan 18
136.0 143.0 94.0 12.0 76.0 533.3 9.0 57.0 533.3
9.5 12.1 50.0 14.4
86.9 79.1 106.5 492.3 102.2

8 6 4 2 0 2003 2004 2005 2006 2007 2008 2009 2010 yt May 5.4 3.2 5.0 5.7 6.4 6.1 6.9 4.8
Note: NWB switched to IFRS presentation of its accounts in 2005. Debt maturity and currency structures are based on dealogic DCM Analytics data.
Public debt maturity structure, May 2010 ( bn)

8 6 4 2 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 2.1 6.1 6.1 3.9 2.6 1.9 1.4 2.3 1.4 0.3 3.7 2.9

AUD/CAD/ NZD 5.0% Others 1.0% CHF 10.4% JPY 6.9% EUR 48.4%
GBP 6.1%
USD 24.0%
Provinces 1% Dutch State 8% Water Boards 91%
Other 4.5%
Housing corporations 59.9%
Water boards 10.4% Municipal authorities 16.5%
Healthcare 8.6%
10 June 2010
365

Description
% $ Index 0.045 % Index 0.512 Total assets 38.1bn LT Senior Unsecured ST Outlook
Michaela Seimen
Ratings table
Moodys Aaa P-1 Stable S&P Fitch AAA NR Stable
Network Rail Ltd was created in 2002 to take over the functions of Railtrack Plc. Its main operating company, Network Rail Infrastructure Ltd, owns and operates the UK rail infrastructure. Following the passage of the Railways Act 2005, debt issued under its MTN and debt issuance programmes will be directly guaranteed by the UK government.
Risk weighting
Basel II RSA: 0%

Purpose: Network Rail Infrastructure Ltd is the main operating company of the Network rail Group. It owns and operates the UKs railway infrastructure having taken responsibility for these in October 2002. Ownership and status: Network Rail Infrastructure Ltd is 100% owned by the acquisition vehicle Network Rail Holdco Ltd, which in turn, is a wholly-owned subsidiary of Network Rail Ltd. The latter was established in March 2002 as a company limited by guarantee (CLG) ie, a private company without shareholders, run along commercial lines. It was created solely for the purpose of acquiring Railtrack Plc, following the latters placement into railway administration in October 2001. As a CLG, it aims to make surpluses from its operations but instead of paying dividends, profits will be invested in improvements in the infrastructure. The company is owned by members, rather than shareholders, which include representatives of regional and local government, rail industry members and public interest members and a special member who may be elected by the Secretary of State for Transport. Debt programmes and support: Medium-term capital market funding was initially provided via a 10bn MTN programme in the name of Network Rail MTN Finance PLC. This was superseded in late 2004 by a 30bn Multi-currency Note Programme in the name of Network Rail Infrastructure Finance Plc. In addition, a 4bn Commercial Paper Programme has been put in place Both issuing vehicles are bankruptcy-remote vehicles and both programmes have received credit support from the SRA and the UK government. The Railways Act 2005 provided for support for Network Rail debt to be provided directly by the UK government through the office of the Secretary of State for Transport (a so called financial indemnity that expires in 2052 (maximum maturity date)). Financials: Network Rails financial year ends on 31 March. Since FY 07, Network rail has generated a profit as a result of higher track access charges and the ending of the deferral of revenue grants from the government, which had depressed revenues previously. As of FY 09, net profit decreased (deferred tax) to 609mn (2008: 1.2bn) owing to higher tax. Funding: The Office of the Rail Regulator (ORR) in its draft determination of Control Period 4 (which began in April 2009) supported Network Rails intention made in its Strategic Business Plan in April 2008 to restrict the use of government guarantees to solely refinanced debt. Thus Network Rail has underlined its intention to shift to a programme of corporate borrowing (ie, without government guarantee) as a means of financing new investment. Network Rail is financed primarily as a result of revenues in the form of direct government grants and track access charges. Revenue requirements are set by the ORR on a five-yearly basis and the current regime runs from April 2009.
Strengths
UK government guarantee.
Weaknesses
Dependent upon government support.
Key points for 2010

Acceptance and funding levels of corporate borrowing without government guarantee
10 June 2010
366
Public sector
mn FY06 FY07 Balance sheet summary Fixed assets 26,960 29,327 Total assets 28,098 30,604 Short term debt 4,186 2,862 Long term debt 14,207 15,725 Total debt 18,393 18,587 Shareholders funds 4,363 5,658 Income Statement Summary & cash flows Revenues 3,837 5,795 of which: Passenger franchise revenue 1,515 2,206 SRA revenue grants 1,983 3,227 Operatng costs -3,369 -3,517 Op Profit (ex exceptionals) 468 2,278 Net int & invest revenues -778 -902 Net income -253 1,035 Cash from operations 690 2,499 Net capex -2,917 -2,872 Net financing 2,230 535 Gross funding 9,090 10,435 Key ratios Gross Capex/Sales 80.5% 56.2% EBITDA margin 36.7% 57.5% EBIT margin 12.2% 39.3% EBITDA/Net int 1.8 x 3.7 x EBIT/Net int 0.6 x 2.5 x Total debt/Capital 74.6% 69.7% Net debt/Capital 74.6% 69.4% Net debt/EBITDA 13.0 x 5.5 x FFO/Net debt 4.1% 14.0% FY08 H108 H1 09 % chg 10.0 12.1 62.9 6.2 0.0 3.0 4.5 14.4 -4.9 7.2 0.5 10.0 -92.4 -4.3 28.8 39.9 -21.0

80 60 40 20 0 -20 -40 0 5 10 15 20 25 30
32,466 31,062 34,154 34,596 34,011 38,132 5,077 2,606 4,245 15,264 17,428 18,508 20,341 9,590 9,591 7,162 6,899 7,106 5,960 2,301 3,283 -3,548 2,412 -849 1,189 2,524 -3,203 1,029 5,444 59.5% 59.9% 40.5% 4.2 x 2.8 x 67.2% 66.6% 5.5 x 13.9% 2,984 1,446 1,346 -1,764 1,220 -428 591 1,712 -1,910 1,400 3,716 56.2% 59.9% 40.9% 4.2 x 2.9 x 67.6% 66.0% 5.2 x 8.6% 3,117 1,654 1,280 -1,891 1,226 -471 45 1,638 -2,460 1,958 2,934 67.7% 59.5% 39.3% 3.9 x 2.6 x 68.4% 66.7% 5.7 x 7.7%

50 30 10 -10 -30 May-09 Aug-09 Nov-09 UKRAIL 4.875% Mar 12 UKRAIL 4.750% Nov 35
Feb-10 UKRAIL 4.625% Jul 20

20 15 10 5 0 2003 15.2 6.1 5.4 4.0 2007 6.8 4.5

14 12 10 8 6 4 2 0 13.0 7.1 1.3 2.1 2.0 1.5 2010 2011 2012 2013 2014 1.4 0.7 2015 2016 2017 2018 2020-2029 >2029 2019
GBP 82.0%
USD 13.0%
Others 5.0%
6,000 4,000 2,000 0 -2,000 -4,000 4,298 245 1,140 1,558
Revenue growth, YE 09
7,000 5,799 6,000 5,000 3,283 3,227 4,000 1,983 2,206 2,058 2,301 3,000 1,515 2,000 1,435 376 361 307 339 362 1,000 0 FY05 FY06 FY07 FY08 FY09* Passenger Franchise Revenue SRA revenue grants Other Revenues
367
Called up share cap & share prem
Reval reserv
Other reserves
Cum P&L
10 June 2010
2010 yt May
2004
2005
2006
2008
2009
Note: Debt maturity and currency structure charts are based on dealogic DCM Analytics data
1.4
Nordic Investment Bank (NIB)

Description
% $ Index 0.060 % Index 0.120 Total assets 26bn LT Senior Unsecured ST Outlook
Michaela Seimen
Ratings table
NIB is a multi-lateral lender created by Nordic governments to provide long-term financing for investment projects that benefit the region, especially by strengthening competitiveness and enhancing the environment. At the start of 2005, its membership was expanded to include the three Baltic countries of Estonia, Latvia and Lithuania. NIB is one of the smaller multi-lateral lending institutions (MLIs) and is fairly highly leveraged, but it has strong membership support from its highly-rated government owners, a relatively low level of country risk exposure, a very good record for asset quality and high levels of liquidity on its balance sheet.
Risk weighting
Basel II RSA: 0%

Purpose: NIB was established in 1975 to provide medium- and long-term financing to support investment projects of benefit to the Nordic countries. This objective covers loans and guarantees extended within the Nordic region, as well as related projects in emerging markets. In 2006, the banks mission was revised to increase the focus on strengthening regional competitiveness and enhancing the environment. Ownership and capital structure: In 2004, a new agreement extended membership to the Baltic countries (Estonia, Latvia and Lithuania) that was implemented in 2005. However, NIBs ownership structure remains much more concentrated than other MLIs, with the five Nordic countries (Denmark, Finland, Iceland, Norway and Sweden) providing 96.6% of the capital base. The quality of its callable capital is very high, with 95.7% provided by AAA countries at end-2009, making it one of the strongest MLI in terms of capital quality. The inclusion of the Baltic members increased the banks authorised capital by 142mn, to 4,142mn. Ratings: NIB lends to public and private sector entities. Manufacturing, energy and transport and communications are the principal borrowing sectors, and there is a particularly strong focus on supporting infrastructure and environmental projects. The bulk of NIBs outstanding loans (85% at end-2009) is advanced within member countries, although new lending has been shifting towards non-members. Loans outside the member countries are made mainly via the Project Investment Loan (PIL) and Environmental Loan (MIL) facilities. A high proportion of PIL loans are protected by preferred creditor status and guarantees from NIB members. The asset quality track record has been strong, albeit in 2009 the bank categorised three loans totalling 24.1mn as non performing. As of year-end 2009, provisions increased to 101.3mn, up from 79.4mn in 2008. Debt leverage and gearing: The main constraint on leverage is a requirement that ordinary loans (within and outside the member countries) should be less than 2.5x the capital base (authorised capital plus accumulated general reserves). The ceiling for ordinary loans was EUR13.45bn at end-2009; separate limits apply to other lending. In particular, it has a EUR4bn limit on the PIL facility. In total, various measures of gearing and debt leverage rank NIB among the most highly leveraged of the MLIs, broadly similar to EIB. Liquidity levels are maintained at high levels: at end-2009, net liquidity amounted to EUR3.5bn (15% of total assets). Financial performance: Lending remained strong in 2009, with loans agreed of 1.4bn, but did not reach the target of 2bn, due to decreased loan demand based on difficult financial market conditions. Total assets remained stable at 22.4bn (2008: 22.6bn). Profit improved in 2009 to 324mn, after a loss in 2008 of 282mn. The loss in 2008 was a result of negative valuation effects on the treasury and higher levels of provisions. These effects have been reversed and improved in 2009. Funding: Capital market funding is spread across a wide range of currencies, although the dollar is the most important. It provided 34% (2008: 70%) of funding during 2009 and accounted for c.50% of outstanding debt at end-2009. Funding in euro accounted for 25% of new borrowings, but less then 10% of outstanding debt. After currency swaps, net exposure is mostly in euros, dollars and the Nordic currencies. In 2009, a total of 4.1bn was borrowed, via 71 transactions in 10 different currencies. Issuance included only one global USD benchmark transaction, compared with three in 2008. The bank focused in 2009 on an extension of maturities, which increased to 4.8 years in 2009, from 3.6 years in 2008. Total debt outstanding as of year-end was 18bn in 19 currencies. NIB targets funding of 4.1bn in 2010.
Strengths
Very high credit quality of member governments, providing strong confidence in callable capital. Relatively low levels of country risk compared with most MLIs. High level of balance sheet liquidity.
Weaknesses
Declining public sector guarantees for the loan book, but asset quality track record has been strong. Mark-to-market exposure to credit spreads on treasury portfolio.
Key points for 2010

Further growth in loan book Exposure to low-rated countries.
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368
Public sector
2006 2007 Balance sheet summary (bn) Total assets 18.0 20.0 Disbursed loans 11.5 12.3 Gross Liquid assets 3.8 4.5 Total borrowings 14.2 15.6 Subscribed capital 4.1 4.1 Paid in capital and reserves 2.0 2.0 Income statement summary (mn) Net interest revenue 178.8 187.1 Operating expenses 32.1 32.0 Write-downs & LLPs 0.0 0.0 Net income 137.5 68.7 Profitability (%) Return on average assets 0.8 0.4 Return on average equity 6.9 3.4 Cost/Income ratio 18.9 31.8 Net int rev/Op inc 105.4 185.8 Gearing, debt leverage & capital ratios (%) Loans/Paid in cap & res 570.7 603.4 Loans/Subscribed cap & res 200.8 213.4 Callable capital/Debt 26.1 23.9 Paid in + res/Total assets 11.2 10.2 Asset quality (%) Non-accrual loans ( mn) 0.0 0.0 Non-accrual/Total loans 0.0 0.0 Cum LLPs ( mn) 0.4 0.3 Cum LLPs/Total loans 0.0 0.0 2008 2009 % chg 22.6 13.1 4.8 17.5 4.1 1.7 25.8 13.8 4.4 18.0 4.1 2.1 14.1 5.4 -8.8 2.6 0.0 18.5
Nordic Investment Bank (NIB)

15 10 5 0 -5 -10 0 1 2 3 4
212.0 219.0 3.3 34.9 35.7 2.3 79.2 42.5 nm -423.7 323.9 -176.4 -2.0 -22.5 -11.3 -68.5 1.3 17.1 8.9 54.5

100 50 0 -50 May-09
755.1 671.2 239.5 238.4 21.2 20.7 7.6 7.9 0.0 0.0 0.0 0.0 79.4 101.3 0.6 0.7
Aug-09
Nov-09
Feb-10 NIB 2.375% Dec 11
NIB 3.625% Jun 13

5 4 3 2 1 0 2003 2004 2005 2006 2007 2008 2009 2010 yt May 2.0 1.5 1.6 1.8 3.7 3.9 3.5 1.5

4 3 2 1 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 1.1 3.0 3.3 2.0 1.4 0.6 0.4 0.2 0.2 0.4 1.4 2.6
Others 8.9% EUR 6.4% JPY 6.3% USD 54.1% GBP 10.4%
AUD/CAD/ NZD 10.5%
Statutory reserve 12% Other Callable 64% Paid-in 7% reserves & retained earnings 17%
Other 5.3% Loans to or guaranteed by government 13.3%
Loans without formal security 72.3%
Loans to or guaranteed by local authorities in member countries 2.6% Loans guaranteed by banks 6.5%
10 June 2010
369
NRW.BANK (NRWBK)
Description
% Index 0.225 % $ Index 0.005 Total assets 161bn LT senior unsecured Pfandbriefe Outlook
Michaela Seimen
Ratings table
Moodys Aa1 NR Stable S&P AANR Stable Fitch AAA AAA Stable
Until 2004, NRW.Bank (NRWBK), which now operates as the development bank of the German state of North Rhine-Westphalia, operated under the name Landesbank NRW. Its activities comprise supporting the states structural, economic and social policies, as well as the public tasks of the government institutions and agencies charged with implementing these policies. NRWBK benefits from an explicit and unconditional guarantee on behalf of North RhineWestphalia ie, the so-called Anstaltslast and Gewhrtrgerhaftung. According to the 2002 EU Consensus, NRWBK will keep its unconditional and explicit guarantee, as well as guarantor and maintenance obligation.
Risk weighting
0% risk-weighted. Under the Basel II standard approach, the risk weighting of the Federal Republic of Germany is applied to NRWBK.
Key features
Explicit guarantee from regional state: With effect from 1 January 2010, North Rhine-Westphalia now holds c.98.6% (previously 64.7%) of NRW.BANK, and the Regional Associations of the Rhineland and Westphalia-Lippe each hold c.0.7% (previously 17.6%). The change in the owner structure follows a special law that was adopted in December 2009 and came into force on January 2010 to increase the development possibilities of NRW.Bank. North Rhine-Westphalia has provided the so-called Anstaltslast (maintenance obligation) and Gewhrtrgerhaftung (statutory guarantee) to NRWBK. Whereas the maintenance obligation requires the public institution responsible for the lenders creation (ie, North RhineWestphalia) to safeguard the banks economic basis and enable it to maintain operations and meet its obligations as they fall due, the statutory guarantee is unlimited in that the owner is responsible for all the entitys liabilities. These forms of support render the explicit guarantee of secondary importance, except that it provides the basis for NRWBKs debt to be zero riskweighted. According to the 2002 EU Consensus, NRWBK will keep its unconditional and explicit guarantee, as well as the maintenance obligation and deficiency guarantee in the future. At end-April 2005, North Rhine-Westphalia provided an explicit guarantee of the book value of the banks holding in German Landesbank WestLB, thereby immunising the bank from valuation losses. Financial performance: Driven by a marked increase in its risk provisions and revaluations of adjustments, NRWBKs net income fell to 32mn in 2008, from 126mn in 2007. Due to lower operating costs and lower risk provisions, net income improved in 2009 to 170.8mn. Yet, as in the case of other development banks, profit maximisation is not a key objective for the bank. Asset quality: With total assets amounting to 161bn as at yearend 2009, NRWBK is Germanys second-largest development bank after KfW (and the third-largest in Europe). Public sector and development business totalled c.140bn as at year-end 2009 (ie, c.90% of NRWBKs total assets). Whereas 62% was from the public finance sector, social housing accounted for a 13% stake, followed by lending to SMEs (7%) and individuals (7%). NRWBK cooperates closely with regional lending institutions, which carry the risk on most of their lending products. Still, NRWBK usually administers these loans until they are repaid. Due to the difficult economic environment new business volume in the Start-up and SME business declined sharply, down c.20%, with new commitments of 2.4bn. Also Municipal and Infrastructure Finance new business volume declined by c.22% to 2.7bn, due to a fall in volume, despite nearly unchanged numbers of commitments. New business for individuals was down by 1.4% compared to 2008 with a level of 1.7bn. However, business volumes for housing programmes increased. As at year-end 2009, 53% of NRWBKs 160bn credit portfolio had a AAA rating, followed by 19% with AA and 14% with A. Social housing accounted for 13%, with the non-performing loans (NPL) ratio of 0.03% being markedly below the German average. Funding: Over the course of 2009, NRWBKs liabilities to banks decreased by 5bn to 48.6bn, mainly due to a decline in time deposits. Liabilities to customers slightly increased to 24.5bn and NRWBKs certified liabilities increased by 5.6bn to 63.3bn. In 2009, placed debt was about 18bn, including 4bn funding brought forward. NRWBK has three funding programmes in place: a 15bn Global Commercial Paper Programme, a 50bn Debt Issuance Programme and an AUS3bn Kangaroo Programme. NRWBKs annual funding strategy comprises about 12bn. The bank intends to further diversify its funding structure. Funding in 2009 was c.75% concentrated in EUR. USD issues comprised about 20% and other currencies (including 14 other currencies) represented about 5% in total funding.
Strengths
NRWBK benefits from its explicit and unconditional guarantee. Also, NRWBKs liabilities benefit from an explicit state guarantee that underlines the lenders distinct role in public policy.
Weaknesses
Given its role as a development bank, NRWBKs profitability remains low. Still, as in the case of other development banks, profit maximisation is not a key objective for NRWBK.
Key points for 2010

Further development of NRWBKs risk provisions and revaluations of adjustments.
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370

Financial summary
2006 Balance sheet summary ( bn) Total assets, of which 135.6 claims on banks 31.0 claims on customers 49.9 holdings of debt securities 48.7 equity holdings 2.4 Total borrowing, of which 111.3 debt securities 46.3 Equity 19.5 Total capital 20.0 Income statement summary ( mn) Net interest revenue 340.5 Operating expenses 186.4 Pre-provision operating incomc 170.6 Risk provisions and writedowns -12.8 of which WestLB write-down 0.0 Net pre-tax incomce 135.8 Pre-tax income (excl WestLB) 135.8 Net income after tax 101.9 Profitability (%) Return on assets 0.1 Return on equity 0.5 Pre-provison op inc/assets 0.1 Pre-provison op inc/equity 0.9 Cost/Income ratio 52.2 Net int rev/Op. income 95.4 Leverage and capital ratios (%) Capital/Debt funding 17.9 Total capital/Total assets 14.7 2007 151.0 36.1 54.1 55.0 2.4 126.7 53.2 19.6 20.1 317.7 201.5 176.2 3.9 0.0 171.6 171.6 133.6 0.1 0.7 0.1 0.9 53.3 84.1 15.8 13.3 2008 159.9 35.3 58.2 60.3 2.4 135.4 57.7 19.7 20.2 500.2 226.1 343.8 272.4 0.0 71.4 71.4 32.8 0.0 0.2 0.2 1.7 39.7 87.8 14.9 12.6 2009 161.0 32.8 62.0 59.9 2.4 136.4 63.3 19.9 20.4 490.5 182.6 403.7 204.7 0.0 199.0 199.0 171.1 0.1 0.9 0.3 2.0 31.1 83.7 15.0 12.7 % chg 0.7 -7.0 6.5 -0.6 -1.0 0.8 9.7 1.3 1.2 -1.9 -19.3 17.4 NM NM NM 178.7 NM
NRW.BANK (NRWBK)
30 20 10 0 -10 -20 -30 -40 0 2 4 6 8 10

75 50 25 0 -25 -50 Jun-09
Sep-09 Dec-09 NRW 3.625% Feb 12 NRW 4.375% Apr 22
Mar-10 NRW 3.500% Nov 15

20 15 10 5 0 2003 2004 2005 2006 2007 2008 2009 2010 yt May 6.0 9.8 5.9 16.4 14.8 12.9 9.3
Note: NRW.Bank accounts are drawn up in accordance with the German Commercial Code and the regulation regarding Accounting for Banks and Financial Services Institutions. Debt maturity and currency structures are based on dealogic DCM Analytics data. The outstanding maturity and currency structure charts include debt incurred by the former Landesbank NRW, but the issuance chart includes only debt issued in the name of NRW.Bank.

15 10 5 0 2020-2029 >2029 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 7.4 7.6 4.1 12.0 6.3 3.0 2.0 1.6 0.6 1.2 0.4 1.2
Public debt currency structure, May 2010

USD 13.7% AUD/CAD/ NZD 2.0% Others 4.5%
EUR 80.0%
Ownership structure, YE 09
Rhineland regional association 1% WestphaliaLippe regional association 1%
EU government related 17% National government related 41% Non-EU government related 4%
Treasury 9%
State of NRW 98%
Loans to individuals 8% Housing business Loans to 13% corporates 8%

371
10 June 2010
Reseau Ferre de France (RESFER)

Description
Michaela Seimen
Ratings table
Rseau Ferr de France (RFF) is a French public entity that owns the French rail infrastructure and has responsibility for its continuing development. Created in 1997, it is structurally loss making and financially dependent on state subsidies. RFFs Aaa/AAA credit rating is entirely dependent on outside financial support and its legal status as a French EPIC, which ensures that the French state takes responsibility for its solvency and liquidity. As the infrastructure owner, privatisation is regarded as a non-starter and a non-issue in France.
Risk weighting Basel II RSA: 0%

Purpose and business description: RFF was established as part of the 1997 reform of the French rail structure, acquiring ownership of the infrastructure (from the previously integrated rail operator, SNCF). Management of the network is contracted out to SNCF, leaving RFF responsible for policy matters and, specifically, for control over investment projects to extend the infrastructure. RFF continues to expand the high-speed rail network. The eastern HSL to Strasbourg opened to passenger traffic in June 2007. Plans for further expansion of the highspeed network include the South Europe Atlantic line from Tours to Bordeaux and the Rhine Rhone link. In 2009, investment spending increased to 3.4bn, from 3bn in 2008. Ownership and support: RFF is wholly owned by the French state and is a public entity with industrial and commercial character (ie, an tablissement public caractre industriel et commercial or EPIC), defined by its founding Law No 97-135. This status means that although its debt issues do not carry explicit government guarantees, the state is ultimately responsible for its solvency and for ensuring access to liquid funds. There is general agreement that there is no real prospect of privatisation for RFF, given its key public mission. Given that the rail reform that created RFF was designed to satisfy EC requirements for the separation of infrastructure ownership from operation, there is no EC pressure for a change of status; this was reaffirmed by the publication of a group of three EU directives on the railways in 2001. French government support is evidenced by RFFs dependence on state subsidies, as outlined below. Financial performance: RFF is financially dependent on French state support. The two key sources of operating income are infrastructure access fees (levied on SNCF) and infrastructure contributions from the state. A trend towards increased sourcing of revenues from access fees continued in 2009, however, state contributions increased again (by 40%) after reduced contributions in 2008. In past years, RFF has regularly made a large net loss, and the resultant substantial negative retained earnings have been balanced through a combination of capital grants and investment subsidies for debt reduction. In 2008, a change in the accounting approach for valuing assets increased assets substantially (by EUR11.3bn), with a corresponding increase in capital and reserves. This took the company back into positive equity at the end of 2008. Excluding the extraordinary income from asset revaluations, the 2008 pre-tax net result would have been -930mn, from -726mn in 2007. As of year-end 2009, RFF reported a profit of 418.3mn. Funding: On RFFs formation, the transfer of infrastructure assets from SNCF was mirrored by the creation of a liability to SNCF, under which RFF is responsible for servicing a substantial part of the debt still carried on SNCFs balance sheet. As time passes, the structure of RFFs debt is changing towards the bulk of its debt being issued in its own name. As would be expected for an infrastructure entity, the debt structure is relatively long term. Total debt remained stable in 2009. In 2009, RFF total debt issuance was c.EUR3bn (EUR3bn in 2008). So far in 2009, supply amounts to EUR150mn and GBP300mn. We understand that funding volume for RFF in 2010 will be around EUR1.3bn.
Strengths
State support enshrined in EPIC status and demonstrated on a continual basis by state subsidies and capital injections. No pressure for change of status, given its strong public policy role in France and the fact that it is seen as fitting EC models for infrastructure provision.
Weaknesses
Weak stand-alone financials entirely dependent on state support. High and growing debt levels.
Key points for 2010

Continuing development of the high speed rail network.
10 June 2010
372
Public sector
2006 2007 2008 2009 % chg Balance sheet summary (bn) Long term assets 24.8 26.6 37.8 40.1 42.5 Total assets 29.1 32.3 43.8 45.5 35.6 Borrowing 27.7 29.2 30.6 30.4 4.8 Retained earnings -21.9 -22.2 -23.0 -14.9 3.6 Total capital -2.5 -1.4 8.6 10.0 721.5 Income statement summary (mn) Infrastructure fees 2304.4 2448.5 2675.8 2855.9 9.3 State infrastructure contr 979.0 828.1 658.2 2325.8 -20.5 Other operating income 1294.0 1398.5 1655.9 1824.9 18.4 Gross revenues 4577.4 4675.1 4989.9 7006.6 6.7 Network + asset -2676.2 -2835.2 -2924.8 -2954.1 3.2 management payments Net operating income (OI) Depreciation Operating result Net int + other fin costs Net income Key ratios (%) OI margin OI/Net interest* Net income/YE assets Net income/YE capital FFO/Capex Capex/Revenue FFO/Total debt Total debt/Total assets Total debt/OI (times) Total debt/Cap (times) 896.6 788.3 799.1 2683.0 -536.7 -639.9 -829.1 -983.3 226.9 -68.8 -213.7 1565.4 -481.9 -584.1 -813.7 -1171.7 -283.4 -795.8 8098.0 418.3 19.6 186.1 -1.0 11.3 -1.7 45.5 -0.1 95.3 30.9 -11.0 16.9 135.0 -2.5 57.8 -11.5 51.0 -0.9 90.5 37.1 -21.2 16.0 98.2 18.0 92.2 1.6 58.2 0.1 70.0 38.4 3.6 38.3 229.0 0.9 4.2 69.1 45.5 7.2 66.9 11.3 3.0 1.4 NM NM NM NM
Reseau Ferre de France (RESFER)

50 40 30 20 10 0 0 5 10 15 20 25 OAS

40 30 20 10 0 Jan-10 Feb-10 Mar-10 Apr-10 May-10
RESFER 5.400% Feb 13 RESFER 4.450% Nov 17
RESFER 4.625% Mar 14 RESFER 4.375% Jun 22

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 3.0 1.9 1.6 1.9 2.1 2.2 1.6 1.1
Note: RFF accounts are available in accordance with French GAAP and IFRS. Our table has continued to use French GAAAP owing to incomplete availability of IFRS information. Debt maturity and currency structure charts are based on dealogic DCM Analytics data
2003
2004
2005
2006
2007
2008
2009
2010 yt May

10 8 6 4 2 0 8.3 5.2 0.3 2010 1.7 2011 0.5 2012 2013 0.7 2014 2015 0.2 2016 1.1 2017 0.1 0.4 2018 2019 2020-2029 >2029

USD 3.7% GBP 17.7% CHF 9.1% Others 1.9%
EUR 67.7%
Capital structure, YE 09 (French GAAP measure)

22,500 15,000 7,500 0 -7,500 -15,000 -22,500 8,909 856 418 14,682
Breakdown of total debt (bn)

30 25 20 15 10 5 0 21 23 25 28 28
16 14 14 12 16 11 10
18 8
20
-14,864 Initial cap endow. Retained earnings Investment grants
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Transferred SNCF debt RFF-issued debt
373
10 June 2010
Societe Nationale des Chemins de fer Franais (SNCF)

Description
% Index 0.042 % Index 0.044 Total assets 47.2bn LT senior unsecured ST Outlook
Michaela Seimen
Moodys Aaa P-1 Stable S&P AA+ A-1+ Negative Fitch AAA F1+ Stable
Ratings table
SNCF is a French public entity that operates French railway services and manages the infrastructure on behalf of Rseau Ferr de France (RFF), the infrastructure owner. In addition, the SNCF Group is involved in wide range of freight, logistics and infrastructure services. Although there is no timescale for the opening of the domestic rail passenger market, SNCF is increasingly moving into a competitive arena in other areas (Domestic freight and international rail passenger traffic). SNCFs credit standing is primarily dependent on its EPIC status. The social importance of SNCFs public mission renders privatisation unlikely in the foreseeable future.
Risk weighting
Basel II RSA: 20%

Purpose and business description: RFF was established as part of the 1997 reform of the French rail structure, acquiring ownership of the infrastructure (from the previously integrated rail operator, SNCF). Management of the network is contracted out to SNCF, leaving RFF responsible for policy matters and, specifically, for control over investment projects to extend the infrastructure. RFF continues to expand the high-speed rail network. The first phase of the eastern HSL to Strasbourg opened to passenger traffic in June 2007. Plans for further expansion of the high-speed network include the South Europe Atlantic line from Tours to Bordeaux (by 2015). Ownership and support: RFF is wholly owned by the French state and is a public entity with industrial and commercial character (ie, an tablissement public caractre industriel et commercial or EPIC), defined by its founding Law No 97-135. This status means that although its debt issues do not carry explicit government guarantees, the state is ultimately responsible for its solvency and for ensuring access to liquid funds. There is general agreement that there is no real prospect of privatisation for RFF, given its key public mission. As the rail reform that created RFF was designed to satisfy EC requirements for the separation of infrastructure ownership from operation. In May 2010 the EC asked the French government to change the status of SNCF from an industrial and commercial public undertaking into a public company (Plc). We understand that this request has also been raised with other railway service companies in Europe to restore healthy levels of competition in European railroad transport. However, French government support is evidenced by RFFs dependence on state subsidies, as outlined below. Purpose and business description: SNCFs key role is the operation of French rail services and management of the French railway infrastructure on behalf of RFF. In 1997, the French government transferred the ownership of the infrastructure to the newly created RFF. SNCF was left with responsibility for operating services, and also for network maintenance and development on a sub-contracted basis. SNCF has also diversified into road (c.31% of business), sea (c.16%) and air (c.10%) transportation services. The key source of growth in recent years has been the high speed TGV services, boosted most recently by the opening of the new eastern TGV line to Strasbourg in June 2007. Increasing involvement by French regions in the organisation and financing of regional services (following the SRU Law) should underpin increasing investment in regional services. SNCF has ambitious longer-term targets for growth in freight traffic and expansion of its logistics entity has been a key source of revenue growth. Liberalisation in the domestic freight market was completed in line with EC requirements in March 2006. However, plans to eliminate freight losses by end-2006 have been missed, and the division remained loss-making in 2007 and 2008. In 2009, this business segment was strongly affected by the difficult economic situation. Ownership and support: SNCF is wholly owned by the French state and is a public entity with industrial and commercial character (ie, an tablissement public caractre industriel et commercial or EPIC). This status means that although its debt issues do not carry explicit government guarantees, the state is ultimately responsible for its solvency and for ensuring access to liquid funds. SNCFs legal status was unaltered by the 1997 reform. Any future change would require new legislation. Although this cannot be ruled out indefinitely, the strong public policy role of the railways in France militates against a change in status. The current organisation seems to be fully compatible with EC requirements.
Strengths
EPIC status, with no pressure in France for privatisation. Political consensus on the importance of its public mission. Modern high-speed train network, which is driving the growing success in gaining market share for medium-distance travel.
Weaknesses
Rigidity of labour practices limits scope for rationalisation and improving profitability, but progress is being made with the move into more open markets.
Key points for 2010

Whether SNCFs increasing move into competitive activities could lead to any EC challenge of its EPIC status. Impact of global economic situation on results. Performance against targets for increasing investment and profitability. Continuing need for improvements in performance on the freight business. 374
10 June 2010

mn Balance sheet summary Total assets Receivable from RFF Assets net of RFF receivable Total debt Capital (Equity + Res) Income statement summary Total revenues Operating income (OI) Net income (Group share) Key ratios Operating income margin Net income/End yr assets Net income/End yr capital Total debt/Total assets Total debt/Operating income Total debt/Capital 13.0 1.8 8.0 41.1 5.2 184.0 17.3 0.1 -0.7 18.9 6.5 12.2 2.2 11.6 46.0 7.6 13.8 1.2 7.4 48.5 8.1 2006 2006 2007 IFRS 2008
Societe Nationale des Chemins de fer Franais (SNCF)

2009 % Chg
27 26
OAS
36,394 130,250 47,854 47,935 47,234 5,142 5,172 3,426 31,252 125,078 44,428 45,542 45,290 14,948 24,659 22,007 23,245 22,878 8,123 -23,260 8,986
0.17
2,393 1,944 -30.15 2.51 5.63
26 25 25 12.8
7,681 6,518 -14.52
13.0
13.2
13.4
13.6
13.8
21,875 21,965 23,691 20,886 20,105 -11.84 2,848 652 3,796 2,887 168 1,042 2,887 2,887 571 0.00

50 OAS
-980 -45.20 14.4 -2.1 -15.0 48.4 7.9
40 30 20 10 0 Jun-09 Sep-09 Dec-09 Mar-10 SNCF 4.875% Jun 23 (L)
-106.0 244.9
302.6 351.0
Note: SNCF implemented IFRS for the first time in 2007. Previous accounts were drawn up in accordance with French GAAP. Debt maturity and currency structure charts are based on dealogic DCM Analytics data
SNCF 4.625% Feb 24 (L)

3.0 2.5 2.0 1.5 1.0 0.5 0.0 2.7 0.9 1.2 0.6 2004 2005 1.1 0.9 0.9

6 5 4 3 2 1 0 4.9

USD 22% GBP 13% CHF 13% EUR 48% Others 5%
0.7 2010
0.2 2011
1.0 0.5 0.6 0.3 0.1 0.2 0.1 0.1 2020-2029 2012 2013 2014 2015 2016 2017 2018 2019
0.2 >2029
Capital structure, YE 09 (French GAAP measure)
Revenue growth (bn)

Total revenues 30 25.2 24.9 22.2 22.5 22.1 22.4 23.1 23.6 25 20.1 18.4 19.8 20
Minority interests 0.8% Reserves for contingencies and losses 10.2% Stockholders ' equity 89.0%
15 10 5 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
375
10 June 2010
2010 yt May
2003
2006
2007
2008
2009
Swedish Export Credit (SEK)

Description
% $ Index 0.041 % Index 0.009 Total assets SEK372bn LT Senior Unsecured ST Outlook
Michaela Seimen
Ratings table
Moodys Aa1 P-1 Stable S&P AA+ A-1+ Stable Fitch NR NR NR
Swedish Export Credit (SEK) is the key provider of long-term export finance in Sweden and is the only institution providing subsidised export credits on behalf of the Swedish government. More broadly, its business rationale can be described as the provision of long-term financial solutions for Swedish business, the public sector and financial institutions. As well as export finance, this includes participation in project and infrastructure finance.
Risk weighting
Basel II RSA: 20%

Purpose: Swedish Export Credit (SEK) was established in 1962, primarily to provide long-term export finance on commercial terms to Swedish industry and commerce. It is the key provider of long-term export finance in Sweden and the only institution providing subsidised export credits on behalf of the Swedish government, through the S-System. Export credit remains the key focus of SEKs business, although it is also involved in longterm loans related to project finance and investment, eg, in infrastructure and R&D projects. The overall rationale for SEKs activities can more broadly be described as the provision of longterm financial solutions in the areas of export and infrastructure finance for Swedish entities, including not only corporates, but also public sector entities and financial institutions. Ownership and status: The ownership structure has seen considerable change in recent years. From its establishment until 2000, SEK was 50%-owned by the Kingdom of Sweden and 50% by Swedish banks. From June 2000 until June 2003, ownership was split between the Kingdom of Sweden (65%) and ABB (35%). Since June 2003, it has been 100%-owned by the Kingdom of Sweden. The move to full government ownership reaffirmed SEKs key public policy role and the closeness of its links to the government. For regulatory purposes, SEK is treated as a financial institution, licensed by the Swedish financial supervisory authority. Its debt is therefore 20% risk weighted. Ratings: Moodys and S&P rate SEK just one notch lower than Sweden, reflecting the strength of support implicit in government ownership, but also the absence of any explicit guarantee covering the debt, or the companys solvency. Moodys, for example, says that an upgrade to the sovereign level would only be triggered by a full explicit debt guarantee from the Kingdom of Sweden. Financials: SEK has expanded strongly in recent years. In 2009, new lending increased by 89% to SEK122.5bn; 80% of lending has gone to the corporate sector. However, SEKs balance sheet remained unchanged, despite an increase in the banks asset portfolio, which was offset by a decrease in the liquidity portfolio and derivatives positions. Net interest revenues rose substantially from SEK143.9mn in 2008, to SEK1.7bn, due to positive changes of fair value positions. Asset quality and capital: Asset quality is protected by the widespread use of third-party guarantees, with a significant part of its loans being government backed. Provisions decreased from SEK557 in 2008, to SEK283mn as of year-end 2009. Provisions were mainly influenced by further write-downs related to an exposure to Glitnir and to loan losses and reversals in regard to Venantius (see below for details). The introduction of IFRS and transitional rules related to implementation of Basel II contributed to a sharp fall in capital adequacy ratios in 2007. However, these ratios improved substantially in 2008 and 2009, standing as of year-end 2009 at 18.7%. In December 2008, the Swedish government took the decision to contribute c.SEK3bn in additional equity to SEK, while allowing it to take over the shares in state-owned Venantius, contributing another SEK2.4bn and thus sharply increasing SEKs equity base. In addition, in December 2008, the Swedish Financial Supervisory Authority decided upon new regulations for calculating capital, with the effect that credit institutions can have a larger proportion of other capital than equity in their capital base. Funding: SEK has a wide range of well-established borrowing programmes and borrows in a broad range of currencies, notably in JPY markets. A large portion of its funding is through small-tomedium-sized MTN transactions and private placements (which are not fully covered in the public issuance chart), but during past years, the institution has also become increasingly active in USD benchmark issuance. In 2009, total long-term funding reported in its annual report amounted to SEK112bn, compared to SEK86.2bn as of year-end 2008. SEK carried out 617 transactions in 2009. Japan is a key market for SEK and provided 29% of its funding in 2009 (2008: 44%) The European markets accounted for 29% (9% in 2008) of SEKs total new borrowing, with one five-year euro public benchmark issuance. The US participated 24% in SEKs 2009 borrowings (32% in 2008). SEK issued a five-year USD global benchmark in 2009, which was SEKs first USD benchmark issuance since 2007. In 2009, a credit facility of up to SEK100bn and the opportunity to purchase estate guarantees on commercial terms for borrowing of up to SEK450bn was granted by the Swedish government to SEK. It did not use the SEK100bn credit facility provided in 2008 by the Swedish government.
Strengths
100% ownership by the Kingdom of Sweden. Public policy role in the provision of export finance. Strong asset quality.
Weaknesses
No explicit government debt or solvency guarantee.
Key points for 2010

Continuing diversification from export finance 10 June 2010 Impact of global financial crises and general economic situation. 376
Public sector
SEK 2006 2006 (IFRS) 245.2 91.1 123.9 4.3 7.4 211.9 793.0 786.3 285.0 501.3 355.5 0.16 8.9 5.0 36.2 100.9 2007 2008 2009 %chg
Swedish Export Credit (SEK)

200 150
297.3 109.3 159.9 4.5 7.5 267.3 370.0 158.8 161.8 10.4 13.7 306.0 371.6 186.9 152.7 13.5 16.6 320.7 0.4 17.7 -5.6 29.4 21.0 4.8 29.2 181.7 24.7
Balance sheet summary (SEK bn) Total assets Net Credits Liquidity portfolio Own funds Total capital Debt security funding Net interest revenue Operating income Operating expenses Pre tax income Net income Profitability (%) Return on assets Return on equity Return on total capital Cost/Income ratio Net int rev/Op. income Loans/Total capital Capital/Debt securities Total reg. capital ratio Total capital/Total assets 0.18 9.8 5.5 34.4 96.3 0.13 8.1 4.7 38.3 101.4 0.04 1.9 1.4 32.5 140.4 0.47 14.5 11.4 14.4 64.4 229.2 95.2 119.3 4.1 7.0 203.4 797.8 828.2 285.0 543.2 385.6
100 50 0 0 2 4 6 8 10
Income statement summary (SEK mn) 833.1 1,543.1 1,994.3 821.6 1,099.3 3,097.2 314.7 506.9 353.0 357.3 445.6

300 200 100 0 -100 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09
185.0 2,368.6 1,180.3 143.7 1,727.3 1,102.0
$ SEK 4.375% Dec 09 $ SEK 5.125% Mar 17
$ SEK 4.875% Sep 11
Gearing, debt leverage and capital adequacy (%) 1364.1 1294.1 1585.6 1330.8 1232.5 3.4 13.8 3.0 3.5 13.8 3.0 2.8 8.9 2.5 4.5 15.5 3.7 5.2 18.7 4.5

10 8 6 4 2 0 6.7 3.8 2.3 2.8 2.5 2.8 0.6 2003 2004 2005 2006 2007 2008 2009 2010 yt May 7.9

6 5 4 3 2 1 0 5.2 3.5 2.4 1.5 1.1 2012 2013 2014 0.6 0.2 2015 2016 1.5 0.3 0.5 2017 2018 2019 2.2 1.2
Others 8.8% ZAR 7.2% AUD/CAD/ NZD 5.4% EUR 22.0% JPY 15.4% USD 41.2%
2010
2011
2020-2029
Share capital 24.0% Subordinated debt 18.9% Profit for the year 10.4%
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>2029
Credit composition, YE 09
Reserves 8.2% Retained profits 38.4%
States and regional governments 13.0% Securitizati on position 9.0% Financial institutions 30.0% Corporates 48.0%
377
OTHER SUPRAS AND AGENCIES

While being less frequent borrowers in euros than most of the issuers for which we have prepared full profiles, the agencies and multi-lateral lending institutions included in this section are also of interest for AAA investors across various currency sectors. We have included charts illustrating issue flow from 2002 to May 2010 and the currency and maturity distribution of public debt for these entities at mid-May 2010. (The maturity structure charts include issues that matured in the first four and a half months of 2010.) In some cases, the charts are rather sparse, where, for instance, individual issuers have issued only occasionally, albeit in fairly large size or where the debt is virtually all in one currency. However, these charts do illustrate the variety of debt management approaches across the range of issuers. Furthermore, the individual issuers charts contribute to a wider overall picture of the sector, illustrating, for example, the episodic nature of issues that have been particularly associated with attempts to find new means of diverting funding away from government balance sheets. Some of these issuers also have smaller funding requirements than may be associated with the larger frequent borrowers that provide the core of the liquid, benchmark AAA market. Nevertheless, they can still add value to AAA portfolios. In some cases, this is through MTNs, which may be tailored to investors cash flow needs and also may provide incremental returns through varying degrees of structuring. In other cases, growth in issuers funding requirements is leading them into the benchmark markets, in which case they provide additional diversification opportunities within the liquid, tradeable AAA markets. Note: The charts for debt issuance and structure are derived from the dealogic DCM Analytics database. Particularly for issuers for which private placements account for an important part of their funding, the illustrated debt figures may fall short of the corresponding balance sheet data.
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African Development Bank (AFDB)

Fritz Engelhard +49 69 7161 1725 fritz.engelhard@barcap.com AFDB promotes African economic development

The African Development Bank (AFDB) is the key regional multi-lateral development bank for Africa. It was established in 1964 and aims to promote economic development and social progress, thereby contributing to poverty reduction, in its African member countries. It has 77 shareholding countries, of which 53 are regional members and 24 are nonregional. The banks loan and equity finance is mostly related to specific projects. Funds are provided to public and private sector borrowers. In addition to project finance, it provides programme, sector and policy-based loans to support improvements to economic management and structure. Loan maturities are generally between 12 and 20 years and are provided on market-based terms, but with grace periods of up to five years. The banks key operational priorities include a focus on the infrastructure sector (especially water and power), promotion of regional integration and good governance, strengthening private sector development and competitiveness. During 2006, the bank introduced major organisational changes designed to enhance the pursuit of these objectives, notably through increased decentralisation, by opening a network of offices in its regional member countries. The very low levels of income on the continent are reflected in the fact that only 15 countries currently meet the income criteria to borrow from the banks main lending arm as at year-end 2008. The remaining 38 member countries have to access the banks concessional arm, the African Development Fund (ADF), which provides grants and concessionary loans with terms of up to 50 years. In April 2010, a committee of governors representing the African Development Bank shareholders endorsed a tripling of the Banks capital resources to nearly $100bn and recommended acceptance by the full membership with approval likely to take place at the AGM to be held in late May 2010. The bank is also involved in multi-lateral debt-relief schemes, notably the Heavily Indebted Poor Countries (HIPC) Initiative and the Multi-lateral Debt Relief Initiative (MRDI), which have contributed to a sharp reduction in aggregate African debt burdens in recent years (eg, the aggregate external debt/GDP ratio has fallen from 52.8% in 2002, to 20.4% in 2008).
Focus on agriculture and rural development
Relatively high non-accruals
At end-2008 (the last date for which data are available), total assets amounted to SDR12.57bn, a 4% increase from SDR12.08bn at end-2007. Net loans outstanding represented 45.5% of the balance sheet. Impaired loans are relatively high compared with other MLIs, although they fell sharply in 2008. At end-2008, impaired loans represented 4.7% of gross loans (from 12.7% in 2006) and were 37% covered by accumulated provisions for impairment. The bank also holds a portfolio of securities for liquidity purposes. Of SDR4.58bn at end-2008, c.SDR0.5bn was in ABS and SDR0.9bn was in corporate bonds and CP.
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Figure 315: AfDB public debt Issuance (USDbn)

6 5 4 3 2 1 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 USD 65% AUD/ CAD/ NZD/ SGD Other 3% 11% JPY 10% ZAR 8% CHF 3%
Currency structure, May 2010
Maturity structure, May 2010 (USDbn)

3 2 2 1 1 0 >2026
380
2010
2012
2014
2016
2018
2020
2022
Agence Franaise de Developpement (AGFRNC)

Risk weighting Basel II RSA: 20% (0% for government-guaranteed issues).

Agence Franaise de Dveloppement (AfD) is Frances development bank. Its key function is to provide a channel for French official development assistance. It provides long-term development funding in more than 60 countries, French overseas departments and territories, although its business is concentrated in African countries. Lending has taken the form of long-term project finance, structural adjustment loans and subsidies, mainly to public sector borrowers. These are inevitably areas of high credit risk, but AfDs direct exposure is reduced in so far as it operates on behalf of third parties and benefits from state loan guarantees. High levels of doubtful loans are reflected in generous provisions, but ultimately the credit rating reflects the strength of state support. AfD is wholly owned by the French state and is an autonomous public industrial and commercial institution, ie, an EPIC. Under French banking law, the institution is also defined as a specialised financial institution, having a permanent mission in the public interest to promote economic development in developing countries and in the French overseas departments and territories. It is therefore subject to the prudential requirements specified by French banking legislation. AfD has its origins in the Caisse Centrale de la France Libre (in effect the treasury and central bank of Free France), founded in 1941. Functional evolution over the years has been reflected in a succession of name changes, most recently to AfD in 1998, as part of a reform under which AfD became the leading public institution for funding French development aid. It also lends on behalf of third parties, principally the French state, and channels French contributions to the IMF Poverty Reduction and Growth Fund. Most of its funding is provided on a subsidised basis. As an EPIC, AfD is subject to French public law. It cannot be declared bankrupt and the French government is ultimately responsible for its solvency and liquidity. Given the nature of its public mission, there is no real prospect of a change in this legal status. The euro is AfDs main issue currency, but it also has significant outstandings in GBP, JPY and CHF. All AfD debt used to carry an explicit guarantee from the French state. This is hardly ever the case now, but there are still some guaranteed issues outstanding.
AfD is Frances development bank, providing long-term development funding in more than 60 countries, French overseas departments and territories
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2024
In 2009, AfD has seen a 38% increase in its financing volume, from 4.5bn in 2008, to 6.2bn in 2009. Total assets grew from 14.1bn at YE 08 to 15.1bn at YE 09. The growth in lending activity was mainly driven by lending to Sub Saharan Africa (2.0bn), lending to the Mediterranean and Middle East (1.51bn), and lending to Asia Pacific (1.1bn). In terms of the type of lending, three-quarters of commitments break down between productive sectors (26.5%), infrastructure and urban development (25.5%) and the environment and natural resources (24.1%). Figure 316: AfD public debt, May 2010 Issuance (bn)
3.0 2.5 2.5 2.0 1.5 1.0 0.5 0.0 2010 yt May 2003 2004 2005 2006 2007 2008 2009 0.7 0.7 0.8 0.5 0.3 0.8 EUR 57.2% 1.1 0.7 0.7 0.1 0.0 1.0 0.5 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 0.3 0.8 Others 36.3% 2.0 1.5 1.1 0.4
Currency structure
Maturity structure (bn)

2.5 1.8 2.0
GBP 6.5%
ASFINAG (ASFING)
Leef Dierks +49 (0) 69 7161 1781 leef.dierks@barcap.com

Established in 1982, Autobahnen- und Schnellstrassen Finanzierungs AG (Ticker: ASFING) is responsible for the financing, construction, maintenance, and operation of the entire Austrian motorway and high-speed road network, which at the time of writing covered approximately 2,100km. ASFINAG also is in charge of road safety and traffic management, as well as collecting highway tolls. Debt issued by ASFINAG benefits from timely, unconditional, and irrevocable guarantee on behalf of the Republic of Austria. Note that the maximum amount of guaranteed debt that ASFINAG can issue annually is being decided upon by the Austrian Parliament. For the period from 2008 to 2014, a sum of 6.1bn has been earmarked for the construction or amplification of roads. Before ASFINAG established its 10bn EMTN programme in 2003 in order to raise funds directly in the market, a significant portion of its debt was provided by the Austrian governments funding agency. The EMTN programme has the benefit of a full, explicit, direct, unconditional, and irrevocable guarantee from the government. This is extended annually (as part of the Austrian budget law) for a predetermined drawdown amount of 2.3bn in 2010. ASFINAGs long-term financial debt increased to 10.2bn as at year-end 2008. Following moderate issuance of only 300mn in 2006, ASFINAG issued 1.3bn in 2007 and 1bn in 2008. In 2009, total issuance amounted to 1.8bn, ie, slightly less than the amount we expect to be issued in 2010 (2.3bn).
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Figure 317: ASFINAG public debt, May 2010

Issuance (bn)
2.5 2.0 2.0 1.5 1.0 0.5 0.0 2010 yt May 2003 2004 2005 2006 2007 2008 2009 0.3 1.8 1.7 1.2 1.3 1.0
Currency structure

2.0 1.5 1.5 1.0 1.3 1.0 0.8 1.0 0.0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029
USD 20.8% CHF 2.4% 1.5
1.0
0.5 EUR 76.8%
Source: Dealogic DCM Analytics, Bloomberg, Barclays Capital
Bank of England (BOEN)

Huw Worthington +44 (0) 20 7773 1307 huw.worthington@barcap.com As the UK central bank it attracts a sovereign-level risk weighting

The Bank of England is the central bank of the UK. It is government-owned; specifically, its stock is held by the Treasury Solicitor on behalf of Her Majestys Treasury. The bank operates under a constitution that was most recently modified and redefined by the Bank of England Act of 1998. Although government-owned, its debt is not explicitly governmentguaranteed. However, the closeness of the linkages to the government is clear enough and, as with other central banks, its debt attracts a sovereign-level risk weighting for capital adequacy purposes. Under the Basel framework and the ECs corresponding solvency ratio directive, this translates to a zero risk weighting. In 2000, the Bank of England Euro Note Programme replaced an earlier UK Government Euro Note Programme, in which notes were issued by the bank as agent for the UK Treasury. Under the earlier programme, obligations were, therefore, unambiguously UK government risk. In contrast, the Bank of England notes are not direct obligations of the UK government, but rather of the bank and have been issued to finance the banks own foreign exchange reserves, which it holds In support of its monetary policy objective.
Euro Note Programme has been replaced by a multi-currency debt issuance programme
In December 2006, the bank announced that it was terminating the Euro Note Programme. However, it indicated that it would continue to finance its portfolio of foreign exchange reserves by issuing medium-term securities on an annual basis. The currency and maturity may vary from year to year. The first such issue, a USD2bn three-year issue, was launched in March 2007, followed by further USD2bn three-year issues in March 2008, 2009 and 2010. The charts in Figure 318 only cover debt issued under the new MTN programme.
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Figure 318: Bank of England foreign currency debt Issuance (USDbn)

2.5 2 1.5 1 0.5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

1800 1600 1400 1200 1000 800 600
USD 100%
400 200 0 2010 2012 2014 2016 2018 2020

383
Caisse des Dpts (CDCEPS)

Risk weighting Basel II RSA: 0%.

CDC is a French public entity originally established in 1816. It is a 100% state-owned financial institution with a range of public remits, as well as more commercial activities. Its key functions include: centralising and managing tax-exempt savings deposits (about 200bn); managing public retirement funds; providing various segregated banking services (eg, it has a legallyappointed monopoly on holding deposits of the legal profession and is banker to the French social security system); various investments connected to local and regional development; and operating a major long-term institutional investment fund. A common thread to these functions is its role in underwriting the security of funds entrusted to it from various sources. CDCs French sovereign-level credit ratings are based primarily on its public entity status, but it is also seen as having a very strong stand-alone position and conservative strategy. According to Articles L518-1 to L518-24 of the French Monetary and Financial Code, CDC is placed under the supervision and the guarantee of the French parliament. The strength of the linkages to the state is also reflected in its zero risk weighting. In H1 09, CDC reported a net profit of 728mn, following a net loss of 1.5bn in FY 08. While CDC benefits from a quite stable deposit base, at end-2006 it created a 6bn EMTN programme. As the issuance chart illustrates, its issuance programme has gathered some pace over the past four years. In 2010, CDC plans to issue 2-3bn of term funding.
CDC is a financial institution with French public entity status
Strong state support
Access to international capital markets
10 June 2010
Figure 319: CDC EMTN issuance, May 2010 Issuance (bn)

3.0 2.5 2.5 2.0 1.5 1.0 0.5 0.5 0.0 2010 yt May 2003 2004 2005 2006 2007 2008 2009 0.1 GBP 6.2% CHF 10.5% 1.2 1.0 0.4 0.0 0.2 EUR 41.1% 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029
Currency structure
Others 42.1%

1.2 1.0 0.8 0.4 0.6 0.7 1.1 1.1 1.1 0.5 0.2 0.0
Caisse Nationale des Autoroutes (CNA)


CNA is wholly owned by the French government. Formed in 1963, its sole function is to act as a non-profit-making financing vehicle for public sector entities socits dconomie mixte concessionaires dautoroutes (SEMCAs) involved in the construction and operation of French toll motorways. Lending grew strongly in the mid-1990s to finance rapid growth in motorway construction. Its balance sheet is basically a match between loans to the SEMCAs and long-term borrowing, which is passed through on identical terms. Therefore, it acts as a straight conduit for funding. Most bond issues are for relatively long maturities of between 10 and 15 years. CNA has the legal status of an EPA (tablissement Public national caractre administratif). The French Government is, therefore, ultimately responsible for maintaining its solvency and liquidity. As a non-commercial public entity, it attracts a 20% risk weighting for capital adequacy purposes. CNA has a clear public role, namely to act as a financing vehicle for French public sector motorway operators. The latter were well supported financially, given their central role in the development and operation of transport infrastructure. However, in 2005, the French government announced its intention to privatise the main SEMCAs and this was accomplished during 2005-06. Although two smaller operators remain state owned, the demand for CNA funding decreased to a much lower level, as the privatised entities lost access to new funding by end-2009. CNAs outstanding debt will therefore trend lower over time.
Non-profit-making financing vehicle
EPA legal status
Lends to French public sector motorway operators
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Figure 320: CNA public debt, May 2010 Issuance (bn)

0.7 0.6 0.5 0.5 0.4 0.3 0.2 0.1 0.0 2010 yt May 2003 2004 2005 2006 2007 2008 2009 0.1 0.1 0.1 EUR 100.0% 0.4 0.4 Others 0.0% 2.0 1.5 1.0 0.5 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 0.3 1.0 0.4 0.4 0.2 0.6 0.7
Currency structure

2.5 2.0 0.3 -
CNAs public policy role and financial standing are unaffected by the trend contraction in its role and balance sheet. CNAs tablissement public status, with all that it implies in terms of ultimate state support, is, therefore, robust.
Erste Abwicklungsanstalt (ERSTAA)


Erste Abwicklungsanstalt (ERSTAA) is a German special purpose agency which was created to allow for an orderly run-off of non-performing or non-strategic assets of WESTLB AG (WESTLB). Between December 2009 and April 2010, WESTLB transferred a total volume of 77bn of such assets, as well as about 26bn of liabilities, mainly grandfathered and secured debt, to ERSTAA. The transferred grandfathered debt continues to benefit from the maintenance guarantees of WestLBs owners. Upon request of WESTLB, ERSTAA was established by the German Federal Financial Market Stabilisation Agency (Finanzmarktstabilisierungsanstalt or FMSA) in compliance with the provisions of section 8a of the Financial Market Stabilisation Fund Act. As ERSTAA is not considered to be a credit institution operating under the German banking act or under the EU Banking Directive, it is not subject to any regulatory capital requirements. Still, to the extent that it needs to act under its own name in order to fulfil its mission, the run-off of WESTLBs legacy portfolio, it is allowed to conduct banking and financial services business in Germany. ERSTAA is regulated and supervised by FMSA and the German banking regulator. ERSTAA is owned by the state of North Rhine-Westphalia (48.2%), the two regional savings banks associations of Westphalia (25%) and Rhineland (25%), as well as the two regional associations of Rhineland and Westphalia. It received 3bn of capital from WestLB and a further 1bn in guarantees from its owners. The owners are obliged, on a pro rata basis, to compensate ERSTAA for any losses not covered by the guarantees and equity. The liability of the two savings banks associations is capped at 4.5bn. In order to strengthen its funding profile, ERSTAA receives funds from banks and also plans to issue debt in the capital markets.
The first German wind-up agency
ERSTAA is regulated and supervised by FMSA and the German banking regulator
Owners are obliged to provide guarantees and capital
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Risk weighting and rating linked to the state of North Rhine-Westphalia
Under German solvency rules, the debt issued by ERSTAA benefits from a 0% risk weighting. The German banking regulator links the risk-weighting to the risk weighting of debt issued by the state of North Rhine-Westphalia, assuming that the state of North RhineWestphalia would regard itself as being obliged to ensure that ERSTAA would be able to fully and timely fulfil all of its liabilities. The liabilities of ERSTAA are rated AA-, Aa1 and AAA by S&P, Moodys and Fitch, and all three rating agencies have linked the debt rating of ERSTAA to the rating of the state of North Rhine-Westphalia (AA, Aa1, AAA).
European Union
Michaela Seimen +44 (0) 20 3134 0134 Michaela.Seimen@barcap.com

The European Union is engaged in sovereign lending via so-called balance-of-payments support and in the form of macro-financial assistance. It is our understanding that the latter form of support is exceptional in nature and is mobilised on a case-by-case basis to help the beneficiary countries deal with serious, but generally short-term, balance of payments or budget difficulties. The European Union is empowered by the Treaty on the Functioning of the European Union (the Treaty) to adopt borrowing and guarantee programmes that mobilise the financial resources to fulfil its mandate. The mandate has so far been used for balance of payments support to member states that have not adopted the euro and in a smaller proportion for the macro-financial assistance programme to assist third countries. As of December 2009, the amount outstanding for the macro-financial assistance programme was EUR585mn. The balance of payments support programme was revived in 2008, and as of January 2010, Hungary, Latvia and Romania requested and received medium-term financial assistance totalling EUR10.7bn. For the balance of payments facility, the Commission can draw additional resources from the member states to honour its financial obligations in a timely manner. There are currently 27 states that are members of the European Union, with borrowings of the European Union being ultimately guaranteed by the 27 member states.
Technicalities of the EU support facility

Under this facility, loans are granted only on a countrys specific request for support from the EU. The Council of the European Union consists of representatives of the 27 member states decides by qualified majority1 about the support the amount of the loan, instalments and the maximum overall maturity of the loan package. This is followed by negotiations with the European Commission (EC) in regard to the details of the loan, including conditionality, in close coordination with the IMF. The EC decides on implementation (financial terms, timing, etc.). The loans are financed exclusively with funds raised on the capital markets in euros only, and those funds are lent to beneficiary countries back-to-back, with the same coupon,
According to the definition by the European Union, a qualified majority (QM) is the number of votes required in the Council for a decision to be adopted when issues are being debated on the basis of Article 205(2) of the EC Treaty. Following the 2000 Inter Governmental Conference and the Nice Treaty, the number of votes allocated to each member state has been re-weighted, particularly for those states with larger populations, so that the legitimacy of the Council's decisions can be safeguarded in terms of their demographic representativeness. After 1 January 2007, following enlargement of the Union, the QM went up to 255 votes out of a total of 345, representing a majority of the member states. Moreover, a member state may request verification that the QM represents at least 62% of the total population of the Union. If this is not the case, the decision is not adopted. This equals roughly a two-thirds majority. Source: http://europa.eu
1
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maturity, etc., meaning each bond is specifically linked to an onward lending programme. It is not yet clear whether this would be the procedure for the extended programme as well. Given that the Commission and the beneficiary country have to agree on loan and funding parameters, EU bond issues are bound to the pace of these negotiations and can therefore not seek advantage of favourable market conditions. However, within these constraints, the EU intends to build a yield curve and enhance the liquidity of its issues wherever possible. In May 2009, the Council of the European Union amended the regulation for the establishment of a facility providing medium-term financial assistance for member states balance of payments2. Due to the scope and intensity of the international financial crisis, the demand for assistance in the member states outside the euro area was expected to increase. As such, the ceiling for outstanding amounts of loans to be granted to member states was raised from EUR25bn to EUR50bn. We expect this regulation to be adjusted by the additional support of EUR60bn in regard to Article 122.2 of the Treaty. In February 2010, the EU set a EUR20bn medium-term note programme in place, which we expect to be increased in the near term. As of today, 11 May 2010, the EU has six benchmark bonds outstanding with a total volume of EUR10.7bn.
Figure 321: Bond issues of the EU since December 2008

Bond EEC 3.25 09/12/11 EEC 3.125 03/04/14 EEC 3.25 07/11/14 EEC 3.125 27/01/15 EEC 3.625 06/04/16 EU 3.375 10/05/19 Total
Source: European Union, Barclays Capital
Amount EUR2bn EUR1bn EUR2bn EUR1.5bn EUR2.7bn EUR1.5bn EUR10.7bn
Issued Dec-08 Feb-09 Mar-09 Jun-09 Jul-09 Mar-10
Beneficiary country Hungary Latvia Hungary Hungary Romania Romania
Procedures in a default scenario

Should a beneficiary country default, the payments will be made from the budget of the European Union. EU member states are legally obliged to ensure that the budget always has sufficient funds to meet the EUs obligations. For this purpose, the Commission may draw on all member states. The general budget of the European Union for the financial year 2010 amounts to EUR141.5bn in commitment appropriations (in payment appropriations, the budget 2010 is set at EUR122.9bn). According to the EU euro medium-term note programme, to date, the EU debt has been serviced through borrower repayments. The Commission has also sometimes made available limited cash resources for short periods to service the debt when repayments from borrowers were not received in time. Based on a statement on the webpage of the European Commission, we understand recipient countries accept to give the Commission preferred creditor status, which means that reimbursements of interest and principal to the EU take priority over funds owed to other creditors. However, at this point in time, we have not been able to further clarify this in the context of cooperation with the IMF.
See Council Regulation (EC) No 431/2009 of 18 May 2009 amending Regulation (EC) No 332/2002.
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Fondo de Reestructuracin Ordenada Bancaria (FROB)

Michaela Seimen +44 (0) 20 3134 0134 Michaela.Seimen@barcap.com
Risk weighting Basel II RSA, 0%

Fondo de Reestructuracin Ordenada Bancaria the Fund for Ordered Bank Restructuring (FROB Bloomberg ticker FOBR) was established on 26 June 2009, in response to the recent financial crises.3 It is a legal entity, having been created by Royal Decree 9/2009. Its purpose is to assist in the restructuring and particularly consolidation of the Spanish banking system and to enhance the capital buffers of Spanish credit institutions. Beneficiaries of this support fund are credit institutions established in Spain. The support structure via FROB will be valid until 30 June 2010. However, given the relative slow process of the restructuring of the Spanish savings banks, we regard it as likely that this deadline will be extended. Spanish savings banks are among the financial institutions in Europe which are currently undergoing the most significant restructuring. Spanish savings banks grew strongly in the years leading up to the financial crisis and account for almost half of Spains overall lending. Owing to the importance of the sector for the Spanish economy, FROBs main focus will be to support this sector. It is our understanding that it is the aim of the Bank of Spain to reduce the current number of 45 Spanish savings banks by about 1/3 via mergers into stronger institutions. The objectives and functions of FROBs support are focused on temporary capital injections to stabilise banks and to assist via financial and management measures in the restructuring of the banking sector.
Support for the integration process of financial institutions

FROB provides support in this respect by temporarily injecting capital into banks, which is carried out by the subscription of preferential shareholdings. Once an integration plan has been approved by the Bank of Spain, these shareholdings are convertible under market conditions. Entities having benefited from this support must undertake a repurchase of the respective preferential shareholdings within a period of five years. This period can be extended by a further two years. FROB may convert preference shares into ordinary shares and therefore shareholdings with voting rights or capital contributions (depending on the nature of entities involved). Both fundamentally and non-fundamentally sound credit institutions are eligible for support from FROB. Fundamentally sound institutions are defined by certain cumulative conditions, among others, the institution may not present any weakness that can affect its viability in the light of the evolution of financial markets. Capital injections by FROB for fundamentally sound institutions may not exceed 2% of Risk Weighted Assets. This threshold can be exceeded if the additional amount of the capital is linked to the costs of the integration between banks to achieve greater efficiency and for institutions which are considered to be non-fundamentally sound. In these cases, special behavioural restrictions must be adhered to by the respective institutions.
Support for the restructuring process of Spanish financial institutions

The restructuring process is divided in three stages: The aim is to let the sector regulate itself as much as possible via initiatives driven by credit institutions themselves and, in the case of weakness institutions to try and find a private solution.
3 On 28 January 2010, the European Commission approved the suggested recapitalisation measures in favour of the banking sector in Spain in the form of support provided by FROB.
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In a second step, Spanish credit institutions can seek support of the relevant Deposit Guarantee Fund to ensure the respective entities viability, in case the Bank of Spain approves a presented action plan. Only as a third and final option, the Bank of Spain will appoint the FROB as the provisional administrator of a financial institution and a restructuring plan will be formulated, with the aim of a merger or the transfer (total or partial) of the entities business. FROB will provide support in the restructuring process via management and financial measures. Financial support measures include guarantees, loans with favourable conditions, subordinate financings, acquisition of asset, capital injections and others. Any credit institution benefiting from FROB support are bound to certain restrictions in regard to business growth, remuneration of senior management, dividend payments and any outstanding hybrid instruments.
Structure
The Fund for Orderly Bank Restructuring is governed and managed by a Governing Committee, which is composed of five members by the Bank of Spain and one representative of each Deposit Guarantee Fund (the Bank Deposit Guarantee Fund, the Savings Bank Deposit Guarantee Fund and the Credit Cooperative Deposit Guarantee Fund). All of these eight members are appointed by the Minister for the Economy and Finance. FROB is subject to Parliamentary controls. A quarterly reporting of the Secretary of State for the Economy is scheduled for the Economy and Treasury of the Congress of Deputies on the aggregated credit evolution, the situation of the banking sector and evolution of the activities of FROB. The Chairman of the Governing Committee of FROB will report to the Committee for the Economy and Treasury of the Congress of Deputies, within 30 days after a transaction has been undertaken by the Fund. Furthermore, the Governing Committee is supposed to report on the management of the Fund to the Ministry of Economy and Finance on a four-monthly basis. The Ministry of Economy has a preliminary report and the right to a veto. FROB benefits from a government guarantee, the terms of which are explained in more detail in the following paragraph.
Funding and government support

The FROB has been established based on a mixed funding model. The fund is capitalised with 9bn, of which 6.75bn have been charged to the General State Budget in 2009 and 2.25bn have been contributed from the Deposit Guarantee Funds. Individual contributions of each deposit fund are assigned according to the percentage of total deposits in credit institutions at the end of the fiscal year 2008. FROB may also fund itself on the securities markets by issuing fixed income securities, receive loans, apply to open credit facilities and undertake other borrowing transactions. However, external funding, regardless of the form of instruments, is limited to the sum of 10 times the funding available at any time. Currently, based on FROBs capitalisation, this equals to a maximal amount of 90bn. Asset/liability management: Any unassigned moneys of the Fund have to be invested into public debt or into other high-quality, low-risk assets.
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Figure 322: Financial Structure of FROB
Liquid assets
(current account, Public Debt)
Allocation
(Government6,750Mn) (FGD 2,250Mn)
9,000Mn
Preference shares
(mainly)
Marketable bonds
(or other kind of outside financing)
Up to 90bn
(leverage 10 x)
Source: FROB presentation from 27 October 2009, Barclays Capital
Under Article 114 of General Budget Law 47/2003 as of 26 November, the General State Administration is authorised to issue guarantees to secure the economic obligations enforceable against the FROB and derived from issues of financial instruments, agreements for loan and credit transactions and realisation of any other borrowing transactions made by FROB. The guarantees for FROB have been limited to a total of 27bn of principal plus the pertinent ordinary interests until 31 December 2009 and for subsequent financial periods, the maximum amounts for the issuance of guarantees will be as determined by the corresponding General State Budget Laws. In Art. 54 of Law 26/2009 as of 23 December 2009, on the State Budget for fiscal year 2010, 27bn have been set aside as endorsement to guarantee certain FROB obligations.
Only one benchmark issuance outstanding to date

On 12 November 2009, FROB completed an inaugural 3bn five-year transaction. The fiveyear maturity aligns the funding with the terms for restructuring operations. According to a press release on 12 November 2009 by FROB, the geographic distribution was as follows: 30% Spain, 15% Germany, 12% France, 11% UK, 9% Switzerland, 9% Middle East & Asia, 5% Scandinavia and 9% Others. By investor type, fund managers provided the core of demand with 37%, followed by banks with 28%. Central banks and insurance companies took 11% of the bond issuance.
Rating and regulatory treatment

The benchmark issue carries an explicit and irrevocable guarantee from the Kingdom of Spain. Owing to this guarantee, the rating of the bond is linked to the rating of the Spanish government, which is rated Aaa/AA/AAA by Moodys/S&P/Fitch, respectively. The Bank of Spain confirmed that FROB debt is 0% risk weighted and satisfies the necessary requirements to be included as guarantee assets (collateral) in the monetary policy operations of the European Central Bank.
Support to Spanish credit entities

As of the time of writing, FROB supplied financial support to four credit entities.
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According to a notice by Banco de Espana dated 22 May 2010, CajaSur, which with total assets of 19bn as of year-end 2008 accounts for about 0.6% of the assets of the Spanish banking system, has been taken into administration, with FROB acting as interim administrator. FROB also announced it will underwrite the equity needed to allow CajaSur to reach a solvency ratio above the minimum required and to facilitate the entity with sufficient liquidity to honour all of its commitments. According to media reports, Cajasur will be recapitalised with more than 500mn.4 In March 2010, the FROB Governing Committee stated its intention to provide financial support to three integration processes among credit entities, based on the integration plans being approved by the Bank of Spain. In a press release by FROB on 25 March 2010, banks involved in these measures and financial aid agreed were given as follows: Caja Manlleu (total assets of 2.6bn as of year-end 2008), Caja Sabadell (12.3bn as of year end 2008) and Caja Terrassa (11.8bn as of year-end 2008) with a support amount of 380mn; Caixa Catalunya (total assets of 63.6bn as of year end 2008), Caja Tarragona (10.8bn as of year-end 2009) and Caja Manresa (6.5bn as of year-end 2009) with a support amount of 1.25bn; Caja Duero (total assets of 21.4bn as of year-end 2009) and Caja Espana (25bn as of year-end 2008) with a support amount of 525mn.
With further mergers among Spanish savings banks planned, need for support by FROB likely to increase
According to media reports5, Spanish savings bank Cajastur may seek up to 1.6bn in support from FROB. Cajastur plans to combine with Caja de Ahorros del Mediterraneo, Caja de Ahorros de Santander y Cantabria and Caja de Ahorros y Monte de Piedad de Extremadura to form the fifth-largest financial group in Spain with more than 135bn in assets.
German Postal Pensions Securitisation (GPPS)


The German Postal Pensions Securitisation (GPPS) was created in 2005 as a securitisation vehicle. It was established in Dublin as a public company under the Irish Companies Acts 1963-2003. Following its founding, in June 2005, GPPS issued three tranches of debt with 2011, 2016 and 2021 maturities with an aggregate amount of 8bn. A year later, in June 2006, a second four-tranche transaction with maturities in 2010, 2017, 2022 and 2037 was issued in the aggregate amount of 7.5bn. Although separate issuing vehicles were used in the 2005 and 2006 transactions, the issuers have the same underlying form and purpose and are traded under the same ticker, thereby being treated as interchangeable in portfolio terms by financial markets. Note that all tranches issued over the course of 2005 and 2006 have been fixed-rate issues, with the exception of the 2037 issue, which is an FRN with a sinking fund that starts in January 2023. The proceeds of the issues were used to purchase receivables related to the payment of pensions that are due to retired civil servants who were previously employed by the Deutsche Bundespost or one of the postal successor companies (Deutsche Post AG, Deutsche Telekom AG, and Deutsche Postbank AG). Figure 323 and Figure 324 illustrate the transaction structure
Securitisation of receivables related to German postal pensions
4 5
Please refer to FT.com on 24 May 2010 Please refer to Bloomberg on 25 May 2010
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in terms of contractual rights/statutory claims and cash flows, respectively. The seller of the receivables was BPS-PT (Bundes-Pensions-Service fr Post und Telekommunikation), which is a registered association charged with handling pension payments to the aforementioned group of beneficiaries. Under the provisions of the Act on Postal Personnel Law, which was adopted as part of the Postal Affairs Reorganisation Act in 1994, BPS-PT collects payments according to an agreed schedule from the postal successor companies and the federal republic. From these payments, it makes pension payments as they come due. In addition to being one of the sources of regular payment flows, the Federal Republic of Germany was also required by the same legislation to make good any deficit between BPS-PTs receipts and obligations and is also required to ensure that BPS-PT is at all times able to meet its obligations.
Figure 323: GPPS transaction structure contractual rights and statutory claims
Postal Successor Companies 1 Obligation to make contributions 4 Pledge
Federal Republic
3 Funding claim pursuant to Bund Obligation
BPS-PT (Seller)
Issuer 2 Sale of Purchased Receivables and Sellers Guarantee
Claims under Notes
Noteholders
Source: GPPS plc Offering Circular June 2005
Figure 324: Cash flows

Postal Successor Companies Payments under Purchased Receivables Note 1 Proceeds Federal Republic 5 Payments under Bund Obligation BPS-PT (Seller) 2 3 Payments under Sellers Guarantee Issuer
4 Debt Service
1 Note Proceeds
Noteholders
Source: GPPS plc Offering Circular June 2005
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Further debt issuance is unlikely in our view
Following a review of securitisation operations undertaken by general governments, Eurostat in June 2007 decided that transactions of this type (where governments have committed to future payments and/or guarantees to the SPV) should be treated as government borrowing, thereby removing the benefit to German government debt ratios of this funding route. Therefore, we do not expect any further issuance from this vehicle. Still, this leaves the Aaa/AAA/AAA rating of the existing issues unaffected as it is already predicated on the ultimate risk lying with the German government. As a securitisation, the risk weighting has fallen from 100% under Basel I to 20% under Basel II, RSA. (We also expect it to be treated as 20% under the Internal Ratings Based (IRB) approach, given that it would be treated as a non-granular securitisation.)
Figure 325: GPPS public debt, June 2010

Issuance (bn)
10 8.0 8 EUR 100% 7.5 3 2.0
Currency structure

3.5 4
6 2 4 1 2 2013 2014 2012
3.0
1.5 1.0 2017 2018 2011 2010 2016
2015
0 2002 2003 2004 2005 2006 2007 2008
Source: Bloomberg, Dealogic DCM Analytics, Barclays Capital
Infrastrutture SpA (CDEP)

Huw Worthington +44 (0) 20 7773 1307 huw.worthington@barcap.com
(Moodys: Aa2/S&P A+/Fitch AA-) Risk weighting Basel II RSA: 0%

Infrastrutture SpA (ISPA) was established in 2002 as a limited liability company under Italian law and a wholly-owned subsidiary of Cassa Depositi e Prestiti (CDEP), with the function of funding major infrastructure projects in Italy. At that time, CDEP was a part of Italys public administration, but was converted in December 2003 into a limited liability company. It is now 70% owned by the state and continues to act as a specialist lender to public sector entities; in effect, it remains a financing arm of the Italian state.
ISPAs debt issues related to financing Italys high speed rail project
ISPAs public debt issues were all issued during 2004-05 under the 25bn ISPA High Speed Railway Funding Notes Programme, to fund project loan tranches granted to Rete Ferroviria Italiana (RFI) Spa and Treno Alta Velocita (TAV Spa) related to financing the Italian project to construct a high speed rail network.
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2021
2022
393
2037
1.5
3.0
Figure 326: ISPA public debt, May 2010 Issuance (bn)

7 6 5 4 3 2 1 0 2002 2003 2004 2005 2006 2007 2008 2009 ytd 2010 2.6 6.5 EUR 100.0%
Currency structure

4.5 4.0 3.5 3.0 2.5 2.0 1.0 1.5 1.0 0.5 2017
0.0
2019-2028 >2028 2010 2011 2012 2013 2014 2015 2016 2018
Debt service is backed by the Italian state
Debt service is provided through a combination of revenues from the project and state transfers from the Republic of Italy, which is also committed to making good any shortfall. The latter are not covered by a direct state guarantee but have been provided for under specific legislation (Article 75 of law No. 289 of 27 December 2002), a Ministerial Implementation Decree and a Credit Facility Agreement. This state support was the key to the sovereign level ratings applied by all three rating agencies, as well as the zero-risk weighting applied to the bonds. ISPAs transaction rights under the loan tranches relating to each issue of notes constitute segregated assets (patrimonio separato) that are available only to meet the obligations of ISPA towards the respective note holders. According to the programme offering circular, ISPA may only be liquidated by operation of law. In the event of the dissolution of ISPA and subsequent winding-up proceedings of any nature, the contracts relating to each pool of segregated assets shall continue in full force and effect. The entities responsible for the winding-up proceedings will provide for the debts owed by ISPA to the relevant ISPA creditors to be paid out of the specific segregated assets only, according to the maturity and other terms contained in the related pre-existing contracts. In May 2005, a Eurostat ruling required that the ISPA notes be consolidated with Italian government debt. This decision was based on the interpretation that the structure of the transaction meant that the risk of repayment remained Italian government risk. Although this ruling did not altogether prevent further funding through this route, it clearly made it much less attractive, given the continuing search for ways of reducing Italian government indebtedness. From a government point of view, therefore, the raison d'tre for a separate entity had effectively disappeared. Following this, the December 2005 Italian Budget Law enacted proposals to merge Infrastrutture Spa (ISPA) into its parent, CDEP, with effect from 1 January 2006; hence, ISPA has ceased to exist as a separate entity and the Bloomberg ticker for its debt issues has changed from ISPA to CDEP. In the 2005 Budget Law, articles 79-82, which confirmed the merger of ISPA into CDEP, also confirmed that the segregated asset provisions and the state contributions to debt service relating to the existing notes will continue unaltered after the merger. As a result, ISPA issues continue to attract sovereign-level credit ratings and risk weightings. (Downgrades of Italys sovereign credit ratings by S&P and Fitch in October 2006, to A+ and AA-,
394
Transaction rights are segregated assets
In 2005, Eurostat ruled that ISPA notes should be treated as government debt, leading to the merger of ISPA into its parent and adoption of the CDEP ticker
Terms of existing notes are unaltered but there will be no new supply in this form
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respectively, have therefore been reflected in CDEPs senior, unsecured credit ratings.) However, with ISPA dissolved, new issuance to fund the remainder of the high speed rail project will need to come in some other form, while trading liquidity in the existing issues will be limited by the absence of new supply.
International Finance Facility for Immunisation (IFFIm)

Huw Worthington +44 (0) 20 7773 1307 huw.worthington@barcap.com IFFIm was created to mobilise capital market funding to support immunisation programmes in developing countries

IFFIm is an international development financing institution established in 2006 to provide a vehicle for mobilising funding with which to expand and accelerate global immunisation programmes in developing countries. It was created pursuant to the UN Millennium Development Goals agreed in 2000, and in particular the fourth goal to reduce by twothirds the mortality rate of children under five by 2015. It was established in the UK as a private company limited by guarantee and is also registered as a UK charity. Financial management of IffIm has been outsourced to IBRD. Funds raised by IFFIm on international capital markets are used to finance vaccination programmes operated by the Global Alliance for Vaccines and Immunisation (GAVI). The intention is that, by accessing capital market funding, IFFIm enables the vaccination programme to be front-loaded. Bondholders will be repaid from the proceeds of grants committed by a group of governments led by the UK and France. Italy, Spain, Norway, Sweden and South Africa have also committed grants on a pre-determined schedule. All these grant obligations carry the full faith and credit of the respective governments. However, if recipient countries enter into protracted arrears to the IMF, donors obligations can be scaled down on a pre-determined basis. Limits on the gearing of debt issuance to donor commitments are intended to limit bondholders exposure to this risk. Although this structure has some characteristics of a government-backed securitisation, IFFIm has been classed as an international organisation by Eurostat for national accounting purposes and as equivalent to a multi-lateral development bank by the EC and the Basel Committee on Banking Supervision, which have therefore assigned a zero-risk weighting to its bond issues. According to its initial plans, IFFIm plans to raise up to $4bn in capital markets over a 10year period. Current donor commitments total $5.3bn spread over 20 years. So far, IFFIm has issued $1.7bn in bonds in a variety of currencies ranging from USD to ZAR.
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Figure 327: IFFIM public debt, May 2010 Issuance (USDbn)

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
ZAR 29% USD 46% NZD 4% AUD 5% GBP 16%

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 2011 2013 2015 2017 2019 2021 2023
396
KommuneKredit (KOMMUN)
Huw Worthington +44 (0) 20 7773 1307 huw.worthington@barcap.com Leading lender to the Danish local government sector Joint and several guarantees from members for KOMMUN debt

KommuneKredit is a specialised financial institution that is the leading lender to the Danish local authority sector, with a dominant market. It was originally established as a credit association under legislation passed in 1899 to provide loans to local governments and entities backed by local government guarantees. The members of the association are all the 98 Danish municipalities and five regions in the local government sector. The members are all jointly and severally liable for KommuneKredits liabilities. The Danish local government sector has robust credit quality, deriving from the close interaction with central government, an extensive equalisation system, low debt levels, limits on the purposes for which governments are allowed to borrow and a good track record for financial performance. Lending is only undertaken either to local governments or with the backing of a guarantee from local government. Notably, no local government in Denmark has ever defaulted: in cases of financial stress, they have been able to call on financial assistance from the Interior Ministry. In June 2005, legislation was passed to implement reform of the sector, including mergers to achieve a reduction in the number of authorities. The number of municipalities was reduced from 271 to 98, and the existing 14 counties were merged into five regions. Elections to the new bodies took place in November 2005, and the reform became fully effective as of 1 January 2007. In parallel with the local government reform, the legal framework for KommuneKredit has been updated with a new act that was adopted in April 2006. This leaves the key features of structure and support unchanged, but increases its minimum capital requirements, allows increased pre-funding (which will strengthen the liquidity position), and gives the Ministry of the Interior and Health increased authority to set financial guidelines.
Sector reform involved consolidation of authorities
Kommunekredits legal framework has also been updated
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Figure 328: KommuneKredit public debt, May 2010 Issuance (EURbn)

1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Swiss Franc 30% ZAR 2% US Dollar 11% AUD 3% 31% HKD 2% Other JPY 2% 12%
Maturity structure, May 2010 (EURbn)

1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 >2028
397
2010
2012
2014
2016
2018
2020
2022
2024
At end-2009, KommuneKredit had total assets of DKK143.2bn, an increase of 11.2% on a year earlier. Outstanding lending increased 6% to DKK111.5bn at end-2009, while cash resources increased to DKK7.1bn. At year end 2009 total equity amounted to DKK4.4bn or 3.2% of liabilities against a legal requirement of minimum of 1%. About 26% of new funding totalling DKK57bn came from the Danish domestic market in 2009, about 61% from European markets, with 10% provided by other markets and Japan fell to 3% from 14% a year earlier. As a result of the financial crisis, other types of funding in the capital markets were used. In particular, short-term funding in the form of CP issuance has been important, with CP issuance of DKK21.2bn in 2009 versus DKK 13.1bn in 2008. In 2009, KommuneKredit envisages long-term funding of 3.5bn in total.
Kommuninvest I Sverige AB (KOMINS)

Huw Worthington +44 (0) 20 7773 1307 huw.worthington@barcap.com Lender to the Swedish local government sector

KOMINS lends to Swedish local authorities and entities owned by them. It is owned by Kommuninvest Co-operative Society, a co-operative grouping of local authorities. Established in 1986 as a combination of local authorities in one area of Sweden, it became a national organisation in 1993 and has grown rapidly in terms of coverage since then, with the growth in 2009 seeing the second highest membership increase ever. It now has 248 members (241 municipalities and seven county councils, out of the countrys total of 290 municipalities and 20 county councils), and the company has a goal of continuing growth in membership such that by 2015 all 310 local governments are hoped to become members. KOMINS takes the form of a not-for-profit joint stock company and is supervised by the Swedish Financial Supervisory Authority. Lending is limited to member authorities and entities owned by them, of which municipal housing corporations are the main borrowers. Its market share in the funding of its members was 51% at end 2009.
Joint and several guarantees from robust local government members
All members also provide joint and several guarantees for KOMINS liabilities. As in other Nordic countries, the credit standing of the local government sector is robust. Local government in Sweden is responsible for c.74% of public consumption and c.25% of Swedish employment. Municipalities right to levy their own taxes is enshrined in the
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NOK 4%
NZD 3%
Swedish constitution, and locally-levied income taxes finance the bulk of local government expenditure. There is also a comprehensive equalisation system.
Rapid growth in coverage, which has driven a rising market share
KOMINS total assets have grown rapidly as it has continued to increase its market share of local authority financing, mainly through growth in its membership base. With total assets of SEK183bn versus SEK142.7bn, of which loans accounted for SEK123bn (SEK105bn in 2008), there is still potential for market share growth, as additional members are added. Net income grew markedly to SEK66.5bn from SEK44.54bn, as pressure on net margins fell. KOMINS issues debt under a 15bn EMTN programme alongside domestic and euro CP programs and Japanese and German private placement markets. Debt is issued across a wide range of currencies. With the growth in its balance sheet and funding requirement, KOMINS has launched USD1bn benchmarks regularly in recent years, and with funding needs likely to continue increasing, benchmark transactions are likely to be at least a periodic feature of KOMINS funding programme. However, it has also been an active borrower historically via structured and non-structured MTNs across a range of currencies, although this has reduced in importance latterly due to increased investor demand for more traditional instruments.
Figure 329: KOMINS public debt Issuance (EURbn)

4 3 3 2 2 1 1 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

3.0
AUD CAD 5% 1%
2.5
USD 41%
13% Other 0% JPY 14% NZD 2%
2.0 1.5 1.0 0.5 0.0 >2028 2010 2012 2014 2016 2018 2020 2022 2024 2026
CHF 14%
NOK ZAR 1% SEK 8% 1%
La Poste (FRPTT)
Fritz Engelhard +49 69 7161 1725 fritz.engelhard@barcap.com Originally, La Poste was formed as an independent, publiclyowned company EC pressure to end French governments unlimited guarantee for La Poste

La Poste was established in 1991, following the law of July 1990, which split the former French Postal and Telecommunication Service (formerly a government department) into La Poste and France Telecom. Originally, La Poste was formed as an independent publicly-owned company (Exploitant Autonome de Droit Public), which means that it was 100% owned by the French government and its status was similar to that of an EPIC. However, already the 1990 law required La Poste to operate on a financially independent and profitable basis. In October 2006, the EC published a recommendation that the French government end the unlimited guarantee that it provides to La Poste as a public entity. The commission argued that this support gives La Poste an unfair advantage and distorts competition within the French postal market. In its view, it therefore acts counter to the liberalisation of EU postal
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markets being pursued by the commission. The EC release states that this action does not call into question La Poste's public entity status per se, although it remains unclear how a removal of the solvency guarantee can be reconciled with retention of La Postes public entity status. More broadly, the ECs drive to liberalise postal markets has progressed further with the adoption by the EU parliament in January 2008 of the Third Postal Directive, which was then formally published in February. This directive sets a deadline of end-2010 for completion of the opening of postal markets to full competition. On 1 March 2010, the legal status of La Poste changed as it was transformed into a Socit Anonyme (SA), a public limited company. The transformation was accompanied by a 2.7bn capital injection from the French government and Caisse des Dpts et Consignations, the two owners of La Posta SA. The transformation law prescribes that the French Republic should keep a majority ownership in La Poste and it also assigns to La Poste the privilege of acting as the universal postal service provider for the next 15 years, with the obligation to maintain its network of 17,000 selling points.
S&P downgrade to A
Between December 2005 and April 2010, its rating was downgraded from AA+ to A. S&P linked the downgrades to the groups weak stand-alone credit profile and the reduction in mail volumes. S&P also revised the stand-alone credit profile on La Poste to a level consistent with BBB- from BBB. The stable outlook reflects S&Ps belief that timely provision of substantial additional capital should provide stability to La Poste's credit profile. S&Ps A rating does not apply to La Banque Postale, which is rated A+. Fitch (the only other agency to rate La Poste) responded to the ECs approval of the Banque Postale by assigning a AA+ rating to the bank, while maintaining its AAA rating with Stable Outlook for La Poste itself. However, the overriding emphasis on state support on which the stable outlook was predicated did not survive the EC recommendation to abolish the guarantee. This caused Fitch to revise its outlook to negative. In April 2008, the negative outlook was converted into a downgrade to AA for La Poste and AA- for La Banque Postale, reflecting Fitchs view that the entitys access to emergency liquidity advances had weakened as a result of the constraints involved in complying with EU rules on unfair competition.
Fitch downgrade to AA
Figure 330: La Poste public debt, May 2010 Issuance (bn)

2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 1.8 GBP 0.8% CHF 2.9% 0.4 0.5 0.5
Currency structure

2.0 1.8 1.6 1.4 1.2 0.8 1.0 0.8 0.6 0.4 0.2 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 0.2 0.5 0.6 0.5 0.8 1.8
0.7 0.8
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2010 yt May
2003
2004
2005
2006
2007
2008
2009
EUR 96.3%
399
LCR Finance (LCRFIN)

Huw Worthington +44 (0) 20 7773 1307 huw.worthington@barcap.com Responsible for building Channel Tunnel Rail Link and operating Eurostar in the UK

LCR Finance plc is a wholly-owned finance subsidiary of London & Continental Railways Limited (LCR). LCRs primary responsibilities has been the building of the Channel Tunnel Rail Link (now called High Speed 1 (HSD)) between the Channel Tunnel and central London, and the operation of Eurostar in the UK the latter through its ownership of Eurostar (UK) Limited, the management of which is contracted out until 2010. LCRs shareholders are Ove Arup, Bechtel, Halcrow, National Express, UBS, London Electricity and SNCF. Bond finance of the construction of the link was provided by: Straight bond issues totalling GBP3.75bn in the name of LCR Finance. These bond issues were backed by an unconditional and irrevocable guarantee of the due and punctual payment of all interest and principal payments related to the bonds from the UK government, specifically via the office of the Secretary of State for Transport. Although the shareholders of LCR are private sector companies involved in the construction of the high speed link, the government in effect controls any changes in ownership and restructuring, a fact that was underlined when the Office for National Statistics (ONS) decided to reclassify LCR (and hence its debt) to the public sector in early 2006. Specifically, the decision reclassified LCR from a private non-financial corporation to a public non-financial corporation. LCR bonds are therefore included within the definition of UK public sector debt (but not in general government indebtedness). Two tranches of securitisations (in the name of CTRL Section 1 Finance plc). Nominal and index-linked tranches were used to securitise track access charges from Eurostar (guaranteed by the UK government) and domestic capacity charges provided by the UK government. Servicing of the bonds is therefore fully UK government risk. In 2005, the ONS reclassified the CTRL bonds as government borrowing because it was deemed to be a government-linked securitisation in which there had been no transfer of risk away from the government. Following the successful completion of the HS1 rail link, the secretary of State for Transport has agreed to acquire CTRLF and LCRF and agreed to the novation of the relevant payment obligations in relation to the bonds referred to above. The straight bond issues remain unconditionally and irrevocably guaranteed by the UK government.
Figure 331: LCR Finance public debt Issuance (EURbn)

1.8 1.7 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 2002 2003 2004 2005 2006 2007 2008 2009 ytd 2010
GBP 100.0%

1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0
2019-2028 >2028 2012 2010 2011 2013 2016 2014 2015 2018 2017
1.7
10 June 2010
400
Municipality Finance (KUNTA)

Huw Worthington +44 (0) 20 7773 1307 huw.worthington@barcap.com Specialised lender to Finnish municipalities and related entities

Municipality Finance (MF) is a specialised lender to Finnish municipalities and related entities, mainly related to investment projects and social housing, and is their leading credit provider. The current entity was created in 2001 through the merger of the former Municipality Finance and Municipal Housing Finance. In 2008, the company achieved continuing growth in loans (taking total assets to 14.56bn, an increase of 16%) and in net interest income (+71% to 50.5mn). The effect on net income was even more marked due to 8.1bn of provisions relating to exposures to Icelandic banks in 2008, meaning that net income rose from 2bn in 2008 to 24.87bn in 2009. Capital adequacy ratios under Basel II regulations saw the total capital ratio as at end-2009 rise sharply due to capital raising and higher retained earnings from 13.6% to 20.17%. MF is closely integrated with the municipality sector. First, it is owned by Finnish municipalities, either directly or through the shareholding of the Local Government Pensions Institution (LGPI). (In 2006, it conducted a share issue through which it increased the number of local authority shareholders by 48, bringing the total number of shareholders to 328, representing c.99% of the Finnish population.) Second, its debt issues are guaranteed by the Municipal Guarantee Board (which, in turn, is owned and guaranteed jointly by the municipalities). Third, MF lends only to municipalities that are members of the MGB and other entities that are linked to municipalities or involved in providing social housing. In 2004, the European Commission accepted the Finnish law under which the Municipal Guarantee Board grants guarantees to MF funding.
Credit ratings underpinned at sovereign level by credit strength of Finlands muni sector
MFs sovereign level credit ratings are therefore underpinned by the credit strengths of Finlands municipality sector in three ways: asset quality; ownership; and the guarantee backing for MFs debt issues. In Finland, municipalities have a strong, self-governing status. They have a broad range of expenditure responsibilities, extensive taxation rights, substantial financial autonomy and a long track record of sound finances. No municipality has defaulted in the past century. In the only case of significant financial distress (in the early 1990s), the central government demonstrated a willingness to provide support. MF is classified and supervised as a financial institution. However, because of the interrelationship with the local authority sector and, in particular, the Municipal Guarantee Board guarantee, MFs bonds are zero-risk weighted in Finland. International funding is raised through its 15bn EMTN programme, a AUD1bn Kangaroo program and a 2bn Tbill programme.
Zero risk weighting
10 June 2010
401
Figure 332: Municipality Finance public debt Issuance (EURbn)

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

AUD GBP 7% 1% USD 34% Other 1% Euro 11% HKD 2% JPY 12% NZD 2% NOK 5%

2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 2011 2013 2015 2017 2019 2021 2023 2025 2027
402
CHF 22%
SEK 1%
ZAR 2%
Oesterreichische Kontrollbank (OeKB)


Established in 1946, Oesterreichische Kontrollbank (OKB) is Austria's main provider of financial and information services to the export industry and the capital market. The bank acts as an agent of the Republic of Austria, which unconditionally and irrevocably guarantees timely payment of OKB's debt obligations issued under the Export Financing Guarantees Act of 1981. Amendments to the act in 2003 removed the direct reference to OKB as the only financial institution charged with administering this business, thereby opening up the possibility of other entities potentially being handed this function in the future. In practice, however, we believe the probability of any significant changes are rather slim. The larger parts of OKBs assets comprise medium- and long-term refinancing for banks and foreign importers financing Austrian exports. Generally, OKBs refinancing is covered by the Republic of Austrias guarantee of the underlying transaction. Given this level of cover, OKB has never suffered any loan losses.
Main activities: Administration of export guarantees and financing of exports
Wholly owned by Austrian banks - but benefits from Republic of Austria guarantees
OKB is an Austrian banking corporation, created as a joint stock corporation under Austrian corporate law. Although all major shareholders currently are Austrian banks, there is no legal clause that would prevent non-banks from purchasing shares from one of the existing shareholders. Still, in practice, the shareholder structure has rarely been subject to changes. At the time of writing, the largest shareholders in OKB were Bank Austria Creditanstalt (24.8%), Unicredit (16.1%), and Erste Bank Group (12.9%). Taking into consideration OKBs ownership structure, a substantial part of the banks export financing business is conducted directly with its shareholders. The Republic of Austria does not have any ownership participation in OKB. In addition to the protection provided to OKBs assets by the republics export guarantees, however, the banks debt issued to finance its export loans is generally covered by an unconditional, full faith and credit guarantee by the Republic of Austria under the terms of the Export Financing Guarantees Act of 1981. As OKB pays a fee for the provision of this guarantee, it, in principle, could also issue non-guaranteed debt. In practice, however, this has generally not been the case, except for short-term debt on some occasions. Note that if the Austrian government
10 June 2010
were to open the business to tender by other entities, it would have to give OKB a two-year notice of its intention. Even in the case of OKB losing its role, the guarantee granted would continue to apply to the outstanding debt. On the basis of the guarantee, OKB debt is rated at the same level as the Republic of Austria and also benefits from a risk weighting of 0%. OKB's multi-currency liability portfolio had a notional amount of 30bn at the time of writing. Approximately three-quarters of the portfolio consists of long-term financing. Whereas USD-denominated debt accounts for 43.8% of OKBs total funding, followed by EUR-denominated issues which amounted to 26.1% and CHF-denominated issues whose proportion stood at 21.6%. Debt issued in GBP and other currencies accounted for an aggregated 8.8%. In 2009, a total of 3.3bn of new debt was issued. In 2010, long-term funding needs will amount to c.4bn, which will be achieved through liquid benchmark issues in USD, EUR, JPY, CHF, and GBP, private placements, and structured MTNs.
Figure 333: OKB public debt, May 2010

Issuance (bn) Currency structure Maturity structure (bn)
8 7 6 5 2.6 1.7 1.9 5.3
4 3
3.5 2.2 1.7 2.4 2.0
GBP 4.9%
CHF 21.6% Others 3.6%
4 3 2 1 0
3.3
EUR 26.1% USD 43.8%
2 1 0
4.8
7.9 7.9
5.3
0.9
2010 yt May
2003
2004
2005
2006
2007
2008
2009
Radio Television Espaola (RTVE)


Until the implementation of legal changes in 2006, Radio Television Espanola (RTVE) was a government-owned Spanish public entity with a public service role for the provision of national television and radio services. Financially, it depended on state subsidies and debt funding. Therefore, its credit quality was entirely determined by its linkages to, and support from, the state. This was reflected both in its sovereign level credit ratings and the fact that it is zero-risk weighted in Spain and various other European countries. In 2006, discussions regarding a reform of RTVE led to legislative changes. As a result of the new legislation, a new public entity, Corporacion RTVE, was created which then took over responsibility for RTVEs commercial activities. Note, however, that the existing debt remained with the existing RTVE, which had entered a liquidation process under which it amortised the debt. Resources for the amortisation came from the Spanish government, with RTVEs budget being included within the governments general budget. As the last bond issued by RTVE matured in April 2010, we will no longer cover this issuer within the scope of the AAA Handbook.
403
Debt fully repaid in April 2010
10 June 2010
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029
0.7 0.5
0.9 0.8
RATP Regie Autonome des Transports Parisiens (RATPFP)


RATP is the Greater Paris Transport Authority. It was created in 1948 to develop, maintain and operate public transportation in the Greater Paris area. Its principal activities are the ownership and operation of metro, tramway and bus lines in the Greater Paris area, as well as operating the urban express (RER) services jointly with SNCF. It has the legal status of an EPIC (a public entity with industrial and commercial character), established with a public service mission to operate and extend public transportation in the Greater Paris region. Consequently, it benefits from the range of state linkages and supports that are normal for EPICs. It cannot go bankrupt and is ultimately guaranteed by the French state, which is also committed to providing it with liquidity support if needed. Management is appointed by the state, which also supervises its budget and accounts. Specifically, it is supervised by the Syndicat des Transports dIle-de-France (STIF), which is the public authority for transport in the Greater Paris area. Although Parisian transport is RATPs raison detre, it is also allowed to compete for projects outside the Ile-de-France region. RATP operates within the context of a three-year contractual agreement with STIF, which defines public transport policy, sets fare levels, etc, and a four-year business plan. The gap between the fares determined by STIF and the fares needed to cover costs is met by public subsidies. The business plan envisages significant investments in rolling stock and the existing network and stations. Together with the higher redemptions that came due last year, this has led to an increase in bond issuance in 2008. RATPs key public service role, and the fact that it is so financially dependent on public subsidies means that its EPIC status is unlikely to be changed in the near future.
Established in 1948 to develop, maintain and operate public transport in Paris
Figure 334: RATP public debt, May 2010 Issuance (bn)

1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 2010 yt May 2003 2004 2005 2006 2007 2008 2009 0.2 0.1 0.1 EUR 67.9% 0.2 0.3 0.9 0.7 CHF 32.1%
Currency structure

0.6 0.5 0.4 0.3 0.2 0.1 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 0.1 0.1 0.3 0.4 0.4 0.6 0.3 0.7 0.6
Rede Ferroviria Nacional (REFER)

Risk weighting Basel II: guaranteed issues: 0%; non-guaranteed issues: 50%
Rede Ferroviria Nacional (REFER) is responsible for operating, maintaining and developing the Portuguese railway infrastructure. REFER was created in 1997 in order to conform to EU directives that required the separation of infrastructure from the operation of services. The latter remained primarily the responsibility of the previous integrated rail operator, Caminhos de Ferro Portugueses.
404
10 June 2010
Portuguese railway infrastructure operator
At the time of writing, REFER is a 100% state-owned company. It has the legal status of an Entidade Publica Empresarial, which means that it is not subject to corporate bankruptcy procedures. Also, its statutory capital must remain entirely and directly held by the Portuguese state. A privatisation of REFER would require a change of the entities legal status, which can only be decided upon in the Portuguese Parliament. Considering REFERs role as an institution that undertakes activities in the public interest, however, we believe that, even in the long term, a privatisation is rather unlikely. As a result of the ongoing economic downturn in Portugal and the sovereigns budgetary pressures which markedly increased as of late, REFERs reliance on external borrowing in order to fund its persistent operating deficits and the better part of its substantial investment programme has shown a tendency to increase. Attributed to the continuing need to modernise the countrys railway network, we believe that debt issuance will likely further increase. For the time being, most of REFERs outstanding debt (much of which is in the form of loans from the EIB) is backed either by government guarantees or by guarantees provided by MBIA. However, there are plans to determine the mix between guaranteed and non-guaranteed funding in the future, depending on the basis of relative funding costs. The entity intends, to an increasing extent, to reduce the proportion of debt issues benefiting from an explicit guarantee on behalf of the sovereign. For individual debt issues, the applicable credit ratings and risk weightings for REFER depend on whether issues benefit from an explicit state-guaranteed or not. Whereas guaranteed issues will benefit from Portugals sovereign rating of Aa2/A+/AA (all outlook negative) and a respective risk weighting of 0%, non-guaranteed issues, in contrast, are subject to REFERs issuer rating of Aa2/A/NR (all outlook negative). In our view, however, the (modest) divergence in ratings reflects the rating agencies different approaches to rating government-related entities (GRE) rather than major differences in their evaluations of REFERs fundamental characteristics. In terms of risk-weighting purposes, REFER is treated as a commercial public entity. Under Basel II, risk weightings for non-guaranteed debt under the standardised approach will be based on credit ratings. With regard to REFER, the split between the ratings assigned by Moodys and S&P has an impact on the risk weighting of non-guaranteed debt. This is the case because the weaker rating will be taken as the basis for the risk weighting. S&Ps A rating therefore implies a 50% risk weighting for REFERs non-guaranteed issues at the time of writing.
Figure 335: REFER debt, May 2010

Issuance (bn)
1.5 EUR 100%
Currency structure

0.75 0.6 0.6 0.5 0.5 0.5 0.50 0.25 0.00
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2021 2024 2026
1.1 1.0 1.0
0.6 0.5
0.0 2005 2006 2007 2008 2009 2010
10 June 2010
405
Socit de Financement de l'Economie Franaise (SFEF)


SFEF has been established in October 2008 as a special financing company to support the French banking system. Its creation is based on the amended French monetary code. Between October 2008 and December 2009 a total financing volume of 265bn has been assigned. SFEF has been set up to encourage the banks participating in the scheme to finance the French economy, with a focus on helping corporates, households and local authorities. SFEF issues debt directly to the market. The respective obligations are guaranteed by the French state. The proceeds from SFEF debt-raising are used to provide funding to French credit institutions. To benefit from this liquidity, credit institutions must pledge assets as collateral. As SFEF debt benefits from an explicit guarantee by the French state, it takes on the sovereign zero-risk weighting and also benefits from triple-A ratings. SFEF has 50mn of capital, which is held by the French state (34%) and the French banking sector (66%), split equally between Banques Populaires, BNP Paribas, Caisse dEpargne, Crdit Agricole, Crdit Mutuel, HSBC France and Socit Gnrale (9.43% each). The State approved the SFEFs executives and statutes and has a blocking minority. The Government Commissioner has a veto right in order to protect the French States financial interests. Furthermore, SFEF is subject to supervision by the Banking Commission. In order to access SFEF funding, participating banks needed to fulfil minimum regulatory capital requirements, pledge eligible assets, comply with a series of ethical guidelines and commit to granting new loans to the broader economy. Eligible collateral consist of French real estate loans, first-tier French mortgages or guaranteed home loans, loans to local authorities, loans to wellrated corporates, loans to French consumers and loans to credit export agencies. The quality of the collateral posted by the banks is supervised by a specific controller.
Frances centralised issuer of government guaranteed debt
Figure 336: SFEF structural overview

French Republic Shareholder banks
Guarantee
34%
66%
Investors
Medium-term bonds issues
SFEF
Loans
Banks
Loans
Broader Economy
Source: SFEF, Barclays Capital
Between November 2008 and September 2009, SFEF issued a total volume of 77bn, which was mainly EUR-denominated (48bn), but also in USD-format ($39bn), and two floating rate notes in CHF (CHF 2bn) and (750mn). About 90% was issued with a fixed coupon and the reminder as floater. According to information from individual annual reports, the largest participants taking advances from SFEF were Crdit Agricole (21.6bn), BNPCE (15.1bn), Socit Gnrale (13.6bn), BNP Paribas (12.8bn) and Crdit Mutuel (11.7bn). Crdit Agricole and BNP Paribas also reported the ratio between advances and pledged assets, which stood at 1.5x and 1.2x, respectively.
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406
Figure 337: Distribution of SFEF advances among French banks, YE 09

Other 3% Credit Agricole 27%
Credit Mutuel 15%
BNPCE 20% Socit Gnrale 18%
BNP Paribas 17%

Source: Individual bank reports, Barclays Capital
Figure 338: SFEF public debt, May 2010 Issuance (bn)

70 60 50 40 30 11.0 20 10 0
2008 2009
Currency structure
58.6

25 22.8 23.5
2014
20 15.1 15 EUR 62% 10 5 0

2010 2011 2012
USD 38%
Undic (UNEDIC)

Undic is the central organisation in the French unemployment benefit system. It was created in 1958 as an association with a public service mission to provide unemployment insurance benefits. It is jointly managed as a not-for-profit entity by employers associations and trade unions, which set levels of welfare contributions and benefits, subject to central government agreement and to maintaining financial balance. Undic is not an EPIC, and thus does not benefit from the solvency and liquidity support typical of that status. However, there is a track record of the government providing support through debt guarantees or subsidies. The 2008 reform confirmed the strategic role of Undic within the French Public Service of Employment. It contained not only the merger of Undics operational network (Assdic) and the state employment agency (ANPE) into a new state institution (Ple emploi), but also confirmed role of Undic as the legal and financial manager of the national unemployment insurance system.
Central organisation in the French unemployment benefit system
10 June 2010
8.2
407
Operating deficits over the period from 2001-05 were reflected in an expanding accumulated deficit, which was partly funded through the issuance of long-term debt issues in 2003 and 2005. Conversely, a move back into operating surplus in 2006 (1.5bn), followed by an increased surpluses in 2007 (3.7bn) and 2008 (4.9bn), reflecting strengthening economic conditions, has reduced the accumulated deficit substantially (-7.8bn between 2006 and 2008). Consequently, the large redemption in September 2008 did not necessitate any bond refinancing. However, Undic forecasts a deficit of 0.9bn for 2009 and a 1.6bn deficit for 2010. Thus funding needs may well increase over the next 12 months. This is reflected in the 3Y 4bn benchmark bond issued in November 2009, which helped the organisation not only refinance a 2.2bn benchmark bond maturing in February 2010, but also cope with additional future funding needs. Undic has set up a 12bn EMTN programme and a 6bn CP programme in order to cope with future total funding needs of 18bn. Debt issuance is purely in -denominated format.
Figure 339: Undic debt, May 2010 Issuance (bn)

4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2010 yt May 2003 2004 2005 2006 2007 2008 2009 3.2 4.0 4.0
Currency structure

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020-2029 >2029 4.0 4.5
EUR 100.0%
10 June 2010
408
US AGENCIES PROFILES
10 June 2010
409
Fannie Mae (FNMA)

Description
% $ Index 3.148 % Index 0.038 Total assets USD869bn LT senior unsecured ST Outlook
Rajiv Setia, James Ma

Ratings table
Fannie Mae is one of the two largest suppliers of funds to the US secondary market in mortgages. Its core function is to securitise mortgage loans originated by lenders in the primary market into FNMA MBS. It also operates a substantial investment to facilitate liquidity and stability in the secondary mortgage markets. In September 2008, FHFA placed FNMA under conservatorship, while agreeing to service senior and subordinate debt. As part of the conservatorship, FNMA receives preferred equity investments from the US Treasury to make up for any GAAP net asset shortfall.
Risk weighting
20%

Purpose: Fannie Mae was established in 1938 to provide additional liquidity to the mortgage market and thereby improve the accessibility and affordability of home ownership throughout the US. It is the largest provider of funds to the mortgage market, through the purchase of residential mortgages and MBS for its own portfolio and, through its credit guarantee business, by the creation and securitisation of MBS. Ownership and capital structure: Fannie Mae is a federallychartered private corporation and has the status of a Government Sponsored Enterprise (GSE). Originally established as a wholly-owned government corporation, private shareholding was introduced in two stages by the FNMA Charter Act in 1954 and by 1968 amendments to the Charter Act. It continues to be regulated by the US government via the FHFA (Federal Housing Finance Agency). FHFA is responsible for Fannie Maes safety and soundness, and also has authority over capital standards, mission supervision and receivership in case of default. FHFA placed FNMA into conservatorship in September 2008, with the goal of restoring operational soundness. As part of the conservatorship, the US Treasury established a Preferred Stock Purchase Agreement (PSPA) with FNMA, and thus far has purchased $75bn in senior preferred shares, along with warrants for 79.9% of common shares. Asset structure and quality: Fannie Mae operates solely in the secondary market for mortgages and its business is concentrated in two main areas. First, it owns a portfolio of mortgage-related securities, which is funded through the issuance of debt securities. The bulk of the portfolio is in agency MBS/loans, but non-agency securities comprise about $89bn (12%) of the retained portfolio. FNMA also has significant offbalance sheet liabilities, created via its role as a guarantor of MBS ($3.2trn outstanding in Q1 10). FNMA generates fee income from these guarantees, but is also exposed to credit losses. While the bulk of its credit book is in agency-conforming MBS, roughly $284bn (10%) is in Alt-A product. Capital adequacy: The legislation governing FNMA provides the basis for minimum, risk-based and critical capital requirements monitored by FHFA. Under conservatorship, the US Treasury has committed to inject senior preferred equity into FNMA in any quarter where there is a net asset shortfall (ie, GAAP assets < liabilities), in the amount of the deficit. FNMA has eliminated its common and preferred dividends as a result. Through Q1 10, the cumulative draw was $75bn for FNMA. The Treasurys commitment under the PSPA is available indefinitely with no cumulative limit through 2012, and a maximum additional $200bn thereafter. The Treasury lacks the authority to increase the limit without consulting Congress. Financial performance: Results have been sharply negative since Q3 08, but net losses date back to Q3 07; FY 09 net losses totalled $72bn. Credit loss provisions in the guarantee book were the primary contributor to the loss, alone totalling $72bn in 2009. OTTI on non-agency MBS in the retained portfolio and MTM losses on derivatives were also significant drags on earnings (in respective order). We expect losses to stay concentrated in the guarantee book, as portfolio non-agency MBS holdings have already been marked down severely. Funding: In 2010, net portfolio growth should be relatively light; as of Q1 10, FNMA had $84bn of room to grow under the $810bn portfolio cap after shrinking by more than $50bn. With the Fed having exited the market, FNM has favoured discount notes as an economically-advantageous source of funds.
Strengths
Under conservatorship, FHFA commits to paying interest and principal to bondholders while the Treasury ensures solvency. Strong government support, Fed purchases, and access to liquidity and capital backstops from the Treasury.
Weaknesses
FNMA could be used as a policy instrument instead of for profit. After Fed purchases end, equilibrium valuations for GSE debt are uncertain, as is the GSEs ultimate form post-conservatorship.
Key points for 2010-11

As the Treasury stake in FNMA grows, dividend payments on preferred equity injections should surpass steady-state earnings. Closer ties to the government are inevitable and should increase investor comfort in FNMA paper as a Treasury surrogate. The administration has shown some capriciousness in changing FNMAs portfolio and debt limits under conservatorship. However, we expect the portfolio business to be de-emphasised, ensuring the long-term supply backdrop remains favourable.
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410
Public sector
Financial summary YE December 2009
$ 2006 2007 2008 % ch 2009 (08-09) -5% -2% 1% 4% -11% -4% 1% -11% 363% -4% 65% -5% 86% 608% 12% 136% 147% -64% -20% 128% 47%
Fannie Mae (FNMA)

Fannie Mae benchmark spreads versus Treasuries (bp)
200 150 100 50 0 Jan-08 Jul-08 2yr Jan-09 5yr Jul-09 10yr Jan-10 30yr
Balance sheet summary ($ bn) Total assets 841 879 912 869 729 728 792 773 Retained mortgage portfolio Tot. issued MBS 2,705 3,027 3,311 3,339 Tot. mortgage credit book 2,526 2,888 3,109 3,241 Investments 379 294 266 238 200 180 229 220 Holdings of FNMA MBS Tot. equity 42 44 -15 -15 42 45 -9 NA Core capital* Tot. debt securities 774 806 883 786 Sub-debt 11 9 7 7 16 75 Senior preferred stock Preferred stock 9 17 21 20 Income statement summary ($ mn) Net interest income 6,752 4,581 8,782 14,510 Guarantee fee income 4,250 5,071 7,621 7,211 -1,744 -4,668 -20,129 -2,811 Non-int. (derivatives) income 9,258 4,984 -3,726 18,910 Tot. operating income Tot. administrative expenses 3,076 2,669 1,979 2,207 4,270 8,320 32,860 77,552 Tot. non-interest expenses 783 5,012 29,809 73,536 Credit related expenses Pre-tax profit 4,213 -5,126 -44,549 -73,007 Net income 3,548 -2,563 -59,776 -72,022 Diluted common shares 972 973 2,487 5,666 3.7 -2.6 -24.0 -12.7 Net income per share ($) Dividends/Common share ($) 1.18 1.90 0.75 Profitability (%) Return on assets 0.4 -0.3 -6.7 -7.9 8.8 -6.0 -416.6 -33.1 Return on equity Oper. exp./Net income 86.7 -104.1 -3.3 -3.1 0.37 0.31 0.22 0.2 Oper. exp./Assets 22.1 -195.6 -49.9 -102.1 Credit expenses/Net income Net int. margin 0.81 0.53 0.98 1.58 Balance sheet & capital ratios (%) Retained portfolio/Assets 86.6 82.8 86.8 88.9 Tot. debt securities/Assets 92.0 91.7 96.8 90.4 Core capital/Assets 5.0 5.2 -0.9 NA Note: *Regulatory capital requirement not binding during conservatorship
Fannie Mae benchmark asset swap levels (bp)

250 200 150 100 50 0 -50 -100 Jan-08
Jul-08 2yr
Jan-09 5yr
Jul-09 10yr
Jan-10 30yr
Gross term debt issuance ($bn)

200 175 150 125 100 75 50 25 0 Callable 2005 Benchmark Sub Debt Other bullets Note 2006 2007 2008 2009
-18% 92% 7% 9% -105% 62% 2% -7%
Outstanding debt profile ($bn)

1.6% 53.9% 22.1% 22.4% 1.4% 51.9% 24.9% 21.8% 1.1% 42.7% 26.7% 29.4% 0.8% 39.7% 21.8% 37.7% 0.9% 46.8% 26.7% 25.5%
Bullet maturity profile ($bn), as at 5 May 2010

300 270 250 200 150 100 50 0 10 11 12 13 14 15 16 17 18 19 20 20+ 119 55 37 45 7 16 18 18
2005 2006 2007 Discount Notes Non Callable Securities
2008 2009 Callable Securities Sub-Debt
Fannie Mae retained portfolio and debt cap ($bn)

1,100 1,000 900 800 700 Jan-07
Government capital infusion ($bn)

20 15.2 15 10 5 10.7 19.0 15.0 15.3
Oct-07
Jul-08
Apr-09
Jan-10
Oct-10 New Caps
0 4Q08 1Q09 2Q09 3Q09 4Q09
FNMA Debt Out
Old FNMA Cap
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411
Fannie Mae (FNMA)

Guarantee fees versus operating income
30 20 10 0 -10 -20 $ bn 200% 100% 0% -100% -200% -300% 2006 2007 2008 2009 Operating income (ex. guarantee fees) Guarantee fees Fees/Operating income ratio (RHS)
Public sector
Cumulative provisions and charge-offs ($bn)
120 Cumulative, $bn 100 80 60 40 20 0 2004 2005 2006 2007 2008 1Q09 2Q09 3Q09 4Q09 FNMA Provisions FNMA Charge-offs
2005
Single family mortgage delinquencies

5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2006 2007 Non-credit enhanced Total Single Family 15% 10% 5% 0% 2009 Credit enhanced (RHS)
Mortgage credit book: Mostly fixed rate

14% 21% 65% 13% 19% 68% 11% 18% 71% 10% 16% 74% 9% 16% 75%
2008
2005
2006 Long-term Fixed
2007
2008
2009 ARMs
Other Fixed
Geographical distribution of mortgage credit book

25% 16% 23% 19% 17% 2005 Midwest 24% 16% 24% 19% 17% 2006 Northeast 23% 16% 25% 19% 17% 2007 Southeast 24% 16% 25% 19% 16% 2008 Southwest 26% 15% 24% 19% 16% 2009 West
Mortgage credit book: Current loan to value ratio

7% 16% 17% 60% 10% 18% 17% 55% 2006 60% to 70 % 20% 19% 15% 46% 2007 34% 17% 13% 36% 2008 37% 19% 13% 31% 2009 above 80%
2005 < 60%
70% to 80%
Net interest income and net interest margin ($bn)

30 $ bn 2.0% 25 1.5% 20 15 1.0% 10 0.5% 5 0 0.0% 2005 2006 2007 2008 2009 Net interest income Net interest margin (RHS)
Investment portfolio mainly in agency MBS ($bn), 31 Mar 10

Non-Agency MBS, 89.1, Other 12% Agency MBS, 25.5, 4% Agency MBS (FNMA), 318.8, 44% Mortgage Loans, 292.4, 40%
Total = $726bn
FNMA MBS in portfolio as % outstanding stabilises ($bn)

$bn 9.1% 4,000 3,000 2,000 1,000 0 2005 2006 2007 MBS held by Others % of PC owned (RHS)
10 June 2010
Retained portfolio: Liquidity ratios ($bn)

100 80 60 40 20 0 $ bn 9.5% 7.1% 52.2 69.4 91.0 93.0 69.4 0% 2005 2006 2007 2008 2009 Liquidity portfolo (short term investments + cash) Ratio of liquidity/Retained portfolio (RHS) 12.5% 11.7% 9.0% 10% 5% 15%
7.4% 200 2,506 180 6.0% 2,847
229 6.9% 3,082
220 6.6% 3,118
10% 8% 5% 3%
234 2,337
0% 2008 2009 MBS in Retained Portfolio
412
Federal Home Loan Banks (FHLB)

Description
% $ Index 2.231 % Index NA Total assets USD1,016bn LT senior unsecured ST Outlook

Ratings table
The FHLB system comprises 12 banks situated in Boston, New York, Pittsburgh, Atlanta, Cincinnati, Indianapolis, Chicago, Des Moines, Dallas, Topeka, San Francisco and Seattle. The banks are GSEs and are owned as co-operatives by member financial institutions to which they supply advances in support of their lending programmes. The FHLBs issues consolidated obligations, consisting of bonds and discount notes, which are the joint and several obligations of the 12 banks and are not guaranteed by the US government. The system is regulated by the Federal Housing Finance Agency.
Risk weighting
20%.

Purpose: The 12 FHL banks are US Government Sponsored Enterprises (GSEs), organised under the authority of the FHLB Act of 1932, as amended. Their primary purpose is to provide liquidity to member financial institutions to assure the flow of credit and other services for housing/community development. Ownership, support, and regulation: Each of the 12 FHL banks is owned in a co-operative structure by its member banks. The FHL Bank system and the Office of Finance are regulated by the Federal Housing Finance Agency (FHFA), as part of the GSE reform legislation bringing regulation of FNMA/FHLMC and FHLB under one part of the Executive branch. The FHFA ensures that the FHL banks operate in a safe and sound manner by setting and enforcing capital and leverage limits, monitors the banks execution of their housing mission, and also holds receivership authority. All 12 banks have completed their SEC registration. The government does not guarantee FHLB debt, but the debt enjoys favourable market treatment due to its GSE status. Also, the FHL banks are exempt from paying federal, state and local taxes, with the exception of real property taxes. Instead, they are obligated to make payments to the Resolution Funding Corporation (REFCORP) and towards the Affordable Housing Program (AHP). By statute, MBS assets held in FHLB investment portfolios cannot exceed 300% of the banks capital. However, to help alleviate secondary market stress, in Q1 08 the FHFB authorised the FHLBs to temporarily increase MBS purchases up to 600% of capital for a two-year period. Asset structure and quality: The assets of FHL banks consists primarily of advances made to members, mortgage assets acquired through the Mortgage Purchase Program (MPP) and Mortgage Partnership Finance (MPF), MBS held in investment portfolios and liquid short-term assets. Advances have traditionally been the main assets on the balance sheet ($631bn as of YE 09); mortgage loans comprise $71bn, MBS $132bn and other investments $152bn. Although the advance business has remained healthy, impairments on non-agency MBS portfolio holdings will remain a drag on earnings in 2010. Capital adequacy: The Gramm-Leach-Bliley (GLB) Act introduced a number of changes in the capital structure of the FHL banks to be implemented by the Finance Board. On 18 July 2002, the Finance Board approved the capital plan submission of banks and gave them up to three years from the effective date of their capital plan to implement the plans. Each banks plan was required to address the different classes of stock with which the bank would capitalise itself. Each FHLB is subject to risk-based capital rules under the new act. As of May 2010, 11 banks have already implemented the new capital plans. The exception, FHLB Chicago, remains bound by the pre-GLB Act requirements in addition to the recent agreements with FHFA. Funding: In 2009, the FHLBs decreased their lending activity as the banking sector deleveraged, and advances shrank by 32% to $631bn. However, the FHLB continues to play an important role in providing liquidity to member institutions. As most of the advances were funded via discount notes, this funding vehicle ran off significantly. In 2010, we expect these advances to keep running off as banks remain flush with cash.
Strengths
Joint and several liability lowers potential for localised default risk in Systemwide securities. High quality asset portfolio, particularly in the advance business. Central role in home finance for small- and medium-sized/ regional banks less easily-serviced by FNMA/FHLMC.
Weaknesses
Although significantly lower than FNMA/FHLMC, the System does have some Alt-A and prime jumbo exposure, which could cause credit losses. As FHLBs reported financial condition has remained solvent, it has also received a lesser degree of government assistance a somewhat counter-intuitive phenomenon.

Expect demand for advances to shrink as large-bank borrowers retain access to CD, CP and term unsecured markets. Even at lower 2006-07 levels of interest-earning assets, expect NIM to create enough earnings to offset upcoming credit losses on non-agency MBS. We expect the FHLBs capital cushion should suffice to offset non-agency MBS losses; accounting rule changes should allow FHLB to spread out losses over a longer period. Main supply technical likely to be negative as FHLB continues to shrink advances outstanding, but this could be tempered with term-out of the current funding profile. 413
10 June 2010
Public sector
Financial summary YE December
2006 Balance sheet summary ($ bn) Total assets 1,016 Advances to members 641 Mortgage loans, net 98 Investments 271 Deposits and borrowings 21 Consolidated obligations 934 Total capital 45 Retained earnings 3 Income statement summary ($ mn) Net interest income 4,293 Operating expenses 671 Total assessments 942 Net income 2,612 Profitability (%) Return on assets 0.3 Return on equity 6.0 Oper. exp./Net income 25.7 Oper. exp./Assets 0.07 Assessments/Net income 36.1 Net int. margin 0.42 Balance sheet & capital ratios (%) Advances&Loans/Assets 72.7 Cons. oblig./Assets 91.9 Tot. capital/Assets 4.4 2007 2008 2009 % ch

FHLB global note spread to Treasuries (bp)
250 200 150 100 50 0 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 2yr 5yr 10yr 30yr
1,274 1,349 1,015 -25% 875 929 631 -32% 92 87 71 -19% 299 306 284 -7% 24 17 19 14% 1,179 1,258 935 -26% 54 51 45 -12% 4 3 6 104% 4,516 5,243 5,432 714 732 943 1,021 600 830 2,827 1,206 1,855 0.2 5.7 25.3 0.06 36.1 0.35 75.8 92.5 4.2 0.1 2.3 60.7 0.06 49.8 0.39 75.3 93.3 3.8 4% 29% 38% 54%
FHLB global note asset swap levels (bp)

250 200 150 100 50 0 -50 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 2yr 5yr 10yr 30yr
0.2 71% 3.9 68% 50.8 -16% 0.08 43% 44.7 -10% 0.54 38% 69.2 92.1 4.4 -8% -1% 16%

400 300 200 100 0 Callable 2005 2006 Benchmark Note 2007 2008 Other Bullet 2009
Outstanding debt ($bn)

800 600 400 200 0 2005 2006 2007 Callable bonds 354 374 312 398 415 496 644
Majority of debt matures over the next two years

250 200
556
190
213
150 100 50
100
76 32 28 2015 19 16 2016 2017 6 2018 10 2019 6 2020 18 >=2020

414
166 2008 Bullets
176 2009
0 2010 2011 2012 2013 2014
Investments held by FHLB ($bn), as at Q4 09

Others, 29, 3% Member mortgage assets, 71, 7% Investments , 284, 28%
10 June 2010
FHLB investment portfolio

Investments as of Q4 09 Short-Term* Non-Mortgage Related** Agency MBS Non-Agency MBS Total Total ($bn) 110.1 21.9 102.4 49.6 284.0 % Total 38.8% 7.7% 36.1% 17.5% 100.0%
Advances, 631, 62%
Note: *Deposits, Fed Funds sold. **CP/GSE debt/Local housing obligations
Total Assets = $1,015bn

FHLB Private-label MBS holdings as of Q4 09 ($bn)
PLS, Par ($mn) 20,500 12,663 6,851 4,744 2,905 3,551 3,700 1,876 1,199 187 571 35 58,782 FY Credit OTTI ($mn) -608 -316 -229 -311 -60 -444 -437 -1 -20 0 -4 0 -2,430 FY Non-credit OTTI ($mn) -3,513 -990 -815 -1,039 -352 -885 -967 -8 -120 0 -75 0 -8,764 Unrealized Mark price losses ($mn) Q4 09 (% Par) -1,945 72 -1,620 84 -1,102 80 -1,398 64 -125 84 -1,022 58 -83 64 -199 89 -198 73 0 100 -67 76 -7 80 75 -7,766 Book value equity ($mn) 6,230 8,253 3,713 994 1,746 2,764 2,378 1,946 5,603 3,467 2,822 2,911 42,827
Public sector
Advances by membership ($bn)
1,000
Par/equity 3.3 1.5 1.8 4.8 1.7 1.3 1.6 1.0 0.2 0.1 0.2 0.0 1.4
$ bn 43 279 255 43 308 270 46 257 339
System bank San Francisco Atlanta Pittsburgh Seattle Indianapolis Boston Chicago Topeka New York Cincinnati Dallas Des Moines Total
73 339 456
800 600 400 200 0
189 134 247 126 464 356 2009
2004 2005 2006 2007 2008 Commercial Banks Thrifts Other
Asset distribution among member banks ($bn)

200 150 100 50 0
Bo st o ew n Yo Pi tts rk bu rg At h la Ci nta nc In in n di an ati ap o Ch li s ic D es ag M o oi ne D s al la s Sa T o pe n Fr an ka ci sc o Se at tl e
Capital distribution among members

60 50 40 30 20 10 0 5.7 4.3 17.4 19.5 2004 4.5 18.6 20.4 2005 4.4 15.6 23.1 2006 18.8 26.9 2007 Thrifts 12.3 14.6 28.8 2008 Other 14.2 9.7 29.2 2009
Held-to-maturity securities
Advances
Mortgage loans (net)
Commercial Banks
Geographic distribution of MPP/MPF loans

17% 16% 20% 15% 31% 2005 Midwest 17% 16% 20% 15% 32% 2006 Northeast 16% 16% 20% 15% 34% 15% 15% 20% 15% 36% 13% 15% 18% 15% 39%
Duration gap (months) for FHLB regional banks

Bank Boston New York Pittsburgh Atlanta Cincinnati Indianapolis Chicago Des Moines Dallas Topeka San Francisco Seatle 2006 2007 2008 2009 min 0.2 0.5 -0.7 2.6 -0.7 0.3 -0.6 -1.2 0.1 -1.2 0.7 1.6 3.5 6.1 0.6 0.8 0.4 5.7 1.8 -1.3 1.0 0.4 -0.2 0.0 -0.6 1.6 1.2 -0.2 -1.8 -1.8 0.9 0.0 -0.3 1.0 -0.3 0.0 -1.4 -7.3 1.2 -7.3 0.2 0.9 2.3 4.8 0.2 1.3 1.4 2.9 0.0 -1.0 0.7 1.5 3.4 3.7 0.6 0.0 0.0 0.2 0.0 -2.2 max 2.6 1.0 6.1 5.7 2.5 1.6 1.0 1.2 4.8 2.9 3.7 1.3 STDV 1.0 0.8 2.0 2.2 1.0 1.4 0.5 2.8 1.5 1.4 1.3 1.1
2007 2008 2009 Southeast Southwest West
FHLB regulatory capital sound for now, Q4 09

Required Reg Capital ($mn) 2,499 4,578 2,612 6,052 2,855 1,864 2,586 2,604 1,705 7,714 2,044 4,152 41,265 Capital Surplus ($mn) 1,378 1,301 1,803 3,133 1,296 967 367 293 275 6,943 646 350 18,752 Reqd RiskBased Cap ($mn) 1,526 607 2,827 3,010 389 889 827 507 647 6,207 2,158 N/A 19,594 Risk-Based Cap Surp ($mn) 2,351 5,267 1,588 6,175 3,762 1,942 2,126 2,390 1,021 8,450 532 N/A 35,604
415
System bank Boston New York Pittsburgh Atlanta Cincinnati Indianapolis Des Moines Dallas Topeka San Francisco Seattle Chicago Total
10 June 2010
Regulatory Capital ($mn) 3,877 5,879 4,415 9,185 4,151 2,831 2,953 2,897 1,980 14,657 2,690 4,502 60,017
Capital to Assets 6.21% 5.14% 6.76% 6.07% 5.82% 6.08% 4.57% 4.45% 4.65% 7.60% 5.26% 4.34% 5.82%
Permanent Capital ($mn) 3,877 5,874 4,415 9,185 4,151 2,831 2,953 2,897 1,668 14,657 2,690 N/A 55,198
Freddie Mac (FHLMC)

Description
% $ Index 2.814 % Index NA Total assets USD842bn LT senior unsecured ST Outlook

Ratings table
Freddie Mac is one of the two largest suppliers of funds to the US secondary market in mortgages. Its core function is to securitise mortgage loans originated by lenders in the primary market into FHLMC MBS. It also operates a substantial investment to facilitate liquidity and stability in the secondary mortgage markets. In September 2008, FHFA placed FHLMC under conservatorship, while agreeing to service senior and subordinate debt. As part of the conservatorship, FHLMC receives preferred equity investments from the US Treasury to make up for any GAAP net asset shortfall.
Risk weighting
20%.

Purpose: Created in 1970 by a Congressional charter, Freddie Mac is a Government-Sponsored Enterprise (GSE) with a public mission to help develop a stable and liquid secondary market for residential mortgages and to improve access to mortgage credit. Ownership and capital structure: Freddie Mac is a private corporation, but the US Treasury is a primary investor at the preferred equity level. It is regulated by the US government via the FHFA (Federal Housing Finance Authority), which oversees FNMA/FHLMC, as well as the FHLBs. FHFA is responsible for Freddie Macs safety and soundness and has authority over capital standards, mission supervision and receivership in case of default. FHFA placed FHLMC into conservatorship in September 2008, with the goal of restoring operational soundness. As part of that process, the US Treasury established a Preferred Stock Purchase Agreement (PSPA) with FHLMC; thus far, it has purchased $62bn in senior preferred shares, along with warrants for 79.9% of the common shares. Asset structure and quality: Freddie Mac operates solely in the secondary market for mortgages, and its business is concentrated in two main areas. First, it owns a portfolio of mortgage-related securities, which is funded through the issuance of debt securities. The bulk of the portfolio is in agency MBS/loans, but non-agency securities comprise about $171bn (23%) of the retained portfolio. FHLMC also has significant offbalance-sheet liabilities, created via its role as a guarantor of MBS ($2.2trn outstanding at YE 09) note that changes in accounting treatment have forced FRE to consolidate this amount on to its balance sheet starting Q1 10. It generates fee income from these guarantees, but is also exposed to credit losses. While the bulk of its credit book is in agency-conforming MBS, roughly $141bn (7%) is in Alt-A product. Capital adequacy: The legislation governing Freddie Mac provides the basis for minimum capital, risk-based capital and critical capital requirements that are monitored by FHFA. Under conservatorship, the US Treasury has committed to inject senior preferred equity into FHLMC in any quarter when there is a net asset shortfall (ie, assets < liabilities under GAAP), in the amount of the shortfall. Through Q1 10, the cumulative draw was $62bn. The Treasurys commitment under the PSPA is available indefinitely with no cumulative limit through 2012, and a maximum additional $200bn thereafter. The Treasury lacks the authority to increase the limit without consulting Congress. Financial performance: Results have been sharply negative since Q3 08, but moderated somewhat from FY 08 to FY 09; 2009 net losses totalled $22bn, with another $4.1bn in dividends paid to the Treasury. Credit loss provisions in the guarantee book, OTTI on non-agency MBS in the retained portfolio, and MTM losses on derivatives have contributed to the loss. We expect losses to stay concentrated in the guarantee business, as most non-agency MBS holdings have already been marked down severely; recent accounting rule changes should cushion price deterioration. Funding: In 2010, net portfolio growth should be moribund; as of Q1 10, FHLMC had less than $60bn of room to grow under the $810bn YE 10 portfolio cap, after zero growth YTD. With the Fed having exited the market, FRE has heavily favoured FRN and callable markets to fund itself economically; we expect this pattern to continue.
Strengths
Under conservatorship, FHFA commits to paying interest and principal to bondholders while the Treasury ensures solvency. Strong government support, Fed purchases and access to liquidity and capital backstops from the Treasury.
Weaknesses
FHLMC could be used as a policy instrument instead of for profit. After Fed purchases end, equilibrium valuations for GSE debt are uncertain, as is the GSEs ultimate form post-conservatorship.

As the Treasury stake in FHLMC grows, dividend payments on preferred equity injections will surpass steady-state earnings. Closer ties to the government are inevitable and should increase investor comfort in FHLMC paper as a Treasury surrogate. The administration has shown some capriciousness in changing FHLMCs portfolio and debt limits under conservatorship. However, we expect the portfolio business to be de-emphasised, ensuring the long-term supply backdrop remains favourable.
10 June 2010
416
Public sector
Financial summary YE December
$ 2005 Balance sheet summary ($ bn) Total assets 799 Retained portfolio 710 Tot. issued PCs 1,336 Holdings of FHLMC PCs 361 Tot. mortgage portfolio 1,685 Investments 57 Tot. equity 26 Core capital* 35 Tot. debt securities 740 Sub-debt 6 Senior preferred stock Preferred stock 5 Income statement summary ($ mn) Net interest income 4,627 Mgmt & guarantee income 2,076 Non-int. (derivatives) income -1,073 Tot. operating income 5,630 Tot. administrative expenses 1,535 Tot. non-interest expenses 3,100 Credit related expenses 347 Pre-tax profit 2,530 Net income 2,113 Diluted common shares 694 Net income per share ($) 3 Dividends/Common share ($) 2 Profitability (%) Return on assets 0.3 Return on equity 7.6 Oper. exp./Net income 72.6 Oper. exp./Assets 0.2 Credit expenses/Net income 16.4 Net int. margin 0.6 Balance sheet & capital ratios (%) Retained portfolio/Assets 88.9 Tot. debt securities/Assets 92.7 Core capital/Assets 4.4 2006 805 704 1,477 354 1,827 69 27 35 744 6 6 3,412 2,393 -307 5,498 1,641 2,809 356 2,282 2,327 683 3 2 0.3 8.8 70.5 0.2 15.3 0.4 87.5 92.5 4.4 2007 794 721 1,739 357 2,103 42 27 38 739 4 14 3,099 2,635 -2,441 3,293 1,674 8,801 3,060 -5,977 -3,094 652 -5 2 2008 851 805 1,827 425 2,207 19 -31 -13 843 5 46 14 2009 842 735 1,870 441 2,251 72 4 N/A 807 1 52 14 % ch (08-09) -1.1% -8.7% 2.3% 3.9% 2.0% 281.0% 113.0% -4.3% -77.8% 14.0% -0.8% % 151.2% -10.0% 82.0% 165.4% 9.7% 65.5% 70.2% 49.8% 57.0% 0.0% 57.6% -100.0% 58.2% 93.6% -155.1% 6.6% -295.8% 144.2% -7.7% -3.3%
Freddie Mac (FHLMC)

Freddie Mac benchmark spreads versus Treasuries (bp)
200 150 100 50 0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 2yr 5y 10yr 30yr
Freddie Mac benchmark asset swap levels (bp)

200 150 100 50 0 -50 -100 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 2yr 5yr 10yr 30yr
6,796 17,073 3,370 3,033 -32,092 -5,765 -21,926 14,341 1,505 1,651 22,190 36,725 17,529 29,837 -44,569 -22,384 -50,119 -21,553 1,468 1,468 -35 -15 1 -2.5 -161.3 -7.7 0.2 -138.4 2.0 87.3 95.8
-0.4 -6.1 -11.5 -2,501.6 -54.1 -3.0 0.2 0.2 -98.9 -35.0 0.4 0.8 90.7 93.0 4.8 94.6 99.1 -1.5

200 150 100 50 0 Floating Callable Rate 2005 2006 $ Ref. Notes Euro Ref. 2007 Sub Debt 2008 Other 2009
Note: *Regulatory capital requirement not binding during conservatorship
Outstanding debt profile ($bn)

13.4% 27.5% 35.3% 23.7% 12.9% 29.3% 37.3% 20.5% 10.3% 31.8% 32.1% 25.7% 12.0% 29.2% 22.6% 36.3% 14.8% 31.4% 25.5% 28.2%
Bullet maturity profile ($bn)

350 286 300 250 200 113 150 75 100 43 26 50 0 10 11 12 13 14
2005 2006 2007 2008 2009 Ref. Bills & Discount Notes Callable Securities $ Reference Notes Other
17 17 15 16
13
4 19
13
17 18
20 20+
Retained portfolio and debt cap ($bn)

1,100 1,000 900 800 700 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 New Caps
Government capital infusion ($bn)

35 30 25 20 15 10 5 0 Capital infusion
FHLMC Debt Out

10 June 2010
Old FHLMC Cap
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
417
Freddie Mac (FHLMC)

Guarantee fees versus operating income
20 10 0 -10 -20 -30 2005 2006 2007 2008 2009 Operating income (ex. guarantee fees) Guarantee fees Fees/Operating income ratio (RHS) 100% 50% 0% -50%
Public sector
Cumulative provisions and charge-offs
60 Cumulative, $bn 50 40 30 20 10 0 2004 2005 2006 2007 2008 1Q09 2Q09 3Q09 4Q09 1Q10 FHLMC Provisions FHLMC Charge-offs
Single family mortgage delinquencies

5% 4% 3% 2% 1% 0% 2004 10% 8% 6% 4% 2% 0% 2005 2006 2007 2008 2009 2010 Non-credit enhanced Credit enhanced (RHS) Total single family
$ bn
Mortgage credit book: Mostly fixed rate

7.5% 9.8% 24% 56% 2005 30-yr Fixed ARMs/FRN 7.1% 11.5% 20% 60% 2006 14.7% 5.2% 16% 63% 14.1% 4.4% 13% 67% 12.0% 3.4% 13% 71%
2007 15-yr Fixed Multifamily
2008
2009
Balloons/Reset Others
Geographical distribution of mortgage credit book

13% 18% 22% 23% 24% 2005 West 13% 18% 21% 24% 24% 2006 Northeast 13% 18% 21% 24% 24% 2007 North Central 13% 18% 21% 24% 24% 2008 Southeast 12% 18% 18% 25% 27% 2009 Southwest
Mortgage credit book: Current loanto-value ratio

8% 18% 18% 56% 10% 20% 18% 52% 2006 60% to 70 % 25% 19% 15% 41% 2007
39% 16% 13% 32% 2008
44% 16% 12% 28% 2009 above 80%
2005 < 60%
70% to 80%
Net interest income and net interest margin ($bn)

15 10 5 0 2005 2006 Net interest income 2007 $ bn 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 2008 2009 Net interest margin (RHS)
Investment portfolio mainly in agency MBS ($bn)

Non-Agency MBS, 175.7, 23% Mortgage Loans, 138.8, 18%
Other Agency MBS, 66.2, 9%
PCs and Structured Securities, 374.6, 50% Total = $867.1bn
FHLMC MBS in portfolio as % outstanding rebounds ($bn)

$bn 2,500 2,000 1,500 1,000 500 0 27.1% 24.0% 354 1,123 20.5% 357 1,382 23.2% 425 1,403 23.6% 441 1,429 30% 20% 10% 0% 2005 2006 2007 PCs held by Others % of PC owned (RHS)
10 June 2010
Retained portfolio: Liquidity ratios ($bn)

100 80 60 40 20 0 $bn 9.5% 67.8 11.4% 7.0% 80.0 50.2 8.0% 64.3 9.8% 15% 10% 72.2 5%
361 974
2008 2009 PCs in Retained Portfolio
0% 2005 2006 2007 2008 2009 Liquidity portfolo (short term investments + cash) Ratio of liquidity/Retained portfolio (RHS)
418
Federal Farm Credit Bank (FFCB)

Description
% $ Index 0.267 % Index NA Total assets USD215bn LT senior unsecured ST Outlook

Ratings table
The Farm Credit System (Farm Credit) is the oldest of the US Government Sponsored Enterprises, established in 1916 when Congress created the Federal Land Banks. Farm Credit is a cooperative system of lending institutions owned by their respective borrowers. Today, the Farm Credit System comprises 96 lending institutions, five system banks AgFirst, AgriBank, Farm Credit Bank of Texas, US AgBank, and CoBank as well as the Federal Farm Credit Banks Funding Corporation, which accesses the bond markets. With $213bn in assets and $163bn in loans, Farm Credit funds approximately 39% of all US farm business debt.
Risk weighting
20%.

Purpose: Farm Credit was created in 1916 to provide accessible credit to American farmers, ranchers, producers and harvesters of aquatic products, co-operatives and farm-related businesses. Ownership, support, and regulation: Farm Credit is a federally chartered network of lending institutions created to provide loans to farmers and farm-related businesses. As a cooperative, Farm Credit is owned by its borrowers and has issued non-publicly traded stock. Farm Credit operates under authority granted by the Farm Credit Act. As a Government-Sponsored Enterprise (GSE), Farm Credit has access to funds at competitive rates and, as a result, can make competitively priced loans to its borrowers. Its GSE status also subjects Farm Credit to regulation by the federal government through the Farm Credit Administration. The Farm Credit Administration, an independent federal regulatory agency, has jurisdiction over the Farm Credit System institutions and is charged with examining credit and collateral quality, capitalisation, interest rate risk, management effectiveness and adherence to the Farm Credit Act. The Administrations enforcement capabilities include the ability to issue cease and desist orders, suspend or remove directors, and impose civil or monetary penalties for violations. The Farm Credit Administration did not enforce any penalties on the Farm Credit System during 2009 and none were outstanding at 31 March 2010. Asset structure and quality: Farm Credits loan portfolio is made up only of retail loans consisting primarily of long-term real estate loans. Net loans increased 2% during 2009. Non-accrual loans as a percent of total loans increased to 2.0% as of Q4 09, more in line with long-term historical norms (this averaged 2.5% in the 1990s). Farm Credits loan portfolio is well- diversified among industry categories and geographically, with the largest five states accounting for only 36% of all loans. This protects Farm Credit from climate and natural disasters affecting the ability of its borrowers to repay their loans. Capital adequacy: Farm Credits administration regulations require that each bank maintain permanent capital of at least 7% of risk-adjusted assets. As of 31 March 2010, all Farm Credit banks met the permanent capital ratios requirement and the ratios ranged between 15.2% and 19.0%. All banks must also hold a net collateral ratio of at least 104% of total liabilities. As of March 2010, all banks were in excess of this requirement, with ratios ranging from 105.5% to 108.9%. Financial performance: Farm Credits 2009 net income was $2.9bn. Net interest income (NII) increased sharply (32%) from 2008. Farm Credits performance is highly dependent on farm business performance, which has remained healthy for the past 10 years according to the USDA. Farm Credit capital ratios have not grown because of increasing dividend and asset growth. Funding: While financial performance has surpassed that of the housing GSEs, Farm Credit paper cheapened to housing GSE names as it was excluded from Treasury capital support and Federal Reserve purchases. Farm Credits banks and associations may not accept deposits and the associations cannot borrow from non-Farm Credit institutions. The banks primarily obtain funds through the issuance of Systemwide debt securities that are joint and several obligations. Longer-term debt issuance by Farm Credit was relatively stable in 2009 at $116bn, from $111bn in 2008. Outstanding Systemwide debt went unchanged during 2009, and actually decreased slightly (-1.0%) in Q1 10.
Strengths
Agriculture has long experienced favourable economic conditions due to consistent federal government support. Well-diversified loan portfolio and good governance has enabled it to avoid recent scrutiny of housing-related GSEs. Joint and several liability and the Farm Credit Insurance Corporation reduce geographical concentration risk.
Weaknesses
Performance can be directly impacted by factors affecting the agricultural and rural economy, including weather conditions, prices of agricultural commodities and changes in government expenditures on agricultural programmes and price controls. Exclusion from government capital and liquidity support, a result of comparatively conservative management, perversely could continue to hurt relative valuations of debt.

Expect a reversal in cheapening relative to housing GSE paper as Fed QE support has recently ended. Less favourable conditions in the agricultural economy could weigh on System financial performance.
10 June 2010
419
Public sector
Financial summary YE December 2009
2006 2007 2008 2009 % ch Balance sheet summary ($bn) Total assets 162.9 186.5 214.4 215.5 1% Net loans 2% 122.7 142.1 160.5 163.5 Investments -4% 30.6 33.8 43.8 42.2 Loan losses allowance 45% 0.7 0.8 0.9 1.4 Capital stock, PC, Pref. Stock 3.6 4.0 4.3 4.8 10% Unallocated surplus 7% 18.7 20.0 21.6 23.0 Fin assistance corp bonds 0.0 0.0 0.0 0.0 Total debt securities -2% 134.5 155.8 180.8 177.3 Income statement summary ($mn) Net interest income 3,584 4,060 4,072 5,392 32% Net non-interest expenses -1,087 -1,135 -1,225 -1,422 -16% LLPs -35 -81 -408 -925 -127% Pre-tax profit 2,462 2,844 3,069 3,045 -1% Net income 2,379 2,703 2,916 2,850 -2% Profitability (%) Return on assets 1.57 1.55 1.46 1.33 -9% Oper. exp/Income ratio 37.6 35.3 37.8 32.0 -15% Net interest margin 2.51% 2.45% 2.13% 2.62% 23% Capital adequacy (%) Total cap/Ttl assets 15.0 14.2 12.7 13.9 10% Debt/Total capital 5.67 6.06 6.90 6.19 -10%

FFCB-designated bond spread versus Treasuries (bp)
250 200 150 100 50 0 -50 May-08
Aug-08 2y
Nov-08 5y
Feb-09 10y
May-09
FFCB-designated bond asset swap spread (bp)

200 150 100 50 0 -50 -100 May-08
Aug-08 2y
Nov-08 5y
Feb-09 10y
May-09
Total debt maturity profile ($bn)

50 40 30 20 10 0 10 11 12 13 14 15 16 17 18 19 20 21+ 30 46 26 17 13 9
7 1
Bullet debt maturity concentrated in short maturities ($bn)

50 40 30 20 10 0 29.5 45.8 26.4 17 12.6 9.2 5.6 4.4 2.5 3.3 1.2 6.9 29 20 10 6 5 3 3 3 41
Debt structure ($bn)

200 175 150 125 100 75 50 25 0
0.5 29.1 36.6 42.8 25.4 19.7 0.5 42.3 43.0 43.8 30.5 16.2 0.2 51.4 41.7 39.9 31.3 11.6
0.4 24.2 32.4 37.7 21.5 17.9
2006 Discos Fixed Rate Callables FRNs
2007
2008 2009 Designated Bonds Fixed Rate Non Callable Bonds Other
Debt distribution, as at 15 May 2009

Other Discos 0.1% 7%
Loan portfolio, YE 09
Agribusiness Communication Energy & water/ waste disposal 2% 14% Production & 5% Rural Intermediate Rural Residential Residential Term Real Estate Real Estate 24% 3% International 3% Real Estate Mortgage 47% Lease 2% Receivables Lease Receivables 1% 1%
420
FRNs 28%
Designated Bonds 18% Fixed Rate Callables 23%
Fixed Rate Non Callable Bonds 24%
10 June 2010

Non-accrual loans and non-performing assets
2.0% 9.08% 1.40% 2.60% 0.43% 2006 2.47% 0.36% 2007 2008 2009 12.60% 2.02% 14% 12% 10% 8% 6% 4% 2% 0% 2.0%
Public sector
Non-performing loans and total risk funds
19.9% 18.6% 30% 24% 18% 12% 6% 0%
16.9% 1.48%
18.3% 2.12%
1.0%
1.0% 0.50% 0.0% 0.44%
0.0%
Non-accrual loans/Total loans Non-performing assets/System combined capital
2006 2007 2008 2009 Nonperforming loans (as % of Loans - LHS) Total risk funds (as a % of loans - RHS)
Geographic distribution: Top five states account for 31%, YE 09

California 10% Texas All other States 64% 8% Minnesota Iowa 4% 6% Illinois 4% Nebraska 4%
Net interest margin

3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 2006 2007 2008 2009 2.51% 2.45% 2.62% 2.13%
Net interest income and net interest income to total interest income ratio
4,500 4,000 3,500 3,000 2,500 3,584 37.3% 35.5% 4,060 37.6% 4,072 59.2% 5,392 80% 60% 40% 20% 0% 2006 2007 2008 2009 Net interest income (LHS) Ratio of net int. income/Total int. income (RHS)
Net interest income and interest-to-revenue ratio
4,000 3,500 3,000 2,500 2,000 1,500 1,000
24.8%
23.7%
26.9%
31.3%
40% 30% 20%
2,379
2,703
2,916
2,850
10%
0% 2006 2007 2008 2009 Net income Ratio of net int. income/Total int. income (RHS)
Structure/ownership of the Farm Credit System
Flow of funds
10 June 2010
421
Tennessee Valley Authority (TVA)

Description
% $ Index 0.214 % Index 0.055 Total assets USD37bn LT senior unsecured Outlook

Ratings table
Moodys Aaa Stable S&P AAA Stable Fitch AAA Stable
The Tennessee Valley Authority (TVA) is the largest power provider in the US, with 33,716 MW of LT-generating capacity available serving >9mn residents of the Tennessee Valley. Created under the Tennessee Valley Authority Act of 1933, TVA funded its operations through Congressional appropriations until 1959, when it was granted authority to access funding from the capital markets. TVA has been self-sufficient since 1959 and has been required to pay back a portion of its original appropriations investment to the US Treasury each year since. Currently, TVA finances its power operations through internally-generated funds and by issuing debt in global and domestic capital markets with a statutory limit of $30bn debt outstanding at any time. One of TVAs six strategic objectives calls for it to continue the trend of debt reduction.
Risk weighting
20%

Purpose: The TVA is a wholly-owned US government corporation, federally chartered under the Tennessee Valley Authority Act of 1933. Its primary objective is to supply affordable, reliable power and agricultural and industrial development to the Tennessee Valley region and provide flood control and navigation of the Tennessee River. Ownership, support, and regulation: TVA is owned by the US government. However, its debt is not guaranteed by the government and it does not receive any funding from US taxpayers. Instead, its debt obligations are backed solely by the proceeds of its power operations and can be met by raising rates when necessary. However, unlike investor-owned utilities, TVA is chartered as a profit-neutral government entity and must charge rates as low as are feasible, providing several benefits as well as additional regulatory oversight. First, TVA is exempt from federal, state and local corporate income taxes (in lieu of taxes, it makes payments of 5% of revenues to the states and localities it serves). Second, it has the authority to borrow up to $150mn from the Treasury under certain circumstances. TVA files annual, quarterly and current reports with the SEC, but is not required to register securities with the SEC. In December 2004, the Consolidated Appropriations Act of 2005 was signed and required the restructuring of the board by increasing the three full-time board members to nine part-time members. Oversight of TVA is handled by the TVA Office of the IG, which conducts audits and investigations of TVA operations and reports findings to the board and Congress. Asset structure and quality: TVA has approximately $37.1bn in assets, which include 11 fossil plants, three nuclear plants and 29 hydro plants, nine combustion turbine plants, 15 solar energy sites, one wind energy site, one pumped-storage plant, and one methane facility; it generated 167bn kWh of electricity in 2009. Capital adequacy: TVAs capital adequacy has steadily improved since 2002, with a total capital/total assets ratio of 10.5% and a total capital/debt funding ratio of 18.6% in 2009, up from 9.6% and 17.5%, respectively, in 2008. TVA is not subject to minimum capital requirements like Fannie Mae and Freddie Mac, but is subject to statutory restrictions that limit the amount of securities outstanding at any time to $30bn, with debt proceeds used solely to fund power operations or refund existing debt. Financial performance: Overall, in 2009, TVA sold 164bn kWh of electricity (versus 176bn in 2008), earning $11.3bn in revenue and resulting in net income of $726mn. Funding and liquidity: While financial performance has surpassed that of the housing GSEs, TVA paper cheapened to housing GSE names as it was excluded from Treasury capital support and Federal Reserve purchases. TVA finances its power operations through internally-generated funds and by issuing debt in global and domestic capital markets. Securities on offer range from overnight discount notes to 50-year maturities. TVA paper consists of discount notes and power bonds, which include innovative structures, such as Valley inflation-indexed power securities (VIPS), Putable Automatic Rate Reset Securities (PARRS) and Electronotes. TVAs total debt outstanding has declined steadily from $27.7bn dollars in 1996, to $22.8bn in 2010, consisting primarily of debt with long-term maturities. Along with the $150mn in borrowing from the US Treasury, TVA also has access to unsecured lines of credit of $2.25bn.
Strengths
Improving capital ratios and structure. Has been steadily reducing its financing obligations while increasing profit margins. Can raise rates to meet obligations.
Weaknesses
Exclusion from government capital and liquidity support a result of comparatively conservative management could, perversely, continue to hurt relative valuations of debt. Exposure to fuel costs and climatic circumstances, eg, drought.

Expect reversal in cheapening relative to housing GSE paper, as Fed QE support is slated to end in 2010. 10 June 2010 Look for liquidity premium to bellwether agencies to decrease due to increased Fed ownership of the latter. 422
Public sector
Financial summary YE September 2009
2006 Balance sheet summary ($bn) Total assets 34.5 Property, plant & equip. 24.4 Def. nuclear gen units 3.5 Investment funds 1.0 Def charges & other assets 2.9 Retained earnings 1.6 Proprietary capital 1.1 Total capital 2.7 Total debt securities 22.9 Income statement summary ($mn) 8,983 Operating revenue Operating expenses 7,560 Interest expenses, net 1,264 Loss: Impairment/Cancellation 0 Net income 113 Profitability (%) Return on assets 0.3 Oper. income/T revenue 16% Int. exp. as % of revenue 14% Capital adequacy (%) Total cap/Total assets 7.8 Ttl. capital/Debt funding 11.8 2007 33.7 24.8 3.1 1.2 2.2 1.8 1.0 2.8 22.6 2008 37.1 25.8 2.7 1.0 5.2 2.6 1.0 3.6 22.6 2009 40.0 26.8 2.4 1.0 7.3 3.3 0.9 4.2 22.6 % ch 8% 4% -12% 5% 41% 28% -9% 18% 0% % 8% 13% -192% N/A -11% -17% -17% -15% 9% 18%
Tennessee Valley Authority (TVA)

TVA Power bonds asset swap spreads (bp)
300 250 200 150 100 50 0 -50 May-08
Nov-08 10yr
Apr-09 30yr
Oct-09 40yr
Apr-10 50yr
9,269 10,382 11,255 7,726 8,198 9,282 1,232 1,376 -1,272 0 0 0 423 817 726 1.3 17% 13% 8.3 12.4 2.2 21% 13% 9.6 15.8 1.8 18% 11% 10.5 18.6
Total debt ($bn)

30 28 26 24 22 20 18 16
24.9
23.3
22.9
22.9
22.6
22.6
22.6
2003
2004
2005
2006
2007
2008
2009
Capital ratios improving

21 18 15 9.7 12 9 6.6 6 2004 15.8 10.4 6.9 2005 11.8 7.8 12.4 8.3 9.6 18.64 11 10 10.54 9 8 7 6 5 2009
Outstanding debt maturity profile fairly stable

50% 40% 30% 20% 10% 0% 46% 29% 17% 11% 8% 2004 10% 43% 36% 43% 31% 15% 10% 45% 33% 16% 6% 2007 41% 36% 13% 10% 43% 41% 12% 4%
2006
2007
2008
Total capital/Debt funding (LHS) Total capital/Total assets (RHS)
2005 2006 ST 11- through 30-yrs
2008 2009 1- through 10-yrs 31- through 50-yrs
Capital structure ($mn)

3,000 2,500 2,000 1,500 1,000 500 0
Interest expense as % of revenue ($mn)

-1,150 25% 20% 15% 10% 5% 0% 2003 2004 2005 2006 2007 2008 Interest Expense, net Interest Expense as % of Revenue (RHS)
306 1,102
1,244 1,148
1,565
1,763
2,571
3,291
-1,200 -1,250 -1,300
1,134
1,041
992
927
-1,350 -1,400
2004 2005 2006 2007 2008 2009 Other Proprietary Capital Retained Earnings
Outstanding debt maturities ($bn)

3 2 1 0 2010 2012 2015 2017 2019 2021 2023 2025 2028 2030 2033 2035 2038 2042 2045 2056
10 June 2010
423
10 June 2010
424
JAPANESE PUBLIC SECTOR PROFILES
10 June 2010
425
Japan Finance Corporation/JBIC (JFC)

Description
% $ Index 0.136 % Index NA Total assets JPY28.0trn LT Senior Unsecured (Domestic/Foreign) Outlook
Joseph Huang
Ratings table
Moodys Aa2/Aa2 Stable R&I LT Senior Unsecured Risk weighting Assuming the debts of former JBIC and the other three public finance agencies, JFC is treated as a Japanese public corporation for regulatory capital purposes and maintains a risk weighting of 10%. AAA (Neg) S&P AA/AA Negative JCR AAA Fitch NR NR
The 100% government-owned Japan Finance Corporation (JFC) was formed on 1 October 2008 by merging Japan Finance Corp for Small and Medium Enterprises (JASME), National Life Finance Corp (NLFC), Agriculture, Forestry and Fisheries Finance Corp (AFC) and the international finance operations of the former Japan Bank for International Cooperation (JBIC). The Okinawa Development Finance Corp is also scheduled to be folded into this group in or after FY 12. The former JBIC ceased to exist after the re-organisation, but JFC continues to use the name JBIC. JFC assumed the outstanding debts of the four merged entities and is the bond issuing entity after October 2008.

Purpose: JFC assumes the policy goals of the four entities that it absorbed: JBIC supports Japanese firms trade financing and overseas investment activities. The SME Unit (the former JASME) provides long-term funds and guarantees to SMEs and accepts insurance on the Credit Guarantee Corps (CGC) guarantees on SME loans. The Micro Business and Individual Unit (the former NLFC) focuses on educational loans and lending to start-ups. The Agricultural, Forestry, Fisheries and Food Business Unit (the former AFC) mainly supports the utilisation and vitality of industries related to natural resources. In addition to these four main business units, JFC also established its Crisis Response Operations, which provide credits to designated financial institutions (ie, Development Bank of Japan and Shoko Chukin Bank) in response to the global financial turmoil. Given JFCs critical policy role as the integrated public financial institution, we believe broad-based government support will continue to underpin its credit profile. Ownership and support: JFC is 100%-owned by the Japanese government. The Ministry of Finance supervises JFCs budget plans and financial statements, which need approval from the Diet. JFCs integral link with the central government comprises capital injections, low-cost funding from the Fiscal Investment and Loan Programme (FILP), guarantees for debt issuance and managerial support. Importantly, the government, as JFCs main creditor, has subordinated its JFC lending to JFCs own bonds. Massive net loss and capital injection: In the six months ended on 31 March 2009, JFC reported a massive net loss of JPY655bn (c.USD6.6bn), mainly due to a loss of JPY633bn in its Credit Insurance Programme account. This programme was set up in response to the governments mandate to support SMEs. As such, the government injected JPY972bn to JFC to offset the negative impact from the substantial policy-directed national burden. This case strengthened our view that despite all the organisational changes, the strength of state support will remain solid. Asset structure and quality: JFCs financials were disclosed by the four main business units on a separate basis, with JBIC accounting for c.33% of JFCs aggregate assets. JBICs exposures (ie, loan, investment and guarantees) are entirely non-Japanese, of which 35% are loans to the Asian-Pacific region. JBICs asset quality has improved over recent years and is the strongest among the four entities within JFC. At end-September 2009, the non-performing loan (NPL) ratio of JBIC fell 13bp h/h to 2.44%. The former AFC came second after JBIC, with an NPL ratio of 3.5%. The former NLFC came third, with an NPL ratio of 7.7%. The former JASME appeared the weakest, with an NPL ratio of 10.3%. Given the lagging effect of asset quality deterioration after the economic downturn, we believe JFCs stand-alone asset quality will remain under pressure but that it will be alleviated by the governments various support mechanisms. Link to sovereign credit quality: JFCs ratings are highly reliant on sovereign credit quality. As we do not expect any change in JFCs ownership structure, we also do not foresee any change in this relationship. However, the underlying trend in the Japanese governments debt dynamics is likely to present challenges over the coming years (ie, the high debt-to-GDP ratio and the increased government budget deficit). Hence, any negative rating actions on Japans sovereign creditworthiness would inevitably have an adverse impact on JFCs ratings as well. Changes on the former JBIC: The erstwhile JBIC has two core operations: the Overseas Economic Cooperation Operation (OECO) and the International Finance Operation (IFO). The IFO account was transferred to JFC and continues its business model. The OECO account, where the bank provides Official Development Assistance (ODA) concessionary loans to developing countries, was taken over by the Japan International Cooperation Agency (JICA).
Strengths
The important and integrated policy roles to support the Japanese economy, especially SMEs. The strong and broad-based support mechanism from the central government.
Weaknesses
Long-term pressure on Japans sovereign credit quality. Asset quality problems stemming from the rapid expansion in directed lending.
Key points for 2010

Any negative rating action on Japans sovereign ratings will inevitably drag down JFCs credit ratings as well. 10 June 2010 426
Public sector
Financial summary YE Mar
JPY Balance sheet summary (JPY bn) Total assets Loans Shareholder's equity Total debt Cash and deposit Income statement summary (JPY bn) Interest on loans Net interest revenue Operating profit Operating expenses Net income Profitability (%) Return on assets Return on equity Cost/Income ratio Leverage and capital ratios Loans/Total capital (times) Total capital/Total assets (%) Bond issuance (JPY bn) Zaito agency bonds Government guaranteed bonds 100.0 88.4 199.0 149.5 70.0 175.5 -64.8 17.4 2.1 43.4 1.9 46.9 3.7 19.9 1.3 3.0 12.8 1.4 2.9 12.5 0.3 1.4 29.0 588 226 202 26 274 588 246 215 27 275 94 28 28 8 27 -84.1 -88.8 -87.0 -69.8 -90.2 FY 06 FY 07 FY 08 % Chg 9,757.0 7,243.1 1,945.9 6,113.1 239.2 -51.5 -58.9 -79.4 -32.3 -22.1
Japan Finance Corporation/JBIC (JFC)

Credit spreads (USD, govt guaranteed, Bid Z-spread, bp)
120 100 80 60 40 20 0 May-09 Jul-09
20,822.7 20,098.4 18,828.8 17,625.5 9,030.0 10,070.9 329.0 9,428.6 9,025.6 307.3
Sep-09 Nov-09
Jan-10 Mar-10
JFCORP 4.625 Dec 2014
Debt maturity structure, May 2010

800 600 400 200 0 2012 2013 2014 2015 2016 2017 2018 >2018 Bond debt (JPY bn) 643 395 235 217 111 100 50 100
Debt currency breakdown, May 2010

EUR 6%
Note: All the financials mentioned on this page refer to JBIC, not JFC. FY 06 and FY 07 figures refer to the former JBIC. FY 08 figures refer to the new JBIC under JFM. Fiscal year runs from April to March, but FY 08 covers the period from 1 October 2008 to 31 March 2009. Accounts based on Japanese GAAP (ie, no special public sector accounting standards).
JPY 46%
USD 48%
Capital structure, FY 08
Others 9%
Solvency and RoE

50% 40% 30% 41.3% 3.6% 43.4% 3.0% 46.9% 6% 4% 2.9% 1.4% Capital 53% 20% 10% FY 05 FY 06 FY 07 FY 08 Return on equity (R) 19.9% 0% -2% Total capital/total assets (L) 2%
Retained earnings 38%
Asset composition, FY 08
Clients' liabilities for acceptance & guarantees 17% Others Cash and 6% deposit 2%
Outstanding loan distribution, FY 08

Europe 11% Others 7% Asia-Pacific 35%
Long-term loans 75%
Middle East 23% America 24%

427
10 June 2010
Japan Expressway Holding and Debt Repayment Agency (JEHDRA)

Description
Joseph Huang
S&P AA/AA Negative JCR NR Fitch NR NR
Ratings table
Moodys Aa2/NR Stable R&I LT Senior Unsecured AAA (Neg)
Japan Expressway Holding and Debt Repayment Agency (JEHDRA) was established as an independent administrative institution on 1 October 2005, with the privatisation of four highway-related public corporations, including Japan Public Highway Corporation. The new expressway agency assumed the vast majority of debts and road assets of these privatised entities and will also undertake new debts related to road construction in accordance with agreements established with operating road entities (six new entities). JEHDRAs total assets stood at JPY41.7trn (USD421bn) at end-March 2009.
Risk weighting
JEHDRA is treated as a Japanese public corporation for capital adequacy and has a weighting of 10%.

Purpose: JEHDRA was established to assume and repay the debts (about JPY40trn in 2005) accumulated by four previous highway-related entities over a 45-year period to minimise the burden on the general public. To do this, JEHDRA will lease the road assets to the six operating road entities, with the proceeds being used to service and ultimately repay its inherited debt. In addition, the new agency may acquire new debt related to the construction of genuinely needed expressways. Impact from discount on tolls: To promote the effective utilisation of expressways, under Japans economic stimulus package, JEHDRA and expressway firms lowered tolls by offering a special weekend toll ceiling of JPY1,000 (unlimited distance) and an all-day weekday discount of 30-50% for a two-year period ending at end-March 2011. As a result, JEHDRA made JPY2.7trn (c.USD27bn) of provisions for these toll discounts in FY 08 ended on 31 March 2009. To offset this negative impact, JEHDRA recorded a significant one-off profit by offloading JPY3.0trn of debt to the governments general account. Ownership and support: JEHDRA is 75%-owned by the central government, and the remainder is held by local governments, including Metropolis of Tokyo (4.8%). The Ministry of Land, Infrastructure, Transport and Tourism (MLIT) remains heavily involved in the supervision, planning, budget, debt repayment and funding of JEHDRAs operations. Given the importance of the road operations to the economy and ownership structure, we believe government support would be forthcoming in the event of financial difficulties. This support could take the form of capital injections, funding and/or debt guarantees. Therefore, we believe JEHDRAs credit profile is strongly linked to the sovereign. Financial performance: Despite the global economic downturn and its short track record, JEHDRAs operating performance has been largely stable, helped by low financing costs and steady leasing income. Indeed, the average funding cost of interestbearing liabilities edged up just slightly to 1.62% at end-March 2009, from 1.59% a year earlier. That said, we believe long-term traffic volume projections, in line with demographic trends, will show limited growth prospects. While details of the agreements between JEHDRA and each operating entity are heavily influenced by the assumption of traffic volumes, JEHDRAs longterm revenue streams will require attention. A more determinable variable will be the amount of new road construction. However, despite privatisation, such plans could still be susceptible to the political motives of central and local governments, in our opinion. Funding: On a management account basis, total debt balance fell 10.8% y/y to JPY31.3trn at end-March 2009, which is JPY432bn lower than the planned debt balance. On a financial statement basis, about 10% of total debt was due within one year. Bonds, accounting for 63% of total debt, were mostly guaranteed or subscribed by the government. Increasingly, the agency is issuing Zaito agency bonds ie, bonds without government guarantees, which accounted for about 20% of annual bond issuance. JEHDRA was able to extend the duration of its borrowing by issuing 40y bonds: JPY240bn issued in FY 07 and another JPY110bn issued in FY 08. While a degree of refinancing risk remains, funding costs are still low and being well supported by the government. Hence, near-term funding problems are unlikely, in our opinion.
Strengths
Strong state support, evidenced by 100% government guarantees and capital injections. ownership,
Weaknesses
Potential political interference. Declining traffic volume over the long term, given Japans limited prospect of economic growth. The pressure on Japans fiscal position would pose medium-term risk of a downgrade in JEHDRAs credit ratings.
Critical policy role as the manager of expressway assets and debt repayment on behalf of the government. Predictable cash-flow generation (ie, c.JPY900bn net highway lease income), underpinned by the virtual monopoly position of highway operations throughout Japan.
Key points for 2010

Further demonstration of ability to issue longer-dated bonds to lower refinancing risk. Ability to continue to reduce funding costs and meet planned debt-reduction targets. 10 June 2010 428
Public sector
JPY Assets (JPY bn) Current assets Fixed Assets Total Assets Liabilities and Capital (JPY bn) Current liabilities of which bonds of which borrowings Long-term liabilities of which bonds of which borrowings Total Liabilities Shareholders equity of which retained earnings Income statement summary (JPY bn) Highway leasing and other income Net highway leasing income Financial and other expenses Operating profit Net income Leverage and capital structure Debt/capital (X) Debt/total assets Short term debt/total debt Bond issuance (JPY bn) Zaito agency bonds Government guaranteed bonds
Japan Expressway Holding and Debt Repayment Agency (JEHDRA)

FY 06 379.3 FY 07 271.4 FY 08 % chg 318.7 17.4 -1.0 -0.8 -23.0 -56.7 156.6 -8.5 3.3 -30.1 -2.9 10.9 68.0 -5.6 -12.1 -2.8 -25.3 42.6
120 90 60 30
42,091.7 41,752.9 41,351.8 42,471.1 42,024.4 41,670.6 4,760.0 3,939.3 605.5 4,534.2 3,780.2 623.3 3,492.0 1,635.3 1,599.6
0 May-09
Jul-09
Sep-09 Nov-09
Jan-10 Mar-10
31,818.9 31,067.5 28,439.4 20,071.1 19,415.0 20,056.8 10,960.7 10,874.7 5,881.6 436.1 1,896.3 979.1 609.2 369.9 383.3 6.0 83.8% 12.8% 530.0 2,190.0 6,411.7 836.2 1,899.7 986.5 579.3 407.2 399.0 5.4 82.6% 12.7% 610.0 2,483.0 7,598.2 7,107.5 1,405.2 1,792.6 867.4 563.3 304.1 569.0 4.3 74.1% 10.5% 590.0 2,393.0 36,589.5 35,612.6 34,563.0
JAPEXP 4.625 Oct 2013

8,000 6,000 4,000 2,000 0 878 739 616 1,167 5,771 2,1782,107 1,9812,325 2,403
2010
2011
2012
2013
2014
2015
2016
2017
2018
Bond debt (JPY bn)

-3.3 -3.6
Note: Fiscal year runs from April to March (eg, FY 08 covers April 2008 to March 2009).
JPY 99.8%
USD 0.2%
Organisational structure post privatisation

Road operation, management and construction Succeeded road assets and existing debt of four corporations
Leasing Fees
East Nippon Expressway Japan Highway Public Corp Split into three entities Central Nippon Expressway West Nippon Expressway Japan Expressway Holdng and Debt Repayment Agancy (JEHDRA)
To merge after operations stablise

Honshu-Shikoku Bridge Authority Metropolitan Expressway Public Corp Hanshin Expressway Public Corp Honshu-Shikoku Metro Expressway Hanshin Expressway
Creditors, including FILPs
10 June 2010
>2018
429
Japan Finance Organization for Municipalities (JFM)

Description
% $ Index 0.025 % Index 0.014 Total assets JPY23.4trn LT Senior Unsecured (Domestic/Foreign) Outlook
Joseph Huang
Moodys Aa2/Aa2 Stable R&I S&P AA/AA Negative JCR NR Fitch NR NR
Ratings table
Japan Finance Organization for Municipalities (JFM) is a 100% localgovernment-owned policy institution that specialises in lending to Japanese local governments. As part of structural reforms to Japanese public financial institutions, the assets and liabilities of the former JFM were taken over by Japan Finance Organization for Municipal Enterprises in October 2008. The entity received a c.JPY17bn capital injection from all local governments and returned the same amount of capital to the central government. In June 2009, the entity experienced another organisational change including expanding lending areas and changing its name to the current one. JFM is the largest bond issuer in the domestic market, with about JPY19trn (USD190bn) of bonds outstanding.
LT Senior Unsecured
AAA (Neg)
Risk weighting
JFM is treated as a Japanese public corporation for capital adequacy and has a risk weighting of 10%.

Purpose: The former JFM was established in 1957, with the aim of providing long-term and low-interest-rate funds to local governments to contribute to the sound management of their municipal enterprises. As a conduit for local governments, JFMs public policy role focuses on maintaining affordable public utility rates (eg, water and sewage systems) and reducing the financial burden of local governments. Its loans stood at JPY22.2trn at end-March 2009, and accounted for around 10% of all local governments debt. Changes after the reform: Following the reforms aimed at decentralising government finances, the newly-formed JFM withdrew from lending to local public corporations related to toll roads and housing supply. Instead, the focus of lending has been put back to projects tied to community facilities (eg, water supply, hospitals and public housing). Also after the reform, the new JFM operates two accounts: the General Account comprises new JFM operations while the Management Account warehouses former JFM assets and debt. Central government guarantees on existing debt are unaffected by the reform. Ownership and support: The new JFM is 100% owned by all of Japans local governments (ie, prefectures, cities, wards, towns and villages). Despite the lack of direct central government ownership, we believe the new JFM will continue to benefit from the involvement and firm support of the central government, given JFMs critical policy role. The new JFM is still required to submit budget plans and various financial reports to the Ministry of Internal Affairs and Communications (MIC). However, JFM is not dependent on subsidies and loans from the central government. Instead, JFM relies completely on the bond market for its funding requirements. Reclassification of reserves: After the reform in October 2008, the former JFM transferred its reserve for interest rate volatility to the new JFM. This reserve stood at JPY3.3trn at end-March 2009, and serves as the buffer to cope with any refinancing risk stemming from a rise in interest rates. However, after the reform, the reserve has been accounted as liability rather than net asset on the balance sheet. This accounting change reduces JFMs reported capital ratios. Persistent duration gap: JFM has a duration mismatch between assets and liabilities, reflecting the 25y average maturity of its fixed-rate lending and its shorter-dated funding profile (mainly 10y bonds). While the entity has issued longer-dated instruments recently, the average duration of its loans is still 7.71 years, versus 4.76 years for that of bonds outstanding. The duration gap was largely flat y/y and stood at 2.95 years at end-March 2009. JFMs duration gap poses significant refinancing risks should interest rates climb from the relatively low base at present. In view of this situation, from FY 09 JFM has sought to mitigate interest rate risk by issuing super-long-duration bonds and leveraging interest rate swaps. JFMs targets include: 1) keeping the outlier ratio (ie, the ratio of interest rate risk to interest volatility reserves and other capital, following a +/-200bp parallel interest-rate shock) below 20%; and 2) keeping the duration gap at two years or less. Asset structure and quality: Long-term loans account for 95% of JFMs total assets. It is also worth noting that the new JFM lends only to local governments, excluding the previously-eligible local public corporations. JFMs track record of asset quality remains intact, and this has been assisted by tight supervision from the MIC. JFMs asset quality is strong, with no defaults on its loans since the inception of the former JFM in 1957. In FY 08 ended on 31 March 2009, there were no loans past due over three months.
Strengths
Important policy role of financing local governments, with very strong backing from the central government. Healthy asset quality, with no non-performing loans.
Weaknesses
Persistent asset-liability mismatch in terms of durations. Industry concentration, with lending focused on governments, which are generally with high debt burden local
Key points for 2010

The progress of terming out debt duration to reduce the duration gap of its loans and bonds. The long-term pressure on Japans fiscal position at both national and local levels.
10 June 2010
430
Public sector
JPY Balance sheet summary (JPY bn) Total assets Loans Shareholder's equity Total debt Cash and deposit Interest on loans Net interest revenue Operating profit Operating expenses Special gains/losses Net income Profitability (%) Return on assets Return on equity Cost/Income ratio Leverage and capital ratios Loans/Total capital (times) Total Capital/Total assets (%) Bond issuance (JPY bn) Zaito agency bonds Government guaranteed bonds 360.0 861.8 370.0 772.4 310.0 1,018.6 7.7 12.4 6.6 14.1 418.5 0.2 1.4 10.9 0.5 1.4 9.8 0.4 0.1 38.5 0.9 FY 06 FY 07 FY 08
Japan Finance Organization for Municipalities (JFM)

Credit spreads (GBP, govt guaranteed, Bid Z-spread, bp)
% Chg -5.6 -4.4 NM 16.8 -72.3 -57.6 -60.7 -61.7 -17.9 NM -94.0
25,446.8 24,752.2 23,369.6 24,267.4 23,230.0 22,215.3 3,154.4 408.1 730 349 344 2 0 344 3,495.4 922.5 687 346 341 1 0 341 53.1 255.5 291 136 131 1 -110 20 21,003.9 19,962.9 23,316.5
120 100 80 60 40 20 0 May 09 Jul 09 Sep 09 Nov 09 Jan 10 Mar 10 GBP JFM 5.75 Aug 2019
Income statement summary (JPY bn)

4,000 3,000 2,000 1,000 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 >2018
14% 12% 10% 8% 6% 4% 2% 0%
2,921 2,139 1,861 2,228 780 1,613 1,268 1,070
845 826
Bond Debt (JPY bn)

-16.2 31.9
Note: FY 08 covers the period from 1 August 2008 to 31 March 2009, except for bond issuance that covers the 12 months ended on 31 March 2009.
JPY 97%
EUR and other 1% USD 2%
Capital structure, FY 08
Solvency and RoE

16% 12.1% 10.9% 12.4% 10.8% 8% 0.6% 4% FY 05 FY 06 FY 07 FY 08 14.9%
Retained earnings 69%
Capital 31%
12%
14.1% 9.8%
Return on equity& reserves (R)
Net assets & reserves/total assets
Bond issuance breakdown in FY 08

Zaito agency bonds 8% Government guarantee bonds 82% Private placement 10%
Long-term Loans 95%
Others 4% Cash and Deposit 1%
10 June 2010
431
Development Bank of Japan Inc. (DBJ)

Description
Joseph Huang
Ratings table
Moodys Aa2/Aa2 Stb R&I LT Senior Unsecured AA S&P AA-/AAStb JCR AAA Fitch NR NR
The Development Bank of Japan Inc. (DBJ) is one of Japans major policy financial institutions. As part of a long-term privatisation process, DBP was converted to a joint-stock company on 1 October 2008. However, in response to the global economic downturn, the government expanded DBJs policy role and amended the DBJ Law in June 2009. The revised law enabled the government to extend its DBJ investment period to end-March 2012, and the timing of DBJs full privatisation was extended to 2017-19 from 2013-15. For the nine months ended on 30 September 2009, DBJ had extended JPY2.6trn of emergency measure loans and purchased JPY361bn of commercial paper. With total assets of JPY15trn, DBJs balance sheet size is smaller than its peers (JFM and JFC), as well as major private-sector banks.
Risk weighting
DBJ is currently 10% risk weighted under the domestic regulations. This could change toward the targeted privatisation period during 2017-19. For instance, if DBJ starts to take deposits, its Basel II risk weight would be 20% under current ratings.

Purpose: DBJs prime objective is to provide long-term, low-cost, fixed-interest financing and investments for projects that have a high policy priority but cannot attract sufficient support from the private sector. The bank finances urban redevelopment, power generation, environmental protection, regional transportation, technological development, and industrial revitalisation projects, etc. Since FY 01, DBJ has also become directly involved in supporting distressed private-sector companies. For instance, DBJ had been supporting Japan Airlines (JAL) Group before its filing for bankruptcy in January 2010. Now DBJ is one of the main banks of JALs high-profile three-year restructuring plan. A step back from privatisation: Despite its privatisation plan, DBJ has expanded its policy role amid the global financial turmoil. From December 2008, DBJ has been one of the two designated institution leading governments crisis response programme to provide financing to and purchase commercial paper from midand large-sized corporations. In February 2010, the government extended DBJs crisis response operations for one year until endMarch 2011. We view the move as near-term credit positive for DBJ, as it reinforced DBJs policy importance. Strategic uncertainty: On the other hand, we believe DBJs renewed lead in policy lending will weigh on its stand-alone credit fundamentals and impinge on its longer-term strategy to increase self-handled funding (ie, bonds issued without government guarantees). Longer term, we believe that establishing a commercially-viable business model and market niche will be challenging for DBJ. The bank plans to increase businesses related to project screening, structured financing, and fund investment. However, with our expectation of intense competition from megabanks, DBJs business will face longterm execution risks, in our view. Asset quality weakened: Loans account for c.88% of DBJs total assets. At end-September 2009, based on Financial Revitalisation Law standards used by private-sector banks, DBJs NPL balance rose 138% h/h to JPY461bn, equal to 3.44% of total lending. We believe the sharp rise in NPLs was mainly due to DBJs increased involvement in the rehabilitation of private-sector firms. The asset quality of DBJs loans to local-government-related projects (so-called third-sector projects) improved in H1 FY 09 but remained weak. The NPL ratio of third-sector loans fell 110bp h/h to 7.6% at end-September 2009. Capital and funding: DBJs capitalisation was strengthened by the governments capital injection of JPY103bn in September 2009. At end-September 2009, the bank had a solid Tier 1 ratio of 24.4%. DBJ does not collect retail deposits and therefore obtains large amount of its funding from borrowing under the Fiscal Investment and Loan Programme (FILP). It has also actively diversified into government-guaranteed bonds, zaito agency bonds (ie, without explicit government guarantees) and interbank borrowings. Given DBJs policy importance and high dependence on wholesale funding, we believe the government will continue to support DBJs need for capital and funding, despite DBJs longer-term privatisation plan. Ownership and support: DBJs credit ratings enjoy a high level of state support, reflecting the governments 100% ownership. Toward full privatisation, we believe that DBJ will be rated more as a stand-alone entity, but the withdrawal of government support will be protracted. Under the revised DBJ Law, the government plans to review DBJ's current organisation and status by endMarch 2012. DBJ is now supervised by the Ministry of Finance (and the Prime Minister for certain operations). If it collects deposits, it will be supervised by the Japanese Financial Services Agency (FSA).
Strengths
High likelihood of support from the government. Strong loss absorption capacity due to its solid capital position.
Weaknesses
Long-term pressure on Japans fiscal position. Latent asset quality pressure resulting from its crisis response operations.
Key points for 2010

Any change in DBJs role as a policy lender for wholesale borrowers in Japan. If treated as a deposit-taking financial institution, the new DBJ could become 20% risk weighted. 10 June 2010 432
Public sector
JPY Balance sheet summary (JPY bn) Total assets Loans Shareholder's equity Total debt Cash and deposit Income statement summary (JPY bn) Interest on loans Net interest revenue Operating profit Operating expenses Net income Profitability (%) Return on assets Return on equity Cost/Income ratio Leverage and capital ratios Loans/Total capital (times) Total capital/Total assets (%) Bond issuance (JPY bn) Zaito agency bonds Government guaranteed bonds 200.0 118.8 235.0 373.8 289.8 378.4 325.5 200.0 12.3 -47.1 6.4 14.7 6.1 15.1 5.5 16.5 5.8 14.9 0.7 4.6 26.7 0.6 3.8 27.0 0.4 2.5 34.0 -0.9 -6.2 38.9 366 96 71 26 92 326 93 69 25 75 306 104 58 30 53 130 52 28 18 -128 -57.4 -50.4 -51.8 -40.5 -344.0 13,685.9 13,078.9 12,527.0 14,028.1 12,873.2 12,089.8 11,470.5 12,008.9 2,010.3 28.2 1,981.4 40.3 2,072.6 182.9 2,086.5 67.5 11,266.3 10,595.6 10,135.7 11,580.9 12.0 4.7 0.7 14.3 -63.1 FY 05 FY06 FY07 FY08 % Chg
Development Bank of Japan Inc. (DBJ)

120 100 80 60 40 20 0 May 09 Jul 09 Sep 09 Nov 09 Jan 10 DBJJP 4.25% Jun 2015 Mar 10

1,000 800 600 400 200 0 899 529 353 324 333 433
334 103
335
230
Bond debt (JPY bn)
Note: Fiscal year runs from April to March (eg, FY 08 covers April 2008 to March 2009). Accounts based on Japanese GAAP (ie, no special public sector accounting standards).

EUR 5% JPY 85% USD 10%
Outstanding debt breakdown, FY 08

Zaito agency bonds 13% Other borrowing 17% Government guarantee bonds 18% FILP borrowing 52%
Solvency and RoE

8% 6% 4% 2% 0% -2% -4% -6% -8% 6.0% 13.0% 4.6% 14.7% 15.1% 3.8% 16.5% 2.5% 20% 14.9% 16% 12% 8% 4% -6.2% FY 04 FY 05 FY 06 FY 07 FY 07 Return on equity (L) Total capital/assets (R) 0%
Cash and deposit 0.5% Others 13.9%
Loan breakdown by industry, FY 08

Real estate 12%
Long-term loans 85.6%
Utilities 17% Others 21%
Transportation 28%
Manufacturing 22%
10 June 2010
433
>2018
2010
2011
2012
2013
2014
2015
2016
2017
2018
Tokyo Metropolitan Government (TOKYO)

Description
% $ Index NA % Index NA Total debt JPY11.1trn LT Senior Unsecured (Domestic/Foreign) Outlook
Joseph Huang
Ratings table
Moodys NR NR R&I LT Senior Unsecured NR S&P AA/AA Negative JCR NR Fitch NR NR
Tokyo Metropolitan Government (Tokyo) is the largest prefecture in Japan. As the nations capital and economic/political centre, Tokyos FY 07 GDP (JPY93trn) was larger than Hollands and accounted for about 18% of Japans total GDP It is also the largest local government bond issuer in Japan, with JPY7.1trn of bonds outstanding at endMarch 2009 (ordinary account basis), which is equivalent to about 18% of the total local government bond market, underlining its benchmark status. Tokyo is the largest local government in Japan in terms of revenue (2.6x the revenue of the second-largest prefecture Osaka in FY 08). Also, it does not rely on the central governments subsidies and ranks highly in terms of intrinsic financial strength.
Risk weighting
Tokyo Metropolitan Government is treated as a Japanese local government for capital adequacy and has a risk weighting of 0%.

Economic structure and performance: As the largest prefecture in Japan in terms of economic value, Tokyo is at the centre of the nations political and economic infrastructure. Most of Japans corporations have head offices in the capital, and it remains the heart of Japans financial markets. The prefecture has a relatively high concentration of exposure to the service, wholesale, and financial industries. It has a population of about 12.8mn 10% of the nations total. Public finance: Despite the economic downturn, Tokyo remains the least reliant on the central government transfers, mainly due to its strong local tax base. Its own-source revenue ratio (ownsource revenues/total revenues) is around 82%, significantly exceeding the prefecture average of c.46%. Therefore, Tokyo is the only prefecture not to receive local allocation tax grants from the central government. Tokyo did encounter some fiscal difficulties in 1999, but a successful reconstruction programme has since put finances in order. The programme, launched by then new Governor Shintaro Ishihara, included cutting operating expenses and capital expenditures. In recent years, Tokyos fiscal reconstruction has led to a reduction in overall debt levels and thus, a stronger financial profile. Changes in tax allocation: As a result of FY 08 tax revisions, part of the local corporate tax is put under the control of the central government for re-allocation among all local governments. Tokyo expected the impact to result in a reduction in tax revenue of JPY190bn in its FY 09 budget, which appears manageable for Tokyo in terms of size (c.4% of total tax revenue in FY08), in our view. Debt: Tokyos outstanding bonds (on all-account basis) peaked at JPY14.1trn in FY 01 and declined steadily since then, reaching JPY11.1trn at end-March 2009. Long-tenor bonds (more than 10y) accounted for 93% of Tokyos total bond issuance in FY 09 ended at end-March 2010. Ailing projects: Tokyo may face some pressure from the financial difficulties of so-called third-sector projects (ie, project invested by local governments and private-sector entities). For example, Tokyo set up ShinGinko Tokyo Ltd (SGT) in 2005 to help SMEs, and currently owns an 84% stake in SGT. Faced by SGTs financial distress, Tokyo injected JPY40bn of capital in 2008 to support the loss-making company. As of end-2009, despite SGTs aggressive NPL write-offs, the NPL ratio remained high at 11%. SME loans accounted for about two-third of SGTs total loan balance. Potential drag from peers: Tokyos stand-alone credit standing is one of the highest among Japanese local governments and public financial institutions. This reflects Tokyos relative financial strength over other local governments and its fiscal discipline during past years. That said, any change in tax regime/allocation across central/local governments is a source of risks for the city, in our view. Given Tokyos peer-leading fiscal position, we believe it could be adversely affected by any structural adjustments/transfers to support other heavilyindebted local/regional governments. Political situation: As a result of the elections for the Tokyo Assembly, Democratic Party of Japan won the majority as opposed to the prefecture governor Ishihara who is largely supported by the Liberal Democratic Party of Japan and New Komeito. The complicated assembly situation may delay the policy decision and implementation process, in our view. Furthermore, Ishiharas current term will end in April 2011.
Strengths
A resilient local tax revenue base and sound fiscal flexibility in Japans context. Track record of fiscal reform that has led to Tokyos improving credit profile.
Weaknesses
Deterioration in the central governments fiscal health. Negative long-term demographics. Fiscal burden from third-sector projects and weak subsidiaries.
Key points for 2010

Impact of ongoing reforms on local and central government finances. Impact from third-sector projects and guarantees to weak affiliated public enterprises. 10 June 2010 434
Public sector
JPY bn Economy Nominal GDP (JPYtrn) GDP per capita (JPY mn) Population (mn) Revenues Revenues Local taxes Local allocation tax grants Subsidies Bond Issuance Expenditures Salary related cost Debt servicing costs Capital expenditure Balances and debt Effective fiscal balance Debt outstanding (ordinary account) Debt outstanding (all accounts) Key ratios Financial capability index Debt burden ratio Current account ratio 1.215 15.5% 84.5% 1.319 11.3% 80.2% 1.406 13.0% 84.1% 137.0 6,762.8 95.6 6,292.6 0.8 5,895.6 -99.2% -6.3% -4.0% 1,592.8 961.9 669.7 1,605.9 752.8 704.3 1,575.5 822.6 741.8 -1.9% 9.3% 5.3% 6,827.8 4,927.1 0.0 352.4 214.3 7,143.6 5,497.3 0.0 348.6 157.3 7,077.4 5,293.3 0.0 404.4 303.9 -0.9% -3.7% NM 16.0% 93.2% 94.1 7.4 12.66 93.0 7.3 12.76 12.84 0.6% FY 06 FY 07 FY 08 % chg
Tokyo Metropolitan Government (TOKYO)

Fiscal soundness
150% 100% 50% 0% 2004 2005 2006 2007 2008 Financial capability index Current account ratio 106.0% 92.6% 110.7% 85.8% 121.5% 131.9% 140.6%
84.5%
80.2%
84.1%
Economic structure, FY 07
Others 25% Manufacturing 9% Financial services 15% Wholesale & retail 21% Service 30%
12,151.0 11,600.0 11,130.3

2,000 1,500 1,000 500 0 1,263 903 711 819 791 976 678 440 390 1,606
Note: 1) Fiscal year runs from April to March. 2) Ordinary account base. 3) Debt burden ratio = debt servicing cost as percentage of general account revenues. 4) Effective fiscal balance: Final revenue minus final expenditure (nominal balance), as well as the deduction of fiscal sources to be set aside for operations carried over the following fiscal year. 5) Current account ratio: This is a measure of the local government's financial flexibility. The lower the %, the less mandatory expenditures it has compared with revenues. Source: Tokyo Metropolitan Government.
2010
2011
2012
2013
2014
2015
2016
2017
2018
Bond debt (JPY bn)
Structure of tax revenues, FY 08

Others Consumption 11% tax 6% Habitant tax 18% Fixed asset tax 20% Corporate tax 45%
JPY 98.1%
USD 0.2% EUR 1.7%
Debt outstanding (all accounts)

15 14 13 12 11 10 9 8 2001 2002 2003 2004 2005 2006 2007 2008 Outstanding (JPYtrn)
10 June 2010 435
>2018
10 June 2010
436
AUSTRALIAN ISSUER PROFILES
10 June 2010
437
New South Wales Treasury Corporation (NSWTC)

Description
% A$ Index 8.1 % Index NA Total assets AUD49bn LT Senior Unsecured (Domestic/Foreign) Outlook
Gavin Stacey
Moodys Aaa/Aaa Stable S&P AAA/AAA Stable Fitch NR NR
Ratings table
New South Wales Treasury Corporation (NSWTC) was established in 1983 under the Treasury Corporation Act 1983 of New South Wales (NSW). It originally operated as part of the NSW Treasury before becoming an independent semi-government entity in 1987. It is the central financing authority for the government of NSW and entities in NSWs public sector. The credit ratings on NSWTC reflect the ratings on its owner and guarantor, the State of NSW. S&P revised the outlook on NSWTC and NSW back to Stable from Negative in June 2009, to reflect its opinion that the government will remain committed to structural improvement in its budgetary performance.
Risk weighting
The Australian Prudential Regulation Authority has designated a zero-risk weighting to the borrowings of NSWTC.

Purpose: Under the Treasury Corporation Act 1983, NSWTCs principal objective is to provide financial services for, or for the benefit of, the NSW government, its public authorities and other public bodies. All NSW government agencies are required to conduct their borrowing through NSWTC, except temporary bank overdrafts. This enables NSWTC to minimise debt costs by consolidating the borrowing requirements of these agencies into a few benchmark issues. NSWTC also provides liability and asset management services for the government and public authorities, although some of its services are contestable by the private sector. Support mechanism: Payment of interest and principal on the debt securities issued by NSWTC are guaranteed by the government of NSW under section 22A(1) of the Public Authorities (Financial Arrangements) Act 1987 (PAFA Act). Section 22B of the PAFA Act also provides a discretionary guarantee covering derivatives entered into by NSWTC. Since early 2009, NSWTC has also been able to issue AUD-denominated securities guaranteed by the Commonwealth government under the Guarantee Scheme offered to state governments. The Australian government has since announced that the scheme will close to new issuance on 31 December 2010. NSWTC currently has c.AUD22bn of securities under the Guarantee Scheme. Link to state government credit quality: NSWTC and NSWs ratings are intertwined given NSWTCs role in issuing debt on behalf of NSW and its dependency on the guarantees provided by the government on its debt, as well as loans to NSW public sector clients (loans to NSW public sector clients accounted for c.77% of NSWTCs total consolidated assets at end-June 2009). Excluding the state, the electricity sector was NSWTCs largest borrower at end-June 2009. Credit profile of the state: As with the other Australian states, NSWs credit profile is underpinned by strong support from the commonwealth government which provided c.35% of NSW total state sectors revenues in FY 08-09 (end-June 2009). While the governments balance sheet is generally robust, it has deteriorated somewhat over the past few years the government incurred a budget deficit in FY 08-09 and forecasts a deficit of c.AUD1.02bn in FY 09-10. The government also expects net financial liabilities (net debt and unfunded superannuation liabilities) relative to revenue for the non-financial public sector to rise to c.110% by 2013, from c.98% in 2009, given its capital spending plans it expects capital spending between FY 09-10 to FY 12-13 to total AUD65.5bn. S&Ps trigger band for the ratio is between 120-130%. In response to the pressures on its balance sheet, the NSW government has since demonstrated fiscal discipline by introducing measures to increase revenues and reduce operating expenses and capital spending. The government is forecasting a return to a budget surplus of AUD872mn in FY 10-11. Capital and funding: NSWTCs domestic Benchmark Bond programme forms the cornerstone of its funding strategy and accounted for c.71% of its total long-term borrowings at endJune 2009. NSWTC also borrows in the offshore market, primarily through its global exchangeable bonds, to diversify its investor base and to smooth its maturity profile. Global exchangeable bonds accounted for c.17% of total long-term borrowings as at end-June 2009. Liquidity: Short-term financial assets (excluding loans to clients) to short-term financial liabilities was roughly unchanged at c.68% from a year ago at end-June 2009.
Strengths
Strong support mechanism from the state government Demonstrated support from the commonwealth government through its guarantee of state borrowings
Weaknesses
Concentrating borrowings in several benchmark lines may lead to some refinancing pressures, although we expect NSWTC to take steps to pre-fund maturing benchmark lines.
Key points for 2010

Progress of the state in improving its budgetary performance and managing its capital spending programme
10 June 2010
438
Financials
Financial summary YE June
AUD FY07 Balance sheet summary (AUD mn)
Total assets Cash and liquid assets Due from financial institutions Securities Loans of which to the Crown of which to other clients Borrowings of which domestic benchmark of which global exchangeable Total equity 287 21 3,847
New South Wales Treasury Corporation (NSWTC)

Credit spreads (Bid OAS)
FY08 FY09 % Chg
32.3 -47.9 36.6 24.9 22.7 26.1 34.1 123.5 -48.4 73.8 83.5 21.2 -317.2 252.4 43.0 427.1
32,370 37,053 49,020 448 21 5,674 233 7,753
1,482 6860.6
27,704 30,333 37,889 10,485 10,642 13,055 17,219 19,692 24,833 30,375 35,225 47,232 12,419 13,790 30,815 14,431 14,275 43 68 23 -22 69 24 34 86% 94% 2.0% 4.6% 43 65 21 -28 58 26 24 82% 95% 2.8% 4.6% 7,366 75 119 26 61 205 38 124 77% 96% 0.2% 6.4%
100 80 60 40 20 0 -20 -40 Jan-09
NSWTC 5.5% '14
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Debt maturity structure, as of May 2010

25 20 15 10 5 0 2010 2011 2012 2013 2014 2015 >2015 Bond debt (AUD bn)
Income statement summary

Net interest income Fee income Other income Operating income Operating expenses Net profit
Company ratios
Loans/total assets Borrowings/total assets
Long-term borrowing composition, FY 09

Retail 0.5% Total domestic bonds 71.0% Capital index bonds Global 3.5% exchangeable 17.1% Euro MTN 7.6% Non-benchmark domestic 0.5%
State data
Gross state product growth Unemployment rate
Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June2009). NSWTCs accounts have been prepared in accordance with the Australian Accounting Standards and other authoritative pronouncements of the Australian Accounting Standards Board. Unemployment rate is the seasonally adjusted unemployment rate at June.
Funding requirement for FY 09-10, AUD5bn pre funded

Refinancing short-term debt 16%, AUD2.5bn Refinancing term debt 19%, AUD3bn
Others 7% Securities 16%
New client funding 65%, AUD9.9bn
Loans 77%
Breakdown of loan portfolio by sectors, FY 09 (AUDbn)

40 30 20 10 0 FY 06 Crown Water sector
10 June 2010
NSW net financial liabilities to total revenue (%)

140 120 100 80 60 40
2005 2006
S&P Trigger Band = 120-130
2010 Budgeted
2007
2008
2009
2011 Est
2012 Est
FY 07 FY 08 FY 09 Electricity sector Transport sector Others
2013 Est
439
Queensland Treasury Corporation (QTC)

Description
Gavin Stacey
Ratings table
Moodys Aa1/Aa1 Stable S&P AA+/AA+ Stable Fitch AA+/AA+ Stable
Queensland Treasury Corporation (QTC) was established in 1988 under the Queensland Treasury Corporation Act 1988 (Act). It originally operated as part of the Queensland Treasury before becoming a separate, autonomous and accountable central financing authority in 1991. Under the Act, QTC represents the Crown and, subject to the Act, may exercise and claim all the powers, privileges, rights and remedies of the Crown.
Risk weighting
The Australian Prudential Regulation Authority has designated a zero-risk weighting to QTCs debt.

Purpose: Similar to the treasury corporations in the other Australian states, profit maximisation is not the key objective of QTC. Its responsibilities include raising funds on behalf of its public sector clients in a cost-effective manner, providing financial risk management services and advice, and investing the states short to medium-term cash surpluses. Support mechanism: Under Section 32 of the Act, payment of principal and interest on inscribed stock issued by QTC are guaranteed by the Treasurer on behalf of the Government of Queensland. Section 33 of the Act enables the Treasurer to guarantee other obligations undertaken by QTC, subject to the approval of the governor in council. Such discretionary guarantees have been granted and operate in support of QTCs offshore debt facilities. However, it has not been the practice of the Treasurer to guarantee risk-management instruments such as swaps, options, futures and foreign exchange contracts. Queensland took up the Commonwealth Governments offer to guarantee state borrowings about AUD49bn worth of QTCs debt is covered under the guarantee (total debt c.AUD60bn at end December 2009). The Commonwealth Government has since announced that the Guarantee Scheme will close to new issuance on 31 December 2010. Given that QTC has displayed its ability to tap the market without the commonwealth guarantee, we do not expect its removal to have a significant impact on QTCs fundraising capabilities. Loan portfolio of QTC: QTCs asset quality is robust, with negligible impaired loans at end-June 2009. As at end-December 2009, QTC on-lent its funds to 269 customers, with loans to government departments/agencies and government-owned corporations accounting for about 71% of total loans. Capital and funding: QTCs main source of funding is its AUDdenominated domestic and global benchmark bonds, which accounted for c.94% of its total borrowings as at 22 April 2010. QTC expects its funding requirement to increase to slightly over AUD25bn in FY 10-11, although the final amount may decline subject to the FY 10-11 State Budget. Liquidity: QTCs liquidity position is solid, supported by QTCs prudent liquidity policies. For example, QTC funds its known and anticipated cash flows (debt service payments and new borrowings) six months ahead of schedule and demonstrated its prudence in managing its liquidity by increasing the time horizon to 12 months during the financial crisis. Credit profile of the state: The State of Queenslands ratings were downgraded by the rating agencies in 2009, reflecting the weakening in the states budgetary performance and increasing debt burden. QTCs total borrowings at end-June 2009 increased c.54% y/y to c.AUD63bn, from c.AUD41bn. In its mid-year fiscal and economic review, the government forecasted a decline in its general government sector budget from a net operating surplus of AUD35mn in FY 08-09, to a deficit of c.AUD2.4bn in FY 09-10. However, the government is targeting a return to a net operating surplus no later than FY 15-16. The government expects net financial liabilities to total revenue in the non-financial public sector (NFPS) to reach c.148% in FY 12-13, from c.108% in FY 0910. On a positive note, the economic recovery and consequent strengthening in commodity prices should support Queenslands economy. Reflecting the improved economic conditions, the government revised gross state product growth estimates for FY 09-10 and FY 10-11 to 1% and 3.5%, from -0.25% and 2.75%, respectively.
Strengths
Strong support from the state government Robust asset quality
Weaknesses
Some potential refinancing pressure due to concentration of borrowings in benchmark lines, although we expect QTC will prudently manage this risk
Key points for 2010

Monitor any introduction of measures to improve the states budgetary performance
10 June 2010
440
Financials
Total assets Cash and liquid assets Securities Loans to govt dept/agencies/corps to others Borrowings of which domestic of which offshore Total equity 0.1
Queensland Treasury Corporation (QTC)

FY08 FY09 % Chg
78.3 -40.7 58.6 34.9 32.3 41.1 53.8 98.5 -24.1 NA -143.3 31.1 NA NA 52.9 NA
40,612 49,915 88,988 1.4 0.8 16,200 16,694 26,475 24,269 32,912 44,408 18,138 23,135 30,616 6,131 9,777 13,792 32,075 40,728 62,624 20,154 25,865 51,345 11,920 14,863 11,279 373 52 25 15 93 33 46 60% 79% 5.5% 3.6% 293 -80 32 16 -32 33 -81 66% 82% 4.7% 3.8% -4,303 35 42 -4,611 -4,534 51 -4,595 50% 70% 0.3% 5.5%
100 80 60 40 20 0 -20 -40 Jan-09
QTC 6% '15
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10

30 25 20 15 10 5 0 2010 2011 2012 2013 2014 2015 >2015

Company ratios
Borrowing composition, 22 April 2010

AUD Global Benchmark Bonds 6% Euro CP 2% Others 4%
State data
Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June 2009). Financial statements have been prepared in accordance with the requirements of the Financial Management Standard 1997 issued pursuant to the Financial Administration and Audit Act 1977 and Australian Accounting Standards (including Australian Intepretations) adopted by the Australian Accounting Standards Board. Unemployment rate is the seasonally adjusted unemployment rate at June.
AUD Domestic Benchmark Bonds 88%
Borrowings by investor location, 22 April 2010
Asset composition (AUDbn)

100 80 60 40 20 0 FY 06 FY 07 FY 08 FY 09 Others Long term assets (managed by Q'land Investment Corp) Securities Loans
Onshore 52%
Offshore 48%
Annual gross state product growth (%)

7 6 5 4 3 2 1 0 FY 00 FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09
NFPSs projected net financial liabilities to revenue (%)

200 150 100 50 0 FY 10 FY 11 FY 12 FY 13
441
10 June 2010
South Australian Government Financing Authority (SAFA)

Description
Gavin Stacey
Ratings table
South Australian Government Financing Authority (SAFA) was established in January 1983 under the Government Financing Authority Act 1982 (Act). SAFA is the central financing authority for the South Australian government and its state-owned entities. It also functions as the captive insurer for the South Australian government. In mid 2009, SAFA took over responsibility of the management of the governments passenger and light commercial fleet operations.
Risk weighting
The Australian Prudential Regulation Authority has designated a zero-risk weighting to SAFAs debt.

Purpose: SAFAs treasury role requires it to provide clients with commercially competitive debt funding and other financial advisory services. Through its insurance division, SAICORP, SAFA insures and reinsures the governments risks in the Australian and international insurance markets as well as providing insurance and risk management advice to the government. Support mechanism: Under section 15(1) of the Act, liabilities incurred or assumed by SAFA are guaranteed by the Treasurer on behalf of the state. South Australia did not utilise the Commonwealth guarantee for state borrowings. Credit profile of the state: South Australias credit profile is underpinned by its modest levels of debt and fiscal discipline, as seen by its use of electric utility sale proceeds to reduce debt in the past. In its FY 09-10 Mid-Year Budget Review, the government forecasted a return to an operating surplus of AUD13mn in FY 10-11, from a deficit of AUD174mn in FY 0910. It also projects the net financial liabilities to revenue for the non-financial public sector (NFPS) to peak at about 114% in FY 11-12. While this is higher than S&Ps trigger band of 8090%, the agency has said that it still views South Australias debt levels as consistent with a AAA rating as it is expecting the ratio to decrease in the medium term due to a cyclical recovery in revenues on the back of improved economic growth. The agency also cited the states history of under-expenditure on capital and the changes in the discount rate used to value the pension liability as other reasons for its relatively sanguine view regarding the rise in the ratio. Loan portfolio of SAFA: As at end-June 2009, total client loans accounted for about 67% of SAFAs total assets, with the majority of these loans being on-lent via the Treasurer to the general government sector. Reflecting the robust quality of the loan portfolio, there were no impaired loans as at June 2009. Capital and funding: SAFA concentrates its long-term debt borrowings in its Select Line fixed interest programme to maximise liquidity. As at June 2009, its Select Lines accounted for c.78% of its total long-term borrowings. SAFAs funding guidelines require it to have a Select Line with a maturity greater than four years. As at end-April 2010, its longest-dated Select Line had a maturity of about five years. Liquidity: SAFAs liquidity guidelines require it to hold the greater of a minimum liquidity buffer of AUD250mn (about 2% of total assets at June 2009), or sufficient liquid assets to cover debt maturing over the next 60 days. Liquid assets comprise cash, discount securities and other highly marketable securities including commonwealth and semi-government bonds. During FY 08-09. SAFAs liquidity exceeded the levels required by its guidelines and averaged c.AUD1.4bn.
Strengths
High likelihood of government support
Weaknesses
Concentrating borrowings in several benchmark lines may lead to some refinancing pressures, although we expect SAFA will prudently manage these risks
Key points for 2010

Progress of the state in returning its finances to a sustainable position
10 June 2010
442

Total assets Cash and liquid assets Securities Loans of which to general govt of which to public corp Borrowings Total equity 9,197 2,189 1,361 5,580 2,994 2,587 6,059 272 32 1.9 154 188 13 149 61% 66% 1.6% 4.9%
South Australian Government Financing Authority (SAFA)

FY08
8,700 1,798 1,216 5,554 2,887 2,667 5,206 232 45 1.7 -2 45 102 -40 64% 60% 4.5% 4.8%
FY09
11,260 2,400 1,172 7,500 4,103 3,396 7,469 190 27 2 15 44 89 -32 67% 66% 1.4% 5.4%
% Chg
29.4 33.5 -3.6 35.0 42.1 27.4 43.5 -18.1 -40.4 -5.9 NA -3.1 -12.8 -20.6
100 80 60 40 20 0 -20 -40 Jan-09
SAFA 6% '13
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10

2.5 2.0 1.5 1.0 0.5 0.0 2010 2011 2012 2013 2014 2015 >2015 Bond debt (AUD bn)

Company ratios
State data
Long-term debt composition, FY 09
Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June 2009). SAFAs accounts have been prepared as general purpose financial statements and comply with the requirements of the Australian Accounting Standards (Accounting Standards) and the requirements of the Treasurers Instructions relating to financial statements by statutory authorities that are pursuant to the Public Finance and Audit Act, 1987.
Select Lines 78%
Others 22%
Loans 67% Others 23%
Loan composition, FY 09
Public nonfinancial corporations 27% Public financial corporations 18%
Securities 10%
General government sector 55%
NFPSs projected net financial liabilities to revenue (%)

120 100 80 60 40 FY08-09 act
10 June 2010
Projected general government net operating balance

350 250 AUD mn
S&P trigger band
150 50 -50
FY 09-10
FY 10-11
FY 11-12
FY 12-13
-150 FY 09-10 FY 10-11 FY 11-12 FY 12-13

443
Treasury Corporation of Victoria (TCV)

Description
Gavin Stacey
Ratings table
Treasury Corporation of Victoria (TCV) is the central financing authority of the State of Victoria and is the successor to the Victorian Public Authorities Finance Agency. TCV was established under the Treasury Corporation of Victoria Act 1992 (TCV Act) and began operations in 1993. It provides loans and financing services as well as corporate financial advice to state and state-related entities. Similar to the treasury corporations of other Australian states, TCVs credit ratings are linked to the ratings of the state.
Risk weighting
The Australian Prudential Regulation Authority has designated a zero-risk weighting to TCVs debt.

Purpose: The TCV Act states that the objectives of TCV are to act as a financial institution for the benefit of the state and participating authorities and to enhance the financial position of itself and its clients. Public entities are required to conduct their borrowing and derivative transactions through TCV and loans to these entities are guaranteed by the state. TCV grants these loans on commercial terms and conditions. Support mechanism: Borrowings and derivative transactions by TCV are guaranteed by the government of Victoria under Section 32 of the TCV Act. TCV decided not to utilise the Commonwealth government guarantee for debt issuance given the strength of Victorias budget and the moderate financing requirement in FY 09-10. Credit profile of the state: Victorias fundamentals are characterised by its fiscal prudence, diversified economy and strong balance sheet. Its economic growth has generally been in line with the national average and stronger than peer, New South Wales. The Victorian governments commitment to fiscal prudence is reflected in its financial objective to maintain a general government sector operating surplus (annual net result from transactions) of at least AUD100mn annually. The government is forecasting a net operating surplus of AUD872mn in FY 10-11 and expects a return to a cash surplus (net cash flows from operating activities less investments in non-financial assets) of c.AUD871mn in FY 12-13. However, as in most Australian states, the government expects capital spending to remain elevated the net infrastructure investment programme by the general government sector is projected to be AUD6.4bn in FY 10-11. According to the governments calculations, general government net debt to gross state product will consequently increase to 4.3% at end-June 2013, from 2.5% at end-December 2009, before declining to 4.1% at end-June 2014. Loan portfolio of TCV: The quality of TCVs loan portfolio is sound, in our view, given that its ultimate credit exposure is to the State of Victoria by virtue of the states guarantee on TCVs loans. Furthermore, the majority of TCVs loans to participating authorities comprise lending to the lower-risk water sector loans to participating authorities in the water sector accounted for about 72% of total loans to participating authorities as at end-June 2009. There were no past due loans at end-June 2009. Capital and funding: TCV primarily funds itself via debt issuance in the domestic market and concentrates its borrowings in its Domestic Inscribed Stock programme (c.73% of total interestbearing liabilities at end-June 2009). Offshore borrowing is also conducted on an opportunistic basis to diversify TCVs funding base and accounted for c.16% of total debt funding last year. TCV has a 10% minimum internal target for its capital adequacy ratio. As at end-June 2009, TCVs total CAR was 20.2%. TCV has largely completed its funding programme for FY 09-10 by raising AUD5.4bn of funds versus a funding requirement of AUD5.6bn. TCV currently forecasts its funding requirement for FY 10-11 to be about AUD5.8bn. Liquidity: TCVs liquidity profile is supported by its internal liquidity guidelines. According to these, TCVs liquid assets must comprise at least 3% of its total liabilities on a daily basis, subject to a minimum of AUD500mn. Moreover, at least 60% of the minimum required liquid assets must comprise cash, commonwealth government and semi-government paper.
Strengths
High likelihood of state support given TCVs integral role. History of fiscal discipline.
Weaknesses
Concentrating borrowings in several benchmark lines may lead to some refinancing pressure, but TCVs liquidity guidelines should help to moderate any potential risks.
Key points for 2010

Monitor progress of the state in improving its budgetary performance and managing its capital spending programme.
10 June 2010
444
Financials
AUD FY07 Balance sheet summary (AUD mn) Total assets 17,105 Cash and liquid assets 3,059 Securities 3,163 Loans 10,144 of which to the Crown 5,883 of which to other clients 4,261 Borrowings 12,700 of which domestic 11,773 of which offshore 926 Total equity 148
Income statement summary Net interest income Fee income Other income Operating income Operating expenses Net profit Company ratios Loans/total assets Borrowings/total assets State data Gross state product growth Unemployment rate
41 8 -12 37 16 22 59% 74% 4.3% 4.6%
Treasury Corporation of Victoria (TCV)

FY08
21,584 4,587 4,499 11,783 6,267 5,516 13,301 12,516 785 125 29 8 -22 15 16 -1 55% 62% 4.0% 4.6%
FY09 % Chg
26,703 5,320 2,539 16,248 8,811 7,437 18,446 15,552 2,893 174 23.7 16.0 -43.6 37.9 40.6 34.8 38.7 24.3 268.7 38.8
100 80 60 40 20 0 -20 Jan-09 Apr-09 Jul-09 Oct-09
TCV 5.75% '16
Jan-10
Apr-10

12 10 8 6 4 2 0 2010 2011 2012 2013 2014 2015 >2015 Bond debt (AUD bn)
43 46.6 8 3.1 16 -176.2 67 342.3 18 14.8 49 -5240 61% 69% 0.8% 6.0%
Borrowing composition, FY 09
Domestic benchmark inscribed stock 73% Domestic benchmark promissory notes 3% Domesticothers 8% Offshore 16%
Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June2009). Accounts have been prepared in accordance with Australian Accounting Standards, the requirements of the Financial Management Act 1994, and other mandatory professional reporting requirements. Unemployment rate is the seasonally-adjusted unemployment rate at June.
Cash and cash equivalents 20% Securities 10% Others 10%
Breakdown of loan portfolio by sectors (AUDbn)

20 15 10 5 0 FY 06 FY 07 Crown FY 08 Others FY 09 Water sector
Loans 60%
Department of Treasury and Finance projections

6 4 2 0 FY 10 FY 11 FY 12 FY 13 FY 14 Real gross state product growth (% y/y) Unemployment rate(%)
Net operating balance (AUDbn)

2.0 1.5 1.0 0.5 0.0 -0.5 FY 11 FY 12 FY 13 General government sector Public non-financial corporations Non-financial public sector FY 14
10 June 2010
445
Western Australian Treasury Corporation (WATC)

Description
% $ Index 3.0 % Index NA Total assets AUD19bn LT Senior Unsecured (Domestic/Foreign) Outlook
Gavin Stacey
Ratings table
Western Australian Treasury Corporation (WATC) was established in 1986 under the Western Australian Treasury Corporation Act 1986 (Act) as the central borrowing authority of the state. The Act was amended in 1998 to expand WATCs role to include the provision of financial management services to the Western Australian public sector. Ratings on WATC are linked to the ratings of the state.
Risk weighting
The Australian Prudential Regulation Authority has designated a zero-risk weighting to WATCs debt.

Purpose: WATC seeks to provide cost-effective debt funding and financial advisory services to its public sector clients. WATC obtains cost-effective funding for its clients by consolidating their debt requirements into benchmark lines. WATC has established short- and long-term borrowing facilities in both the domestic and overseas markets. In the Australian market, each benchmark bond line generally has a minimum issue size of AUD1bn. Loans to clients are made on a commercial basis and primarily driven by the cost of WATCs borrowings, while pricing for financial advice and funds management is determined on a cost-recovery basis. Support mechanism: Under Section 13(1) of the Act, financial liabilities incurred or assumed by WATC are guaranteed by the Treasurer on behalf of the state. WATC did not utilise the Commonwealth government guarantee on state borrowings. Credit profile of the state: Western Australias economy has benefitted from favourable commodity prices over the past few years, resulting in higher economic growth than the other Australian states. The states finances have therefore been robust, supported by strong taxation revenue and mining royalties. In its FY 10-11 state budget, the government forecasted an increase in the general government sectors net operating balance from AUD286mn in FY 10-11 to AUD652mn in FY 11-12, driven by a c.4% y/y increase in revenues and a decline in expense growth However, notwithstanding the improved economic outlook, the government expects the nonfinancial public sectors net financial liabilities to revenue to increase to c.69.6% in FY 13-14, from c.54% in FY 08-09, due to its capital spending plans (S&Ps trigger for the ratio is 90%). Loan portfolio of WATC: The state only guarantees WATCs loans to the state government authorities. While loans to the local government do not have the benefit of the state guarantee, we do not consider the lack of a guarantee a significant credit negative for WATC, given that loans to the local government typically account for a small percentage of WATCs loan portfolio (c.2.9% of total loans at end June 2009). WATCs largest borrowers (Electricity Networks Corporation, Housing Authority and Water Corporation) accounted for about 64% of total loans at end-June 2009. Capital and funding: WATCs funding is largely sourced from the domestic markets. Offshore borrowings accounted for c.17% of total borrowings at end-June 2009. About 48% of WATCs total borrowings had a tenor of less than one year at end-June 2009 (c.38% at end-June 2008). Liquidity: WATCs liquidity policy requires that holdings of liquid assets and/or standby facilities equal at least 9% of total liabilities. As at end-June 2009, cash and short-term investments accounted for c.31% of borrowings maturing within a year.
Strengths
Strong support mechanism from the state States economic growth supported by commodities sector
Weaknesses
Dependence on the commodities sector may lead to volatility in the states finances
Key points for 2010

Monitor progress of proposed tax on mining industry Review potential measures to shore up states finances
10 June 2010
446
Financials
AUD FY07 Balance sheet summary (AUD mn) Total assets Cash and liquid assets Securities Loans of which maturity < than 1y of which maturity > than 1y Borrowings of which maturity < than 1y of which maturity > than 1y Total equity Income statement summary Net interest income Fee income Other income Operating income Operating expenses Net profit Company ratios Loans/total assets Borrowings/total assets State data Gross state product growth Unemployment rate 5.8% 3.6% 5.1% 3.1% 0.7% 5.2% 77% 97% 80% 98% 83% 97% 53 0.3 0 54 40 10 47 0.3 0 47 41 4 27 0.3 21 49 14 24 13,049 4 2,711 9,998 2,847 7,151 12,665 NA NA 66 FY08 FY09
Western Australian Treasury Corporation (WATC)

% Chg 33.4 -28.9 -1.9 39.3 61.8 27.7 32.1 65.2 12.5 33.4 -41.5 0.3 NA 3.5 -64.9 437.0
14,326 19,110 4 2,754 3,876 7,530 5,218 8,851 65 3 2,702 6,272 9,615 8,619 9,962 87
11,406 15,887
14,070 18,581
100 80 60 40 20 0 -20 -40 Jan-09
WATC 7% '15
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10

5 4 3 2 1 0 2010 2011 2012 2013 2014 2015 >2015 Bond debt(AUD bn)
Debt composition, FY 09
Note: Fiscal year runs from July to June (eg, FY 09 covers July 2008 to June 2009). WATCs accounts have been prepared in accordance with Australian Accounting Standards (including the Australian Accounting Interpretations). The financial report also complies with International Financial Reporting Standards. Unemployment rate is the seasonally adjusted unemployment rate at June.
Domestic 83%
Overseas 17%
Others 3% Loans 83% Securities 14%
Loans to clients, FY 09
Public Others Transport 22% Authority Electricity 7% Generation Corporation Water 7% Corporation 18%
Electricity Networks Corporation 25% Housing Authority 21%
Forecasted net financial liabilities to revenue (NFPS, %)

100 90 80 70 60 50 40 S&P Trigger Level
Projected general government net operating balance

AUD mn 1000 800 600 400 200 0 FY08-09 FY 09act 10
FY08-09 FY 09-10 FY 10-11 FY 11-12 FY 12-13 Fy 13-14 act

10 June 2010
FY 1011
FY 1112
FY 1213
FY 1314
447
10 June 2010
448
GERMAN LNDER PROFILES
10 June 2010
449
State of Berlin (BERGER)

Description
% Index 0.260 % Index NA Total debt 60.5bn LT senior unsecured Covered bond rating Outlook
Leef H Dierks
Ratings table
Moodys Aa1 Aa1 Stable S&P NR NR NR Fitch AAA AAA Stable
The City-State of Berlin (BERGER) was made the capital of the Federal Republic of Germany after reunification in 1990. With a GDP of only 90.1bn in 2009, up 1.7% y/y from 88.6bn in 2008, Berlin ranks among the smaller states in terms of economic strength. The de-facto absence of an industrial basis, the regions generally weak economic performance, as well as several other factors relating to the reunification of West and East Berlin have put considerable strains on Berlins public finances, with contingent liabilities generated by the turmoil surrounding former Bankgesellschaft Berlin (BGB) causing further pressure. After generating budget surpluses in 2007 and 2008, the fiscal situation worsened again in 2009 and caused Berlin to report a budget deficit of 1.62% of GDP.
Risk weighting
Debt issued by the State of Berlin is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economics: In contrast to the overall economic development which saw German GDP contracting by 3.5% y/y in 2009, Berlin recorded a 1.7% y/y GDP increase at the same time. Still, Berlin ranks among the economically weaker states, accounting for only 3.7% of German GDP. The state faces a comparatively high unemployment rate at 16.1% in 2009. Public finances: Berlin strongly relies on federal transfers and on payments attributed to the German financial equalisation scheme which, in 2009, accounted for a combined 30% of the states revenues. Tax revenues of 9.4bn accounted for 49% of all revenues in 2009. Yet, as combined revenues amounted to only 19.1bn in 2009, while aggregate expenditures totalled 22bn, a funding gap of 2.8bn had to be closed by tapping the capital market. Of the aggregate 22bn of expenditures scheduled for 2010, a high 11% (2.4bn) corresponds to interest rate payments. Personnel expenditures account for 30% (6.6bn) of the scheduled expenditures. Berlins estimates indicate that revenues are set to decrease to 19.1bn in 2010, before modestly increasing to 19.2bn in 2011. At the same time, expenditures are set to further increase to 22bn in 2010 and 2011, thereby pointing towards a persistent budget deficit in the years ahead. Berlin plans gross debt issuance totalling 11.3bn in 2010, of which 8.6bn will be used to repay old debt. As at year-end 2009, 40% of Berlins debt was issued in the form of Schuldscheindarlehen (SSD) with bonds accounting for 60% of this. Indebtedness: Berlins aggregate debt burden has steadily increased since German reunification in 1990. Whereas in 1992, overall debt amounted to 10.5bn, the volume had grown to 60.5bn as at year-end 2009. Berlins projections point towards a further increase in its overall debt to 66.2bn by year-end 2010. According to the medium-term financial planning, Berlins overall debt will grow to 70.2bn by 2013. Assuming a balanced budget, Berlin estimates this figure to grow to 73.9bn in 2020. Yet, if expenditures increase at the average pace observed between 2008 and 2013, Berlin points out that its aggregate debt will grow to 83.1bn by 2020. With funds received from the so-called solidarity pact set to gradually decline from 1.6bn in 2010 to nil in 2020, funding needs are likely to play a more prominent role in the medium term. Berlins claim for federal financial assistance for experiencing an extreme financial crisis was rejected by the German Constitutional Court in October 2006, on the basis that the state had not exhausted its potential for revenue and expenditure flexibility. Political environment: Following the regional elections held in September 2006, the City State of Berlin is currently governed by a so-called red-red coalition between social-democratic SPD and leftist Die Linke. Whereas the SPD occupies 52 of the 149 parliamentary seats, Die Linke holds 23 seats. With 37 seats, conservative CDU is the states second-strongest political power, followed by the Greens, who occupy 24 seats. The Liberal FDP holds 13 seats. The next regional election is not scheduled to be held before Q2 11.
Strengths
Berlin will probably benefit from financial support given its role as the German capital.
Weaknesses
In the de-facto absence of an industrial sector and considering the steadily declining tax base, Berlin strongly relies on transfer payments within the scope of the German financial equalisation scheme and faces the highest debt/GDP ratio of all German states. Available funds, however, are likely to decline in the long run.
Key points for 2010

Carefully monitor Berlins efforts to curb its budget deficit and its willingness to further consolidate its public finances.
10 June 2010
450

Financial summary
bn Economy
Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn)
State of Berlin (BERGER)

Financial deficit/GDP
2007
83.6 2.0 24.5 3.4 10.0 4.4 2.9 8.0 25.4 6.2 2.5 1.8 0.00 10.3 20.7 4.6 56.6 39.5 24.8 18.3 223 16.6
2006
80.6 1.2 23.7 3.4 9.1 4.3 2.7 2.6 18.7 6.3 2.4 1.8 0.00 9.9 20.4 -1.8 59.0 48.5 25.4 -9.5 316 17.3
2008
87.5 1.1 25.6 3.4 10.7 4.4 3.3 3.4 21.7 6.3 2.3 1.6 0.00 10.7 20.9 0.8 56.0 49.1 23.8 3.9 258 16.3
2009
90.1 -0.7 26.3 3.4 9.7 4.0 3.1 2.0 18.8 6.3 2.2 1.6 0.0 9.3 19.4 -1.50 58.8 51.7 21.5 -8.0 313 17.1
8% 4% 0% -4% 1991 1995 Berlin 1999 2003 2007 all Lnder
Revenues
Tax revenues Federal transfers Financial equalisation Other revenues Total revenues
Political representation (% of votes)

Left Party 13% Greens 13% FDP 8% Others 14% CDU 21%
Expenditure
Staff Interest costs Investment spending Transfers to munis Other expenditures Total expenditure
SPD 31%
Balances and debt

Financial balance Debt outstanding
Debt structure, 2009

Domestic credit (incl Schuldscheine) 40% Bonds 58% Other Capital makets 2%
Ratios (%)
Taxes/Total revenues Expend./GDP Financial balance/Revenues Debt/Revenues Debt per capita ()
Note: Debt outstanding in this table and in the debt structure chart excludes intra-Government debt.
Structure of tax revenues, 2009

Withholding tax on interest 3% Income and Corporate Taxes 38% VAT 46%
Debt/GDP
80% 60% 40% Municipal trade taxes 1% Own taxes 12% 20% 0% 1992 Berlin 1996 2000 2004 all Lnder 2008
10 June 2010
451
State of Hesse (HESSEN)

Description
Leef H Dierks
Ratings table
Moodys NR NR NR S&P AA AA Stable Fitch AAA AAA Stable
Despite a 2.2% y/y contraction in its GDP to 216.5bn in 2009, from 221.4bn in 2008, Hesse ranks among the economically stronger German regions, accounting for 9.2% of Germanys 2009 GDP (2107.2bn). Geographically, Hesse makes up 5.9% of Germany with a population of 6.1mn in 2009. Despite being the fourth-largest German state in terms of aggregate GDP, the nominal per capita income of 69,500 is the second-highest one in Germany and stands at 116.2% of the national average. Hesse is among the strongest contributors to the German financial equalisation scheme.
Risk weighting
Debt issued by the State of Hesse is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economics: Hesse is among Germanys most affluent states, with the disposable per capita income standing at 121% of the domestic average at the time of writing. Economic growth is supported by the regions strong transport infrastructure, its leading role in the German financial services sector and by the chemical and pharmaceutical industry in the heavily industrialised Rhine-Main area. Owing to strong growth in the finance industry, Hesse benefited from above-average GDP growth rates between 1995 and 2001. It also benefits from a relatively moderate unemployment rate of 7.5%, as at end-April 2010, the latest date for which was available. Overall, the financial and corporate services sector accounted for 38.8% of the gross value added (GVA) in 2009, which is significantly above the German average of 31%. The manufacturing sector accounted for 17.5% and thus less than the domestic average (22%). Indebtedness: Hesses overall debt has steadily increased over the course of the past few years, growing from 31.2bn at yearend 2005, to 32.3bn in 2008 and 36.2bn in 2009. In anticipation of net new capital market borrowing of 3.4bn in 2010, Hesse expects its debt level to grow to 39.6bn by yearend 2010. In line with this development, net new debt has sharply increased to 3.4bn in 2010, from 2.9bn in 2009 and 894mn in 2008. Public finances: Despite the 2.2% y/y decline in Hesses GDP, which fell to 216.5bn in 2009, from 221.4bn in 2008, Hesse is still among the largest contributors to the German financial equalisation scheme, with payments scheduled to amount to 2.2bn in 2010, ie, 5% y/y less than in 2009 (2.3bn). Overall, Hesse estimates its 2010 expenditures will climb to 27.8bn in 2010, from 27.7bn in 2009. Thereof, 1.5bn will correspond to interest rate payments with 3.9bn scheduled for the repayment of debt. Personnel expenditures are estimated to increase to 7.8bn in 2010, from 7.7bn in 2009, thus accounting for 40% of Hesses total expenditures. Political environment: Following the regional elections held in January 2009, Hesse is governed by a CDU/FDP coalition government, which holds 66 of the parliaments 118 seats. Conservative CDU secured 37.2% of the vote, and is thus the states strongest political party, followed by the socialdemocratic SPD, whose share of the vote stood at 23.7%. The Liberal FDP secured 16.2% of the vote, followed by the Greens (13.7%) and leftist Die Linke (5.4%). In May 2010, Prime Minister Roland Koch (CDU) announced his resignation. We do not expect this move to have any significant implications.
Strengths
Hesse is among the economically stronger German states and benefits from a sound structural mix of its industrial and services sector.
Weaknesses
Hesses reliance on capital market funding has steadily increased over the course of the past few years, with corresponding growth in the overall amount of debt outstanding. At the same time, tax revenues have markedly declined since 2007.
Key points for 2010

Monitor the further development of Hesses public finances, which, despite a previously sound fiscal management, have come under pressure as of late.
10 June 2010
452

Financial summary
bn Economy Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn) Revenues Tax revenues Federal transfers Other revenues Total revenues Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures Total expend before fin equal Fin equal contributions Total expenditure Balances and debt Financial balance Debt outstanding Ratios (%) Taxes/Total revenues Expend. before Fin Eq/GDP Financial balance/Revenues Debt/Revenues Debt per capita () 2005 202.7 1.0 33.3 6.1 13.1 1.3 2.6 17.0 6.8 1.4 1.6 3.2 3.4 16.4 1.3 17.7 -0.6 30.2 77.0 8.1 -3.7 177.5 4,959 2006 209.2 2.8 34.4 6.1 15.1 1.4 2.4 18.9 7.0 1.4 1.7 3.4 3.5 16.9 2.2 19.1 -0.3 29.4 80.1 8.1 -1.3 155.5 4,831 2007 216.7 2.3 35.7 6.1 17.1 1.4 2.0 20.5 7.2 1.4 1.8 4.1 3.5 17.9 3.2 21.1 -0.6 30.0 83.6 8.3 -3.0 146.6 4,937 2008 220.8 1.3 36.4 6.1 16.8 1.4 1.8 20.0 7.4 1.4 1.8 4.1 3.7 18.4 2.6 21.0 -1.1 30.6 84.3 8.3 -5.4 153.0 5,034 2009 216.5 -4.3 35.7 6.1 14.8 1.4 1.3 17.4 7.7 1.3 1.8 3.2 2.9 17.0 1.8 18.8 -2.60 33.4 84.7 7.8 -14.9 191.5 5,513
State of Hesse (HESSEN)

Withholding tax on interest 5% Income and Corporate Taxes 52% VAT 28% Municipal trade taxes 4% Own taxes 11%
Debt/GDP
30% 20% 10% 0% 1991 1995 Hesse 1999 2003 2007 all Lnder
2 1 0 -1 1992 1996 Hesse 2000 2004 all Lnder 2008

Greens 13.7% FDP 16.2% The Left 5.4% Others 3.8%

Domestic credit (incl Schuldscheine) 35% Bonds 64%
SPD 23.7%
CDU 37.2%
Other Capital makets 1%
10 June 2010
453
State of Saxony-Anhalt (SACHAN)

Description
% Index 0.094 % Index NA Total assets 19.8bn LT senior unsecured Covered bond rating Outlook
Leef H Dierks
Ratings table
Moodys Aa1 NR Stable S&P AANR Stable Fitch AAA AAA Stable
With a GDP of 51.5bn in 2009, down a strong 4.2% y/y from 53.7bn in 2008, Saxony Anhalt (SACHAN) ranks among the weaker German states in terms of economic strength. Its GDP accounted for a low 2.1% of the overall German GDP of 2,407bn in 2009. Following a very strong economic growth in the wake of German reunification, growth rates have slowed markedly and, in recent years, moved in line with the average development.
Risk weighting
Debt issued by the State of Saxony-Anhalt is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economics: Following German reunification in 1990, the State of Saxony-Anhalt has been subject to a marked population decline. In 2009, the states population amounted to only 2.4mn, down from 2.9mn in 1990. By 2025, this figure is expected to have declined further to 2mn. As this development has constrained economic growth in recent years, GDP growth has fallen behind that of the domestic average over the past few years. As is the case for other East German states, SACHANs per capita GDP converged upwards towards the national average in recent years but still stands at only 71% of the national average, and is thus broadly in line with its peers. In April 2010, the latest date for which data were available, Saxony-Anhalt recorded an unemployment rate of a high 13.2%. Indebtedness: In the years ahead, the aggregate amount of debt outstanding is set to steadily increase. Whereas total debt stood at 19.8bn as per year-end 2009, the volume will grow to 20.5bn in 2010 and 21.0bn in 2011 before remaining stable at 21.3bn, according to the 2010-11 budget plan. This corresponds to a relatively high per capita debt of 8,353 in 2009 which will grow to 9,319 by 2013, also as a result of the ongoing population loss. Public finances: According to the 2010-11 budget, SaxonyAnhalt plans to generate revenues of 9.9bn in 2010 and 9.8bn in 2011. With 4.5bn and 4.6bn, respectively, tax revenues will account for a relative low 45% of the states total revenues. At the same time, Saxony-Anhalt estimates transfer payments to amount to a combined 3.2bn in each 2010 and 2011, highlighting the states high reliance on external funding. Net new borrowing is estimated to amount to 660mn in 2010 and 500mn in 2011 before declining to 250mn in 2012. In 2010, 8.9% of Saxony-Anhalts expenditures were related to interest payments, which is expected to increase to 9.4% in 2011, 10.1% in 2012, and 10.5% in 2013. Saxony-Anhalts plans to present a balanced budget in 2013. Political environment: Following the regional elections held in March 2006, the State of Saxony-Anhalt is governed by a socalled grand coalition between conservative CDU and socialdemocratic SPD. Whereas the CDU occupies 40 of the 97 parliamentary seats, the SPD holds 24 seats, thereby securing a strong 35 seat majority. Leftist Die Linke, with 24% of the vote, is the states second strongest political power holding 26 seats, followed by liberal FDP, which holds seven seats. The next regional elections are scheduled to be held in Q2 11.
Strengths
Saxony-Anhalt (strongly) relies on funds from the German financial equalisation scheme. In the long run, however, amounts will likely decline.
Weaknesses
Saxony-Anhalt has become subject to a pronounced population loss after German reunification, which, in combination with the absence of a sound industrial basis and a high unemployment rate, reduces the states potential tax base.
Key points for 2010

Monitor the development of the expected tax revenues as a shortfall is likely to increase Saxony Anhalts borrowing requirements.
10 June 2010
454

Financial summary
bn Economy Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn) Revenues Tax revenues Federal transfers Financial equalisation Other revenues Total revenues Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures Total expenditure Balances and debt Financial balance Debt outstanding Ratios (%) Taxes/Total revenues Expenditure/GDP Financial balance/Revenues Debt/Revenues Debt per capita () 46.4 21.5 -11.6 211 48.8 20.6 -5.7 203 50.7 19.3 1.2 202 52.7 18.3 0.5 201 56.1 16.0 -2.3 227 -1.1 19.2 -0.5 19.3 0.1 20.1 0.1 19.8 -0.20 19.8 2.3 0.9 2.0 3.3 1.7 10.2 2.3 0.9 1.7 3.3 1.8 10.1 2.2 0.9 1.6 2.8 2.2 9.8 2.2 1.0 1.5 2.7 2.4 9.8 2.3 0.8 1.6 2.2 1.3 8.3 4.2 3.3 0.6 1.1 9.1 4.6 3.2 0.6 1.1 9.5 5.0 3.2 0.6 1.0 9.9 5.2 3.1 0.7 0.9 9.9 4.9 2.7 0.5 0.5 8.7 2005 47.4 -0.2 19.1 2.5 2006 48.7 1.8 19.8 2.5 2007 51.0 2.1 21.0 2.4 2008 53.8 3.0 22.4 2.4 2009 51.5 -4.7 21.7 2.4
State of Saxony-Anhalt (SACHAN)

SPD 21.4% PDS 24.1% Greens 3.6% CDU 36.2% FDP 6.7% Others 8.1%

Domestic credit (incl Schuldscheine) 32.1% Other Capital makets 3%
Bonds 65%
6%
2%
7,770 7,883 8,269 8,259 8,368
-2% 1991 1995 1999 Sachsen-Anhalt 2003 2007 all Lnder

Muni trade taxes 1% Own taxes VAT 68% 7%
Debt/GDP
50%
25% Income & Corp Taxes 23% Withholding tax 1% 0% 1991 1995 1999 2003 2007 all Lnder Sachsen-Anhalt
10 June 2010
455
Free State of Thuringia (THRGN)

Description
% Index NA % Index NA Total debt 15.7bn LT senior unsecured ST Outlook
Leef H Dierks
Ratings table
Moodys NR NR NR S&P NR NR NR Fitch AAA NR Stable
Founded within the scope of German reunification in 1990, the Free State of Thuringia is among the economically weaker German states. It accounts for only 2% of the German GDP and for 2.8% of Germanys population. Among the industrial centres is Eisenach (automotive), Erfurt (microelectronics), Jena (information technology and optical electronics and pharmaceuticals.) Following German reunification, Thuringia has suffered strong emigration from which the state has still not recovered. Owing to a low and declining tax base, its revenues structure is very heavily biased towards federal and EU transfer payments.
Risk weighting
Debt issued by the Free State of Thuringia is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economics: With a GDP of 48.9bn in 2009, down 3% y/y from 50.4bn in 2008, Thuringias GDP ranks among the lower of the German states and accounted for only 2.0% of total German GDP of 2,407bn in 2009. As in the case of other former East German states, Thuringia has been subject to pronounced emigration, with its population falling to 2.3mn in 2009, from 2.7mn in 1989. Net emigration currently stands at 10,000 annually. Thuringia, which, together with the Free State of Saxony ranks among the economically stronger East German states, hosts major industries in telecoms, microelectronics and optical electronics. The construction sector, as well as primary activities and services, provide relatively high proportions of GDP. Financial services, in contrast, remain under-represented. As with other East German states, Thuringias per capita GDP has converged upwards towards the national average in recent years, but still stands at only 71% of this average, and is thus broadly in line with its peers. With an unemployment rate of 11.5% as at end-April 2010, the latest date for which data were available, Thuringia features a lower unemployment rate than the East German average (13.5%), but a markedly higher one than the West German states (7.2%). Political environment: Following the regional elections held in August 2009, the Free State of Thuringia is governed by a socalled grand coalition government formed by conservative CDU and social democratic SPD. Whereas the CDU secured 31.2% of the vote, the SPD secured 18.5% and thus is the states thirdstrongest political party behind leftist Die Linke with 27.4% of the vote. Liberal FDP secured 7.6% followed by the Greens (6.2%). The next elections are scheduled to be held in autumn 2014. Public finances: As in the years before, the Free State of Thuringia strongly relies on federal transfers and on payments from the German financial equalisation scheme. According to the 2009-13 budget plan, a very high 37% of the estimated revenues of 9.9bn correspond to the above measures, with tax revenues accounting for only 4.3bn (or 43%) of the revenues. This level is expected to further decline in 2010. Overall, at 47.6% of the national average, Thuringias taxation base is remarkably low. At the same time, with expected expenditures climbing from 9.9bn in 2010, to 10.0bn in 2011, 10.1bn in 2011, and 10.2bn by 2013, net new borrowing is estimated to amount to 880mn in 2010, 750mn in 2011, 917mn in 2012, and 988mn in 2013. Whereas personnel expenditures are set to increase to 2.5bn by 2013 from 2.3bn in 2010, expenditures related to investments are set to decline to 1.6bn by 2013, from 1.9bn in 2010. The share of expenditures related to the payment of interest will increase to 7.7% by 2013, from 6.9% in 2010. Indebtedness: According to Thuringias 2009-13 budget plan, the amount of debt outstanding, which stood at 15.7bn as at year-end 2009, is set to markedly increase, growing to 16.6bn in 2010, 17.2bn in 2011, 17.6bn in 2012, and 17.5bn in 2013. Yet, between 2007 and 2009, the amount of debt outstanding remained stable as net new borrowing stood at nil.
Strengths
Thuringia (heavily) relies on funds from the German financial equalisation scheme. Amounts are likely to decline in the long run.
Weaknesses
Thuringias reliance on tax revenues has fallen in recent years with the proportion on funding related to transfer payments, in contrast, steadily growing. With an already low tax base and strong emigration, we believe Thuringias public finances are likely to remain under pressure in the years ahead.
Key points for 2010

The growing imbalances between Thuringias (tax) revenues and public sector expenditures need to be carefully monitored, particularly in light of the strong reliance on federal transfer payments. However, we expect this to decline in the years ahead.
10 June 2010
456

Financial summary
bn Economy Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn) Revenues Tax revenues Federal transfers Financial equalisation Other revenues Total revenues Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures Total expenditure Balances and debt Financial balance Debt outstanding Ratios (%) Taxes/Total revenues Expenditure/GDP Financial balance/Revenues Debt/Revenues Debt per capita () 49.2 19.5 -5.6 185 6,820 52.8 18.8 2.2 170 6,826 53.9 18.1 3.8 164 7,891 56.6 15.7 -2.4 192 6,959 -0.5 15.8 0.2 15.7 0.4 15.3 -0.2 15.7 2.4 0.7 1.6 2.9 1.3 9.0 2.4 0.7 1.6 2.9 1.4 9.1 2.1 0.7 1.4 2.7 2.1 9.0 2.2 0.6 1.4 2.4 1.1 7.7 4.2 2.8 0.6 0.9 8.5 4.9 2.9 0.7 0.8 9.3 5.0 2.8 0.7 0.9 9.4 4.6 2.5 0.5 0.5 8.2 2006 46.2 2.7 19.9 2.3 2007 48.1 2.0 20.9 2.3 2008 49.8 1.9 21.9 2.3 2009 48.9 -4.3 21.7 2.3
Free State of Thuringia (THRGN)

6%
2%
-2% 1991 1995 Thuringia 1999 2003 2007 all Lnder
Debt/GDP
40%
20%
0% 1991 1995 Thuringia 1999 2003 2007 all Lnder

Other Capital makets 1%
Domestic credit (incl Schuldscheine) 61%
Bonds 38%
Note: Debt outstanding in this table and in the debt structure chart excludes intra-government debt.

Muni trade taxes 1% Own taxes 7% Income & Corp Taxes 22% VAT 69% Withholding tax 1%

SPD 14.5% PDS 26.1% Greens 4.5% CDU 43.0% Others 12.0%
Economic structure (% of gross value added)

Financial Services 23.3% Trade, Transport, hotels etc 15.4% Construction 5.4% Other Services 25.3% Agric, For, Fish 1.8% Manufacturing 28.9%
GDP growth rates (%)

15 10 5 0 -5 1992 1996 Thuringia 2000 2004 Germany 2008
10 June 2010
457
State of North Rhine-Westphalia (NRW)

Description
% Index 0.234 % $ Index 0.005 Total debt 122.5bn LT senior unsecured Covered bond rating Outlook
Leef H Dierks
Ratings table
Moodys Aa1 Aa1 Stable S&P AAAAStable Fitch AAA AAA Stable
With a GDP of 521.8bn in 2009, or 21.7% of the entire German GDP, North Rhine-Westphalia (NRW) is the economically strongest German state. North Rhine-Westphalia, which was founded in 1946, borders the Netherlands and Belgium. Compared with other economies, North Rhine-Westphalia would be ranked 17th on a global scale. Overall, the regions economy is highly diversified, with a sector breakdown of the gross value added (GVA), which mirrors the national average. The per capita income of its 18mn inhabitants, corresponding to 22% of Germanys entire population, mostly reflects the domestic average,
Risk weighting
Debt issued by the State of North Rhine-Westphalia is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economics: Following a sharp 4.7% y/y contraction in 2009, North Rhine-Westphalias GDP fell to 521.8bn in 2009 from 547.5bn a year before. This corresponds to 21.7% of Germanys GDP of 2,407bn in 2009. In the years before, North RhineWestphalia had recorded sound economic growth, which peaked at 5.5% y/y in 2007. Compared with other economies, North Rhine-Westphalia would be ranked 17th on a global scale. Overall, the regions economy is highly diversified, with a sector breakdown of the gross value added (GVA), which mirrors the national average. At the time of writing, 10 of the German corporates listed in the DAX-30 had their headquarters in NRW with 37 of the biggest 100 corporates headquartered in NRW. 99% of all companies and more than 70% of all employers belong to smaller and medium-sized companies (SME). Public finances: According to North Rhine-Westphalias 2010 budget, tax revenues are generated to amount to 37bn in 2010, down 1.5bn y/y from 38.5bn in 2009. Tax revenues accounted for 69.6% of all revenues in 2009. Public sector expenditures, in contrast, are set to decline only modestly, thereby requiring NRW to gradually increase its net borrowing to 6.5bn in 2010 after 5.9bn in 2009. For the time being, the volume of investments has been cut 2bn y/y to 5bn in 2010. Personnel expenditures, which account for 39.1% of all expenditures, increase to 20.8bn in 2010 from 20.6bn in 2009. North Rhine-Westphalia recorded expenditures of 200mn within the scope of the German financial equalisation scheme in 2009, but it expects this volume to decline to 100mn annually in the years ahead. Indebtedness: According to the 2009-13 budget plan, which was adopted before the regional elections held in May, North Rhine-Westphalias total debt will markedly increase in the years ahead. Whereas the regions total debt stood at 125.5bn as per year-end 2009 (53bn in 1992), the current budget foresees an increase to 129.1bn by 2010, 135.7bn by 2011, 142.1bn by 2012, and 148.5bn by 2013. Net new borrowing is not set to markedly decrease in the years ahead but will instead remain largely stable at about 6.6bn between 2011 and 2013 because of a dramatic decline in tax revenues. Interest payments as a percent of overall expenditures amounted to 8.6% in 2009 and are set to increase to 8.7% in 2010 and to 10.3% by 2013. Political environment: The previous CDU/FDP coalition government lost its parliamentary majority in recent regional elections which were held in May 2010. The conservative CDU secured 67 seats. At the time of writing, the SPDs (67 seats) coalition talks with FDP (13 seats), Greens (23 seats), and leftist Die Linke (11 seats) had failed, with the outcome thus pointing towards a grand (CDU/SPD) coalition or (less likely, though) towards new elections. Alternatively, a coalition between SPD, FDP and the Greens could emerge.
Strengths
North Rhine-Westphalia is the strongest states in Germany in economic terms, benefiting from a well diversified economy, particularly in the heavily industrialised Rhine-Ruhr area. Attributed to the fact that more than a fifth of the entire German population lives in the state, it benefits from a broad tax base.
Weaknesses
At 122.5bn, North-Rhine-Westphalia had the highest volume of debt outstanding of all German states with no balanced budget expected in the years ahead. Net new borrowing is set to total 6.6bn annually between 2010 and 2013.
Key points for 2010

Monitor the development of North Rhine-Westphalias 2010 tax revenues, which, in the case of being markedly lower than expected, could lead to higher borrowing needs. 10 June 2010 458

Financial summary
bn Economy Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn) Revenues Tax Revenues Federal transfers Other Revenues Total Revenues Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures Total expend before Fin Equal Fin Equal contributions Total expenditure Balances and Debt Financial Balance Debt Outstanding Ratios (%) Taxes/total revenues Expend. Before Fin Eq/GDP Financial balance/revenues Debt/Revenues Debt per capita () 83.4 9.4 -7.6 254.1 6,260 84.5 9.2 -2.1 237.8 6,335 84.2 9.2 0.2 227.0 6,322 85.1 9.0 -10.4 266.7 6,734 -3.4 112.9 -1.0 114.1 0.1 113.6 -4.70 120.5 18.6 4.6 4.6 10.1 9.5 47.5 0.3 47.8 19.4 4.7 4.5 11.2 9.1 48.9 0.1 49.0 19.0 4.8 4.8 12.2 9.2 50.0 0.0 50.0 19.9 4.6 5.4 10.7 6.1 46.7 0.0 46.7 37.0 3.8 3.6 44.4 40.5 3.8 3.7 48.0 42.1 3.6 4.3 50.0 38.5 3.9 2.8 45.2 2006 505.9 2.6 28.0 18.0 2007 529.4 2.6 29.4 18.0 2008 541.1 1.7 30.1 18.0 2009 521.7 -5.8 29.2 18.0
State of North Rhine-Westphalia (NRW)

Political representation (seats), 2010
CDU 67 SPD 67
Die Linke 11 Greens 23 FDP 13

Domestic credit (incl Schuldscheine) 37% Bonds 56% Other Capital makets 6%
2 1 0 -1 1991 1995 NRW 1999 2003 2007 all Lnder

Withholding tax on interest 3% VAT 33%
Debt/GDP
25 20 Municipal trade taxes 3% Own taxes 11% 15 10 1991 1995 NRW 1999 2003 2007 all Lnder
Income and Corporate Taxes 49%
10 June 2010
459
State of Baden-Wrttemberg (BADWUR)

Description
Leef H Dierks
Ratings table
Moodys Aaa NR Stable S&P AA+ AA+ Stable Fitch AAA NR Stable
The state of Baden-Wrttemberg (BADWUR) is located in the southwest of Germany, bordering France and Switzerland. BadenWrttemberg was founded in 1952 following a referendum on the merger of the states of Wrttemberg-Baden, WrttembergHohenzollern and Baden. It is Germanys third-largest state in terms of land area (10%), population (13%) and GDP (16 %). With the per capita disposable income at 110% of the domestic average at the time of writing, Baden-Wrttemberg is among Germanys most affluent states. It has a strong and diversified economy, with a particularly strong export-oriented manufacturing and automotive base.
Risk weighting
Debt issued by the State of Baden-Wrttemberg is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economics: Attributed to the importance of the industrial sector and its focus on engineering, automotive and manufacturing, the GDP sharply contracted 5.8% y/y in 2009, down from a 2.1% y/y growth in 2008 and a 4.8% y/y growth in 2007. This decline was only surpassed by the economically markedly weaker Saarland (-7.1% y/y). Overall, with a GDP of 344bn in 2009, which accounted for 16.1% of Germanys aggregate GDP (2.124bn in 2009), Baden-Wrttemberg is the economically third-strongest German state after North Rhine-Westphalia and Bavaria. With the disposable per capita income standing at 110% of the domestic average at the time of writing, Baden-Wrttemberg is among Germanys most affluent states. Baden-Wrttembergs economic structure is dominated by the manufacturing sector, which accounted for one third of the states gross value added (GVA) ie, markedly more than the sectors 29% share in the national GVA. Furthermore, on a nationwide basis, Baden-Wrttembergs manufacturing sector accounts for c.20% of the domestic total. Baden-Wrttembergs manufacturing sector, which accounts for 40% of all employment, is strongly geared towards exports (benefiting from its geographical location). As of late, the structural change has caused the weight of the tertiary sector to increase, to 60%. Political environment: Following the regional elections held in March 2006, the State of Baden-Wrttemberg, which is generally considered a stronghold of the conservative CDU, is currently governed by a coalition of the CDU (59 seats) and liberal FDP (15 seats), which together hold a comfortable 84seat majority in the 139-seat state parliament. The socialdemocratic SPD, which with 27.3% of the vote is BadenWrttembergs second-strongest political power, occupies 38 seats, followed by the Greens, which hold 17 seats. The next regional elections are scheduled to be held in Q2 11. Public finances: Following a budget surplus of 1.5bn in 2007 and 1.4bn in 2008, Baden-Wrttemberg generated a 1.4bn budget deficit in 2009. Tax revenues, which accounted for 74% of all revenues in 2009, fell to 24.7bn from 28bn in 2008. Expenditures, at the same time, increased to 34.6bn in 2009 from 31.5bn in 2008. In 2009, Baden-Wrttemberg contributed 1.5bn (2008: 2.5bn) to the German financial equalisation scheme, thereby being the third-largest payer after Bavaria and Hesse. The contribution corresponded to 6.1% of its 2009 tax revenues. The 2010-11 budget foresees expenditures of 34.9bn in 2010 and 35.1bn in 2011 of which more than 40% are related to personnel expenditures. Provided these figures materialise, Baden-Wrttemberg will generate budget deficits of 2.8bn in 2010 and 3.0bn in 2011. Indebtedness: As per year-end 2009, BADWURs capital market debt amounted to 41.7bn, and this stood largely unchanged largely from the 2008 volume. Interest payments amounted to 1.6bn in 2009 and are expected to increase to 1.9bn in 2010 and 2bn in 2011. Hence, 8.1% of the 2010 expected tax revenues will be used for interest payments. We expect net borrowing, which in 2009 amounted to a negative 16mn, to surge to 2.7bn in 2010 before gradually declining to 2.1bn in 2011. Employment: At 5.1% at year-end 2009, Baden-Wrttemberg benefits from one of the lowest unemployment levels in Germany. This comes despite one of the strongest population growth rates in Germany, which is due to natural growth and migration.
Strengths
Baden-Wrttemberg is one of the economically strongest states in Germany. A pick-up in global economic growth will likely be reflected in an above average recovery of the regions exportoriented manufacturing sector.
Weaknesses
After generating budget surpluses in 2007 and 2008, BadenWrttemberg reported a 1.4bn budget deficit in 2009 as tax revenues fell while expenditures increased.
Key points for 2010

Monitor the development of BADWURs public finances, particularly given the pronounced increased in net new borrowing as foreseen in the 2010-11 draft budget.
10 June 2010
460

Financial summary
bn Economy Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn) Revenues Tax revenues Federal transfers Other revenues Total revenues Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures Total expend before fin equal Fin equal contributions Total expenditure Balances and debt Financial balance Debt outstanding Ratios (%) Taxes/Total revenues Expend. before fin eq/GDP Financial balance/Revenues Debt/Revenues Debt per capita () 2006 337.6 4.4 30.1 10.7 24.0 2.3 5.7 31.9 13.0 2.3 3.0 7.6 4.8 30.6 2.2 32.9 -0.9 41.1 75.2 9.1 -2.9 128.7 3,823 2007 353.0 2.8 31.4 10.7 26.9 2.1 5.3 34.4 12.8 1.9 2.8 8.1 5.0 30.7 2.1 32.9 1.5 41.7 78.4 8.7 4.4 121.4 3,881 2008 364.3 0.5 32.8 10.8 28.0 2.1 5.7 35.8 13.1 1.9 3.0 8.6 5.3 31.9 2.6 34.5 1.4 41.7 78.1 8.7 3.8 116.4 3,878 2009 343.7 -7.4 32.0 10.8 24.7 2.4 5.0 32.1 13.6 1.6 3.4 9.1 1.6 29.3 1.9 31.2 -1.4 41.7 76.9 8.5 -4.4 129.9 3,879
State of Baden-Wrttemberg (BADWUR)

Income and Corporate Taxes 53% Withholding tax on interest 3% VAT 30% Municipal trade taxes 3%
Own taxes 11%

SPD 25.1% FDP/DVP 10.7% Greens 11.7% Others 8.4%
CDU 44.1%
2%
0%
-2% 1992 1996 2000 2004 2008 Baden Wrttenberg all Lnder
Debt/GDP
30% 20% 10% 0% 1991 1995 1999 Baden Wrttemberg 2003 2007 all Lnder

Other Capital makets 6% Intra Govt Debt 4%
Domestic credit (incl Schuldscheine) 64%
Bonds 26%
10 June 2010
461
State of Bavaria (BAYERN)

Description
Leef H Dierks
Ratings table
The Free State of Bavaria (BAYERN) is located in south east Germany and borders Austria and the Czech Republic. It is the largest German state in terms of land area (15%). With a GDP of 429.9bn in 2009, sharply down from 444.8bn in 2008, which corresponds to 17.8% of the entire German 2009 GDP (2,407bn), Bavaria is the second-strongest regions in terms of economic strength, only surpassed by North Rhine-Westphalia. With a disposable per capita income of 117% of the national average, Bavaria is among the most affluent German states. Also, Bavaria is the only German state that was Aaa/AAA/AAA-rated at the time of writing.
Risk weighting
Debt issued by the Free State of Bayern is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economic environment: The Free State of Bavaria benefits from a strong and well-diversified economy, with a sector structure very close to the domestic average. Within the manufacturing sector, the focus is on the automotive and technology sectors with large corporates such as BMW or Siemens, among others, being headquartered in Bavaria. Overshadowed by the globally decelerating economic growth and the global financial crisis, in 2009, Bavarias GDP contracted a strong 3.4% y/y to 429.9bn from 444.8bn in 2008. In 2008 and 2007, economic growth still amounted to 2.5% y/y and 4.6% y/y, respectively ie, largely reflecting the development of the aggregate German GDP. Public finances: In 2009, Bavaria generated tax revenues of 31bn, down from 33.3bn in 2008. This amount corresponded to 78.9% of all 2009 revenues (ie, down slightly from 81% in 2008). Personnel expenditures accounted for 41.4% in 2009 with the investment ratio standing at a high 13.6% of all expenditures. Following the adoption of rescue measures for Bayerische Landesbank in 2008 and 2009, however, Bavaria reported a budget deficit of 8.0bn the highest of all German regions. In 2008, the budget deficit still stood at 139mn after a surplus of 2.6bn was generated in 2008. In 2010, Bavaria expects total revenues to amount to 42.3bn, of which 28.7bn (or 67.8%, -5.0% y/y) is tax-related. Expenditures are forecast to grow by 2.1% y/y to 42.4bn, of which 17.2bn will be personnel costs. Indebtedness: With expenditures scheduled to be in line with revenues, Bavaria plans to present a balanced 2010 budget within the line of its 2009-10 budget. Net new capital market borrowing is expected to be nil in 2010. This, however, could come under pressure in case of further financing needs of Bayerische Landesbank. In 2009, Bavaria contributed 3.4bn within the scope of the German financial equalisation scheme. This amount is expected to stand largely stable at about 3.5bn in 2010. Overall, attributed to a prolonged track record of sound fiscal management, Bavarias debt-to-GDP ratio is the lightest among the German states by a substantial margin. Compared with other German regions, interest payments stood at a markedly lower level than those of its peers, amounting to a moderate 2.7% in 2009. This figure is expected to increase gradually to 3.1% in 2010. Overall, debt per capita stood at 2,606 in 2009 clearly below the national average of 5,417. Political environment: The Bavarian political scene is characterised by a high degree of stability, having been dominated and governed by the conservative Christian Social Union (CSU) since 1945. Still, in the elections held in autumn 2008, the CSUs share of the vote fell to 44%, from 61% in 2003, with the number of parliamentary seats falling to 92 from 124 (out of 187). This forced the party into a coalition government with the liberal FDP (16 seats). The Social-democratic SPD, the states second-largest political power, secured 38 seats, followed by the Greens (20 seats) and the Free Voters (19 seats).
Strengths
Bavaria is one of the economically strongest regions in Germany and, despite the high budget deficit recorded in 2009, generally benefits from solid public finances, which makes it a key contributor to the Financial Equalisation System.
Weaknesses
Bavarias public finances have come under pressure in 2008-09 as a result of capital injections into state-owned Bayerische Landesbank.
Key points for 2010

The effect of potential capital injections into Bayerische Landesbank on Bavarias public finances needs to be monitored carefully.
10 June 2010
462

Financial summary
bn Economy Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn) Revenues Tax revenues Federal transfers Other revenues Total revenues Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures Total expend before fin equal Fin equal contributions Total expenditure Balances and debt Financial balance Debt outstanding Ratios (%) Taxes/Total revenues Expend. before fin eq/GDP Financial balance/Revenues Debt/Revenues Debt per capita () 2005 323 1.7 32.2 12.5 25.9 2.6 4.6 33.2 14.8 1.0 4.0 6.5 5.8 32.2 2.2 34.4 -1.3 23.1 78.2 10.0 -3.8 70 1,851 2006 338 3.3 33.2 12.5 27.9 2.7 4.8 35.5 15.1 1.1 4.2 7.0 5.7 33.1 1.9 35.0 0.5 23.1 78.6 9.8 1.3 65 1,847 2007 353 2.8 34.7 12.5 31.1 2.7 4.7 38.5 15.3 1.0 4.2 7.6 5.4 33.6 2.3 35.9 2.6 22.8 80.7 9.5 6.7 59 1,821 2008 364 1.4 35.5 12.5 33.3 2.7 5.1 41.1 15.8 0.9 7.7 8.1 5.6 38.1 3.1 41.2 -0.1 22.1 81.0 10.5 -0.3 54 1,767 2009 344 -5.0 34.4 12.5 31.0 2.8 3.9 37.7 16.6 0.9 3.5 6.9 4.1 32.0 3.6 35.6 -8.0 27.6 82.2 9.3 -21.2 73 2,206
State of Bavaria (BAYERN)

FW 10% Greens 9% FDP 8% The Left 4% CSU 44% Others 6%
SPD 19%

Other Capital makets 3% Domestic credit (incl Schuldscheine) 61%
Bonds 36%
2% 1% 0% -1% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Bavaria all Lnder

Withholding tax on interest 3% VAT 29% Municipal trade taxes 3% Own taxes 12%
Debt/GDP
30% 20% 10% 0% 1992 1996 Bavaria 2000 2004 all Lnder 2008
Income and Corporate Taxes 52%
10 June 2010
463
State of Brandenburg (BRABUR)

Description
% Index 0.048 % Index NA Total debt 18.1bn LT senior unsecured Bond rating Outlook
Leef H Dierks
Ratings table
Moodys Aa1 Aa1 Stable S&P NR NR NR Fitch AAA AAA Stable
Geographically, the former East German State of Brandenburg (BRABUR) surrounds the city state of Berlin. With a GDP of 53.9bn in 2009, down 0.9% y/y from 54.4bn in 2008, Brandenburg ranks among the economically weaker German states. Its GDP accounts for only 2.2% of the German GDP (2.4bn). In terms of land area, however, Brandenburg, which lacks any noteworthy industry basis, accounts for 8.7% of Germany. As in the case of its East German peers, tax revenues, which Brandenburg estimates to total 4.8bn in 2010, down 744mn y/y, only account for only a small proportion (45.7%) of all revenues. Transfer payments as well as revenues from the issuance of new debt will account for 30.9% and 20.2%, respectively, thereby highlighting Brandenburgs ongoing reliance on federal transfers and fiscal equalisation payments.
Risk weighting
Debt issued by the State of Brandenburg is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economics: Being the geographically largest state in what previously was East Germany, the State of Brandenburg, which covers 8.3% of the German land area, surrounds the city state of Berlin. In strong contrast to other former East German states, the State of Brandenburg has not been subject to a pronounced emigration but, largely attributed to its vicinity to Berlin, has managed to keep its population figures stable at about 2.5mn since 1990. In terms of the age structure, a high 34% of Brandenburgs population was older than 55 years in 2008. Adding to a potential strain on the public finances is Brandenburgs relatively high unemployment rate in 2009 of 14.5%. Indebtedness: Brandenburgs aggregated debt sharply increased since German reunification in 1990. Whereas Brandenburgs debt amounted to 2.8bn in 1992, it has since climbed to 18.0bn in 2008. Taking into consideration a population loss of annually 10,000 inhabitants, however, the per-capita income has increased to 7,117. Brandenburgs interest payments have recorded an annual average increase of 37% since 1991 and meanwhile account for a high 14% of all tax revenues. The recent 2009-13 finance plan foresees that net new debt, which is scheduled to amount to 651mn in 2010, will be reduced to 500mn in 2011 and 350mn in 2012. After a final 200mn borrowing in 2013, Brandenburg expects to present a balanced budget provided taxes are not lowered. Despite this development, the overall amount of debt outstanding is set to increase further from 18.8bn in 2010 to 19.3bn in 2011, 19.6bn in 2012 and to 19.8bn in 2013. This translates into a per capita debt of 7,869 by 2013, provided the population number remains stable. Public finances: Following a 460mn budget surplus in 2007 and a deterioration of public finances in 2008 that led to a 144mn budget deficit, Brandenburg generated a budget deficit of 513mn, or 1% of GDP, in 2009. Whereas revenues amounted to 9.5bn in 2009, stable from 2008 but down from 10.3bn in 2007, expenditures sharply increased to 10bn in 2009 from 8.4bn in 2008. In 2010, Brandenburg expects its total revenues to increase to 10.5bn, with expenditures largely comparable ie, in principle anticipating a balanced budget. Political environment: Following the regional elections held in September 2009, the State of Brandenburg is governed by a socalled red-red coalition between the social-democratic SPD and leftist Die Linke. Whereas the SPD occupies 31 of the 88 parliamentary seats, Die Linke holds 26 seats, thereby securing a comfortable 13 seat majority. Conservative CDU holds 19 seats followed by liberal FDP (seven seats) and the Greens (five seats). The next elections will be held in autumn 2014.
Strengths
Brandenburg (strongly) relies on funds from the German financial equalisation scheme. In the long run, amounts will likely decline.
Weaknesses
Brandenburg is exposed to an ageing population and a population loss of c.10,000 annually. In combination with the absence of a sound industrial base, this reduces the potential tax base.
Key points for 2010

The (political) willingness to curb new borrowing needs to be carefully monitored, particularly in light of the 650mn Brandenburg plans to borrow this year.
10 June 2010
464

Financial summary
bn Economy Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn) Revenues Tax revenues Federal transfers Financial equalisation Other revenues Total revenues Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures Total expenditure Balances and debt Financial balance Debt outstanding Ratios (%) Taxes/Total revenues Expend./GDP Financial balance/Revenues Debt/Revenues Debt per capita () 47.3 19.7 -5.6 49.2 19.9 -3.0 53.2 18.7 4.5 54.7 18.3 1.4 56.8 15.4 -5.7 -0.5 17.0 -0.3 17.2 0.5 17.4 0.1 17.2 -0.5 17.4 2.1 0.8 1.8 3.2 1.9 9.7 2.0 0.8 1.8 3.3 2.0 10.0 2.0 0.8 1.7 3.3 2.0 9.8 2.0 0.8 1.6 3.5 2.1 10.1 2.0 0.7 1.7 2.7 1.1 8.3 4.3 3.1 0.6 1.8 9.2 4.8 3.1 0.6 1.8 9.7 5.5 3.1 0.7 1.7 10.3 5.6 3.1 0.6 1.6 10.2 5.0 2.7 0.6 1.1 8.8 2005 2006 2007 2008 2009 49.0 0.9 19.1 2.6 50.2 1.3 19.7 2.6 52.6 2.0 20.7 2.5 54.9 1.5 21.7 2.5 53.9 -2.1 21.4 2.5
State of Brandenburg (BRABUR)

CDU 19.4% PDS 28.0% DVU 6.1% Greens 3.6% SPD 31.9% FDP Others 3.3% 7.7%

Domestic credit (incl Schuldscheine) 39% Other Capital makets 1%
Bonds 59%
10% 6% 2% -2% 1991 1995 1999 2003 2007 Brandenburg all Lnder
186 178 168 169 198 6,640 6,749 6,827 6,803 6,929

Muni trade taxes 1% Own taxes 8%
Debt/GDP
40%
20% VAT 63% Income & Corp Taxes 27% Withholding tax 1%
0% 1992 1996 2000 2004 2008 Brandenburg all Lnder
10 June 2010
465
State of Lower Saxony (NIESA)

Description
% Index NA % Index NA Total debts 53.2bn LT senior unsecured Covered bond rating Outlook
Leef H Dierks
Ratings table
Moodys NR NR NR S&P NR NR NR Fitch AAA NR Stable
With a GDP of 206bn in 2009 and thus contributing 8.8% of Germanys total GDP, the state of Lower Saxony (NIESA) is Germanys fifth-largest state in terms of economic strength. It accounts for 13% of the German land area, thereby ranking second only to the Free State of Bavaria. As at year-end 2009, Lower Saxony had a population of c.8mn (or 10% of the German total of 82mn). In 2010, Lower Saxony expects to receive 169mn within the scope of the German financial equalisation scheme.
Risk weighting
Debt issued by the State of Lower Saxony is subject to a risk weighting of 0% within the Basel II RSA.
Key features
Economics: With a GDP of 205.6bn in 2009, down 3.5% y/y from 213.1bn in 2008, Lower Saxony contributed 8.8% to the total German GDP of 2,407bn in 2009. At the same time, the states per capita GDP stands at only 88% of the domestic average, living standards (statistically) are towards the lower end of the range for the former West German states. The neighbouring City State of Hamburg, for example, had a percapita GDP in excess of 164% of the domestic average. Lower Saxonys industrial structure largely resembles the German average, albeit financial services are slightly under-represented. Also, being a so-called territorial state, Lower Saxony is subject to an above-average weight in agriculture, manufacturing and construction. The states industrial centre lies in the Hannover-Braunschweig-Wolfsburg triangle, where several car and car parts makers are located, among them Europes largest car maker Volkswagen. Political environment: Following the regional elections held in January 2008, the state of Lower Saxony is governed by a coalition of conservative CDU and liberal FDP, which is in its second term. Whereas the major parties, ie, the CDU and socialdemocratic SPD lost 6pp (to 42.5%) and 3pp (to 30.3%), respectively, leftist Die Linke obtained 7.1% of the vote, thereby winning the right to parliamentary representation. Indebtedness: Lower Saxonys indebtedness has more than doubled since 1990 when it stood at 20.6bn. As at year-end 2009, the latest date for which data were available, the amount had increased to 53.2bn, up from 50.2bn in 2008. According to the 2009-13 budget plan, the states overall (capital market) debt is set to further grow to 56.1bn in 2010, 58.2bn in 2012, and 61.0bn in 2013. Lower Saxony plans to reduce net borrowing to nil by 2017. Public finances: With Lower Saxony estimating its expenditures to total 25.2bn in 2010, the state will be subject to a budget deficit, which it plans to cover by net new borrowing of 2.3bn. This volume is set to decline to 2bn in 2011, 1.6bn in 2012 and 1.3bn in 2013. Gross borrowing is expected to amount to a high 9.0bn in 2010. Tax revenues are estimated to amount to 15.5bn in 2010, thereby accounting for 62% of all revenues. Still, Lower Saxony will also receive 169mn of transfer funds from the German financial equalisation scheme. With regards to its expenditure structure, with 9.6bn, personnel expenditures are likely to account for a large part of (38%) the budget. Interest payments account for 9.6% of all expenditures and are set to grow from 2.2bn in 2009, to 2.4bn in 2010, 2.5bn in 2011, 2.8bn in 2012 and to 2.9bn by 2013. The respective quota in terms of all spending will grow to 10.9% by 2013, from 10.6% in 2012, and 10.0% in 2011. In terms of the interest payment to tax revenues ratio, the state expects the current level of 12.7% to increase to 15.1% by 2013. Note that in 2010, Lower Saxony plans to take an additional 789mn from its accrued reserves.
Strengths
With a GDP of 205.6bn, Lower Saxony is the fifth-largest German state in terms of economic power and benefits from a relatively well balanced structure of the manufacturing and services industry.
Weaknesses
Despite an already relatively high debt level of 53.2bn at the time of writing, Lower Saxony will not cut its net new borrowing to nil before 2017, thereby causing the overall amount of debt outstanding to grow to 61.0bn by 2013.
Key points for 2010

In light of net new borrowing of 2.3bn in 2010, the consolidation efforts of Lower Saxonys public finances should be carefully monitored.
10 June 2010
466

Financial summary
bn Economy Nominal GDP (bn) Real GDP growth (%) GDP per capita ('000) Population (mn) Revenues Tax revenues Federal transfers Financial equalisation Other revenues Total revenues Expenditure Staff Interest costs Investment spending Transfers to munis Other expenditures Total expenditure Balances and debt Financial balance Debt outstanding Ratios (%) Taxes/Total revenues 74.3 74.2 10.9 -1.3 73.3 11.3 -2.9 76.8 10.9 -1.8 78.2 11.0 -6.8 232 6,477 Expenditure/GDP 11.3 Financial balance/Revenues -14.6 Debt/Revenues Debt per capita () -2.8 47.9 -0.3 48.8 -0.7 49.4 -0.4 50.2 -1.50 51.5 8.4 2.3 1.9 4.9 4.3 21.8 8.5 2.3 1.5 5.2 4.3 21.8 8.7 2.2 2.3 6.0 4.2 23.4 8.9 2.2 1.9 6.0 4.5 23.5 9.2 2.2 2.0 5.8 3.4 22.6 14.1 2.1 0.3 2.8 19.0 16.0 2.1 0.3 3.5 21.5 16.7 2.1 0.3 4.0 22.8 17.7 1.9 0.4 3.4 23.0 17.4 1.8 0.1 3.1 22.2 2005 2006 2007 2008 192.7 199.0 206.6 214.4 2.2 2.4 2.0 1.9 24.1 8.0 24.9 8.0 25.9 8.0 26.9 8.0 2009 205.6 -4.7 25.9 8.0
State of Lower Saxony (NIESA)

CDU 42.5% Greens 8.0% FDP 8.2% PDS 7.1% SPD 30.3% Others 3.9%

Other Capital makets 3.7%
Domestic credit (incl Schuldscheine) 51.1%
Bonds 45.2%
3%
1%
252 227 217 218 5,982 6,107 6,191 6,301
-1% 1991 1995 1999 2003 2007 Lower Saxony all Lnder

VAT 44% Municipal trade taxes 3% Own taxes 10% Withholding tax on interest 2% Income and Corporate Taxes 41%
Debt/GDP
25% 20% 15% 10% 1991 1995 1999 2003 2007 all Lnder Lower Saxony
10 June 2010
467
10 June 2010
468
PFANDBRIEF ISSUER PROFILES
10 June 2010
469
Aareal Bank AG (AARB)

Description
% Index 0.030 % Index NA Total assets 40bn LT senior unsecured Covered bond rating* Outlook Discontinuity factor** Collateral score**
Fritz Engelhard
Ratings table
Moodys NR NR NR S&P NR NR NR Fitch AAAA/AAA Stable 24.6/5.6 -
Aareal Bank AG (AARB) is a specialised property finance bank focusing on structured property finance, consulting and property management services. While 63% of its shares are free float, a 37% stake is held by a holding company, which is largely owned by German insurance companies. At YE 09, Aareal Group had total assets of 39.6bn and about 2,300 employees. Lending activity was secured by property located in more than 25 countries. Reacting to ongoing disruptions in financial markets, the bank adopted a buymanage-hold approach. While it remained profitable, in March 2009 it agreed with the German Financial Markets Stabilisation Fund (SoFFin) to receive 525mn of Tier 1 capital through a silent participation. SoFFin also provided a 4.0bn guarantee facility. Both measures were taken to ensure the long-term future of the banks business and to help it get through the difficult market environment. Aareal Bank expects markets to remain challenging this year, but anticipates a recovery in 2011 and plans to pay back a first tranche of its SoFFin participation in early 2011.
Note: *Mortgage Pfandbriefe/Public sector Pfandbriefe, **In %
Risk weighting
Pfandbriefe carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Resilient bottom line income: Aareal Group reported net income of 67mn in FY 09. While this is 14% down from FY 08, we think this is very impressive given the challenging environment in its core markets. Net interest income remained above 450mn. Net fees and commission income continued to contribute to a diversification of earnings, amounting to 133mn in FY 09, down from 150mn in FY 08, mainly because of more prudent new business origination. The 67mn swing in the banks trading income was largely due to revaluations of credit derivative positions. This swing helped to compensate for the 70mn increase in loan-loss provisions, which was at the upper end of the banks projections for FY 09. Sound business franchise: The disruptions in financial markets offer Aareal Bank the opportunity to leverage its sound business franchise more strongly. As many of its peers struggle to remain competitive, profitability in the banks core business is increasing. Also, its international profile, which incorporates real estate lending in 25 countries, gives it the flexibility to benefit from a broad spectrum of market opportunities and diversify its credit exposure across different property cycles. Strengthened capitalisation: The banks Tier 1 ratio increased from 8.0% at YE 08 to 11.0% at YE 09. This was mainly the result of the 525mn capital injection in Mar 09. In addition, risk-weighted assets decreased by 1.4bn or 5.9% in 2009. The bank also increased its wholesale deposits (YE 09: 8.1bn versus YE 08: 7.2bn), which also included 3.8bn of deposits from the institutional housing sector. Potential support: While Aareal Bank, unlike many other Pfandbriefbanks, is not part of a larger banking group, we would expect it to gain support from the German private banking sector, as it has a sizeable (10.2bn at YE 09) volume of outstanding Pfandbriefe, as well as 8.5bn of Schuldscheindarlehen held by non-banks.
Weaknesses
Challenging conditions in core markets: Market conditions in some of the banks target sectors have become more challenging over the past 12 months. The economic slowdown in many industrial countries has had a negative impact on tenant quality and it also has put pressure on the achievable rental income, as well as the valuation of underlying properties. Notwithstanding this, pressure on risk provisions is mitigated by the banks strong track record of managing its exposure through different market cycles. This is reflected in the benign increase of the banks NPL ratio from 2.9% at YE 08 to 3.9% at YE 09. In addition, the portfolio provision of 34mn created at YE 08 was not utilised, but increased by 14mn at YE 09. Securities holdings: As of 31 December 2009, Aareal Bank AG added a net 3,872mn or 28% of the groups debt securities holdings to the fixed-assets account. The non-realised loss on the portfolio amounts to 298mn, or 14% of total group equity as of YE 09. While this appears manageable, we note that swap spreads, in particular for some public sector debtors, remain volatile and this in turn exposes the bank to potential write-offs. Regulatory challenges: Some of the planned changes to the international regulatory environment for credit institutions may be quite challenging for Aareal Bank. For example, the EU proposed a further harmonisation of the risk-weighting approach to commercial mortgage credit. This could eventually lead to a doubling of the capital charge on these types of assets. In addition, the maintenance of a liquidity buffer, as stipulated by the Basel Committee as well as proposed amendments to the Capital Requirements Directive, could have a lasting negative impact on the banks profitability and internal capital generation capacity. Event risk: According to German newspaper Boersen-Zeitung, Aareal Bank is among the bidders for Westdeutsche Immobilienbank, a subsidiary of WestLB AG. An acquisition could potentially have a negative impact on the credit profile.
Key points for 2010

Monitor the development of the banks NPL ratio and risk provisioning. 10 June 2010 Track acquisition activities and their impact on the portfolio composition as well as capitalisation levels. 470

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortg. Pfandbriefe Total equity Profitability (%) Net int. margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 379.0 145.0 13.0 605.0 356.0 249.0 89.0 160.0 125.0 38,274 23,341 1,735 20,682 9,707 22,643 2,685 3,119 1,372 0.98 0.3 9.6 58.8 62.6 35.7 1.4 4.6 29.5 8.2 13.5 3.6 2007 399.0 142.0 -26.0 751.0 361.0 390.0 77.0 313.0 308.0 40,202 24,985 1,738 22,550 9,117 23,834 3,090 4,714 1,627 1.02 0.8 20.5 48.1 53.1 19.7 0.7 2.3 32.8 8.0 12.3 4.0 2008 456.0 150.0 -23.0 538.0 347.0 191.0 80.0 111.0 78.0 41,159 24,771 1,875 22,813 7,310 22,330 2,985 7,016 1,429 1.12 0.2 5.1 64.5 84.8 41.9 0.9 2.9 31.2 8.0 12.0 3.5 2009 456.0 133.0 44.0 601.0 361.0 240.0 150.0 90.0 67.0 39,569 23,459 1,717 21,288 8,066 23,517 2,811 7,368 2,077 1.13 0.2 3.8 60.1 75.9 62.5 1.2 3.9 29.4 11.0 15.0 5.2
Aareal Bank AG (AARB)

Net interest margin, credit costs and RoA
1.5% 1.0% 0.5% 0.0% -0.5% 01 02 03 04 05 Net interest margin 06 07 Credit costs 08 09 RoA
Efficiency
100% 80% 60% 40% 20% 0% 01 02 03 04 05 06 07 08 09 Cost/Income ratio 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% Cost/Assets Ratio (RS)
Capital
20% 15% 10% 5% 0% 01 02 03 04 05 06 07 08 09 Tier 1 ratio Total capital ratio
Asset Quality
12% 10% 8% 6% 4% 2% 0% 04 05 06 07 08 09 Prob loans/Gr loans (LS) 60% 50% 40% 30% 20% 10% 0% Coverage ratio (RS)
Securities portfolio (13.8bn) by product type, YE 09

ABS 4% Bank debt 16% Public sector 71%
Covered Bonds 9%
Over-collateralisation mortgages
bn 10 5 0 Dec-05 Dec-06 Dec-07 Restricted assets Over-collateralisation
10 June 2010
Counterparty type mortgages, YE 09

OC (x) 2.0 1.5 1.0 0.5 0.0 Dec-08 Dec-09 Covered bonds
Logistics 14% Hotel 12% Wholesale/ Retail 22% Residential 13% Other 3%
Office 36%
471
Bayern LB (BYLAN)
Description
% Index 0.313 % Index 0.019 Total assets 339bn LT senior unsecured Public sector Pfandbriefe Mortgage Pfandbriefe Outlook Discontinuity factor*** Collateral score***
Fritz Engelhard
Ratings table
Moodys * A1 Aaa Aaa 12.2/7.4 ** Aaa Aaa Aaa * NR NR NR S&P ** NR NR NR * A+ AAA AAA Fitch ** AAA AAA AAA
With total assets of 339bn as at year-end 2009, BayernLB (BYLAN) is Germanys second-largest Landesbank. Through BayernLB Holding AG, the bank is owned by the Free State of Bavaria (94.03%) and the Association of Bavarian Savings Banks (5.97%). In April 2008, BYLAN received 4.8bn of protection from its owners against default risks of its ABS investments. Following EU approval, between December 2008 and March 2009, the Free State of Bavaria injected a total of 10bn of fresh capital into BYLAN. In December 2008, SoFFIn agreed to provide 15bn worth of federal guarantees to support the banks refinancing activities. Only 5bn of this amount was used and the remaining 10bn was cancelled with SoFFIn in October 2009. On 14 December 2009, BayernLB transferred its 67.08% stake in Hypo Alpe Adria Bank International AG (HGAA) for 1 to the Republic of Austria, committed to maintain existing liquidity facilities for HGAA and waived 825mn of its claims against HGAA. On 21 December 2009, Bayern LB announced the sale of 25.2% of its shares in SaarLB to the State of Saarland and thus reduced its ownership from 75.1% to 49.9%.
Stable
Watch neg. 19.0/8.3 -
Notes: *Non guaranteed **Guaranteed ***In % Mortgage/Public sector
Risk weighting
Strengths
Ownership support: BYLAN is indirectly owned through a holding model by the Free State of Bavaria and the Association of Bavarian Savings Banks. Ownership support became apparent during the course of 2008, when BYLAN repeatedly benefited from guarantee and capital measures. Restructuring and recapitalisation: In early 2009, the bank triggered a restructuring plan called Hercules. It included a discontinuation of certain activities, the reduction of risk assets head count and expenses as well as the focus on four major segments, namely institutional clients, commercial real estate, SMEs and retail banking. The transfer of HGAA was the major event that helped progress with the restructuring. Riskweighted assets decreased by 62bn, or 31% in FY 09. As the decrease in core capital only amounted to 3.3bn or 18.2%, the banks core capital ratio increased from 9.2% at YE 08 to 10.9% at YE 09. Pfandbrief over-collateralisation: As at end-March 2009, public-sector Pfandbriefe issued by BYLAN benefited from an over-collateralisation of 34% on a nominal basis and 29% on a present value basis. At the same time, its mortgage Pfandbrief investors benefited from an over-collateralisation of 37% on a nominal basis and 38% on a present value basis.
Weaknesses
Fallout from financial market crisis and HGAA: The deconsolidation of HGAA was a major step in the restructuring of BYLAN, but it weighed significantly on the banks FY 09 results. BYLAN claims that the HGAA transfer has put a 3.3bn strain on FY 09 operating earnings. While the banks legacy structured credit position (YE 09: 17.5bn) benefit from the risk shield of the Free State of Bavaria, EU approval for the state aid provided by the banks owners is expected in Q2 10. Asset quality: Although headline asset quality measures improved in 2009 on the back of the deconsolidation of HGAA, the bank remains exposed to some headwinds. In particular the 51bn gross commercial property financing portfolio, which at YE 09 made up 14% of total gross credit risk exposures (YE 08: 12%) might suffer from an increase in NPLs and write-downs, as market conditions remain challenging in this segment. In addition, the bank still has significant exposure to some regional hotspots, including 11.4bn to Hungary, 9.7bn to Spain, 6.8bn to Italy, 2.1bn to Portugal and 1.5bn to Greece. Event risk: Ongoing ownership discussions across German public sector banks might change the risk profile of the bank. In particular, acquisitions might induce Landesbanks to increase the respective debt financing. Yet, in our opinion, given the substantial support mechanisms within the German savings banks finance group (Sparkassen Finanzgruppe), a deterioration of the credit profile is unlikely.
Key points for 2010

Monitor ownership support, the execution of the banks restructuring plan and EU state aid procedures. Track BYLANs high risk exposures and their impact on bottomline earnings.
10 June 2010
472

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which mortgages Customer deposits Debt funding of which PS Pfandbriefe of which mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 1,820 404 656 2,980 1,466 1,514 0 1,332 1,000 344,369 137,097 35,217 21,413 76,704 115,760 50,808 4,576 12,559 0.30 8.1 49.2 61.1 0 1.5 4.8 32.3 7.7 10.7 3.6 2007 2,170 380 -696 1,987 1,765 222 115 255 92 415,639 175,567 33,558 25,518 92,617 135,348 53,897 5,472 12,893 0.02 0.7 88.8 109.2 52 1.3 6.2 20.8 6.4 11.4 3.1 2008 2,670 584 -4,207 -953 2,620 -3,573 1,656 -5,166 -5,084 421,666 202,567 30,548 22,533 91,307 129,300 35,747 3,484 11,265 <0 <0 <0 <0 -46 1.7 6.9 24.1 8.0 12.3 2.7 2009 2,561 434 -450 2,545 2,125 420 3,277 -2,765 -2,619 338,818 158,962 31,477 22,724 92,197 101,685 26,675 5,707 14,061 -0.69 -20.7 83.5 100.6 780 1.7 5.4 32.4 10.9 15.7 4.2
Bayern LB (BYLAN)
Capital ratios
20 15 10 10.9 5 0 2006 2007 Tier 1 ratio 2008 2009 Total capital ratio 7.7 6.4 8.0 10.7 11.4 12.3 15.7
Gross credit risk exposure (371bn) by sector, YE 09

Retail Retail Clients Clients 12%12% Corporates 23% Other 0.1%
Financial Institutions 51%
Real Estate 14%
Asset quality
50 40 30 20 10 0 06 Coverage ratio 07 08 09 Prob loans/Gr loans (RS) 8 6 4 2 0
Over-collateralisation public sector

80 60 40 20 0 01 02 03 04 05 Restricted assets Overcollateralisation (RS) 06 07 08 09 Covered bonds 0.5 0.0 bn 1.5 1.0
12 10 8 6 4 2 0 bn 2.0 1.5 1.0 0.5 0.0 01 02 03 04 05 Restricted assets Overcollateralisation (RS) 06 07 08 09 Covered bonds
Geographical split public sector, Q1 10

Switzerland 4% Germany 91% Other 5%
Property type mortgage collateral, Q1 10

Other 4% Residential 29%
Commercial 67%
10 June 2010 473
Berlin-Hannoversche Hypothekenbank (BHH)

Description
Fritz Engelhard
Moodys NR Aa1/Aaa NM 14.4/5.4 S&P NR NR/NR Fitch A+ AA+/AAA Stable 17.4/7.3 -
Ratings table
Berlin-Hannoversche Hypothekenbank AG (BerlinHyp) is a medium-sized mortgage bank, with total assets of 41bn, as at 31 December 2009. It is incorporated as a private mortgage bank, 91.58%-owned by Landesbank Berlin AG (LBB), with Norddeutsche Landesbank owing a further 8.07%. The remaining 0.35% is free float. LBB is 98.6%-owned by a group of German savings banks (Sparkassen Finanzgruppe). BerlinHyp is part of LBBs real estate finance operations. The banks operations focus on public sector financing and mortgage loans for commercial and, to a lesser degree, residential properties, with a particular emphasis on metropolitan areas. BerlinHyp resulted from the merger of Berliner Hypotheken- und Pfandbriefbank and the former Braunschweig-Hannoverschen Hypothekenbank in 1996. Its legal predecessor, Berliner Pfandbriefinstitut, started issuing Pfandbriefe in 1868.
Note: *Mortgage Pfandbriefe/Public sector Pfandbriefe. ** shown in %
Risk weighting
Strengths
Shareholder support: In our view, BerlinHyp benefits from the support of LBB. As at 31 December 2009, BerlinHyp accounted for 29% of LBB Groups total assets. It assumes responsibility for real estate lending within LBB Group, coordinates its credit approval process with LBB and makes use of LBBs branch network. LBB also issued a Letter of Comfort to the benefit of BerlinHyp. BerlinHyp received 84.9mn of new share capital from LBB in November 2009, reflecting support from the latter. This led to an increase of banks core Tier 1 capital ratio from 6.5% at YE 08 to 7.6% at YE 09 and also, in part, helped to compensate the expiry of 200mn of profit participation certificates in January 2010. A well-established Pfandbrief issuer: With a total volume of 23.4bn of outstanding mortgage and public sector Pfandbriefe as of YE 09, BerlinHyp is a medium-sized issuer in this asset class. Thus, the bank also benefits from substantial systemic support for the Pfandbrief product and from the overall promise of the German government, ie, if the functioning of the Pfandbrief market is hampered, the government will take shortterm measures to ensure payments on Pfandbriefe. Satisfactory bottom-line results: Over the past five years, BerlinHyp has consistently improved its financial performance, mainly through reduced loan-loss provisions and tight cost control. Loan loss provisions as a percentage of average assets decreased from the high levels above 0.5%, to a lower level of c.0.2%. BerlinHyp has no exposure to structured credit products. Its net income increased from 45mn in FY 08 to 59mn in FY 09. Over-collateralisation: BerlinHyps Pfandbriefe feature decent over-collateralisation. At YE 09, nominal over-collateralisation stood at 9% for public sector Pfandbriefe and 10% for mortgage Pfandbriefe.
Weaknesses
Securities holdings: As of 31 December 2009, BerlinHyp allocated 5,625mn, or 44% of its debt securities holdings to the fixed-assets account. The reported non-realised loss on the portfolio amounts to 81.7mn, or 10.4% of total equity. On the back of ongoing spread volatility, the securities portfolio remains exposed to mark-to-market swings. At YE 09, 4.1bn or 32% of BerlinHyp s 12.8bn securities portfolio, consisted of exposure to non-domestic financials. Within its public sector cover pool, the bank had 615mn of exposure to Portugal, Greece and Spain, which represented 4.8% of cover pool assets. Reliance on wholesale funding: BerlinHyp relies heavily on wholesale funding; 92% of the banks funding is either from debt securities or inter-bank deposits. Thus the bank is relatively strongly exposed to refinancing risk. However, this is mitigated by the fact that BerlinHyp belongs to a large banking group. In addition, BerlinHyp owns a large portfolio of comparatively liquid assets and makes strong use of secured funding. Exposure to commercial property markets: As of YE 09, 90% or 9.1bn of BerlinHyps mortgage Pfandbrief cover pool consisted of domestic mortgages and 73% of the pool consisted of commercial property. Ongoing weakness in commercial real estate markets exposes the bank to potential losses.
Key points for 2010

Monitor the development of the credit spread environment and its impact on the banks performance. Watch the development of the relationship between LBB and BerlinHyp, as well as LBBs credit profile.
10 June 2010
474

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which mortgages Customer deposits Debt funding of which PS Pfandb. of which mortgage Pfandb. Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset Quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2005 222.3 -0.5 0.0 224.2 75.0 149.1 90.8 45.7 36.7 39,591 31,073 15,661 15,407 2,469 25,325 13,453 9,493 638 0.10 5.9 33.5 99.2 60.9 na na na na 10.1 1.6 2006 217.4 6.9 0.0 224.3 78.7 145.6 75.8 71.9 54.5 40,639 29,339 14,595 14,546 2,977 25,206 13,828 9,538 732 0.14 8.0 35.1 96.9 52.1 na na na na 9.8 1.8 2007 225.7 8.9 0.0 234.6 76.3 158.3 81.6 77.0 55.1 41,198 27,834 13,278 14,254 2,967 26,189 15,865 8,401 743 0.13 7.5 32.5 96.2 51.6 na na na 5.3 9.7 1.8 2008 214.4 12.8 0.0 227.2 74.2 153.1 93.5 57.6 44.7 41,487 27,790 12,475 14,965 2,086 28,052 15,764 9,682 720 0.11 6.1 32.6 94.4 61.1 na na na 6.5 11.7 1.7
Berlin-Hannoversche Hypothekenbank (BHH)

Securities portfolio (12.8bn) by type of counterparty
2009 214.0 7.8 0.0 221.8 82.3 139.5 62.8 78.5 58.9 41,291 28,516 12,596 15,625 3,124 26,070 13,132 10,226 789 0.14 7.8 37.1 96.5 45.0 na na na 7.6 13.3 1.9
Nondomestic Financials 32% Domestic Financials 49%
German States 19%
Securities booked under fixed assets

6 4 2 0 00 01 02 03 04 05 06 07 08 09 Bookvalue of securities in fixed assets account in % of total assets (RS) bn 15% 10% 5% 0%
Capital ratios
15% 9.7% 10% 5.3% 5% 0% 07 Tier 1 ratio 08 Total capital ratio 09 6.5% 11.7% 13.3% 7.6%

OC (x) 25 bn 20 15 1.12 1.10 1.09 10 1.08 1.08 1.09 5 1.06 1.06 1.03 1.04 0 00 01 02 03 04 05 06 07 08 09 Restricted assets Covered bonds Over-collateralisation 1.15 1.10 1.05 1.00
15 10 1.10 5 1.04 0 00 1.06 1.05 1.04 1.03 1.04 05 1.05 06 1.07 1.05 1.05 1.00 bn OC (x) 1.15 1.10
01 02 03 04 Restricted assets Over-collateralisation
07 08 09 Covered bonds
Public sector cover pool exposure by region

100% 80% 60% 40% 20% 0% 05 GER 06 07 08 09 Other AUT, NED, SWI ESP, PORT, GRE 93% 92% 90% 92% 89%
Property type mortgage collateral

100% 80% 60% 40% 20% 42% 43% 45% 46% 49% 0% 2000 2002 2004 2006 Residential 2008 Commercial 58% 57% 55% 54% 51% 36% 36% 36% 30% 27%
64% 64% 64% 70% 73%
10 June 2010
475
Dekabank Deutsche Girozentrale (DEKA)

Description
% Index 0.078 % Index NA Total assets 133bn LT senior unsecured Public sector Pfandbriefe Mortgage Pfandbriefe Outlook Discontinuity factor*** Collateral score***
Fritz Engelhard
Ratings table
Moodys * Aa2 Aaa 3.5 ** Aaa Aaa Stable * A AAA Stable S&P ** AA AAA * NR NR NR Fitch ** NR NR -
DekaBank was established in 1999 through the merger of Deutsche Girozentrale and DekaBank. It is the central investment arm of the German Sparkassen (savings bank) system. It had 151bn in funds under management as at 31 December 2009. On the same date, its balance sheet totalled 133bn. It is incorporated as a public law institution and is 50%-owned by the German Sparkassen and Giro Association (DSGV), with the remaining 50% owned by 12 Landesbanks, of which 49.17% is via GLB GmbH & Co, a holding company.
Note: *Non guaranteed **Guaranteed ***In % Mortgage/Public sector
Risk weighting
Strengths
Asset management: Funds under management increased from 142bn in 2008, to 151bn in 2009, reflecting a more stable investment climate and market environment. DekaBank remained the third-largest company in the German investment market. It benefits from referrals from the savings banks and has been able to bolster its recurring profitability significantly through this business line. The important role of the banks fund management business is highlighted by the fact that fees and commissions income contributed 58% to the banks operating income in 2009. Improved capitalisation: The banks Tier 1 ratio (including market risk) increased from 8.4% at year-end 2008 to 9.7% at year-end 2009. The groups economic and regulatory solvency position appears sound, particularly in light of its large exposure to low-risk banks and public-sector entities. While risk-weighted assets decreased 10.8% to 20.7bn, the banks core capital increased from 2.6bn at YE 08 to 2.8bn at YE 09 on the back of 357mn of additions to the fund for general bank risks. Market risk appears conservatively managed: The banks main exposure is to credit spread risk, which at YE 09 made up 86% of all market risk in 2009. The overall value-at-risk indicator stood at 112mn at YE 09 or 4.0% of core capital. Pfandbrief cover pool: As of 31 December 2009, DekaBanks public sector Pfandbriefe benefited from 13.0% overcollateralisation on a nominal basis and 13.4% on a present value basis. Some 94% of exposures were domestic.
Weaknesses
Exposure to financials and commercial real estate: At 31 December 2009, c.50% of gross credit risk exposure was to banks (YE 08: 55%). In FY 08, the bank reported a 352mn net increase of risk provisions, which were largely due to an Icelandic exposure as well as the banks real estate lending. Exposure to commercial real estate decreased slightly from 9.1bn, or 6% of gross credit risk exposures at YE 08 to 7.4bn, or 5% of total credit risk exposures at YE 09. On the back of the global economic downturn, market conditions deteriorate rapidly in this sector. This exposes the bank to further risk provisions. Headline risk: Potential mergers among Landesbanks, as well as the acquisition of Landesbank Berlin (LBB) by the DSGV in June 2007, may alter DekaBanks role within the group of German savings banks. In this respect, DekaBank is exposed to headline risk. However, given the substantial support mechanisms within the German public-sector banking group, a deterioration of the credit profile is unlikely, in our view. Funding: DekaBank relies heavily on capital markets and interbank funding. To fund its substantial business with German Landes and savings banks more efficiently, diversifying its refinancing structure is crucial, in our opinion. Diversification: The flipside of Dekabanks strong franchise in asset management is that it relies heavily on fee and commission income from this business. The earnings generation derived from other business activities is relatively poor. This is reflected in the banks low net interest margin, which stood at 33bp in 2009.
Key points for 2010

Monitor any further M&A activity in the German Landesbank sector. Track DekaBanks exposure to high risk sectors, including commercial real estate, and the impact on bottom-line results.
10 June 2010
476

mn 2005 2006 2007 2008 2009 Income statement summary Net interest income 409 256 203 390 453 Net fees & com's 773 883 985 959 980 Trading income 172 77 95 505 355 Operating income 1,154 1,207 1,184 1,052 1,689 Operating expenses 731 760 692 808 806 Pre-provision income 423 447 492 244 883 Loan loss provisions -36 -2.2 -31.9 291.9 352.4 Pre-tax profit 423 447 524 -49 520 Net income 321 329 401 -74 388 Balance sheet summary Total assets 114,982 104,928 106,482 138,609 133,283 Customer financing 20,510 22,263 24,703 29,759 23,863 Customer deposits 27,565 25,984 26,611 33,745 23,773 Debt funding 42,671 34,368 31,765 29,081 27,028 of which PS Pfandbriefe 34,950 37,037 29,812 24,128 22,000 of which Mortgage Pfandbriefe na na na na na Total equity 3,668 2,924 3,297 3,240 3,500 Profitability (%) Net int. Margin 0.35 0.23 0.19 0.32 0.33 Return on assets 0.28 0.30 0.38 -0.06 0.29 Return on equity 8.8 10.0 12.9 -2.2 11.5 Cost/Income ratio 63.3 63.0 58.5 76.8 47.7 Net int inc/Op inc 35.4 21.2 17.1 37.1 26.8 Asset quality (%) LLPs/Pre-prov inc -8.5 -0.5 -6.5 119.6 39.9 LLRs/Gross loans na na na na na Prob loans/Gr loans na na na na na Coverage ratio na na na na na Capital adequacy (%) Tier 1 ratio 8.4 8.1 6.9 8.4 9.7 Total capital ratio 14.5 14.1 12.2 12.5 13.8 3.2 2.8 3.1 2.3 2.6 Equity/Assets ratio
Dekabank Deutsche Girozentrale (DEKA)

Efficiency
100% 80% 60% 40% 20% 0% 0.5% 0.6% 0.7% 47% 63% 63% 58% 0.7% 77% 48% 0.6% 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4%
0.7%
04 05 06 07 08 09 Cost/Income ratio (LHS) Cost/Assets ratio (RHS)
Net interest margin and credit costs

0.4% 0.3% 0.2% 0.1% 0.0% -0.1% -0.2% 0.25% 0.35% 0.23% 0.19% 0.24% 0.26% 0.00% -0.03% 0.32% 0.33%
0.05% -0.03%
04
05 06 Net interest margin
07
08 09 Credit costs
Customer deposits to loans

200% 160% 120% 80% 40% 0% 04 05 06 07 08 09 Cust. deposits to loans Wholesale funding % of total funding 74% 124% 134% 117% 73% 72% 68% 64% 108% 113% 68% 75% 70% 65% 60% 55% 50% 45%
100%

60 52 48 44 50 36 38 41 45 38 41 35 37 3730 40 33 33 34 2724 25 22 30 1.37x 20 1.17x1.27x 1.18x 1.25x 1.21x 1.12x1.13x 1.13x 10 1.09x 0 00 01 02 03 04 05 06 07 08 09 Restricted assets (bn) Covered bonds (bn) Over-collateralisation (x) 2.0 1.8 1.6 1.4 1.2 1.0
Capital ratios
20% 15% 10% 5% 0% 04 05 Tier 1 ratio 06 07 08 09 Total capital ratio 14.3% 8.1% 14.5% 8.4% 14.1% 8.1% 12.2% 6.9% 12.5% 8.4% 13.8% 9.7%
Geographical split public sector collateral, Q4 09

Spain 1% Germany 94% UK 1% Sweden 1% Other 6%
Gross credit exposure 147bn at YE 09

Transport Real Estate & Trade 5% Other 6% 3% Utility & Project Finance 5% Funds 10%
Domestic Public Sector 11% Corporates 11% Financials 50%

477
10 June 2010
Deutsche Bank AG (DB)

Description
% Index NA % Index NA Total assets 1,500bn LT senior unsecured Covered bond rating* Outlook Discontinuity factor** Collateral score**
Fritz Engelhard
Ratings table
Moodys Aa3 Aaa Stable 13.0 S&P A+ AAA Stable Fitch AANegative -
Deutsche Bank (DB) was founded in 1870 and with total assets of 1,500bn as of YE 09, is Germanys largest credit institution. The bank is a major player in global corporate and investment banking, which in the past eight years on average contributed 60% to total net operating income. In addition, DB has a solid franchise in domestic retail banking and it has also built up a sound international franchise in asset and wealth management. In September 2008, DB announced an agreement to acquire a minority stake in Deutsche Postbank AG (DPB) with the option to buy additional shares. In February 2009, the respective agreement was amended, giving DB the option to acquire a majority stake in DPB at the earliest in February 2012. In May 2009, DB issued its inaugural jumbo mortgage Pfandbrief. As this was the only Pfandbrief issued by DB in 2009, as of YE 09 Pfandbrief funding made up only 0.8% of the groups total long-term debt funding.
Note: *Mortgage Pfandbriefe, **In %
Risk weighting
Strengths
Solid capital markets franchise: DB accumulates significant earnings through its corporate and investment banking operations. It also avoided the catastrophic losses that some of its peers incurred throughout the financial market crisis. In FY 09, the banks capital markets operations contributed 18.8bn, or 67% to total net revenues. Between 2002 and 2010, the corporate and investment banking division contributed on average 60% to total net revenues. Although capital market conditions remain challenging, DB may benefit from its solid market position, combined with persistently elevated profit margins. Investments in the growth of retail banking: DB has a sound market position in the German retail banking market. In order to diversify its earnings and funding mix, over the past four years the bank invested more strongly in the growth of its retail banking, asset and wealth management businesses. Following smaller acquisitions, such as the purchase of Norisbank in 2006 and Berliner Bank in 2007, the takeover of DPB would help DB significantly increase its depository base. Improved capitalisation and reduced leverage: In the course of 2009, DB has made significant progress to improve its capital base and reduce leverage. The banks Tier 1 ratio increased from 10.1% at YE 08 to 12.6% at YE 09, and the core tier ratio increased from 7.0% to 8.7% within same period. At the same time, DB significantly reduced its leverage ratio as measured by the ratio between total assets and shareholders equity which decreased from 59x at YE 08 to 40x at YE 09.
Weaknesses
Earnings volatility: In FY 09, DB generated only 30% of its net revenues from its retail banking and asset management businesses, the lowest in the past eight years. The bank plans to increase its stake in DPB and will eventually become a majority owner in two years. While this may help improve the earnings mix and the funding position of DB, it might only reflect in the banks P&L and funding position from 2012 onwards. Furthermore, DPB still needs to manage down some high risk exposures and in the past, its retail banking business suffered from rather low profitability. Remaining risky asset exposure: In the course of 2009, DB made some progress in the reduction of its overall credit risk position. In particular the total credit risk exposure to financial institutions was reduced by 46bn. However, the bank remains substantially exposed to some high risk asset classes. Total exposure to commercial real estate amounted to 34.3bn at YE 09, only marginally down from 34.9bn at YE 08. The leverage loan book including reclassified assets amounted to 12.5bn as of YE 09, down from 14.3bn at YE 08. The fair value exposure to monocline insurers after credit valuation adjustments stood at 4.0bn at YE 09, down from 6.1bn at YE 08. Pure commercial real estate pool with low granularity: As of YE 09, the cover pool of DBs mortgage Pfandbriefe consisted of 25 commercial and multi-family loans. The properties backing the loans were largely (92%) located in Germany. All loans were originated between January 2006 and January 2008, at the peak of the commercial property cycle. As the respective property markets have suffered significant market value declines since the origination date, the overall loan portfolio is characterised by significant leverage.
Key points for 2010

Monitor potential changes to the composition of the cover pool through potential portfolio additions. Track how the acquisition of Deutsche Postbank AG progresses.
10 June 2010
478

mn 2006 2007 2008 2009 Income statement summary Net interest income 7,008 8,849 12,453 12,459 Net fees & com's 12,282 12,282 9,741 8,911 Trading income 8,892 7,175 -9,992 7,109 Operating income 29,581 30,829 13,613 27,952 Operating expenses 19,567 21,160 17,945 19,712 Pre-provision income 10,014 9,669 -4,332 8,240 Loan loss provisions 298 612 1,076 2,630 Pre-tax profit 8,339 8,749 -5,741 5,202 Net income 6,079 6,510 -3,896 4,958 Balance sheet summary Total assets 1,584,493 1,925,003 2,202,423 1,500,664 Customer loans 178,524 198,892 269,281 258,105 of which home loans 41,185 42,015 42,092 46,248 Customer deposits 411,916 457,946 395,553 344,220 Debt funding 111,363 126,703 133,856 131,782 of which covered bonds 0 0 0 1,000 Total equity 34,309 38,049 37,396 37,929 Profitability (%) Return on assets 0.47 0.37 -0.19 0.27 Return on equity 17.8 18.0 <0 13.2 Cost/Income ratio 66.1 68.6 >100 70.5 Net int inc/Op inc 23.7 28.7 91.5 44.6 Asset quality (%) LLPs/Pre-prov inc 3.0 6.3 -24.8 31.9 LLRs/Gross loans 0.94 0.86 0.73 1.32 Prob loans/Gr loans 1.82 1.59 1.71 3.53 Coverage ratio 52.0 54.2 42.5 37.5 Capital adequacy (%) Tier 1 ratio 8.5 8.6 10.1 12.6 Total capital ratio 12.5 11.6 12.1 13.9 2.2 2.0 1.7 2.5 Equity/Assets ratio
Deutsche Bank AG (DB)

Net interest margin, credit cost and RoA
1.0% 0.8% 0.6% 0.4% 0.2% 0.0% -0.2% -0.4% 2002 2003 2004 2005 2006 2007 2008 2009 NIM Credit costs RoA
Contribution of major business segments to net revenues

80% 60% 40% 20% 0% 2002 2003 2004 2005 2006 2007 2008 2009 Corporate & Investment Banking Private Clients & Asset Management
Capital ratios
16 14 12 10 8 6 2003 10.0 8.6 8.7 8.5 2006 8.6 2007 2008 2009 Total capital ratio 2004 2005 Tier 1 ratio 10.1 12.6 13.9 13.2 13.5 12.5 12.1 13.9
11.6
Change in credit exposure by industry sector (y/y in bn)

60 40 20 0 -20 -40 -60 Fin. Inst. Manufact. Priv. Househ. 2008 2009
bn 2.0 1.5 1.0 0.5 0.0 Jun 09 Sep 09 Restricted assets (bn) Over-collateralisation (x) OC (x) 1.8 1.6 1.4 1.2 1.0 Dec 09 Covered bonds (bn)
Com. Real Estate
Fund Manag.
Geographical breakdown mortgage collateral, YE 09

United Kingdom 5% Germany 92% Switzerland 2% France 1%
Property type mortgage collateral, YE 09

Retail 28% Logistics 5%
MultiFamily 33% Office 34%
10 June 2010
479
Deutsche Genossenschafts-Hypothekenbank (DGHYP)

Description
% Index 0.136 % Index NA Total assets 68bn LT senior unsecured Covered bond rating Outlook Discontinuity factor** Collateral score**
Fritz Engelhard
Moodys NR NR/NR NR 12.6/2.1 S&P A AAA/AAA Negative Fitch A+ AAA/AAA Stable 15.5/7.3 -
Ratings table
With consolidated assets of 68bn as at 31 December 2009, DG Hyp is the German co-operative banking systems largest Pfandbrief-bank. It is 100% owned by DZ Bank, the larger of the two remaining central banks in the co-operative banking system. On 27 September 2007, negotiations with MunHyp, another Pfandbriefbank, were terminated, as no agreement could be reached on key aspects of the planned combination. Shortly after the termination of merger talks, the bank decided to discontinue residential mortgage lending and focus on commercial property business from 2008 onwards. Through its own network the bank is represented in the larger German business centres and also in the UK and the US. It also acquires business in co-operation with DZ Bank, including transactions in France, Scandinavia, EMEA, Benelux and Austria.
Note: *Mortgage Pfandbriefe/Public sector Pfandbriefe. **In %
Risk weighting
Strengths
Integration with the co-operative banking system: DG Hyp benefits from the system of solidarity between cooperative banks and the comprehensive protection scheme that has prevented insolvencies of member institutions since it was introduced in 1932. The respective protection scheme is managed by the Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (BVR: National Association of German Co-operative Banks), which is responsible for group-wide risk monitoring, as well as the restructuring of troubled member banks through the central restructuring committee. The extraordinary income contribution DG Hyp received from DZ Bank in 2007 highlights the latters commitment to the bank. One of the largest Pfandbrief issuers: With a total volume of 46bn of outstanding mortgage and public-sector Pfandbriefe, DG Hyp is among the largest issuers of this asset class. Thus, the bank also benefits from substantial systemic support for the Pfandbrief product and from the overall promise of the German government; ie, if the functioning of the Pfandbrief market is hampered, the government will take short-term measures to ensure payments on Pfandbriefe. Over-collateralisation: DG Hyps Pfandbriefe feature decent over-collateralisation. At YE 09, nominal over-collateralisation stood at 7% for public-sector Pfandbriefe and 27% for mortgage Pfandbriefe.
Weaknesses
Securities holdings: At end-June 2007, just before the financial markets crisis gained momentum, DG Hyp owned a 5.25bn portfolio of mortgage-backed securities, which made up 6.2% of the banks balance sheet. As at YE 09, the portfolio decreased to 3.7bn, or 5.4% of total assets. It was rededicated to the fixed assets account. Spread widening on the banks 30.2bn of fixed income securities caused valuation losses, which were compensated by extraordinary income contributions from DZ Bank (223mn in FY 08 and 223mn in FY 07). As of YE 09, the reported non-realised losses on securities booked under fixed assets amounted to 1,3bn, or 89% of total equity. At the same time, within its public sector Pfandbrief cover pool, the bank had a combined 8.5bn exposure to Spain, Italy, Portugal and Greece, which represented 25.4% (YE 08: 24.3%) of the total. This portfolio exposes DG Hyp to further mark-to-market swings. Challenging conditions in commercial property markets: Market conditions in some of the banks target sectors have become more challenging over the past 12 months. The economic slowdown in many industrial countries has had a negative impact on tenant quality and has also put pressure on the achievable rental income, as well as the valuation of underlying properties. Risk provisions for DG Hyps loan book increased from 61.5mn in FY 08 to 124.7mn in FY 09. The respective losses were mainly the result of legacy subordinated loans (B-Notes), which are no longer part of the banks core business. Moderate capitalisation: We regard DG Hyps capitalisation as moderate. Its Tier 1 capital ratio decreased from 7.3% at YE 08 to 6.9% at YE 09. The capital base decreased to 1.4bn at YE 09, due to the redemption of 421mn of silent participations. Given the banks business focus on less granular commercial property lending and its substantial exposure to public sector borrowers, which are subject to negative rating migration, we regard the capital base as rather small.
Key points for 2010

Watch the banks integration into the co-operative banking system and the performance of the system as a whole. Examine the development of commercial property financing and its impact on the composition of the mortgage Pfandbrief collateral pool.
10 June 2010
480

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Net int. margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov Inc LLRs/Gross lans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2005 324 -59 0 290 183 107 56 51 51 79,140 61,132 36,342 24,790 9,069 67,602 43,309 18,485 1,481 0.42 0.07 3.5 63.0 111.9 52.0 na na na 7.0 10.6 1.9 2006 326 -46 0 297 204 93 60 33 30 85,671 61,568 38,037 23,531 11,542 71,591 47,975 17,364 1,665 0.40 0.04 1.8 68.8 109.9 64.7 na na na 6.4 9.6 1.9
Deutsche Genossenschafts-Hypothekenbank (DGHYP)

Capital ratios
2007 297 -36 0 273 169 104 190 62 49 83,335 60,958 38,460 22,499 13,811 68,374 44,363 15,901 2,001 0.35 0.06 2.5 61.9 108.6 182.1 na na na 6.3 9.4 2.4 2008 163 2 0 174 130 44 173 58 58 76,016 53,602 31,828 21,774 13,813 62,697 39,125 13,914 1,847 0.20 0.07 3.2 74.6 93.7 391.8 na na na 7.3 10.2 2.4 2009 164 11 1 189 123 66 203 15 13 68,075 49,354 28,119 21,235 13,173 53,034 31,787 14,364 1,426 0.23 0.02 0.9 64.9 86.7 304.7 na na na 6.9 9.2 2.1
11% 10% 9% 8% 7% 6% 5% 01 02 03 04 Tier 1 ratio 05 06 07 08 Total capital ratio 09
Net interest income, cost of credit and RoA

0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% 02 03 04 05 Net interest margin 06 07 Credit costs 08 09 RoA

40 30 20 10 0 02 03 04 05 06 07 08 09 Bookvalue of securities in fixed assets account in % of total assets (RS) bn 50% 40% 30% 20% 10% 0%

70 50 30 10 -10 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) 1.10 1.08 1.06 1.04 1.02 1.00 06 07 08 09 Covered bonds (bn)
25 20 15 10 5 0 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) 06 1.3 1.2 1.1 1.0 07 08 09 Covered bonds (bn)
Geographical breakdown public sector

100% 80% 60% 40% 20% 0% 2005 2006 2007 2008 Domestic borrowers IT, SP, PT, GR Other foreign borrowers
10 June 2010
Breakdown by property type mortgage

100% 11% 11% 14% 15% 23% 24% 30% 29% 39% 89% 89% 86% 85% 77% 76% 70% 71% 61%
13% 78%
19% 69%
21% 68%
24% 65%
25% 63%
80% 60% 40% 20% 0%
2009
2001 2002 2003 2004 2005 2006 2007 2008 2009 Residential Commercial
481
Deutsche Hypothekenbank (DHY)

Description
Fritz Engelhard
Ratings table
Moodys Aa3 Aaa/Aaa Stable S&P NR NR/AAA NR Fitch NR NR/NR NR -
Established in 1872, Deutsche Hypothekenbank (DHY) is a mortgage bank that focuses on large-volume commercial transactions for real estate developers, construction companies and public-sector financing. It is also engaged in financing residential buildings for investment purposes. Operations are being expanded outside Germany, especially in its targeted European markets of the UK, France, Benelux, Spain, and also the US. In December 2007, Nord LB made a public offer for all of DHYs shares and finally acquired a 98.4% stake in DHY at end-January 2008. The acquisition was driven by the strategic interest in enhancing Nord LBs expertise in, and exposure to, commercial property markets.
Risk weighting
Strengths
Shareholder support: In our view, DHY benefits from the support of Nord LB. As at 31 December 2009, DHY accounted for 14% of Nord LB Groups total assets. DHY assumes responsibility for commercial real estate and public sector lending within Nord LB Group. it has adapted Nord LBs risk management systems and also originates business through Nord LBs network. Furthermore, DHY benefits from a letter of comfort from Nord LB and since 1 January 2009, it has been part of the Sparkassen Haftungsverbund, a support mechanism set up to guarantee solvency and provide liquidity in the event of difficulties. In October 2008, NordLB injected 180mn of core capital into DHY. Strategic focus: Over the past few years, DHY has adjusted well to the increasingly challenging environment facing German Pfandbrief banks. It has developed a strong business franchise in European commercial mortgage markets and kept a lean organisational structure. In 2009, DHY originated 1.4bn of new mortgage business (2008: 1.8bn). The bank virtually halted its lending to the US and the UK, which only amounted to 187mn compared to 766mn in 2008 and 2bn in 2007. The focus was very much on domestic lending (853mn). Consequently, the share of non-domestic new mortgage business dropped further from 85% in 2007 over 59% in 2008 to 39% in 2009. Conservative market risk management: DHY manages market risk rather conservatively. The bank calculates a daily value at risk (VaR) on the basis of a confidence level of 95% and a 1-day holding period. The VaR fluctuated around an average of 1.6mn in 2009, or 0.24% of the banks equity (2008: 0.18%).
Weaknesses
Securities holdings: As of 31 December 2009, DHY had net additions of 813mn, or 6.6% of its total 12.3bn debt securities holdings, from the trading book to the fixed assets account. The reported net non-realised loss on the portfolio amounts to 161mn, or 25% of total equity. In 2009, a net loss of 36mn (2008: 94mn was realised on the securities portfolio mainly due to write-offs from exposures to Icelandic banks and MBS holdings. Within the banks public sector collateral pool, relative exposure to Italy, Spain, Portugal, Greece and Ireland increased slightly from 12% at YE 08 to 13% at YE 09. Weak bottom-line performance: In FY 09, DHY reported a net loss of 32mn and thus it broke the banks track record of reporting small but regular positive returns over the past 10 years. Increased earnings from higher interest rate margins and its capital market business were insufficient to cope with a strong increase in operating expenses (YY: +17mn or +45%), a further increase in risk provisions (YY: +6mn or +6%) as well as ongoing write-offs from the securities portfolio. Exposure to commercial property markets: Market conditions in commercial real estate markets, in particular in some of the banks non-domestic target sectors, remain very challenging. This exposes the bank to further provisioning needs. Capitalisation: Although DHYs capitalisation improved in 2008 on the back of its parents capital injection, capital ratios remain under pressure on the back of a rather weak internal capital generation capacity, volatility in capital markets and exposure to commercial real estate.
Key points for 2010

Monitor the impact of credit spread developments on the banks securities portfolio. Watch the evolution of commercial property markets and the development of the banks asset quality. Track the relationship between Nord LB and DHY, as well as Nord LBs credit profile.
10 June 2010
482

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Net int. margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr lLoans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 83.3 1.1 0.0 110.5 34.9 74.5 22.9 51.6 39.1 2007 84.6 6.0 0.0 111.9 34.6 76.2 26.7 49.5 36.7 2008 91.7 9.4 0.0 119.8 38.4 95.4 98.4 -3.0 0.6 2009 113.5 16.7 0.0 131.8 55.6 75.2 104.5 -29.3 -32.2
Deutsche Hypothekenbank (DHY)

Efficiency
50% 40% 30% 20% 10% 0% 00 01 02 03 04 05 06 07 08 09 Cost/Income ratio Cost/Assets ratio (RS) 0.4% 0.3% 0.2% 0.1% 0.0%
Capital ratios
14% 12% 10% 8% 6% 4% 00 01 02 03 04 05 06 07 08 09 Tier 1 ratio Total capital ratio
34717 35430 18556 17104 12443 9643 8273 8544 9,422 10,048 29855 29310 20093 19056 5301 5365 503 521 0.25 0.1 8.0 31.5 75.4 30.8 na na na 5.5 9.1 1.4 0.24 0.1 7.2 30.9 75.7 35.1 na na na 5.5 9.3 1.5
36047 34050 15582 14854 8955 8128 9094 9779 9,991 10,121 27349 25398 17757 16329 5882 5472 687 655 0.26 0.0 0.1 32.1 76.5 103.2 na na na 8.4 12.1 1.9 0.32 -0.1 -4.8 42.2 86.1 139.0 na na na 6.8 9.1 1.9

15 10 5 0 00 01 02 03 04 05 06 07 08 09 Bookvalue of securities in fixed assets account in % of total assets (RS) bn 40% 30% 20% 10% 0%

25 20 15 bn OC (x) 1.10 1.07 1.05
8 6 4 2 0 1.05 1.06 1.20 1.15 1.14 1.14 1.14 1.12 1.14 06 07 08 09 Covered bonds (bn) 1.24 bn OC (x) 1.3 1.2 1.1 1.0
10 1.07 1.07 1.06 5 1.04 1.04 1.04 1.02 1.03 1.03 0 1.00 00 01 02 03 04 05 06 07 08 09 Restricted assets (bn) Covered bonds (bn) Over-collateralisation (x)
00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x)
Geographical split public sector collateral

100% 80% 60% 40% 20% 0% 2008 Germany IT, SP, PT, GR, IR 2009 Other non-domestic 26% 12% 62% 30% 13% 58%
Geographical split mortgage collateral

100% 80% 60% 40% 20% 0% 2006 Germany 2007 2008 UK Netherlands US 2009 Others 71.4% 65.5% 65.8% 14.5% 13.0% 12.2% 9.9% 63.4%
10 June 2010
483
Deutsche Kreditbank (DKRED)

Description
% Index 0.015 % Index NA Total assets 52bn LT senior unsecured Covered bond rating Outlook Discontinuity factor* Collateral score*
Fritz Engelhard
Ratings table
Moodys NR Aaa/Aaa Stable 12.2/4.3 S&P NR NR/NR Fitch NR NR/NR -
Deutsche Kreditbank (DKB) was established in 1990 to provide commercial banking services to clients in Eastern Germany and take over the debt of the former central bank of the German Democratic Republic. In 1995, the German government sold DKB in a public offering to Bayern LB. Since then, DKB has been a wholly-owned subsidiary of Bayern LB. DKBs business focus is on providing its services to Eastern German retail, corporate and public sector clients. In recent years, DKB has concentrated particularly on extending its retail banking franchise by offering direct banking and brokerage services. In 2007, DKB started offering direct banking products to Austrian clients. As of YE 09, the bank had 1.8mn clients. In 2006, it set up a Pfandbrief programme, launching the first public sector jumbo Pfandbrief in November 2006. In July 2009, DKB issued its first mortgage Pfandbriefe.
Note: Mortgage Pfandbriefe/Public sector Pfandbriefe. *In %
Risk weighting
Strengths
Ownership: DKB is wholly owned by Bayern LB, which in turn is majority (94%) owned by the Free State of Bavaria. As of 31 December 2009, DKB made up 15% of Bayern LBs group assets. Within Bayern LB, DKB plays a particularly important role with regard to Bayern LBs strategic objective of further developing the groups retail banking franchise. It is also worth noting that Bayern LB has issued a letter of comfort to the benefit of DKB. In October 2008, Bayern LB transferred its remaining retail business to DKB. We believe that, if required, there is a strong likelihood that Bayern LB and its owners will provide support to DKB. Note, however, that Bayern LB is currently in state aid discussions with the EU, and at this stage it is unclear to what extent a disposal of DKB could become subject to EU approval. Diversification of funding: Over the past six years, DKB has managed to reduce its reliance on interbank funding. The ratio of interbank liabilities to total customer financing dropped from 72% in 2002 to 39% in 2009. This was mainly due to strong growth of the banks deposit base. The share of customer deposits to total loans increased from 25% in 2002 to a historically high 54% in 2009. This also reflects the fact that the bank managed to strongly increase the number of its clients in recent years. The ability to issue Pfandbriefe further contributes to the diversification of the banks funding structure. Asset quality: While DKB struggled with high risk provisions in 2002 and 2003, when loan-loss provisions made up 1.9% and 0.5% of total assets, the bank has managed to improve asset quality over the past four years. This was attributed to a change in risk management and also to an improved economic environment. The NPL ratio dropped from 4.4% at YE 06 to 2.6% at YE 09.
Weaknesses
Earnings volatility: The banks earnings were subject to substantial volatility over the past two years. While DKRED weathered the financial market crisis rather well, with a comparatively small (145mn) of write-offs on financial assets in FY 08, the banks net interest income is subject to substantial swings. Following a 4% decrease (from 396mn in FY 07 to 379mn in 2008) the bank reported a strong (28%) increase to 483mn in 2009. These swings not only reflect changes in capital market funding costs, but to a large extent also interest rate developments. Lack of asset diversification: The geographical focus firmly ties the performance of the banks portfolio to the economic cycle in eastern Germany. Given the challenging market conditions in this area, this also limits the capacity for a persistent strengthening of the banks bottom-line performance. The focus on eastern German business is also reflected in the exposure of DKBs public sector Pfandbrief cover pool to eastern Germany. In March 2010, exposure to mortgage debtors from eastern German federal states made up 67% of cover pool assets. Capitalisation: Owing to the successful development of its retail banking franchise, DKB significantly extended its mortgagelending business. The volume of mortgage lending grew 244% between YE 02 and YE 09. The strong growth of the banks mortgage-lending business represents an ongoing challenge with regards to DKBs capitalisation. While the banks core capital benefited from a 300mn capital increase in FY 08, DKRED capital ratios remain under pressure. Competitive environment: DKB competes within a market that which is dominated by a strong presence of savings banks. This generally suggests a rather challenging environment. The bank appears well-equipped to cope with this situation due to the focus on serving the needs of eastern German clients as well as its solid retail banking franchise. However, there is increased margin pressure, which is partly reflected in DKBs net interest margin, which stood at 96bp in 2009.
Key points for 2010

Monitor the development of the banks capitalisation. Watch the development of the relationship between DKRED and BYLAN as well as BYLANs credit profile.
10 June 2010
484

mn Income statement summary Net interest income Net fees & com's Trading income Operating income* Operating expenses Pre-provision income* Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Interbank liabilities Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Net int. margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 372 -1 35 476 260 217 122 185 165 38,162 32,397 7,772 11,507 20,158 12,189 3,069 1,000 1,770 1.10 0.49 10.6 54.5 78.2 56.1 2.5 4.4 56.7 7.4 9.7 4.6 2007 396 -26 61 431 289 143 66 625 563 41,656 37,811 7,206 14,116 20,090 15,816 3,072 2,667 2,094 0.99 1.41 29.2 66.9 91.8 46.4 1.4 3.9 35.1 6.7 8.5 5.0 2008 379 -35 13 356 299 57 68 -26 -21 49,349 45,175 6,670 17,295 24,887 17,677 3,016 3,947 1,989 0.83 -0.05 -1.0 84.0 106.3 119.3 0.9 2.8 33.0 7.6 9.2 4.0 2009 483 -46 14 452 328 124 99 106 113 51,842 47,602 6,312 20,181 18,592 25,790 3,674 3,905 1,219 2,023 0.96 0.22 5.6 72.5 107.0 79.9 0.7 2.6 26.6 7.1 8.6 3.9
Deutsche Kreditbank (DKRED)

Net interest income, credit costs and RoA
2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% 01 02 03 04 Net interest margin 05 06 07 Credit costs 08 09 RoA
Securities portfolio (1.5bn) by type of counterparty, YE 09

Public Sector 11% Non-Banks 16% Banks 73%

100% 80% 60% 40% 20% 0% 25% 26% 02 54% 42% 39% 31% 36% 38% 80% 60% 40% 20% 0% 03 04 05 06 07 08 09 Cust. deposits to loans Wholesale funding % of total funding (RS)

6 4 2 0 1.19 1.00 bn 1.2x 2.93 2.67 1.1x 4.33 3.95 4.82 1.2x 3.90 1.25 1.20 1.15 1.10 1.05 1.00 06 07 08 09 Restricted assets (LHS) Covered bonds (LHS) Over-collateralisation (RHS)
Asset quality
5% 4% 3% 2% 1% 0% 06 07 Prob Loans/Gross Loans 08 09 Coverage Ratio (RS) 57 35 4.4 3.9 2.8 33 2.6 27 100% 80% 60% 40% 20% 0%
1.1x
Geographical split public sector,YE 09
Capital ratios (%)

10 9 8 7 6 5 4 06 9.7 8.5 9.2 8.6
Germany 89%
Greece 1% Others 8% Italy 2%
7.4
7.6 6.7
7.1
07 Tier 1 ratio
08 Total capital ratio
09
10 June 2010
485
Deutsche Pfandbriefbank AG (HYPORE)

Description
% Index 0.164 % Index 0.123 Total assets 273bn LT senior unsecured Covered bond rating Outlook Discontinuity factor* Collateral score*
Fritz Engelhard
Ratings table
Moodys A3 Aa3/Aaa Negative 20.6/4.8 S&P BBB NR/AAA Watch Pos Fitch AAA+/AAA Stable 13.9 / 7.7 -
With total assets of 273bn at YE 09, Deutsche Pfandbriefbank AG (HYPORE) is the main subsidiary of Hypo Real Estate Holding AG (HRG), a banking group that specialises in real estate and public sector lending. The financial market turbulences in H2 08 unveiled the groups reliance on wholesale funding and exposure to liquidity risk. In October 2008, a consortium of German financial institutions, the German government and Deutsche Bundesbank started negotiating liquidity protection measures for the group, which were finalised in November 2008. In April 2009, the German Financial Markets Stabilisation Act was amended, which paved the way for the takeover of the group by the German financial market stability fund (SoFFin) in June 2009. In January 2010, HRG submitted an application for the transfer of 210bn of non-strategic assets to a deconsolidated environment.
Note: Mortgage Pfandbriefe/Public sector Pfandbriefe. *In %
Risk weighting
Pfandbriefe carry a 10% risk weighting under the standardised approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
External support: Between 6 October 2008 and 13 November 2008, Hypo Real Estate Group benefited from a 35bn emergency facility provided by Deutsche Bundesbank. Until February 2009, the facility was increased to 102bn, or about 25% of total group assets, with 50bn guaranteed by a consortium of German financial institutions and the Federal Republic of Germany and the remainder by SoFFin. While the initial 50bn liquidity line was restructured and reduced to 43bn at YE 09, SoFFin extended another 10bn on 28 May 2010, in order to help the bank cope with current market conditions. Furthermore, as HRG reported that its core capital decreased to 3.4% at YE 08, below the regulatory minimum of 4%, SoFFin repeatedly injected capital. As of 30 April 2010, those injections amounted to 6.3bn. We expect HRG to continue to benefit from substantial public sector and industry support as the group is regarded as systemically relevant. Restructuring: In Q4 08, HRGs management was reshuffled. The initial focus has been on stabilisation of the company, but new management has also worked out a plan for a substantial restructuring of the group. The future business focus of the group should be on public sector and real estate business in Germany and Europe, Pfandbrief-eligible assets and a strengthening of the client franchise. Non-core activities, such as infrastructure finance, structured credit and securities business and high risk real estate business are wound down and/or sold. Although the newly named CEO, Axel Wieandt, resigned on 25 March 2010, because of differing views with SoFFin regarding the management of the company, the remaining management team underlined that it would continue with the planned restructuring strategy, including the establishment of a work-out entity. Over-collateralisation: HYPOREs Pfandbriefe feature moderate over-collateralisation. At YE 09, nominal overcollateralisation stood at 6% for public sector Pfandbriefe and 13% for mortgage Pfandbriefe.
Weaknesses
Restricted access to capital markets funding: Although HRG is fully owned by the German government, its solvency and liquidity positions were stabilised and progress was made with regards to the restructuring plan, there are a number of signs which indicate that the banks access to capital funding is still rather limited. This is reflected by the fact that the amount of own securities held on HYPOREs balance sheet increased from 28bn at YE 08 (pro forma HYPORE old and DEPFA) to 75bn at YE 09. The financing of these large holdings of own securities is largely reflected by the high amount (72bn at YE 09) of interbank liabilities. We also note that some of the non-retained securities were placed through big tickets with mostly domestic banks. Deutsche Bank for example reported that in December 2009 it took 9.2bn of SoFFin-guaranteed notes issued by HYPORE, which qualify for ECB repo transactions. On a positive note though it is worth recognising that the bank managed to issue a 1bn public sector Pfandbrief in January 2010. Imposed business restrictions: The substantial support HRG receives from the German government is still subject to approval by EU and German regulatory authorities. The respective talks started on 7 May 2009. On 7 October 2009, the EU commission commented on the restructuring plan and mentioned it will help restore the long time viability of the group. On 13 November 2009, the EU commission extended this investigation, as HRG modified its restructuring plan before the EU commission has completed its assessment. Usually EU approval is subject to substantial limitations, including the necessity to wind down and/or dispose of certain operations, reduce risk exposures and restrictions relating to the competitive behaviour. In our view, the respective restrictions could substantially hamper the ability of HRG to recover from the financial stress in 2008. Worsening prospects within defined core markets: The environment in a number of the banks public sector and real estate core markets is difficult. This exposes the bank to further write-downs on loans and securities. In addition, expenses for liquidity support and deconsolidation will continue to have a negative impact on earnings.
Key points for 2010

Track progress with regards to the planned transfer of assets to a work-out entity. Monitor the development of EU state aid procedures.
10 June 2010
486

mn Income statement summary Net interest income* Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgae Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio* Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 250 20 0 296 104 192 125 63 129 2007* 2008** 683 196 0 1,123 240 883 103 526 40 708 147 0 921 246 675 1,537 -2,685 -2,824 2009 681 -23 0 747 324 422 1,975 -1,605 -1,660
Deutsche Pfandbriefbank AG (HYPORE)

Securities portfolio by counterparty, YE 09: 116bn
100% 80% 60% 40% 20% 0% Own Securities Dec 08 Public sector Securities Dec 09 Other Securities 36% 27% 65% 37% 20% 15%
73,770 127,448 249,371 272,944 58,310 92,308 119,536 100,428 27,391 28,955 58,925 48,974 30,531 54,300 50,095 44,831 6,669 17,165 15,804 13,742 45,844 80,177 162,970 182,585 24,973 28,413 65,338 53,938 16,782 21,233 22,650 21,403 1,965 3,670 1,803 2,491 0.17 6.3 35.1 84.4 65.2 na na na 6.9 10.1 2.7 0.04 1.4 21.4 60.8 11.6 na na na na na 2.9 -1.50 -103.2 26.7 76.9 227.6 na na na na na 0.7 -0.64 -77.3 43.4 91.2 467.6 na na na na na 0.9
Public sector cover pool by counterparty

Central Government 26%
Other 37%
Local Authority 4%
Regional Authority 33%
Mortgage cover pool by property type

100% 80% 60% 40% 20% 0% 02 03 04 Commercial 05 06 07 08 09 Residential 39% 40% 39% 36% 41% 46% 30% 61% 60% 61% 64% 59% 54% 70% 73% 27%
Note: *pro forma Hypo Real Estate Bank AG & Hypo Real Estate International AG **pro forma Hypo Real Estate Bank AG & Deutsche Pfandbriefbank AG

80 60 40 20 0 02 03 04 05 06 Restricted assets (bn) Over-collateralisation (x) 1.12 1.10 1.08 1.06 1.04 1.02 1.00 07 08 09 Covered bonds (bn)
40 30 20 10 0 02 03 04 05 06 Restricted assets (bn) Over-collateralisation (x) Other 10% 1.05 1.00 07 08 09 Covered bonds (bn) 1.10
Geographical split public sector, Q4 09: 57bn

Other 12% Greece 7% Spain 4% Italy 13% Austria 12%
10 June 2010
Geographical split mortgage, Q4 09: 22bn

Netherlands 4% Sweden 4% US 6% UK 10% France 7%
487
Portugal 3%
Germany 43%
Germany 59%
France 6%
Deutsche Postbank AG (DPB)

Description
Fritz Engelhard
Ratings table
Moodys Aa3 Aaa/RWN 2.4/4.3* S&P AAAA/Positive Fitch A+ AAA/Stable 13.7/9.9 -
The roots of Deutsche Postbank AG (DPB) date back to 1990, when the German government decided to separate banking business from Deutsche Bundespost. Following a 1bn capital injection in November 2008, Deutsche Post AG (DP) owned 62.3% in DPB. In September 2008, Deutsche Post AG agreed to a step-by-step transfer of its stake to Deutsche Bank AG (DB). Currently, Deutsche Post AG still owns 39.5% of the bank and Deutsche Bank AG owns 25% plus one share. In two years, a 2.7bn mandatory exchangeable bond will be settled with 60mn Postbank shares (27.4%). Finally, DB has the option to acquire another 12.1% of the bank from Deutsche Post AG. The banks core business is retail banking, which it offers through a large domestic network, mainly providing low-cost and highly standardised retail banking products. In addition, it offers corporate banking services with a focus on cash management as well as transaction banking services. The banks financial markets division operates as an individual profit centre. In January 2008, DPB launched its first jumbo mortgage Pfandbrief and in July 2008 it issued its first jumbo public sector Pfandbief.
Note: *Mortgage Pfandbriefe/Public sector Pfandbriefe, in %
Risk weighting
Strengths
Strong deposit base: DPB has a strong liquidity profile. As of YE 09, total deposits were 132bn, exceeding the banks customer loan portfolio (111bn). Following a decline of the deposit to loan ratio from 148% at YE 05, to 112% at YE 08, the ratio increased again and reached 119% at YE 09. In order to preserve this comfortable liquidity position, the bank invests the deposit overhang in liquid assets. Sound loan portfolio: DPBs loan book is geared towards German retail mortgage lending. The share of mortgage loans as a percentage of total customer loans stood at 63% at YE 09. The strong exposure to the rather stable German housing market results in a rather low overall NPL ratio of only 1.4% at YE 09. As of 31 March 2010, the banks mortgage Pfandbriefe were purely backed by a highly granular portfolio of German residential mortgage loans. As of 31 December 2009, the average loan size stood at 96,421 and only 1.6% of all mortgages exceeded 300,000. Exposure to Eastern Germany and Berlin made up 18.8% of the total collateral pool, basically reflecting the overall structure of the German housing market. However, as of YE 08, DPB also owned 18.0bn (YE 08: 15.9bn) of commercial property loans, of which 65% (YE 08: 62%) were non-domestic. While an inclusion of this portfolio into the cover pool cannot be ruled out, so far the cover pool is purely domestic and DPB has limited itself to cap the amount of commercial mortgages it may include in the pool to 20% of the total. Support: With Deutsche Post AG and DB, DPB currently has two rather strong major shareholders, who we think are likely to lend their support. Furthermore, given DPBs significant volume of retail client deposits, the bank is of high systemic importance. Thus, we regard it as probable that, in case of need, the bank would benefit from government support.
Weaknesses
Capitalisation: The banks capitalisation is modest. DPBs reported Tier 1 capital ratio stood at 7.2% at YE 09. However, when including exposure to market risk, it would only amount to 6.6% at YE 09 (YE 08: 6.5%). In our view, this is rather moderate owing to DPBs significant investments in high risk assets, including exposures to structured credit and financials. Profitability: In FY 09 DPB reported a pre-tax loss of 398mn after an adjusted loss of 1,064mn in FY 08. The reduced loss was mainly a result of lower write-offs on the banks financial assets portfolio. Otherwise, operating income was down by 301mn on the back of a 90mn (3.6%) decrease of net interest income, a 102mn (7.1%) decrease of fee and commission income and a 109mn negative swing in trading income. Securities portfolio: As of YE 09, DPB owned a 71.8bn (YE 08: 82.5bn) securities portfolio, of which 5.9bn (YE 08: 6.3bn) were structured credit exposures. The structured credit portfolio mainly contained CDOs (73%). Within the structured credit portfolio, the share of investment grade exposures decreased from 99% at YE 07 to 41% at YE 09. At YE 09, 59.4bn or 83%, of DPBs financial assets were booked under loans and receivables. In FY 09, write-offs on financial assets caused a loss of 157mn. Due to continued stress in financial markets, DPB remains exposed to write-downs and negative rating migration in its securities portfolio. Execution risk: Although DB has the option to acquire a majority stake in DPB, there is still an element of uncertainty regarding this transaction. While the very strong deposit base and the potential benefit from more pronounced cross-selling appear to give DB a strong incentive to raise its stake in DPB, overcoming DPBs reputation as a low-cost producer, as well as taking over the banks significant credit spread and commercial real estate exposures, may reduce Deutsche Banks appetite to go ahead with its acquisition.
Key points for 2010

Monitor the development of the capital markets environment and its effect on the banks performance. 10 June 2010 Watch the development of the relationship between Deutsche Bank AG and DPB. 488

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Net int. Margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2005 1,675 699 205 2,831 1,886 945 205 719 492 2006 2,145 1,407 264 4,021 2,812 1,209 337 941 694 2007 2,240 1,429 290 4,119 2,937 1,182 338 992 870 2008 2,495 1,431 -389 3,537 2,969 568 498 -1,064 -886 2009 2,405 1,329 -498 3,236 2,864 372 678 -398 76
Deutsche Postbank AG (DPB)

Efficiency
100% 80% 60% 40% 20% 0% 05 06 07 08 09 Cost/Income ratio (LS) 1.4% 1.7% 1.5% 1.4% 1.3% 66.6% 69.9% 71.3% 83.9% 88.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%
140,280 184,887 202,913 231,282 226,609 52,873 87,182 92,064 105,318 111,043 8,682 3,147 3,546 2,182 1,589 28,953 59,148 64,715 69,370 70,217 78,481 101,316 110,696 117,472 131,988 18,521 20,934 15,161 22,078 22,229 30 59 81 0 1,735 67 53 11 3,675 4,237 5,061 5,207 5,225 5,019 5,251 1.25 0.35 10.0 66.6 59.2 21.7 1.4 1.1 127 8.3 10.7 3.6 1.32 0.43 13.5 69.9 53.3 27.9 1.3 1.0 125 6.6 9.6 2.8 1.16 0.45 16.7 71.3 54.4 28.6 1.2 1.0 126 6.8 9.6 2.6 1.15 -0.41 -17.3 83.9 70.5 87.7 1.2 0.9 130 7.2 10.4 2.2 1.05 0.03 1.5 88.5 74.3 182.3 1.5 1.4 105 7.6 9.2 2.3
Cost/Assets ratio (RS)

1.5% 1.0% 0.5% 0.0% -0.5% 05 06 Net interest margin 07 08 Credit costs 09 RoA

200% 150% 100% 50% 0% 05 06 07 08 09 Cust. deposits to loans Wholesale funding % of total funding 40% 20% 0% 60%
8,000 6,000 4,000 2,000 0 Q1 08 Q1 09 Q1 10 Covered bonds (mn) Restricted assets (mn) Over-collateralisation (x) 2,777 1,760 1.58x 5,622 4,878 1.15x 1.17x 7,094 6,041 2.0 1.5 1.0 0.5 0.0
Capital ratios (%)

12 9 6 3 0 05 06 Tier 1 ratio 07 08 Total capital ratio 09 8.3 6.6 6.8 7.2 7.6 10.7 9.6 9.6 10.4 9.2
Mortgage pool breakdown by loan type, Q1 10

Single Family 50% MultiFamily 8% Other 0.1%
Mortgage pool geographical breakdown, YE 09

Berlin 4.9% Western Germany 78.9% Eastern Germany 16.2%
Apartments 42%
10 June 2010
489
Dexia Kommunalbank Deutschland AG (DEXGRP)

Description
% Index 0.186 % Index 0.077 Total assets 47bn LT senior unsecured Covered bond rating* Outlook Discontinuity factor** Collateral score**
Fritz Engelhard
Moodys NR NR NR S&P NR -/AAA Stable Fitch NR NR NR -
Ratings table
With total assets of 47bn at YE 09, Dexia Kommunalbank Deutschland AG is a medium-sized Pfandbriefbank. In 1998, it discontinued its mortgage business and public sector lending became the banks sole activity. On 1 October 2003, Dexia Crdit Local (DCL: AA/Aa1/AA+), Paris, acquired the 49.52% shareholding from the Dr Schuppli Group that it did not already own. Since then, the bank has been wholly owned by DCL. On 8 February 2006, the banks name was changed from Dexia Hypothekenbank Berlin, to underline that it focuses purely on public sector lending. On 14 November 2008, DCL presented a transformation plan, which includes a run-off of bond portfolios, discontinuation of proprietary trading and a geographical focus of public sector lending activities in France, Belgium, Luxembourg, Italy, Spain and Portugal. In a further announcement on 30 January 2009, it has been clarified that Pfandbrief business will be maintained purely as a secured funding platform without any commercial development.
Risk weighting
Strengths
A medium-sized Pfandbrief issuer: With a total volume of 35bn of outstanding public sector Pfandbriefe Dexia Kommunalbank is a medium-sized issuer in this asset class. Thus, the bank benefits from systemic support for the Pfandbrief product and from the overall promise of the German government, ie, if the functioning of the Pfandbrief market is hampered, the government will take short-term measures to ensure payments on Pfandbriefe. Asset quality: Public sector loans account for 98% of total loans as at end-December 2009 and 69% of total assets, with the balance of the loan portfolio made up of mortgage loans. As at end-December 2009, assets held as cover for Dexia Koomunalbanks public sector Pfandbriefe were mainly (82%) rated AAA or AA. Geographically, assets in the cover fund are predominantly German (74%), with 6% from Austria. Interest rate risk management: Interest rate risk is managed on the basis of a value-at-risk (VAR) model, with a confidence level of 99% and a holding period of 10 days. In 2009, the average VAR was 1.1mn, or 0.4% of average equity, and the maximum VAR stood at 2.7mn, or 0.9% of average equity. Over-collateralisation: Dexia Kommunalbanks public sector Pfandbriefe feature a good level of over-collateralisation. At YE 09, over-collateralisation stood at 5.1% on a nominal basis and 9.0% on a present value basis.
Weaknesses
Fall-out from financial market crisis: As of 31 December 2009, Dexia Kommunalbank dedicated an amount of 14bn or 76% of its debt securities holdings to its fixed assets account. The reported non-realised loss on the portfolio was 472mn, or 143% of total equity. As the spread environment remains challenging, the securities portfolio remains exposed to mark-tomarket swings. Furthermore, in FY 09 the banks net interest income decreased substantially on the back of charges for derivative replacement trades triggered by the Lehman bankruptcy, as well as the closing of derivatives with a negative present value. Strategic orientation: Within its strategy, Dexia Group intends to use its Pfandbriefbank as a pure funding entity. As Germany is not part of the groups business focus, the geographical composition of the cover pool is subject to substantial changes. In the course of 2009, exposure to Germany decreased by 2.7bn, while exposure to Italy and Spain increased by more than 1bn. Funding profile: Dexia Kommunalbank is almost wholly reliant on wholesale funding for its operations, using secured and unsecured bonds to fund its long-term assets. This is somewhat mitigated by the fact that the balance sheet is characterised by a high proportion of central bank repo eligible assets. Public sector Pfandbrief ALM: Since the bank started reporting on the maturity structure of its Pfandbrief programme, according to article 28 Pfandbrief Act, the public sector Pfandbrief programme had an average 2.1bn shortfall in the up-to-1y maturity bracket and an average 1.9bn shortfall in the 1-5y maturity bracket. The respective exposure to liquidity risk is somewhat mitigated by the fact that the Pfandbrief Act foresees the possibility of transferring cover assets and Pfandbriefe to another Pfandbrief bank in a stress scenario.
Key points for 2010

Monitor the development of the credit spread environment and its effect on the banks non-realised losses. Watch the development of the relationship between DCL and Dexia Kommunalbank AG, as well as DCLs credit profile.
10 June 2010
490

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgae Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2005 64.0 -6.0 0.0 58.0 15.3 42.7 27.3 23.8 17.0 39,223 24,503 24,336 35 10,387 29,785 29,311 17 291 0.05 5.9 26.4 110.3 64.0 na na na na 14.8 0.7 2006 67.0 -4.0 0.0 63.0 19.0 44.0 23.6 31.1 19.0 45,693 28,969 28,757 35 14,127 36,281 35,873 3 296 0.04 6.5 30.2 106.3 53.5 na na na na 14.5 0.6 2007 71.7 -3.7 0.0 68.5 18.4 50.1 33.4 17.0 10.2 46,215 32,632 32,216 135 15,707 36,416 35,989 0 295 0.02 3.4 26.8 104.7 66.5 na na na na 15.1 0.6 2008 80.5 -0.6 0.0 80.4 20.1 60.3 54.7 3.0 0.4 48,969 33,235 32,744 121 16,171 37,682 37,306 0 291 0.00 0.1 25.0 100.2 90.6 na na na na 16.4 0.6
Dexia Kommunalbank Deutschland AG (DEXGRP)

2009 45.2 -1.4 0.0 43.8 16.4 27.4 20.3 5.4 0.6 47,291 33,404 32,848 150 17,014 35,485 35,165 0 331 0.00 0.2 37.5 103.2 74.0 na na na na 18.4 0.7
0.3% 0.2% 0.2% 0.1% 0.1% 0.0% 00 01 02 03 04 05 06 07 08 09 RoA Net interest margin Credit costs
Securities portfolio (18.3bn) by type of counterparty, YE 09
Other issuers 48%
Public Sector 52%

20 15 10 5 0 02 03 04 05 06 07 08 09 Bookvalue of securities in fixed assets account in % of total assets (RS) bn 40% 30% 20% 10% 0%

50 40 30 20 10 0 bn OC (x) 1.15 1.10 1.05 1.00 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) 06 07 08 09 Covered bonds (bn)
Rating split public sector cover pool, YE 09

A+ - ABBB 12% 5% NR 1% AA+ - AA61% AAA 21%
ALM public sector

10 5 0 -5 -10 05 06 Net nom. OC up to 1Y (P) Net nom. OC 5Y to 10Y (P) 07 08 09 Net nom. OC 1Y to 5Y (P) Net nom. OC >10Y (P) bn
Geographical split public sector cover pool, YE 09

Austria 6% Germany 74% Other 10%
France Greece 1% 2% Spain 2%
Italy 5%
10 June 2010
491
Dsseldorfer Hypothekenbank AG (DUSHYP)

Description
% Index
0.030
Fritz Engelhard
Ratings table
Moodys
LT senior unsecured Covered bond rating * Outlook Discontinuity factor* Collateral score* NR NR/NR -
% Index
NA
Total assets
24bn
S&P
NR NR/AAA -
Fitch
ANR/AAA WN - / 6.1 -
With total assets of 24.2bn at year-end 2009, Dsseldorfer Hypothekenbank AG (DUSHYP) is a relatively small Pfandbriefbank. Since its inception (founded by the Schuppli family in 1997), the bank has focused on public sector lending. In 2002, it experienced troubles in its non-Pfandbrief business, given its exposure to subinvestment grade sovereigns. In 2003, DUSHYP started to enhance its mortgage lending activities. Here, the focus has been strongly on the commercial property lending business, which made up 86% of total property lending as of YE 09. On 22 April 2008, the bank was acquired by the German deposit guarantee fund. According to a statement by the Association of German Banks, this action was taken to help overcome difficulties DUSHYP encountered as a result of the strained market environment. In February 2009, DUSHYP announced that it is in discussions with SoFFin to access the German financial markets stabilisation scheme. On 12 March 2009, SoFFin agreed on a 2.5bn guarantee for the issuance of GGBs.
Note: *Mortgage Pfandbriefe/Public sector Pfandbriefe, in %
Risk weighting
Strengths
Institutional support: Although it is a relatively small independent Pfandbriefbank (total volume of 11bn of outstanding mortgage and public-sector Pfandbriefe), DUSHYP benefits from systemic support from the German banking community for the Pfandbrief product and from the overall promise of the German government ie, if the functioning of the Pfandbrief market is hampered, the government would take short-term measures to ensure payments on Pfandbriefe. Systemic support is also highlighted by the fact that in 2009, the bank received a total of 1.57bn of private sector support, of which 1,070mn came from the German deposit insurance scheme and a further 500mn from a consortium of private banks. Restructuring: DUSHYP kicked off a restructuring plan in Q4 09. It includes the further development of the banks core real estate business, the reduction of capital market activities, and the maintenance of the banks slim cost and organisational structure. We also note that asset-liability mismatches within the banks public sector Pfandbrief business were reduced, which is not only positive in case of potential wind-down, but also helps the banks saving costs for maintaining additional liquidity.
Over-collateralisation: As of YE 09, the banks public sector Pfandbriefe benefitted from 8% over-collateralisation on a nominal basis and 7.4% over-collateralisation on a present value basis.
Weaknesses
Uncertainty regarding future ownership: The Association of German Banks regards the takeover of DUSHYP as an interim solution. Thus, the bank will probably be transferred to another party. However, as many other Pfandbriefbanks currently suffer from the fallout of the financial market crisis, the number of potential buyers is limited. On 12 March 2010, when presenting its annual results, the banks management indicated that it expects a clarification of this issue in the course of H1 10. It also highlighted that it expects the new owners to inject fresh capital and indicated a target level of 8% for the banks core Tier 1 ratio. Credit spread risk: As of 31 December 2009, DUSHYP held 13.2bn, or 98.5%, of its debt securities holdings in the fixed assets account. The reported net non-realised loss on the portfolio amounts to 382mn, or 124% of total equity. Ongoing spread volatility exposes the bank to potential write-offs. As of January 2010, total public sector exposure to Greece amounted to 422mn, or 137% of the banks equity. Reliance on wholesale funding: DUSHYP is almost wholly reliant on wholesale funding for its operations. This is mitigated somewhat by the fact that the bank owns a rather large portfolio of repo eligible assets, which enables it to make strong use of secured funding.
Key points for 2010

Monitor the evolution of the banks ownership. Track the development of the credit spread environment and its effect on the banks bottom-line results.
10 June 2010
492

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Risk provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2005 42 0 0 42 9 32 6 26 18 18,639 11,614 10,392 1,221 1,218 15,043 13,862 828 220 0.10 8.6 22.2 100.8 17.9 na na na 8.0 13.0 1.2 2006 49 1 1 50 15 35 6 30 22 25,360 14,707 13,310 1,367 2,028 16,621 15,350 846 307 0.10 8.4 30.2 96.9 16.2 na na na 7.0 10.0 1.2 2007 42 1 -2 40 15 25 25 0 0 26,719 14,284 12,785 1,435 2,410 16,698 15,565 790 349 0.00 0.0 38.4 104.9 2008 27 1 0 29 14 15 216 -215 -215 2009 53 -14 0 38 27 12 12 2 2
Dsseldorfer Hypothekenbank AG (DUSHYP)

Securities booked under fixed assets, YE 09: 13.2bn
12 10 8 6 4 2 0 bn 60% 40% 20% 0% 03 04 05 06 07 08 09 Bookvalue of securities in fixed assets account in % of total assets (RS)
Capital ratios (%)

15 10 9.0 5 0 03 04 05 Tier 1 ratio 06 07 08 Total capital ratio 09 8.0 8.0 7.0 7.5 8.6 12.0 13.0 11.0 10.0 10.2 10.6 9.0 7.4
24,466 24,170 12,806 10,975 11,196 9,480 1,573 1,469 2,309 2,120 13,546 13,377 12,520 9,917 900 854 307 307 -0.84 -65.5 47.8 95.2 0.01 0.5 69.6 137.4 103.2 na na na 7.4 9.0 1.3
Over-collateralisation mortgage
1.5 1.0 0.5 0.0 1.3 1.2 1.1 1.0 0.9 02 03 04 05 06 07 08 09 Restricted assets (bn) Over-collateralisation (x) Covered bonds (bn)
99.3 1443.5 na na na na na na 7.5 10.2 1.3 8.6 10.6 1.3

20 16 12 8 4 0 02 03 04 05 06 07 08 09 Restricted assets (bn) Over-collateralisation (x) 1.00 Covered bonds (bn) 1.10 1.05 1.15
Rating public sector,YE 09

BB 1% BBB 14% AA 37% NR 9% AAA 17%
A 22%
ALM public sector

10 5 0 -5 -10 Mar 06 Dec 06 Sep 07 Jun 08 Mar 09 Dec 09
Geographical split public sector, YE 09

Austria 15% Spain Italy 6% 5% Greece 3% Portugal 2% Other 17%
Net nom. OC up to 1Y (P) Net nom. OC 5Y to 10Y (P)

10 June 2010
Net nom. OC 1Y to 5Y (P) Net nom. OC >10Y (P)
Germany 52%
493
Eurohypo AG (EURHYP)
Description
% Index
0.461
Fritz Engelhard
Ratings table
Total assets
256bn LT senior unsecured Covered bond rating* Outlook Discontinuity factor** Collateral score**
% Index
NA
Moodys
A1 Aaa/Aaa Negative -
S&P
AAAA/AAA Negative -
Fitch
A AAA/AAA Negative 21.8/6.6 -
Eurohypo is Germanys largest Pfandbrief bank, with 109bn of total outstanding Pfandbriefe as at 31 December 2009. Its oldest legal predecessors, Deutsche Hypothekenbank and Frankfurt Hypothekenbank, started issuing Pfandbriefe in 1862. Following a squeeze-out of minority shareholders in 2007, the bank is fully owned by Commerzbank AG. Eurohypo concentrates on two segments: real estate and public finance. In January 2008, the merger of Hypothekenbank in Essen AG (EssenHyp) with Eurohypo took effect. It was driven by Commerzbanks intention to bundle its Pfandbrief business into a single legal unit. During 2008, the banks management was reshuffled. New managements stated mission is to downsize and reposition the banks property and public sector businesses. Under the terms of the state aid approval Commerzbank AG received from the European Comission in May 2009, Eurhypo needs to be sold until 2014 years.
Risk weighting
Strengths
Systemic support: Being the largest Pfandbrief issuer, Eurohypo benefits from the overall promise of the German government, ie, if the functioning of the Pfandbrief market is hampered, the government would take short-term measures to ensure payments on Pfandbriefe. Over-collateralisation: Eurohypos Pfandbriefe feature decent over-collateralisation. At YE 08, nominal over-collateralisation stood at 5% for public sector Pfandbriefe and 11% for mortgage Pfandbriefe. Modest market risk: The banks exposure to market risk is assessed and managed using Commerzbank Groups Value-atRisk (VaR) methodology, which assumes a one-day holding period and a 97.5% confidence interval. At YE 09, the maximum VaR was 74mn, or 1.3% of average equity, down from 185mn, or 3.3% of average equity in 2008. Credit spread exposures from positions classified as loans and receivable were not subject to this limit from May 2009 onwards. Decent business franchise: Eurohypo has a decent business franchise in its core markets and offers an array of products ranging from traditional fixed-interest loans to structured financing and REIB. The bank has been increasingly able to build on this franchise, as reflected in the decent contribution of net fees and commission income to operating income (FY 09: 12%).
Weaknesses
Uncertainty regarding ownership: On 7 May 2009, the agreement between the European Commission and the German government with respect to the state aid provided to Commerzbank AG was published on the Commissions website1. The disposal of its Pfandbriefbank subsidiary, Eurohypo AG is one of the key elements. According to Commerzbank AG, the sale must be concluded within the next five years and the target price is the banks book value of about 4.0bn. Commerzbanks management underlined that an integration into Hypo Real Estate would not be on the agenda, as there would be no strong advantage gained in combining the two large entities. Thus, the sale to another domestic or international bank as well as an IPO seem to be more likely. The discussion surrounding Eurohypos ownership exposes investors to significant event risk. Credit spread risk: As at 31 December 2009, Eurohypo allocated 74.2bn, or 92%, of its 80.7bn debt securities holdings to the loans and receivables account. The re-categorisation helped the bank avoid realising a loss of 1,309mn, or 23% of total equity. The banks non-public sector debt securities holdings as of YE 09 made up 38bn, or 47% (YE 08: 45%) of total debt securities. These risk positions expose the bank to potential further losses. Reliance on wholesale funding: Eurohypo relies strongly on wholesale funding: 96% of the banks funding is either from debt securities or inter-bank deposits. Thus, the bank is strongly exposed to refinancing risk. However, this is mitigated by the fact that Eurohypo owns a large portfolio of central bank repo eligible assets and frequently uses secured long-term funding. Exposure to commercial property markets: Market conditions in commercial property markets have become challenging. The economic slowdown in many industrial countries has had a negative impact on tenant quality and it also has put pressure on the achievable rental income, as well as the valuation of underlying properties. This exposes the bank to potential write-offs.
http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/711
Key points for 2010

Monitor the development of the credit spread environment and its impact on the banks performance. Monitor the discussion surrounding the disposal of Eurohypo.
10 June 2010
494

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 1,249 177 98 1,575 547 1,028 360 653 434 2007 1,179 227 -11 1,389 542 847 259 588 355 2008 1,149 251 -810 -84 460 -544 858 -1,409 -1,240 2009 1,288 149 -53 1,236 434 802 1,174 -515 -902
Eurohypo AG (EURHYP)
Capital ratios
15% 10% 5% 0% 01 02 03 04 05 06 07 08 09 Tier 1 ratio Total capital ratio
Debt securities (YE 09: 80.7bn) by type of counterparty

224,332 214,215 291,600 256,061 187,532 167,772 194,708 185,313 109,252 79,717 92,965 72,049 97,432 96,243 94,724 88,100 8,745 12,779 13,283 10,796 136,117 123,905 166,011 134,810 54,230 48,211 86,945 63,710 43,921 39,601 47,241 45,610 6,168 5,572 5,654 5,654 0.19 7.1 34.7 79.3 35.0 na na na 7.2 10.4 2.7 0.16 6.0 39.0 84.9 30.6 na na na 7.4 10.7 2.6 -0.49 -22.1 <0 <0 -157.7 na na na 7.8 11.6 1.9 -0.33 -16.0 35.1 104.2 146.4 na na na 8.6 12.6 2.2
100% 80% 60% 40% 20% 0% 2005 2006 2007 Public Sector 2008 Other 2009 70% 66% 58% 55% 53% 30% 34% 42% 45% 47%
Debt securities (YE 09: 89.5bn) by type of accounting

100% 80% 60% 40% 20% 0% 2008 L&R 2009 AfS 88% 92% 12% 8%

120 104103 96 93 89 85 100 80 78 70 67 67 62 80 55 53 50 47 60 1.07x 40 1.01x 1.05x 1.05x 1.04x 1.05x 20 1.03x 1.04x 0 02 03 04 05 06 07 08 09 Restricted assets (bn) Over-collateralisation (x) 1.10 1.08 1.06 1.04 1.02 1.00
52 53 48 60 54 51 54 48 5245 50 45 48 43 44 46 39 40 1.16x 20 0 1.06x 02 03 04 05 06 07 08 09 Restricted assets (bn) Over-collateralisation (x) 1.12x 1.12x 1.11x 1.12x 1.11x 1.11x 120% 115% 110% 105% 100% Covered bonds (bn)
Covered bonds (bn)
Geographical distribution public sector (YE 09: 67bn)

Other NonDomestic IT, SP, PT, 16% GR, IR 5% USA 4% Austria 5%
Property type mortgage collateral

100% 80% 60% 40% 20% 39% 40% 45% 47% 48% 50% 0% 2002 2003 2004 2005 2006 2007 2008 2009 Commercial Residential 61% 60% 55% 53% 52% 50% 48% 43%
52% 57%
Germany 70%
10 June 2010
495
HSH Nordbank (HSHN)

Description
% Index
0.179
Fritz Engelhard
Ratings table
Total assets
175bn LT senior unsecured Mortgage Pfandbriefe Ship Pfandbriefe Outlook Discontinuity factor*** Collateral score***
% Index
NA
Moodys
* A3 NR Aaa Negative 7.5 Public sector Pfandbriefe Aaa ** Aa1 Aaa NR *
S&P
** AAAAA NR NR Negative * A
Fitch
** AAA AAA NR NR Watch neg -
With total assets of 175bn as at year-end 2009, HSH Nordbank (HSHN) is Germanys fifth-largest Landesbank. HSHN provides ship, real estate, and corporate financing, as well as central banking services to the 20 savings banks in Schleswig-Holstein and Hamburg. It has 4,188 employees. HSHN is owned by the City of Hamburg (43%), the State of Schleswig-Holstein (42.5%), the Savings Banks Association for Schleswig-Holstein (5%) and J.C. Flowers (9.2%). In November 2008, a new CEO was appointed and SoFFin allocated a guarantee volume of 10bn to HSHN. In April 2009, the parliaments of the City of Hamburg and the State of Schleswig-Holstein decided to inject 3.0bn of capital into HSHN and to provide a further 10bn risk shield. Final EU approval of these state aid measures is expected by mid-2010. The bank also received approval to issue 30bn of SoFFIN-guaranteed notes. The volume was reduced to 17bn at end-2009. In January 2008, HSHN launched its inaugural so-called Schiffspfandbrief, ie, a covered bond backed by ships as collateral.
BBB+ NR NR
NR NR
Risk weighting
Strengths
Ownership support and restructuring: HSHN is largely owned by public sector entities. The commitment by the two German states (Hamburg and Schleswig-Holstein) to inject a further 3bn of capital into the institution has led to an increase in public sector ownership and also underlines the support for the entity from regional authorities. The bank has also set up a restructuring unit, to which 77bn of assets were transferred. The combined effect of the capital increase and the risk shelter reflects in an increase of the banks Tier 1 ratio from 5.1% at YE 08 to 10.5% at YE 09. General support mechanism: Like other domestic companies, HSHN benefits from the protection of the German SparkassenFinanzgruppes institutional guarantee system through its membership in the security reserve of the Landesbanken and Girozentralen. Along with the 11 regional Sparkasse support funds and the guarantee reserve of the Landesbausparkassen, this security reserve is one of the 13 security guarantee schemes that together form the joint institutional guarantee system of the German Sparkassen-Finanzgruppe. Pfandbrief over-collateralisation: As at end-March 2010, public-sector Pfandbriefe issued by HSHN benefited from an over-collateralisation of 21% on a nominal basis and 18% on a present value basis. However, the bank increased the weight of its public sector cover pool exposure to Italy, Spain, Portugal and Greece from 4.6% in Q1 09 to 6.8% in Q1 10. Mortgage Pfandbrief investors benefited from an over-collateralisation of 33% on a nominal basis and 36% on a present value basis. Finally, Schiffspfandbrief investors benefited from an overcollateralisation of more than 200% on a nominal basis and on a present value basis.
Weaknesses
Fall-out from financial market stress: The financial market crisis had a strong impact on HSHNs performance. The net losses of 2.8bn in FY 08 and 0.7bn in FY 09 mainly resulted from significant loan-loss provisions. (FY 08: 1.9bn; FY 09: 2.8bn). HSHN has booked 72% of its total 190bn credit risk exposures under loans and receivables (L&R), thus, it is not clear to what extent HSHN is exposed to further write-offs. Ownership support appears strong, but the fees HSHN needs to pay for the respective support schemes and restructuring costs are likely to burden its performance over the next few years. Furthermore, the banks funding was characterised by the fact that it used 8bn of retained SoFFin-guaranteed notes for ECB repo transactions. Exposure to shipping and property markets: With a total exposure of 25bn to ship financing as at YE 09, HSHN is the worlds largest ship financier and, thus, has been exposed to the downturn in the maritime freight market. Furthermore, as of YE 09, more than half of the 27bn mortgage portfolio consisted of commercial loans. Although, these exposures have been partly transferred to the banks restructuring unit, on the back of the difficult environment in these sectors, the respective exposures may lead to further problems. Event risk: While the banks current public sector owners committed to maintain their majority stake at least until end-2013, the bank could be subject to a change of ownership beyond that date. In particular it could be part of a consolidation within the German Landesbank sector. This might have a material impact on the banks risk profile. Yet, in our opinion, given the substantial support mechanisms within the German savings banks finance group (Sparkassen Finanzgruppe), a deterioration of its credit profile is unlikely.
Key points for 2010

Monitor the execution of HSHNs restructuring plan as well as the EUs final decision on state aid measures. Track HSHNs exposure to ship financing and property markets and the impact on bottom-line results.
10 June 2010
496

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which mortgages Customer deposits Debt funding of which PS Pfandbriefe of which mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) Llps/Pre-prov inc Llrs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 1,356 424 141 2,075 862 1,213 237 976 460 2007 1,601 326 -576 1,500 984 516 -15 129 275 2008 2,051 270 -1,127 1,028 899 129 1,888 -2,968 -2,809 2009 2,121 211 568 2,930 830 2,100 2,794 -1,261 -670
HSH Nordbank (HSHN)

Current ownership
Savings Schleswig Banks Holstein Schleswig 10% Holstein 5% J.C. Flowers 9% Hamburg 11%
Finanzfonds (Hamburg, Schlesw. Hol.) 65%
189,382 204,827 208,370 174,533 100,993 104,064 117,610 110,557 12,197 9,914 10,585 9,809 30,528 33,665 31,603 26,661 46,351 50,394 52,469 49,803 66,371 79,525 67,934 62,005 10,529 8,651 9,200 8,779 4,930 1,282 2,447 4,235 7,173 4,368 2,005 4,491 0.25 6.5 41.5 65.3 19.5 na na na 6.8 9.9 3.8 0.14 4.8 65.6 106.7 -2.9 na na na 6.2 10.4 2.1 -1.36 -88.2 87.5 199.5 1463.6 na na na 5.1 8.3 1.0 -0.35 -20.6 28.3 72.4 133.0 na na na 10.5 16.1 2.6
Breakdown of L&R credit exposures (YE 09: 137bn)

Financial Assets 12.2% Claims against Clients 76.6% Other Assets 0.3% Claims against Financial Institutions 10.9%
Capital ratios (in%)

20 15 10 5 9.9 6.8 10.4 6.2 2007 Tier 1 ratio 8.3 5.1 2008 2009 Total capital ratio 10.5 16.1
0 2006

25 20 15 10 5 0 03 04 05 06 Restricted assets (bn) Over-collateralisation (x) 1.24 1.20 1.16 1.12 1.08 1.04 1.00 07 08 09 Covered bonds (bn)
20 17 14 11 8 5 2 -1 03 04 05 06 Restricted assets (bn) Over-collateralisation (x) 07 08 09 Covered bonds (bn) 2.0 1.8 1.6 1.4 1.2 1.0
Geographical breakdown public sector, Q1 09
Property type mortgage, Q1 10

Residential 28%
Germany 77%
AT,CH,BE 13% IT,SP,PT,GR 7% Other 3%
Commercial 72%
10 June 2010
497
Landesbank Baden-Wrttemberg (LBBW)

Description
% Index
0.166
Fritz Engelhard
Ratings table
Moodys
* LT senior unsecured Mortgage Pfandbriefe Outlook Discontinuity factor*** Collateral score
***
% Index
0.011
Total assets
412bn
S&P
* ANR NR ** AA+ AAA AA+ *
Fitch
** AAA AAA NR
** Aaa Aaa Aaa -
With total assets of 411.7bn as at year-end 2009, down 8.1% y/y from 447.7bn at year-end 2006, Landesbank Baden-Wrttemberg (LBBW) is Germanys largest Landesbank, providing banking services through 13,360 employees as at year-end 2009. Shortly after acquiring BW-Bank and Landesbank Rheinland-Pfalz (LRP) in 2005, LBBW implemented a new group structure under which it operates as a universal and international commercial bank, while at the same time being a wholesale bank and the central banking institution for a total of 55 savings banks in Baden-Wuerttemberg. In early 2008, LBBW acquired the troubled Landesbank Sachsen (LBSACH), which was transformed into Sachsen Bank in April, providing banking services to small and medium-sized enterprises (SMEs), as well as wealth management services in Saxony. As a result of this acquisition, LBBW also acts as the central banking institution for the savings banks in the Free State of Saxony. In November 2008, LBBWs owners agreed to inject 5bn of capital into the bank and the state of BadenWrttemberg provided a 12.7bn risk shelter against losses from the banks credit securities portfolio.
Aa1 NR
A+ NR NR
Public sector Pfandbriefe NR
Stable 9.2/5.0
Negative
Stable -/7.4 -
Note: *Non guaranteed **Guaranteed ***In % Mortgage/Public Sector
Risk weighting
Strengths
Support and improved capitalisation: Based on LBBWs important role in the regional economy, we believe support from the state of Baden-Wuerttemberg is probable, although within the limits set by the European Commission. In addition to the state, which owns 37.8%, LBBWs owners comprise the Savings Bank Association of Baden-Wuerttemberg (40.5%), the City of Stuttgart (18.9%) and L-Bank (2.7%). Support from the banks owners has been underlined by the commitment to provide 5bn of fresh capital as well as the 12.7bn risk shelter. We also note that LBBW has agreed to a number of strategic measures, including the reduction of balance sheet by 40% and cost reductions of 700mn until 2013. Futhermore, a 13.3% reduction of risk-weighted assets combined with a 23.8% increase in Tier capital helped improve the banks capitalisation. Diversified business profile: In addition to providing central banking services to savings banks, LBBW also focuses on retail banking and corporate clients through its subsidiary, BW-Bank, and operates as a savings bank to the City of Stuttgart, where LBBW has a branch network of 212 retail offices. Furthermore, LBBW positioned its subsidiaries, Rhineland Palatinate Bank and Saxony Bank, as wholesale banks for SME in the respective German states. As a result of this structure, we believe LBBW is in a sound position to diversify its income structure and, thus, to differentiate itself from most other German Landesbanks. Pfandbrief over-collateralisation: As at end-March 2010, public-sector Pfandbriefe issued by LBBW benefited from an over-collateralisation of 23.0% on a nominal basis and 22% on a present value basis. At the same time, its mortgage Pfandbrief investors benefited from an over-collateralisation of about 200% on a nominal basis and on a present value basis.
Weaknesses
Weak underlying performance and legacy portfolio: The financial market crisis continues to have a noticeable effect on LBBWs bottom-line performance. In FY 09, LBBW reported a net loss of 1.5bn following a net loss of 2.1bn in FY 08. While net interest income as well as the banks trading income recovered strongly, the bottom-line result was burdened by 1.5bn of risk provisions (FY 08: 0.9bn) revaluations of structured credit exposures (492mn) and increasing operating expenses. Loss provisions include a further 200mn (FY 08: 265mn) write-off on Icelandic exposures 260mn. As the capital markets environment remains challenging, further write-offs from the banks high risk exposures are possible. Exposure to cyclical downturn: Challenging economic conditions expose LBBWs significant corporate and real estate exposures, which totalled 150bn at YE 09, to an increase in NPLs and writedowns. This is reflected by an increase of the groups NPL ratio from 4.5% at YE 08 to 4.9% at YE 09. Charges from state aid measures and restructuring: On 15 December 2009, the EU approved the state aid measures for LBBW. The respective measures triggered a number of charges including 519mn of write-off on goodwill for the stake in Sachsen LB, 368mn restructuring charges and 157mn of fees for the provided guarantee commitments. In particular the fees that LBBW needs to pay for the respective support schemes are likely to burden LBBWs bottom-line performance over the next few years.
Key points for 2010

Monitor further M&A activity in the German Landesbank sector. Track LBBWs high risk exposures and their impact on bottom-line results.
10 June 2010
498

mn 2006 2007 Income statement summary 2,057 2,127 Net interest income 529 584 Net fees & com's 190 -656 Trading income 3,304 2,639 Operating income 1,457 1,650 Operating expenses 1,848 989 Pre-provision income Provisions 163 186 Pre-tax profit 1,684 335 Net income 828 326 Balance sheet summary 428,253 443,424 Total assets Customer financing 117,601 146,394 98,578 83,156 of which public sector 16,045 10,389 of which mortgages 91,815 96,451 Customer deposits Debt funding 156,634 138,339 of which PS Pfandbriefe 79,919 70,897 of which mortgage Pfandbriefe 7,134 1,609 Total equity 11,887 10,420 Profitability (%) Return on assets 0.40 0.15 7.2 2.9 Return on equity Cost/Income ratio 44.1 62.5 Net int inc/Op inc 62.3 80.6 Asset quality (%) LLPs/Pre-prov inc 8.8 18.8 LLRs/Gross loans 1.8 1.3 Prob loans/Gr loans 4.1 2.7 44.3 49.1 Coverage ratio Capital adequacy (%) Tier 1 ratio 7.4% 6.5% Total capital ratio 11.0% 9.7% Equity/Assets ratio 2.8 2.3 2008 2,294 549 -2,108 735 1,789 -1,054 883 -2,662 -2,112 447,738 149,854 87,685 12,624 103,232 134,495 72,132 2,829 6,060 -0.95 -25.6 243.4 312.1 -83.8 1.5 4.5 32.9 6.9% 10.1% 1.4 2009 2,778 657 748 4,183 1,909 2,274 1,527 -1,214 -1,482 411,694 149,633 72,706 33,277 105,212 110,725 59,200 4,162 10,506 -0.69 -17.9 45.6 66.4 67.2 2.2 4.9 44.0 9.8% 13.3% 2.6
Landesbank Baden-Wrttemberg (LBBW)

Current ownership, YE 09
State of BW 38%
City of Stuttgart 19% L-Bank 3%
Savings Assoc. BW 40%
Capital ratios
14% 12% 10% 8% 6% 4% 03 04 05 06 07 08 09 Tier 1 ratio Total capital ratio
Credit risk exposure (YE 09: 512bn) by counterparty

Corporates 25% Commercial Real Estate 5% Credit Institutions 39% Public Sector 16% Retail 4% Financial Services 11%

120 100 80 60 40 20 0 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) 06 07 08 09 Covered bonds (bn) 1.5 1.4 1.3 1.2 1.1 1.0
12 10 8 6 4 2 0 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) 06 07 08 09 Covered bonds (bn) 3.0 2.6 2.2 1.8 1.4 1.0

Switzerland 1% Italy 1% Germany 95% Others 2% Greece 1%

Other 24% Appartment 13% Single Family 17% Multi Family 26%
Shopping 7% Office 13%
10 June 2010
499
Landesbank Berlin (LBBER)

Description
% Index
0.063
Fritz Engelhard
Ratings table
Total assets
144bn LT senior unsecured Mortgage Pfandbriefe Outlook Discontinuity factor*** Collateral score***
% Index
0.014
Moodys
* A1 NR 13.1/4.2 Public sector Pfandbriefe Aaa ** Aa1 Aaa Aaa *
S&P
** NR NR NR *
Fitch
** AAA AAA NR -
With total assets of 144bn at year-end 2009, Landesbank Berlin AG (LBBER) is Germanys largest savings bank, providing universal banking services, with a clear focus on private and corporate banking, capital markets services and real estate financing. LBBER was created in 1990 from the merger between West and East Berlin savings banks. In 1994, LBBER became part of Bankgesellschaft Berlin and was the only German Landesbank to be part of a private sector banking group. In June 2007, the City State of Berlin decided to sell its 80.95% stake in Landesbank Berlin Holding AG to the acquisition company of the Association of German Savings Banks (DSGV), which now owns 98.66% of the bank; the remaining 1.34% is free float. While LBBER has a stable ownership structure, we believe it might still be part of a broader reshaping of the German Landesbank landscape, as pressure from the federal government increases to accelerate the consolidation of the sector.
NR NR NR
AAAAA NR
Stable
Stable
Risk weighting
Strengths
Sound market position: Owing to its Berliner Sparkasse franchise, LBBER enjoys sound market share in its core retail market. As at year-end 2009, Berliner Sparkasse had 11.9bn (YE 08: 12.4bn) of retail deposits. In order to improve its profitability, the bank intends to strengthen its cross-selling capacities, in particular with regard to its securities brokerage and consumer credit business. In addition, LBBER aims to expand its direct banking activities through its netbank subsidiary. Support scenarios: Similarly to other German players, LBBER is a member of the Sparkassen-Finanzgruppe and, as such, is supported by the Sparkassen Haftungsverbund, a support mechanism set up to guarantee solvency and provide liquidity in the event of difficulties. Over-collateralisation: LBBERs Pfandbriefe feature very high over-collateralisation. On 31 March 2010, for public sector Pfandbriefe, over-collateralisation stood at a nominal 51% and 54% on a present value basis. For mortgage Pfandbriefe overcollateralisation stood at a nominal 25% and 27% on a present value basis.
Weaknesses
Weak underlying performance and legacy portfolio: Although LBBERs bottom-line result recovered from last year on the back of reduced write-offs from financial assets, legacy exposure to Icelandic banks led to another 85mn write-off in FY 09 (FY 08: 293mn). Furthermore, the 5% increase of operating expenses and the doubling of risk provisions weighed on LBBERs bottomline results. As of YE 09 the bank kept on holding 65% (YE 08: 85%) of its 48.7bn (YE 08: 50.5bn) of financial assets under the loans and receivable account. As the capital markets environment remains challenging, further losses from the banks high risk exposures are possible. Exposure to cyclical downturn: Challenging economic conditions expose LBBERs significant corporate and real estate exposures, which totalled 55bn at YE 09, to an increase in NPLs and writedowns. This is reflected by an increase in the groups NPL ratio from 7.7% at YE 08, to 8.7% at YE 09. Geographical concentration: LBBERs loan portfolio remains mostly focused on the Berlin area and the East German states, which at YE 09 together accounted for 49% of the entire loan book (YE 08: 52%). Still, this concentration is gradually being reduced as LBBER undertakes geographical diversification.
Key points for 2010

Monitor further M&A activity in the German Landesbank sector and potential implications for LBBER. Track LBBERs legacy and commercial real estate exposures and their impact on bottom-line results.
10 June 2010
500

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pr e-provision income Pr ovisions Pr e-tax profit Net income Balance sheet summary Total ass ets Customer financing of which public sector of which mortgages Customer deposits Debt funding of which PS Pfandbriefe of which mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income r atio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Pr ob loans/Gr loans Cover age ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 850 368 80 1,866 1115 751 123 780 685 2007 815 297 -45 1,067 898 169 -68 306 230 2008 1,247 302 -344 1,205 878 327 63 9 29 2009 862 262 478 1,602 923 679 185 339 272
Landesbank Berlin (LBBER)

Net interest income, credit cost and RoA
1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% -0.2% 00 01 02 03 04 05 06 07 08 09 RoA Net interest margin Credit costs
141,619 142,163 145,388 143,835 50,898 47,026 47,462 48,592 21,388 15,186 13,442 14,944 14,885 14,545 15,248 15,942 28,367 29,552 32,720 35,129 35,686 34,184 32,272 30,501 14,588 15,291 13,838 11,534 7,726 6,625 7,887 7,893 2,620 2,831 1,945 2,712 0.48 30.6 59.8 45.6 16.4 3.5 na na 7.2 10.6 5.1 0.16 8.4 84.2 76.4 -40.2 2.9 10.5 30.4 6.7 10.2 6.0 0.02 1.2 72.9 103.5 19.3 2.6 7.7 45.1 7.8 11.0 4.1 0.19 11.7 57.6 53.8 27.2 2.2 8.7 36.7 8.5 11.8 5.6
Capital ratios (%)

14 12 11.1 10 8 6 8.8 7.5 8.1 7.8 8.5 11.1 11.6 10.6 11.0 11.8
10.2
7.2 2006
6.7
4 2003
2004 2005 Tier 1 ratio
2007 2008 2009 Total capital ratio
Credit risk exposure (YE 09: 119.2bn) by counterparty

Other 12% Retail 4% Corporate 4%
Capital Markets 38%
Real Estate 42%

25 20 15 10 5 0 01 02 03 04 05 06 Restricted assets Over-collateralisation 07 08 09 Covered bonds bn 1.8 1.6 1.4 1.2 1.0
10 8 6 4 2 0 01 02 03 04 05 06 Restricted assets Over-collateralisation 07 08 09 Covered bonds bn 2.2 2.0 1.8 1.6 1.4 1.2 1.0

Eastern Europe 3% Other 2%
Property type mortgage collateral,Q1 10
Germany 95%
Residential 38%
Commercial 62%
10 June 2010
501
Landesbank Hessen-Thringen (HESLAN)

Description
% Index
0.045
Fritz Engelhard
Ratings table
Moodys
* LT senior unsecured Public sector Pfandbriefe Mortgage Pfandbriefe Outlook Discontinuity factor*** Collateral score*** Aa2 Aaa Aaa - / 5.2 ** Aaa Aaa Aaa * A AAA NR -
% Index
0.018
Total assets
149bn
S&P
** AA AAA AA *
Fitch
** AAA AAA AAA
With total assets of 149bn at year-end 2009, Landesbank HessenThringen (HESLAN) is one of Germanys medium-sized landesbanks, providing wholesale commercial banking services in, and acting as principal bank to, the states of Hesse and Thuringia. Furthermore, it operates as the central banking institution to around 50 regional savings banks and acts as a public promotional and development bank for the respective states. Through the acquisition of Frankfurter Sparkasse in 2005, Germanys fourth-largest savings bank and regional market leader in the Rhine-Main area, HESLAN also provides retail banking services. 85% of HESLAN is owned by the savings bank association of Hesse and Thuringia, another 10% is owned by the State of Hesse and the remaining 5% is owned by the State of Thuringia. HESLAN neither participated in the SoFFin guarantee scheme nor in the SoFFin capitalisation scheme.
A+ AAA AAA
Stable
Negative
Stable 11.7/7.1 -
Risk weighting
Strengths
Diversified operations: HESLANs group structure rests on a three-pronged strategy: in addition to its role as a central bank for the savings banks in Hesse and Thuringia, HESLAN provides wholesale and investment banking services, private and SME banking, as well as public sector and infrastructure lending. Furthermore, following the acquisition of Frankfurter Sparkasse in 2005, HESLAN also benefits from its retail banking operations, particularly in the larger Rhine-Main area, where it is (regional) market leader. Support mechanism: Like other domestic companies, HESLAN benefits from the protection of the German SparkassenFinanzgruppes institutional guarantee system through its membership in the security reserve of the Landesbanken and Girozentralen. Along with the 11 regional Sparkasse support funds and the guarantee reserve of the Landesbausparkassen, this security reserve is one of the 13 security guarantee schemes that together form the joint institutional guarantee system of the German Sparkassen-Finanzgruppe. Pfandbrief over-collateralisation: As at end-March 2010, public-sector Pfandbriefe issued by HESLAN benefited from an over-collateralisation of 39% on a nominal basis and 37% on a present value basis. At the same time, its mortgage Pfandbrief investors benefited from an over-collateralisation of more than 55% on a nominal basis and on a present value basis.
Weaknesses
Event risk: Ongoing ownership discussions across German public sector banks might change the risk profile of the bank. In particular, acquisitions might induce landesbanks to increase their respective debt financing. Yet, in our opinion, given the substantial support mechanisms within the German savings banks finance group (Sparkassen Finanzgruppe), a deterioration of the credit profile is unlikely. Exposure to commercial real estate: HESLAN runs a 36.7bn (YE 09) international real estate financing portfolio, of which 82% (29.9bn) was backed by commercial property. The economic slowdown in many industrial countries has had a negative impact on tenant quality and has put pressure on the achievable rental income, as well as the valuation of underlying properties. This exposes the bank to potential write-offs. Modest public-sector commitment: Compared with the other German landesbanks profiled in this section, the proportion of public-sector ownership in HESLAN is low, with a stake of 15% held by the states of Hesse (10%) and Thuringia (5%). Consequently, support from the states in the case of financial distress could be lower than for other landesbanks, for which the proportion of public ownership is higher.
Key points for 2010

Monitor further M&A activity in the German Landesbank sector. Track HESLANs exposure to property markets and the impact on bottom-line results.
10 June 2010
502

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which mortgages Customer deposits Debt funding of which PS Pfandbriefe of which mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 676 214 68 1,295 880 415 36 342 250 2007 638 78 -69 886 541 345 67 248 203 2008 789 127 -216 985 595 390 11 170 114 2009 1,112 100 -41 1,344 599 745 12 132 69
Landesbank Hessen-Thringen (HESLAN)

Capital ratio
10% 9% 8% 7% 6% 5% 4% 01 02 03 04 05 06 07 Tier 1 capital ratio 08 09
Securities portfolio (YE 09: 52bn) by counterparty

167,677 158,746 162,081 148,895 77,802 77,727 84,631 79,577 16,498 16,127 17,740 16,483 9,373 7,131 8,735 9,538 48,086 34,048 42,291 38,369 44,741 42,728 46,473 49,919 17,539 16,926 17,295 13,933 4,846 4,299 5,091 5,546 4,929 5,233 5,304 5,375 0.15 5.3 68.0 52.2 8.6 na na na 6.9 11.1 2.9 0.12 4.0 61.1 72.0 19.3 na na na 6.5 11.4 3.3 0.07 2.2 60.4 80.1 2.8 na na na 8.3 14.1 3.3 0.04 1.3 44.6 82.8 1.6 na na na 8.8 13.5 3.6
ABS 4% Financial Institutions 84% Govt. Bonds / Agencies 11% Corporates 1%

100% 80% 60% 40% 20% 0% 02 03 04 05 06 07 08 09 Wholesale funding % of total funding Cust. deposits to loans

50 2.23x 2.4 2.0 1.24x 1.16x 1.6 1.10x 1.15x 21.4 19.6 19.3 19.5 19.9 21.1 18.2 17.5 16.9 17.3 13.9 1.2 14.4 0.8 0.4 0.0 03 04 05 06 07 08 09 Restricted assets (bn) Covered bonds (bn) Over-collateralisation (x) 1.59x 31.6 1.41x
12 10 8 6 4 2 0 1.67x 7.3 1.04x 5.1 1.43x 4.6 4.8 1.23x 1.40x 4.3 1.45x 1.51x 5.1 5.5 1.8 1.6 1.4 1.2 1.0 0.8 03 04 05 06 Restricted assets (bn) Over-collateralisation (x) 07 08 09 Covered bonds (bn)
40 32.2 30 20 10 0
Counterparty type public sector collateral, Q1 10

Other 47% Central Govt 4% Regional Authorities 15% Local Authorites 34%
10 June 2010

Residential 20%
Commercial 80%
503
Muenchener Hypothekenbank (MUNHYP)

Description
% Index
0.085
Fritz Engelhard
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor** Collateral score** A1 Aaa /Aaa Stable -/5.2*
% Index
NA
Total assets
36bn
S&P
NR NR/NR -
Fitch
A+ NR/NR Stable -
Established in 1896, MunHyp is the only German mortgage bank that operates under the legal framework of a registered cooperative (eingetragene Genossenschaft). Its share capital is owned by 87,527 co-operative members, made up of individuals as well as banks in the co-operative banking sector. There is no major shareholder. The bank is a member of the co-operative FinanzVerbund (financial association) of the German Volksbanks and Raiffeisenbanks. MunHyp has 12 regional offices in Germany; offices in London (since 2006) and Paris (since 2007) and co-operation partners in Madrid, New York and Vienna. The banks business focus is on domestic residential real estate lending, which it derives from its strong ties with a network of local co-operative banks. On 27 September 2007, negotiations with MunHyp and DGHYP, another Pfandbriefbank, were terminated. According to a press statement issued by MUNHYP, no agreement could be found on key aspects of the planned merger.
Risk weighting
Strengths
Low risk profile: MunHyps risk culture is characterised by its focus on high-quality property and public sector lending, conservative underwriting standards and tightly controlled exposure to market risk. Compared with most of its competitors, the banks performance has been resilient against the stress in the global financial system. Among others, the focus on prudent risk policies is reflected by the fact that the bank virtually halted its new commercial real estate business in FY 09 (+85mn versus +2.3bn FY 08), but continued to expand its residential mortgage business at a regular pace (+1.8bn in FY 09 vs. +1.8bn in FY 08). Member of FinanzVerbund: MunHyps position within the FinanzVerbund (co-operative banking sector association) is aimed at strengthening its franchise by enhancing ties with the co-operative banks in the face of pressures prevalent within the German banking sector. These ties allow it to access 13,625 domestic branches of the FinanzVerbund and act as a major source of MunHyps domestic retail business, where the Volksbanken and Raiffeisenbanken command domestic market shares of 13% in non-bank lending and 17% of retail savings deposits. Its membership also benefits from the Garantiefonds and Garantie-Verbund support mechanism, which has prevented insolvencies of member institutions since it was introduced in 1932. Over-collateralisation: MunHyps Pfandbriefe benefit from decent over-collateralisation. At YE 08, over-collateralisation on a present value basis stood at 7.5% for public sector Pfandbriefe and 21% for mortgage Pfandbriefe.
Weaknesses
Performance remains weak: The banks bottom-line performance is still weak compared with domestic and international peers. After-tax return on equity remained low at 2% in FY 09. On the back of rising administrative costs the banks cost-income ratio increased again above 50% in FY 09. Provisioning needs for loan exposures increased from 19.8mn in FY 08 to 32.4mn in FY 09, which was largely due to specific provisions for the banks 2.6bn US commercial real estate exposures. Capitalisation: Despite the issuance of 100mn of new Tier 1 capital in November 2009, the banks capitalisation remains modest. The Tier 1 ratio, increased only slightly from a rather low 5.6% at YE 08 to 6.5% at YE 09. On the back of its low profitability, the banks internal capital generation capacity remains weak. Credit spread risk: As of 31 December 2009, MunHyp allocated 6.4bn, or 94%, of its debt securities holdings to the fixed assets account. The reported non-realised loss on the portfolio amounted to 175.2mn (YE 08: 172.5mn), or 23% (YE 08: 26%) of total equity. These positions also contain a 60mn exposure to the largest Icelandic energy supplier, which so far has met all scheduled payments. Ongoing credit spread volatility exposes the bank to mark-to-market swings in this portfolio. Business model: In 2009, net non-bank lending of the German cooperative banking sector increased by more than 5%. Despite this increase, MUNHYP hardly managed to expand its domestic retail business. This reflects difficulties in competing with rather cheap funding via deposits of local co-operative banks.
Key points for 2010

Monitor the development of the credit spread environment and its effect on the banks performance. Watch the development of the banks capitalisation and the management of its commercial real estate exposures.
10 June 2010
504

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2005 2006 2007 2008 2009 108.1 110.5 134.2 114.9 126.8 -10.2 -13.7 -21.2 -27.8 -30.0 0.0 0.0 0.0 0.0 0.0 100.8 120.1 131.6 111.1 105.4 50.5 53.4 49.7 52.5 57.5 50.2 66.7 82.0 58.6 47.8 19.6 49.0 26.7 29.7 24.3 26.0 13.4 51.8 25.6 19.3 10.2 11.3 12.0 10.2 11.0 34015 30761 18985 11776 7,779 30498 16422 10214 659 0.03 1.8 50.1 107.3 39.0 na na na 8.4 12.6 1.9 31932 29555 17516 12039 8,168 28183 14337 10215 636 32933 30587 16712 13876 8,085 28424 13323 10645 644 36134 31733 16039 15694 9,115 30234 13019 12208 666 35733 30985 14570 16415 9,282 27894 10895 13004 763
Muenchener Hypothekenbank (MUNHYP)

0.5% 0.4% 0.3% 0.2% 0.1% 0.0% 00 01 02 03 04 05 06 07 08 RoA 09 Net interest margin Credit costs
Efficiency
60% 50% 40% 30% 20% 10% 0% 00 01 02 03 04 05 06 07 08 09 Cost/Income ratio Cost/Assets ratio (RS) 0.5% 0.4% 0.3% 0.2% 0.1% 0.0%
0.03 0.04 0.03 0.03 1.7 1.9 1.6 1.5 44.5 37.7 47.3 54.6 92.1 101.9 103.4 120.4 73.5 na na na 6.8 10.4 2.0 32.6 na na na 6.5 9.7 2.0 50.8 na na na 5.6 8.9 1.8 50.7 na na na 6.5 10.0 2.1

8 6 4 2 0 00 01 bn 100% 80% 60% 40% 20% 0% 02 03 04 05 06 07 08 09 Bookvalue of securities in fixed assets account in % of total assets (RS)

bn 20 15 10 5 0 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) OC (x) 1.15 1.10 1.05 1.00 06 07 08 09 Covered bonds (bn)
Capital ratios
15 10 5 0 04 05 06 Tier 1 ratio 07 08 Total capital ratio 09 6.8 8.4 6.8 6.5 11.6 12.6 10.4 9.7 8.9 10.0
5.6
6.5
bn 20 15 10 5 0 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) OC (x) 1.18 1.15 1.12 1.09 1.06 1.03 1.00 06 07 08 09 Covered bonds (bn)
Geographical split mortgages

100% 80% 60% 40% 20% 0% 01 Berlin 02 03 04 05 06 07 08 09 East Germany West Germany Non-domestic
505
10 June 2010
Nord/LB (NDB)
Description
% Index
0.147
Fritz Engelhard
Ratings table
% $ Index
0.005
Total assets
239bn LT senior unsecured Public sector Pfandbriefe Mortgage Pfandbriefe Outlook Discontinuity factor*** Collateral score***
Moodys
* Aa2 Aaa Aaa Negative 15.6/3.1 ** Aa1 *
S&P
** NR NR NR * A
Fitch
** AAA NR NR
With total assets of 239bn at year-end 2009, Norddeutsche Landesbank (NDB) is Germanys fourth-largest Landesbank, providing universal banking services through its 6,463 employees. In addition to operating as the state bank for the states of Lower Saxony, Saxony-Anhalt and Mecklenburg-Western Pomerania, NDB provides central banking services for the savings banks in these three states. Also, owing to its 92.5% stake in Bremer Landesbank, NDB is active in the City State of Bremen. NDBs further participations include a 49% stake in the joint venture with DnB NOR, which is called Bank DnB NORD A/S. In January 2008, NDB took over Deutsche Hypo (DHY), a specialist commercial property lender, which is also discussed in this publication. NDB has not participated in either of the SoFFin schemes, but it benefits from a 20bn tailor-made guarantee agreement with the states of Lower Saxony and Saxony-Anhalt, which expired in December 2009 and on which it used slightly less than 14bn. On 2 February 2010, NDB announced the sale of its 25% stake in Berenberg Bank.
ANR NR
NR NR Stable -
Negative -
Notes: *Non guaranteed **Guaranteed ***In % Mortgage/Public sector
Risk weighting
Strengths
Regional public sector support: Based on NDBs important role in the regional economy, we believe support from the states of Lower Saxony and Saxony-Anhalt is probable. The individual guarantee framework provided by both states in late 2008 underlines this support. It has been approved by the European Commission. In addition to the state of Lower Saxony and the State of Saxony-Anhalt, which own 41.75% and 8.25%, respectively, NDBs owners further comprise the Savings Banks Association of Lower Saxony (37.25%), the Holding Association of the Savings Banks of Saxony-Anhalt (7.53%), and the Holding Association of the Savings Banks of MecklenburgWestern Pomerania (5.22%). General public sector guarantee scheme: As with other domestic public sector companies, NDB benefits from the protection of the German Sparkassen-Finanzgruppes institutional guarantee system through its membership in the security reserve of the Landesbanken and Girozentralen. Along with the 11 regional Sparkasse support funds and the guarantee reserve of the Landesbausparkassen, this security reserve is one of the 13 security guarantee schemes that together form the joint institutional guarantee system of the German Sparkassen-Finanzgruppe. Pfandbrief over-collateralisation: As at YE 09, public-sector Pfandbriefe issued by NDB benefited from an overcollateralisation of 16% on a nominal basis and 14.5% on a present value basis. At the same time, its mortgage Pfandbrief investors benefited from an over-collateralisation of more than 200% on a nominal basis and on a present value basis.
Weaknesses
Profitability: While NDB was much less affected by the financial market crisis of 2008/09 than most of its domestic peers, the subsequent recovery in many markets did not reflect in its bottom-line results. Following a small pre-tax profit of 22mn in FY 08, NDB reported a 92mn pre-tax loss in FY 09. The 96mn decrease of net interest income largely reflects increased costs for maintaining appropriate liquidity. The 741mn swing in trading income was outpaced by a 776mn increase of risk provisions, which was largely due to the banks specialist lending activities, but also because of a 134mn special provision for potential damage to its Swiss subsidiary, Skandifinanz Bank AG, from a fraud case in its export finance operations. Specialist lending: Within its total group-wide credit exposures of 255bn, NDB has 20bn of exposures to shipping markets, 20bn of exposures to property (largely commercial) markets and 7bn of exposures to aircraft finance markets. The significant downturn in these markets exposes the bank to increasing provisioning needs. The banks non-performing loan ratio more than doubled, from 1.5% in FY 08, to 3.3% in FY09. Event risk: Ongoing ownership discussions across German public sector banks might change the risk profile of the bank. In particular, acquisitions might induce Landesbanks to increase the respective debt financing. Yet, in our opinion, given the substantial support mechanisms within the German savings banks finance group (Sparkassen Finanzgruppe), a deterioration of its credit profile is unlikely.
Key points for 2010

Monitor further M&A activity in the German Landesbank sector. Track NDBs exposure to specialist lending markets and the impact on bottom-line results.
10 June 2010
506

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing Customer deposits Debt funding of which PS Pfandbriefe of which mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 1,133 169 58 1,541 821 720 0 439 281 2007 1,478 162 -462 1,508 792 716 38 503 305 2008 1,462 180 -313 1,142 898 244 266 22 151 2009 1,366 177 428 2,136 986 1,150 1,042 -92 -141
Nord/LB (NDB)
Deposits to loans
125% 100% 75% 50% 25% 0% 00 01 02 03 04 05 06 07 08 09 Wholesale funding % of total funding Cust. deposits to loans (RS) 80% 60% 40% 20% 0%
203,093 201,584 244,329 238,688 78,961 88,442 112,172 112,083 51,035 47,562 61,998 61,306 64,980 63,424 82,964 85,091 8,327 19,246 23,993 22,251 31 222 822 1,139 6,350 6,301 5,695 5,842 0.14 4.8 53.3 73.5 0.0 1.9 3.6 52 7.7 10.8 3.1 0.15 4.8 52.5 98.0 5.3 1.3 2.1 59 7.0 9.5 3.1 0.07 2.5 78.6 128.0 109.0 1.1 1.5 70 8.1 10.0 2.3 -0.06 -2.4 46.2 64.0 90.6 1.6 3.3 47 8.7 9.7 2.4
Credit exposures (YE 09: 255bn) by type of business

Public Sector 18% Real Estate 7% Shipping 7% Airtraffic 3%
Other 21%
Financial Institutions 44%
Capital ratios
12 10.8 10 8 7.7 6 4 2 0 2006 9.5 10.0 8.1 9.7 8.7
7.0
2007 Tier 1 ratio
2008 Total capital ratio
2009

50 40 30 20 10 0 99 00 01 02 03 04 05 06 07 08 09 Restricted assets (bn) Over-collateralisation (x) Covered bonds (bn) 1.8 1.6 1.4 1.2 1.0
4 3 2 1 0 0.7 0.2 07 08 Restricted assets (bn) Over-collateralisation (x) 09 Covered bonds (bn) 1.6 0.8 1.1 2.5 3.5 3.0 2.5 2.0 1.5 1.0
Geographical breakdown public sector, YE 09

Other 1.3% Luxembourg 1.7% Austria 1.7% Germany 95.3%
Geographical breakdown mortgage, YE 09
Other 4% Netherlands 2% Poland 4%
Germany 90%
10 June 2010
507
SEB AG (SEBAG)
Description
% Index
0.031
Fritz Engelhard
Ratings table
% Index
NA
Total assets
53bn LT senior unsecured Covered bond rating Outlook Discontinuity factor* Collateral score*
Note: *In %
Moodys
Baa1 Aa1/Aa1 Negative 8.5/5.2
S&P
ANR/NR Stable -
Fitch
A+ -/Positive -
SEB AG is a wholly-owned subsidiary of the Swedish bank, SEB (Skandinaviska Enskilda Banken). The bank has a countrywide presence in Germany, with 174 branches and about 1mn customers. At year-end 2009, total assets stood at 53bn. SEB AG focuses on investment banking, retail banking, commercial real estate and asset management.
Risk weighting
Strengths
Low credit risk in public sector financing: Public sector exposures make up 15% of the total credit risk exposure of the group. In its Pfandbrief business, the bank specialises in the provision of public sector loans, mainly to domestic counterparts. At 31 March 2010, non-German exposure represented about 15% of the total outstanding, and the banks public sector Pfandbriefe benefited from 5% nominal over-collateralisation. Improved capitalisation: While the banks capital base was rather stable, a 16% reduction in risk-weighted assets (RWAs) helped improve capital ratios. This significant decrease of RWAs was largely the result of lower customer financing as well as a reduction of securities holdings. The Tier 1 ratio increased from 7.2% at YE 08, to 8.8% at YE 09. Institutional support: Although it is a relatively small Pfandbrief issuer (total volume of 7.7bn of outstanding mortgage and public-sector Pfandbriefe), SEBAG benefits from systemic support from the German banking community for the Pfandbrief product and from the overall promise of the German government ie, if the functioning of the Pfandbrief market is hampered, the government would take short-term measures to ensure payments on Pfandbriefe.
Weaknesses
Potential divestment of retail business: On 14 May 2010, Skandinaviska Enskilda Banken confirmed that it is in dialogue with third parties regarding a possible divestment of its German retail banking business. The Swedish parent highlighted, that it had not been satisfied with the profitability of its German retail banking business. As the potential loss of 22bn of customer deposits would worsen the banks refinancing structure, we would regard this as a negative. Modest profitability: SEB AG reported a 15mn net loss in FY 09 after 108mn net profit in FY 08. This was largely due to a 7% decrease in net interest income, a 20% drop in fee and commission income, as well as a 44mn loss from trading activities, which largely resulted from valuation losses on the banks securities holdings. At the same time, risk provisions more than doubled to 69mn, on the back of increasing provisions for specific credit risk. Furthermore, bottom-line results are burdened by a relatively high cost base. This is reflected in the cost/income ratio, which was 77%, on average, in 2002-09. Exposure to credit spreads: Similar to most of its peers, the bank has suffered from the volatile spread environment. Its 6.4bn securities portfolio suffered valuation losses of 9.5mn in FY 09, or 0.4% of total equity. The bank classified 4.3bn of financial assets in order to avoid marked-to-market losses. As the credit spread environment remains challenging, the bank is exposed to further mark-to-market swings in its securities portfolio. Competitive environment: SEB AG faces strong competition from other German banks (ie, commercial and public sector), including savings banks. In FY 09, the bank suffered from a 16% decrease of customer deposits and a 10% fall in customer financing. Within its Pfandbrief business, the bank competes with a number of German Pfandbriefbanks, which also focus on domestic mortgage lending and public sector finance.
Key points for 2010

Monitor the development of the banks funding profile and bottom-line results. Watch the development of the relationship between SEB and SEB AG, as well as SEBs credit profile.
10 June 2010
508

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 403 200 12 619 423 196 112 168 146 51,718 27,171 19,125 11,932 12,070 4,298 2,376 0.27 6.2 68.3 65.2 57.1 0.3 2.1 12.9 7.9 10.8 4.6 2007 390 228 -2 621 449 173 47 106 55 61,507 25,662 24,867 10,561 10,757 4,085 2,296 0.10 2.4 72.2 62.8 27.0 0.3 2.5 12.9 7.3 11.1 3.7 2008 388 219 15 653 429 224 31 171 108 2009 360 175 -44 500 437 63 69 -16 -15
SEB AG (SEBAG)
2.0% 1.5% 1.0% 0.5% 0.0% -0.5% 02 03 04 05 Net interest margin 06 07 08 Credit costs 09 RoA

120% 100% 80% 60% 40% 20% 0% 04 05 06 07 08 09 Cust. deposits to loans Wholesale funding % of total funding (RS) 80% 60% 40% 20% 0%
60,137 52,743 29,306 26,393 26,236 22,057 11,494 7,968 11,529 9,204 4,148 3,789 2,358 2,310 0.18 4.6 65.7 59.4 14.0 0.2 2.3 10.1 7.2 10.2 3.9 -0.03 -0.6 87.5 71.9 110.7 0.3 2.9 9.4 8.8 13.3 4.4
Capital ratios (%)

15 10.4 10 5 0 05 06 Tier 1 ratio 07 08 Total capital ratio 09 7.4 7.9 7.3 7.2 8.8 10.8 11.1 10.2 13.3

15 12 9 6 3 0 12.4 11.7 12.1 11.2 1.05x 1.02x 05 06 07 Restricted assets (bn) Over-collateralisation (x) 11.3 10.8 1.05x 11.9 11.5 1.04x 1.10 1.08 1.06 1.04 1.02 1.00 0.98
10 8 6 4 2 0 05 06 Restricted assets (bn) Over-collateralisation (x) 1.34x 1.03x 4.5 4.4 1.04x 4.5 4.3 1.06x 4.3 4.1 1.15x 4.8 5.1 4.1 3.8 1.0 0.5 0.0 07 08 09 Covered bonds (bn) 1.5
9.7 9.2 1.05x
08 09 Covered bonds (bn)
Geographical split public sector, March 2010

Other 6% Spain 3% Germany 85% Austria 6%
Property type mortgage collateral, March 2010
Commercial 26%
Residential 74%
10 June 2010
509
UniCredit Bank AG (HVB)

Description
% Index
0.0.219
Fritz Engelhard
Ratings table
Total assets
% Index
0.007
Moodys
A1 Aa1/Aaa Stable -
S&P
A -/AAA Stable -
Fitch
A+ AAA/AAA Stable 17.1/11.9* -
UniCredit Bank AG (HVB) is a large private bank in Germany, with total assets of 363bn at YE 09. In Germany, it has a 5% market share, about 23,000 employees and 631 branches. Since 17 November 2005, it has been a member of the UniCredit Group, which acquired 95.4% of HVB. In June 2007, the squeeze-out of other shareholders was approved by HVBs annual general meeting. UniCredit Group has a strong banking presence in Italy, Germany, Austria, and Central and Eastern Europe, with about 170,000 employees and 40mn customers. HVBs business divisions are geared to the structure of UniCredit. The bank focuses on retail, private and corporate banking in Germany, as well as investment banking.
Risk weighting
Strengths
Ownership and support: Within UniCredit Group, HVB plays a strategically important role. The strong operational integration and the 100% ownership lead us to believe that HVB would benefit from potential liquidity and solvency support. Furthermore, being a Pfandbriefbank, HVB would also benefit from the overall promise of the German government, ie, if the functioning of the Pfandbrief market is hampered, the government would take short-term measures to ensure payments on Pfandbriefe. Capitalisation: Following the transfer of Bank Austria Creditanstalt, as well as HVBs asset management operations to UniCredit, the banks capital ratio improved markedly. On the back of a 22.3% decrease of risk-weighted assets and a 3.8% decrease of core capital, the banks core Tier 1 ratio increased from an already high 14.3% at YE 08 to 17.8% YE 09. However, it is worth noting that the respective capital is partly reserved for businesses on the balance sheet of UniCredit and thus not freely available. Funding profile: After the spin-off of major parts of its commercial real estate business in 2003, the further spin-off of participations in early-2007 and low asset growth in recent years, the banks reliance on wholesale funding decreased substantially. The ratio of customer deposits to total loans doubled from 25% in 2002, to 50% in 2005 and stood at 56% at YE 09. In the course of FY 09, the bank also reduced its trading book by 65.6bn or 33% to 133.4bn. This also helped reduce the banks liabilities versus central banks (-21.2bn) as well as interbank liabilities (-12bn).
Weaknesses
Weak underlying earnings in the core domestic business: In terms of earnings contributions, HVB plays a minor role within UniCredit Group. Revenues from HVBs domestic retail business remain weak and are likely to be subdued so long as the banks lending volume decreases. In 2008, the German retail divisions operating profit (162mn) contributed only 1.3% to UniCredit Group earnings and only 6% to the Groups total operating profit from retail operations. These indicators reached a new multi-year low in the course of Q1 10, when its operating profit (20mn) contributed only 0.7% of UniCredit Groups total and only 3% of the Groups total operating profit from retail operations. While measures were taken to improve back-office efficiency and strengthen cross-selling activity, the major challenge of tackling domestic competition remains. Run-down of mortgage business: Following a decline of the banks mortgage portfolio by 7.2bn or 10.3% in 2008, HVBs total mortgage portfolio decreased by another 6.7bn, or 10.7% in 2009. The mortgage collateral pool of HVBs Pfandbriefe is now down 25bn or 44% from its peak in 2002. This reflects the strategic reduction of the banks mortgage business. On this background, the commitment to HVBs mortgage Pfandbrief business appears increasingly vulnerable. Securities holdings: As at 31 December 2009, HVB allocated 21.6bn or 23.5% of its total 92bn of debt securities holdings to the fixed-assets account. The reported non-realised loss on the portfolio amounts to 934mn, or 4.0% of total equity. The respective risk positions expose the bank to potential write offs.
Key points for 2010

Monitor the decrease of the banks mortgage business and its impact on HVBs Pfandbriefe. Watch the development of the relationship between HVB and UniCredit, as well as UniCredits credit profile.
10 June 2010
510

mn 2006 2007 2008 2009 Income statement summary Net interest income 3,399 3,753 4,059 4,476 Net fees & com's 1,753 1,721 1,453 1,187 Trading income 768 592 -1,911 1,074 Operating income 5,920 6,403 3,889 7,136 Operating expenses 3,695 3,485 3,383 3,498 Pre-provision income 2,225 2,918 506 3,638 Loan loss provisions 933 536 760 1,601 Pre-tax profit 1,618 2,962 -595 1,266 Net income 1,640 2,050 -671 819 Balance sheet summary Total assets 358,299 422,129 458,602 363,420 Customer financing 174,606 160,246 175,518 145,919 of which public sector 26,679 30,287 37,076 38,601 of which Mortgages 79,634 69,956 62,723 56,012 Customer deposits 74,153 93,471 100,376 82,434 Debt funding 89,080 90,572 39,308 37,803 of which PS Pfandbriefe 7,053 7,579 7,601 7,200 of which Mortgage Pfandbriefe 40,529 37,261 31,707 30,603 Total equity 21,019 23,998 23,024 23,638 Profitability (%) Return on assets 0.46 0.53 -0.15 0.20 Return on equity 8.1 9.1 -2.9 3.5 Cost/Income ratio 62.4 54.4 87.0 49.0 Net int inc/Op inc 57.4 58.6 104.4 62.7 Asset quality (%) LLPs/Pre-prov inc 41.9 18.4 150.2 44.0 LLRs/Gross loans 3.4 3.1 2.7 3.5 Prob loans/Gr loans 4.0 2.8 2.1 3.3 Coverage ratio 86.8 108.5 125.9 103.8 Capital adequacy (%) Tier 1 ratio 8.0 13.7 14.3 17.8 Total capital ratio 11.8 17.8 17.8 21.2 Equity/Assets ratio 5.9 5.7 5.0 6.5
UniCredit Bank AG (HVB)

1.5% 1.0% 0.5% 0.0% -0.5% -1.0% 00 01 02 03 04 Net interest margin 05 06 07 Credit costs 08 09 RoA
Efficiency
100% 80% 60% 40% 20% 0% 00 01 02 03 04 05 06 07 08 09 Cost/Income ratio Cost/Assets ratio 0.0% 1.0% 0.5% 1.5%

80% 60% 40% 20% 0% 00 01 02 03 04 05 06 07 08 09 Cust. deposits to loans Wholesale funding % of total funding bn 100% 80% 60% 40% 20% 0%

30 20 10 0 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) 06 07 08 09 Covered bonds (bn) 2.0 1.8 1.6 1.4 1.2 1.0
Asset quality
6% 5% 4% 3% 2% 1% 0% 00 01 02 03 04 05 06 07 08 09 Gross NPLs/loans 150% 100% 50% 0% Reserve coverage (RS)
80 60 40 20 0 00 01 02 03 04 05 06 07 08 09 Restricted assets (bn) Over-collateralisation (x)
10 June 2010
Geographical split mortgage collateral

1.3 1.2 1.1 1.0 Covered bonds (bn) 100% 80% 60% 77% 76% 75% 75% 74% 75% 75% 75% 76% 76% 77% 40% 20% 0% 99 00 01 Berlin 02 03 04 05 06 07 08 East Germany West Germany 09
511
West-LB AG(WESTLB)
Description
% Index
0.17
Fritz Engelhard
Ratings table
Total assets
242bn LT senior unsecured Public sector Pfandbriefe Mortgage Pfandbriefe Outlook Discontinuity factor*** Collateral score***
% Index
NA
Moodys
* A3 Aaa -/4.5 ** Aa1 Aaa *
S&P
** AAAAA Stable -
Fitch
* NR NR NR ** NR NR NR
WestLB was created in 1969 by the merger of Landesbank fr Westfalen Girozentrale, Mnster and Rheinische Girozentrale and Provinzialbank, Dsseldorf. On 30 August 2002, it was transformed into a joint stock company, while its public-interest activities were integrated into NRW.BANK. WestLB is the central clearing bank for the savings banks in North Rhine-Westphalia and Brandenburg and offers a broad range of products and services, focusing on lending, structured finance, capital market and private equity products, asset management, transaction services and real estate finance. WestLB regards itself as one of Germanys leading financial services providers. Between 2004 and 2009, the bank on four occasions appointed a new chairman of its management board. In November 2009, WestLB agreed with the German SoFFin, to transfer 85bn of non-performing or non-strategic assets and 26bn of liabilities into a work-out entity. On 23 December, the respective run-off institution, named Erste Abwicklungsanstalt (EAA) was created. Until 30 April 2010, a total of 77bn assets as well as about 26bn of liabilities, mainly grandfathered and secured debt, were transferred. The transferred grandfathered debt continues to benefit from the maintenance guarantees of WestLBs owners. Furthermore, the bank is obliged to dispose of Westimmo within the next two years in order to comply with EU state aid rules.
BBB+ AAA -
Negative
11.7/7.1 -
Risk weighting
Strengths
Ownership: WestLB is owned by the Sparkassen and Giro Association of the Rhineland (25.032%), the Sparkassen and Giro Association of Westphalia-Lippe (25.032%), the State of North Rhine-Westphalia (17.766%) and NRW Bank (30.862%), which, in turn, is owned by North Rhine-Westphalia (98.6%) state and the two savings banks associations (1.4%). WestLB is also a member of the joint liability scheme of the German savings banks finance group (Sparkassen Finanzgruppe). Historically, WestLBs owners repeatedly provided liquidity and solvency support. However, following the transfer of grandfathered debt to EAA, the incentive to lend further support in the future has been diminished. Restructuring process: The risk shield provided by its owners allowed WestLB to continue to pursue its transformation process, which includes a more conservative risk policy, costcutting measures and a stronger focus on developing its retail and commercial banking activities. This last point is underlined by the banks investments in private banking, asset management and consumer finance activities. Furthermore, the combination of deleveraging, asset transfers to EAA and capital injections will help improve the banks capital ratios. On a proforma basis, WestLB indicated that its Tier 1 ratio would be 8.2% at YE 09, when including the additional injection of 1.5bn of silent participations by SoFFin. Over-collateralisation: As at end-March 2010, public-sector Pfandbriefe issued by WestLB benefited from an overcollateralisation of 14% on a nominal basis and 12% on a present value basis. However, it should be noted that exposure to Spain, Portugal and Greece increased from 491mn, or 4.5% of cover pool assets in Q1 09, to 806mn, or 6.9% of cover pool assets.
Weaknesses
Business franchise: Over the past decade, WestLB repeatedly suffered from losses in its capital markets, structured credit and leveraged finance operations. These losses triggered not only a number of liquidity and solvency protection measures, but were also accompanied by ongoing restructuring and repositioning initiatives, as well as frequent changes in the banks management. The respective events have adversely affected the banks business franchise. Transparency on remaining risk exposures: The significant transfer of assets to EAA changes substantially the risk profile of WestLB. While the transferred assets largely consist of nonperforming or impaired assets, the asset portfolio retained by the core bank might still include substantial risk positions. For example, in its annual report the bank stated that of the 18bn of exposures to Italy, Spain, Portugal and Greece, it would transfer 10bn to EAA. At this stage it is unclear to what extent the remaining 8bn of exposures to these countries might have a negative impact on bottom-line results of the core bank. Event risk: Ongoing ownership discussions across German public sector banks might change the risk profile of the bank. Following the transfer of legacy risk positions to EAA, WestLBs ability to participate in the consolidation process of the German Landesbank sector has increased. Yet, in our opinion, given the substantial support mechanisms within the German savings banks finance group (Sparkassen Finanzgruppe), a significant change in the underlying risk profile is unlikely.
Key points for 2010

Monitor WestLBs role in the consolidation of the German Landesbank sector. 10 June 2010 Track WestLBs remaining risk exposures and their impact on bottom-line earnings. 512

mn 2006 2007 Income statement summary Net interest income 1,144 1,090 Net fees & com's 325 406 Trading income 429 -1,616 Inc. from participations 551 291 Operating income 2,827 278 Operating expenses 1,830 1,576 Pre-provision income 997 -1,298 Loan loss provisions -202 238 Pre-tax profit 1,006 -1,502 Net income 799 -1,601 Balance sheet summary Total assets 285,287 286,552 Customer financing 66,546 81,253 of which public sector 6,169 6,053 of which Mortgages 5,874 7,881 Customer deposits 46,956 24,851 Debt funding 48,906 49,831 of which PS Pfandbriefe 23 2,377 Total equity 6,756 4,429 Profitability (%) Net int. Margin 0.39 0.38 Return on assets 0.28 -0.56 Return on equity 12.6 -28.6 Cost/Income ratio** 64.7 83.2 Net int inc/Op inc 40.5 392.1 Asset quality (%) LLPs/Pre-prov inc -20.3 -18.3 LLRs/Gross loans 1.5 1.4 Prob loans/Gr loans 0.8 0.2 Coverage ratio 185 791 Capital adequacy (%) Tier 1 ratio 8.1 5.6 Total capital ratio 12.1 8.6 Equity/Assets ratio 2.4 1.5 2008 1,216 341 47 -19 1,987 1,341 646 479 26 18 2009 1,868 264 -71 -10 2,012 1,192 820 796 -503 -531
West-LB AG(WESTLB)
Net interest margin and credit costs
0.8% 0.6% 0.4% 0.2% 0.0% -0.2% 04 05 06 Net interest margin 07 08 09 Credit costs
Exposure at default (YE 09: 161bn) by sector

Financials 35.1% Public Sector 21.4%
288,122 242,311 112,233 96,897 6,195 5,193 5,087 7,433 29,722 27,643 41,573 36,198 8,449 10,914 3,821 3,733 0.42 0.01 0.4 69.1 61.2 74.1 1.1 0.2 458 6.4 10.1 1.3 0.70 -0.20 -14.1 57.2 92.8 97.1 1.8 0.3 573 8.2 10.9 1.5
Industry & Services 43.9%
Capital ratios (%)

15 10.5 10 5 5.8 0 2002 7.6 6.9 8.3 8.1 5.6 6.4 12.5 11.5 14.2 12.1 8.6 10.9
10.1
8.2
2003
2004 2005 Tier 1 ratio
2006 2007 2008 2009 Total capital ratio

15 1.28x 10 5 0 3.0 2.4 9.4 8.4 11.7 10.9 11.0 10.1 1.4x 1.3x 1.2x 1.12x 1.07x 1.09x 1.1x 1.0x Dec 09 Covered bonds (bn)
Efficiency
100% 80% 60% 40% 20% 0% 04 05 06 Cost/Income ratio (LHS) 0.71% 81.4% 67.8% 64.7% 83.2% 69.1% 57.2% 1.4 1.2 1.0 0.62% 0.63% 0.55% 0.8 0.47% 0.45% 0.6
Dec 06 Dec 07 Dec 08 Restricted assets (bn) Over-collateralisation (RHS:x)
0.4 07 08 09 Cost/Assets ratio (RHS)
Geographical split public sector,Q1 10

Austria 3% Switzerland Belgium 4% 1% Spain 5% Portugal 1% Greece Other 1% 3%
Rating split public sector, YE 09

AA 31.7% AA+ 8.4% AA13.2% A+ 1.8% A0.0%
Germany 82%
BBB+ 0.8%
AAA 43.4%
A 0.7%
10 June 2010
513
Westdeutsche Immobilienbank AG (WESTIB)

Description
% Index
NA
Fritz Engelhard
Ratings table
Moodys
LT senior unsecured Covered bond rating* Outlook Discontinuity factor** Collateral score** NR NR/NR -
% Index
NA
Total assets
27bn
S&P
BBB+ AAA/AAA Negative -
Fitch
NR NR/NR -
Westdeutsche Immobilienbank AG (WESTIB) is wholly owned by WestLB. With total assets of 26.9bn as at 31 December 2009, WESTIB provides specialist real estate funding, real estate investment banking, real estate management and consulting, and has about 500 employees. Through its 94.6%-owned subsidiary, Westdeutsche Immobilien- Holding, WESTIB also offers a range of property-related services. WESTIB funds mortgage loans through the issuance of mortgage Pfandbriefe and public sector business through public sector Pfandbriefe. Initially created in 1995 as a public sector credit institution, WESTIB changed its legal form and became an AG (joint stock company) in December 2006. On 12 May 2009, the European Commission decided on state aid measures for WestLB. The decisions include the obligation of WestLB to dispose of WESTIB within a time frame of two years.
Notes: *Mortgage Pfandbriefe/Public Sector Pfandbriefe. **In %
Risk weighting
Strengths
A well-established Pfandbrief issuer: With a total volume of 10bn of outstanding mortgage and public sector Pfandbriefe as of YE 09, WESTIB is a medium-sized issuer in this asset class. Thus, the bank also benefits from substantial systemic support for the Pfandbrief product in particular, the overall promise of the German government, that in case the functioning of the Pfandbrief market is endangered, the government would be prepared to take short-term measures to ensure payments on Pfandbriefe. Decent business franchise: WESTIB has a good business franchise in its core markets and is able to offer a wide range of products from traditional fixed-interest loans to structured financing. The bank has been increasingly able to build on this franchise, as reflected in the rise in net fees and commission income from 26mn in 2008, to 32mn in 2009. Close co-operation with savings banks: As a consequence of the strategic restructuring attributed to the change in ownership and the end of the German maintenance obligation and deficiency guarantee, WESTIB works closely with German savings banks with a focus on the federal states of North RhineWestphalia and Brandenburg. For the public finance business in particular, its public sector clients are served together with the respective partner banks. This helps leverage the banks franchise and enhance its access to attractive business opportunities. However, on the back of the planned disposal of WESTIB, the respective co-operation could be endangered. Over-collateralisation: WESTIBs Pfandbriefe benefit from good over-collateralisation. As of 31 March 2010, nominal overcollateralisation stood at 125% for public sector Pfandbriefe and 28% for mortgage Pfandbriefe. At the same reporting date, the risk-adjusted over-collateralisation stood at 14% for public sector Pfandbriefe and 22% for mortgage Pfandbriefe.
Weaknesses
Reliance on wholesale funding: As a specialised real estate finance bank, WESTIB is dependent on refinancing its business through the capital markets. At YE 09, wholesale funding made up about 70% of the banks total funding. Access to the capital markets is critical to the banks business model. However, in our view, its dependence on providing wholesale funding and its related exposure to liquidity risk is mitigated by its access to the Pfandbrief market, and also because a substantial proportion of its assets can be used for repo transactions. Exposure to commercial property markets: As of YE 09, 61% or 6.0bn of WESTIBs mortgage Pfandbrief cover pool consisted of commercial mortgages. The downturn in some of the banks target markets has a negative impact on tenant quality and valuations. This reflects in the fact that the banks risk provisions more than doubled between YE 08 and YE 09. Capitalisation: Although the banks business focus is on low-risk exposures, we regard the capital base as rather small. On 31 December 2009, the banks Tier 1 ratio stood at 8.2% (YE 08: 8.4%). WESTIB had no exposure to the US subprime market and did not report any losses from exposures to failed banks, however, it suffered from the pressure in financial markets. As of YE 09, the banks non-realised net losses on AfS financial assets stood at 110mn. Furthermore, the bank is expanding strongly in financing for the domestic and international commercial property markets. In the course of 2009, a total amount of 6.2bn (FY 08: 5.5bn) of new commercial real estate business was originated. While the wind-down of the banks retail property business helps release some capital, we still believe that further capital increases may be needed to cope with WESTIBs business strategy.
Key points for 2010

Track the discussion surrounding the future ownership of WESTIB.
10 June 2010
514

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which mortgagePfandbriefe Total equity Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 204 0 -60 200 84 116 21 51 29 2007 156 19 22 196 83 113 -7 105 92 2008 179 26 17 222 81 142 27 121 97 2009 199 32 4 235 88 148 66 75 83
Westdeutsche Immobilienbank AG (WESTIB)

1.0% 0.5% 0.0% -0.5% -1.0% 00 01 02 03 04 05 06 07 08 RoA 09 Net interest margin Credit costs
Efficiency
23,185 23,827 26,171 26,889 16,575 17,855 19,241 21,198 2,987 2,384 1,787 1,566 5,498 6,555 4,036 6,322 4,306 5,120 5,756 6,864 11,548 10,621 9,142 8,869 4,756 4,241 2,803 2,458 4,626 5,783 7,071 7,799 875 916 861 906 0.12 3.4 42.1 102.2 17.9 1.4 na 6.4 10.5 3.8 0.39 10.3 42.3 79.6 -6.0 1.1 na 6.1 9.5 3.8 0.39 10.9 36.3 80.5 19.3 1.1 na 8.4 12.7 3.3 0.31 9.4 37.3 84.4 44.8 1.2 na 8.2 10.7 3.4
150% 100% 50% 0% 00 01 02 03 04 05 06 07 08 09 Cost/Income Cost/Avg assets (RS)
1.0% 0.8% 0.6% 0.4% 0.2% 0.0%

60% 40% 20% 0% 00 01 02 03 04 05 06 07 08 09 Cust deposits/Loans Wholesale funding/Tot. Funding (RS) 100% 80% 60% 40% 20% 0%

mn 8,000 6,000 4,000 2,000 0 00 01 02 03 04 05 06 07 08 Public Sector loans (mn) Overcollateralisation (x) OC (x) 1.8 1.6 1.4 1.2 1.0 09
Capital ratios
14% 12% 10% 8% 6% 4% 02 03 04 05 06 07 08 09 Tier 1 ratio Total capital ratio
Pfandbriefe (mn)
Geographical split mortgages (Q1 10: 9.9bn)

Other NonDomestic 14% France 5% USA 11% UK 8% Germany 62%
mn 10,000 7,500 5,000 2,500 0 00 01 02 03 04 05 06 07 08 Restricted Assets (mn) Overcollateralisation (x) OC (x) 1.6 1.4 1.2 1.0 09 Pfandbriefe (mn)
10 June 2010
515
WL-Bank (WLBANK)
Description
% Index
0.104
Fritz Engelhard
Ratings table
Total assets
% Index
NA
Moodys
NR NR NM -
S&P
A+ AAA/AAA Stable -
Fitch
A+ NR Stable -
Established in 1877, WL-Bank is one of the three mortgage banks in the German cooperative banking system and therefore benefits from the sectors comprehensive protection scheme. As a mediumsized company (consolidated assets of 43bn as at YE 09) that principally distributes its products through the network of cooperative banks focusing on the states of Rhineland and Westphalia, its activities are concentrated on the provision of residential mortgages (88% of mortgage asset pool collateral) and public sector loans. It is incorporated as a joint-stock company, but its shares are not listed and any transfer of ownership must be approved by the bank. Aside from being the majority owner of WLBank, Westdeutsche Genossenschafts-Zentralbank (WGZ) has issued a Letter of Comfort in favour of the bank.
Risk weighting
Strengths
Ownership: WL-Bank is 91% owned by WGZ, the regional central bank for the 300 local co-operatives active in the states of Rhineland and Westphalia (the only other central cooperative bank in Germany is DZ Bank, which acts as a central body for approximately 1,300 local cooperative banks). A further 5% of its shares are directly owned by 107 regional cooperative banks. Ownership aside, WL-Bank benefits from its relationship with local co-operative banks in a number of ways, including access to their clients for the origination of new mortgage loans and the placing of the Pfandbriefe used to refinance them, and integration into the sectors EDP system, which allows efficient processing of loans and the sharing of the relevant costs. As part of the co-operative banking system, WLBank benefits from the comprehensive protection scheme that has prevented insolvencies of member institutions since it was introduced in 1932, and the system of solidarity between cooperative banks. Business enhancement: While in recent years WL-Bank has further strengthened its origination platform for business with the local co-operative banks in Germany, it has also developed its direct origination capacities. Portfolio acquisitions, such as the purchase of a 455mn retail mortgage portfolio from Coreal-Credit Bank AG in January 2008, have led to a significant increase of direct business from 580mn in FY 07, to 1,496mn in FY 08. As this strengthens the banks business profile and also enhances opportunities to access higher margin business, we regard this as a positive. Over-collateralisation: WL-Banks Pfandbriefe benefit from decent over-collateralisation. As of 31 March 2010, overcollateralisation on a present value basis stood at 8% for public sector Pfandbriefe and 19% for mortgage Pfandbriefe.
Weaknesses
Securities holdings: Capital markets exposure has increased in recent years. The share of securities holdings as a percentage of total assets increased from 21% at YE 03 to 34% at YE 09. As of 31 December 2009, WL-Bank allocated 13bn or 89% of its debt securities holdings to the fixed-assets account. The reported non-realised loss on the portfolio amounts to 362mn, or 110% of total equity. Ongoing volatility in capital markets exposes the bank to mark-to-market swings in its securities portfolio. Performance: Not unusually for a German mortgage bank, the underlying profitability of WL-Bank is low and largely reliant on the thin lending margins available for public sector and mortgage financing. Fierce competition in the domestic residential mortgage lending market is reflected in the net interest margin, which remained below 30bp in 2009. Furthermore, the cost-income ratio increased from 35% in FY 08 to 43% in FY 09 on the back of a 9% decrease in operating earnings and an 11% increase in operating expenses. Reliance on wholesale funding: As a formerly specialised mortgage bank, WL-Bank is heavily dependent on refinancing its business through the capital markets. As of 31 December 2009, wholesale funding made up 98% of the banks total funding. Thus, access to the capital markets is critical to the banks business model. However, in our view, its dependence on providing wholesale funding and its related exposure to liquidity risk is mitigated by its access to the Pfandbrief market, and also because a substantial proportion of its assets can be used for repo transactions. Business model: Over the past three years, the annual amount of transferred business from the co-operative banking network was rather low and with only 570mn of new business in 2009, its share within the total new mortgage business remained below 30%. In our view, this reflects difficulties in competing with rather cheap funding via deposits of local co-operative banks.
Key points for 2010

Monitor evolution in performance for the system as a whole, given that this is the main source of downwards rating pressure. Track the development of the credit spread environment and its impact on the banks performance.
10 June 2010
516

mn Income statement summary Net interest income Net fees & com's Other income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which Mortgages Customer deposits Debt funding of which PS Pfandbriefe of which Mortgage Pfandbriefe Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 91 -14 1 77 36 41 18 27 18 36,804 24,506 17,023 7,482 844 33,252 25,686 6,450 294.5 0.05 6.1 46.8 117.1 43.8 na na na 5.2 9.3 0.8 2007 95 -14 5 86 34 53 17 33 19 40,610 25,549 17,665 7,880 875 33,865 26,635 6,364 304.5 0.05 6.2 39.1 110.4 32.4 na na na 5.9 10.3 0.7 2008 112 -15 2 100 35 65 34 30 20 40,576 25,406 16,547 8,859 865 32,581 23,838 7,008 315.5 0.05 6.4 35.1 112.8 51.9 na na na 5.8 9.5 0.8 2009 106 -18 2 91 39 52 -1 51 26 43,380 27,393 17,286 10,107 923 34,717 24,553 7,850 330.1 0.06 8.1 42.9 117.3 -1.0 na na na 9.1 14.5 0.8
WL-Bank (WLBANK)
0.5% 0.4% 0.3% 0.2% 0.1% 0.0% -0.1% 00 01 02 03 04 Net interest margin 05 06 07 Credit costs 08 09 RoA
Capital ratios
16% 14% 12% 10% 8% 6% 4% 01 02 03 04 05 06 07 08 09 Tier 1 ratio Total capital ratio

15 10 5 0 03 04 05 06 07 08 09 Bookvalue of securities in fixed assets account in % of total assets (RS) bn 30% 25% 20% 15% 10%

30 1.10 20 10 0 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) 1.05 1.00 06 07 08 09 Covered bonds (bn)
10 8 6 4 2 0 00 01 02 03 04 05 Restricted assets (bn) Over-collateralisation (x) 1.20 1.15 1.10 1.05 1.00 06 07 08 09 Covered bonds (bn)
Geographical split public sector, March 2010 (25.8bn)

Austria 3.9% Italy 1.6% Spain 3.8% Portugal 0.3% Greece 1.5%
Geographical split mortgages, March 2010 (11.4bn)

Other West German States 27% East German States & Berlin 19%
Germany 81.6% Other 7.2%
North Rhine Westphalia 54%
10 June 2010
517
10 June 2010
518
SPANISH COVERED BOND PROFILES
10 June 2010
519
AyT Cdulas Cajas (AYTCED)

Description
% Index
0.608
Leef H Dierks
Ratings table
Total assets
NA LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
% Index
NA
Moodys
NA Aaa NA -
S&P
NA AAA NA -
Fitch
NA AAA NA -
With a total volume outstanding of 48bn from 23 benchmark issues at the time of writing, Ahorro y Titulizacin Cdulas Cajas (AYTCED) is Europes third largest covered bond issuer, accounting for c.5% of all benchmark covered bonds issued. Technically, AYTCED, which was founded in 1993, operates as a fund that refinances Cdulas Hipotecarias (CH) and Cdulas Territoriales (CT) issued by smaller- and medium-sized Spanish savings banks under the Spanish Securitisation Law. AYTCED purchases non-benchmark CH and CT originated by savings banks and then issues a (benchmark) covered bond whose principal amount corresponds to the aggregate amount of the principals of the respective Cdulas acquired. AYTCEDs activities are managed by AyT SGFT, an independent company authorised by the Spanish Ministry of Economy and Treasury, which is designed to represent and protect the interests of the bondholders and to enter into various contracts for the issuer.
Risk weighting
As Spanish Cdulas Hipotecarias and Cdulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach when looking through the underlying assets.
Strengths
Liquidity facility: AYTCEDs Multi-Cdulas transactions benefit from the provision of a liquidity facility provided by the Instituto de Crdito Local (ICO), designed to give additional safety and ensure the timeliness of repayments to investors, thereby reducing the bonds default probability. ICO has an unlimited and irrevocable guarantee of the Kingdom of Spain and is rated Aaa/AA+/AA. AYTCED further benefits from being half-owned (50%) by the Spanish savings banks association, CECA. Also, in terms of exchanging debt instruments for liquidity, AYTCED (in contrast to Spanish plain vanilla covered bond issuers) benefits from a direct access to Banco de Espaa. Market position: Within the scope of its 200bn Multi-Cdulas programme, AYTCED has to date launched 11 covered bond transactions with an aggregate amount of nearly 20bn. The programme has a legal life of 50 years and comprises 43 Spanish savings banks, thereby offering Multi-Cdulas investors credit exposure to the Spanish savings banks sector as a whole. Covered bond investors thus benefit from a potentially higher degree of geographical diversity across Spain than in the case of some plain-vanilla Cdulas Hipotecarias. Over-collateralisation: In contrast to plain-vanilla CH or CT, MultiCdulas issued out of the AYTCED programme are subject to a mandatory over-collateralisation of at least 150%. This clearly exceeds the legal requirement of 125% for CH and 143% for CT. Flexible issuance programme (FIP): In late 2006, AYTCED established its so-called flexible issuance programme (FIP). This programme foresees the issuance of at least one 10-year standard benchmark covered bond within the first quarter of each year. This, however, was neither the case in 2008, 2009, or 2010. The FIP also allows for more flexible reverse-inquiry transactions of MultiCdulas in an attempt to smooth covered bond supply throughout the year. Still, these measures currently are of subdued importance.
Weaknesses
Funding costs: In light of the currently more attractive funding levels when issuing plain-vanilla Cdulas Hipotecarias, several Spanish savings banks, which previously relied upon AYTCEDs Multi-Cdulas structure for their refinancing purposes, have meanwhile started tapping capital markets on their own. As a consequence of this development, the last benchmark issuance of an AYTCED deal dates back to July 2009. Consolidation pressures: In our view, the ongoing consolidation among Spanish savings banks, which will likely result in larger institutions with higher refinancing needs and direct capital market access, could trigger more savings banks tapping the capital markets on their own. As AYTCEDs Multi-Cdulas transactions involve up to 25 different smaller and medium-sized Spanish savings banks, the sectors consolidation could result in potential headline risks for AYTCED. Non-performing loan ratio: Over the past few months, the nonperforming loan (NPL) ratio of Spanish savings banks has steadily increased with the sectors average standing at 5.1% at the time of writing. In light of the economic situation in Spain, we believe that the NPL ratios of some of the savings banks involved could be subject to further increases, particularly in light of their exposure towards mortgage lending and lending to property developers, where the respective NPL ratio had reached 9.6% at the time of writing. Structures complexity: AYTCED Multi-Cdulas transactions involve up to 25 different small- to medium-sized savings banks. The structure of an AYTCED deal is thus rather extensive with regards to the information requirements imposed on the participating entities. Within the programmes framework, however, the process has been largely standardised and should significantly simplify matters.
Key points for 2010

Monitor potential spill-over effects attributed to the ongoing consolidation on the Spanish savings bank sector which might reduce the number of savings banks relying on AYTCED for refinancing purposes.
10 June 2010
520

Involved lender Bancaja CAM Caixa Catalunya Ibercaja Caixa Galicia Unicaja Cajasol CCM Caja Murcia Caja Espana Cajasur BBK Caixa Penedes Kutxa Caja Duero Caja Navarra Caixanova Caixa Sabadell Caja G. Canarias CajaStur Cja Granada Sanostra Caixa Laietana Caja Cantabria Caixa Terrassa Caja Burgos CAI Caja I. Canarias Caixa Tarragona Caixa Girona Vital Kutxa Caja Extremadura Caixa Manresa Caja Avila Caja Segovia Circulo Burgos Caja Rioja Caja Badajoz Caixa Manlleu Guadalajara Caixa Ontinyent Caja Jaen Caixa Pollenca Total OC % 471 276 261 375 225 193 298 230 249 271 236 336 247 461 263 283 266 208 229 336 294 200 201 209 198 222 410 207 244 298 442 501 217 284 209 337 364 295 252 298 297 243 1,121 273 Cdulas 6.678 10.886 8.384 5.875 7.502 8.345 5.642 5.383 4.524 4.142 4.624 3.863 4.809 1.800 3.837 3.113 3.207 3.485 3.287 2.515 2.526 3.386 2.997 3.005 2.910 2.646 1.365 2.370 1.835 1.495 1.102 0.800 1.756 1.270 1.526 0.705 0.521 0.601 0.610 0.334 0.195 0.241 0.020 136.095 NPL (%) all 5.06 4.00 5.49 3.38 4.93 2.50 5.11 na 2.32 5.50 10.86 2.53 6.36 2.83 5.38 2.54 4.96 4.60 3.79 3.09 5.02 5.13 6.19 5.55 6.34 4.58 3.83 8.38 4.36 4.72 2.40 3.98 1.92 6.54 3.84 4.32 4.45 4.05 6.18 4.16 4.28 5.04 1.81 4.55 coverage 47 73 47 74 42 139 51 na 90 53 50 98 44 114 48 72 79 40 65 92 71 40 32 53 47 63 54 23 37 46 74 117 72 56 85 131 84 73 28 55 50 61 102 66 5.10 4.97 5.29 2.74 4.81 2.94 6.36 na 3.05 4.60 10.91 2.93 5.09 3.01 5.24 3.81 4.46 5.80 4.53 2.31 5.31 4.92 5.68 5.18 6.69 5.28 4.24 8.68 6.41 5.24 3.22 3.44 3.05 9.34 3.15 5.49 3.37 3.79 5.88 4.01 4.39 4.77 2.00 4.72 LTV Maturity Seasoning % 61 59 61 60 58 55 63 58 59 62 58 60 55 54 60 60 58 61 64 57 62 50 58 60 56 58 59 61 58 60 65 47 59 66 60 58 57 58 49 57 63 54 49 59 239 236 250 272 250 239 225 230 177 241 230 283 247 244 283 290 261 278 265 236 234 218 318 261 323 175 208 239 305 264 221 228 276 206 258 154 229 251 249 251 43 46 50 246 months 28 35 32 36 36 48 47 37 44 46 54 41 38 46 41 49 42 48 53 40 47 40 54 43 34 37 46 51 43 44 45 47 51 36 43 46 44 48 44 40 227 228 252 41 issued bn mortgages
AyT Cdulas Cajas (AYTCED)

Type of property (%) Residential Commercial Developers % LTV > 80% 44.7 44.3 59.0 68.4 68.3 68.5 59.6 52.6 64.0 51.0 65.9 79.3 77.3 73.7 79.3 71.7 53.3 66.4 59.2 62.2 59.7 62.5 58.0 70.5 62.7 59.7 50.7 78.2 68.3 60.7 57.3 55.3 61.3 32.5 51.7 37.8 49.2 68.3 65.6 52.7 52.8 53.9 47.7 58.5 32.9 30.0 7.7 3.6 9.0 5.6 8.0 10.7 6.1 6.2 4.6 4.3 5.8 16.4 4.3 7.3 9.3 6.4 9.2 3.5 6.2 10.6 24.3 7.0 3.9 12.2 8.7 5.9 5.5 6.5 8.3 9.4 2.7 2.6 8.0 9.2 18.5 6.8 5.6 5.6 10.9 19.5 10.4 13.4 22.4 19.0 33.2 23.9 21.6 12.6 14.4 17.4 18.7 38.1 15.0 9.7 7.1 7.0 9.7 15.1 33.0 17.1 12.4 9.9 16.0 16.3 16.3 16.5 31.0 28.2 35.2 14.2 25.4 32.4 26.7 13.0 25.9 49.9 39.8 42.9 24.6 21.2 23.3 28.6 20.9 14.1 7.4 21.4 14.3 14.1 16.9 9.4 11.1 4.0 10.1 6.7 5.0 10.9 5.8 19.5 5.2 15.0 19.5 9.8 8.3 7.7 14.3 13.7 11.7 6.3 7.2 11.2 7.7 14.8 18.7 4.2 9.1 10.8 22.5 9.8 9.8 10.9 11.8 11.7 7.7 6.3 5.4 6.1 12.4 3.7 2.5 11.5
10 June 2010
521
Bancaja (CAVALE)
Description
% Index
0.091
Leef H Dierks
Ratings table
Total assets
111.5bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Note: as at 7 June 2010.
% Index
NA
Moodys
A3 Aaa Negative 32.2
S&P
NR NR NR -
Fitch
BBB NR Stable -
With total assets of 111.5bn at year-end 2009, up 4.7% y/y from 106.5bn a year before, Bancaja, ie, Caja de Ahorros de Valencia, Castelln y Alicante (CAVALE) is Spains third largest savings bank and the countrys sixth largest financial institution. CAVALE is the result of the merger of five Valencia-based savings banks and Sindibank. Headquartered in Castelln, CAVALE is the largest financial institution in Comunidad Valenciana. The lender focuses on providing retail and private banking services as well as insurance and real estate services to more than 2.5mn clients via more than 6,000 employees in more than 1,100 branch offices, of which more than half (57%) were located in Comunidad Valenciana where CAVALE has a c.25% market share. Following a countrywide expansion in previous years, CAVALE meanwhile generates 40% of its business volume outside of Comunidad Valenciana. CAVALEs roots date back to 1878, when the Real Sociedad Econmica de Amigos del Pas de Valencia founded the parent company, Caja de Ahorros de Valencia.
Risk weighting
As Spanish Cdulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Funding profile: Following a strong 16.5% y/y increase in its customer deposits to 50.7bn in 2009 from 43.5bn in 2008, CAVALE markedly reduced its dependency on capital market access for refinancing purposes. Nonetheless, in between 2008 and 2009, CAVALE had strongly relied upon the issuance of government-guaranteed debt instruments. Whereas the customer deposit to loan ratio grew to 63% in 2009 from 52% a year before, the percentage of wholesale funding to total funding fell to 50% from 55%. Customer lending, in contrast, contracted at a pace of 3.4% y/y with mortgage lending growing by a modest 0.6% y/y to 56.5bn and thus 70% of all lending as per year-end 2009. At the same time, however, the surge in deposit taking appears to have affected CAVALEs net interest margin (NIM), which fell by 8.2% y/y to 1.3bn in 2009 from 1.4bn in 2008. In light of the ongoing consolidation on the Spanish banking market, this effect could gain further momentum as higher interest rates paid on customer deposits could have a detrimental impact on CAVALEs NIM and thus its profitability. Support mechanism: Like any other Spanish savings bank, CAVALE benefits from internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederacin Espaola de Cajas de Ahorros (CECA) which offers technological and advisory services which are particularly relevant for smaller savings banks but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAVALE benefits from the depositor guarantee fund Fondo de Garanta de Depsitos (FGD) of Spanish savings banks. In addition to the FGD, cajas benefit from federal support in the form of the FROB (Fondo De Reestructuracin Ordenada Bancaria), which, if necessary, provides funding for the sectors consolidation.
Weaknesses
Asset quality: As at year-end 2009, CAVALEs non-performing loan ratio (NPL) stood at 4.6%, up from 4.1% a year before. The coverage ratio fell to 54.5% from 58.2% as per year-end 2008. Overall, non-performing loans stood at 4.0bn in 2009, up from 3.7bn a year before. Despite standing slightly below the national average, CAVALEs NPL could become subject to a further increase in light of the macroeconomic development in Spain where we expect the GDP to contract by 0.6% y/y in 2010. Also, as c.98% of all mortgage loans granted in Spain are pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 2011, however), need to be watched. Bancaja Habitat: Approximately 20% of CAVALEs overall risk exposure refers to lending to property developers, among them the fully-owned (100%) entity Bancaja Habitat. This, in our view, needs to be carefully monitored, particularly in light of the ailing Spanish housing market, which remains subject to a pronounced supply overhang. Market consolidation: a potential merger with one or more domestic peers, which could arise from the ongoing consolidation process on the Spanish savings banks market, needs to be carefully monitored.
Note: At the time of writing, CAVALE had a 750mn Cdulas Hipotecarias outstanding. Mortgage loans granted amounted to c.56bn as per year-end 2009, the latest date for which data were available.
Key points for 2010

Monitor eventual changes in CAVALEs refinancing strategy which has so far been reliant on customer deposits and the issuance of government-guaranteed debt instruments.
10 June 2010
522

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006
1,150 282 576 2,008 705 1,303 310 1,246 867 79,577 65,586 276 44,050 32,110 30,235 0 3,092 1.2 31.9 35.1 57.3 23.8 0.5 0.5 350.2 7.4 13.1 3.9
Bancaja (CAVALE)
Efficiency
2007
1,326 342 59 1,803 771 1,031 463 774 604
2008
1,443 325 105 1,864 855 1,009 720 531 499
2009
1,324 305 466 2,039 848 1,191 965 371 370
50%
48.9% 1.0% 42.8% 0.9% 35.1%
45.9% 41.6% 0.8% 0.8%
1.1% 0.9% 0.7%
40%
1.0%
30% 2005 2006 2007 Cost/Income ratio 2008 2009 Cost/Assets ratio
99,585 106,500 111,459 79,963 83,902 81,011 316 468 524 54,232 56,023 56,345 36,732 43,490 50,668 40,362 34,322 35,015 0 1,000 1,750 3,564 3,753 3,907 0.7 18.1 42.8 73.5 44.9 0.6 0.9 230.4 7.5 11.9 3.6 0.5 13.7 45.9 77.4 71.4 0.8 4.3 56.8 7.5 11.1 3.5 0.3 9.7 41.6 65.0 81.0 1.2 4.7 54.2 8.1 12.3 3.5
Customer deposits to customer loan

75% 60% 45% 30% 2005 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding % of total funding 57.0% 41.9% 54.0% 57.8% 54.9% 62.5% 49.0% 51.8% 45.9% 49.9% 40% 50% 60%
Net interest margin, credit costs, and RoA

2% 1.5% 1.6% 1.2% 1% 0.6% 0.4% 0.4% 0% 2005 2006 2007 2008 2009 RoA Net interest margin Credit costs 0.7% 0.5% 0.5% 0.7% 1.5% 1.4%
1.2% 0.9% 0.3%
10 June 2010
523
Banco Bilbao Vizcaya Argentaria (BBVASM)

Description
% Index
0.564
Leef H Dierks
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
% Index
0.043
Total assets
535bn
S&P
AA NR Negative -
Fitch
AANR Positive -
Aa2 Aaa Negative 23.6/6.3
With total assets of 535bn, down 1.4% y/y from 543bn in 2008, Banco Bilbao Vizcaya Argentaria BBVA (BBVASM) is Spains secondlargest commercial bank and among the 20 largest credit institutions in Europe. It was created through the merger of Banco Bilbao Vizcaya (BBV) and Argentaria in 1999. BBVASM provides retail, wholesale and investment banking services, as well as leasing, factoring and asset and pension fund management services in Spain, Mexico (via Bancomer and Grupo de Hipotecaria Nacional), the US (via Compass), and South America (via Forum in Chile and Granahorrar in Colombia). As a result of its international expansion in recent years, BBVASM generated only 41% of its 2009 pre-tax income in Spain and Portugal. Operations in Mexico accounted for 23% of the lenders pre-tax income. As per year-end 2009, BBVASM had a total of 103.721 employees (down 4.8% y/y) in 7,466 branch offices (down 4.1% y/y), of which 41% are located in Spain.
Risk weighting
As Spanish Cdulas Hipotecarias and Cdulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Funding base: As per year-end 2009, BBVASMs customer deposits corresponded to a high 79% of all lending, thereby keeping the reliance on the wholesale funding markets at moderate levels. Despite a 0.4% y/y decrease in customer deposits, this level has not markedly changed over the course of the past few years, particularly as overall lending fell 3.5% y/y in 2009. Wholesale funding accounted for 43% of BBVASMs total funding. The latter was relatively strongly geared towards refinancing through mortgage-covered bonds, which as per end H1 09, the latest date for which data were available, accounted for 48% of its long-term debt funding. At the same time, public sector covered bonds accounted for an additional 8%. Profitability: Despite the second consecutive decline in BBVASMs net income to 4.6bn in 2009 (-14.7% y/y), the net interest income experienced an 18.8% y/y increase to 13.9bn in 2009. This more than offset the 32.8% y/y fall in trading income to 892mn in 2009 from 1.3bn in 2008. At the same time, BBVASMs net interest margin (NIM) increased by 23bp to 264bp in 2009, from 241bp in 2008; an important development when considering that net interest income accounted for 72% of the 2009 operating income of 19.2bn. The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental impact on BBVASMs NIM and thus, its profitability. International expansion: In 2009, BBVASM generated only 41% of its ordinary income in its domestic market, ie, in Spain and Portugal. This illustrates the increasing importance of the lenders international operations, particularly in Latin America, which should be a well-suited buffer with which to weather potentially adverse developments in the Spanish housing markets.
Weaknesses
Asset quality: Over the course of the past 12 months, the aggregate amount of doubtful assets has nearly doubled to 15.9bn per year-end 2009, from 8.7bn in 2008, thereby taking the overall non-performing loan ratio (NPL) to 4.3%. The coverage ratio stood at 57%. With regard to the Spanish and Portuguese operations, the respective NPL ratio stood at 5.1%, ie, largely in line with the national average, with a coverage ratio of c.48%. Doubtful mortgage loans in Spain and Portugal stood at 6.4bn. As a result of this development, loan-loss provisions nearly doubled to 5.2bn in 2009, from 2.8bn in 2008, thereby putting considerable strains on BBVASMs net income, which fell by 15% y/y to 4.6bn in 2009. Nonetheless, over the course of the past year, the gross amount of new NPLs in Spain and Portugal has started to slow gradually, falling to 2bn in Q4 from 2.2bn in Q1 09. Still, with regard to mortgage lending, which accounted for c.40% of BBVASMs total lending as per year-end 2009, a total of 17.7bn has been granted to property developers. Thereof, 17% (or 3bn) has been characterised as doubtful. Expected losses amount to 917mn, for which specific provisions of 1bn have been made. Despite the gradual moderation of late, the further NPL development needs to be carefully monitored, particularly in light of macroeconomic developments in Spain, where we expect the GDP to contract by 0.6% y/y in 2010. Also, as c.98% of all mortgage loans granted in Spain are pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), need to be watched. US operations: Despite being irrelevant for the quality of the collateral pool of BBVASMs covered bonds, the further development of the US operations, which generated a pre-tax loss of 1.6bn in 2009, needs to be monitored. Overall, BBVASMs net income fell for the second consecutive year.
Note: As at year-end 2009, BBVASM had covered bonds outstanding totalling 34.5bn.
Key points for 2010

Carefully watch further development of mortgage loans granted to property developers (and individual clients) in Spain, particularly in light of the ongoing economic deceleration. Public sector lending almost doubled to 38.4bn in 2009, from 19.8bn in 2008. This development, in our view, needs to be monitored, particularly in light of potentially higher funding needs for the Kingdom of Spain. 524
10 June 2010

Financial summary
mn 2006 Income statement summary 7,995 Net interest income Net fees & com's 4,335 Trading income 1,261 14,959 Operating income Operating expenses 6,480 8,479 Pre-provision income Loan loss provisions 1,477 Pre-tax profit 7,030 Net income 4,736 Balance sheet summary Total assets 411,916 Customer loans 256,565 of which public sector 17,964 of which mortgages 107,837 Customer deposits 192,374 Debt funding 91,271 of which Cedulas 36,029 Total equity 22,319 Profitability (%) Return on avg assets 5.1 Return on avg equity 24.6 Cost/Income ratio 43.3 Net int inc/Op inc 53.4 Asset quality (%) 17.4 LLPs/Pre-prov inc LLRs/Gross loans 2.6 Prob loans/Gr loans 0.9 Coverage ratio 277.1 Capital adequacy (%) Tier 1 ratio 7.8 Total capital ratio 12.0 Equity/Assets ratio 5.4 2007 9,422 4,723 1,545 16,136 7,199 8,937 1,902 8,495 6,126 502,204 310,882 17,573 123,998 236,183 117,909 39,730 27,943 5.6 27.2 44.6 58.4 21.3 2.2 1.1 208.2 7.3 10.7 5.6 2008 11,686 4,527 1,328 17,541 7,756 9,785 2,797 6,926 5,385 542,650 335,260 19,576 125,540 255,236 121,144 38,481 26,705 4.4 21.0 44.2 66.6 28.6 2.2 2.6 83.9 7.9 12.2 4.9 2009 13,882 4,430 892 19,204 7,662 11,542 5,199 5,736 4,595 535,065 323,442 38,345 127,957 254,183 117,817 34,708 30,763 3.5 16.1 39.9 72.3 45.0 2.6 4.8 54.7 9.4 13.6 5.7
Banco Bilbao Vizcaya Argentaria (BBVASM)

Breakdown by type of borrower, Q1 10
Commercial 24%
Residential 76%
Geographical split, Q1 10
Basque 4% Andalusia 16% Castilla Leon 4% Madrid 20% Valencia Galicia 12% 4%
Canary Islands 5% Balearic Islands 3% Other 13%
Catalonia 19%
Domestic asset quality

5% 4.3%
3% 0.7% 0.6% 0.6% 0.4% 0.2% 0.3% 0.3% 0.3% 0%
2.0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Gross NPLs/Mortgage loans
Customer deposits to loans (net)

120% 37% 38% 42% 44% 44% 44% 47% 42% 43% 50%
Over-collateralisation (bn)
160 120 11.2x 107.8 124.0 125.5 128.0 12 8
80% 111% 104% 40% 2001
25% 95% 86% 84% 75% 76% 76% 79% 0%
6.8x 5.6x77.0 64.0 80 56.0 57.0 63.6 4.1x 40
2003 2005 2007 2009 Cust. deposits to loans Wholesale funding % of total funding
36.0 39.7 38.5 34.7 4 18.9 26.9 5.0 8.4 11.4 3.3x 3.0x 3.1x 3.3x 3.7x 0 0 2001 2003 2005 2007 2009 Residential mortgages Cedulas Over-collateralisation
10 June 2010
525
Bankinter (BKTSM)
Description
% Index
0.05
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
S&P
A NR Stable -
Fitch
A+ AAA Stable 41.2 -
With total assets of 55bn as per year-end 2009, largely stable versus a year before, Bankinter (BKTSM) currently is Spains sixthlargest commercial bank. BKTSM focuses on providing retail banking services to 793,000 private medium- and high-income individuals, as well as small- and medium-sized enterprises (SMEs) through its 369 branch offices and more than 4,500 employees. BKTSM also benefits from a strong internet banking franchise. Headquartered in Madrid, Bankinter SA (BKT) was originally established in June 1965 as a wholesale bank via a joint-venture with Banco de Santander and Bank of America. In 1972, BKTSM was listed on the Spanish stock exchange, thereby gaining full independence from its founders.
Risk weighting
Strengths
Asset quality: As per year-end 2009, BKTSM benefited from a comparatively sound asset quality, with the non-performing loan (NPL) ratio standing at 2.8%. Despite having nearly doubled from 1.5% a year before, it stands clearly below the sector average of 5.1%. At the same time, the coverage ratio stands at 73%. With regard to BKTSMs mortgage loan book, which accounted for a high c.71.5% of all lending as per yearend 2009, the respective NPL ratio stood at 2%, more than double the level observed in 2008 (0.9%) but markedly below the national average. Whereas BKTSMs market share in mortgage lending stood at c.4%, its share in lending to property developers stood at a very low 0.3%. A reason for concern, however, could arise from the fact that the quarterly gross NPL entries steadily increased throughout 2009. Net NPL entries fell at the same time as recoveries markedly picked up. Also, note that BKTSMs lending to the public sector more than quintupled to 213mn in 2009 from 39mn in 2008. Despite the overall volume being fairly modest, this further development should be watched closely. Profitability: Despite the 14% y/y increase in loan-loss provisions to 221mn in 2009 from 193mn in 2008, which we believe is moderate in comparison with its domestic peers, BKTSM could keep its 2009 net income stable at 254mn after 252mn in 2008. This is mostly attributable to the 17.7% y/y increase in BKTSMs net interest income, which amounted to 793mn in 2009 after 673mn in 2008, thereby offsetting the c.10% declines in net fee and commission and trading income, respectively. Overall, net interest income accounted for 71% of all operating income, with BKTSAM benefiting from a 16bp increase in its net interest margin to 151bp in 2009 from 135bp in 2008. The ongoing consolidation on the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental effect on BKTSMs NIM and, thus, its profitability. Also, over 2009, BKTSMs cost-to-income ratio was subject to a marked increase to 57% from 47% a year before.
Weaknesses
SME business: Spurred by a 49bn loss in its SME division in 2009 (after generating a 48bn income in 2008), BKTSMs 2009 earnings were mostly driven by its capital market activity. Earnings in all customer business divisions, in contrast, contracted. Further development needs to be monitored carefully, in our view, particularly in light of BKTSMs exposure to the Spanish SME sector, which could be affected by more than the average from a further delay in the economic recovery. (We expect the Spanish GDP to contract 0.6% y/y in 2010.) Still, this potential weakness is partly mitigated by the fact that lending to SMEs remained stable over the past year, thereby not increasing BKTSMs exposure towards this market segment. Capital market reliance: With customer deposits falling 5% y/y to 21.8bn in 2009 and lending to customers contracting 0.6% y/y to 39.9bn in 2009, BKTSMs overall reliance on capital markets has gradually increased. As per year-end 2009, deposits accounted for 55% of all lending, down from 57% a year before. Overall, the proportion of wholesale funding versus total funding grew to 47% in 2009 from 39% in 2008. Despite the benign conditions on global capital markets at the time of writing, this development, in our view, needs to be monitored. Overall, the wholesale funding structure appears to be relatively well balanced, however, with senior debt accounting for 24.4% as per year-end 2009, followed by covered bonds (22.9%), securitisations (20.3%), commercial paper (15.4%), and interbank liabilities (15.2%), among others. Capitalisation: With 7.4%, BKTSMs Tier 1 ratio was below market average as at end 2009.
Note: At the time of writing, BKTSM had two benchmark EUR-denominated Cdulas Hipotecarias outstanding, totalling 2.0bn.
Key points for 2010

Carefully monitor the further performance of BKTSMs exposure towards domestic smaller to medium-sized enterprises business in light of the expected 2010 GDP contraction in Spain.
10 June 2010
526

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 457 217 98 818 402 416 97 316 208 46,076 31,654 na 24,622 17,471 14,794 0 2,521 0.5 8.3 49.2 55.9 23.3 0.3 0.3 571.0 6.9 10.0 5.5 2007 569 244 74 947 512 435 76 484 362 49,649 37,580 60 25,975 21,285 16,805 0 1,745 0.8 17.0 54.1 60.0 17.4 0.2 0.4 371.0 6.3 9.6 3.5 2008 673 226 103 1,056 498 558 193 337 252 53,468 40,144 39 28,537 22,914 14,352 2,000 1,965 0.5 12.1 47.2 63.8 34.6 0.5 1.5 116.6 7.4 10.2 3.7 2009 793 202 89 1,111 632 478 221 346 254 54,468 39,884 213 28,498 21,783 19,090 2,000 2,553 0.5 12.2 56.9 71.4 46.1 0.6 2.8 72.5 7.4 10.4 4.7
Bankinter (BKTSM)
NIM, credit costs and RoA
2.0% 1.0% 1.0% 0.5% 0.2% 0.0% 2006 2007 Net interest margin 1.2% 0.8% 0.2% 0.4% 2008 Credit costs 1.4% 1.5%
0.5%
0.5% 0.4% 2009 RoA
Efficiency
75% 57% 50% 49% 25% 0.9% 0% 2006 2007 Cost/Income ratio 1.0% 2008 2009 Cost/Assets ratio 0.8% 54% 1.1% 47% 1.2% 1.8%
1.3%

60% 38.5% 57.1% 50% 2008 2009 Customer deposits to loans Wholesale funding in % of total funding 54.6% 30% 46.7% 50%
55%
40%
10 June 2010
527
Banco Santander (SANTAN)

Description
% Index
0.50
Leef H Dierks
Ratings table
Total assets
1,111bn LT senior unsecured Covered bond rating (Cdulas Hipotecarias) Covered bond rating (Cdulas Territoriales) Outlook Discontinuity factor Collateral score
% Index
0.196
Moodys
Aa2 Aaa Aaa Negative 21.0
S&P
AA AAA NR Negative -
Fitch
AA AAA AAA Stable 40.8 -
With total assets amounting to 1,111bn as at year-end 2009, up 6% y/y from 1.050bn as at year-end 2008, Banco Santander (SANTAN) is Spains largest commercial bank and ranks among the worlds largest financial institutions. At year-end 2009, SANTAN was the 8th largest bank in the world by market value. It is headquartered in Madrid and provides global universal banking services through nearly 170,000 employees in more than 13,500 branch offices. As at year-end 2009, SANTAN had 92mn customers of which 29% were located in Europe, 27% in the UK, and 43% in the Americas. In addition to its own issues of Cdulas Hipotecarias and Cdulas Territoriales, SANTAN also backs the Multi-Cdulas Programme PITCH, and regularly taps the market through its subsidiaries Abbey (UK), and Banco Santander Totta (Portugal). Also, Santander Consumer Finance has issued a benchmark Cdulas Hipotecarias.
Risk weighting
Strengths
Profitability: Following a 41% y/y increase in SANTANs net interest income to 26.3bn in 2009, from 18.6bn in 2008, the lenders overall profitability remained high, with net income largely unchanged at 9.5bn (+1.4% y/y) in 2009 versus 9.3bn in 2008. This arose despite a sharp 59% y/y increase in SANTANs loan-loss provisions. At the same time, the average net interest margin (NIM) increased to 243bp in 2009 from 190bp in 2008 and 175bp in 2007. Taking into consideration that SANTAN started attracting customer deposits via relatively high interest rates in early 2010, the lenders NIM and thus its profitability could come under pressure. Asset quality: Approximately 58% of all lending (of which Spain and Portugal combined accounted for 41%) conducted on behalf of SANTAN was backed by mortgage loans. Still, as 96% of all mortgage loans granted are subject to a variable interest rate, potential rate hikes might leave their mark on SANTANs asset quality. In our view, this is mitigated by the facts that c.94% of all mortgage loans are secured on first homes and the average LTV stands at a modest 56%. Geographical diversification: Over the past few years, SANTAN has steadily increased its international presence. At the time of writing, the lender had concentrated its operations in nine major markets, eg, Spain, Portugal, Germany, the UK, the US, Brazil, Mexico, Chile, and Argentina. Underlining this international presence, in 2009 only c.37% of SANTANs profits were generated in Spain and Portugal. Capitalisation: As at year-end 2009, SANTANs Tier 1 ratio stood at a high 10.1%, up from 9.1% a year before and 7.7% in 2007. The total capital ratio stood for 2009 was 14.2% versus 13.3% in 2008.
Weaknesses
Loan-loss provisions: With the non-performing loans ratio increasing to 324bp in 2009, from 204bp in 2008 (but still remaining below the 505bp industry average), SANTANs net loanloss provisions experienced a marked 43.7% y/y increase to 9.5bn in 2009 from 6.6bn in 2008. Overall, non-performing loans amounted to 24.6bn in 2009, up a strong 73% y/y from 14.2bn in 2008. With loan-loss allowances standing at 18.5bn in 2009 versus 6.7bn in 2008, the respective NPL coverage stands at 75.3% in 2009, down from 90.6% in 2008 and 151% in 2007. Similarly to its domestic peers, SANTAN has created a new business unit designed to recover loans. Still, taking into consideration the economic situation in Spain (which accounts for 115bn and thus c.17% of all lending) as well as potential ECB rate hikes (which we do not expect to occur before Q1 11) we caution that the potentially deteriorating asset quality could trigger a medium-term increase in SANTANs loan-loss provisions. Property developers: As at year-end 2009, SANTANs exposure to property developers in Spain amounted to 12.2bn, or c.1.6% of its global credit portfolio. Even though this reflects a 9.3% y/y decline versus 2008, we caution that this sector will probably cause further write-offs, particularly as the respective NPL ratio stood at 6.2% and thus clearly above SANTANs average of 3.2%. At the same time, SANTAN has reduced markedly the volume of its property acquisitions, which amounted to 2.9bn in 2009, down from 3.8bn in 2008. Note that property is being sold through SANTANs fully-owned subsidiary Altamira.
Note: In Q3 09, the latest date for which data were available, SANTAN had issued Cdulas Hipotecarias with a nominal amount of 25.560bn. The respective overcollateralisation stood at 219%
Key points for 2010

The further development of SANTANs NPL ratio, which stood at 324bp as at year-end 2009, needs to be carefully monitored, particularly in light of the economic situation in Spain.
10 June 2010
528

Financial summary
mn 2006 Income statement summary Net interest income 12,480 Net fees & com's 7,024 Trading income 2,149 Operating income 21,936 Operating expenses 10,025 11,911 Pre-provision income Loan loss provisions 2,551 Pre-tax profit 8,779 Net income 6,582 Balance sheet summary Total assets 833,873 Customer loans 484,790 of which public sector 5,329 of which mortgages 302,587 Customer deposits 314,377 Debt funding 204,832 of which CH 22,500 of which CT 2,000 Total equity 42,431 Profitability (%) Return on assets 0.80 Return on equity 16.0 Cost/Income ratio 45.7 Net int inc/Op inc 56.9 Asset Quality (%) LLPs/Pre-prov income 21.4 LLRs/Gross loans 0.5 Problem loans/Gr loans 0.9 Coverage ratio 187.5 Capital adequacy (%) Tier 1 ratio 7.4 Total capital ratio 12.5 Equity/Assets ratio 5.1 2007 15,295 8,040 2,998 27,065 10,940 16,125 3,470 10,910 8,631 912,915 533,751 5,633 322,687 317,043 241,935 26,500 2,000 57,558 0.99 17.3 40.4 56.5 21.5 0.6 1.1 150.5 7.7 12.7 6.3 2008 18,625 8,451 2,802 29,878 11,892 17,986 5,976 11,370 9,332 2009 26,299 9,080 3,423 39,382 14,824 24,558 9,484 11,764 9,458
Banco Santander (SANTAN)

Customer deposits to customer loans
120% 37.4% 45.2% 47.4% 50.2% 60% 36.0% 39.4% 35.6% 46.9% 46.9% 40% 80% 104%103% 92% 88% 20% 72% 65% 59% 66% 73% 40% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding in % of total funding 0%
1,049,632 1,110,529 611,811 664,146 7,668 9,803 353,327 411,778 405,615 487,681 265,465 243,295 24,950 25,560 2,000 2,000 60,001 73,871 0.95 15.9 39.8 62.3 33.2 1.0 2.3 90.6 9.1 13.3 5.7 0.88 14.1 37.6 66.8 38.6 1.4 3.6 75.3 10.1 14.2 6.7
Over-collateralisation
100 bn 8.9x 50 23.3 26.7 0 0.0x 35.1 43.3 51.1 59.4 83.3 53.8 56.0 26.3 25.6 2.0x 2.2x 5 10
22.5 26.5
3.5x 3.6x 19.0 10.0 12.0 3.0 2.7x 2.6x 3.1x
2001 Mortgages
0 2003 2005 2007 2009 Cedulas Over-collateralisation (x) rhs
Asset quality (Spain)

200% 156% 166% 182% 188% 151% 133% 2 150% 2.27 2.17 2.20 91% 136% 1.84 1 75% 100% 1.20 1.06 0.93 1.14 3 0 2001 2003 2005 2007 2009 Reserve coverage Gross NPLs/Spanish loans 50%
Geographical split (consumer loans), 2010

Continental Europe 47%
LTV ratios, 2010

60-80% 26% 80-100% 15% 0-20% 9% 40-60% 27% 20-40% 23%
United Kingdom 33% Latin America 15%
US 5%
10 June 2010
529
Banco Popular (POPSM)

Description
% Index
0.149
Leef H Dierks
Ratings table
Total assets
129bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Note: as at 7 June 2010
% Index
NA
Moodys
Aa3 Aaa Negative 22.2%
S&P
A NR Negative -
Fitch
AAAAA Negative 41.3 -
Founded in 1926, Banco Popular (POPSM) is Spains third-largest commercial bank (and fifth-largest banking group) with total assets amounting to 129bn as at year-end 2009, up a strong 17.1% y/y from 110bn as per year-end 2008. In addition to retail banks operating on a country-wide level, Banco Popular comprises five regional retail banks, Banco de Andaluca, Banco de Castilla, Banco de Crdito Balear, Banco de Vasconia, and Banco de Galicia Operations are limited to retail and commercial banking, serving 6.7mn clients through 14,400 employees in 2,420 branch offices. POPSMs overall market share amounted to 4.4%. In addition to its domestic operations, POPSM has operations in Portugal and the US (Totalbank), respectively. POPSM also controls Banco Popular Hipotecario, a fullyowned subsidiary that specialises in property financing.
Risk weighting
Strengths
Funding structure: With customer deposits recording a 15.3% y/y increase to 59.6bn in 2009, from 51.7bn in 2008, and customer lending growing at a more moderate 3.5% y/y to 95.0bn from 91.7bn over the same period, POPSMs depositto-loan ratio increased to 62.7% in 2009, from 56.3% a year before. In light of interbank deposits nearly doubling to 20.8bn in 2009 from 10.6bn in 2008, however, the overall reliance on wholesale funding stood stable at around 47% of all funding. With regard to the 34.4bn wholesale funding, 29% was accounted for by covered bonds, followed by the EMTN programme (24%), and POPSMs ECP programme (17%). The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental impact on POPSMs NIM (257bp in 2009) and thus the lenders profitability. Eventually, any such development might drive POPSM to increase its reliance on wholesale funding. Over-collateralisation: With a total of 16bn of covered bonds outstanding as at year-end 2009 and a collateral pool comprising 33.5bn, the over-collateralisation of the covered bonds issued by POPSM stood at a sound 210%. Yet, only 19.4bn and thus 57.9% of the collateral pool corresponded to residential mortgage loans of which, however, 81% were secured by loans on first homes. From a geographical point of view, the Mediterranean Rim regions of Andalusia (24%), Comunidad Valenciana (9%), and Catalonia (9%), accounted for the bigger portion (42%), followed by Galicia (22%), and Madrid (15%). The weighted average LTV stood at 57%, with a high 32% of all residential mortgage loans, however, being subject to a LTV of 70% or higher. All mortgage loans were selforiginated.
Weaknesses
Non-performing loans: As at year-end 2009, POPSMs nonperforming loan (NPL) ratio stood at 4.8%, strongly up (201bp) from 2.8% a year before as gross NPL had increased by 81% y/y to 5.5bn, from 3.0bn in 2008. Gross lending, however, increased at a pace of 3.5% y/y. The coverage ratio stood at 50.3% in Q4 09, with overall loan-loss provisions amounting to 2.7bn. Mortgage lending to property developers amounted to 7.5bn or 15.7% of all lending as per year-end 2009. This corresponds to a 10% y/y (831mn) decline. Exposure to SME sector: Further developments need to be carefully monitored, particularly in light of POPSMs exposure to the Spanish SME and corporate sector, which accounted for 58% of all 2009 revenues. In our view, POPSM might be affected by more than the average from a further delay in the economic recovery. (We expect Spanish GDP to contract by 0.6% y/y in 2010.) Mitigating potential adverse effects on POPSMs asset quality is the fact that roughly 50% of POPSMs loan book consists of mortgage lending. Potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), therefore could be less significant for the quality of POPSMs loan book than for its domestic peers. Still, public sector lending on behalf of POPSM almost trebled to 420mn in 2009, from 144mn in 2008. This development, in our view, needs to be monitored, particularly in light of potentially higher funding needs for the Kingdom of Spain and the respective autonomous communities.
Note: In addition to its covered bond programme, POPSM was involved in the InterMoney Cdulas covered bond programme. For more detailed information on the InterMoney Cdulas issues, please refer to the respective profile within this section.
Key points for 2010

Following a 201bp increase over the course of 2009, the further development of POPSMs NPL ratio, which stood at 4.8% as at year-end 2009, needs to be closely monitored.
10 June 2010
530
Financial and spreads

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 2,284 884 73 3,336 1,108 2,228 342 1,943 1,337 107,169 86,642 130 46,860 42,662 36,323 9,400 6,641 1.5 22.8 33.2 68.5 15.4 2.1 0.9 218.4 7.9 9.7 6.2 2008 2,535 865 74 3,567 1,216 2,351 998 1,461 1,052 110,376 91,702 144 48,276 51,665 31,825 9,160 7,058 1.1 17.0 34.1 71.1 42.5 2.4 3.2 73.0 8.1 9.1 6.4 2009 2,822 763 356 3,950 1,188 2,762 1,752 1,073 766 129,290 94,956 420 47,656 59,558 32,154 10,694 8,448 0.7 11.0 30.1 71.4 63.4 2.8 4.8 50.3 9.1 9.6 6.5
Banco Popular (POPSM)

Breakdown of mortgages by LTV, 2010
LTV <30% 15%
LTV >70% 32%
LTV 50%75% 44%
LTV 25%50% 26%
Breakdown of mortgages by region, 2010

Madrid 15% Catalua and C.Valenciana 18% Galicia 22% Others 21% Andalucia 24%

300 206 200 100 0 2003 0.9 0.8 0.9 2005 Coverage ratio 0.8 2007 2009 222 249 262 218 73 3.2 0.9 0 Prob loans/Gross loans 50 5.6 6 4 2

75 50 25 0 2003 2004 2005 Cust deposits/loans 66.5 64.4 52.4 47.8 49.2 56.3 62.7 37.2 39.2 49.3 54.0 51.7 45.1 47.1 60 40 20
0 2006 2007 2008 2009 Wholesale funding/Tot. funding
10 June 2010
531
Banco Sabadell (BANSAB)

Description
% Index
0.122
Leef H Dierks
Ratings table
Total assets
Note: as at 7 June 2010
% Index
NA
Moodys
S&P
A NR Stable -
Fitch
A NR Negative -
With total assets of 83bn as at year-end 2009, up 3% y/y, Banco Sabadell (BANSAB) is Spains fourth-largest banking group. In addition to its Banco Sabadell brand, BANSAB operates through Sabadell Atlntico, Banco Herrero, Solbank, ActivoBank, and Banco Urquijo. BANSAB provides corporate, commercial and private banking services as well as asset management services. In 2008, BANSAB sold 50% of its insurance operations to Zurich. BANSAB, which operates through nearly 9,500 employees in 1,200 branch offices, was originally founded in 1881 to provide commercial banking services to the industry in Catalonia, which is still BANSABs core market. In addition, Banco Sabadell holds a 40% stake in Dexia Sabadell Banco Local, an entity specialising in medium- and long-term financing to the various territorial governments in the Spanish market.
Risk weighting
Strengths
Funding profile: With customer deposits of 39.1bn as at yearend 2009, ie, virtually unchanged from year-end 2008 (39.2bn), BANSABs reliance on wholesale funding remained relatively moderate, despite increasing by 4pp to 46% in 2009, from 42% in 2008. In aggregate, customer deposits accounted for nearly two-thirds (62%) of all customer lending in 2008 and 2009. This stability is largely attributed to the moderation in customer lending, which grew at a pace of only 0.3% y/y to 63.2bn in 2009, from 63.1bn in 2008. Mortgage lending, which accounted for 51% of all lending, increased at a pace of 2.1% y/y. Profitability: Despite the challenging conditions in its domestic market, BANSABs net interest income increased by 10% y/y to 1.6bn in 2009, from 1.5bn in 2008 and 1.3bn in 2007. At the same time, the net interest margin (NIM) increased to 200bp from 180bp in 2008 and 170bp in 2007. The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates being paid on customer deposits. This, in turn, could have a detrimental impact on BANSABs net interest margin and thus the lenders profitability. Capitalisation: Following the issuance of preference shares and subordinated bonds, which are mandatorily convertible into shares, BANSAB increased its Tier 1 and core capital ratios. In early 2010, BANSAB conducted a sale and lease-back operation on 378 properties worth 403mn. Even though this elevated the lenders core capital by another 30bp, we highlight that this is a one-off effect.
Weaknesses
Asset quality: Over the course of the past year, the proportion of non-performing loans (NPL) has increased to 3.7% (or 2.7bn) of all lending, from 2.4% in 2008 (1.6bn) and 0.5% in 2007. Despite this ratio being below the national average, BANSABs coverage ratio has markedly fallen of late, declining to c.69% as at year-end 2009 from c.107% at year-end 2008. Including mortgage loans, the coverage ratio stands at c.125%. Roughly 60% of the doubtful loans are secured by mortgage loans. Since Q3 09, the net increase in NPLs has started to gradually decline and grew at a pace of 215mn in Q4 09, up from 208mn in Q3, but down from 265mn in Q2 and 325mn in Q1 09. As at yearend 2009, 32bn (+3% y/y) and thus 49% of BANSABs total loan portfolio (65bn) consisted of mortgage lending. Loans to property developers accounted for 11%, followed by lending to the construction sector, which corresponded to 5% of all lending. Despite this moderation, further NPL development needs to be carefully monitored, particularly in light of macroeconomic developments in Spain, where we expect GDP to contract by 0.6% y/y in 2010. Also, as c.98% of all mortgage loans granted in Spain are pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), need to be watched. Solvia: The latter is BANSABs subsidiary, which manages real estate assets that are not connected with the banking business and are held for sale. As at year-end 2009, assets amounted to 1.5bn; of these, 52% was development land. Plots prepared for development made up 33% and the remaining 15% of the portfolio was split between rental property and real estate developments for sale. 75% of the assets were residential properties. 50% of the assets were located in Catalonia, mainly in Barcelona, and another 25% were in Madrid.
Note: At the time of writing, BANSAB had a total of six benchmark Cdulas Hipotecarias totalling 8.5bn outstanding. Mortgage loans granted amounted to c.32bn as at year-end 2009, the latest date for which data were available.
Key points for 2010

Carefully monitor further NPL developments in light of the ongoing economic deceleration in Spain. BANSABs asset quality could also come under (renewed) pressure in the case of (earlier-then-expected) ECB hikes. 10 June 2010 532

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 1,076 550 36 1,793 849 944 249 712 572 72,780 54,557 143 23,240 30,091 25,690 5,950 4,159 0.9 15.3 47.4 60.0 26.4 0.4 0.5 429.4 7.3 11.4 5.7 2007 1,292 630 93 2,175 1,025 1,150 212 990 788 76,776 61,999 266 33,881 33,350 29,000 7,500 4,605 1.1 18.0 47.1 59.4 18.5 0.3 0.5 367.5 7.2 10.9 6.0 2008 1,453 558 68 2,227 979 1,248 879 686 676 80,378 63,066 na 31,375 39,199 24,118 8,700 4,448 0.9 14.9 44.0 65.2 70.5 1.4 2.5 107.1 7.3 9.8 5.5 2009 1,601 511 248 2,505 1,037 1,468 838 568 522 82,823 63,233 na 32,022 39,131 24,852 13,109 5,297 0.6 10.7 41.4 63.9 57.1 1.3 3.7 69.2 9.1 10.8 6.4
Banco Sabadell (BANSAB)

Geographical split (consumer loans), 2010
Madrid 14% Andalusia 6% Valencia & Balearics 7% Asturias 4% Other 27%
Catalonia 40%
Breakdown of mortgages by type, 2010

Other 5%
Developers 25%
Residential 52% Commercial 18%
mn 7.5x 40 20 0 2003 2004 Mortgages 2005 2006 Cdulas 2007 2008 2009 Overcollateralisation Over-collateralisation (x) 5.8x 14.6 2.5 33.9 4.8x 23.2 20.0 4.2 3.9x 6.0 31.4 4.5x 7.5 3.2x 9.8 32.0 8 6 13.1 4 2.4x2 0
11.3 1.5
Customer deposits to customer loan (net)

100% 80% 91% 60% 40% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 24% 50% 49% 41% 83% 36% 36% 27% 72% 73% 42% 46% 40% 60%
61% 55% 54% 62% 62% 20%
10 June 2010
533
Banco Pastor (PASTOR)

Description
% Index
0.067
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
S&P
NR NR NR -
Fitch
NR NR NR -
With total assets of 32.3bn as per year-end 2009, up 19% y/y from 27.1bn as per year-end 2008, Banco Pastor (PASTOR) is among the medium-sized commercial banks in Spain, focusing on the provision of domestic retail banking, ie, deposit-taking and lending services to individual customers and small- and medium-sized enterprises (SMEs) through 4,200 employees in 610 branch offices. PASTOR, which was founded in 1776 and thus is Spains secondoldest bank, is headquartered in La Corua. More than a third (233 or 38%) of PASTORs branch offices are located in the lenders core market, Galicia, where it benefited from a sound 10.1% market share and where 32% of all loans were granted as at year-end 2009. At the time of writing, PASTOR was the seventh-largest banking group in Spain.
Risk weighting
Strengths
Funding profile: As at year-end 2009, customer deposits of 13.7bn, up 2.6% y/y, accounted for a high 67% of all lending, which at the same time stood at 20.8bn, down 2% y/y. In consequence, PASTORs reliance on wholesale funding stood at a relatively moderate 41% as per year-end 2009, up from 37% a year before. In terms of its institutional funding structure, covered bonds accounted for 42% of wholesale funding, followed by interbank deposits (23%), floating rate notes (FRN) (15%), and securitisations (13%). Ownership structure: With the Pedro Barri de la Maza Foundation (PBMF), ie, the descendants of the banks founding family holding a 42.2% stake of the share capital as at year-end 2009, PASTOR benefits from a stable ownership structure. Retail investors held 24.11% of the shares as at year-end 2009, followed by institutional investors (18.0%) and domestic rival Caixanova, which holds a 5.4% stake. Ponte Gadea Group and Casagrande Cartagena hold a 5.1% stake each. Note that apart from Caixanova, which acquired the respective stake in 2007, these ratios have not changed materially during the past few years. Profitability: Despite the net interest margin (NIM) declining to 190bp in 2009 from 210bp in 2008 to 547mn, PASTOR generated the highest net interest income in its history. The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental impact on PASTORs NIM and thus the lenders profitability. Also, over the course of the past few years, PASTORs cost-income ratio has steadily declined, falling to a low 33% in 2009, from 39% in 2008 and 42% in 2007. Among the drivers behind this development, which are supportive for the lenders operating income, is the closure of 55 branch offices over the course of the past year. Capitalisation: In 2009, PASTORs Tier 1 ratio improved to 10.6%, from 7.5% in 2008.
Weaknesses
Asset quality: In 2009, PASTORs loan-loss provisions amounted to 604mn, up 172% y/y from 245mn in 2008. At the same time, loan-loss reserves increased to 830mn, from 493mn in 2008, thereby taking the coverage ratio to 118.7% as per yearend 2009 from 114.2% a year before. As per year-end 2009, PASTORs overall NPL ratio stood at 4.9% and thus only slightly below the sectors NPL average of 5.1%. Yet, as of recent, NPL growth has started showing signs of a slowdown, remaining unchanged in Q4 09. Overall, net NPL entries have steadily fallen over the course of the past five quarters, amounting to 118mn in Q4 09. Still, as per year-end 2009, the volume outstanding of repossessed properties amounted to 921mn, with a loss provision of 15%. As per year-end 2009, 12.1bn (-2% y/y) and thus 59% of PASTORs total loan portfolio (20.4bn) consisted of mortgage lending. Loans to property developers accounted for 9% of all lending. Whereas 6.7bn or 56% of PASTORs mortgage portfolio consisted of commercial mortgage lending (average LTV: 48.1%), the remaining 44% (5.2bn) were residential mortgage loans (average LTV: 59.7%). Despite the moderation in NPL growth, further development needs to be carefully monitored, particularly in light of macroeconomic developments in Spain, where we expect GDP to contract by 0.6% y/y in 2010. Also, as 95.7% of all mortgage loans granted by PASTOR are pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), need to be watched. Also, note that between April and November 2009, PASTOR increased its market share in mortgage lending to 3.3% from 1.0%, thereby making it potentially more vulnerable to a further downturn on the Spanish housing market.
Note: At the time of writing, PASTOR had four EUR-denominated benchmark covered bonds outstanding with an aggregate amount of 4.2bn.
Key points for 2010

Carefully monitor further NPL developments given the ongoing economic deceleration in Spain. PASTORs asset quality could also come under (renewed) pressure in the case of (earlierthen-expected) ECB hikes. Over-collateralisation: As at end-February 2010, the latest date for which data were available, the amount of PASTORs Cdulas Hipotecarias outstanding amounted to 5.5bn. Mortgage loans eligible for inclusion in the collateral pool amounted to 8.0bn, thereby taking the over-collateralisation to 114%. 534
10 June 2010
Financial and spreads

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which Mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 442 143 9 611 281 330 92 251 162 23,782 19,681 42 11,384 10,966 9,229 2,000 1,155 1.0 17.6 46.0 72.3 27.9 2.0 273.9 7.3 12.3 4.9 2007 527 161 24 730 304 426 127 295 209 25,326 20,428 46 11,121 12,956 7,682 2,000 1,278 1.0 18.0 41.7 72.3 29.8 2.7 277.0 7.2 11.7 5.0 2008 526 163 156 851 331 520 245 221 164 27,121 20,788 213 11,746 13,330 7,197 3,430 1,370 0.7 12.9 38.8 61.8 47.1 2.3 114.2 7.5 10.6 5.0 2009 547 154 343 1044 345 699 604 131 101 32,325 20,385 204 12,080 13,683 7,983 4,000 1,430 0.4 7.4 33.0 52.4 86.4 3.9 118.7 10.6 12.5 4.4
Banco Pastor (PASTOR)

Shareholder structure, 2010
Board of Directors 0.2% P. Barri de la Maza Foundation 42% Pontegadea Inversiones 5% Retail lnvestors 24%
Caixanova 5% Casagrande Cartagena 5% Institutional lnvestors 18%
Regional structure, 2010

Other 16% Madrid 16% Andalucia 11% Catalunya 13%
Levante 13%
Galicia 31%

50 93 87 30 12 10 2001 2003 2005 2007 2009 Wholesale funding to total funding Customer deposits to loans 14 76 21 33 57 63 64 56 50 38 48 40 37 41 67 100
75
67

3 2 1 1.0 0 2006 NIM 2007 1.0 0.7 2008 Credit costs 2.3 1.3 2.3 1.3 0.9 0.5 0.4 2.1 1.9
Domestic asset quality, 2010

340 240 140 40 2009 RoA 2004 2005 2006 2007 2008 2009 Coverage ratio Problem loans/Gross loans 1.0 0.7 0.8 0.7 114 0 284 267 274 277 3.7 2.2 119 2 4
10 June 2010
535
Banesto (BANEST)
Description
% Index
0.221
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
Aa3 Aaa Negative -
S&P
AA NR Negative -
Fitch
AA AAA Stable 41.5 -
With total assets of 122bn as at year-end 2009, up 4.4% y/y from 117bn in 2008, Banco Espaol de Crdito Banesto (BANEST) is the fifth-largest bank in Spain. BANESTs main focus is on providing commercial, wholesale, and retail banking services to its more than 2.2mn individual and c.400,000 small- and medium-sized corporate clients (SMEs). After a pronounced reduction in headcount over the course of the past year, BANEST had 8,905 employees (down 813 y/y) in 1,773 branch offices (down 142 y/y) as at year-end 2009. Its average market share stood at around 9% in 2008, but had increased to 10.4% in new lending in 2009. BANEST was originally founded in 1902 and has become a majority-owned subsidiary (87% as at year-end 2009) of Banco Santander (SANTAN).
Risk weighting
Strengths
Funding structure: Following a moderate 1.9% y/y decline in customer deposits to 57.1bn in 2009, from 58.2bn in 2008 and a 2.8% y/y decline in customer lending to 75.6bn, from 77.8bn at the same time, BANESTs 2009 deposit-to-loan ratio stood at a sound 75.5%, slightly up from 74.8% in 2008. At the same time, wholesale funding, among it more than 16bn of covered bonds, accounted for 53.5% of BANESTs total funding. Profitability: Over the course of 2009, BANEST increased its net interest income, which accounted for 69.4% of the lenders operating income, by 9.6% y/y to 1.7bn, from 1.6bn a year before, thereby offsetting the 1.9% y/y decline in the net interest and commission income, which fell to 608mn in 2009, from 619mn a year before. At the same time, the net interest margin (NIM) remained stable at 152bp. The ongoing consolidation in the Spanish banking market could eventually lead to higher interest rates paid on customer deposits, which in turn could have a detrimental impact on CAIXABs NIM and thus its profitability. Still, we regard BANESTs closure of 142 branch offices and the lay-off of 813 employees over the course of 2009 as the right measure to position itself for the challenging environment in the Spanish banking sector. BANESTs cost-toincome ratio fell to a low 35.9% in 2009, from 38.5% in 2008. Ownership: As at year-end 2009, Banco Santander (SANTAN) held an 87% stake in BANEST. Considering its strategic importance and the close integration, especially with regards to IT-systems and the insurance business, BANESTs individual credit ratings are likely to remain strongly dependent on the close ties between both banks. Also, in our view, this makes the likelihood of potential support in the event of distress relatively high.
Weaknesses
Increase in NPL ratio: With a non-performing loan (NPL) ratio of 2.9% as per year-end 2009, BANEST benefitted from a relatively high asset quality compared to its domestic peers. Still, as this ratio stood at 1.6% as at year-end 2008 and only 0.5% at yearend 2007, further developments need to be carefully monitored, particularly in light of BANESTs exposure to the Spanish SME sector, which could be affected above average from a further delay in the economic recovery. (We expect Spanish GDP to contract by 0.6% y/y in 2010.) In total, NPLs stood at 2.6bn in 2009, of which 1.3bn were secured with expected losses amounting to 839mn. With loan-loss provisions of 1.6bn, the coverage ratio stood at 63.4%, down from 105.37% as per yearend 2008. Mitigating the potential adverse effects on BANESTs asset quality is the fact that only 49% of BANESTs loan book consists of mortgage lending. Potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), therefore could be less significant for the quality of BANESTs loan book than for its domestic peers. Still, we note that public sector lending on behalf of BANEST increased by 35.6% y/y to 2.0bn in 2009, from 1.4bn in 2008. This development, in our view, needs to be monitored, particularly in light of potentially higher funding needs for the Kingdom of Spain.
Note: Banco Santander (SANTAN), BANESTs parent company, is extensively covered in a subsequent profile within this section.
Key points for 2010

Monitor further development of BANESTs non-performing loans, which, however, are markedly lower than that of most domestic peers.
10 June 2010
536

Financial summary
mn 2005 2006 2007 2008 2009 Income statement summary 1,109 1,235 1,461 1,578 1,731 Net interest income Net fees & com's 514 546 574 619 608 105 125 138 151 157 Trading income Operating income 1,701 1,874 2,137 2,309 2,495 Operating expenses 785 819 859 889 895 Pre-provision income 916 1,055 1,278 1,420 1,601 151 190 229 300 382 Loan loss provisions Pre-tax profit 850 1,927 1,100 1,146 1,157 Net income 570 1,451 765 780 560 Balance sheet summary Total assets 84,453 104,504 110,068 117,186 122,301 Customer loans 48,106 61,154 74,201 77,802 75,617 of which public sector 923 762 959 1,448 1,964 of which mortgages 26,536 33,279 37,110 37,292 37,364 Customer deposits 35,800 45,161 53,340 58,179 57,076 Debt funding 20,082 26,038 30,293 30,552 32,574 of which Cedulas 10,250 13,250 14,958 14,918 16,050 Total equity 3,431 4,315 4,748 5,070 5,299 Profitability (%) Return on average assets 0.8 1.7 0.8 0.7 0.5 Return on average equity 17.7 39.5 18.4 17.8 11.5 Cost/Income ratio 46.1 43.7 40.2 38.5 35.9 Net int inc/Op inc 65.2 65.9 68.4 68.4 69.4 Asset quality (%) LLPs/Pre-prov inc 16.5 18.0 17.9 21.1 23.9 LLRs/Gross loans 2.1 1.9 1.8 1.9 2.1 Prob loans/Gr loans 0.6 0.5 0.5 1.8 3.2 Coverage ratio 371.7 393.1 329.5 108.8 65.2 Capital adequacy (%) Tier 1 ratio 7.1 7.4 7.0 7.7 8.7 Total capital ratio 11.4 11.2 10.4 10.7 11.3 Equity/Assets ratio 4.1 4.1 4.3 4.3 4.3
Banesto (BANEST)
Customer deposits to customer loans (net)
80% 40% 0% 2004 2005 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding % of total funding 58.4% 59.3% 58.7% 52.5% 54.3% 53.5% 65%
78%
74%
74%
72%
75%
74.4%
45%
25%
Asset quality
4% 359 2% 0.7% 0% 2004 2005 2006 2007 2008 2009 Prob Loans/Gross Loans Coverage Ratio 0.6% 0.5% 0.5% 372 393 329 1.8% 109 65 0 250 3.2% 500

2 1.7% 1.6% 0.8% 1.7% 1.4% 1.5% 0.8% 1.5% 0.7% 0.5% 0.3% 0.2% 2004 2005 0.2% 2006 0.2% 2007 0.3% 2008 2009 RoA 1.5%
0.7% 0.3%
Net interest margin
Credit costs
40 9.8x 20 9.8 26.5 13.3 2.5x 15.0 14.9 2.5x 2.5x 16.1 8x 33.3 17.7 13.3 10.3 5.3x 6.4 2.8x 2.6x 37.1 37.3 37.4 12x
Efficiency
60% 40% 2% 20% 0% 2004 2005 2006 Cost/Income ratio 1.4% 1.1% 1.0% 0.9% 2007 0.9% 2008 0.8% 0% 2009 Cost/Assets ratio 50.9% 46.1% 43.7% 4% 40.2% 38.5% 35.9%
4x 2.3x 0x
2002 2003 2004 2005 2006 2007 2008 2009 Mortgages ( bn) Cedulas ( bn) Over-collateralisation
10 June 2010
537
Bilbao Bizkaia Kutxa (BILBIZ)

Description
% Index
0.014
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
S&P
NR NR NR -
Fitch
A+ NR Stable -
Bilbao Bizkaia Kutxa (BILBIZ) was formed as a result of the merger between Caja de Ahorros y Monte de Piedad Municipal de Bilbao and Caja de Ahorros Vizcana (in February 1990). With total assets of 30bn, it ranks among the medium-sized savings banks, providing retail banking services through 413 branch offices of which 238 are located in Bizcaia region. As at year-end 2009, BILBIZ, which is headquartered in Bilbao, had 3,000 employees.
Risk weighting
Strengths
Asset quality: As at year-end 2009, the non-performing loan ratio (NPL) of BILBIZ stood at a very moderate 2.49%, up only 30bp from 2.19% a year before. This is significantly below the industrys average of 5.1%. The overall coverage ratio stood at 100.3% of doubtful assets for 2009. At the same time, the covered bonds issued by BILBIZ (3.8bn, of which 1.0bn was issued publicly) benefited from a collateral pool of 8.0bn, implying a very sound over-collateralisation of 210%. Still, with mortgage lending accounting for a high 15.4bn, or 72% of all lending, up from 14.7bn at year-end 2008, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11), need to be carefully monitored as they could trigger a deterioration of BILBIZ asset quality. This becomes particularly evident as 75% of all lending corresponds to floating rate loans tied to the Euribor. Still, BILBIZ impairment losses increased by 18.4% to 182.7mn in 2009 from 154.4mn in 2008, thereby reducing the lenders net income by 14.4% y/y to 293mn in 2009 from 342mn in 2008. Profitability: In 2009, BILBIZ net interest income increased by 21.5% to 457mn, up from 376mn a year before. This development is attributed to lower interest rates paid on customer deposits, which fell from an average of c.5% in 2008 to c.2% in 2009. In light of the ongoing consolidation in the Spanish banking market, this effect could be reversed again as higher interest rates paid on customer deposits could have a detrimental impact on BILBIZ NIM and thus its profitability. Funding profile: As at year-end 2009, BILBIZ benefited from a very sound funding profile with customer deposits accounting for 90% of all lending, slightly down from 97% in 2008. At the same time, wholesale funding as a percentage of all funding stood at a modest 22% in 2009 versus 17% in 2008.
Weaknesses
Market consolidation: In late May, merger talks between BILBIZ and Caja de Ahorros del Mediterrneo (CAM) collapsed. In light of the ongoing consolidation on the Spanish savings bank sector, any potential mergers involving BILBIZ need to be monitored. Domestic exposure: As a result of its business model, BILBIZ operations are exclusively limted to the Spanish market.
Note: At the time of writing, BILBIZ had one benchmark covered bond outstanding totalling 1.00bn. Overall, the 3.8bn of Cdulas Hipotecarias issued were secured by a mortgage pool of 8.0bn as at year-end 2009.
Key points for 2010

The impact of potential ECB rate hikes on BILBIZ hitherto sound asset quality needs to be carefully monitored. A potential merger with other domestic savings banks needs to be carefully assessed, particularly if BILBIZ has to rely on the FROB.
10 June 2010
538

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which CH Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2008 376 127 83 838 308 530 155 327 342 29,667 20,978 608 14,688 20,334 2,512 2,720 3,914 1.2 8.7 36.7 44.9 29.3 na 2.2 na 14.0 21.5 13.2 2009 457 134 82 849 310 539 204 275 293 29,806 21,178 795 15,361 19,086 3,864 3,832 4,123 1.0 7.3 36.5 53.8 37.9 2.5 2.5 100.3 14.6 22.2 13.8
Bilbao Bizcaia Kutxa (BILBIZ)

100 17.2 75 96.9 21.8 30 20 90.1 10 0 2008 Cust deposits/loans Wholesale funding/Tot. funding
50
NIM, credit costs, and RoA

2 1.3 1 1.15 0.5 1.5 0.7 0.98 2
0 2008 Credit costs RoA 2009 NIM
10 June 2010
539
Caixa dEstalvis de Catalunya (CAIXAC)

Description
% Index
0.018
Leef H Dierks
Ratings table
Moodys
% Index
NA
Total assets
63.7bn
S&P
NR NR NR -
Fitch
NR NR NR -
A3 Aaa Negative 33.1/11.6
With total assets of 63.7bn at year-end 2009, virtually unchanged from year-end 2008, Caixa dEstalvis de Catalunya (CAIXAC) is Spains third-largest savings bank. CAIXAC was founded as Caja de Ahorros Provincial de la Diputacin de Barcelona in 1926 to provide banking services to the local industry, especially to smaller- and medium-sized enterprises (SME), public-sector entities and corporates. Today, CAIXAC focuses on providing retail banking services through nearly 6,900 employees in 1,155 branch offices, of which 725 (almost two-thirds) were located in Catalonia, where CAIXAC is the second-largest savings bank in terms of market share at roughly 15% in 2009. CAIXACs domestic market share stood at c.5%. At the time of writing, Caixa Catalunya had agreed to merge with Caixa Tarragona and Caixa Manresa to a new entity called Caja Catalana, which is scheduled to start operations on 1 July 2010.
Risk weighting
Strengths
Funding profile: CAIXACs funding profile markedly improved over 2009, with the customer deposit-to-loans ratio growing to 61.4% from 53.6% a year before. At the same time, with interbank liabilities standing at nil in 2008 and 2009, CAIXACs reliance on wholesale funding remained relatively moderate and stood at 43.4% in 2009 after 42.5% in 2008. Support mechanism: As with any other Spanish savings bank, CAIXAC benefits from the internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederacin Espaola de Cajas de Ahorros (CECA), which not only offers technological and advisory services particularly relevant for smaller savings banks but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAIXAC benefits from the depositor guarantee fund Fondo de Garanta de Depsitos (FGD) of Spanish savings banks.
Weaknesses
Non-performing loan ratio: In Q4 09, CAIXAC reported a nonperforming loan (NPL) ratio of 5.3%. Despite this being down from 5.7% in Q3, 5.4% in Q2 and 5.7% in Q1, the overall level remains high and stands above the sectors average of 5.1%. The coverage ratio fell to 48.2% as per year-end 2009. Net impairment losses surged to 256mn in 2009, from 110mn in 2008 with noncurrent assets held for sale comprising 887.6mn of properties foreclosed in connection with non-performing loans held for sale and not as part of the groups ordinary course of business. In light of the current economic situation in Spain and potential rate hikes on behalf of the ECB (which we do not expect before Q1 11), CAIXACs NPL ratio could increase further, thereby triggering the need for further write-downs, which would adversely affect the lenders profitability. With mortgage lending accounting for a high 74.6% of CAIXACs total lending as at year-end 2009, any increase in the 12 months Euribor (ie, the interest rate to which 98% of all Spanish mortgage loans are pegged) would likely also leave its mark on the lenders NPL ratio. Profitability: Driven by a surge in net impairment losses on other assets to 525.9mn in 2009 from 110.4mn in 2008, CAIXACs net income more than halved (-58.2% y/y) to 77mn in 2009 from 185mn in 2008 and 493mn in 2007. Adding to the pressure was the 7.2% y/y decline in net interest income and the 17.4% slump in net fee and commission income, which could not be offset by the sharp increase in CAIXACs trading income to 133mn in 2009 from 49mn in 2008. PROCAM: CAIXAC faces a high exposure to the Spanish property market through its fully-owned property developer PROCAM which comprises 49 investment companies and 29 associated developers.
Key points for 2010

Monitor Caixa Catalunyas merger with Caixa Manresa and Tarragona to new Caja Catalana, particularly in light of support of 1.25bn provided by the Spanish Orderly Bank Restructuring Fund, the so-called FROB.
10 June 2010
540

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which mortgages Customer deposits Debt funding Of which cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPS/Pre-prov inc LLRS/Gross loans NPLs/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 630 300 132 1,107 595 512 217 479 360 67,551 42,737 28,872 24,870 17,336 1,750 2,200 0.6 17.5 53.7 57.0 42.4 1.9 0.8 253 8.3 11.5 3.3 2007 787 323 -6 1,158 647 511 345 594 493 68,201 50,514 33,368 26,514 21,912 3,250 2,619 0.7 20.5 55.9 68.0 67.5 2.0 1.1 194 5.5 6.3 3.8 2008 897 350 49 1,293 666 626 771 205 185 63,627 50,011 35,533 26,828 19,806 5,000 2,766 0.3 6.9 51.6 69.4 123.1 2.9 5.3 57 6.3 10.1 4.3 2009 832 289 133 1,254 633 621 22 75 77 63,650 44,381 33,096 27,256 20,864 8,434 2,835 0.1 2.8 50.5 66.4 3.6 2.5 5.3 48 6.1 9.4 4.5
Caixa dEstalvis de Catalunya (CAIXAC)

NPLs/Gross loans 6% 213 3% 1.0% 0% 2004 2005 2006 2007 Prob loans/Gross loans 2008 2009 Coverage ratio 0.9% 0.8% 230 253 194 1.1% 57 48 0 5.3% Coverage ratio 5.3% 500 250
Customer deposits to customer loan (net)

75% 50% 25% 0% 2004 2005 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding in % of total funding 31.4% 66.6% 63.2% 58.2% 52.5% 53.6% 61.4% 25% 37.9% 41.1% 45.2% 42.5% 43.4% 50%
0%
40 28.9 30 20 10 0 2005 Mortgages 1.8 22.0 12.6x 33.4 16.5x 35.5 33.1 20 15 10.3x 3.3 7.1x 5.0 10 8.4 3.9x 5
0 2006 2007 2008 2009 Cedulas Over-collateralisation (x) rhs
10 June 2010
541
Caixa Galicia (CAGALI)

Description
% Index
0.055
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
S&P
NR NR NR -
Fitch
BBB+ NR Stable -
With total assets of 46.3bn in 2009, Caixa Galicia (CAGALI) is Spains sixth-largest savings bank and among the countrys 10 largest financial institutions. CAGALI is the result of the 1978 merger between Caja de Ahorros y Monte de Piedad de La Corua y Lugo and Caja de Ahorros de El Ferrol. It focuses on retail banking as well as on providing financial services to small and medium-sized enterprises (SMEs). Attributed to its historical roots and its headquarters in La Coruna, CAGALI has a strong presence in the autonomous region of Galicia, where 444 (-20 y/y) of its 828 (-63 y/y) branch offices were located and where it is market leader with a share of c.20% in retail banking. Recently, CAGALI has started to extend its international presence, with offices being opened in the US and Portugal.
Risk weighting
As Spanish Cdulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standardised Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Funding profile: As per year-end 2009, CAGALI benefited from a relatively sound funding profile with customer deposits, which were up 6% y/y to 28.6bn in 2009 from 26.9bn in 2008, accounting for 80% of all lending. Customer lending, in contrast, modestly contracted by 2.3% y/y to 35.3bn in 2009 from 36.2bn in 2008. At the same time, the percentage of wholesale funding to all funding stood at a moderate 33%, thereby illustrating CAGALIs relatively modest capital market reliance. Nonetheless, in between 2008 and 2009, CAGALI had strongly relied on the issuance of government-guaranteed debt instruments. Support mechanism: Similarly to any other Spanish savings bank, CAGALI benefits from internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederacin Espaola de Cajas de Ahorros (CECA) offers technological and advisory services these are particularly relevant for smaller savings banks but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAIXAC benefits from the depositor guarantee fund Fondo de Garanta de Depsitos (FGD) of Spanish savings banks. In addition to the FGD, cajas benefit from federal support in the form of the FROB, which, if necessary, provides funding for the sectors consolidation.
Weaknesses
Profitability: Driven by a sharp 62% y/y fall in trading income to 151mn in 2009 from 395mn in 2008, CAGALIs net income fell by nearly 60% to 91mn from 225mn a year before. In light of the ongoing consolidation in the Spanish banking market, we caution that this effect could become even more pronounced in the near term as higher interest rates paid on customer deposits could have a detrimental impact on CAGALIs NIM (which nonetheless increased by 8bp to 146bp in 2009 from 138bp in 2008) and thus, its profitability. Non-performing loan ratio: As at year-end 2009, the proportion of CAGALIs non-performing loans (NPL) to total loans stood at a high 4.9%, up 150bp from 3.4% in 2008 and 0.7% in 2007. This is only marginally below the sectors average which stood at 5.1% for the same timeframe. Overall, doubtful assets increased by 500mn to 1.9bn in 2009 versus 1.4bn in 2008. Note that in 2009, CAGALI made an extraordinary provision of 58.7mn to anticipate future deterioration in the value of the real estate portfolio. In 2008, the respective figure amounted to 27.8bn. A positive, however, is the 886mn y/y reduction in lending to property developers and larger corporates, which more then offset the increase in lending to households and SMEs (+373mn y/y) and the public sector (+102mn y/y). In terms of new financing, mortgage lending increased by 1.1bn in 2009, followed by lending to property developers, which grew by 925mn y/y. Market consolidation: With many of CAGALIs domestic peers in the process of merging to larger institutions as of late, further activities on behalf of CAGALI need to be carefully monitored.
Note: At the time of writing, CAGALI had one EUR-denominated benchmark Cdulas Hipotecarias outstanding with a nominal value of 1.50bn.
Key points for 2010

With CAGALIs NPL ratio standing only slightly below the industrys average of 5.1% as at year-end 2009, the further development of the lenders asset quality needs to be carefully monitored, particularly in light of potential ECB rate hikes. Monitor the ongoing merger activity on the Spanish savings bank sector
10 June 2010
542

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which Mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 477 119 343 1002 384 619 155 443 357 42,813 28,098 1,056 16,294 21,680 0 2,570 0.9 15.8 38.3 47.6 25.0 1.3 390.2 5.0 9.7 6.0 2007 580 143 380 1214 458 756 279 454 401 47,726 35,229 1,200 21,477 23,560 1,500 2,682 0.9 15.3 37.7 47.8 36.9 0.9 368.0 6.1 10.7 5.6 2008 651 137 395 1250 514 736 596 191 225 46,626 36,165 21,987 26,938 9,656 1,500 2,318 0.5 9.0 41.1 52.1 81.0 2009 677 155 151 1036 462 573 430 73 91 46,340 35,335 23,097 28,554 11,247 1,500 2,300 0.2 3.9 44.6 65.4 75.0
Caixa Galicia (CAGALI)

2 1.20 1 1.11 0.90 0 2006 NIM 2007 1.28 1.00 0.89 0.40 0.48 2008 Credit costs 0.16 0.20 2009 RoA 1.38 1.46

39.3 29.1 91.7 77.2 0 2005 2006 2007 2008 2009 Wholesale funding in % of total funding Customer deposits to loans 23.5 66.9 36.4 32.9 74.5 80.8 75 50 125 100
40 20

800 0.7 0.56 600 400 335 200 2001 2002 2003 Coverage ratio 2004 2005 2006 2007 Problem loans/Gross loans 578 0.47 487 0.37 353 0.31 0.27 631 0.5 390 0.33 368 0.25 0.1 0.3
6.6 10.1 5.0
8.5 11.3 5.0
10 June 2010
543
Caja Mediterrneo (CAJAME)

Description
% Index
0.065
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
S&P
NR NR NR -
Fitch
BBB+ NR Negative -
Caja Mediterrneo (CAJAME) is the fourth-largest savings banks in Spain with total assets amounting to 75.5bn at year-end 2009, largely unchanged from 75.0bn a year before. CAJAMEs focus lies in providing retail banking services as well as financial services to small- and medium-sized enterprises (SME). Over the course of the past 133 years, CAJAME in its current form emerged from more than 30 savings banks in the regions of Comunidad Valenciana and Alicante, where nowadays nearly 600 of its 1,000 offices are located. A total of 115 offices were closed over the course of 2009, thereby improving CAJAMEs cost/income ratio to 33% in 2009, from 46% a year before. In late May, CAM announced that it would merge with Cajastur, Caja Santander y Cantabria, and Caja Extremadura.
Risk weighting
Strengths
Interest income: Despite the currently prevailing low interest rate environment in Spain, CAJAMEs net interest income increased by 33.2% y/y to 1.6bn in 2009, from 1.2bn in 2008, despite mortgage lending falling by 9.0% y/y to 38.5bn in 2009, from 42.3bn in 2008. Deposit taking fell by 1.8% y/y to 41.2bn in 2009, from 41.9bn in 2008. At the same time (and in contrast to most its domestic peers), CAJAME increased its net interest margin (NIM) by 50bp to 213bp in 2009, from 163bp in 2008. This development, in our opinion, is favourable and could further benefit from potential ECB rate hikes, which, however, we do not expect to occur before Q1 11. Yet, the increasing competition for customer deposits in Spain could potentially reduce CAJAMEs NIM in the months ahead. Funding structure: Customer deposits accounted for a high 77.8% of all lending in 2009, up from (an already high) 71.6% in 2008. Accordingly, CAJAMEs reliance on wholesale funding remained largely stable at around 38.8% of all funding in 2009, ie, unchanged from the years before. Support mechanism: Like its domestic peers, CAJAME benefits from the internal support mechanisms of the domestic savings bank system. It is part of the Spanish savings banks association, Confederacin Espaola de Cajas de Ahorros (CECA). Not only does the latter offer technological and advisory services which are particularly relevant for smaller savings banks but it also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAJAME benefits from the depositor guarantee fund Fondo de Garanta de Depsitos (FGD) of Spanish savings banks. In addition to the FGD, cajas benefit from federal support in form of the FROB, which, if necessary, can provide funding for the sectors consolidation.
Weaknesses
Non-performing loans: The proportion of CAJAMEs nonperforming loans (NPL) to total loans stood at 4.5% as at year-end 2009, up from 3.8% in 2008. Overall, doubtful loans amounted to 2.5bn in 2009. Taking into consideration that a high 72% of all lending is backed by mortgage loans, the impact of potential ECB rate hikes needs to be carefully monitored as it could lead to a deterioration of CAJAMEs asset quality, particularly as c.99% of all mortgage loans granted in Spain are pegged to the 12m Euribor. Mediterranean CAM International Homes: Mediterranean CAM International Homes was set up in early 2007, in line with CAJAMEs strategic expansion plans throughout Spain. Whereas in its initial stages, Mediterranean CAM International Homes sold properties developed by CAMs real estate clients, at the end of 2008, CAJAME decided to increasingly focus on the sale of properties owned by CAJAME, among them repossessed properties, both new-builds and previously owned properties, commercial premises, offices, plots, storage facilities and garages. Consolidation pressures: Despite being among the larger players, CAJAME might be affected by the consolidation process in the Spanish savings banks market. New entities emerging from the potential merger[have these potential mergers been reported upon?] of its peers Unicaja, Caja Jaen, and CajaSur to Unicajasur, for example, could put pressure on CAJAME in its core market. In response, in late May, CAM announced that it would merge with Cajastur, Caja Santander y Cantabria, and Caja Extremadura.
Note: At the time of writing, CAJAME had two Cdulas Hipotecarias totalling 2bn outstanding. The issuer had previously also participated in various MultiCdulas transactions.
Key points for 2010

Monitor the further development of CAJAMEs NPL ratio, which stood only slightly below the industrys average at the time of writing.
10 June 2010
544

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 1,128 191 112 1,606 630 976 573 602 440 72,871 58,339 897 42,483 41,415 15,388 0 3,946 0.6 11.6 39.2 70.2 58.7 1.0 0.7 201.0 7.4 11.7 5.4 2008 1,206 193 -35 1,527 701 826 982 387 432 75,473 58,495 869 42,288 41,910 13,352 1,000 3,576 0.6 11.5 45.9 78.9 118.8 1.7 3.8 51.0 7.6 10.5 4.7 2009 1,606 165 273 2,227 734 1,493 847 322 265 75,532 52,896 977 38,478 41,175 16,094 2,000 3,806 0.4 7.2 33.0 72.1 56.7 1.6 4.5 71.0 9.1 11.4 5.0
Caja Mediterrneo (CAJAME)

80% 38.0% 38.2% 38.8% 40%
60% 71.0% 40% 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 71.6% 77.8%
30%
20%

3% 2% 1% 0% 1.7% 0.8% 0.6% 2007 Net interest margin 1.6% 1.3% 0.6% 2008 Credit costs 1.1% 0.4% 2009 RoA 2.1%
Efficiency ratios
50% 45.9% 40% 39.2% 0.93% 30% 2007 Cost/Income ratio 2008 2009 Cost/Assets ratio 0.95% 33.0% 0.8% 0.97% 1.0% 1.2%
10 June 2010
545
La Caixa (CAIXAB)
Description
% Index
0.393
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
Aa2 Aaa Negative 21.0
S&P
AAAAA Negative -
Fitch
AANR Negative -
With total assets of 272bn as at year-end 2009, up 4.2% y/y, La Caja de Ahorros y Pensiones de Barcelona (CAIXAB) is Spains largest savings bank and the countrys third-largest financial entity. CAIXAB operates as a universal bank, focusing on the provision of retail banking and insurance services to more than 10.5mn retail and SME clients through more than 27,000 employees in 5,300 branch offices of which 1,665 are located in Catalonia. CAIXAB is market leader with a 30% market share in online banking services in Spain. In deposit taking and lending, CAIXAB, which is the result of the 1990 merger of Caja de Pensiones, founded in 1904, and Caja de Barcelona, founded in 1844, had market shares of 10.4% and 10%, respectively. Also, with a market share of 10.5%, CAIXAB was leader in mortgage lending in 2009. Through its investment vehicle CaixaCorp, CAIXAB held a 20% stake in Mexican Inbursa, 30% in Portuguese Banco BPI, 15% in Hong Kongs Bank of East Asia, and 10% of Austrian Erste Group Bank, as well as Gas Natural and Abertis, among others, as at year-end 2009.
Risk weighting
Strengths
Profitability: Notwithstanding the third consecutive decline of CAIXABs net income to 2bn in 2009 (-14% y/y), from 2.3bn in 2008, owing to a doubling in loan-loss provisions to 1.4bn in 2009, from 600mn in 2008, CAIXABs net interest income increased by 12% y/y to 3.9bn from 3.5bn a year before. At the same time, the net interest margin (NIM) increased by 10bp to 148bp from 138bp a year before. The ongoing consolidation in the Spanish banking market, however, could eventually lead to higher interest rates paid on customer deposits. This, in turn, could have a detrimental impact on CAIXABs NIM and thus its profitability. Market position: As at year-end 2009, CAIXAB was market leader in mortgage lending in Spain, benefiting from a market share of 10.5%. In deposit taking and lending, CAIXAB had market shares of 10.4% and 10%, respectively, thereby ranking second on the domestic market. Also, with a 30% share, CAIXAB was the clear market leader in online banking services in Spain. Funding structure: As at year-end 2009, CAIXABs customer deposits corresponded to a high 75% of all lending, thereby keeping the reliance on wholesale funding markets at moderate levels. In 2009, wholesale funding accounted for 37% of CAIXABs total funding. Participations: Despite potentially adding unwanted volatility to the investment portfolio, CAIXABs participations in Mexican Inbursa, Portuguese Banco BPI, Hong Kongs Bank of East Asia, Austrian Erste Group Bank, Gas Natural, or Abertis, among others, diversify the lenders revenue structure. Also, unrealised gains of 4.0bn on listed investments in 2009 serve as a certain buffer.
Weaknesses
Asset quality: In 2009, CAIXABs doubtful loans increased by 36.8% y/y to 6.2bn, up from 4.5bn as per year-end 2008. Overall, the non-performing loan (NPL) ratio amounted to 3.4% as at year-end 2009, clearly below the national average of 5.1%. The coverage ratio stood at 127%. Over the course of the year, total NPL stood relatively stable at between 3.4% and 3.5%, gradually declining towards the end of the year. Of the 6.3bn of nonperforming loans, 4.1bn corresponded to mortgage loans. In addition to the comparatively moderate NPL ratio, CAIXAB, in our view, benefits from the fact that 66% (or 114bn) of its total loan book (174bn) was mortgage lending, of which 90% was secured on first and primary homes. Further mitigating the NPL ratio was a very low weighted average LTV of 49% in the mortgage loan book. Servihabitat: The latter is CAIXABs subsidiary, which manages real estate assets which are not connected with the banking business but are held for sale. As at year-end 2009, assets amounted to 3.1bn. Of these, 2.7bn was related to properties available for sale. Thereof, 1.9bn corresponded to properties from developers. Over the course of 2009, the portfolio increase attributed to property developers steadily slowed to 104mn in Q4, from 1.2bn in Q1 09.
Note: As at year-end 2009, CAIXAB had covered bonds outstanding totaling 26.75bn.
Key points for 2010

Closely monitor whether the gradual fall in the volume of NPL is a sustainable development. Public sector lending on behalf of CAIXAB increased 36.1% y/y to 6.3bn in 2009, from 4.6bn in 2008. This development, in our view, needs to be monitored, particularly in light of potentially higher funding needs for the Kingdom of Spain.
10 June 2010
546

Financial summary
mn 2006 Income statement summary Net interest income 2,521 Net fees & com's 1,299 Trading income 1,214 Operating income 6,761 Operating expenses 2,633 Pre-provision income 4,128 Loan loss provisions 478 Pre-tax profit 4,013 Net income 3,143 Balance sheet summary Total assets 209,123 Customer loans 138,706 of which public sector 2,353 of which mortgages 99,137 Customer deposits 117,685 Debt funding 39,457 Of which cedulas 23,750 Total equity 10,769 Profitability (%) Return on assets 1.6 Return on equity 33.1 Cost/Income ratio 38.9 Net int inc/Op inc 37.3 Asset quality (%) LLPS/Pre-prov inc 11.6 LLRS/Gross loans 1.5 Prob loans/Gr loans 0.3 Coverage ratio 446.0 Capital adequacy (%) Tier 1 ratio 8.3 Total capital ratio 11.3 Equity/Assets ratio 5.1 2007 3,348 1,257 415 5,624 2,815 2,809 582 2,725 2,625 248,495 158,642 2,516 113,930 127,077 50,796 26,250 14,415 1.1 20.8 50.1 59.5 20.7 1.6 0.6 281.0 9.8 12.1 5.8 2008 3,508 1,250 163 6,752 3,050 3,702 617 2,616 2,317 260,827 175,471 4,616 117,924 134,734 49,837 28,300 15,619 0.9 15.4 45.2 52.0 16.7 1.7 2.5 67.3 10.1 11.0 6.0 2009 3,932 1,303 130 7,187 3,084 4,103 1,401 2,131 2,004 271,873 173,641 6,298 114,360 129,831 52,738 26,750 16,696 0.8 12.4 42.9 54.7 34.1 2.2 3.6 61.0 10.4 11.0 6.1
La Caixa (CAIXAB)
Geographical split, 2010
Other 24% Andalusia 13% Madrid+ Castilla 22% Catalonia+ Balearics 41%
Lending to private borrowers, 2010

Other collateral 10%
Mortgage collateral 90%
160 120 80 40 0 2003 2004 2005 2006 2007 2008 2009 Mortgages Cedulas Over-collateralisation (rhs) 49.1 bn 7.3x 8
5.2x
5.6x
99.1
113.9 117.9 4.3x 26.3
61.7
79.2 14.3
4.2x 23.8
114.4 4.2x 4.3x 4 26.8 0
11.8
28.3
Customer deposits to loans (net)

33.9%31.9%36.7% 40% 125% 22.6% 30.6% 25.8% 25.3% 24.9% 30% 100% 75% 50% 2002 2003 2004 2005 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding in % of total funding 110% 102% 95% 90% 85% 80% 77% 75% 20% 10%

3% 1.9% 2% 1% 0% 2002 2003 2004 2005 2006 2007 2008 2009 RoA Net interest margin Credit costs 0.7% 0.3% 0.8% 0.3% 1.9% 1.7% 0.8% 1.4% 1.1% 1.6% 1.3% 1.5% 0.9% 1.4% 0.2% 1.5% 0.5% 0.8%
0.3% 0.2%
1.1% 0.2% 0.3%
10 June 2010
547
Caja Madrid (CAJAMM)

Description
% Index
0.414
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
S&P
A NR Negative -
Fitch
A+ AAA Negative 41.5 -
Caja de Ahorros y Monte de Piedad de Madrid (CAJAMM) is Spains second-largest savings bank and fourth-largest financial institution in terms of total assets, which amounted to 191.4bn in 2009, up 6% y/y from 181.0bn in 2008. CAJAMM, which was founded in 1869, provides universal banking services (ie, retail, private, commercial, and wholesale banking as well as asset management services) with a focus on smaller- and medium-sized enterprises (SMEs) particularly in the greater Madrid region. As at year-end 2009, CAJAMM, which serves more than 7mn clients, had 15,259 employees in 2,175 branch offices (of which more than 1,050 were located in Madrid), 22 of which corresponded to its US operations (City National Bank of Florida). CAJAMM benefited from a market share of 6.9% in customer lending and 7.4% in deposit taking in 2009. In addition to its banking operations, CAJAMM has formed an alliance in the countrys insurance sector by holding a 14.95% stake in Mapfre, which has a market share of more than 17%. Also, through Cibeles, CAJAMM has a 10.36% interest in Mapfre Amrica, a holding company whose activity is concentrated in 11 countries in Latin America, mainly Brazil and Mexico, and whose market share in non-life insurance is above 6%.
Risk weighting
Strengths
International business: Caja Madrids international business is concentrated in the US and Mexico, where, through its daughter Cibeles, it holds an 83% shareholding in retail-banking focused City National Bank of Florida, which was acquired in late 2008 and a 40% shareholding in Grupo Hipotecarias Su Casita, which, at the time of writing, is Mexicos second-largest mortgage company. Funding profile: Following the 7.2% y/y growth in customer deposits to 89.9bn in 2009, from 83.9bn in 2008, and the gradual 0.6% y/y decline in customer lending to 117.8bn in 2009, from 118.4bn in 2008, CAJAMMs deposit to loan ratio improved to 76.4% in 2009, from 70.8% in 2008. At the same time, the ratio of wholesale funding as a percentage of all funding fell to 46.1%, from 47.1%. This decline is less pronounced as interbank liabilities had increased by 1.2bn to 21bn in 2009. Support mechanism: Like any other Spanish savings bank, CAJAMM benefits from the internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederacin Espaola de Cajas de Ahorros (CECA), which not only offers technological and advisory services particularly relevant for smaller savings banks but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, CAJAMM benefits from the depositor guarantee fund Fondo de Garanta de Depsitos (FGD) of Spanish savings banks. As no savings bank has ever defaulted on its obligations since the sector emerged in 1837, the FGD has accumulated significant reserves that it is authorised to use to rescue or manage the liquidation of a troubled savings bank.
Weaknesses
Non-performing loan ratio: As at year-end 2009, CAJAMMs non-performing loan (NPL) ratio stood at a relatively high 5.4%, up from 4.9% a year before. This level is slightly above the sectors average which, in our view, is partly due to the fact that CAJAMMs risk exposure towards construction and property development accounted for a high 19.7% of all credit risk in 2009, slightly down from 22.9% in 2008. Whereas corporate risk exposure accounted for 47.5% of the total exposure at year-end 2009, the credit risk arising from mortgage lending to individuals accounted for 33.6% of the total credit risk. Overall, impairment losses climbed to 3.1bn in 2009, from 2.9bn in 2008. Total provisions increased to 3.4bn as at year-end 2009, with the coverage ratio falling to 43.4% in 2009, from 43.3% in 2008. Given the current economic situation in its domestic market, we expect the NPL ratio is likely to further increase over the course of the year. This could leave its mark on the lenders profitability, which had come under pressure in 2009 already as loan-loss provisions were up 65.7% y/y to 1.4bn, from 869mn in 2008. ar r ear Market exposure: As at year-end 2009, mortgage lending accounted for a high two-thirds of all lending (65.8%) and through its 27.7% stakeholding in Realia, CAJAMM faces a sizeable exposure to the Spanish real estate market which has experienced pronounced price declines in the past quarters. Note that (as many of its domestic peers), CAJAMM has meanwhile started selling residential property directly. Overall, the downturn experienced by the property market has led to a further decline in financing to the property developer segment, with the number of properties financed falling by 14.2% y/y to 83,238 units in 2009.
Key points for 2010

The steady increase of CAJAMMs NPL ratio, which climbed to 5.4% in 2009, from 4.9% in 2008, needs to be carefully monitored as it increasingly has an impact on the lenders profitability. The recently announced merger between Caja Madrid, Caja Canarias, Caixa Laietana, Caja de Avila, Caja Segovia, and Caja Rioja needs to be carefully assessed.
10 June 2010
548

Financial summary
mn 2006 Income statement summary Net interest income 1,659 Net fees & com's 825 Trading income 196 Operating income 3,156 Operating expenses 1,372 Pre-provision income 1,784 Loan loss provisions 443 Pre-tax profit 1,322 Net income 1,032 Balance sheet summary Total assets 136,952 Customer loans 95,078 of which public sector 3,010 of which mortgages 63,197 Customer deposits 57,515 Debt funding 49,392 of which Cedulas 20,250 Total equity 9,635 Profitability (%) Return on assets 0.83 Return on equity 13.2 Cost/Income ratio 43.5 Net int inc/Op inc 52.6 Asset quality (%) LLPs/Pre-prov inc 24.8 LLRs/Gross loans 1.9 Prob loans/Gr loans 0.7 Coverage ratio 265 Capital adequacy (%) Tier 1 ratio 7.4 Total capital ratio 12.8 Equity/Assets ratio 7.0 2007 1,997 853 2,505 5,682 1,495 4,187 965 3,366 2,869 158,855 107,759 3,063 70,242 58,522 58,918 23,500 9,636 1.94 29.8 26.3 35.1 23.1 2.2 1.0 210 8.7 12.0 6.1 2008 2,209 803 346 3,490 1,747 1,743 869 1,206 841 180,971 118,437 3,373 73,753 83,866 55,015 24,500 10,220 0.49 8.5 50.0 63.3 49.9 2.4 5.4 44 7.7 10.1 5.6 2009 2,532 771 600 3,871 1,587 2,285 1,441 364 267 191,904 117,780 4,116 77,518 89,924 56,302 24,100 10,268 0.14 2.6 41.0 65.4 63.1 2.6 6.2 42 8.9 10.6 5.4
Caja Madrid (CAJAMM)

Gross NPLs/mortgages 6% 4% 2% 0% 221%198% 267%297%238%265% 210% Reserve coverage (mortgages) 6.2% 400% 5.4% 44% 200% 42%
0.8% 0.9% 0.8% 0.6% 0.7% 0.7% 1.0%
0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Gross NPLs/loans Reserve coverage mortgages

100% 75% 40.8 39.1 40.9 38.9 44.0 50% 25% 0% 2000 2003 2006 2009 Customer deposits to loans Wholesale funding % of total funding 25% 88% 89% 84% 83% 73% 64% 60% 54% 71% 76% 0% 49.4 50.6 55.1 75% 47.1 46.2 50%
100 80 60 40 20 0 12 10 63.2 8 48.0 5.7x 23.5 36.8 6 29.0 11.5 16.5 20.3 3.0x24.5 24.1 24.1 3.7x 3.6x 4 3.1x 17.1 19.8 3.2x 2.9x 2 1.5 3.5 6.5 8.0 3.0x 3.2x 0 2000 2003 2006 2009 11.4x 77.5 70.2 73.8 Mortgages Cedulas Overcollateralisation (rhs)

2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 0.4 0.8 0.7 0.7 0.3 0.7 0.3 0.3 0.8 0.2 0.8 0.3 2.1 2.1 2.1 2.0 1.6 1.6 1.3 0.8 0.4 0.7 0.5 0.5 1.4 1.3 1.9 1.4 0.8 0.1
Efficiency
75% 50% 25% 0% 2002 2003 2004 2005 2006 2007 2008 2009 Cost/Income ratio Cost/Assets ratio (rhs) 1.8 59.0 1.8 60.3 2.0% 1.6 56.4 51.2 1.5 43.5 1.1 1.0 26.3 50.0 1.0 41.0 1.0% 0.9 0.0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Net interest margin Credit costs RoA
10 June 2010
549
Cedulas TDA (CEDTDA)

Description
% Index
0.241
Leef H Dierks
Ratings table
Total assets
NA LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
% Index
NA
Moodys
NA Aaa NA -
S&P
NA AAA NA -
Fitch
NA AAA* NA -
Cdulas Titulizacin de Activos (CEDTDA), which was established in 1992, operates as a fund designed to refinance Cdulas Hipotecarias (CH) issued by smaller- and medium-sized Spanish commercial and savings banks under the Spanish Securitisation Law. Technically, CEDTDA purchases separate non-benchmark CH originated by commercial and savings banks, which have the same coupon, payment date and maturity, and then issues a (benchmark) multicdulas with a principal amount equal to the sum of the separate CH. Its activities are managed by TdA SGFT; an entity authorised by the Ministerio de Economa y Hacienda and supervised by the Comisin Nacional de Mercado de Valores CNMV, the Spanish financial markets supervisory authority. At the time of writing, CEDTDA had a total of 11 benchmark multi-cdulas outstanding in the combined amount of 22bn.
Note: Watch Negative. As at 7 June 2010
Risk weighting
As Spanish Cdulas Hipotecarias and Cdulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach when appraising the underlying assets.
Strengths
Liquidity facility: CEDTDAs multi-cdulas transactions benefit from the provision of a liquidity facility provided by Caja Madrid (CAJAMM), Spains second-largest savings bank in terms of total assets at the time of writing. The liquidity facility is designed to provide additional safety and ensure the timeliness of repayments to investors, thereby reducing the bonds default probability. Also, in terms of exchanging debt instruments for liquidity, CEDTDA (in contrast to Spanish plain vanilla covered bond issuers) benefits from its direct access to Banco de Espaa. Diversification: CEDTDA multi-cdulas typically involve up to a dozen Spanish savings banks, thereby offering multi-cdulas investors credit exposure to the Spanish savings banks sector as a whole. Covered bond investors thus benefit from a potentially higher degree of geographical diversity across Spain than in the case of some plain-vanilla Cdulas Hipotecarias. Transaction structure: In order to ensure that deals generate sufficient excess spread to cover the general expenses of the fund, coupons on the multi-cdulas are higher than the joint CH. Note that payments from individual CH into CEDTDA are due two working days before the payments are due on the Multi Cdulas to guarantee sufficient time to rectify any potential cash-flow problems
Weaknesses
Funding costs: In light of the currently more attractive funding levels when issuing plain-vanilla Cdulas Hipotecarias, several Spanish savings banks, which previously relied upon CEDTDAs multi-cdulas structure for their refinancing purposes, have meanwhile started tapping capital markets on their own. Consolidation pressures: In our view, the ongoing consolidation among Spanish savings banks, which is likely to result in larger institutions with higher refinancing needs and direct capital market access, could trigger more savings banks tapping the capital markets on their own. As CEDTDAs multi-cdulas transactions involve up to 11 different smaller and medium-sized Spanish savings banks, the sectors consolidation could result in potential headline risks for CEDTDA. Non-performing loan ratio: Over the past few months, the nonperforming loan (NPL) ratio of Spanish savings banks has steadily increased with the sectors average standing at 5.1% at the time of writing. In light of the economic situation in Spain, we believe that the NPL ratios of some of the savings banks involved could be subject to further increases, particularly in light of their exposure towards mortgage lending and lending to property developers, where the respective NPL ratio had reached 9.6% at the time of writing. Ownership structure: Shareholders of CEDTDA include Caja Castilla La Mancha (CCM), which holds a 12.9% stake (at the time of writing) but had to be bailed out after merger talks with domestic rival, Unicaja, were discontinued. Other shareholders include Caja Madrid, Caja de Ahorros del Mediterrneo, EBN Banco, Caja de Burgos, Unicaja, and IberCaja, which each hold 12.9%, as well as JP Morgan, which holds a 10% stake.
Key points for 2010

Monitor potential spill-over effects from ongoing consolidation in the Spanish savings bank sector that might reduce the number of savings banks relying on CEDTDA for refinancing purposes.
10 June 2010
550

Outstanding issues
Issue
Cdulas TDA 1 Cdulas TDA 2 Cdulas TDA 3
Cedulas TDA (CEDTDA)
Coupon %
3.250 4.500 4.375
ISIN
ES0317018002
Maturity
16 Jun 10
Volume bn
Involved parties
1.750 Caja Madrid, Caja Burgos, CAM, CCM, Ibercaja, Unicaja 2.000 Caixa Catalunya, Caja Laboral, Caja Terrassa, Caixanova, Caja Espana, Unicaja, Caja Madrid, CCM, Ibercaja, Caixa Tarragona, Banco Gallego 2.000 Caja Madrid, Caixa Penedes, Caja Castilla La Mancha, Caja Laboral, Unicaja, Caja Burgos, Caixa Terrassa, Caixa Girona, Caixa Manresa, Caixanova, Banco Gallego 1.500 Ibercaja, CAM, Caixa Penedes, Unicaja, CCM, Caja Madrid, Caja Laboral, Bnanco Gallego, Caixa Manresa 3.000 Banco Gallego, Caixa Manresa, Caixa Penedes, Caixa Terrassa, Ibercaja, Caixanova, Caja Madrid, Unicaja 2.000 Caja Murola, Caja Duero, Caixa Penedes, Caixa Terrassa, Ibercaja, Caixa Girona, Caja Madrid, CCM, Unicaja, Sa Nostra, Banco Gallego 1.150 Caixa Sabadell, Sa Nostra, Caixa Laietana, Unicaja, CCM, Cajasol 2.250 Caixa Sabadell, Sa Nostra, Caixa Laietana, Unicaja, CCM, Ibercaja, Caja Madrid, Caja Murcia, Caixa Girona, Caja Espana, Caja Cantabria, Caixa Terrassa 1.310 CCM, Caja Madrid, Caixa Girona, Caja Espana, Cajasol, Caja Burgos 3.805 Caixa Sabadell, Sa Nostra, Caixa Laietana, Unicaja, CCM, Caja Duero, Caja Madrid, Caixanova, Caixa Manresa, Caja Espana, Caixa Terrassa, Cajasol
ES0317019000 26 Nov 13 ES0317043000 03 Mar 16
Cdulas TDA 5 Cdulas TDA 6 Cdulas TDA 7 Cdulas TDA A-3 Cdulas TDA A-4
4.125 3.875 3.500 4.000 4.125
ES0317045005 29 Nov 19 ES0317046003 23 May 25 ES0317047001 20 Jun 17
ES0371622038 23 Oct 18 ES0371622012 10 Apr 21
Cdulas TDA A-5 Cdulas TDA A-6
4.250 4.250
ES0371622046 28 Mar 27 ES0371622020 10 Apr 31
Source: TdA Titulizacin de Activos, 31 March 2010
10 June 2010
551
Intermoney Titulizacion (IMCEDI)

Description
% Index
0.134
Leef H Dierks
Ratings table
Moodys
Note: *Watch Negative. As at 7 June 2010
% Index
NA
Total assets
NA
S&P
NA NR NA -
Fitch
NA AAA* NA -
NA Aaa NA -
InterMoney Titulizacin (IMCEDI) operates as a fund that refinances Cdulas Hipotecarias (CH) issued by smaller- and medium-sized Spanish savings banks under the Spanish Securitisation Law. Technically, IMCEDI purchases separate non-benchmark CH originated by commercial and savings banks, which have the same coupon, payment date and maturity, and then issues a (benchmark) multi cdulas with a principal amount equal to the sum of the separate CH. At the time of writing, IMCEDI had a total of 13 multicdulas transactions outstanding with a nominal volume of nearly 20bn, four of which with an aggregated volume of 7bn were originated on behalf of Grupo Banco Popular (GBPCED), exclusively. The latest issue was launched in November 2007. IMCEDI is owned by holding company CIMD, of which, in turn, two-thirds is owned by financial institutions, among them: ICAP (20%), Cajasol (10.7%), Cajamar (9.1%), BBVA (8.6%), Crdito Agricola (8.1%), Grupo Banco Popular (5.4%), and Cajacrculo (5.4%).
Risk weighting
As Spanish Cdulas Hipotecarias and Cdulas Territoriales are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach when looking through the underlying assets.
Strengths
Liquidity facility: IMCEDIs multi-cdulas transactions benefit from the provision of a liquidity facility provided by the IXIS CIB and HSBC, designed to give additional safety and ensure the timeliness of repayments to investors, thereby reducing the bonds default probability. In terms of exchanging debt instruments for liquidity, IMCEDI (in contrast to Spanish plain vanilla covered bond issuers) benefits from direct access to Banco de Espaa. Diversification: IMCEDIs multi-cdulas typically involve up to 10 Spanish commercial and savings banks, thereby offering multicdulas investors credit exposure to the Spanish savings banks sector as a whole. Covered bond investors thus benefit from a potentially higher degree of geographical diversity across Spain than in the case of some plain-vanilla Cdulas Hipotecarias. Transaction structure: In order to ensure that deals generate sufficient excess spread to cover the general expenses of the fund, coupons on the multi-cdulas are higher than the joint CH. Payments from individual CH into IMCEDI are due two working days before the payments are due on the multi cdulas to guarantee sufficient time to rectify any potential cash-flow problems.
Weaknesses
Funding costs: In light of the currently more attractive funding levels when issuing plain-vanilla Cdulas Hipotecarias, several Spanish commercial and savings banks, which previously relied upon IMCEDIs multi-cdulas structure for their refinancing purposes, have meanwhile started tapping capital markets on their own. As a consequence of this development, the last benchmark issuance of a multi-cdulas by IMCEDI on the primary market dates back to November 2007. Non-performing loan ratio: Over the past few months, the nonperforming loan (NPL) ratio of Spanish commercial and savings banks has steadily increased, with the sectors average standing at 5.1% at the time of writing. In light of the economic situation in Spain, we believe that the NPL ratios of some of the savings banks involved could be subject to further increases, particularly given their exposure to mortgage lending and lending to property developers, where the respective NPL ratios had reached 9.6% at the time of writing. Consolidation pressures: In our view, the ongoing consolidation among Spanish banks, which is likely to result in larger institutions with higher refinancing needs and direct capital market access, could trigger more banks tapping the capital markets on their own. As IMCEDIs multi-cdulas transactions involve up to a dozen different smaller and medium-sized Spanish banks, the sectors consolidation could result in potential headline risks for IMCEDI.
Note: Of the 13 IMCEDI multi-cdulas outstanding, four deals (CEDGBP) refer to Grupo Banco Popular (POPSM) and its subsidiaries, exclusively. These are the 5.75% CEDGBP June 2010, the 3.75% CEDGBP April 2011, the 4.250% February 2014, and the 4.25% CEDGBP April 2017, and. For detailed information on POPSM, please refer to the respective issuer profile within this section.
Key points for 2010

Monitor potential spill-over effects from ongoing consolidation in the Spanish savings bank sector, which might reduce the number of savings banks relying on IMCEDI for refinancing purposes.
10 June 2010
552

Multi-Cdulas outstanding
Issue
IM Cdulas 1 GBP IM Cdulas 2 IM Cdulas 3 IM Cdulas 4 IM Cdulas 5 IM Cdulas M1 IM Cdulas 7 Cdulas GBP 2 IM Cdulas 9 IM Cdulas 10 Cdulas GBP 3 Cdulas GBP 4 IM Cdulas 14
Intermoney Titulizacion (IMCEDI)
Coupon %
4.250 4.500 4.000 3.750 3.500 3.500 4.000 3.750 4.250 4.500 4.250 5.750 3.250
ISIN
ES0347858005 ES0347859003
Maturity
12 Feb 14 11 Jun 14
Volume bn
2.000 Banco Popular Espanol
Involved parties
1.475 Caja Laboral Popular, Banco de Valencia, Banca March, Caixa Peneds, Banco Espirito Santo 1.060 Cajamar, Caja Laboral Popular, Banco de Valencia, Banco Espirito Santo, Caixa Manresa, Caixa Tarragona, La Caja de Canarias 2.075 Banco de Valencia, Caja Cantabria, Banco Pastor, Cajamar, Caixa Terrassa, Caja Espana, Cajasol, Caixa Manresa, Ipar Kutxa, La Caja de Canarias 1.250 Caja Laboral Popular, Banca March, Caja Espana, Banco de Valencia, Caixa Terrassa, Sa Nostra, Caixa Girona 1.655 Cajamar, Caja Laboral Popular, Caja Murcia, Banco Gallego, Caja Cantabria, Caja Segovia 1.250 Caja Laboral Popular, Caja San Fernando, Banca March, Ipar Kutxa, Caixa Terrassa 3.000 Banco Popular Espanol 1.275 Cajamar, Caja Laboral Popular, Banca March, La Caja de Canarias, Banco Espirito Santo, Caja Cantabria 1.300 Caja Murcia, Banca March, Caixa Manrea, Banco Guipuzcoano, Caja San Fernando, Banco Gallego, Caixa Girona 2.000 Banco Popular Espanol 1.000 Banco Popular Espanol 1.200 Caixa Murcia, Caixanova, Cajastur, Caja Cantabria
ES0347852008 19 Nov 14 ES0347848006 11 Mar 15 ES0347849004 15 Jun 20
ES0362859003 02 Dec 15 ES0347784003 31 Mar 21 ES0318821008 ES0347785000 ES0349045007 ES0318822006 ES0316988007 12 Apr 11 09 Jun 16 21 Feb 22 26 Apr 17 25 Jun 10
ES0347462006 31 Mar 15
Source: Intermoney Titulizacin, 31 March 2010
10 June 2010
553
Unicaja (UNICAJ)
Description
% Index
0.029
Leef H Dierks
Ratings table
% Index
NA
Total assets
Moodys
S&P
NR NR NR -
Fitch
A+ NR Stable -
Montes de Piedad y Caja de Ahorros de Ronda, Cdiz, Almera, Mlaga y Antequera, ie, Unicaja (UNICAJ) is the result of the 1991 merger between five Andalusia-based savings banks: Monte de Piedad y Caja de Ahorros de Ronda, Caja de Ahorros y Monte de Piedad de Cdiz, Monte de Piedad y Caja de Ahorros de Almera, Caja de Ahorros Provincial de Mlaga and Caja de Ahorros y Prstamos de Antequera. With total assets of c. 34bn as per year-end 2009, UNICAJ is among the medium-sized Spanish savings banks providing retail banking services through its 902 branch offices. With headquarters in Malaga, UNICAJs activity is geared towards the autonomous community of Andalusia, where it claims to be market leader in retail banking. Since late 2009, UNICAJ has been in merger talks with domestic peer CajaSur and Caja Jaen. The potential merger, which has partly been approved already by regulators, would create a new entity (UnicajaSur) with total assets of c. 60bn. Yet, in late May, talks collapsed and CajaSur was seized by Banco de Espaa and has now been put into administration by the FROB.
Risk weighting
As Spanish Cdulas Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standardised Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Funding profile: In 2009, UNICAJs customer deposit to loan ratio stood at a very high 99%, only marginally down from 100% in 2008, thereby indicating that in principle, all loans granted (24.0bn in 2009, down 1.8% from 24.4bn in 2008) could be refinanced through deposit taking (23.8bn in 2009, down 2.5% y/y from 24.4bn in 2008). This leaves UNICAJs capital market reliance standing on a relatively low level, with wholesale funding accounting for only 21% of all funding in 2009, albeit sharply up from 14% in 2008. Support mechanism: Like any other Spanish savings banks, UNICAJ benefits from the internal support mechanisms of the Spanish savings bank system. It is part of the Spanish savings banks association, Confederacin Espaola de Cajas de Ahorros (CECA), which offers technological and advisory services particularly relevant for smaller savings banks but also has its own banking licence and can provide liquidity and arrange support for stressed savings banks. Furthermore, UNICAJ benefits from the depositor guarantee fund Fondo de Garanta de Depsitos (FGD) of Spanish savings banks. In addition to the FGD, cajas benefit from federal support in the form of the FROB, which, if necessary, provides funding for the sectors consolidation.
Weaknesses
Loan-loss provisions: Over the course of 2009, UNICAJs loan-loss provision increased 35% y/y to 398mn in 2009, from 294mn a year before. This affected the lenders net income, which fell by 28% y/y to 205mn in 2009, from 286mn a year before. Dependency on interest income: Given its focus on retail banking, 68% or 756mn of UNICAJs operating income (1.1bn) was accounted for by the lenders net interest income. Despite developing favourably over the course of the past two years with the net interest margin (NIM) increasing to 228bp in 2009, from 203bp in 2008 and 186bp in 2007, we caution that in light of ongoing consolidation in the Spanish banking market, UNICAJs NIM could come under pressure as a result of higher interest rates paid on customer deposits. This, in turn, could possibly have a detrimental impact on UNICAJs NIM and thus its profitability. Market consolidation: Following the failure of merger talks between Unicaja, CajaSur and Caja Jaen in late May, pressure to merge its operations with one or more domestic peers is likely to increase in the months ahead.
Note: At the time of writing, UNICAJ had one EUR-denominated benchmark Cdulas Hipotecarias with a nominal amount of 1bn outstanding.
10 June 2010
554

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Cedulas Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 2008 2009
Unicaja (UNICAJ)
120 16.1 100 97.1 80 2007 2008 2009 Customer deposits to loans Wholesale funding in % of total funding 13.8 100.1 99.4 20.6 30 20 10 0
611 136 82 950 382 567 107 458 358 32,845 23,964
660 134 157 1,032 395 637 294 338 286 32,156 24,396
756 126 157 1,102 394 708 398 231 205 34,185 23,955
NIM, credit costs and RoAA

3 2
23,267 3,085 3,216 1.1 11.1 40.3 64.4 18.9 24,422 3,122 230 2,724 0.9 9.6 38.3 64.0 46.2 23,815 5,033 1,580 2,908 0.6 7.3 35.8 68.6 56.1
1.9 1.1 0.3 2007 NIM
2.0 0.9 0.9 2008 Credit costs
2.3 1.2 0.6 2009 RoAA
1 0
9.8
10.2 13.2 8.5
8.5
10 June 2010
555
10 June 2010
556
FRENCH COVERED BOND PROFILES
10 June 2010
557
Banque Fdrative du Crdit Mutuel (CMCICB)

Description
% Index
0.077
Fritz Engelhard
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor* Collateral score* Aa3 Aaa Stable 6.1
Ratings table
% Index
NA
Total assets
421bn
S&P
A+ AAA Stable -
Fitch
AAAAA Stable 19.8 -
Banque Fdrative du Crdit Mutuel (BFCM) is the issuing vehicle for the French regional banking group Crdit Mutuel Centre Est Europe (CMCEE) and Crdit Industriel et Commercial (CIC). CMCEE is itself part of a federation of co-operative banks that form Groupe Crdit Mutuel. CMCEE operates predominantly in France, where it has a strong domestic presence, with a domestic market share of 12% in term of deposits and 18% in terms of loans at YE 09. In July 2007, CMCICB issued its first French common law covered bond. In December 2008, CM Group received a 1.2bn capital injection via super subordinated debt (TSS: titres super subordonnes) through the French bank rescue fund (SPPE: Socit de prise de participation de ltat).
Notes: *In %
Risk weighting
Currently, CMCICB covered bonds are treated as senior bank debt and thus carry a 20% risk weighting under the RSA approach.
Strengths
Size and support: With total assets of 421bn as of YE 09, Crdit Mutuel Group is an important member of the French banking market. The key role BFCM plays in the activities of CMCEE, which itself is a key part of the Crdit Mutuel Group, means that support would most likely be forthcoming should BFCM require it. The fact that in 2008 the French government included CM Group in its recapitalisation measures for the French banking system highlights that it regards CM Group as systemically relevant. Improved capitalisation and funding profile: Given that CM Groups main exposure is to low risk residential mortgage and retail banking businesses, we consider its Tier 1 capital ratio of 10.3% (YE 09), which has increased from 8.8% at YE 08, to be reasonably sound. Furthermore, the group managed to increase its deposit base 17.3bn or 20% in FY 09. As growth in customer loans was 3%, the deposit-to-loan ratio increased from 60% at YE 08 to 69% at YE 09. Covered bond programme: CM Groups covered bond programme contributes positively to the liquidity management of the group, as it helps to lengthen the liability structure and also facilitates access to central bank funding. The credit enhancement for the covered bonds, which is expressed as an asset percentage level of 78.9%, has increased from 88.7% at YE 09. Furthermore, the cover pool contains a quite high ratio (Q1 10: 84%) of owner-occupied home loans.
Weaknesses
Fallout from financial market crisis: Mid-2008, Crdit Mutuel Group reclassified 18.8bn of assets it held on its trading book and 6.5bn it held in AfS accounts. Among the assets that were re-classified were high-risk exposures, which at YE 09 amounted to 13.1bn (YE 08: 17bn) and included 5.3bn of RMBS, 2.1bn of US RMBS, 1.8bn of CLO/CDO, 1.5bn of other ABS and 2.1bn of leveraged loans. As the market environment in these sectors remains volatile, the group is exposed to potential writeoffs from these exposures. Exposure to cyclical downturn: The groups total loan book (YE 09: 152bn) suffered from the more challenging economic environment. This is reflected in an increase of NPLs and writedowns. The groups loan provisions nearly doubled in 2009, and the NPL ratio increased from 2.9% at YE 08 to 4.0% at YE 09. However, further fallout should be mitigated by the banks conservative risk appetite and the fact that its core market in France benefits from a high degree of fiscal economic support. Intra-group exposures: Within the covered bond programme, a substantial percentage (58%) of the cover pool assets are secured by a guarantee provided by specialist insurance companies, which are partly owned by CM Group (CMH: Cautionnement Mutuel de lHabitat). The respective default risk is mitigated by the fact that upon a downgrade of BFCM below A-, the programme foresees that BFCM will pay and maintain the registration cost of the respective mortgages or similar legal privileges, securing the payment of the respective home loans granted by the counterparties belonging to the group.
Key points for 2010

Monitor the evolution of the balance sheet and the level of provisioning. Track the effect of financial market volatility on the groups bottom-line results.
10 June 2010
558

mn 2006 Income statement summary Net interest income 662 Net fees & com's 1,214 Trading income 2,616 Operating income 5,557 Operating expenses 3,002 Pr e-provision income 2,555 Loan loss provisions 90 Pr e-tax profit 2,606 Net income 1,642 Balance sheet summary Total ass ets 339,025 Customer loans 99,963 of which Mortgages 39,954 Customer deposits 61,080 Debt funding 79,166 of which covered bonds 0 Total equity 8,394 Profitability (%) Return on assets 0.48 Return on equity 22.0 Cos t/Income r atio 54.0 Net int inc/Op inc 11.9 Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Pr ob loans/Gr loans Cover age ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 3.5 0.37 1.28 28.8 9.2 11.8 2.5 2007 97 1,475 2,768 5,387 3,085 2,302 128 2,253 1,464 395,910 121,660 49,682 69,980 106,518 4,500 9,492 0.37 16.4 57.3 1.8 5.6 0.52 1.76 29.3 8.8 10.8 2.4 2008 1,559 1,490 117 3,902 3,154 748 1,016 -167 29 425,223 147,689 55,006 88,306 109,430 14,155 11,475 0.01 0.3 80.8 40.0 135.8 0.56 2.87 19.7 8.8 9.0 2.7
Banque Fdrative du Crdit Mutuel (CMCICB)

2009 4,502 2,115 7,497 4,448 3,049 1,892 1,504 808 420,516 152,072 56,408 105,649 94,788 14,155 15,171 0.19 6.1 59.3 60.1 62.1 0.73 3.97 18.3 10.3 10.0 3.6
1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 2006 NIM 2007 2008 Credit costs 2009 RoA
Efficiency
90% 70% 50% 30% 10% -10% 2006 2007 2008 Cost/Avg assets (RS) 2009 Cost/Income 0.9% 1.1% 0.8% 0.7% 54% 57% 81% 59% 2.0% 1.5% 1.0% 0.5% 0.0%

120% 100% 80% 60% 40% 20% 0% 80% 75% 70% 65% 60% 55% 2006 2007 2008 2009 Cust deposits/Loans (LS) Wholesale funding/Tot. funding
61
58
60
69
Asset quality
5 4 3 2 1 0 2006 2007 Prob loans/Gr loans 2008 1.3 1.8 29 29 20 2.9 4.0 18 30 25 20 15 10 5 0
Capital ratios (%)

14 12 10 8 6 2006 2007 2008 Capital adequacy (%) 2009 Tier 1 ratio 11.8 10.8 9.2 8.8 9.0 8.8 10.0 10.3
2009 Coverage ratio (RS)
CMCICB CB: Breakdown by loan type, Q1 10

Buy to let 14% Owener Occupied 83% Second Home 3%
CMCICB CB: Breakdown by security type, Q1 10
Mortgages 42%
Guaranteed exposures 58%
10 June 2010
559
BNP Paribas (BNP)

Description
% Index
0.223
Fritz Engelhard
Ratings table
Total assets
2,058bn LT senior unsecured Covered bond rating* Outlook Discontinuity factor*/** Collateral score**
Note: *BNP PCB/SC F, **In %
% Index
NA
Moodys
Aa2 Aaa/Aaa Stable 6.4/8.1
S&P
AA AAA/AAA Negative -
Fitch
AA AAA/AAA Negative 20.3/11.8 -
BNP Paribas (BNP) is a large, well-diversified international banking group organised around three business lines: Retail Banking; Corporate and Investment Banking (CIB) and Investment Solutions (Private Banking, Asset Management, Securities Services, Insurance). BNP operates in more than 80 countries, although France, Italy, Belgium and Luxembourg, its core markets, remain most important, with 53% of total commitments as of YE 09. The US and Asia/Pacific represent about 20% of credit risk exposures, while western European countries make up 17%. In 2006, BNP acquired BNL, the seventh-largest bank in Italy. Following shareholder approval in Q2 09, BNP acquired the Fortis activities in Belgium and Luxembourg. With regards to covered bond funding, in November 2006, BNP introduced the first French common law covered bond programme (BNPPCB), and in February 2009, it started its Obligations Foncires programme with issuance via BNP Paribas Public Sector SCF (BNPSCF).
Risk weighting
Currently, BNPPCB covered bonds are treated as senior bank debt and thus carry a 20% risk weighting under the RSA approach. The banks Obligation Foncires carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Recovery of bottom-line performance: Following a 61% drop in net income in FY 08, the banks FY 09 bottom-line performance increased by 93% and reached 5.8bn. This was largely due to the increase in the banks revenues from retail banking operations as well as the recovery of its CIB businesses. Strengthened capitalisation: The bank improved its solvency position through both the control of risk-weighted assets and the increase of Tier 1 equity. The impact of the 166bn increase in risk-weighted assets from the Fortis acquisition in H1 09, was compensated through 73bn of reductions, which mainly came from reductions in capital market risk positions (-68bn). Tier 1 capital increased by 51%, from 41.8bn at YE 08, to 62.9bn at YE 09, mainly through an increase in core Tier 1 capital (+20.6bn). Organic capital generation contributed 4.6bn to this increase, highlighting the banks good internal capital generation capacity. Diversity and size: BNP is one of Europes largest banking companies. Following the acquisition of Fortis activities in Belgium and Luxembourg, it has a 605bn (YE 09) deposit base (YE 08: 414bn) the largest in the eurozone. In addition, through its US subsidiary, BancWest, BNP is the fourth-largest bank in California. The contribution of the more volatile trading income to the groups operating income stood at a low 14% in FY 09. This compares with an average of 31% between 2001 and 2007. Asset management: With the acquisition of Fortis, BNP further strengthened its asset management activities in France and the rest of Europe. As of YE 09, the group had 588bn assets under management and ranks among the top 10 asset managers in Europe.
Weaknesses
Exposure to cyclical downturn: The global economic downturn led to decreasing corporate earnings and rising unemployment. This has left its mark on BNPs substantial customer financing activities (YE 09: 670bn). The banks NPL ratio increased from 3.7% at YE 08 to 5.1% at YE 09. The cost of risk in BNPs CIB financing business increased from 355mn in FY 08, to 1.4bn in FY 09. However, further fallout should be mitigated somewhat by the banks conservative risk appetite, a high degree of sector diversification and the fact that core markets in France, Belgium and Italy benefit from a high degree of fiscal economic support. Event risk: The acquisitions of BNL in 2006 and Fortis in 2009 underline BNPs ambitions to continue expanding internationally. This generates an element of event risk, which, at best, in our view, is likely to be credit neutral. Competition: The French banking market is characterised by fierce competition. Following the merger of Credit Agricole and Lyonnais and, more recently, the merger between Group Caisse dpargne and Groupe Banque Populaire, competitive pressure, particularly in French retail banking, is rising. Changes to the cover pool composition: Between the inception of the common law covered bond programme in November 2006 and February 2010, the latest available reporting date, the share of buy-to-let home loans increased from 12.7% to 15.9%. Over the same period, the weighted average indexed LTV increased from 58% to 64%. The change in these risk factors not only mirrors the development of existing cover assets over time, but also reflects that the composition of the cover pool can be influenced by portfolio additions from BNP. However, larger shifts in the risk profile of the pool are limited through the banks strategic commitment to the covered bond programme, transparent reporting and rating agency surveillance.
Key points for 2010

Monitor the evolution of the balance sheet and the level of provisioning. 10 June 2010 Track the development of cover pool assets.
560

Financial summary
mn 2006 2007 2008 2009 Income statement summary Net interest income 9,124 9,708 13,498 21,021 Net fees & com's 6,104 6,322 5,859 7,467 Trading income 8,940 10,350 3,157 5,649 27,943 31,037 27,376 39,319 Operating income Operating expenses 16,137 17,773 17,324 21,958 Pr e-provision income 11,806 13,264 10,052 17,361 Loan loss provisions 810 1,472 3,783 7,818 Pr e-tax profit 10,570 11,058 3,924 9,000 Net income 7,308 7,822 3,021 5,832 Balance sheet summary Total ass ets 1,440,343 1,694,454 2,075,551 2,057,698 Customer loans 393,133 445,103 494,401 678,766 of which Mortgages na na na na Customer deposits 298,652 346,704 413,955 604,903 Debt funding 139,519 159,697 175,831 239,238 of which covered bonds 0 11,000 12,700 19,533 Total equity 44,487 50,527 54,758 68,326 Profitability (%) Return on assets 0.54 0.50 0.16 0.28 Return on equity 17.2 16.5 5.7 9.5 Cos t/Income r atio 57.7 57.3 63.3 55.8 Net int inc/Op inc 32.7 31.3 49.3 53.5 Asset quality (%) LLPs/Pre-prov inc 6.9 11.1 37.6 45.0 LLRs/Gross loans 3.43 2.81 2.91 3.79 Pr ob loans/Gr loans 3.23 2.87 3.65 5.08 Cover age ratio 106.3 98.0 79.8 74.5 Capital adequacy (%) Tier 1 ratio 7.4 7.4 7.8 10.0 Total capital ratio 10.5 10.5 11.1 14.1 Equity/Assets ratio 3.1 3.0 2.6 3.3
BNP Paribas (BNP)

Net interest margin, credit cost and return on equity
1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 1.02% 0.68% 0.52% 0.05% 2005 NIM 0.68% 0.54% 0.06% 2006 0.62% 0.50% 0.09% 2007 Credit costs 0.72% 0.38% 0.20% 0.16% 2008 RoA 0.28% 2009
Customer loans to deposits

160% 120% 80% 40% 0% 2005 2006 2007 2008 2009 Cust deposits/Loans (LS) Wholesale funding/Tot. Funding (RS) 82% 76% 78% 84% 89% 47% 49% 49% 47% 43% 50% 45% 40% 35% 30%
Capital ratios (%)

16 14 12 10 8 6 2005 2006 Tier 1 ratio 2007 2008 2009 Total capital ratio 11.0 7.6 10.5 7.4 10.5 7.4 11.1 7.8 14.1 10.0
BNPSCF programme: Asset coverage

3.0 2.5 2.0 1.5 1.0 0.5 0.0 bn
Asset quality
10% 8% 6% 4% 2% 0% 4.1% 2005 3.2% 2006 2.9% 2007 3.7% 2008 2009 5.1% 82% 106% 98% 80% 74% 120% 100% 80% 60% 40% 20% 0%
Mar-09 Aug-09 Dec-09 Feb-10 Cover Assets Outstanding Covered Bonds
Prob loans/Gr loans (LS)
Coverage ratio (RS)
BNPPCB programme: Asset coverage

25 20 15 10 5 0 bn
BNPPCB programme: Share of buy-to-let and WA LTV

18% 16% 14% 12% 66% 62% 58% 54%
Feb-07
Jun-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aggregate CB outstanding principal amount Adjusted Aggregated Asset Amount
10% 50% Feb-07 Jun-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 % buy-to-let (LS) Weighted average indexed LTV (RS)
10 June 2010
561
BPCE Group (BPCOV / CDEE)

Description
% Index
NA
Fritz Engelhard
Ratings table
Total assets
1,029bn LT senior unsecured Covered bond rating Outlook Discontinuity factor* Collateral score*
Notes: *In %
% Index
NA
Moodys
Aa3 Aaa Stable 7.4
S&P
A+ AAA Stable -
Fitch
NR NR -
BPCE Group was formed in mid-2009 through the merger between Groupe Banques Populaires (GBP) and Group Caisse dpargne (GCE). Its ambition is to provide a full range of services to all types of customers. Through GBP it has a nationwide presence via 20 regional Banques Populaires with a total of 6.5mn personal customers and leading market shares among SMEs. Through GCE, it has a countrywide presence via 17 regional savings banks with a focus on retail and commercial banking. Furthermore, it owns a number of specialised entities through which it provides corporate and investment banking (CIB) services and real estate financing. In 2008, prior to their merger, GBP and GCE have set up individual French common law covered bond programmes. The respective issuing entities were named Banques Populaires Covered Bonds (BPCOV) and GCE Covered Bonds (CDEE) and continue to operate as separate funding units. Via Caisses dEpargne Participations, BPCE, also owns Credit Foncier de France and thus it is also the final owner of Compagnie de Financement Foncier (CFF), the largest French covered bond issuer.
Risk weighting
Currently, BPCOV and CDEE covered bonds are treated as senior bank debt and thus carry a 20% risk weighting under the RSA approach.
Strengths
Size and support: With total assets of 1,029bn as of YE 09, BPCE is an important player in the French banking market, with a strong local presence across the country and a group-wide 368bn deposit base. This means that it benefits from a strong element of systemic support. The fact that the French government included BPCE in its recapitalisation measures for the French banking system highlights that the government regards the group as systemically relevant. Furthermore, we note that the group is headed by a former government official. Restructuring and capitalisation: BPCE SA is the central holding entity of the group. It is in charge of strategic decision making, risk policy and treasury operations, including wholesale funding. The three-year strategic project Ensemble (Together), includes the concentration on bank insurance businesses, the realisation of synergies from the merger (cost: 1bn pa; revenues: 0.8bn pa) and the simplification of the group structure. The groups capitalisation was strengthened in the course of 2009. While the groups former central bodies, Banque Fdrale des Banques Populaires (BFBP) and Caisse Nationale des Caisses d'Epargne (CNCE) had a Tier 1 ratio of 6.4% and 8.1%, respectively, at YE 08, BPCE had a Tier 1 ratio of 9.1% at YE 09. Covered bond programmes: The BPCOV and CDEE covered bond programmes contribute positively to the liquidity management of the group, as they help to lengthen the liability structure and also facilitate access to central bank funding. As of January 2010, both cover pools were characterised by a benign weighted average indexed LTV (BPCOV: 62%; CDEE: 60%) and a quite high ratio of owner-occupied home loans (BPCOV: 90%; CDEE: 94%).
Weaknesses
Fall-out from financial market crisis: In FY 09, BPCE reported a net pre-tax loss of 368mn, following a pro-forma pre-tax loss of 3.7bn. While pre-tax income from the groups core banking and insurance businesses increased by 1.5bn, pre-tax income from CIB and specialised services decreased by 1.1bn and results from the workout portfolio together with other operations burdened FY 09 group pre-tax results with a 3.0bn loss, following a 6.4bn loss in FY 08. The group remains exposed to a total of 24.2bn of sensitive risk positions, which include 8.2bn of leveraged loans, 7.4bn of RMBS, 6.1bn of CDO and a 1.4bn monoline exposure. As the situation in financial markets remains volatile, the new group remains exposed to further fallout. Exposure to cyclical downturn: The global economic downturn has led to decreasing corporate earnings and rising unemployment. This exposes BPCEs loan book, which amounted to 517bn as of YE 09, to an increase in NPLs and write-downs. However, the total fallout should be mitigated by the conservative risk management of the groups loan business and the fact that its core market in France benefits from a high degree of fiscal economic support. This is also reflected by the fact that the combined NPL ratio of the GBP and GCE networks so far increased only slightly from 2.9% at YE 08, to 3.3% at YE 09. Intra-group exposures: Within both covered bond programmes, a substantial percentage (BPCOV: 55%; CDEE: 65%) of cover pool assets are secured by a guarantee provided by specialist insurance companies, which also belong to the group. The respective default risk is mitigated by the fact that upon a downgrade of the sponsor bank below A- the programme foresees that the sponsor bank will pay and maintain the registration cost of the mortgages or similar legal privileges, securing the payment of the respective home loans granted by the counterparties belonging to the group.
Key points for 2010

Monitor the restructuring of the group and its impact on funding activities and profitability. 10 June 2010 Track the development of the groups structured credit exposures and their impact on bottom-line earnings. 562

mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which Mortgages Customer deposits Debt funding of which covered bonds* Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio
*BPCOV, CFF and GCE Covered Bonds
BPCE Group (BPCOV / CDEE)

Pre-tax profit by business line
2008 na na na 16,096 16,337 -241 3,146 -3,740 -1,847 2009 na na na 21,227 16,359 4,868 4,145 -368 537 1,028,802 517,440 na 367,717 219,391 115,412 43,988 0.05 1.4 77.1 na 85 2.1 3.6 58 9.1 na 4.3
4 2 0 -2 -4 -6 -8
1.3
2.9
1.2
0.0
0.2
-0.2
-3.0 Bank & Insurance CIB / Services Equity Interests -6.4 Workout & Other 2009
2008
Efficiency (Group BPCE)

120% 100% 80% 60% 40% 20% 0% 101% 77% 3.0% 2.6% 2.2% 1.8% 1.4% 1.0% 0.6% 0.2% -0.2%
1,143,679 512,363 na 371,053 229,856 113,840 31,514 na na 101.5 na <0 na na na na na 2.8
1.6%
1.5%
2008 Cost/Income (LS)
2009 Cost/Avg assets (RS)
Customer deposits to loans (Group BPCE)

160% 120% 80% 40% 0% 2008 2009 Cust deposits/Loans (LS) Wholesale funding/Tot. Funding (RS) 72% 71% 50% 48% 55% 50% 45% 40% 35% 30%
BPCOV over-collateralisation, January 2010

20 15 10 5 0 Jan-08 Jul-08 Jan-09 Jul-09 Adjusted aggregate asset amount (bn) Outstanding CBs (bn) Jan-10
GCE over-collateralisation, January 2010

30 20 10 0 Sep-08 Nov-08 Apr-09 Oct-09 Adjusted aggregate asset amount (bn) Outstanding CBs (bn)
BPCOV breakdown by loan type, January 2010
GCE breakdown by loan type, January 2010
buy to let 8% owner occupied 90% vacation / second home 2%
owner occupied 94%
buy to let 4% vacation / second home 2%
10 June 2010
563
Caisse de Refinancement de lHabitat (CRH)

Description
% Index
0.476
Fritz Engelhard
Ratings table
Moodys
Note: *in %
% Index
NA
Total assets
41bn
S&P
NR NR NR -
Fitch
NR AAA NR 37.9 -
NR Aaa NR -
CRH was established in 1985 as a socit financire for the special purpose of refinancing residential mortgage loans originated by its shareholders through the issuance of debt obligations collateralised by a portfolio of mortgage notes (billets de mobilisation). The mortgage notes, in turn, are backed by portfolios of home loans secured by mortgages or guarantees. Only financial institutions can be shareholders of CRH and are subject to prior approval from the Board of Directors of CRH. Between 2008 and 2009, the shareholder structure of CRH was rather stable, with Crdit Agricole (40.2%), Crdit Mutuel group (33.2%), Socit Gnrale (12.6%) and BNP Paribas (8.9%) being the top four shareholders, owning a combined 95% of CRH. In 2009, gross issuance of CRH bonds amounted to 5.1bn. Since 1 July 2008, CRH bonds are listed in the iBoxx France Covered Legal Index. Since January 2010, CRH is also in charge of administrating and controlling the activities of SFEF, the special financing agency set up in October 2008 to support the French banking system.
Risk weighting
CRH bonds carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Shareholder support: CRH is owned by major French banks. The banks participating in the CRH scheme have an aggregate market share in the French home loan market of about 85%. The credit profile of CRH bonds reflects the credit quality of CRHs major shareholders. According to CRHs statutes, its shareholders have to make liquidity advances to CRH of up to 5% of the respective outstanding mortgage notes and capital contributions in relation to their use of the CRH scheme. We believe it is very likely that CRH may benefit from additional solvency commitments, as well as operational support in case of need. Legal framework: CRH is a unique covered bond issuer because it has been created due to a specially designed law (No. 85-695 from July 1985). The legal framework ensures the prior claim of CRH on the loan portfolio of a defaulted stakeholder. It also sets supervisory standards with regards to eligibility criteria, asset coverage, as well as interest rate and liquidity risk. Over-collateralisation: The CRH law requires the mortgage notes issued by the individual banks to be collateralised by a home loan portfolio representing at least 125% of the value of outstanding. If a bank fails to comply with this limit, CRH can require it to acquire CRH bonds and exchange them for the respective amount of mortgage notes. We also note that, historically, overcollateralisation has been managed rather conservatively. Additional self-commitments: Beyond the legal framework, CRH has made a number of self-commitments, including: the geographical scope (only French home loans); the single loan amount (capped at 1mn); the composition of the asset pool (no inclusion of RMBS); interest rate cash flow coverage; and limiting any shareholder to finance only up to 50% of its annual residential home loan origination through the CRH scheme.
Weaknesses
Residual exposures in a stress scenario: In case one of CRHs shareholders defaults, all mortgage notes would become due and payable and CRH would become owner of the pledged home loan portfolio. As CRH has neither the capacity to manage home loans nor is it prepared to actively manage interest rate risk, investors would potentially be exposed to operational, liquidity and market risk. However, this is mitigated by the fact that CRH can draw on the liquidity lines jointly provided by its shareholders. In addition, it would likely seek to assign the loan portfolio to a third party and buy back outstanding CRH bonds with the respective proceeds. Furthermore, through internal regulations, CRH ensures that interest rate payments from the home loan portfolios match the interest rate payments on the mortgage notes at all times. Conflict of interest: CRH provides funds to its major shareholders. Thus, there is a potential conflict of interest with regards to CRHs ability to manage its assets as well as supervise and control the quality of the collateral provided by individual banks. This is clearly mitigated by the strict regulatory set-up, the stipulated financing limit for individual banks and the incentive of CRHs shareholders to jointly maintain it as a funding source. Lack of flexibility: The flipside of CRHs rather strict ALM regime is that it is quite inflexible with regards to its primary markets approach. In particular, CRHs inability to more actively manage liquidity and market risk limits its ability to adapt its issuance activity more narrowly to investor needs. This also results in frequent and sometimes quite substantial taps of outstanding benchmark bonds, which could create spread volatility. Disclosure on mortgage portfolio: Compared with other covered bond issuers, disclosure on the mortgage portfolios finally backing the covered bonds is rather poor. This is mitigated by the fact that the respective mortgage loans must fulfil minimum quality criteria and are also subject to monthly surveillance and regular (at least every two years) audits from CRH employees. We also note that recovery from cover pool assets would only become relevant following a default of CRH.
Key points for 2010

Monitor the evolution of issuance activity and policy. 10 June 2010 Track the development of CRHs shareholder structure. 564

mn Income statement summary Net interest income Operating expenses Pre-tax profit Net income Balance sheet summary Total assets Mortgage notes & CDs Secured debt funding Subordinated debt Total equity Annual issuance & redemption Gross new CRH bond issued Redemption of CRH bonds Net new issuance Capital adequacy (%) Total capital ratio Equity/Assets ratio 9.2 0.5 8.9 0.5 8.8 0.5 8.7 0.5 8.7 0.5 3,050 1,486 1,564 7,655 736 6,919 8,325 0 8,325 7,400 3,805 3,595 5,050 3,265 1,785 19,474 26,998 34,646 38,525 40,626 18,864 26,194 34,361 38,310 40,481 18,864 26,194 34,329 38,172 40,265 73 104 105 135 157 158 171 180 150 208 Pledged mortgage collateral 28,100 38,500 48,500 55,800 58,100 2.2 1.4 0.8 0.5 3.2 1.6 1.7 1.0 5.7 1.7 4.0 2.5 8.0 1.9 6.1 3.8 2.8 1.8 0.9 0.6 2005 2006 2007 2008 2009
Caisse de Refinancement de lHabitat (CRH)

Shareholder structure, YE 09
Socit Gnrale 13% Banques Populaires 5% Other 1% Groupe Crdit Agricole SACrdit Lyonnais 39%
Groupe BNP Paribas 9% Groupe Crdit Mutuel CIC 33%
Net issuance
10 8 6 4 2 0 2004 2005 2006 2007 2008 2009 Net new issuance (bn) 2.6 1.6 6.9 3.6 1.8 8.3
Redemption profile
10 8 6 4 2 0 0.0 5.1 4.3 5.0 3.7 3.0 bn 7.8
7.3 4.0 2.9
2.0
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Structural overview
Secured by mortgages or guarantees Pledge of Home Loan Portfolio Privilege on the portfolio of notes
Home Loans ( 58.1bn) Home Buyers Banks
Billets de Mobilisation ( (40.3bn) CRH Notes Proceeds
CRH Bonds (40.3bn) ( Bond Holders
Bond Proceeds
60 40 20 0 2004 2005 2006 2007 Pledged mortgage collateral Overcollateralisation (RS) bn 1.55 1.50 1.45 1.40 1.35 2008 2009 Secured debt funding
Composition of secured bank notes portfolio

100% 80% 60% 40% 20% 0% 03 04 05 06 07 08 09 CASA / CL Socit Gnrale Crdit Mutuel CIC Banques Populaires BNP Paribas Other
10 June 2010
2020
565
Crdit Agricole SA (ACAFP)

Description
% Index
0.09
Fritz Engelhard
Ratings table
Total assets
Note: *In %
% Index
NA
Moodys
S&P
AAAAA Negative -
Fitch
AAAAA Stable 22.2 -
Crdit Agricole SA (CASA) is the main operating entity of Crdit Agricole Group, with the ambition to be a retail bank leader in France and Europe. With 26mn clients and more than 9,000 branches, it is the leading provider of retail banking services in France. Its international retail banking operations, with a major presence in Italy and Greece, comprise 6.5mn clients and 2,400 branches. The bank also runs specialised consumer finance operations. Within its corporate and investment banking (CIB) activities, it is present in more than 50 countries. Since 31 December 2009, the group also owns a 75% stake in Amundi, which resulted from the merger between the asset management operations of Crdit Agricole and the European and Asian asset management businesses of Socit Gnrale, which holds the remaining 25% of Amundi. With regards to covered bond funding, in January 2009, CASA launched its first French common law covered bond. It is also the largest shareholder in CRH (YE 09: 39.7%).
Risk weighting
Currently, ACAFP covered bonds are treated as senior bank debt and thus carry a 20% risk weighting under the RSA approach.
Strengths
Strengthened capitalisation: In the course of 2009, CASA substantially improved its capital position. Its Tier 1 capital ratio increased from 8.6% at YE 08 to 9.5% at YE 09. This was due to a 3.6% or 12.1bn reduction in risk-weighted assets, which stood at 326bn at YE 09, combined with a 6.5% or 1.9bn increase of Tier 1 capital, which largely (98%) consisted of core capital. Diversity and size: CASA is the largest French retail bank and one of Europes largest banking groups. In our view, due to the banks size and market position, there is a high likelihood of public sector support. CASA enjoys a strong position in asset management. The 75%-owned Amundi operations had a total of 670bn of assets under management as at YE 09, and was the third-largest asset management company in Europe. Improved loan to deposit ratio: CASA managed to reduce its reliance on wholesale funding in the course of 2009. Following a significant decrease from 141% at YE 06 to 121% at YE 08, CASAs loan to deposit ratio increased again to 128% at YE 09. This was the result of a 10.1% or 42.7bn increase in deposits, which compared with a rather moderate 3.8% or 13.3bn increase in customer loans. In 2009, financing through Socit de Financement de lEconomie Francaises (SFEF) amounted to 18.6bn (total SFEF usage as of YE 09: 21.6bn) and represented 63% of the groups total 29.3bn term-funding activities.
Weaknesses
Capital markets: In FY 09, management launched an initiative to reduce risk-weighted assets and the cost base of the CIB division. This limited the banks ability to benefit from the recovery of capital markets. Thus, increased revenues from capital market operations (851mn in FY 09 after 536mn in FY 08) were insufficient to compensate for ongoing losses from legacy portfolios (1.5bn in FY 09, from 3.4bn in FY 08). In total, the CIB division had a loss for the third year in a row, when including income from discontinued operations (-0.6bn in FY 09, -2.9bn in FY 08, -2.0bn in FY 07). The losses were largely due to write-downs on US mortgage exposures, monoline exposures, credit and equity derivative trading as well as macro hedging activity. The poor bottom-line performance of the banks CIB operations is a drain on the banks overall capacity to generate earnings, given that as of YE 09 about 40% of total risk-weighted assets were allocated to CIB activities. Exposure to cyclical downturn: The global economic downturn led to decreasing corporate earnings and rising unemployment. This has left its mark on CASAs substantial corporate and retail lending activities (YE 09: 362bn). The banks NPL ratio increased from 3.9% at YE 08, to 4.7% at YE 09. The banks net allocations to risk provisions increased from 3,165mn in FY 08 to 4,689mn in FY 09. However, the overall fallout should be mitigated somewhat by the banks conservative risk appetite, a high degree of sector diversification and the fact that its core lending activities in France and Italy benefit from a high degree of fiscal economic support. International retail exposure: In FY 09, the banks international retail operations generated a loss for the second year in a row (-458mn after -420mn in FY 08). Following the 485mn of goodwill impairment and 657mn cost of risk, the overall contribution of Greek Emporiki Bank to the groups net income amounted to a loss of 937mn in FY 09. This could not be compensated by a return from CASAs other operations in Italy, Eastern Europe and Africa/Middle East.
Key points for 2010

Monitor the evolution of the balance sheet and of the level of provisioning. Track the development of the groups capital markets operations and their effect on bottom-line earnings.
10 June 2010
566

mn 2006 Income statement summary Net interest income 9,651 Net fees & com's 3,805 Trading income 7,704 Operating income 16,187 Operating expenses 9,848 Pre-provision income 6,339 Loan loss provisions 612 Pre-tax profit Net income 6,912 5,319 2007 7,908 4,681 7,690 15,768 12,119 3,649 1,897 4,817 4,556 2008 12,113 4,398 8,630 15,956 11,992 3,964 3,165 1,172 1,266 2009 14,290 4,776 5,055 17,942 11,516 6,426 4,689 1,499 1,446
Crdit Agricole SA (ACAFP)

1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 2005 NIM 2006 2007 Credit costs 2008 2009 RoA 0.06% 0.05% 0.14% 0.29% 0.21% 0.84% 0.77% 0.72% 0.52% 0.75%
Balance sheet summary Total assets 1,261,296 1,414,223 1,653,220 1,557,342 Customer loans 248,185 302,444 349,037 362,348 of which Mortgages Customer deposits Debt funding of which covered bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio na 350,811 141,294 0 34,908 0.42 15.2 60.8 59.6 9.7 3.02 3.84 78.7 8.2 8.8 2.8 na 387,253 200,525 0 46,474 0.32 9.8 76.9 50.2 52.0 2.79 3.52 79.3 8.1 8.6 3.3 na 421,411 222,083 0 47,336 0.08 2.7 75.2 49.6 79.8 2.67 3.93 67.9 8.6 9.4 2.9 na 464,080 217,852 4,750 51,964 0.09 2.8 64.2 79.6
Efficiency
100% 80% 60% 40% 20% 0% 2005 2006 2007 2008 2009 Cost/Avg assets (RS) 0.82% 0.85% 63.8% 60.8% 0.91% 0.78% 0.72% 0.8% 0.7% Cost/Income (LS) 76.9% 75.2% 1.0% 64.2% 0.9%

200% 49% 170% 141% 45% 44% 128% 121% 128% 43% 48% 50% 48% 46% 44% 42% 40% 2005 2006 2007 2008 2009 Cust deposits/Loans (LS) Wholesale funding/Tot. Funding (RS)
73.0 3.30 4.69 70.3 9.5 9.8 3.3
150% 100% 50% 0%
Asset quality
8% 6% 4% 2% 0% 2005 2006 2007 2008 2009 Prob loans/Gr loans (LS) 4.4% 3.8% 82% 79% 79% 100% 68% 70% 4.7% 80% 60% 40% 20% 0% Coverage ratio (RS)
Capital ratios (in %)

10 9 8 7 6 2005 2006 Tier 1 ratio 2007 2008 2009 Total capital ratio 8.2 8.2 8.1 8.5 8.8 8.6 9.5 8.6 9.4 9.8
3.5%
3.9%
ACAFP covered breakdown by loan type, March 2010

Buy to let Other/no 10.9% Data 0.2% Owner Occupied 86.5% Vacation/se cond home 2.3%
ACAFP covered breakdown by type of security, YE 09

CAMCA guarantee 9% Mortgage 66% Credit Logement guarantee 25%
10 June 2010
567
CIF Euromortgage (CIFEUR)

Description
% Index
0.022
Fritz Engelhard
Ratings table
Total assets
21.7bn LT senior unsecured* Covered bond rating Outlook Discontinuity factor** Collateral score**
Notes: *Parental rating **In %
% $ Index
NA
Moodys
A1 Aaa Negative 0.0
S&P
A NR Negative -
Fitch
A+ Aaa Negative 9.8 -
CIF Euromortgage is a specialised bankruptcy-remote mortgage credit institution established to refinance the housing loans of the Credit Immobilier de France Group (CIF Group) through the issuance of obligation foncires (OF). It is 100% owned by Caisse Centrale du Credit Immobilier de France (3CIF), the central funding vehicle for the CIF Group and a leading residential mortgage provider in France. Investors in the covered bonds issued by CIF Euromortgage enjoy a prior claim on a portfolio of AAA-rated RMBS notes and French mortgage notes that are secured by French home loans originated through the CIF Group network. Furthermore, the cover pool consists of AAA-rated tranches of RMBS from other European countries.
Risk weighting
Obligation Foncires carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Close integration with the CIF group: The residential mortgage loans granted by 14 Socits Financires Rgionales and by Banque Patrimoine et Immobilier (BPI) that all belong to the CIF Group are transferred to CIF Assets and BPI Mater Mortgage two fonds communs de crances (French SPVs). The AAArated tranches issued by these SPVs, together with French mortgage promissory notes (billets hypothcaires) from CIF Group banks as well as other European AAA-rated RMBS tranches originated outside the CIF Group, are ultimately purchased by CIF Euromortgage, which refinances these investments through the issuance of OF. Importantly, CIF has no staff and relies on the back-office facilities and IT infrastructure of its parent to manage operations according to pre-defined standards with regard to assets eligibility criteria, asset and liability management, counterparty risk management and over-collateralisation. To protect the position of holders of OF, CIF Euromortgage is excluded by law from any bankruptcy proceeding that could affect its parent. Crdit Immobilier de France: A specialist in residential mortgage lending, it enjoys a strong and defensible franchise with about 1mn clients and a 5.9% market share of the French housing loan market. It displays a sound and stable financial profile. Caisse Centrale du Crdit Immobilier, one of the groups principal operating entities with responsibility for its funding, liquidity and risk management, carries long-term credit ratings of A1, A and A+, respectively, assigned by Moodys, S&P and Fitch. The strong cohesion and the solidarity mechanisms of the whole Crdit Immobilier de France network, as well as the low business risk and conservative financial fundamentals, are the key factors that underpin the stable credit quality of the group.
Weaknesses
Market risk: CIF Euromortgage takes on no interest rate and currency risk. All assets and liabilities are floating rate as they are swapped into -denominated floating rate (3mth Euribor) and, in order to avoid basis risk, further into Eonia. Liquidity risk: To minimise exposure to liquidity risk, CIF Euromortgage keeps assets and liabilities at floating conditions and maintains a structural excess cash position over a rolling twoyear horizon to retain the flexibility of not having to tap the capital markets to refinance its investment portfolio. The liquidity gap beyond two years is limited to one standard covered bond issue. It is worth noting that as of June 2009, 88% of CIF Euromortgages RMBS assets were eligible for ECB repo transactions. Over-collateralisation: OFs issued by CIF Euromortgage benefit from various layers of credit enhancement, which are designed to compensate mainly for residual default and liquidity risk. The respective company act contains rules that oblige CIF Euromortgage to provide a level of over-collateralisation commensurate with triple-A ratings. As of June 2009, overcollateralisation excluding credit enhancements from individual RMBS notes stood at 103.4% (YE 08: 102.8%). When including credit enhancements of individual RMBS notes, overcollateralisation stood at 114.0%. The over-collateralisation level is monitored internally on a weekly basis and externally at least on a quarterly basis by a specific controller.
Key points for 2010

Track the development of CIF Group and the role of funding via CIF Euromortgage.
10 June 2010
568

mn Balance sheet (CIFEUR) Total assets Fixed Income Securities Debt funding of which OF Overcollateralisation Total equity Key figures (CIF Group) New mortgage origination Outstanding mortgages NPL ratio mortgages Total group equity Tier 1 Ratio 2005 14,306 14,063 13,320 13,650 102.65 110 2006 15,539 14,550 15,257 14,846 102.39 111 2007 17,034 15,924 16,799 16,373 102.11 110 2008 Jun. 2009 19,656 18,014 19,213 18,395 102.80 112 21,739 18,289 21,097 19,909 103.24 108 -
CIF Euromortgage (CIFEUR)

External versus CIF Group RMBS
100% 80% 60% 40% 20% 0% 27% 29% 23% 18% 14% 6% 80% 10% 11% 79% 9% 10% 81%
43%
57%
73%
71%
77%
82%
2002 2003 2004 2005 2006 2007 2008 Internal RMBS CIF Mortgage Notes
5,540 6,720 6,530 6,360 23,640 25,980 28,128 30,878 1.3% 1.2% 1.3% 1.6% 2,380 2,410 2,410 2,410 13.8 13.2 14.1 15.0
Jun. 2009 External RMBS
CIF: NPL ratio

2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 CIF NPL Ratio 1.94%
1.77% 1.50% 1.31% 1.24% 1.28%
1.56%
25 20 15 10 5 0 2005 2006 2007 Restricted Assets Overcollateralisation (RS) 2008 Jun. 2009 Privileged liabilities bn 104% 103% 102% 101% 100%
Property types (CIF assets and BPI combined)

Buy to let 15% Second Home 2%
Owneroccupied 83%
Over-collateralisation and credit enhancement, June 2009 CIF Assets/BPI Master Mortgage CIF Assets/BPI Master Mortgage AAA/Aaa Senior un its 14122mn Sub. units (A2) 1,405mn Liquidities 352mn Reserve fund 352mn Purchase of AAA/ Aaa units CIF EUROMORTGAGE AAA/Aaa Senior units 14,791mn 14,122mn Mortgage notes 1,860 1,970 European EMBS 1,578mn 1,820mn Liquidities 2,093mn AAA/Aaa rated Obligations Foncires Fonci res +RCB 21,025mn 19,478mn Reserve Fund 527mn
Loans
RMBS Overcollateralisation : 114.1% (CIF Assets), 111.9% (BPI)
CIF Euromortgage Overcollateralisation 103.37%
Global overcollateralisationratio Overcollateralisation ratio 114.04% 111.7%
10 June 2010
569
Compagnie de Financement Foncier (CFF)

Description
% Index
0.668
Fritz Engelhard
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor* Collateral score*
Notes: * In %
% Index
0.139
Total assets
98bn
S&P
A AAA Stable -
Fitch
Aa3 Aaa Stable 7.4
With a balance sheet total of 98.2bn as at 31 December 2009, CFF is the largest of the three covered bond funding vehicles that are part of BPCE group. Its primary role is to refinance specific eligible mortgage and public sector assets through the issuance of Obligations Foncires (OF). It is a wholly-owned subsidiary of Credit Foncier de France, which, in turn, is 100% owned by Caisses dEpargne Participations (the renamed former Caisse Nationale des Caisses dEpargne), which is part of BPCE group, the newly created central body of Groupe Caisse dEpargne (GCE) and Groupe Banques Populaires (GBP), equally owned by the Caisse dEpargne savings banks and the Banque Populaire regional banks. When CFF started operations, it principally refinanced assets acquired from Crdit Foncier de France, but the scope of its activities has since widened to encompass assets of GCE. Between 2002 and 2008, CFFs exposure to mortgage markets decreased from 60% to 45%, while public sector exposures increased from 28% to 46%. These ratios were unchanged between YE 08 and YE 09.
Risk weighting
Obligations Foncires carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Low default risk: At YE 09, CFFs assets consisted of public sector assets (46%), mortgage market exposures (45%) and substitute assets (9%). Substitute assets increased 1.0bn in the course of 2009, while public sector loans and public sector securities increased 1.0bn. With respect to the mortgage portfolio, mortgages increased (+1.4bn), while the volume of RMBS notes decreased from 15.7bn to 14.3bn. Asset quality indicators for the total of 22.7bn of mortgage loans owned by CFF indicate only a limited deterioration of asset quality. The balance of doubtful loans in the mortgage portfolio granted at market conditions increased from 1.3% at YE 08, to 1.5% at YE 09. Also worth mentioning is that the mortgage portfolio enjoys a low, but rising, weighted average indexed LTV of 59.5% (in 2009) and still provides a good cushion in case of further property price declines. Market and liquidity risk kept to a minimum: Compagnie de Financement Foncier manages the assets and liabilities of CFF to minimise the potential effect of unforeseen market movements on its P&L. For this reason, assets and liabilities are either at floating conditions or are swapped into Euribor. There is adequate liquidity through the fact that, as at 31 December 2009, 33bn of the banks assets were ECB repo eligible (24bn securities, 9bn loans). At YE 09, CFF used 3bn of its assets as collateral for central bank repo business and 0.6bn for interbank repo business. The average duration of assets has been matched as closely as possible and stands at 6.44 years for assets and 6.45 years for liabilities. Management has attempted to limit this gap to no more than two years; as at YE 07 the gap reached an historical maximum at 1.2 years.
Weaknesses
Weak credit profile of BPCE: BPCE group, the parent of Crdit Foncier and final owner of CFF, struggles to cope with the fallout from the financial markets crisis. Although the French government injected capital into the group and mediated the merger between GCE and GBP, the newly created BPCE group still has substantial exposure to troubled securities and also suffers from low profitability. The weakened financial profile of its final parent, as well as the reshuffling of the groups operations, exposes CFF to an element of uncertainty. However, this is mitigated by the fact that CFFs assets fit largely into the business focus of the new strategy. Exposure to structured credit: At YE 09, CFF Obligations Foncires were backed by a portfolio of mostly Spanish (6.7bn) and Italian (3.8bn) RMBS and a 7.5bn public sector ABS portfolio of mostly US student loan (3.0bn) and Dutch government-guaranteed home loan exposures (4.0bn). While the structured credit exposures largely consist of prime RMBS notes and the majority (67%) of the exposures benefit from triple-A ratings, secondary market valuations of these assets suffered substantially and parts of the portfolio already have been subject to negative rating migration.
Key points for 2010

Monitor the transformation BPCE and its effect on CFF. Track the development of CFFs structured credit portfolio.
10 June 2010
570

mn 2005 Income statement summary Net interest income 210 Net fees & com's 21 Trading income 10 Operating income 250 Operating expenses 104 Pre-provision income 146 Loan loss provisions -1 Pre-tax Profit 145 Net income 86 Balance sheet summary Total ass ets 57,404 Customer loans 23,033 of which Mortgages 17,910 Customer deposits 30 Debt funding 50,042 of which OF 49,747 Total equity 438 Profitability (%) Return on assets 0.16 Return on equity 23.8 Cost/Income r atio 41.7 Net int inc/Op inc 84.0 Asset quality (%) LLPs/Pre-prov inc -0.7 LLRs/Gross loans 0.1 Prob loans/Gr loans 2.8 Cover age ratio 4.0 Capital adequacy (%) Tier 1 ratio na Total capital ratio na Equity/Assets ratio 0.8 2006 185 24 -1 196 103 93 3 95 62 70,691 25,644 19,401 122 61,931 61,680 500 0.10 13.3 52.6 94.7 2.9 0.1 2.6 3.6 na na 0.7 2007 183 19 -2 188 104 84 -3 81 53 94,397 35,944 21,925 91 79,952 79,395 553 0.06 10.1 55.4 97.7 -3.6 0.1 1.7 3.4 na na 0.6 2008 174 31 -7 187 106 81 4 85 62 95,940 36,311 21,258 33 80,148 79,960 1,420 0.07 6.3 56.8 93.4 5.0 0.0 1.0 3.9 na na 1.5 2009 358 15 1 362 100 262 -4 258 175 98,245 37,184 22,693 5 82,199 81,957 1,560 0.18 11.8 27.6 99.0 -1.6 0.0 1.1 4.0 na na 1.6
Compagnie de Financement Foncier (CFF)

Profitability
0.8% 0.6% 0.4% 0.2% 0.0% 01 02 NIM 03 04 05 06 07 RoA 08 09
Development of asset type exposure

16% 29% 15% 32% 16% 31% 17% 38% 12% 41% 9% 46% 10% 46%
56%
53%
53%
45%
48%
45%
45%
Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Mortgage Public Sector Substitute Assets
Asset quality
70% 65% 60% 55% 50% 45% 03 04 05 06 07 08 09 WA indexed LTV NPL Ratio (RS) 2.0% 1.5% 1.0% 0.5% 0.0%
140 90 40 -10 00 01 02 03 04 05 06 07 08 09 Restricted assets (bn) Overcollateralisation (RS) 1.2x 1.2x 1.1x 1.1x 1.0x Covered bonds (bn)
Duration gap
2.5 (years) 2.0 1.5 1.0 0.5 -0.08 -0.10 -0.20 0.0 -0.5 2003 2004 2005 Duration gap
1.20 0.90 0.90 -0.01
2006 2007 2008 2009 Limit for duration gap
Asset type exposure,YE 09

Substitute Assets 9% Other Public Sector Assets 12% Public Sector Securities 12% Public Sector Loans 22%
10 June 2010
Geographical exposure, YE 09
Mortgages 12% RMBS Notes 15% Other Home Loan Assets 18% Other 8%
US 5% Netherlands 5% Germany 2% Italy 8%
France 64% Spain 8%

571
Dexia Municipal Agency (DEXMA)

Description
% Index
0.433
Fritz Engelhard
Ratings table
Moodys
LT senior unsecured* Covered bond rating Outlook Discontinuity factor** Collateral score**
Notes: *Parental rating; **In %
% Index
0.019
Total assets
81bn
S&P
A AAA Negative -
Fitch
A1 Aaa Stable 4.8
Dexia Municipal Agency (DEXMA) is a Socit de Credit Foncier (SCF), wholly owned by Dexia Credit Local (DCL) one of Dexia groups main operating units. It was established in 1998 as a special-purpose financial institution to refinance the public sector loans provided by the group through the issuance of Obligation Foncires (OF). The company has no staff of its own but uses the resources of its parent. In recent years, Dexia MAs activities expanded from refinancing the local authority business in France to public sector financing in other European markets. The share of French exposures decreased from 94.2% at YE 03, to 63.3% at YE 08, but increased slightly again to 65.9% at YE 09. Dexia group suffered heavily from the financial market crisis and as a result, on 14 November 2008, DCL presented a transformation plan, which includes a run-off of bond portfolios, discontinuation of proprietary trading and a geographical focus of public sector lending activities in France, Belgium, Luxembourg, Italy, Spain and Portugal. In Germany, DCL operates via Dexia Kommunalbank Deutschland AG (wholly owned), a Pfandbriefbank that is also profiled in this book.
Risk weighting
Obligations Foncires carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Support for Dexia Group: In the course of H2 08, Dexia Group strongly benefited from support by the Belgian, French and Luxembourg authorities. On 30 September, the group recapitalised and received 6.0bn of new capital. On 9 October 2008, a guarantee scheme for new debt obligations of various operating entities of the group was announced. The support was provided by the governments of Belgium (60.5%), France (36.5%) and Luxembourg (3%). On 26 February 2010, the state aid was approved by the European Commission. As Dexia MA is strongly integrated into the group, it also benefits from public sector support for its parent. Operational integration with DCL: Dexia MAs funding is an integral part of the public sector business undertaken by DCL. Over the past nine years DEXMAs balance sheet on average made up more than 20% of DCLs total assets (YE 09: 23%). DEXMA benefits from a liquidity facility from the parent, which increases the over-collateralisation enjoyed by covered bondholders and is used to finance assets pending the issuance of OF. There is also a declaration of financial support, in which DCL states it will hold more than 95% of Dexia MAs capital on a long-term basis, ensure its subsidiary develops its activities in accordance with the law and has the financial resources needed to meet its obligations. Low default probability: The assets refinanced by Dexia MA mainly include loans to French local authorities (YE 09: 29.3bn), French public sector entities (YE 09: 10.5bn) and French provinces (YE 09: 6.5bn). In addition, the company finances public sector entities directly by buying securities that are issued in the capital markets (these bonds are treated as loans if they are held to maturity). The overall default probability of Dexia MAs portfolio is very low. This is reflected in gross non-performing loans (NPLs) running at 1bp of loans outstanding as at December 2009.
Weaknesses
Weakened profile of Dexia group: Dexia Group reported net income of 1.0bn in FY 09, following a net loss of 3.3bn in FY 08, but losses from the financial crisis still represented a 687mn FY 08: 3.8bn) burden on the banks bottom-line result. The groups total run-off portfolio stood at 162bn at YE 09 (YE 08: 191bn). The 134bn bond sub-portfolio had an average life of 11 years and contained 28.8bn of ABS/MBS, 29.9bn of unsecured bank debt and 13.2bn of covered bonds. The combination of ongoing spread volatility and rating downgrades in these products exposes the group to further head wind. Disposal of operating entities in Italy and Spain: The EUs approval of the state aid for Dexia Group includes an agreement to sell DCLs stake in Dexia Crediop (Italy) by 31 October 2012 and the stake in Dexia Sabadell (Spain) by 31 December 2013. A sale might have negative implications for DEXMA, which owns a substantial amount of debt sponsored by these institutions (YE 09: 3.8bn of ABS sponsored by Dexia Crediop, 3.2bn of Cdulas Territoriales from Dexia Sabadell), and also has a management agreement in place with Dexia Crediop. Sovereign risk exposures: Increased volatility in sovereign and sub-sovereign debt markets accompanied by negative rating migration in this sector challenges the banks risk management capacity. In the case of DEXMA, such challenges might come from the following exposures (YE 09): 3.4bn to Spain, 0.7bn to Greece, 0.2bn to Iceland, 0.2 to Portugal, 0.2bn to Ireland. Maturity mismatch: Although DEXMAs duration gap decreased from 2.88 years at YE 08 to 1.93 YE 09, it was well above the 1.49 years reached in September 2009 and also substantially wider compared to peers. DEXMA established a minimum limit for the duration gap of three years, which is approximately equivalent to the minimum over-collateralistion of 5%. Reservations about possible refinancing risk are lessened by the liquidity line provided by the parent and the close integration in Dexia Group.
Key points for 2010

Monitor the transformation of Dexia Group and its effect on DEXMA. 10 June 2010 Track the development of sovereign risk exposures and the duration gap. 572

mn 2005 Income statement summary Net interest income 213 Net fees & com's -3 Trading income 0 Operating income 210 Operating expenses 66 Pre-provision income 144 Loan loss provisions 1 Pre-tax profit 137 Net income 89 Balance sheet summary Total ass ets 53,394 Customer financing 48,556 of which public sector 47,843 Customer deposits 0 Debt funding 42,619 of which covered bonds 41,741 Total equity 801 Profitability (%) Return on assets 0.18 Return on equity 11.3 Cos t/Income ratio 31.6 Net int inc/Op inc 101.2 Asset quality (%) LLPs/Pre-prov inc 0.7 LLRs/Gross loans 0.0 Prob loans/Gr loans 0.0 Coverage ratio 31.1 Capital adequacy (%) Tier 1 ratio (DCL) 8.6 Total capital ratio (DCL) 12.6 Equity/Assets ratio 1.5 2006 273 -3 0 270 74 197 0 197 123 61,550 54,212 53,375 0 49,283 48,333 897 0.21 14.4 27.2 101.1 0.0 0.0 0.0 17.5 8.4 11.5 1.5 2007 201 -5 1 203 83 120 0 120 80 73,524 63,649 62,724 0 57,537 56,403 1,050 0.12 8.2 40.9 99.0 0.0 0.0 0.0 10.2 7.5 11.2 1.4 2008 255 -4 3 254 92 162 0 159 113 81,368 69,508 65,183 0 63,351 61,997 1,141 0.15 10.3 36.2 100.4 0.0 0.0 0.0 9.9 7.5 12.5 1.4 2009 282 -5 28 305 92 213 0 207 134 81,472 71,811 66,552 0 65,298 63,909 1,240 0.16 11.3 30.2 92.5 0.0 0.0 0.0 19.1 8.9 14.9 1.5
Dexia Municipal Agency (DEXMA)

Capital ratios (in %, Dexia Crdit Local)
15 10 5 0 02 03 04 05 06 07 08 09 Tier 1 ratio (DCL) Total capital ratio (DCL)
Balance sheet
25% 20% 21% 20% 23% 20 21% 24% 23% 20% 20% 17% 15 12.0 15% 8.0 9.1 8.2 7.8 10 6.8 6.3 10% 5.4 5 5% 0.1 0 0% 01 02 03 04 05 06 07 08 09 YY change of tot. Assets in bn Tot. assets of DEXMA in % of DCL
Issuance activity Obligations Foncires

10 8 6 4 2 0 03 04 05 06 07 08 09 Net Issuance (bn) Avg. maturity of newly issued OF (in years, RS) 4.8 6.4 7.2 5.0 5.2 1.2 8.7 20 15 10 5 0
Over-collateralisation (monthly)
120 115 110 105 100 Jan-05 Jan-06 OC Jan-07 Jan-08 Jan-09
Structure of new business

100% 80% 60% 40% 20% 0% 74% 68% 75% 70% 53% 47% 52% 77% 59% 62%
2004
2005
2006
2007
2008
DEXMA Committment
Domestic share of new business Share of loans in new business
Geographical split, YE 09 (77.9bn) public sector pool

Switzerland 6.1% Belgium 5.6% Italy 9.5% Spain 4.5% France 63.3% Germany 1.1% Other 9.9%
Duration gap
3.5 3.0 2.5 2.0 1.5 1.0 2003 2004 2005 Duration gap 2006 2007 2008 Limit for duration gap
573
(years) 3.0
3.0
3.0
3.0 1.91
3.0 2.01
3.0 2.88
1.44
1.73
1.75
10 June 2010
HSBC France (HSBC)

Description
% Index
NA
Fritz Engelhard
Ratings table
Total assets
Note: *In %
% Index
NA
Moodys
Aa3 Aaa Negative -
S&P
AA AAA Negative -
Fitch
AA NR Stable -
In 2000, HSBC acquired Credit Commercial de France (CCF), a French commercial bank created in 1894. It renamed the bank in 2005 to HSBC France (HSBC). In France, the bank has 11,700 employees and a network of about 400 branches. It offers financing and investment banking services with a focus on corporate clients. The bank also provides asset management, insurance, direct and private banking products. While the bank didnt participate in the French governments recapitalisation scheme for the banking industry, in 2008 it underwrote 9.43% of the capital of Socit de Financement de lEconomie Franaise (SFEF). In July 2008, the bank set up an 8bn French Common Law covered bond programme. HSBC Covered Bonds (France) issued its first jumbo benchmark covered bond in January 2010.
Risk weighting
Currently, HSBC covered bonds are treated as senior bank debt and thus carry a 20% risk weighting under the RSA approach and may achieve a lower risk weighting under the IRB.
Strengths
Strengthened capitalisation: The bank improved its solvency position mainly through the reduction of risk-weighted assets. From YE 08 to YE 09 risk-weighted assets were reduced by 11.2bn, or 24% to 36.2bn. This significant decrease, which was mainly driven by a reduction of credit risk exposures, resulted in an increase of the banks Tier 1 ratio from 9.5% at YE 08 to 12.2% at YE 09. It is also worth noting that the banks capital base purely consists of core Tier 1 capital. Business franchise and support: HSBC France has a sound business franchise in the French banking market. Furthermore, it benefits from the global presence and franchise of HSBC group and manages to leverage this expertise with its domestic clients. Given that HSBC France is a relevant part of HSBCs presence in Europe, we would expect that it would benefit from parental support in case of need. Over-collateralisation: The covered bonds issued by HSBC Covered Bonds (France) benefit from decent overcollateralisation. As of April 2010, an amount of 1.8bn covered bonds was backed by an adjusted amount of 3.8bn of French home loans.
Weaknesses
Exposure to cyclical downturn: The global economic downturn led to decreasing corporate earnings and rising unemployment. This has left its mark on HSBCs customer financing activities (YE 09: 50bn). The banks NPL ratio, which decreased consistently between 2005 and 2008, increased from 1.9% at YE 08 to 2.6% at YE 09. The cost of risk in HSBCs financing business increased from 127mn in FY 08, to 178mn in FY 09. However, so far the deterioration is moderate and further fallout should be mitigated somewhat by the banks conservative risk appetite, a high degree of sector diversification and the fact that the core market in France benefits from a high degree of fiscal economic support. Competition and profitability: The French banking market is fiercely competitive and thus characterised by low margins in standard banking products. The banks cost-income ratio stood at 68% in FY 09. Although this is an improvement from the 85% level in FY 08, it still is rather high compared to domestic and international peers. Above-average cover pool risk-factors: Some risk factors of the mortgage cover pool backing the covered bonds of HSBC are above the average of other French mortgage covered bond programmes. For example, as of April 2010, the share of buy-tolet mortgages stood at 15.6% and the share of loans for vacation homes stood at 8.5%, while owner-occupied loans only made up 75.9% of the total pool. Furthermore, 4.7% of the loan pool had an LTV above 100%.
Key points for 2010

Monitor the evolution of the balance sheet and the level of provisioning. 10 June 2010 Track the development of cover pool assets.
574

Financial summary
mn 2006 Income statement summary Net interest income 526 Net fees & com's 891 Trading income 938 2,388 Operating income Operating expenses 1,741 Pr e-provision income 647 Loan loss provisions 10 Pr e-tax profit 801 Net income 612 Balance sheet summary Total ass ets 132,847 Customer loans 42,019 of which Mortgages Customer deposits 33,406 Debt funding 17,837 of which covered bonds Total equity 5,425 Profitability (%) Return on assets 0.47 Return on equity 11.4 Cos t/Income r atio 72.9 Net int inc/Op inc 22.0 Asset quality (%) LLPs/Pre-prov inc 1.5 LLRs/Gross loans 1.65 Pr ob loans/Gr loans 2.82 Cover age ratio 58.5 Capital adequacy (%) Tier 1 ratio 9.9 Total capital ratio 9.6 Equity/Assets ratio 4.1 2007 179 964 1,339 2,494 1,908 586 52 1,051 977 198,627 55,196 3,980 44,690 23,102 5,095 0.59 18.6 76.5 7.2 8.9 1.18 2.32 50.8 8.8 9.8 2.6 2008 -190 716 1,435 1,982 1,693 289 127 1,744 1,766 266,025 51,286 3,137 53,791 20,558 5,276 0.76 34.1 85.4 -9.6 43.9 1.03 1.86 55.5 9.5 9.6 2.0 2009 610 741 985 2,346 1,587 759 178 406 348 213,444 49,780 3,002 49,338 14,935 5,108 0.15 6.7 67.6 26.0 23.5 1.23 2.64 46.5 12.2 12.2 2.4
HSBC France (HSBC)

1.5% 1.0% 0.5% 0.0% -0.5% 2005 NIM 2006 2007 2008 Credit costs 2009 RoA
Efficiency
100% 80% 60% 40% 20% 0% 2005 2006 2007 2008 2009 Cost/Income (LS) Cost/Avg assets (RS) 1.6% 1.3% 78% 73% 77% 85% 68% 2.4% 2.0% 1.6% 1.2% 0.8% 0.4% 0.0%
1.2% 0.7% 0.7%
Customer loans to deposits

160% 120% 80% 40% 0% 2005 2006 2007 2008 2009 Cust deposits/Loans (LS) Wholesale funding/Tot. Funding (RS) 92% 48% 80% 81% 56% 62% 54% 105% 53% 99% 70% 60% 50% 40% 30%
Asset quality
6% 4% 3.6% 2% 0% 2005 2006 2007 2008 2009 Prob loans/Gr loans (LS) 2.8% 2.3% 63% 80% 58% 51% 55% 47% 60% 40% 1.9% 2.6% 20% 0% Coverage ratio (RS)
Capital ratios (%)

13 12 11 10 9 8 2005 2006 Tier 1 ratio 2007 2008 2009 Total capital ratio
HSBC programme: Asset coverage

4 bn 3 2 1 0 Feb-10 Mar-10 Apr-10 Aggregate CB outstanding principal amount Adjusted Aggregated Asset Amount Overcollateralization (RS) 225% 224% 186% 250% 200% 150% 100% 50% 0%
HSBC programme: Share of buy-to-let and WA LTV

64% 63% 62% 61% 60% Feb-10 Mar-10 Weighted average indexed LTV (LS) % buy-to-let (RS) 16.0% 15.8% 15.6% 15.4% 15.2% 15.0% Apr-10
10 June 2010
575
Socit Gnerale (SOCGEN)

Description
% Index
0.244
Fritz Engelhard
Ratings table
Total assets
% Index
0.170
Moodys
S&P
A+ AAA Stable -
Fitch
With total assets of 1,024bn as at year-end 2009, Socit Gnrale (SOCGEN), originally founded in 1864, is one of the largest European banks, providing universal banking services (Retail Banking in France; International Retail Banking; Financial Services; Corporate and Global Investment Management and Services) through 156,681 employees to clients in 83 countries, with France accounting for 47% of the groups credit risk at YE 09. Other Western and Eastern EU countries represent 29% of risk, while North America represents 8% of assets. In February 2009, the bank announced a number of strategic initiatives: a groupwide cost reduction; restructuring of asset management; and an improvement in earnings quality and risks in the CIB division. In March 2008, the bank presented its Obligation Foncires programme (Socit Gnrale SCF) and issued its first jumbo transaction in May 2008.
Risk weighting
The banks Obligations Foncires carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive, and may achieve a lower risk weighting under the IRB.
Strengths
Strengthened capitalisation: Like many of its peers, SocGen managed to strengthen its capital base significantly in 2009. The banks Tier 1 ratio increased from 8.8% at YE 08 to 10.7% at YE 09. This was not only the result of a 4.8bn capital increase, but also reflects a 6.2%, or 21bn, reduction of risk-weighted assets that was driven by a 43% reduction of market risk in the banks Corporate and Investment Banking (CIB) division. Improved loan-to-deposit ratio: SocGen also managed to reduce its reliance on wholesale funding in 2009. Following a significant decrease from 101% at YE 06 to 80% at YE 08, the groups loan-to-deposit ratio increased again to 87% at YE 09. This was the result of a 6.2%, or 17.5bn, increase in group deposits and a 2.8%, or 10bn, decrease of group customer loans. In 2009, financing through Socit de Financement de lEconomie Francaises (SFEF) amounted to 11.8bn (total SFEF usage as of YE 09: 13.6bn), representing 32% of the groups total 37bn term-funding activities. The refinancing plan for 2010 foresees a reduced funding volume of 25-30bn. Public sector cover assets: The cover pool of Socit Gnrale SCF consists of advances to SocGen, which are secured by a pool of loans to French public sector entities. The high quality of the provided securities is reflected in the quite low collateral score of 4.5 assigned by Moodys as of 31 March 2008. However, we note that other eligible assets under the covered bond programme are property loans secured by mortgages or guarantees, as well as ABS notes. Over-collateralisation: Through a clause in Socit Gnrale SCFs management regulations, the banks covered bonds benefit from a contractually committed nominal overcollateralisation of 5%. As of 31 December 2009, nominal over-collateralisation stood at 19%.
Weaknesses
Fall-out from financial crisis: 2009 was the third year in a row in which the SocGens net income had been strongly driven by non-recurring items of the CIB divisions legacy portfolio (2007: 2.7bn; 2008: -3.3bn; 2009: -2.8bn). This was largely due to write-downs on exotic credit derivatives (cumulative FY07 FY09 2.5bn), unhedged CDOs (cumulative FY07 FY09: 1.7bn) and monoline exposures (cumulative FY07 FY09: 2.7bn). As of FY 09, SocGens reclassified assets helped it avoid mark-to-market losses of 2.2bn. The recognition of the fair value option on its own liabilities contributed an additional 698mn to the groups total income. Remaining high risk exposures consist of a net CDO US RMBS non-prime portfolio (2.9bn), further RMBS exposures (US, Spain, UK: 1.9bn), CMBS notes (7.0bn) largely (77%) related to US properties and leveraged buyout exposures (5.0bn). Exposure to cyclical downturn: The global economic downturn led to decreasing corporate earnings and rising unemployment. This has left its mark on SocGens substantial on-balance-sheet credit risk exposures (YE 09: 486bn). The banks NPL ratio increased from 3.0% at YE 08 to 5.1% at YE 09. The banks net allocations to risk provisions increased from 2,655mn in FY08 to 5,848mn in FY 09. Further fallout should be mitigated somewhat by a certain degree of sector diversification and the fact that core markets in France and western Europe benefit from a high degree of fiscal economic support. Exposure to CEE and Russia: Through its international retail banking activities, SocGen has significant exposure to CEE countries and Russia. As of YE 09, retail loan exposure to CEE and Russia amounted to 53bn, or 15% of total loans. In a harsh stress scenario, these exposures could have a negative effect on earnings and capital. Whilst in February 2009, SocGen has put its expansion in the region on hold, in May 2009 it acquired an additional 7% stake in Russias Rosbank.
Key points for 2010

Monitor the composition of the banks collateral pool. Track the development of the groups structured credit exposures and their effect on bottom-line earnings.
10 June 2010
576

mn 2006 2007 2008 2009 Income statement summary Net interest income 2,819 2,102 7,948 11,635 Net fees & com's 6,853 7,528 7,415 7,812 10,984 10,252 4,770 947 Trading income 22,124 19,603 21,866 21,730 Operating income Operating expenses 12,985 13,520 14,656 14,836 Pre-provision income 9,139 6,083 7,210 6,894 Loan loss provisions 679 905 2,655 5,848 Pre-tax profit 8,078 1,886 4,008 800 Net income 5,221 947 2,010 678 Balance sheet summary Total assets 956,841 1,071,762 1,130,003 1,023,701 Customer loans 263,547 305,173 354,613 344,543 of which Mortgages 67,363 77,477 85,810 89,204 Customer deposits 267,397 270,662 282,514 300,054 Debt funding 310,206 352,210 428,175 315,009 0 0 1,165 6,163 of which covered bonds Total equity 33,432 31,275 40,887 46,838 Profitability (%) Return on assets 0.58 0.09 0.18 0.06 Return on equity 17.2 2.9 5.6 1.5 Cost/Income ratio 58.7 69.0 67.0 68.3 Net int inc/Op inc 12.7 10.7 36.3 53.5 Asset quality (%) LLPs/Pre-prov inc 7.4 14.9 36.8 84.8 LLRs/Gross loans 2.51 2.03 1.88 2.63 Prob loans/Gr loans 3.29 3.09 3.04 5.09 Coverage ratio 76.3 65.6 61.8 51.7 Capital adequacy (%) Tier 1 ratio 7.8 6.6 8.8 10.7 Total capital ratio 11.1 8.9 11.6 13.0 Equity/Assets ratio 3.5 2.9 3.6 4.6
Socit Gnrale (SOCGEN)

1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 1.1% 0.7% 0.5% 0.3% 0.2%
2005 NIM
2006
2007 Credit costs
2008
2009 RoA
Efficiency
100% 80% 60% 40% 20% 0% 2005 2006 2007 2008 2009 Cost/Income (LS) Cost/Avg assets (RS) 1.4% 1.4% 1.3% 1.3% 1.4% 61% 59% 69% 67% 68% 3.0% 2.6% 2.2% 1.8% 1.4% 1.0% 0.6% 0.2% -0.2%

160% 120% 80% 40% 0% 2005 2006 2007 2008 2009 Cust deposits/Loans (LS) Wholesale funding/Tot. Funding (RS) 98% 101% 89% 80% 87% 79% 76% 78% 76% 66% 90% 80% 70% 60% 50% 40% 30%
Asset quality
6% 5% 4% 3% 2% 1% 0% 5.1% 70% 3.9% 76% 66% 3.3% 3.1% 62% 3.0% 52% 100% 80% 60% 40% 20% 0% 2005 2006 2007 2008 2009 Prob loans/Gr loans (LS) Coverage ratio (RS)
Capital ratios (%)

14 12 10 8 6 2005 2006 Tier 1 ratio 2007 2008 2009 Total capital ratio 7.6 7.8 6.6 11.3 11.1 8.9 11.6 13.0 10.7 8.8
SCF programme: Asset coverage

10 8 6 4 2 0 Jun-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Collateral Security Assets (bn) Financial exposure (bn) Over-collateralisation (RS) 2.0 1.8 1.6 1.4 1.2 1.0
SCF programme: Breakdown by type counterparty, Dec 09

Other Utilities 5% 9% Public Health 13% District Groups 13% Regions 13% Departments 31% Districts 16%
10 June 2010
577
10 June 2010
578
IRISH COVERED BOND PROFILES
10 June 2010
579
Allied Irish Bank (AIB)

Description
% Index
0.133
Fritz Engelhard
Ratings table
Total assets
Note: * In%
% Index
0.145
Moodys
A1 Aaa Stable 6.6
S&P
AAAA Negative -
Fitch
AAAA Stable 14.0 -
Allied Irish Bank (AIB) is a universal financial services group providing a wide range of financial services through four operating divisions: AIB Bank Republic of Ireland, AIB Bank GB and NI, Capital Markets, and AIB Poland. AIBs services include retail and corporate banking, insurance, mortgages, treasury and asset management, investment banking activities and financial advisory services. The bank operates principally in the Republic of Ireland (70% of the loan book) and the UK (20%) and owns a 70.5% share of Bank Zachodni, a franchise in western Poland (comprising 6.5% of the loan book) and a 24% share in M&T Bank in the US (2.6%). In the Republic of Ireland, AIB holds in excess of 20% of all domestic loans and deposits. In April 2006, AIB launched its inaugural mortgage Asset Covered Securities (ACS) transaction via AIB Mortgage Bank.
Risk weighting
Irish ACS carry a 10% risk weighting under the Standardised A125 approach of the EU Capital Requirements Directive (CRD).
Strengths
Government support: Being a large Irish bank, AIB benefits from substantial support. In May 2009, the Irish government injected 3.5bn of preference shares. Furthermore, AIB benefits from the introduction of the Eligible Liabilities Guarantee (ELG) scheme that was introduced in December 2009 and allows AIB to issue guaranteed debt securities until September 2010. Also in December 2009, The Irish government introduced the National Asset Management Agency (NAMA) scheme, which was set up to acquire non-performing or non-strategic assets from participating banks. At YE 09, AIBs shareholders approved the banks participation in the scheme and AIB estimates that it may transfer an amount of 23bn of mainly land and development loans to NAMA. The respective transfer will help reduce AIBs exposure to real estate, as well as total riskweighted assets. Improved funding and cost profile: To cope with the significant effect of the financial market crisis on the banks liquidity and solvency position, AIB started a number of initiatives to stabilise the group, strengthen the capital position, enhance funding sources and reduce costs. The respective measures already show some results. Between December 2008 and December 2009, the group reduced its interbank liabilities by 7.8bn and its outstanding debt securities by 7.1bn. Furthermore, customer deposits stabilised between March 2009 and December 2009, following large institutional outflows in Q1 09. On the cost side, in the 12 months to December 2009, total administrative expenses were reduced 446mn, or 20%. Capitalisation: The banks capitalisation benefitted from the Irish government injection of 3.5bn and a number of additional capital measures. The transfer of assets to NAMA will help improve capital ratios.
Weaknesses
Pressure on sovereign debt market: As in a number of other markets, Irish government bonds suffered from rising pressure in European sovereign debt markets. 5y swap spreads increased from mid swaps +85bp in mid April to mid-swaps 275bp in early May. The pressure on Irish government bonds and the Irish economy leads to a rather restrictive management of country exposure to Ireland by many investors and other counterparties. This limits the ability of Irish banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations. Fall out from the financial market crisis: Like its large domestic peers, AIB suffers from its historically strong reliance on wholesale funding, its high exposure to property financing and its strong non-domestic real estate exposure. To stabilise its liquidity and solvency position, AIB made use of a number of emergency facilities. The costs for using these facilities combined with challenging conditions in term funding markets, high competition for deposits and only slow progress in repricing the loan book have a negative effect on bottom-line earnings. Furthermore, AIB delivered its restructuring plan to the Irish government for submission to the European Commission on 12 November 2009. At this stage, it is unclear to what extent the pending decisions could hamper the ability of AIB to recover. Exposure to UK and Irish property price inflation: Residential mortgage sector lending is exposed to the UK and Irish property markets. The downturn in these markets has had a negative effect on asset quality. The banks impaired loans increased from 3bn at YE 08 to 6.5bn at YE 09. The Irish market has not yet shown signs of stabilisation and, according to the permanenttsb/ESRI Index at 31 December 2009, was down 32% from the peak in February 2007. In the UK, however, the situation looks better as house prices started to increase in spring 2009. In addition, the Irish and UK commercial property markets have stabilised following a peak-to-trough decrease in capital values of 50% and 45%, respectively, according to IPD indices.
Key points for 2010

Monitor the evolution of sovereign debt position of the Republic of Ireland and the development in sovereign debt markets. Track the use of emergency liquidity measures, the build up of deposits and the development of bottom-line results.
10 June 2010
580

mn 2006 2007 Income statement summary Net interest income 2,999 3,418 Net fees & com's 1,074 1,256 Trading income 173 74 4,326 4,868 Operating income Operating expenses 2,314 2,376 2,012 2,492 Pre-provision income Loan loss provisions 118 106 Pre-tax profit 2,615 2,511 Net income 1,933 2,069 Balance sheet summary Total assets 158,526 177,888 107,443 127,974 Customer loans na na of which public sector 26,644 30,101 of which mortgages Customer deposits 74,875 81,308 Debt funding 33,275 46,471 of which ACS 5,424 7,083 Total equity 9,912 11,204 Profitability (%) Return on average assets 1.33 1.23 Return on average equity 21.09 19.60 Cost/Income ratio 53.49 48.81 Net int inc/Op inc 69.33 70.21 Asset quality (%) LLPs/Pre-prov inc 5.86 4.25 LLRs/Gross loans 0.65 0.58 Prob loans/Gross loans 6.19 5.25 Coverage ratio 10.53 10.98 Capital adequacy (%) Tier 1 ratio 8.20 7.50 Total capital ratio 11.10 10.10 Equity/Assets ratio 6.25 6.30 2008 3,867 1,041 -73 5,068 2,187 2,881 1,822 1,034 890 2009 3,233 761 11 4,236 1,741 2,495 5,355 -2,656 -2,334
Allied Irish Bank (AIB)

4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% 04 NIM 05 06 07 Credit costs 08 09 RoA
182,174 174,314 129,871 103,620 na na 31,625 33,081 92,604 83,953 42,340 35,240 13,169 10,760 10,313 11,335 0.49 8.27 43.15 76.30 63.24 1.73 8.98 19.32 7.40 10.50 5.66 -1.31 -21.56 41.10 76.32 214.63 2.80 10.58 26.48 7.20 10.20 6.50
Efficiency
60% 50% 40% 30% 20% 10% 0% 04 05 06 Cost/Income 07 08 09 Cost/Avg assets (RS) 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

100% 80% 60% 40% 20% 0% 04 05 06 Cust deposits/Loans 79% 77% 70% 64% 71% 81% 60% 50% 40% 30% 20% 10% 0% 07 08 09 Wholesale funding/Tot. funding

12% 10% 8% 6% 4% 2% 0% 06 07 Prob loans/Gross loans 08 30% 25% 20% 15% 10% 5% 0% 09 Coverage ratio (RS)
Capital
12% 10% 8% 6% 4% 04 05 06 Tier 1 ratio 07 08 09 Total capital ratio
Over-collateralisation mortgage ACS

25 20 15 10 5 0 2.00 1.50 1.00 0.50 0.00 Dec 06 Dec 07 Dec 08 Dec 09 Restricted assets (bn) Covered bonds (bn) Over-collateralisation (x)
10 June 2010
Development of LTV measures mortgage ACS pool

80% 76% 75% 70% 70% 65% 60% Jun 09 Sep 09 Dec 09 Mar 10 WA indexed LTV WA current LTV
581
73% 70% 62% 62% 62%
64%
Bank of Ireland (BKIR)

Description
% Index
0.147
Fritz Engelhard
Ratings table
Total assets
Note: * In %
% Index
0.069
Moodys
A1 Aaa Stable 6.8
S&P
AAAA Stable -
Fitch
ANR Stable 19.6 -
Bank of Ireland (BOI) is a diversified financial services group with total consolidated assets of 181bn as at 31 December 2009, making it the largest Irish bank by total assets. BOI operates principally in the UK and Ireland (29% and 60% of profit before tax). In Ireland, BOI provides banking, mortgage, insurance products and services, asset financing corporate finance, stockbroking and investment services. The UK operations comprise retail banking provided by BOIs retail network and Bristol and West (B&W), which provides mortgage lending, and savings and investment products to UK retail customers. In September 2004, BKIR launched its inaugural mortgage Asset Covered Securities (ACS) transaction via Bank of Ireland Mortgage Bank.
Risk weighting
Irish ACS carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive (CRD) and may achieve a lower risk weighting under the IRB.
Strengths
Government support: Being the largest Irish bank, BOI benefits from substantial support. In March 2009, the Irish government injected 3.5bn of preference shares. Furthermore, BOI benefits from the introduction of the Eligible Liabilities Guarantee (ELG) scheme that was introduced in December 2009 and allows BOI to issue guaranteed debt securities until September 2010. Also in December 2009, The Irish government introduced the National Asset Management Agency (NAMA) scheme, which was set up to acquire non-performing or non-strategic assets from participating banks. At YE 09, BOI held a 46bn run-off portfolio. An amount of 12bn of this portfolio was held for sale to NAMA. The respective transfer will help reduce BOIs exposure to real estate, as well as total risk-weighted assets. Improved funding and cost profile: To cope with the significant effect of the financial market crisis on the banks liquidity and solvency position, BOI started a number of initiatives to stabilise the group, strengthen the capital position, enhance funding sources and reduce costs. The respective measures already show good results. Between March 2009 and December 2009 the group reduced its interbank liabilities by 15bn and its outstanding debt securities by 3.8bn. Within the same period, customer deposits increased by 1.7bn. On the cost side, in the nine months to December 2009, expenses were reduced 11%. Improved capitalisation: The capital injection of the Irish government in March, the repurchase of 1.7bn of Tier 1 securities in June and the debt for debt exchange of lower Tier 2 securities in February 2010 all helped strengthen the banks capital base. Furthermore, on April 26, BOI announced a proposal to raise 3.4bn of equity Tier 1 capital. The proposal includes a 500mn institutional placement of ordinary shares, a partial conversion of the Irish governments preference shares of 1bn to ordinary shares and a rights issue of up to 1.9bn. These measures should allow BOI to fulfil its regulatory obligation to raise an additional 2.7bn of equity. Following the completion of the transaction, the Irish governments ownership in BOI will be capped at 36% (currently: 34%).
Weaknesses
Pressure on sovereign debt market: As in a number of other markets, Irish government bonds suffered from rising pressure in European sovereign debt markets. 5y swap spreads increased from mid swaps +85bp in mid-April to mid-swaps 275bp in early May. The pressure on Irish government bonds and the Irish economy leads to a rather restrictive management of country exposure to Ireland by many investors and other counterparties. This limits the ability of Irish banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations. Fall-out from the financial market crisis: BOI suffers from its historically strong reliance on wholesale funding, its high exposure to property financing and its strong non-domestic real estate exposure. To stabilise its liquidity and solvency position, BOI made use of a number of emergency facilities. The costs for using these facilities combined with challenging conditions in term funding markets, high competition for deposits and only slow progress in re-pricing the loan book have a negative effect on bottom-line earnings. Furthermore, BOI submitted its restructuring plan to the European Commission on 30 September 2009. At this stage, it does not look like the pending decisions could materially hamper the ability of BOI to recover. Exposure to UK and Irish property price inflation: Residential mortgage sector lending is exposed to the UK and Irish property markets. The downturn in these markets has had a negative effect on asset quality. The NPL ratio within the groups residential mortgage portfolio increased from 2.8% in March 2008 to 5.6% in March 2009 and 6.2% in December 2009. The Irish market has not yet shown signs of stabilisation and, according to the permanent-tsb/ESRI Index at 31 December 2009, was down 32% from the peak in February 2007. In the UK, however, the situation looks better as house prices started to increase in spring 2009. In addition, the Irish and UK commercial property markets have stabilised following a peak to trough decrease in capital values of 50% and 45%, respectively, according to IPD indices.
Key points for 2010

Monitor the evolution of sovereign debt position of the Republic of Ireland and the development in sovereign debt markets. Track the use of emergency liquidity measures, the build up of deposits and the development of bottom-line results.
10 June 2010
582

Financial summary YE March (2009 YE March & Dec)
mn 2006 2007 2008 2009 2009* Income statement summary Net interest income 2,307 2,757 3,263 3,670 2,905 Net fees & com's 742 738 666 485 292 Trading income 30 70 -246 -307 -37 Operating income 3,195 3,764 3,921 3,957 4,799 Operating expenses 2,020 2,159 2,020 2,121 1,841 Pre-provision income 1,175 1,605 1,901 1,532 2,949 Loan loss provisions 103 103 232 1,513 5,409 Pre-tax profit 1,524 1,956 1,933 -23 -2,417 Net income 1,221 1,652 1,704 18 -1,959 Balance sheet summary Total assets 162,212 188,813 197,434 194,116 181,106 Customer loans 101,246 125,048 135,738 133,740 119,439 of which public sector na na na na na of which mortgages 50,623 58,811 60,028 31,214 32,706 Customer deposits 61,710 72,277 86,234 83,119 84,812 Debt funding 43,307 67,329 68,650 53,075 49,197 of which ACS 2,000 6,400 6,900 10,000 9,035 Total equity 5,186 6,724 6,522 6,913 6,437 Profitability (%) Return on average assets 0.84 0.94 0.88 0.01 -1.04 Return on average equity 25.81 27.74 25.73 0.27 -29.34 Cost/Income ratio 63.22 57.36 51.52 53.60 38.37 Net int inc/Op inc 72.21 73.25 83.22 92.75 60.54 Asset quality (%) LLPs/Pre-prov inc 8.8 6.4 12.2 98.8 183.4 LLRs/Gross loans 0.4 0.3 0.4 1.3 4.6 Prob loans/Gross loans 0.8 0.8 0.5 7.0 13.0 Coverage ratio 45.2 44.2 87.8 19.1 35.8 Capital adequacy (%) Tier 1 ratio 7.5 8.2 8.10 12.0 9.8 Total capital ratio 10.6 11.8 11.10 15.2 13.4 Equity/Assets ratio 3.2 3.6 3.30 3.6 3.6
Note: As of 31 December 2009/annualised income figures.
Fritz Engelhard (BKIR)

4% 3% 2% 1% 0% -1% -2% Mar 05 Mar 06 Mar 07 Credit costs Mar 08 Mar 09 NIM Dec 09 RoA
Efficiency
80% 60% 40% 1.8% 20% 0% Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Dec 09 Cost/Avg assets (RS) Cost/Income 1.4% 1.2% 1.0% 1.1% 1.0% 68% 63% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%
57%
52%
54% 38%

80% 60% 40% 20% 0% 75% 64% 62% 71% 60% 50% 40% 30% 20% 10% 0%
61%
58%
Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Dec 09 Cust deposits/Loans Wholesale funding/Tot. funding

15% 10% 5% 0% 100% 80% 60% 40% 20% 0% Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Dec 09 Prob loans/Gross loans Coverage ratio (RS)
Capital
16% 14% 12% 10% 8% 6% 4% Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Total capital ratio Dec 09 Tier 1 ratio

15 10 5 0 Mar 07 Mar 08 Restricted assets (bn) Over-collateralisation (x)
10 June 2010

1.50 1.00 0.50
0.00 Mar 09 Dec 09 Covered bonds (bn)
90% 85% 80% 75% 70% 65% 60%
78% 70%
82% 69%
84%
88%
69%
69%
Jun 09
Sep 09
Dec 09
Mar 10
WA indexed LTV
WA current LTV
583
Depfa ACS Bank (DEPFA)

Description
% Index
0.345
Fritz Engelhard
Ratings table
Total assets
Notes: *In %
% Index
NA
Moodys
A3 Aa2 Negative 4.9
S&P
BBB AA Stable -
Fitch
AAAA Stable 9.5 -
Depfa ACS Bank was established in October 2002 as a 100%-owned subsidiary of Depfa Bank PLC to take advantage of the Irish Asset Covered Securities Act, 2001. As of October 2007, Depfa Bank PLC is itself wholly owned by Hypo Real Estate Holding AG (HRG). Depfa ACS Bank is a designated credit institution approved by the Central Bank of Ireland to issue Irish Asset Covered Securities (ACS). The financial market turbulence in H2 08 unveiled HRGs reliance on wholesale funding and exposure to liquidity risk. In October 2008, a consortium of German financial institutions, the German government and Deutsche Bundesbank started to negotiate liquidity protection measures for the group, which were finalised in November 2009. In early April, the German Financial Markets Stabilisation Act was amended. This paved the way for the takeover of the group by the German Financial Market Stability Fund (SoFFin) in June 2009. In January 2010, HRG submitted an application for the transfer of 210bn of non-strategic assets to a deconsolidated environment.
Risk weighting
Irish ACS carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
External support: Neither Depfa Bank PLC and Depfa ACS Bank were included in the Irish bank support scheme, nor do they qualify for SoFFIN. However, to a large extent the support measures for HRG were needed to overcome the liquidity problems of the groups Irish operating entities. As Depfa Bank plc has no direct access to government support schemes, the vast amount of external liquidity support consists of intra-group funding, mainly from HRGs German main operating entity, Deutsche Pfandbriefbank AG (HYPORE). Thus, any failure of Depfa Bank plc or Depfa ACS Bank to meet their obligations would immediately have significantly negative repercussions on the German entities of HRG. In addition, Depfa Bank plc is an important derivative counterparty with a total notional amount of 407bn at YE 09. Thus, any failure to support Depfa Bank plc, would bear the risk of further systemic stress, a situation the German authorities are well aware of, as the government has repeatedly highlighted the systemic relevance of HRG. Collateral with low default risk: Depfa ACS Banks focus on public sector lending has given rise to a portfolio of high-quality assets with rather low default risk. The credit risk profile of Depfa ACS Bank is therefore limited. As at YE 09, 78% of its cover pool exposure was granted to counterparts rated at least AA- by external rating agencies. Over-collateralisation: Depfa ACS Bank covered bonds feature satisfactory levels of over-collateralisation. As at end-December 2009, according to the banks corporate presentation, overcollateralisation stood at 9.9% on a nominal basis and 11.8% on a present value basis. Furthermore, Depfa ACS Bank undertakes to ensure that nominal over-collateralisation will not fall below 5%.
Weaknesses
Restricted access to capital markets funding: Although HRG is fully owned by the German government, its solvency and liquidity positions were stabilised and progress was made with regards to the restructuring plan, the groups access to capital markets funding is still rather limited. On a positive note though it is worth recognising that the German operating entity of HRG, Deutsche Pfandbriefbank AG, managed to issue a 1bn public sector Pfandbrief in January 2010. Imposed business restrictions: The substantial support HRG receives from the German government is still subject to approval by EU and German regulatory authorities. The respective talks started on 7 May 2009. On 7 October 2009, the EU commission commented on the restructuring plan and mentioned it will help restore the long time viability of the group. On 13 November 2009, the EU commission extended this investigation, as HRG modified its restructuring plan before the EU commission has completed its assessment. Usually EU approval is subject to substantial limitations, including the necessity to wind down and/or dispose of certain operations, reduce risk exposures and restrictions relating to the competitive behaviour. In our view, the respective restrictions could substantially hamper the ability of HRG to recover from the financial stress in 2008. Uncertain ownership: A high portion of Depfa Bank plcs and Depfa ACS Banks businesses are subject to a wind down and/or disposal, as they do not form part of the newly defined core business of HRG. This situation creates a number of uncertainties with regards to the medium-term commitment of HRG to its Irish entities, the future ownership of these entities and the willingness and ability to maintain the high quality and high ratings for the secured funding instruments. In this respect it will be important to track the set-up of a work-out entity. Eventually, Depfa ACS Bank will be transferred to this entity, just as it was the case with WestLB Covered Bond Bank, which was transferred to the work-out entity of WestLB.
Key points for 2010

Track progress with regards to the EU state aid approval. Monitor the role HRGs Irish operations play in the groups transformation process.
10 June 2010
584

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector of which mortgages Customer deposits Debt funding of which ACS Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPS/Pre-prov inc LLRS/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 81 -2 -5 93 12 81 0 81 71 73,314 67,684 56,841 0 0 43,969 43,969 605 0.13 14.7 12.9 114.8 na na na na na na na 2007 141 -2 -10 145 -19 126 0 126 110 68,963 63,065 55,707 0 1 46,579 46,579 701 0.19 21.1 -13.1 102.8 na na na na na na na 2008 136 -11 -20 118 -17 101 0 101 89 96,067 83,018 71,742 0 0 52,773 51,430 715 0.13 15.7 -14.4 86.8 na na na na na na na 2009 89 -58 2 24 -7 17 -10 7 7 86,959 75,481 66,155 0 0 50,842 50,842 571 0.01 1.4 -29.2 27.0 na na na na na na na
Depfa ACS Bank (DEPFA)

Net asset liability profile, YE 09
10 8 6 4 2 0 -2 -4 bn 8.6
2.6
-1.9 <1yr
-0.5 1-5yr 5-10yr >10yr
Net asset liability profile

20 15 10 5 0 -5 -10 bn 9.3 9.8
8.6
Dec-08 <1yr
Mar-09 1-5yr 5-10yr
Dec-09 >10yr
Cover pool: breakdown by type of counterparty, YE 09

Sovereign 9% Other 3% Local Government 29%
Public Sector 59%
60 50 40 30 20 10 0 bn 120% 115% 110% 105% 100% 04 05 06 Restricted assets Over-collateralisation 07 08 09 Covered bonds
Cover pool: Geographical split, YE 09 (53.5bn)

Nordic 4.0% Other 6.8% BeNeLux, 11.4% Poland, 2.3% Japan 2.3% Germany, 20.3% Austria 1.7% Iberia 1.3% Italy France 5.9% 3.4% Supra 2.6%
Canada 4.8% USA 21.0% UK/ Ire 8.2%
Cover pool: Breakdown by rating, YE 09 (53.5bn)

Single A 18% Double A 44% Triple B 3% Other 1% Triple A 34%
10 June 2010
585
EBS Building Society (EBSBLD)

Description
% Index
0.029
Fritz Engelhard
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor* Collateral score*
Note: * In %
% Index
NA
Total assets
21bn
S&P
NR NR -
Fitch
BBBNR Watch + 12.1 -
A2 Aaa Negative 9.5
EBS Building Society (EBSBLD) was founded in 1933 and today is the fourth-largest building society in the UK and Ireland, and the sixth largest credit institution in Ireland, with total assets of 21bn as at 31 December 2008, the latest available annual data. EBSBLD specialises in mortgage financing. As of 31 December 08 about 80% of its balance sheet consisted of property financing. In December 2008, it established EBS Mortgage Finance, a designated credit institution approved by the Central Bank of Ireland to issue Irish Asset Covered Securities (ACS). In November 2009, the first jumbo ACS was launched.
Risk weighting
Irish ACS carry a 10%risk weighting under the Standardised Approach of the EU Capital Requirements Directive (CRD) and may achieve a lower risk weighting under the IRB.
Strengths
Government support: Being the sixth-largest Irish credit institution with a market share of about 9% in the Irish deposit market, EBSBLD benefits from public sector support. The Irish Building Society Act was amended in order to allow a capital injection by the Irish government. EBSBLD estimates it would require at least 300mn of government capital. Furthermore, EBSBLD benefits from the introduction of the Eligible Liabilities Guarantee (ELG) scheme, which was introduced in December 2009 and which allows EBSBLD to issue guaranteed debt securities until September 2010. Also in December 2009, The Irish government introduced the National Asset Management Agency (NAMA) scheme, which was set up to acquire nonperforming or non-strategic assets from participating banks. EBSBLD intends to sell a total amount of 1bn of assets to NAMA. The respective transfer will help reduce EBSBLDs exposure to real estate, as well as total risk-weighted assets. Improved funding and cost profile: In order to cope with the impact of the financial market crisis on the banks liquidity and solvency position, EBSBLD focused on strengthening its capital position, enhancing its funding sources and reducing costs. The respective measures already show good results. In the 12 months to December 2009, the group increased its customer deposits by 673mn. On the cost side, in the six months to June 2009, expenses were reduced by 8.3%. Over-collateralisation: The mortgage covered bonds issued by EBS Mortgage Finance feature high levels of overcollateralisation. As at end-December 2009, overcollateralisation stood at 42% on a nominal basis Furthermore, EBS Mortgage Finance is publicly committed to maintaining an over-collateralisation level of 21%.
Weaknesses
Pressure on sovereign debt market: As in a number of other markets, Irish government bonds suffered from rising pressure in European sovereign debt markets. 5y swap spreads increased from mid swaps 85bp in mid April, to mid-swaps 275bp in early May. The pressure on Irish government bonds and the Irish economy leads to a rather restrictive management of country exposure to Ireland by many investors and other counterparties. This limits the ability of Irish banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations. Fall-out from the financial market crisis: EBSBLD suffers from rather strong reliance on wholesale funding and its high exposure to property financing. In order to stabilise its liquidity and solvency position, EBSBLD made use of a number of emergency facilities. The costs for using these facilities combined with challenging conditions in term funding markets, high competition for deposits and only slow progress in repricing the loan book have had a negative impact on bottom-line earnings. Furthermore, EBSBLD is in the process of submitting its restructuring plan to the European Commission. At this stage it is unclear to what extent the resolution of state aid procedures could hamper the ability of EBSBLD to recover. Exposure to Irish property price inflation: Residential mortgage sector lending is strongly exposed to the Irish property markets. The downturn in these markets has had a negative impact on asset quality. The NPL ratio within the groups residential mortgage portfolio increased from 2.8% at YE 08 to 4.9% at YE 09. The Irish market has not yet shown signs of stabilisation and according to the permanent-tsb/ESRI Index at 31 December 2009, was down 32% from the peak in February 2007. In the Irish commercial property markets, however, the situation has stabilised, following a peak-to-trough decrease in capital values of 50%, according to IPD indices.
Key points for 2010

Monitor the evolution of the Republic of Irelands sovereign debt position. Track the use of emergency liquidity measures, the build-up of deposits and the development of bottom-line results.
10 June 2010
586

Financial summary YE March (2009 YE March & Dec)
mn 2006 Income statement summary Net interest income 150 Net fees & com's 16 Trading income 170 Operating income 89 Operating expenses 81 Pre-provision income 5 Loan loss provisions 66 Pre-tax profit Net income 58 Balance sheet summary Total assets 19,306 14,634 Customer loans na of which public sector 12,000 of which mortgages 10,071 Customer deposits 7,087 Debt funding of which ACS 660 Total equity Profitability (%) Return on average assets 0.32 9.12 Return on average equity Cost/Income ratio 52.59 88.40 Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc 5.71 LLRs/Gross loans 0.02 Prob loans/Gross loans na na Coverage ratio Capital adequacy (%) Tier 1 ratio 7.50 11.00 Total capital ratio 3.42 Equity/Assets ratio 2007 2008
EBS Building Society (EBSBLD)

1.0% 0.8% 0.6% 0.4% 0.2% 0.0% -0.2% -0.4% 2005 NIM 0.84% 0.32% 0.03% 0.90% 0.29% 0.10% 0.76% 0.47%
174 16 194 98 96 19 67 56 19,476 15,882 na 12,032 9,544 5,937 830 0.29 7.51 50.57 89.58 19.94 0.03 na na 9.00 11.90 4.26 -
155 14 172 90 82 95 -38 -38 21,374 16,901 na 13,107 10,126 3,895 1,500 668 -0.19 -5.05 52.35 90.02 115.71 0.09 na na 7.90 10.60 3.13
-0.19%
2006
2007 Credit costs
2008 RoA
Efficiency
54% 52% 50% 48% 46% 44% 42% 40% 06 Cost/Income 07 08 Cost/Avg assets (RS) 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

70% 49.7% 65% 68.8% 60% 44.9% 55% 2006 Cust deposits/Loans 60.1% 59.9% 47.4% 52% 50% 48% 46% 44% 42% 2007 2008 Wholesale funding/Tot. funding

6% 5% 4% 3% 2% 1% 0% 06 07 08 09 Prob loans/Gross loans (mortgages)
Capital
14% 12% 10% 8% 6% 4% 06 Tier 1 ratio 07 08 Total capital ratio

4 3 2 1 0 Dec 08 Restricted assets (bn) Over-collateralisation (x) 1.50 1.40 1.30 1.20 1.10 1.00 Dec 09 Covered bonds (bn)

72% 70% 68% 66% 64% 62% 60% 70% 66% 66% 64% Sep 09 Dec 09 Mar 10 66% 66% 63% Jun 09 66%
WA indexed LTV
WA original LTV
10 June 2010
587
10 June 2010
588
UK COVERED BOND PROFILES
10 June 2010
589
Abbey National (ABBEY)/Santander UK

Description
% Index
0.091
Michaela Seimen
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score Aa3 Aaa Negative 10.5 AAA
% Index
0.2
Total assets
288bn
S&P
Fitch
AAAAA Stable 14.4 -
The 1944 merger of the National Freehold Land and Building Society and the Abbey Road Building Society formed the Abbey National Building Society. In July 1989, it became the first building society to convert from mutual to PLC status in the UK. In September 2003, after an unsuccessful foray into the wholesale banking market, the name was changed to simply Abbey and all of the business units outside of UK personal financial services were placed in the Portfolio Business Unit (PBU) with a view to exiting these business lines by end-2005. In November 2004, Abbey was acquired by Santander. In 2008, Abbey acquired Alliance and Leicester and 20bn of retail deposits alongside outlets of Bradford And Bingley, making it one of the UKs leading personal financial services companies, offering a full range of personal banking services ranging from mortgages and savings products to personal loans and credit cards.
Risk weighting
UK registered covered bonds carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Strong market position: As at year-end 2009, the enlarged Abbey enjoyed a c.13.5% share of the UK outstanding mortgage stock, making it one of the largest mortgage lender in the UK with 10.2% of deposits/savings (third largest in the UK) and c.8.9% of outstanding bank accounts. Asset quality: A large part of the loan book of Santander UK comprises mortgages. In the past, Abbey has eschewed to a great extent riskier forms of mortgage lending, with only smaller exposures of the mortgage book comprising buy-to-let and little in the way of self-certified loans, etc. Overall loan-loss provisions remained stable over recent quarters, showing decreasing shares of provisions on mortgage business, but increasing provisions on retail and corporate business. Total non-performing loans amounted to 1.71% in 2009. As of yearend 2009, c.90% of Abbeys retained mortgage business had a LTV < 75%, whereas averaged indexed mortgage LTVs on stock stood at c.52%. Santander support: Santanders acquisition of Abbey adds significant financial and strategic resources to a group previously weakened by asset write-offs, weak levels of regulatory capital and poor (although recently recovering) levels of earnings. In addition, given Santanders increasingly key position in the UK mortgage market and savings market, there is a reasonable chance that support would be forthcoming for the group from the UK authorities, given its stance during recent bank recapitalisation moves in the UK.
Weaknesses
Concentration: Residential mortgages represent a large part of loans. While asset quality remains relatively good, a slowdown in the UK housing market had negative implications for revenue growth. Earnings: Based on the enlargement of the group and first benefits of efficiency effects consolidated profit increased in the last year, despite increased loan-loss provisions. Funding: Along with other major UK banks and building societies, Abbey participated in the Bank of Englands Special Liquidity Scheme. In the UK, Santander is primarily funded by its commercial bank (retail and corporate) franchise, including retail and corporate deposits. For wholesale funding, Santander in the UK uses its wholly-owned subsidiary Abbey National Treasury Services plc (ANTS), which is diversified across funding types and geography, including collateralised borrowings, mortgage securitisations and long-term debt issuances. ANTS has a EUR25bn covered bond programme in place.
Key points for 2010

Monitor: The evolution of asset quality and performance, particularly with reference to any deterioration in the UK housing market. The Impact of deleveraging process on results. Any increase in market share in the UK.
10 June 2010
590

mn 2006 Income statement summary Net interest income 1,437 Net fees & com's 699 289 Trading income 2,454 Operating income 1,323 Operating expenses 1,104 Pre-provision income 264 Loan loss provisions 840 Pre-tax profit Net income 684 Balance sheet summary Total assets 190,690 Customer loans 127,929 101,700 of which Mortgages 77,353 Customer deposits 48,924 Debt funding of which covered bonds 2,300 2,235 Total equity Profitability (%) Return on average assets 0.4 30.6 Return on average equity Cost/Income ratio 53.9 58.6 Net int inc/Op inc Asset quality (%) LLPs/Pre-prov Inc 23.91 LLRs/Gross loans Prob loans/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio 10.40 12.00 Total capital ratio 1.17 Equity/Assets ratio 2007 2008* 2009*
Abbey National (ABBEY)

Average indexed LTV on mortgage stock
bn 25 20 15 10 5 0 Jan-09
1,597 689 298 2,585 1,277 1,308 214 1,110 822 199,372 134,999 110,500 89,846 55,775 2,750 2,330 0.4 35.3 49.4 61.8 16.36
1,916 735 397 3,049 1,360 1,689 362 1,329 991 303,647 192,638 159,200 136,398 64,766 8,500 5,078 0.3 19.5 44.6 62.8 21.43 0.54 1.28 42 8.50 14.00 1.67
3,501 884 451 4,860 1,985 2,876 784 2,107 1,536 288,229 202,232 166,800 147,964 52,052 5,268 5,261 0.5 29.2 40.8 72.0 27.26 0.67 1.86 36 9.50 17.60 1.83
Apr-09
Jul-09
Oct-09
Jan-10
Mortgage Balance
Outstanding CBs
Average new business LTV

% 95 90 85 80 75 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10
Asset Percentage used
na na 1.17
Note: * P&L includes B&B but excludes A&L, balance sheet is for combined entity

90% 80% 70% 60% 60.5% 50% 2006 2007 Cust deposits/Loans 66.6% 70.8% 73.2% 38.7% 38.3% 32.2% 26.0% 45% 40% 35% 30% 25% 20% 15%

1.5% 1.0% 0.5% 0.0% 2006 NIM 2007 2008 Credit costs 2009 RoAA 0.72% 0.36% 0.13% 0.82% 0.41% 0.11% 0.76% 0.33% 0.14% 1.18% 0.53% 0.26%
2008 2009 Wholesale funding/Tot. funding
10 June 2010
591
Lloyds Banking Group (LBG)

Description
% Index
0.192
Michaela Seimen
Ratings table
Total assets
1.1trn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
% Index
0.81
Moodys
Aa3 Aaa Stable 5.4
S&P
A+ AAA Stable -
Fitch
AA-AAA Stable 14.1 -
Lloyds Banking Group was formed after the acquisition of Halifax Bank of Scotland (HBOS), which was itself formed by the combination previously of Halifax, a de-mutualised former building society, and Bank of Scotland. LBG is one of the largest retail banks in the UK, with over 3,000 branches and more than 30mn customers. LBG is also well positioned in the business banking sector. As a result of HM Treasurys investment in LBG, the bank was required to submit a restructuring plan to the European Commission in the context of a state aid review. The restructuring plan aims to limit any competition distortions resulting from state aid received. The plan was approved in November 2009 and stipulates the disposal of part of LBGs retail banking business, an asset reduction of 181bn of a specific pool of assets by 2014 and certain behavioral commitments. As at year-end 2009, LBG had total assets of c.1,027bn.
Risk weighting
Strengths
Market position: The acquisition of HBOS made LBG the dominant bank in the UK in terms of residential mortgage lending with a 24% share of all new mortgage business. In addition, Scottish Widows is the second-largest provider in the life pensions and unit trust market. Capitalisation: Weaker market conditions and accelerated deterioration of credit quality drove HBOSs guided loss before taxes to 8.5bn in 2008 (5bn higher than expected), straining the combined groups capital base. On a proforma basis, LBGs core Tier 1 capital ratio of 6-6.5% as at end-2008 looked even weaker when adjusted for fair value gains from HBOS. Hence, two placing and open offers were made in 2009, with the UK government eventually holding 43.3% of LBG. The multiple capital injections have strengthened the groups capital base and resulted in an increase in the groups capital Tier 1 ratio to 9.6%. We note that the bank narrowly avoided having to join the UKs Asset Protection Scheme. Potential government support: Given the market shares enjoyed by LBG, it should be viewed as a highly systemically important institution in the UK. As such, it seems reasonable that further support would be forthcoming for LBG from the UK authorities.
Weaknesses
Performance: LBG is highly leveraged towards UK household prospects. Further developments in LBGs rating performance will be reliant on the restructuring process, improvement of its credit profile and development of its capital base. Funding: In past years HBOS was a large user of RMBS, and the difficulties in this market meant that it had to become more active in the short term and commercial paper markets. In 2008, LBGs group members participated in and benefited from usage of the BoEs SLS facility.
Key points for 2010

Monitor: The evolution of asset quality and performance, particularly with reference to any deterioration in the UK housing market. The impact of restructuring on performance.
10 June 2010
592

HBOS 2007 2008 8,171 1,127 -2,878 8,092 5,114 2,978 12,050 -10,825 -7,416 LBG Consolidated LLOYDS 2007 2008 2009 6,099 2,624 3,123 12,798 4,937 7,861 1,796 4,000 3,321 7,718 2,537 -9,186 1,601 5,267 -3,666 3,012 807 845 9,026 2,737 19,098 36,351 10,684 25,667 16,673 1,042 2,953 1,027,255 626,969 362,667 406,741 268,229
Lloyds Banking Group (LBG)

Average indexed LTV on mortgage stock Llyods
bn 15 10 5 0 Jan-09 Mar-09 May-09 Jul-09 Mortgage Balance
mn Income statement summary Net interest income 7,304 Net fees & com's 1,260 Trading income 178 Operating income 11,046 Operating expenses 4,979 Pre-provision income 6,067 Loan loss provisions 2,072 Pre-tax profit 5,474 Net income 4,113 Balance sheet summary Total assets 667,017 Customer loans 430,007 of which public sector of which Mortgages 235,858 Customer deposits 243,221 Debt funding 230,773 of which PS UK ACS of which Mortgage UK ACS 39,184 Total equity 22,234 Profitability (%) Return on average assets 0.65 Return on average equity 18.95 Cost/Income ratio 45.08 Net int inc/Op inc 66.12 Asset quality (%) LLPs/Pre-prov inc 34.15 LLRs/Gross loans 0.78 Prob loans/Gross loans 2.05 Coverage ratio 37.95 Capital adequacy (%) Tier 1 ratio 8.10 Total capital ratio 12.00 Equity/Assets ratio 3.33
Sep-09 Nov-09 Outstanding CBs
Jan-10
Average new business LTV Lloyds

% 95 90 85 80 75 70 Jan-09 Mar-09 May-09 Jul-09
689,917 353,346 436,033 435,223 209,814 242,735 239,758 102,739 114,643 222,251 156,555 170,938 218,567 63,530 92,966 34,022 13,499 -1.09 -41.51 63.20 100.98 404.63 2.40 3.68 65.17 8.10 12.00 1.96 0 12,425 0.94 26.73 38.58 47.66 22.85 1.13 2.50 45.34 8.10 12.00 3.52 0 9,699 0.21 7.64 328.98 482.07 -82.16 1.45 3.47 41.78 8.10 12.00 2.22
44,107 0.29 6.70 29.39 24.83 64.96 2.56 3.84 66.51 9.60 12.40 4.29
Sep-09 Nov-09
Jan-10
Average indexed LTV on mortgage stock HBOS

bn 60 40 20 0 Jan-09 Mar-09 May-09 Jul-09 MortgageBalance
Sep-09 Nov-09 OutstandingCBs
Jan-10
Average new business LTV HBOS

% 95 90 85 80 75 70 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Asset Percentage used
Jan-10

2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 21.4% 2008 NIM
10 June 2010
Customer deposits to loans Lloyds

72% 48.3% 49% 48% 70.4% 46.3% 64.9% 2008 2009 Wholesale funding/Tot. funding 47% 46% 45% Cust deposits/Loans
1.96% 162.3% 76.3% 0.88%
70% 68% 66% 64% 62%
28.7% 2009 Credit costs RoA
593
HSBC Holdings (HSBC)

Description
% Index
0.309
Michaela Seimen
Ratings table
Total assets
2.53trn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
% Index
0.867
Moodys
S&P
AA AAA Negative -
Fitch
HSBC is one of the largest banking and financial services organisations in the world. Its banking network comprises c.9,500 properties in 86 countries. The bank was established in 1865 in Hong Kong and expanded primarily in the Asia-Pacific region for the next 100 years or so. The past 20 years have seen it expand into the US, Europe and the UK, where in the early 1990s it acquired Midland Bank, which led the group to move its head offices to London. Further acquisitions followed the move, some of the most notable being CCF in France and Household in the US. HSBC is listed in London, New York, Paris and Bermuda, and its shares are held by in excess of 220,000 shareholders in more than 121 countries.
Risk weighting
Strengths
Sound asset quality: HSBCs residential mortgage business is subject to a strict underwriting process, through which credit scoring is carried out on all applications, as is income and affordability verification. This is reflected in the performance of the banks residential mortgage portfolio, whose arrears of greater than three months have been better than the market average over the past years. UK mortgage impairments in recent years have been broadly stable despite the higher levels of balances. Average LTV ratios for new UK business in the banks mortgage portfolio were below 55% in 2009. Global diversification: HSBCs business is geographically well diversified, and while performance can be affected by localised factors, the group has proved it has the spread and management experience to control this effectively. Funding/capitalisation: With an advances-to deposits ratio at 77.3%, HSBCs reliance on capital markets is lower than many of its peers. In terms of capitalisation, as at 31 March 2010, HSBC had a core Tier 1 ratio of 9.7% and a Tier 1 ratio of 11.1%. The capital was further strengthened in April 2009 via a 12.5bn rights issue, making HSBC notable as one of a select band of European banks to tap markets in meaningful size, vindicating its decision to not seek governmental help. Potential government support: Given HSBCs key position in the UK mortgage market and savings market, there is a reasonable likelihood that support would be forthcoming from the UK authorities, given the governments stance during recent bank recapitalisation moves in the UK.
Weaknesses
Emerging market risk: With Asia, the Middle East and Latin America accounting for almost 30% of risk-weighted assets, ratings might be sensitive to the greater volatility of potential returns in these markets. US consumer credit: A major feature of recent results has been the growth in provision charges for US mortgages, the vast majority of which came from HSBC Finances US mortgage book. However, the decision to exit US subprime lending and wind down the US consumer finance unit sets HSBC on track to put the subprime losses behind it.
Key points for 2010

Monitor the evolution of asset quality and performance, particularly with reference to any deterioration in the UK housing market.
10 June 2010
594

$ mn 2005 2006 2007 2008 2009 Income statement summary Net interest income 34,486 37,795 42,563 40,730 31,334 Net fees & com's 17182 14,456 22,002 20,024 17,664 Trading income 5,864 8,222 9,834 6,560 9,863 Operating income 61,704 70,070 87,601 88,571 78,631 Operating expenses 29,514 33,553 39,042 49,099 34,395 Pre-provision income 28,123 31,813 39,951 32,583 31,786 Loan loss provisions 7,801 10,573 17,242 24,937 26,488 Pre-tax profit 20,966 22,086 24,212 9,307 7,079 Net income 15,873 16,871 20,455 6,498 6,694 Balance sheet summary Total assets 1,501,970 1,860,758 2,354,266 2,527,465 2,364,452 Customer loans 740,002 868,133 981,548 932,868 896,231 of which resid. mortgages 233,866 265,337 269,068 243,337 260,669 Customer deposits 739,419 896,834 1,096,140 1,115,327 1,159,034 Debt funding 204,609 252,997 271,398 209,126 177,374 of which covered bonds 0 1,371 2,190 2,053 Total equity 98,226 114,928 135,416 100,229 135,661 Profitability (%) Return on average assets 1.14 1.00 0.97 0.27 0.27 Return on average equity 16.08 15.83 16.34 5.52 5.68 Cost/Income ratio 47.83 47.88 44.57 55.43 43.74 Net int inc/Op inc 50.78 49.22 43.14 48.06 51.80 Asset quality (%) LLPs/Pre-prov inc 27.74 33.23 43.16 76.53 83.33 LLRs/Gross loans 1.53 1.56 1.96 2.56 2.85 Prob loans/Gross loans 1.55 1.74 2.00 2.72 3.41 Coverage ratio 99.04 90.09 98.07 94.31 83.45 Capital adequacy (%) Tier 1 ratio 9.00 9.40 9.30 8.30 10.80 Total capital ratio 12.80 13.50 13.60 11.40 13.70 Equity/Assets ratio 6.54 6.18 5.75 3.97 5.74
HSBC Holdings (HSBC)

bn 40 30 20 10 0 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10
Mortgage Balance
Outstanding CBs

% 95 90 85 80 75 70 Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
LLP/Pre-provision income
100% 80% 60% 40% 20% 0% 2005 2006 2007 2008 2009 LLPs/Pre-prov inc 27.7% 33.2% 43.2% 76.5% 83.3%
* P&L Includes B&B but excludes A&L, balance sheet is for combined entity.

150% 100% 50% 0% 2005 2006 2007 2008 2009 Cust deposits/Loans 99.9% 103.3% 111.7% 21.7% 22.0% 19.8% 15.8% 119.6% 13.3% 129.3% 25% 20% 15% 10% 5% 0% Wholesale funding/Tot. funding

2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 2005 2006 NIM 2007 RoA 0.56% 1.14% 0.63% 1.00% 2.25% 2.05% 1.79% 0.82% 0.97% 1.08% 1.2% 1.0% 0.8% 1.74% 1.67% 0.6% 0.4% 0.27% 0.27% 0.2% 0.0% 2008 2009 Credit costs 1.02%
Cost to income/average assets

60% 50% 40% 30% 20% 10% 0% 47.83% 2.12% 47.88% 2.00% 44.57% 1.85% 55.43% 2.01% 1.41% 43.74% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 2005 2006 2007 2008 2009 Cost/Income
10 June 2010

4.0 3.0 90.1% 2.0 1.0 0.0 2005 2006 2007 2008 2009 Prob loans/Gross loans Coverage ratio
595
99.0%
98.1% 94.3% 2.72 3.41 83.5%
1.55
1.74
2.00
105% 100% 95% 90% 85% 80% 75%
Cost/Avg assets
Nationwide Building Society (NWIDE)

Description
% Index
0.152
Michaela Seimen
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score Aa3 Aaa Stable 5.0
% Index
0.321
Total assets
191bn
S&P
A+ AAA -ve -
Fitch
AAAAA Stable 14.6 -
Nationwide Building Societys (Nationwide) position as the largest UK building society and the fourth-largest UK mortgage lender was furthered in 2009 by the acquisition of the Derbyshire, Cheshire and selected assets and liabilities of Dunfermline Building Societies following the purchase of Portman the previous year. Gross mortgage lending in FY 10 of 12bn (net 1.8bn) resulted in a market share of 8.7%, versus a c.9% natural share. This represents a large increase on the 3.3% share in H1 09, which was as a result of a continued focus on quality rather than quantity. At the same time, Nationwide is the second-largest provider of savings accounts, with total balances of c.121bn as of 4 April 2010. As UCB Home Loans Corporation Ltd (UCBHL) and TMW (acquired as part of Portman), Nationwide also runs an operation specialising in self-certified mortgages and buy-to-let lending. As of 4 April 2010, it had a lending book of 15.7bn.
Risk weighting
Strengths
Sound asset quality: Loans secured on residential property represents the largest asset class in Nationwides credit portfolio, at 90% of customer loans outstanding. Commercial mortgage lending represents c.14.6% (c.7.1bn of which is to UK registered social landlords and 1.3bn under PFI) and other loans 0.6%. Residential mortgage lending continues to be accompanied by a strict origination policy. The business focus is on prime markets; the ability of the borrower to pay at stressed interest rate levels is regarded as an important credit risk factor. The strict origination criteria and the professional monitoring of each loan are reflected in the good performance of the banks residential mortgage portfolio. As at 4 April 2010, 0.68% of the mortgage portfolio was three months or more in arrears. This compares well with a UK industry average of 2.22%. The indexed LTV of the residential mortgage book has fallen to 48% as at April 2010, versus 52% in April 2009, while the average eLTV of new lending stands at c. 63% currently. Capitalisation: Given that 97% of Nationwides loan book consists of secured credits, we regard the reported Tier 1 ratio of 15.3% as high. The negative rate of new mortgage origination while added to drop-in customer deposits in 2010 meant that the loan to deposit ratio increased to 116.8%, from 112.4%. However, the societys reliance on capital markets is moderate compared with some peers. In addition, the covered bond programme has helped expand the groups investor base, as well as diversify its funding mix across markets and maturities. Potential government support: Given Nationwides key position in the UK mortgage market and savings market, there is a reasonable likelihood that support would be forthcoming for Nationwide from the UK authorities.
Weaknesses
Performance: Nationwides overall performance is comparatively weak versus some of its peers, reflecting its status as a building society, but also the focus on residential mortgage business. The potential to improve profitability materially is limited by the fact that Nationwide, like other building societies, rewards its members with a particularly competitive pricing policy while potentially restricting its access to equity capital markets. However, the fact that the contributions of fees and commissions to total operating income increased from 7.8% in 2001, to 17.2% in 2010, indicates that the successful diversification of income streams helps protect bottom-line results. Concentration: Residential mortgages represent about 75% of loans. While asset quality remains solid, a prolonged slowdown in housing sales and a return to housing price falls in the UK could have negative implications for revenue growth. M&A: Further activity in terms of takeovers of smaller struggling UK building societies could result in deterioration of asset quality and added pressure to funding requirements.
Key points for 2010

10 June 2010
596

mn 2006 2007 2008 2009 2010 Income statement summary Net interest income 1,234 1,479 1,796 1,758 1,714 Net fees & com's 306 332 332 355 373 Trading income 0 0 0 0 0 Operating income 1,574 1,870 2,125 2,258 2,164 Operating expenses 991 1,109 1,292 1,378 1,346 Pre-provision income 583 761 833 880 818 Loan loss provisions 76.6 133.6 106 394 549 Pre-tax profit 559 652 686 190 341 Net income 397 464 495 146 264 Balance sheet summary Total assets 120,586 137,379 179,027 202,353 191,397 Customer loans 101,348 115,938 142,804 155,469 152,429 of which resid. mortgages 89,587 101,883 127,078 129,916 127,313 Customer deposits 80,919 86,795 113,816 128,292 120,943 Debt funding 22,213 30,489 35,830 37,027 38,968 of which covered bonds 1,369 5,913 9,356 9,408 9,050 Total equity 5,773 6,510 8,065 6,511 7,882 Profitability (%) Return on average assets 0.36 0.39 0.36 0.09 0.15 Return on average equity 7.25 8.00 7.74 2.17 3.65 Cost/Income ratio 62.98 59.29 60.80 61.03 62.20 Net int inc/Op inc 78.41 79.10 84.53 77.86 79.21 Asset quality (%) LLPs/Pre-prov inc 13.15 17.55 12.71 44.77 67.11 LLRs/Gross loans 0.15 0.18 0.15 0.30 0.49 Prob loans/Gross loans 0.04 0.04 0.05 0.27 NA Coverage ratio 380.10 429.05 271.57 110.85 NA Capital adequacy (%) Tier 1 ratio 8.80 8.70 9.70 15.10 15.30 Total capital ratio 11.00 11.00 12.40 19.40 19.50 Equity/Assets ratio 4.79 4.74 4.50 3.22 4.12
Nationwide Building Society (NWIDE)

bn 50 40 30 20 10 0 Jan-09 Mar-09 May-09 Jul-09 Mortgage Balance
Sep-09 Nov-09 Jan-10 Outstanding CBs

% 95 90 85 80 Jan-09 Mar-09 May-09 Jul-09
Sep-09 Nov-09
Jan-10

85% 80% 75% 80% 70% 2006 2007 Cust deposits/Loans 75% 80% 83% 79% 21.5% 26.0% 23.9% 22.4% 24.4% 30% 25% 20% 15% 10% 5% 0%
2008 2009 2010 Wholesale funding/Tot. funding

1.5% 1.0% 0.5% 0.0% 2006 NIM 2007 2008 Credit costs 0.36% 0.07% 0.39% 0.10% 0.36% 0.07% 0.09% 0.21% 2009 0.15% 0.28% 2010 RoA 1.06% 1.15% 1.14% 0.92% 0.87%

0.30 0.25 0.20 0.15 0.10 0.05 0.00 380% 429% 272% 0.05 111% 2006 2007 2008 Prob loans/Gross loans 2009 Coverage ratio 0.27 500% 400% 300% 200% 100% 0% 0.04 0.04
40 30 20 10 0 Feb 07 Oct 07 Apr 08 Oct 08 Feb 09 Aug 09 Feb 10 Outstanding CBs
Efficiency
65% 63% 61% 59% 57% 55% 2006 2007 Cost/Income 2008 2009 2010 Cost/Avg assets
597
0.85% 63.0%
0.86%
0.82%
0.72%
0.68% 62.2%
1.0% 0.8% 0.6% 0.4% 0.2% 0.0%
60.8% 59.3%
61.0%
Adjusted Loan Balance

10 June 2010
Yorkshire Building Society (YBS)

Description
% Index
0.022
Michaela Seimen
Ratings table
Moodys
LT senior unsecured Covered bond rating Discontinuity factor Collateral score Outlook Baa1 Aa1 6.0 Negative
% Index
0.051
Total assets
23bn
S&P
A AA+ Negative
Fitch
A AAA 13.7 Stable
With total assets of 22.7bn and mortgages outstanding of 15bn as at year-end 2009, YBS is the UKs third-largest building society,. Headquartered in Bradford, historically YBS has had a strong regional bias towards Yorkshire and Humberside in the north of England; however, the completion in April this year of the of the acquisition of Chelsea building society will result in a national network of 178 branches 2.8mn members and assets of 36bn. YBS has thus far focused on prime residential mortgage lending. It is engaged in three principal activities: residential mortgage lending, retail deposit taking and the sale of third-party general insurance.
Risk weighting
Strengths
Sound asset quality: Residential mortgages represent the largest asset class on YBSs balance sheet, at 66% of total assets and the vast majority of customer loans. YBSs residential mortgage lending has had an average growth of c.9% per annum over the past six years. This growth has, however, been accompanied by a strict origination policy, which reflects the performance of the banks residential mortgage portfolio. As at YE 09, 1.84% of the loan portfolio was three months or more in arrears, below the industry average and a level that represents a decline from the peak seen in Q1 09. In addition, it is worth noting that due to its focus on returning value to its members, YBS has a strong business franchise in its core market, with a loyal customer base. Funding/solvency: The expansion of its loan book has not caused material strains on YBSs funding and solvency position. With the rate of new mortgage origination roughly matching customer deposits, management has not been forced to substantially increase its reliance on wholesale funding. With a customer deposits-to-loans rate of c.99% as of YE 09, the societys reliance on capital markets is very moderate compared with some of its peers. In addition, the covered bond programme expands the groups investor base and helps diversify its funding mix across markets and maturities. Potential government support: Additionally there is a reasonable chance that support would be forthcoming for YBS from the UK authorities, given their stance during recent bank recapitalisation moves in the UK.
Weaknesses
Performance: Due to its strong focus on offering competitive services to its members, YBSs net interest margin (NIM) ranks among the industrys lowest; it stood at 0.65% in 2009, 0.71% in 2008, following 0.97% in 2007, 0.94% in 2006 and 0.96% in 2005. The banks capitalisation also ranks among the industrys strongest, although this will fall following the merger with the Chelsea. Consequently, the societys profitability, as measured by return on equity, persistently fell over the past decade and turned negative in 2010. Concentration: YBS is highly dependent on net interest income, which declined to 148mn in 2009, from 165mn in 2008. In recent years, YBS has expanded into a variety of non-core activities, for example, Yorkshire Investment Services Ltd, which was set up to gain revenues from treasury operations, Yorksafe Insurance Company, which provides supplementary mortgage indemnity insurance cover to the society, and Yorkshire Key Services, which was established to offer YBSs mortgage operating platform to third parties. However, profit contribution from these other activities remains moderate and has failed to grow substantially over the past six years. Consequently, the net interest income to operating income ratio has remained around the low-80s recently. As residential mortgages make up 75% of total assets, a slowdown in housing sales could have negative implications for revenue growth. In addition, in common with other mortgage providers in the UK, YBS entered some of the riskier specialist mortgage lending businesses in the early to mid2000s, and although this did not include buy-to-let, some 25% of Chelseas loan book was in this area. Further deterioration in the UK housing market could see this business line suffer disproportionately. Merger: The merger with Chelsea building society creates a much larger organisation and the deal represents a potential risk for management in terms of executing the integration of the businesses while managing the operations of the combined entities successfully.
Key points for 2010

10 June 2010
598

mn Income statement summary Net interest income Net fees & com's Other op income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which res. mortgages Customer deposits Debt funding Of which Covered Bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPS/Pre-prov inc LLRS/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 165 26 7 198 117 94 4 78 54 17,566 13,269 13,264 12,883 3,367 1,154 911 0.3 5.9 59.2 83.4 3.72 0.11 0.03 400 13.4 14.8 5.2 2007 188 27 14 229 120 64 5 55 39 20,498 15,362 15,358 14,872 4,072 2,362 954 0.2 4.1 52.5 82.1 7.87 0.12 0.04 276 11.2 11.8 4.7 2008 165 27 5 196 122 44 25 8 9 23,032 16,292 16,287 15,445 4,590 3,000 909 0.0 1.0 62.4 83.9 57.08 0.25 0.47 54 14.1 14.8 3.9 2009 148 26 5 179 124 49 59 -13 -3 22,722 14,979 14,975 14,884 5,810 2,800 900 0.0 -0.4 69.6 82.8 121.15 0.34 0.59 58 14.2 15.6 4.0
Yorkshire Building Society (YBS)

bn 6 4 2 0 Jan-09 Mar-09 May-09
Jul-09
Sep-09 Nov-09 Outstanding CBs
Jan-10
Mortgage Balance

% 95 90 85 80 75 70 Jan-09 Mar-09 May-09
Jul-09
Sep-09 Nov-09
Jan-10

1.2% 0.9% 0.6% 0.3% 0.0% -0.3% 2006 NIM 2007 2008 2009 RoA Credit costs 0.31% 0.02% 0.19% 0.02% 0.11% 0.94% 0.92% 0.71% 0.04% 0.65% -0.01% 0.26%
5 4 3 2 1 0 Jan-07

100% 98% 96% 94% 97.1% 2006 96.8% 2007 94.8% 2008 99.4% 2009 23.0% 21.5% 22.9% 28.1% 30% 25% 20% 15% 10% 5% 0%
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
92% Cust deposits/Loans
Adjusted Loan Balance
Outstanding CBs
Wholesale funding/Tot. funding
Lending structure, YE 09
Accord nonprime lending 15% Accord prime lending 31%

80% 70% 60% 50% 40% 30% 20% 10% 0% 0.67% 59.2% 52.5% 0.59% 62.4% 0.53% 69.6% 0.55% 0.8% 0.6% 0.4% 0.2% 0.0% 2006 2007 Cost/Income 2008 2009 Cost/Avg assets
599
Society prime lending 54%
10 June 2010
10 June 2010
600
SWEDISH COVERED BOND PROFILES
10 June 2010
601
Lnsfrskringar Hypotek (LANSBK)

Description
% Index
NA
Leef H Dierks
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score A2 Aaa Stable 3.6
% Index
NA
Total assets
SEK157bn
S&P
A AAA* Stable -
Fitch
NR NR NR -
With aggregate mortgage lending amounting to SEK70.5bn as at end-March 2010, the latest date for which data were available, Lnsfrskringar Hypotek (LANSBK) is among the largest retail mortgage providers in Sweden. Lnsfrskringar Hypotek is owned by Lnsfrskringar Bank, which is owned by Lnsfrskringar AB. The latter, in turn, is wholly owned by 24 regional and 14 local insurance companies. Lnsfrskringar ABs offers non-life insurance, accident and medical insurance, life assurance, pension saving plans, fund savings and various banking services to 3.3mn clients on the Swedish market. Lnsfrskringar is market leader in the domestic private pension market in terms of new sales. With regards to its banking operations, Lnsfrskringar Bank is Swedens fifth-largest retail bank with a market share of 3.5% in deposit taking and 4.1% in retail and mortgage lending.
Note: Senior unsecured ratings refer to Lnsfrskringar Bank. * CreditWatch Negative. As at 7 June 2010.
Risk weighting
As Swedish Skerstllda Obligationer (covered bonds) are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Collateral pool: Virtually all mortgages granted on behalf of LANSBK are eligible for inclusion in the lenders collateral pool. At the time of writing, the loan portfolio primarily comprised loans secured by collateral in private homes (80%) and owner-occupied apartments (19%), with a very small portion of second homes (1%). As at end-Q1 10, the average loan to value ratio (LTV) was 60% with the average loan granted amounting to SEK369,000. The nominal over-collateralisation stood at 114.6% as of Q1 10. Asset quality: Overall, Lnsfrskringar Bank benefits from a high asset quality with loan losses falling to SEK50mn in 2009, from SEK65mn in 2008. Impaired loans amounted to SEK213mn in 2009, from SEK192mn in 2008, which corresponds to an NPL ratio of only 0.21% in 2009, from 0.22% in 2008. Retail mortgage lending accounted for 75% of all lending, followed by lending to the agricultural sector, which accounted for 11%. With regards to the loan portfolio of LANSBK, impaired loans amounted to only SEK5mn or 0.01% of all lending.
Weaknesses
Geographical concentration: LANSBKs operations are limited to the Swedish market with the collateral pool backing the covered bonds issued consisting of residential mortgage loans, which are exclusively secured by properties located in Sweden. As a result of this geographic concentration, further developments in the Swedish housing market and their potential impact on asset quality need to be carefully monitored. This becomes particularly evident in light of potential rate hikes from the Swedish Riksbank, which we expect in Q3 10 and the fact that 69% of the mortgage loans in the collateral pool are subject to a floating interest rate. Capital market reliance: Over the course of 2009, LANSBKs debt securities in issue increased by 27% y/y to SEK62bn, from SEK49bn in2008 of which covered bonds accounted for a high SEK55bn in 2009 (88%), up from SEK42bn in 2008. With Lnsfrskringar Banks long-term financing operations primarily being conducted through covered bond issuance on behalf of LANSBK and customer deposits accounting for only 37% of all customer loans granted, potential distortions on the (Swedish) covered bond market might leave their mark on LANSBK funding structure. This, however, is mitigated by the fact that SEKdenominated Swedish covered bond market is among the most liquid ones.
Note: At the time of writing, LANSBK had issued one EUR-denominated benchmark covered bond (1.00bn) within the scope of its covered bond programme.
Key points for 2010

Despite a low NPL ratio of 0.21% and an over-collateralisation ratio of 114.6% as at year-end 2009, further developments in the Swedish housing market need to be thoroughly assessed, particularly in light of a potential rate hike in Q3 10.
10 June 2010
602

Financial summary
SEK mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2008 2009
2.0%
Lnsfrskringar Hypotek (LANSBK)

1.0% 0.9% 0.4% 0.0% 2009
1,340 -362 -3,161 137 4,404 -4,267 65 -3,395 -2,480 130,554 78,564 na na 34,624 48,592 7,466 -1.9 -33.2 3,212.4 977.2 -1.5 na 0.0 na na na 5.7
1,241 -340 520 3,422 3,712 -290 50 693 509 157,005 99,582 na na 36,981 61,136 8,058 0.4 6.6 108.5 36.3 -17.4 na 0.0 na 12.5 14.8 5.1
1.0% 0.0% -1.0% -1.9% -2.0% Net Interest Margin Credit Costs RoA 0.0% 2008

50% 45% 40% 35% 30% 25% 2008 Customer deposits to loans 62.5% 44.1% 75% 37.1% 69.0% 70% 65% 60% 2009 Wholesale funding in % of total funding 80%
Collateral pool: Geographical structure, 2010

Central Sweden 39% Stockholm 17% Northern Sweden 8% Southern Sweden 15%
Western Sweden 21%
Collateral pool: Structure, 2010

Tenantowned apartments 19%
Single family homes 80%
Leisure homes 1%
10 June 2010
603
Nordea Hypotek (NBHSS)

Description
% Index
0.173
Leef H Dierks
Ratings table
Total assets
SEK393.3bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
% Index
0.068
Moodys
Aa2 Aaa NR 6.1
S&P
AAAAA* NR -
Fitch
AANR NR -
Nordea Hypotek (NBHSS) is a fully-owned (100%) subsidiary of Nordea Bank, one of the largest financial institutions in the Nordic countries in terms of total assets (508bn as at year-end 2009). With total assets of SEK393bn as at year-end 2009, up 9% y/y, NBHSS is Swedens third-largest mortgage lender with a market share of roughly 15%, granting long-term loans to Swedish households, municipalities, municipal housing companies and corporates. All loans granted are secured by mortgages, tenant-owner units, or municipal/state guarantees. NBHSS is fully embedded into its parent company Nordea Bank, for which it operates as a funding vehicle. Nordea Bank, whose total operating income is only 23% accounted for by its domestic market, Sweden, originates all mortgage loans for NBHSS through its Swedish branch offices.
Note: * CreditWatch Negative. As at 7 June 2010.
Risk weighting
Strengths
Asset quality: Standing at SEK354bn at year-end 2009, the collateral pool of the covered bonds issued by NBHSS corresponded to c.95% of all lending, including mortgage loans secured by residential (85%) or commercial property (4%), and loans to or guaranteed by the public sector (11%). The average loan-to-value ratio stood at 52% with 68% of all loans being floating rate mortgage loans. With a gross impairment rate of only 0.007% as at year-end 2009, up from 0.004% in 2008, nonperforming loans (NPLs) stood at very low levels. Allowances for impaired loans amounted to 0.023% of all loans granted. The nominal over-collateralisation provided by the collateral pool amounted to 129% as at year-end 2009. Parent company: With only two employees, NBHSS is operationally fully embedded into Nordea Bank, for which it serves as a funding vehicle with central corporate functions such as finance, product development or marketing being provided by the parent. The latter is licensed by the Swedish Financial Supervisory Authority to issue covered bonds according to the Swedish Covered Bond Act. As a result of the high level of integration into Nordea Bank, we assume that there is a high probability of the parent providing support to its subsidiary in the case of distress. Given its systemic importance for the Swedish (and Nordic) market, Nordea Bank, which made 25% of its operating income in Denmark in 2009, would probably benefit from governmental support in the case of distress. Funding structure: As at year-end 2009, NBHSS had issued a total of 27bn of covered bonds, thereof only 26% being EURdenominated. SEK-denominated covered bonds, in contrast, accounted for 74%, thereby illustrating a) the issuers reliance on a strong and liquid domestic market, and b) the possibility to access other than the domestic market, too. NBHSS plans to issue one to two EUR-denominated benchmark covered bonds annually.
Weaknesses
Geographical concentration: NBHSS operations are limited to the Swedish market with the collateral pool backing the covered bonds issued consisting of mortgage loans (85%) that are exclusively secured by properties located in Sweden. As a result of this geographic concentration, with a stable 34% of all cover pool dwellings being located in the larger Stockholm area, further developments in the Swedish housing market and their potential impact on asset quality need to be carefully monitored. This becomes particularly evident in light of potential rate hikes of the Swedish Riksbank, which we expect in Q3 10 and the fact that 68% of the mortgage loans in the collateral pool are subject to a floating interest rate.
Note: At the time of writing, NBHSS had issued a total of five EUR-denominated benchmark covered bonds (6.75bn) within its 10bn covered bond programme. NBHSS also issues registered covered bonds.
Key points for 2010

Despite a very low NPL ratio of 0.007% and an over-collateralisation ratio of 129% as at year-end 2009, further developments in the Swedish housing market need to be thoroughly assessed, particularly in light of a potential rate hike in Q3 10.
10 June 2010
604

SEK mn 2006* 2007* 2008* 2009* Income statement summary 1,969 1,911 2,325 3,141 Net interest income Net fees & com's 51 52 47 0 Trading income 21 -6 -110 46 Operating income 2,048 1,957 2,262 3,187 Operating expenses 507 506 506 552 Pre-provision income 1,541 1,451 1,756 2,635 Loan loss provisions 8 7 -2 -61 1,556 1,458 1,755 2,575 Pre-tax profit Net income 1,119 1,049 1,262 1,895 Balance sheet summary Total assets 284,934 319,658 361,865 393,281 Customer loans 283,637 316,689 340,491 374,243 of which public sector na 39,261 38,784 39,900 of which mortgages na na na na Customer deposits na na na na Debt funding 184,674 230,225 276,186 276,670 Total equity 11,416 11,416 11,416 13,311 Profitability (%) Return on assets 0.4 0.4 0.4 0.5 Return on equity 9.8 9.2 11.1 15.3 24.8 25.9 22.4 17.3 Cost/Income ratio Net int inc/Op inc 96.1 97.6 102.8 98.6 Asset quality (%) LLPs/Pre-prov inc 0.5 0.5 -0.1 -2.3 0.0 0.0 0.1 0.2 LLRs/Gross loans Prob loans/Gr loans 0.0 0.0 0.0 0.0 na na na na Coverage ratio Capital adequacy (%) Tier 1 ratio 7.4 7.0 6.8 8.0 Total capital ratio 9.0 9.3 9.0 10.2 Equity/Assets ratio 4.0 3.6 3.2 3.4
Note: *Figures were prepared according to the so-called limited IFRS.
Nordea Hypotek (NBHSS)

Geographical spread, 2010
Western Sweden 26% Stockholm 34%
Southern Sweden 18%
Northern and Central Sweden 22%

Tenantowner apartments 18% Single and two family properties 50% Multi-family properties Other 17% collateral 5% Municipalities and municipal guarantees 11%
10 June 2010
605
Skandinaviska Enskilda Banken (SEB)

Description
% Index
0.096
Leef H Dierks
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score*
Note: * In %.
% Index
0.089
Total assets
SEK2,308bn
S&P
A NR Stable -
Fitch
A+ NR Stable -
A1 Aaa Negative 3.5%
Skandinaviska Enskilda Banken AB (SEB) was created in 1972 through the merger between Stockholms Enskilda Bank (founded in 1856) and Gothenburg-based Skandinaviska Banken (founded in 1864). SEB offers universal banking services in Sweden, Estonia, Latvia, Lithuania and Germany, and also aims to be a universal bank in Ukraine and Russia. In terms of total assets, which exceeded SEK2,300bn as at year-end 2009, SEB is among the largest Swedish banks, generating roughly 52% of its operating income in the domestic market, down from 65% in 2008. Business in the Nordic countries generated 70% of all operating income, with Norway accounting for 8%, Denmark 7% and Finland 3%, respectively. SEBs German retail operations, according to SEB are to be sold in the near future. The Baltic countries, which experienced a pronounced deterioration in their asset quality in 2009, accounted for an aggregate 11% of SEBs operating profits. Overall, operating profits were driven by the merchant banking division (45%), followed by retail banking (26%), and wealth management (8%).
Risk weighting
Strengths
Asset quality: As at year-end 2009, the collateral pool backing the covered bonds issued by SEB had a nominal value of SEK259.5bn. With covered bonds issued totalling SEK160.5bn at the same time, the over-collateralisation amounted to a sound 162%. The weighted average LTV stood at 45%, with 73% of the entire cover pool having a LTV of less then 60%. Nearly two-thirds (65%) of the collateral pool consists of mortgage loans secured on single family houses, followed by tenantowned apartments (23%), and multi-family dwellings (11%). The proportion of cover pool assets in arrears stood at a low 0.36% as at year-end 2009. Funding structure: As at year-end 2009, SEB had issued covered bonds in the nominal amount of SEK160.5bn. Thereof, roughly one-third (ie, 30.4%) was EUR-denominated. SEKdenominated covered bonds, in contrast, accounted for 69.15%, with the remaining 0.45% being NOK-denominated papers. This structure, in our view, highlights SEBs reliance on a strong and liquid domestic covered bond market and, at the same time, its possibility to access the EUR-market, too, provided funding conditions are sufficiently attractive. In total, covered bonds accounted for 18% of SEBs entire funding needs. Customer deposits accounted for 58% of all funding as per year-end 2009. Note that SEB also issues covered bonds (Pfandbriefe) through its German daughter SEB AG. Market position: SEB benefits from relatively sound market shares in the Nordic markets, which range from 14% in lending to 21% in deposit taking in Sweden. Market shares in Baltic markets also are relatively high with 15-30% in lending and 1916% in deposit taking, respectively.
Weaknesses
Lending to Baltic countries: As at year-end 2009, lending to the Baltic countries amounted to SEK143bn, or c.11% of SEBs total lending. As a result of the sharp GDP contraction, with a surge in unemployment and the deteriorating asset quality in these countries, SEBs net credit losses more than tripled to SEK12.5bn in 2009, from SEK3.2bn in 2008. Of these, SEK9.6bn was directly related to the Baltic countries, up from SEK1.8bn in 2008. As at year-end 2009, the latest date for which data were available, the net credit loss level in the Baltic countries stood at 5.4%. With provisions of SEK606mn, the net credit loss level in the Ukraine amounted to 19.4% in 2009. SEBs Baltic residential mortgage lending amounted to SEK50bn as at year-end 2009. Thereof, 6% were in arrears for 60 days or more. In 2009, SEBs net income was heavily affected by the surge in loan-loss provisions, which caused it to fall to SEK1.2bn, from SEK10.1bn in 2008. Geographical concentration: SEBs collateral pool exclusively (100%) consists of mortgage loans secured by properties located in Sweden. As a result of this geographic concentration, with 42% of all cover pool dwellings being located in the larger Stockholm area, further developments in the Swedish housing market and their potential impact on asset quality need to be carefully monitored. This becomes particularly evident in light of potential rate hikes from the Swedish Riksbank, which we expect in Q3 10 and the fact that 71% of the mortgage loans in the collateral pool are subject to a floating interest rate. Another 19% of the mortgage loans in the cover pool are subject to a fixed rate mortgage loan, which will be reset in less than 24 months.
Note: At the time of writing, SEB had a total of four EUR-denominated benchmark covered bonds totaling 4.5bn outstanding. SEB also issues registered covered bonds.
Key points for 2010

The surge in loan-loss provisions to SEK12.5bn in 2009, from SEK3.2bn in 2008, needs to be carefully monitored, particularly in light of SEBs exposure towards the Baltic countries. Still, we highlight that this is of minor relevance for the covered bonds collateral pool.
10 June 2010
606

Financial summary
SEK mn 2006 Income statement summary 14,218 Net interest income Net fees & com's 16,146 Trading income 873 32,923 Operating income Operating expenses 21,523 11,400 Pre-provision income Loan loss provisions 5,726 15,562 Pre-tax profit Net income 12,623 Balance sheet summary Total assets 1,934,441 Customer loans 950,861 of which public sector na of which mortgages na Customer deposits 643,326 Debt funding 438,032 na of which Covered Bonds Total equity 67,267 Profitability (%) 0.7 Return on assets Return on equity 20.3 Cost/Income ratio 65.4 43.2 Net int inc/Op inc Asset quality (%) 50.2 LLPs/Pre-prov inc LLRs/Gross loans 0.0 0.0 Prob loans/Gr loans Coverage ratio 92.9 Capital adequacy (%) Tier 1 ratio 8.2 Total capital ratio 11.0 Equity/Assets ratio 3.5 2007 15,919 17,051 1,067 35,335 21,840 13,495 5,961 17,018 13,642 2008 18,710 15,254 2,970 38,887 23,883 15,004 3,231 12,471 10,050 2009
Skandinaviska Enskilda Banken (SEB)

70%
19,490 14,460 4,485 44,213 23,702 20,511 12,448 3,372 1,178
67.7% 63.2%
70.3% 64.9% 67.4%
60% 50%
60% 41.1% 50% 2005 42.1% 42.5% 40.7% 38.1%
40% 30%
2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding

2,344,462 2,510,702 2,308,227 1,067,341 1,296,777 1,187,837 na na na na na na 750,481 841,034 801,088 554,553 576,449 492,406 na na 160,513 76,719 83,729 99,669 0.6 18.9 61.8 45.1 44.2 0.0 0.0 86.6 8.6 11.5 3.3 0.4 12.5 61.4 48.1 21.5 0.0 0.0 68.5 8.4 10.6 3.3 0.0 1.3 53.6 44.1 60.7 0.0 0.0 69.5 12.8 13.5 4.3
Multi-family properties 10% Single family properties 66%
Tenantowner apartments 23%
Geographical spread, year-end, 2009

Malm 8% East excl. Stockholm 16% South excl. Malm 6% Gothenburg 18% West excl. Gothenburg 6% North 5%
Note: Figures were prepared according to IAS/IFRS.
Stockholm 41%
Efficiency
80% 70% 60% 50% 2005 2006 2007 Cost/Income ratio 2008 2009 Cost/Assets ratio 1.1% 76.6% 1.0% 65.4% 61.8% 1.1% 1.1% 1.0% 61.4% 53.6% 0.9 1.2 1.1

1.0% 0.8% 0.4% 0.7% 0.3% 2005 0.3% 2006 0.6% 0.1% 0.0% 0.3% 2007 2008 2009 RoA 0.0% 0.7% 0.7% 0.8% 0.4% 0.8% 0.5%
0.5%
1.0
Net interest margin
Credit costs
10 June 2010
607
Stadshypotek (SHBASS)
Description
% Index
0.175
Leef H Dierks
Ratings table
Total assets
SEK723bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
% Index
0.11
Moodys
NR Aaa NR 7.6
S&P
AANR Stable -
Fitch
AANR Stable -
Stadshypotek (SHBASS) is one of Swedens largest mortgage lenders. As at year-end 2009, it had a market share of c.25% of the domestic mortgage market. Operationally, SHBASS, which was fully acquired by Svenska Handelsbanken in 1997, is fully integrated into Handelsbanken, which executes central corporate functions such as treasury and funding directly. Within Handelsbankens domestic operations, mortgage financing is principally conducted through SHBASS, with the primary source of funding being the issuance of SEK-denominated covered bonds. Mortgage lending, however, takes place through Handelsbankens 461 branch offices. As of late, SHBASS extended its operations towards Norway (Handelsbanken Eiendomskreditt), where in 2008, a SEK44bn mortgage loan portfolio was acquired in order to expand the collateral pool for issuing covered bonds.
Risk weighting
Strengths
Asset quality: The collateral pool backing the covered bonds issued by SHBASS exclusively (100%) consists of mortgage loans secured by properties located in Sweden. In line with the population density, 33% of the cover pool assets being located in the larger Stockholm area, followed by East (18%) and West (16%) Sweden and the North (12%). There was no exposure towards the Baltic countries in SHBASS collateral pool. As at year-end 2009, the nominal over-collateralisation amounted to 143% with the weighted average un-indexed LTV of the cover pool standing at 35.5%. More than 80% of all mortgage loans used for the cover pool had an LTV of below 50%. The collateral pool was balanced between fixed (46%) and floating (54%) rate mortgage loans. In 2009, recoveries exceeded new loan losses with the net amount recovered totalling SEK31mn. This corresponds to a loan-loss ratio of 0% of lending. After deducting provisions for probable loan losses, the volume of impaired loans stood at SEK116mn, of which SEK61mn were non performing. Market position: In 2009, customer lending increased by 11% y/y to SEK685bn, from SEK615bn in 2008 (when SEK44bn of Norwegian mortgage loans were acquired). This development underlines SHBASS strong position in the domestic mortgage market where it benefits from a c.25% market share in the retail market and c.30% in the corporate market. Also, in terms of refinancing, SHBASS was strongly reliant on the domestic market with SEK-denominated issuance accounting for 68% of the lenders long-term funding. As per year-end 2009, the latest date for which data were available, only 31% of SHBASSs long-term funding was made up of EUR-denominated debt instruments.
Weaknesses
Geographical concentration: As the collateral pool backing the EUR-denominated covered bonds issued by SHBASS exclusively (100%) consists of mortgage loans secured by properties located in Sweden, further developments in the Swedish housing market and their potential impact on the asset quality need to be carefully monitored. This becomes particularly evident in light of potential rate hikes from the Swedish Riksbank, which we expect in Q3 10 and the fact that 54% of the mortgage loans in the collateral pool were subject to a floating interest rate as at yearend 2009.
Note: At the time of writing, SHBASS had a total of three EUR-denominated benchmark covered bonds in the aggregate amount of 4.75bn outstanding within the scope of its 15bn EMT Covered Note Programme.
Key points for 2010

Despite an over-collateralisation ratio of 143% as at year-end 2009, further developments in the Swedish housing market need to be thoroughly assessed, particularly in light of a potential rate hike in Q3 10.
10 June 2010
608

Financial summary
SEK mn 2006* Income statement summary 4,180 Net interest income -47 Net fees & com's 0 Trading income 4,445 Operating income 142 Operating expenses 4,303 Pre-provision income 278 Loan loss provisions Pre-tax profit 4,581 Net income 3,322 Balance sheet summary Total assets 490,722 Customer loans 480,219 6,787 of which public sector na of which mortgages 0 Customer deposits 311,687 Debt funding of which Covered Bonds 19,872 Total equity Profitability (%) 0.7 Return on assets 17.1 Return on equity 3.2 Cost/Income ratio 94.0 Net int inc/Op inc Asset quality (%) 6.5 LLPs/Pre-prov inc 27.7 LLRs/Gross loans 0.1 Prob loans/Gr loans na Coverage ratio Capital adequacy (%) Tier 1 ratio 7.1 Total capital ratio 8.3 4.0 Equity/Assets ratio 2007* 3,703 -39 0 4,024 168 3,856 70 3,926 2,826 540,900 523,758 5,732 na 0 401,007 338,213 19,873 0.6 14.4 4.2 92.0 1.8 28.7 0.0 na 28.5 40.3 3.7 2008* 3,900 -31 0 3,798 189 3,609 73 3,682 2,655 2009* 6,067 -24 0 5,942 207 5,735 55 5,761 4,240
Stadshypotek (SHBASS)
Breakdown of mortgages by structure, year-end 2009
Commercial 3%
Multi-family housing 25%
Single-family homes and housing cooperative apartments 71%
659,498 722,790 615,263 684,920 8,974 15,801 na na 0 0 439,204 467,335 358,280 20,018 21,682 0.5 13.5 5.0 102.7 2.0 28.7 0.0 na 25.9 37.1 3.0 0.7 20.8 3.5 102.1 1.0 28.7 0.0 na 28.4 39.9 3.0
Geographical split, year-end 2009

Gothenburg area Malmo area 9% 5% Stockholm area 32% North 12% East 17% West 16% South 9%
Efficiency
8% 7.0% 5.4% 6% 0.17% 4% 2% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Cost/Income ratio Cost/Assets ratio 3.4% 2.0% 2.4% 3.2% 4.2% 5.0% 3.5% 0.2% 0.4%
0.07% 0.04% 0.03% 0.03% 0.04% 0.03%0.03% 0.03% 0.0%
Note: * Figures denote IAS/IFRS numbers. Since 2007, capital adequacy figures have been prepared according to Basel II.

3% 2.4% 1.3% 1.3% 1.3% 1.2% 0.9%
2% 1.7% 1% 0%
0.9% 0.7% 0.7% 1.0%
0.9% 0.9% 0.9% 0.7% 0.1% 0.0% 0.1% 0.0% 0.0% 0.7% 0.0% 0.0% 0.1% 0.6% 0.5%0.0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Net interest margin Credit costs RoA
10 June 2010
609
Swedish Covered Bond Corporation (SCBCC)

Description
% Index
0.029
Leef H Dierks
Ratings table*
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score A1 Aaa Negative 9.0
% Index
NA
Total assets
SEK198bn
S&P
A+ AAA** Negative -
Fitch
NR NR NR -
SCBC, the Swedish Covered Bond Corporation, is a wholly-owned subsidiary of the Swedish Housing Finance Corporation, SBAB, for which it operates as a funding vehicle. SBAB, in turn, Swedens fifthlargest mortgage provider with a market share of 9.5%, is fully (100%) owned by the Kingdom of Sweden, but is among the companies in which state ownership will eventually be reduced. SCBC was established in 2006, when the company received a permit from the Swedish FSA to issue covered bonds (skerstllda obligationer), thereby becoming the first Swedish issuer to tap the EUR-denominated benchmark covered bond market. In principle, SCBC's business activities are focused on the issuance of covered bonds in the Swedish and international capital market for which two funding programmes are used; a Swedish bond loan programme for issue of covered bonds and an EMTN programme.
Note: *Ratings of Swedish Housing Finance Corporation (SBAB) As at 7 June 2010. ** CreditWatch negative.
Risk weighting
Strengths
Asset quality: The collateral pool backing the covered bonds issued by SCBC fully (100%) consists of residential mortgage loans on property located in Sweden. There is no exposure towards the Baltic countries. Loans in arrears account for less than 0.01% as any loan which is in arrears for 30 days will be bought back by parent company SBAB. Nearly two-thirds (62%) of the cover pool consists of lending to owner-occupied dwellings, with single family houses accounting for 40% and owner-occupied flats for 22% as at yearend 2009. Parent company: SCBC is the dedicated covered bond funding vehicle of state-owned SBAB, securing term funding through the 10bn EUR-denominated covered bond programme and the SEK84bn Swedish covered bond programme. SCBC itself does not carry out any mortgage lending itself, but acquires loans from SBAB on an ongoing basis. The latter also performs all financing, administrative, credit management, risk management and operating services for SCBC. As a result of this embedding, we believe that an implicit financial support on behalf of the Swedish government is highly likely in a case of distress. Funding structure: As at year-end 2009, SCBC had issued a total of SEK131bn of covered bonds, 23% being EURdenominated. SEK-denominated covered bonds, in contrast, accounted for 66%, thereby illustrating: a) the issuers reliance on a strong and liquid domestic market; and b) the possibility to access other than the domestic market, too. SCBC plans to issue one to two EUR-denominated benchmark covered bonds annually. Technically, SCBC is fully reliant on the capital markets as it does not hold any deposits within its scope of being a funding vehicle.
Weaknesses
Geographical concentration: SCBCs operations are limited to the Swedish market, with the collateral pool backing the covered bonds issued exclusively (100%) consisting of residential mortgage loans secured by properties located in Sweden. With a high 44.6% of the collateral pool being located in the larger Stockholm region, any further developments in the Swedish housing market and their potential impact on the asset quality need to be carefully monitored. This becomes particularly evident in light of potential rate hikes from the Swedish Riksbank, which we expect in Q3 10 and the fact that 55% of the mortgage loans in the collateral pool are subject to a floating interest rate. Note that 84% of the cover pool assets are located in the countrys economic hubs, however. Also, we believe that the risk is partly mitigated as parent company SBAB buys back any loan that is in arrears for 30 days or more. Privatisation: In June 2007, the Swedish Riksdag approved the governments proposal to reduce state ownership in six companies, among them SBAB.. As outlined in Government Bill 2008/209:104, the government intends to implement a sale at a time that is adjudged as the most appropriate occasion from a commercial viewpoint. Currently, however, a sale is not being considered. In our view, further developments surrounding the eventual privatisation need to be closely monitored.
Note: At the time of writing, SCBCC had five EUR-denominated benchmark covered bonds outstanding with an aggregate amount of 5.5bn.
Key points for 2010

Despite no date having been fixed for the potential privatisation of SCBCs parent company SBAB, any related spill-over effects should be monitored.
10 June 2010
610

Financial summary
SEK mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which CBs Total equity Profitability (%) Return on avg assets Return on avg equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007* 840 6 0 874 309 567 71 566 408 138,053 128,205 6,954 121,180 0 120,800 105,361 5,823 0.6 14.0 35.4 96.1 12.5 na na na 8.5 8.5 4.2 2008* 797 -5 0 1,428 399 1,029 17 1,012 720 184,446 157,792 4,996 152,796 0 146,004 126,578 9,383 0.8 15.3 27.9 55.8 1.7 na na na 10.0 10.0 5.1 2009* 813 -59 0 175 444 -270 25 -295 -217 198,112 173,371 7,229 166,142 0 166,589 139,963 9,615 -0.2 -4.5 253.7 464.6 -9.3 na na na 11.1 11.1 4.9
Swedish Covered Bond Corporation (SCBCC)

Breakdown of mortgage lending, 2010
Private multifamily dwellings 14% Tenantowner associations 23% Single-family dwellings and holiday homes 44% Tenantowned apartments 19%
Breakdown of mortgage lending, 2010 (%)

50 40 30 20 10 0 Stockholm Skane Vstra Gtaland Uppsala 22.9 12.8 3.4 44.6
SEK mn 200 150 100 50 0 2007 Mortgages 2008 Covered Bonds 1.2x 1.2x 1.2x 2009 Over-collateralisation 121 105 Over-collateralisation (x) 2.0 166 153 140 127 1.5 1.0
Note: * Annual Report was prepared in compliance with IAS/IFRS.
10 June 2010
611
Swedbank Hypotek (SPNTAB)

Description
% Index
0.083
Leef H Dierks
Ratings table
Total assets
SEK1,795bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
% Index
NA
Moodys
A2 Aaa Negative 7.3
S&P
A AAA* Stable -
Fitch
NR NR NR -
Swedbank Hypotek (SPNTAB) is the largest residential mortgage lender in Sweden, benefiting from a market share of more than 30%. Founded in 1893, SPNTAB is Swedens oldest mortgage institution. The lender is fully (100%) owned by Swedbank, which, with total assets of more than SEK1,795bn as at year-end 2009 and headquarters in Stockholm, is Swedens largest financial institution. In addition to its strong presence on the domestic market, Swedbank also operates in the Baltic countries as well as Russia and the Ukraine. In the wake of the financial crisis with the respective GDP contracting by 14% y/y in Estonia and the Ukraine, 16% y/y in Lithuania, and 18% y/y in Latvia, lending to these countries was reduced and stood at 209% of equity in 2009 compared with 290% in 2008. Swedbank provides universal banking services through 19,000 employees in 771 branch offices. In Q4 09, Swedbank created a new business area, Ektornet, which manages properties taken over by the bank.
Note: * CreditWatch Negative. Ratings refer to Swedbank as at 7 June 2010.
Risk weighting
Strengths
Asset quality: At the time of writing, the collateral pool behind SPNTABs covered bonds exclusively consists of mortgage loans granted on Swedish property. There is thus no cover pool exposure towards the Baltic region or other Nordic countries. At 90.3%, residential mortgage loans, ie, secured by single family houses, condominiums, and multi-family houses, accounted for the biggest proportion of the SEK608bn collateral pool. SPNTABs total mortgage loan portfolio of SEK672bn represents c.56% of Swedbanks total loans to the public. The average weighted LTV stood at 44% with loans being due for more than 60 days not being eligible for inclusion in the collateral pool. In Q3 09, 80% of the total lending book had an LTV of less than 50%. Nonetheless, according to SPNTAB, in Sweden, the banking sector has a specific problem to address concerning the imbalance between the length of funding and lending in the mortgage market. Although the credit quality of Swedish mortgages presumably remains good, this imbalance could become an issue for households and banks going forward if it is not addressed in time. Parent company: With not a single employee as at year-end 2009, SPNTAB is fully embedded (and dependent) into Swedbank for which it operates as a (covered bond) funding vehicle. Instruments of choice are covered bonds with the domestic market (characterised by a continuous refinancing through roll-overs and buybacks) providing c.50% of the term funding needs. Market share: With a market share of more than 30%, SPNTAB is the leading mortgage lender in Sweden. Over the course of 2009, mortgage financing through SPNTAB increased by SEK49bn (+8% y/y).
Weaknesses
Credit provisions: Provisions for impaired loans of Swedbank surged to SEK16.9bn in 2009, from SEK1.8bn in 2008, thereby leaving a mark on the institutions profitability. Whereas provisions for loan losses amounted to SEK21.8bn in 2009, from SEK2.6bn in 2008. Net write-offs amounted to SEK2.8bn in 2009, from SEK518mn in 2008. In response, net profits fell by more than SEK20bn to a net loss of SEK10.4bn in 2009, from a net profit of SEK10.9bn in 2008. According to Swedbank, net writeoffs are expected to increase as the financial turmoil continued for an extended period. The credit impairment ratio increased to 1.74% in 2009, from 0.24% in 2008. Gross impaired loans stood at SEK40.1bn in 2009, mostly attributed to the Baltic countries (particularly Latvia SEK13.4bn), which accounted for SEK26.6bn thereof. Regional concentration: The collateral pool behind the covered bonds issued exclusively (100%) consists of loans granted on properties located in Sweden. The biggest part (90.3%) refers to residential mortgages, followed by loans to the agricultural sector (6.7%), loans to the public sector (2.9%) and commercial mortgage loans (0.1%). Still, we believe that risks stemming from the regional concentration of the collateral pool are mitigated by its sound asset quality, with virtually no nonperforming loans included.
Note: At the time of writing, SPNTAB had five EUR-denominated Swedish benchmark covered bonds in the aggregate amount of 5.4bn outstanding within the scope of its 25bn EMTN programme. Swedbank also issues registered covered bonds.
Key points for 2010

Despite a sound over-collateralisation ratio as at year-end 2009, further developments in the Swedish housing market need to be thoroughly assessed, particularly in the light of a potential rate hike in Q3 10. 10 June 2010 612

Financial summary (Swedbank)
SEK mn 2006* 2007* 2008* Income statement summary 15,977 19,157 21,702 Net interest income 8,869 9,880 8,830 Net fees & com's 2,738 1,691 2,351 Trading income 28,711 31,952 35,499 Operating income 14,480 16,014 17,086 Operating expenses 14,231 15,938 18,413 Pre-provision income -205 619 3,156 Loan loss provisions 14,263 15,586 13,819 Pre-tax profit 10,880 11,996 10,939 Net income Balance sheet summary Total assets 1,352,989 1,607,984 1,811,690 Customer loans 946,319 1,135,287 1,287,424 of which public sector 9,341 of which mortgages 472,061 Customer deposits 400,035 458,375 508,456 Debt funding 595,633 712,852 638,120 of which Covered Bonds 271,236 Total equity 60,277 68,323 86,462 Profitability (%) 0.9 0.8 0.6 Return on assets 19.1 18.7 14.1 Return on equity 50.4 50.1 48.1 Cost/Income ratio 55.6 60.0 61.1 Net int inc/Op inc Asset quality (%) -1.4 3.9 17.1 LLPs/Pre-prov inc na na na LLRs/Gross loans na na na Prob loans/Gr loans na na na Coverage ratio Capital adequacy (%) Tier 1 ratio 6.5 6.2 8.1 9.8 9.3 11.2 Total capital ratio 4.5 4.2 4.8 Equity/Assets ratio 2009* 20,765 7,825 2,770 33,269 16,959 16,310 24,641 -9,461 -10,442 1,794,687 1,290,667 6,670 510,537 504,424 741,241 341,372 89,974 -0.6 -11.8 51.0 62.4 151.1 na na na 10.4 13.5 5.0
Swedbank Hypotek (SPNTAB)

50% 41.2% 40% 30% 20% 2005 61.9% 59.8% 60.9% 55.7% 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 42.3% 70% 40.4% 39.5% 39.1% 60% 59.5% 50%
Loan portfolio by collateral structure, 2010

Residential mortgages 90.3%
Public 2.9% Commercial 0.1% Forest and Agriculture 6.7%
Geographical spread of collateral pool, 2010

Middle 32% South 24%
Note: * Figures with an asterisk were prepared according to IAS/IFRS
North 7% West 20% East 17%
SEK mn 600 400 200 0 2008 Mortgages Covered Bonds Over-collateralisation (x) 511 2.0 341 1.5x 1.5
472
1.7x 271
1.0 2009 Over-collateralisation
Efficiency
60% 1.1% 1.1% 1.1% 50% 46.7% 40% 2005 2006 2007 Cost/Income ratio 2008 2009 Cost/Assets ratio 1.0% 50.4% 50.1% 48.1% 0.9% 1.2 51.0% 1.1 1.0 0.9

1.5% 1.0% 0.5% 0.0% 0.0% 2005 2006 2007 2008 Credit costs 2009 RoA Net interest margin 1.3% 1.3% 1.3% 1.3% 0.6% 0.9% 0.8% 0.0% 0.2% 1.2% 1.4%
1.0%
10 June 2010
613
10 June 2010
614
PORTUGUESE ISSUER PROFILES
10 June 2010
615
Banco BPI (BPIPL)

Description
% Index
0.028
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
A1 Aaa Negative 3.6
S&P
AAAA* Negative -
Fitch
Banco BPI (BPIPL) is Portugals fourth-largest financial institution with total assets amounting to 47.5bn as at year-end 2009. BPIPL, which had more than 9,400 employees as per year-end 2009, focuses on providing retail and commercial banking, as well as asset management and insurance services, to c.1.6mn clients in Portugal and has steadily increased its presence in Angola and Mozambique. In Angola, BPIPL is market leader in commercial banking with a market share close to 25% through its 50.1%-stake in Banco de Fomento. BPIPLs history dates back to only 1981. In 1985, the lender was transformed into an investment bank which allowed it to attract sight and term deposits, grant short-term loans, participate in the interbank markets and engage in currency operations.
Risk weighting
As Portuguese covered bonds are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Profitability: Largely attributed to a sharp increase in its trading income which jumped to 215mn in 2009 from 21mn in 2008 (due to gains on equity instruments held for trading) and a moderate 16% y/y increase in its loan-loss provisions to 166mn in 2009 from 144mn in 2008, BPIPLs net income grew by 54% y/y to 274mn in 2009 from 178mn in 2008. Still, this is partly overshadowed by the fact that the net income is still markedly lower than in 2007 (372mn) and that BPIPLs net interest income has steadily declined to 136bp in 2009 from 162bp in 2008 and 174bp in 2007. Yet, net interest income only accounts for a relatively moderate 54% of BPIPLs net income. Asset quality: BPIPL benefited from an 11% market share in domestic lending in 2009. With regards to the composition of the c.30bn loan book, a relatively modest 39% is secured by mortgage loans. Overall, 51% of all lending was granted to individuals and small businesses with the remaining 42% consisting of lending to corporate and institutional banking and project finance. International activities accounted for 4% of the loan book. Despite the relatively modest share of mortgage lending, the overall ratio of non-performing loans (NPLs) stands at a low 1.8% as per year-end 2009, up from 1.2% in 2008 and 1.0% in 2007, but still markedly below the market average of c. 3%. Stakeholders: As per year-end 2009, the major stakeholder of BPIPL included Spanish savings bank La Caixa (30.1%), Brazilian Banco Ita (18.9%), Santoro (9.7%), and German insurer Allianz (8.8%). In total, institutional investors own 87.9% of the capital, thereby providing BPIPL with a relatively stable investor base.
Weaknesses
Deposit growth: Over 2009, BPIPLs customer deposits declined by nearly 12% y/y to 22.6bn from 25.6bn as per year-end 2008. This is largely attributed to a decline in term deposits as a result of the low interest rate environment. Consequently, the customer deposit to loan ratio fell to 75.5% in 2009 from 87.6% in 2008. At the same time, BPIPL tried to countersteer this development by increasingly relying on interbank funding with deposits related to the Portuguese central bank jumping to 2.5bn in 2009 from nil a year before. Also, resources attributed to other credit institutions more than doubled to 4.7bn in 2009 from 2.0bn a year before. The proportion of wholesale funding as a percentage of total funding increased to 30% in 2009 from 26% in 2008 and thus remains below the level of 33% witnessed in 2007. Geographical concentration: With only 10.6mn inhabitants, Portugal, ie, BPIPLs domestic market, is a relatively small economy, which, as of late, has come under pressure for its relatively high budget deficit of 9.2% of GDP in 2009 and 8.3% in 2010 (BarCap estimate). Pressure on sovereign debt market: Portugese government bonds suffered from rising pressure in European sovereign debt markets. The pressure on Portugese government bonds and the Portugese economy leads to a rather restrictive management of country exposure to Portugal by many investors and other counterparties. This limits the ability of Portugese banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations.
Note: At the time of writing, BPIPL had a total of three EUR-denominated benchmark covered bonds totaling 3bn outstanding within the scope of its 7bn covered bond programme.
Key points for 2010

With loan impairments being driven by BPIPLs lending to smaller and medium-sized enterprises (SMEs), the hitherto low NPL ratio needs to be monitored, particularly in light of the current economic environment in Portugal.
10 June 2010
616

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which CB Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 662 343 198 1,202 608 594 112 453 372 40,546 27,231 2008 676 306 21 1,002 645 357 144 220 178 43,003 29,275 10,532 25,634 7,185 1,962 0.4 9.2 64.4 67.5 40.2 1.2 2009 617 311 215 1,144 622 521 166 301 274 47,456 29,956 11,113 22,618 9,743 2,000 2,303 0.6 12.8 54.4 54.0 31.9
Banco BPI (BPIPL)

Efficiency
4 64.4 2 1.5 50.6 0 2007 2008 Cost/Avg assets 2009 Cost/Income 1.5 1.4 54.4 70 65 60 55 50

4 1.6 1.6 2 1.4 0.92 0.3 2007 Credit costs 0.3 0.43 2008 RoA 0.4 1 0.61 2
20,622 6,273 1,905 0.9 19.5 50.6 55.1 18.9 1.0
2009 NIM

75 32.7 26.4 50 75.7 87.6 30.1 75.5 40 30 20 10 25 2007 Cust deposits/loans 0 2008 2009 Wholesale funding/Tot. funding
1.8
4.7
8.8 11.3 4.6
8.6 11.0 4.9
10 June 2010
617
Banco Comercial Portugus (BCPPL)

Description
% Index
0.122
Leef H Dierks
Ratings table
Moodys
% Index
NA
Total assets
95.6bn
S&P
ANR Stable -
Fitch
A+ AAA Negative 14.9% -
A1 Aaa Negative 4.5%
With total assets of 95.6bn at year-end 2009, up 1.2% y/y from 94.4bn in 2008, Banco Comercial Portugus (BCPPL) is Portugals largest privately-owned commercial bank and second-largest banking group, benefiting from a market share of c.25% in customer lending. BCPPL provided universal banking services through five business units, ie, retail and commercial banking, capital markets services, insurance, asset management, leasing and factoring to 2.6mn clients through more than 10,000 employees in more than 900 branch offices in its domestic market, which accounted for 72% of net income in 2009. Its international operations (11,500 employees in 900 branch offices and c.2.5mn clients) include retail services in Poland, Greece, Mozambique, and Romania, among others. BCPPL was set up in 1985 as the first private-owned bank to be incorporated following the start of the deregulation and development of the Portuguese financial system. Currently, major shareholders include Spanish Banco Sabadell (BANSAB) and domestic Caixa Geral de Depositos (CXGD).
Risk weighting
Strengths
Funding profile: Spurred by a steady increase in customer deposits, which were up 3.1% y/y to 46.3bn in 2009, from 44.9bn in 2008, BCPPL has gradually reduced its reliance on wholesale funding in recent years with the respective ratio falling to 37% of all funding in 2009, from 53% in 2006. Customer deposits, in contrast, corresponded to 62% of all lending in 2009, up from 60% in 2008 and thus stands at its highest level since 2005. At the same time, BCPPLs debt funding declined by 2.7% y/y in 2009, from a strong 31% y/y in 2008. The lenders Tier 1 ratio further increased to 9.3% in 2009, from 7.1% in 2008. Market position: BCPPL benefits from a sound position in its domestic market where it had a market share of c.25% in gross customer lending and c.22% in deposit taking. In Poland, BCPPL enjoyed a 10% market share in mortgage lending.
Weaknesses
Non-performing loan ratio: Over the course of 2009, BCPPLs NPL ratio more than doubled to 2.6%, from 1.1% in 2008. Including doubtful loans, the respective ratio stands at 3.4% in 2009, up from 1.3% in 2008. Consequently, the coverage ratio fell to 106.1% in 2009, from 173.9% in 2008. Among the sectors most strongly affected from this development were consumer credits as well as loans to the construction and commerce sectors. This development, in our view, needs to be closely monitored, particularly given macroeconomic developments in Portugal where we expect GDP to increase by 1.2% y/y in 2010, after contracting by 2.7% in 2009. Also, as Portuguese mortgage loans are usually pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), need to be watched with regards to the further development of BCPPLs asset quality. Interest income: Following rate cuts on behalf of the ECB, BCPPLs net interest margin (NIM) and thus net interest income came under pressure in 2009. The 53bp drop in the NIM to 144bp in 2009, from 197bp in 2008, led to a 22.5% y/y decline in BCPPLs net interest income. Despite a marked increase in the lenders trading income, which recovered to 225mn in 2009, from 18mn in 2008 (overshadowed by impairment losses related to shareholdings in Banco BPI), operating income fell 4.8% y/y to 2.4bn. Geographical concentration: With only 10.6mn inhabitants, Portugal, ie, BCPPLs domestic market, is a relatively small economy. Risks associated to the limited size, however, are mitigated because of BCCPLs international presence. Still, in 2009, only 5% of BCPPLs net income was generated abroad.
Note: At the time of writing, BCPPL had a total of three EUR-denominated benchmark covered bonds totalling 3.5bn outstanding within the scope of its 10bn covered bond programme.
Key points for 2010

The sharp increase in BCPPLs NPL in 2009 and the associated drop in the coverage ratio need to be closely monitored in the quarters ahead.
10 June 2010
618

Financial summary
mn 2006 Income statement summary Net interest income 1,431 Net fees & com's 714 Trading income 395 Operating income 2,658 Operating expenses 1,614 Pre-provision income 1,044 Loan loss provisions 120 Pre-tax profit 994 Net income 839 Balance sheet summary Total assets 79,045 Customer loans 56,670 of which public sector na of which mortgages 23,115 Customer deposits 33,244 Debt funding 25,620 Of which Covered Bonds 1,000 Total equity 4,629 Profitability (%) Return on assets 1.1 Return on equity 18.2 Cost/Income ratio 60.7 Net int inc/Op inc 53.8 Asset quality (%) LLPS/Pre-prov inc 11.5 LLRS/Gross loans 2.1 Prob loans/Gr loans 0.9 Coverage ratio 249.4 Capital adequacy (%) Tier 1 ratio 6.6 Total capital ratio 11.0 Equity/Assets ratio 5.9 2007 1,537 665 392 2,692 1,634 1,058 260 688 619 88,166 65,650 715 25,503 39,247 29,724 2,500 4,618 0.7 13.4 60.7 57.1 24.6 1.8 0.8 220.2 5.5 9.6 5.2 2008 1,721 740 18 2,546 1,558 988 545 342 258 94,424 75,165 570 28,538 44,907 20,516 3,500 6,248 0.3 4.7 61.2 67.6 55.1 1.9 1.1 173.9 7.1 10.5 6.6 2009 1,334 732 225 2,424 1,436 988 560 296 249 95,550 75,191 667 29,069 46,307 19,953 4,500 7,221 0.3 3.7 59.2 55.0 56.7 2.8 2.6 106.1 9.3 11.5 7.6
Banco Comercial Portugus (BCPPL)

70% 65% 60% 65.0% 55% 2005 58.7% 59.8% 59.7% 61.6% 36.7% 2009 42.6% 53.2% 60% 49.4% 37.1% 40% 30% 50%
2006 2007 2008 Customer deposits to loans Wholesale funding % of total funding
Efficiency
80% 70% 60% 1.5% 50% 2005 2006 2007 Cost/Income ratio 2008 2009 Cost/Assets ratio 1.0% 2.3% 68.5% 2.1% 60.7% 2.0% 60.7% 1.8% 61.2% 59.2% 1.5% 2.5% 2.0%

2% 1.8% 1.1% 1% 0.1% 0% 2005 2006 2007 Net interest margin 0.2% 1.8% 1.1% 1.9% 0.8% 0.3% 0.3% 2008 Credit costs 2.0% 0.6% 1.4%
0.6% 0.3% 2009 RoA
Breakdown of mortgages by LTV, year-end 2009

60-70% 22.3% 70-80% 23.0% <30% 11.6% 40-50% 14.7% 30-40% 10.0%
50-60% 18.5%
10 June 2010
619
Banco Esprito Santo (BESPL)

Description
% Index
0.092
Leef H Dierks
Ratings table
Total assets
% Index
NA
Moodys
A1-* Aaa* Negative 4.6
S&P
AAAA* Negative -
Fitch
With total assets of 82bn at year-end 2009, up from 75bn in 2008) Banco Esprito Santo (BESPL), which is headquartered in Lisbon, is Portugals second-largest privately-owned bank, providing retail, corporate, and investment banking as well as asset management services in Portugal, Spain, Angola, and Brazil. Originally, BESPL was founded in 1920 and then re-established in 1976 after the nationalisation of credit institutions and insurance firms in Portugal in 1975. In 1991, BESPL was re-privatised. As per year-end 2009, BESPL had a workforce of more than 9,350 employees of which nearly 7,800 (83%) were located in Portugal where the lender operates through more than 700 branch offices. The lenders domestic operations accounted for 66% of the net profit in 2009 (2008: 64%), followed by Angola, which accounted for 17% (2008: 12%), and the UK (13%) (2008: 10%). Among the major stakeholders in BESPL is French Crdit Agricole which held a 10.8% stake as per year-end 2009, unchanged from a year before.
Note: *Watch Negative. As at 7 June 2010.
Risk weighting
Strengths
Market position: Over the past few years BESPL has seen its market share on the domestic market steadily grow from 8.5% in 1992 to 18% in 2005 and 21.2% in 2009. The lenders sound market position becomes particularly evident in business areas such as corporate lending (24.1%, albeit down from 25.6% in 2008) and pension funds (26.7%, up from 25.6% a year before). In areas such as trade financing, BESPL benefits from a market share of 26.3% (down from 27.3% in 2008), followed by asset management where the respective share stands at 20.1% (up from 18.9% in 2008). Asset quality: The volume of loans classified as overdue increased by 40% y/y to 894mn in 2009 from 637mn in 2008, mostly driven by a 65bp y/y increase in overdue loans to the corporate sector. Overall, however, BESPLs non-performing loan (NPL) ratio stood at a moderate 160bp as per year-end 2009, up 51bp y/y from 109bp in 2008. This is clearly below the industrys average of 310bp in 2009. So far, BESPLs mortgage lending in particular appears to benefit from a sound credit quality, with the respective NPL ratio standing at a low 73bp in 2009 after 64bp in 2008. Coverage stands at a comparatively high 192% with regard to the total loan book, spurred by a very high coverage of 258% when it comes to mortgage lending. Still, note that in light of the current economic situation in Portugal and potential ECB rate hikes (which we do not expect to occur before Q1 11, however), BESPLs NPL ratio could increase, particularly as 90% of all loans and advances to customers are subject to a variable interest rate. Income structure: In 2009, BESPLs net interest income accounted for a moderate 58% of the total operating income. Fee and commission income accounted for 33%, thereby at least partly shielding BESPL off the currently prevailing low interest rate environment. Still, despite the latter, BESPL could keep its net interest margin (NIM) stable at around 150bp over the course of the past four years. Capitalisation: BESPLs Tier 1 ratio improved to 8.3% in 2009, from 6.6% in 2008.
Weaknesses
Exposure to real estate sector: As at year-end 2009, 10.3% of BESPLs loan book referred to the real estate sector, slightly down from 10.7% in 2008. At the same time, another 10.2%, down from 11.9% in 2008, consisted of lending to the construction sector. In light of the current economic situation in Portugal, this combined 20% exposure to the housing and construction industry might leave its mark on the lenders asset quality. Still, risks are somewhat mitigated by the fact that international activities account for a relatively high 19% of all lending as per year-end 2009. Mortgage lending accounted for 22.5% of all lending, virtually unchanged from 22.9% in 2008. Loan-loss provisions: Driven by a 40% y/y increase in gross nonperforming loans to 894mn in 2009 from 637mn in 2008, BESPLs loan-loss provisions surged by 97% y/y to 540mn in 2009 from 274mn in 2008. Despite not (yet) being of material impact on BESPLs profitability, any further development needs to be carefully monitored. Funding structure: Over the course of the past four years, BESPLs reliance on customer deposits as a funding instrument has been steadily declining, to 52% in 2009 from 56% in 2008, and 63% in 2006. At the same time, the lenders reliance on wholesale funding has increased to 63% of all funding in 2009 from 57% in 2008, spurred by a 40% y/y increase in funding from the Eurosystem (which was covered by securities from the AfS portfolio pledged as collateral). Pressure on sovereign debt market: Portugese government bonds suffered from rising pressure in European sovereign debt markets. The pressure on Portugese government bonds and the Portugese economy leads to a rather restrictive management of country exposure to Portugal by many investors and other counterparties. This limits the ability of Portugese banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations.
Note: At the time of writing, BESPL had a total of three EUR-denominated benchmark covered bonds totalling 3.5bn outstanding within the scope of its 10bn covered bond programme.
Key points for 2010

Following the de-facto doubling of BESPLs loan-loss provisions in 2009, the latters impact on future profitability needs to be carefully assessed, particularly in light of the potentially rising ratio of non-performing loans. 10 June 2010 620

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding Of which Obrigacoes Hipote Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPS/Pre-prov inc LLRS/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 830 560 165 1,669 822 847 182 572 463 59,139 34,883 na 8,438 21,994 21,270 0 4,822 0.8 11.8 49.3 49.7 21.4 2.4 1.3 184.0 8.4 13.1 8.2 2007 954 612 232 1,821 881 940 213 788 635 68,355 42,170 na 10,075 23,775 26,408 0 5,414 1.0 12.4 48.4 52.4 22.7 2.3 1.2 195.1 7.4 11.4 7.9 2008 1,086 599 213 1,899 924 975 274 511 427 75,187 47,049 na 10,394 26,387 27,426 2,663 4,653 0.6 8.5 48.6 57.2 28.1 2.4 1.3 180.2 6.6 10.5 6.2 2009 1,201 680 189 2,070 968 1,102 540 685 575 82,297 48,979 na 10,726 25,446 35,740 3,649 6,939 0.7 9.9 46.8 58.0 49.0 3.1 1.8 173.7 8.3 11.3 8.4
Banco Esprito Santo (BESPL)

Efficiency
60% 1.6% 57.9% 50% 49.3% 40% 2005 2006 2007 Cost/Income ratio 48.4% 48.6% 46.8% 2.0% 1.5% 1.4% 1.3% 1.2% 1.0%
0.0% 2008 2009 Cost/Assets Ratio
Asset quality
Gross NPLS/Mortgages 2 1.5% 1.3% 169.9 1 184.0 Reserve Coverage Mortgages 1.8% 200 195.1 1.3% 1.2% 173.7 175 180.2 150 2005 2006 2007 Prob Loans/Gross Loans 2008 2009 Coverage Ratio

75% 50% 25% 0% 46.0% 2005 49.2% 57.1% 52.6% 67.3% 63.1% 56.4% 56.1% 52.0% 62.6% 70% 60% 50% 40% 2006 2007 2008 2009 Custumer deposits to loans Wholesale funding in % of total funding

2.0% 1.5% 1.0% 0.6% 0.4% 2005 2006 Net interest margin 1.5% 0.8% 0.3% 0.3% 0.0% 0.6% 0.4% 1.5% 1.0% 0.7% 0.7% 1.5% 1.5%
2007 2008 Credit costs
2009 RoA
10 June 2010
621
Banco Santander Totta (SANTAN)

Description
% Index
0.053
Leef H Dierks
Ratings table
Moodys
LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score Aa3 Aaa* Negative 4.1
% Index
0.196
Total assets
48.4bn
S&P
AAAAA Negative -
Fitch
With total assets of 48bn at year-end 2009, up from 45bn in 2008, Banco Santander Totta (SANTAN), which is an almost fullyowned (99%) subsidiary of Spanish Banco Santander, is the thirdlargest privately-owned bank in Spain. The lender provides retail and commercial banking as well as asset management and insurance services through more than 6,200 employees in more than 760 branch offices across Portugal where it benefits from a market share of 9.5% in customer lending and of 8.8% in deposit taking. In mortgage lending, Santander Totta benefits from a sound 12.8% market share. Originally, the bank was founded in December 2004 as the result of a merger between Banco Totta & Aores, Crdito Predial Portugus and Banco Santander Portugal.
Risk weighting
As Portuguese Obrigaes Hipotecarias are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Asset quality: As per Q1 10, the latest date for which data were available, Santander Totta featured a non-performing loan (NPL) ratio of 2.3%, up from 1.9% a year before. This is lower than the industrys average of 3.1%. At the same time, the coverage ratio had dropped to 64%, down from 71% in Q1 09. In response to this increase, net loan-loss provisions surged by 606% y/y to (a still moderate) 91mn in 2009 from 13mn in 2008. In light of the current economic situation in Portugal and potential ECB rate hikes (which we do not expect to occur before Q1 11, however), Santander Tottas NPL ratio could further increase, particularly with mortgage loans accounting for 48% of all lending as per end Q1 10. Ownership structure: Santander Totta benefits from being almost fully-owned (99%) by Spanish Banco Santander (SANTAN). SANTAN is portrayed individually within the scope of this publication. Capitalisation: As per year-end 2009, Santander Totta benefited from a relatively sound capitalisation with its Tier 1 ratio standing at 11.0%. The core capital ratio stood at 9.2%. Also, despite a 2.7% y/y GDP contraction in Portugal in 2008, Santander Totta could maintain its profitability with the net interest income increasing by 1.1% y/y to 235mn in 2009 from 518mn in 2008.
Weaknesses
Market exposure: Santander Tottas lending to domestic corporates, which was fuelled by a 9% y/y growth in lending to small businesses accounted for an aggregate 40% as per yearend 2009. At the same time, lending to large corporates plummeted by 21% y/y to 3.8bn, thereby further exposing Santander Totta towards lending to Portuguese individuals and smaller to medium-sized individuals. Consumer lending increased by 7.6% to 1.6bn as per year-end 2009. Funding structure: Largely attributed to the currently prevailing low interest rate environment, Santander Tottas customer deposits contracted by 3.6% y/y to 14.9bn as per year-end 2009. As customer lending fell by a more moderate 0.8% y/y to 34.4bn at the same time, Santander Tottas overall reliance on customer deposits as a funding instrument nonetheless remained stable at a relatively low 43% of all funding in 2009 after 42% in 2008. Attributed to transfers from off-balancesheet investment funds, Santander Tottas customer deposits had increased by a very strong 31% y/y in 2008. Pressure on sovereign debt market: Portugese government bonds suffered from rising pressure in European sovereign debt markets. The pressure on Portugese government bonds and the Portugese economy leads to a rather restrictive management of country exposure to Portugal by many investors and other counterparties. This limits the ability of Portugese banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations.
Note: At the time of writing, Banco Santander Totta had a total of three EURdenominated benchmark covered bonds totalling 3bn outstanding within the scope of its 5bn covered bond programme.
Key points for 2010

Santander Tottas net loan-loss provision surged by 606% y/y to (a still comparatively moderate) 91mn in 2009 from 13mn in 2008. The further development of this number needs to be carefully monitored, particularly in light of a potentially further growing NPL ratio.
10 June 2010
622

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which OH Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset Quality (%) LLPs/Pre-prov income LLRs/Gross loans Problem loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2008 750 353 54 1,214 536 678 13 640 531 44,929 32,594 na 15,976 15,497 8,970 1,000 1,648 1.2 31.5 44.2 61.8 1.9 1.7 77 10.1 3.7 2009 793 340 51 1,269 544 725 91 643 531 48,430 32,294 na 16,236 14,946 11,931 2,000 1,762 1.1 31.0 42.9 62.5 12.6 2.3 65 11.2 3.6
Banco Santander Totta (SANTAN)

Geographical spread (collateral pool)
Ilhas 2% Centro 15% Algavre 6% Alentejo 2% Other 9% Lisboa e Vale do Tejo 37%
Norte 29%
Efficiency
50% 45% 40% 35% 30% 2008 Cost/Income ratio 2009 Cost/Assets ratio 0.8% 1.19% 44.2% 1.17% 42.9% 1.0% 1.2%

50% 44.4% 45% 36.7% 48% 60% 50% 40% 46% 30% 2008 2009 Customer deposits to loans Wholesale funding in % of total funding
40%

2% 1.7% 1.1% 0.2% 0% 2008 Net interest margin 2009 Credit costs RoA 1.7% 1.1% 0.2%
10 June 2010
623
Caixa Econmica Montepio Geral (MONTPI)

Description
% Index 0.014 % Index NA Total assets 17.3bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table
Moodys Baa1 Aa1 Negative S&P NR NR NR Fitch AAAA Stable 14.9 -
With total assets of 17bn at year-end 2009, Caixa Econmica Montepio Geral (MONTPI) is Portugals sixth-largest financial institution. The savings bank provides retail banking and insurance, as well as real-estate and asset management services to 1.2mn clients. Originally, MONTPI was founded in 1844 and until 1991 specialised in mortgage financing. MONTPI is fully owned by Montepio Geral Associao Mutualista (MGAM), a private mutual not-for-profit association whose goal is to promote the mutual idea among its clients which the lender tries to make member of the mutual association (more than 420,000 members at the time of writing). As per year-end 2008, MONTPI had a market share of c.5.6% in customer lending and 4.9% in deposit taking.
Risk weighting
Strengths
Funding situation: In 2009, MONTPIs managed to increase its reliance on customer deposits as a funding source. Whereas customer deposits accounted for a rather modest 54% of all funding as at year-end 2008, this ratio increased to 61% as at year-end 2009, while reducing the reliance on wholesale funding. As per year-end 2009, wholesale funding accounted for 41% of all funding, down from 46% as per year-end 2008. Capitalisation: In 2009 MONTPIs Tier 1 ratio improved to 9.5%, from 8.3% in 2008.
Weaknesses
Market exposure: Attributed to its historical roots, MONTPI benefits from a sound market position with regards to mortgage lending, which amounted to 9.3% as per year-end 2008, the latest date for which data were available. With regards to mortgage lending to the construction sector, however, the market share stands at 12.0% clearly above that of mortgage lending to households, which was 8.7% at the same time. In 2008, lending to the construction sector and for housing purposes accounted for a combined 24.3% of all new lending. In light of the currently less benign economic environment in MONTPIs domestic market, this exposure needs to be carefully monitored as the ratio of non-performing loans (NPL) could increase in a stronger-than-expected economic downturn. Whereas a high 21% of the mortgage loan book was related to construction sector in Q1 09, 73% referred to mortgage loans secured by first homes. Non-performing loans: Over the past few quarters, MONTPIs NPL ratio has steadily increased to 3.3% of all loans in Q1 09 from 2.2% in Q4 10. This development was spurred by the NPL ratio attributed to corporate construction, which surged to 4.8% in Q1 09 from 3.2% in Q4 07. Still, this weakness is somewhat mitigated by a relatively sound coverage ratio of 105% as per Q1 09, slightly down from 110% in 2008. Geographical concentration: With only 10.6mn inhabitants, Portugal (ie, MONTPIs domestic market) is a relatively small economy. Whereas the countrys GDP contracted 2.7% y/y, our growth forecast stands at a modest 1.2% y/y in 2010 and 1.4% y/y in 2011. Pressure on sovereign debt market: Portugese government bonds suffered from rising pressure in European sovereign debt markets. The pressure on Portugese government bonds and the Portugese economy leads to a rather restrictive management of country exposure to Portugal by many investors and other counterparties. This limits the ability of Portugese banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations.
Note: At the time of writing, MONTPI had one EUR-denominated benchmark covered bonds with a nominal amount of 1bn outstanding within the scope of its 5bn covered bond programme.
Key points for 2010

The steady increase in MONTPIs NPL in recent quarters needs to be carefully monitored, particularly in light of the sharp increase in NPLS related to the corporate construction sector.
10 June 2010
624

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which CB Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2008 315 71 4 410 237 173 98 34 16,852 15,329 57 9,569 8,330 5,448 824 0.2 4.1 57.8 76.8 56.6 0.0 2.5 2009 321 75 2 418 227 192 148 44 17,245 15,142 50 10,104 9,181 5,296 1,000 986 0.3 4.9 54.2 76.7 77.1 0.0 3.3
Caixa Econmica Montepio Geral (MONTPI)

Efficiency
4 57.8 54.2 2 1.4 1.3 0 2008 Cost/Avg assets 2009 Cost/Income 50 55 60

2 1.9 1.9 0.9 1 0.6 0.20 2008 Credit costs RoA 0.26 1 2009 NIM 2

75 45.8 41.2 50
8.3 11.8 4.9
9.5 13.3 5.7
50 54.3 25 2008 Cust deposits/loans 60.6
40
30 Wholesale funding/Tot. funding
10 June 2010
625
Caixa Geral de Depsitos (CXGD)

Description
Leef H Dierks
Ratings table
Moodys Aa2 Aaa Negative 3.7/5.8 S&P A+ AAA Negative Fitch A+ AAA Negative 15.3/32.0 -
With total assets of 121bn as at year-end 2009, up 9% y/y from 111bn a year before, Caixa Geral de Depsitos (CXGD) is Portugals largest bank with an overall market share of around 30%. CXGD provides retail and commercial banking, capital markets services, insurance, asset management, leasing and factoring to more than 5mn clients. Domestic operations accounted for roughly 80% of CXGDs 2009 income. CXGD was established in 1876 to encourage savings and to manage public debt. It remains wholly (100%) owned by the Portuguese government. Despite operations being geographically concentrated in Portugal, CXGD, which had more than 20,000 employees as at year-end 2009, also operated in Spain (Banco Caixa Geral), Macau (Banco Ultramarino), Mozambique (BCI Fomento) and South Africa (Mercantile Bank). In 2009, CXGD further increased its international reach to Brazil and Angola.
Note: * in %. Mortgage/public sector. As at 7 June 2010.
Risk weighting
Strengths
Funding structure: As at year-end 2009, deposits accounted for a high 75% of CXGDs total lending, thereby reducing the lenders potential capital markets exposure. With customer deposits up 4.2% y/y to 57.8bn in 2009, wholesale funding as a percentage of all funding accounted for a relatively moderate 35%. Over the course of 2009, there was a 21.8% y/y increase (4.5bn) in the balance of resources taken from institutional investors in the form of own issues. The balances on debt issued under CXGDs EMTN programme and covered bonds were up 54.3% y/y (10.5bn) and 6.1bn (2.8% y/y), respectively. In 2009, CXGD made 71 private placements totalling 2.9bn. Under the scope of the same programme, a subordinated debt issue of 539mn was also placed. Potential support measures: As Portugals largest financial entity (wholly owned by the Portuguese state) and therefore of systemic importance for the countrys economy, we consider CXGD to be highly likely to benefit from governmental support in the case of distress.
Weaknesses
Profitability: In 2009, CXGDs net income fell for the third consecutive year, down 39.2% y/y to 279mn, from 459mn in 2008 and 856mn in 2007. This was mostly due to a 25.4% y/y contraction in net interest income, which fell to 1.6bn in 2009, from 2.2bn in 2008, mostly as a result of lower interest rates which caused CXGDs net interest margin to fall to 152bp in 2009, from 222bp in 2008. This, in our view, is particularly critical as in 2009, mortgage lending and medium- to long-term corporate lending, accounted for an aggregate 76% of all domestic lending. Also, the sharp increase in non-performing loans (NPL) left its mark on CXGDs profitability in 2009. The cost-to-income ratio stood at a rather high 69.3% in 2009. Asset quality: CXGDs NPL ratio stood at 3.0% at year-end 2009, up from 2.3% in 2008 and 2.0% in 2007. The accumulated impairments on loans and advances to customers stood at 2.4bn as at year-end 2009. The coverage ratio fell to 100% in 2009, from 118% in 2008 and 121% in 2007. Despite the moderation in NPL growth in recent quarters, further developments need to be carefully watched, particularly in light of macroeconomic developments in Portugal, where we expect GDP to increase by 1.2% y/y in 2010, after contracting by 2.7% in 2009. Also, as all mortgage loans are usually pegged to the 12m Euribor, potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11), need to be monitored with regard to the further development of CXGDs asset quality. In this context, note that gross loans and advances to customers were up 2.2bn as at year-end 2009 to 79.6bn from a year before. With regards to domestic operations, CXGDs corporate lending was up 4.4% y/y (or 933mn). Domestic mortgage lending increased by 4.2% y/y (or 1.3bn). Pressure on sovereign debt market: Portugese government bonds suffered from rising pressure in European sovereign debt markets. The pressure on Portugese government bonds and the Portugese economy leads to a rather restrictive management of country exposure to Portugal by many investors and other counterparties. This limits the ability of Portugese banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations.
Note: At the time of writing, CXGD had a total of four benchmark covered bonds outstanding with an aggregate amount of 8.25bn. Thereof, 1bn corresponded to a public sector covered bond.
Key points for 2010

Despite being of subordinated relevance for the quality of the collateral pool, CXGDs profitability, which has meanwhile declined for the third consecutive year, needs to be carefully monitored.
10 June 2010
626

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding Of which Covered Bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPS/Pre-prov inc LLRS/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 1,715 364 114 2,324 1,547 776 219 987 734 96,252 57,282 3,413 31,002 53,771 15,286 2,000 4,313 0.8 18.0 66.6 73.8 28.2 2.5 2.2 112.0 7.1 10.6 4.5 2007 2,032 395 84 2,600 1,593 1,007 269 1,075 856 2008 2,201 419 247 3,046 1,680 1,366 448 662 459 2009 1,641 448 199 2,508 1,738 770 417 375 279 120,985 77,222 33,504 57,795 25,173 6,088 7,157 0.3 5.0 69.3 65.4 54.2 3.0 3.0 100.7 8.5 12.6 5.9
Caixa Geral de Depsitos (CXGD)

Efficiency
90% 1.2% 70% 50% 45.0% 30% 2002 2003 2004 2005 2006 2007 2008 2009 Cost/Income ratio Cost/Assets ratio 51.7% 1.2% 74.7%71.7% 66.6% 69.3% 1% 61.3% 55.1% 0% 1.8% 1.8% 1.8% 1.7% 1.7% 1.6% 2%
103,554 111,060 67,907 75,311 2,545 3,006 32,872 32,166 54,039 55,484 18,898 23,074 5,391 5,922 5,541 5,484 0.9 18.6 61.3 78.2 26.7 2.5 2.0 121.3 6.7 10.1 5.4 0.5 9.5 55.1 72.3 32.8 2.7 2.3 117.5 7.0 10.7 4.9

35.1%35.4% 40% 110% 22.9%36.8%31.3% 24.2% 22.1% 25.9% 90% 20% 70% 103% 103% 102% 100% 94% 80% 74% 75% 50% 0% 2002 2003 2004 2005 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding
bn 40 31.0 15.0x 32.9 32.2 33.5 15 10 20 2.0 0 2006 Mortgages 2007 Cedulas 2008 2009 6.1x 5.4 5.3x 6.1 5.5x 5 6.1 0 Over-collateralisation (x)
627
Asset quality
4% 111.7 112.0 105.2 101.4 107.3 101.5 3.0 3.1 121.3 117.5 150 100.7 100 2% 2.7 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Gross NPLs/loans Coverage ratio (rhs) 2.4 2.7 2.2 2.0 2.3 3.0 50 0
NIM and credit costs

3% 2.0% 2% 1% 0% 2002 2003 2004 2005 2006 2007 2008 2009 Net interest margin Credit costs RoA 1.7% 1.9% 1.7% 2.0% 2.1% 2.2% 1.5% 0.9% 0.5% 0.3% 0.4%
1.0% 0.8% 0.4% 0.2%
0.2% 0.3%
0.7% 0.8%
0.3% 0.3% 0.3%
10 June 2010
10 June 2010
628
ITALIAN ISSUER PROFILES
10 June 2010
629
Banca Carige (BANCAR)

Description
Leef H Dierks
Ratings table
Moodys A2 Aaa Stable 6.7 S&P ANR Negative Fitch A AAA Negative 13.7 -
With total assets of 36bn as per year-end 2009, Banca Carige (BANCAR) ranks among the 10 largest Italian banks with operations concentrated in the northern part of Italy, particularly Liguria, where more than 250 (39%) of its 640 banking branches were located. Banca Carige is strongly geared towards retail banking with lending to small and medium sized corporates (SME) accounting for a high 78% of all lending in 2009. In addition to parent company Banca Carige, the banking group comprises Cassa di Risparmio di Savona, Cassa di Risparmio di Carrara, Banca del Monte di Lucca, and Banca Cesare Ponti.
Risk weighting
As Italian Obbligazioni Bancarie Garantite (covered bonds) are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach, but may qualify for lower risk weightings in the IRB Approach.
Strengths
Funding profile: As at year-end 2009, customer deposits accounted for a relatively sound 66% of customer lending (2008: 57%), thereby only modestly exposing BANCAR to the wholesale funding market for its refinancing purposes with the latter corresponding to 43% of all funding in 2009, down from 48.5% in 2008. Collateral pool: The collateral pool backing the 1bn covered bond hitherto issued by BANCAR refers to residential and commercial mortgage loans. Commercial mortgage loans account for a negligible 5% (100mn) of the 2.2bn cover pool, however. As at January 2010, the latest date for which data were available, the programmes over-collateralisation amounted to a comfortable 229%, with the weighted average LTV standing at a rather low 48.2%. A high 45% of all mortgage loans were secured on property located in Liguria, followed by Lombardy (14%), and Piedmont (10%). Generally, the collateral pool is strongly biased towards the north of Italy, where 79.4% of the cover assets are located.
Weaknesses
Profitability: Over the course of the past year, BANCARs profitability has come under pressure with the net income falling 1.8% y/y to 209mn in 2009, from 213mn in 2008. Despite this move being negligible, the net interest income has fallen a strong 10.3% y/y to 727mn, from 811mn in 2008, largely as a result of the low interest rate environment. The recovery of BANCARs trading income, which was up to 15mn in 2009 after recording a 63mn loss in 2008, compensated for this development which nonetheless needs to be monitored in the quarters ahead, particularly as the net interest margin (NIM) fell 40bp to 213bp in 2009, from 253bp in 2008. Non-performing loans: The proportion of BANCARs net nonperforming loans (NPL) increased to 3.3% at end H1 09, the latest date for which data were available. This corresponds to a 30bp increase since end-2008. The gross NPL ratio stood at 3.3%, up from 2.9%. Despite these numbers being fairly moderate, the gross impaired loan ratio had climbed to 6.9% from 6.0%. Coverage of the NPLs stood at 49.1% at end-June 2009. Write-offs arising from the relatively high ratio of impaired loans could eventually affect BANCARs profitability. Commercial mortgage lending: At end-June 2009, the latest date for which data were available, BANCARs stock of commercial mortgage loans amounted to 3.3bn. This compares with 6.4bn of residential mortgage lending at the same time, thereby illustrating the lenders exposure to the domestic SME sector, which could be affected above average in the case of an economic downturn. This risk is somewhat mitigated by relatively strict underwriting rules.
Note: At the time of writing, BANCAR had one EUR-denominated benchmark covered bond outstanding with an aggregate amount of 1bn within the scope of its 5bn covered bond programme.
Key points for 2010

The further development of BANCARs relatively high impaired loan ratio needs to be monitored, particularly as a further increase of potential write-downs could leave its mark on the lenders profitability.
10 June 2010
630

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans Customer deposits Debt funding of which covered bonds Total equity Profitability (%) Net int. Margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2008 811 253 -63 1,016 623 393 309 213 31,986 20,916 12,005 9,579 3,576 2.5 0.7 6.0 63.0 40.6 2009 727 279 15 1,034 654 380 313 209 36,299 22,786 15,062 10,020 1,000 3,853 2.0 0.6 5.6 58.1 42.6
Banca Carige (BANCAR)

Collateral regional distribution, 2010
South 11% North 79% Centre 10%
Efficiency
70% 63.0% 60% 1.95% 58.1% 50% 2008 Cost/Income ratio (LHS) 1% 2009 Cost/Assets ratio (RHS) 1.92% 2% 3%

3.3 3.3 49.1 7.9 10.0 10.6
3% 2%
2.53 2.00
7.9 10.6 11.2
1% 0.67 0% 2008 Net interest margin 2009 RoA 0.61

68% 64% 60% 56% 52% 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 46% 57% 41% 40% 45% 66% 50%
10 June 2010
631
Banco Popolare (BPIM)

Description
Leef H Dierks
Ratings table
Moodys A2 Aaa Stable S&P ANR Negative Fitch AAAA Negative 17.0 -
With total assets of c.136bn at year-end 2009, Banco Popolare (BPIM) is the fourth-largest Italian financial institution and the countrys largest co-operative bank. BPIM was not established until 2007, when Banca Popolare di Verona e Novarra merged with Banca Popolare Italiana. Owing to its historical roots, BPIM benefits from a sound market share of c.10% in the economically strong northern Italy, where more than two-thirds of the nearly 2,300 branches were located in 2009. BPIMs core business model is focused on providing universal banking services through more than 20,000 employees to its retail and SME clients with the respective revenues accounting for a high 86% of all 2009 revenues. The remaining 14% refers to Private and Investment Banking.
Risk weighting
Strengths
Market presence: BPIM benefits from a relatively strong position in northern Italy where its market share amounted to c.10%, making it the regions third-largest player. Regional market shares range from 14.1% in Liguria to 10.7% in Tuscany and to 8.9% in Veneto and Piedmont. Overall, the economically more resilient northern parts of Italy (including Tuscany) accounted for more than 80% of BPIMs branch network in 2009. On a national level, BPIMs market share in deposit taking stood at 5.2%, i.e. largely on the same level as in the case of lending (5.0%). Cover pool assets: Cover pool assets backing the 1bn covered bond hitherto issued by BPIM exclusively refer to residential mortgage loans, of which a high 64% were located in northern Italy. More precisely, 24% were located in Lombardy, followed by Tuscany (16%), Emilia Romagna (12%), and Veneto (11%). The weighted average current LTV stood at a comparatively low 49%, with 64% of all mortgage loans being subject to a variable interest rate. As at January 2010, the latest date for which data were available, the programmes over-collateralisation stood at a high 143%.
Weaknesses
Impaired loans: Net non-performing loans of BPIM sharply increased by 32% y/y, standing at 1.3bn in 2009, from 990mn in 2008. As past due loans increased by another 28%% y/y to 539mn in 2009, from 420mn in 2008, overall net impaired loans were up 27% y/y to 4.9bn. Gross impaired loans increased by 19% y/y to 7.1bn. As at Q3 09, the latest date for which data were available, the respective coverage ratio stood at 71%, slightly down from 73% at year-end 2008. At year-end 2009, the gross non-performing loan (NPL) ratio stood at 344bp (up from 252bp a year before) with the net NPL ratio amounting to 173bp (up from 122bp a year before). At the same time, loans placed on the so-called watch list climbed to 4.5% of all lending in 2009, from 3.9% in 2008. Despite growing at a pace of 9.7% y/y in 2009, mortgage lending 30.5bn) accounted for only 32% of BPIMs lending at year-end 2009. Net interest income: Largely as a result of the low interest rate environment, which saw the lenders net interest margin (NIM) sharply decreasing to 153bp in 2009, from 186bp in 2008, BPIMs net interest income fell by nearly 13% y/y to 1.97bn in 2009, from 2.26bn in 2010. As trading losses were reduced to 70mn in 2009, from more than 500mn a year before, however, BPIMs operating income increased by 7.2%. Despite the latter being a rather favourable development, the lenders further profitability needs to be carefully monitored. Higher interest rates might prove to be beneficial as a 100bp shift of the yield curve translates into a 7.7% y/y increase in BPIMs net interest income (or 150mn). Note that the 2009 results are partly overshadowed by the restructuring of Banca Italease.
Note: At the time of writing, BPIM had one EUR-denominated benchmark covered bond outstanding with an aggregate amount of 1bn within the scope of its 5bn covered bond programme.
Key points for 2010

In light of the marked increase in its NPL ratio in 2009, the further development of BPIMs asset quality needs to be carefully monitored, particularly as rising loan-loss provisions could affect the lenders profitability. 10 June 2010 632

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans Customer deposits Debt funding of which covered bonds Total equity Profitability (%) Net int. Margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 2008 2,255 1,261 523 3,441 2,702 740 557 302 121,327 81,097 51,352 24,253 10,188 186.0 0.0 -3.0 27.4 46.7 2009 1,969 1,228 69 3,688 2,605 1,083 493 258 135,709 95,350 53,192 25,228 12,112 153.0 0.0 2.1 41.6 47.1
Banca Popolare (BPIM)

Efficiency
50% 41.6% 40% 30% 20% 2008 Cost/Income ratio (LHS) 2.23% 27.4% 2.03% 2% 3%
1% 2009 Cost/Assets ratio (RHS)

2% 1.86% 1% 0% -0.25 -1% 2008 Net interest margin 2009 RoA 0.20 1.53%
Collateral pool regional distribution, Q1 10

Other 18% Lombardy 24% Lazio 10%
6.4 10.6 8.4
7.7 10.8 8.9
Liguria 9% Veneto 11% EmiliaRomagna 12%
Toscana 16%

64% 60% 56% 53% 52% 52% 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 50% 56.% 63.% 60%
10 June 2010
633
Banca Popolare di Milano (PMIIM)

Description
Leef H Dierks
Ratings table
Moodys A1 Aaa Stable 7.5% S&P ANR Negative Fitch A AAA Negative 16.5% -
With total assets of 44bn at year-end 2009, Banca Popolare di Milano (PMIIM) is Italys eighth-largest bank, with business operations focusing on the north-western part of the country, and benefiting from market shares of around 20% in Alessandria and 13% in Milan, Lecco and Varese, respectively. In Lombardy, the average market share amounted to 7.2%. PMIIM is a listed Italian co-operative bank (fourth largest co-operative bank in terms of total assets) that was established in Milan in 1865 and operates in retail, corporate, and investment banking, as well as wealth management services serving c.1.3mn retail and SME clients, as well as 3,000 larger corporate clients through more than 700 branch offices. PMIIM was the first Italian entity to issue an Obbligazioni Bancarie Garantite within the scope of the Italian dedicated covered bond legislation.
Risk weighting
Strengths
Funding structure: Over the course of 2009, PMIIMs funding profile showed signs of a marked improvement with customer deposits accounting for 68% of all lending, ie, strongly up from 59% in 2008. Despite this favourable development, the current ratio level still trails that observed in the years before, when it stood at 73% in 2007 and 79% in 2006. The reliance on wholesale funding further decreased, albeit at a moderate pace, to 53% of all funding in 2009, from 56% in 2008 and 61% in 2007. Market presence: Attributed to its historical roots, PMIIM benefits from a comparatively strong position in northern Italy with a sound 7.2% market share in Lombardy (which accounted for c.21% of the Italian GDP in 2009) where 62% of its branch offices were located in 2009. In Lombardy, PMIIM appears to be well anchored among the local smaller-tomedium-sized corporates (SME), with the respective commercial banking operations accounting for approximately two-thirds of the lenders income in 2009. Wealth management and investment banking accounted for a modest 12% each. Collateral pool: The collateral pool backing the covered bonds hitherto issued by PMIIM exclusively refer to residential mortgage loans, of which a high 64% were located in Lombardy, ie, in one of Italys economically strongest regions. Another 9% of the cover assets were located in the region of Lazio. In terms of borrowers, 75% were from Lombardy. The weighted-average current LTV stood at a modest 53%. With regards to the interest type, only 17% were fixed rate mortgage loans, compared to 27% with a floating rate. The biggest proportion (56%) referred to mixed rate mortgages, of which 60% were fixed and 40% were variable. The programmes overcollateralisation stood at a sound 115% at year-end 2009.
Weaknesses
Non-performing loans: Over the course of 2009, PMIIMs nonperforming loan (NPL) ratio nearly doubled to 1.1%, up from 0.6% at year-end 2008. Despite this level still being on very moderate levels, the pace of the increase needs to be carefully monitored as higher loan-loss provisions might leave their mark on PMIIMs profitability in the medium term. What is more, loans put on PMIIMs so-called watch list amounted to 3.1% of all lending in Q2 09, thereby taking the overall amount of net doubtful loans to 4.8% of all lending. Net interest income: Over the course of the past year, PMIIMs net interest income fell 17% to 885mn, from 1.1bn a year before. At the same time, owing to the current low interest rate environment, the lenders net interest margin (NIM) recorded a decline to 198bp in 2009, from 241bp in 2008. Despite this being more than offset by a marked recovery in PMIIMs trading income, which climbed to 294mn in 2009, from a 31mn loss in 2008, the further impact of a declining interest income which nonetheless only accounted for a moderate 48% of the operating income in 2009, down from 68% in 2008 on PMIIMs profitability needs to be monitored.
Note: At the time of writing, PMIIM had a total of two EUR-denominated benchmark covered bonds outstanding with an aggregate amount of 2bn within the scope of its 10bn covered bond programme.
Key points for 2010

The development of PMIIMs NPL ratio needs to be carefully monitored, particularly in the case of potential ECB rate hikes which, however, we do not expect before Q1 11.
10 June 2010
634

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans Customer deposits Debt funding of which covered bonds Total equity Profitability (%) Net int. Margin Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 1,028 586 -91 1,702 1,065 637 124 556 335 43,627 29,767 21,616 8,065 0 1,660 2.5 0.8 23.1 62.6 60.4 19.5 2008 1,067 518 -31 1,564 1,008 556 35 213 75 45,039 32,899 19,375 13,153 1,000 1,660 2.4 0.2 4.5 64.4 68.2 6.2 na 0.6 65.5 7.6 11.9 3.7 2009 885 647 294 1,861 1,177 684 17 217 104 44,281 32,852 22,162 12,012 2,000 1,660 2.0 0.2 6.2 63.2 47.5 2.5 na 1.1 54.9 8.7 12.8 3.7
Banca Popolare di Milano (PMIIM)

100% 80% 60% 40% 20% 0% 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 65% 61% 79.% 70% 73.% 59.% 56% 67.% 60% 53% 50%
Efficiency
66% 64% 62.2% 62% 60% 2006 2007 Cost/Income ratio (LHS) 62.6% 2.27% 63.2% 1% 2008 2009 Cost/Assets ratio (RHS) 2% 2.57% 2.54% 2.64% 3%
64.4%

3% 2% 2.28% 2.45% 2.41% 1.98%
7.2 9.4 3.8
1% 0%
0.31%
0.30%
0.08% 2008
0.04% 2009 Credit costs
Collateral pool regional distribution, YE 09

Other 19% Puglia 3% EmiliaRomagna 5% Lazio 9%
Lombardy 64%
10 June 2010
635
Cassa Depositi E Prestiti (CDEP)

Description
% Index 0.074 % Index NA Total assets 227bn LT senior unsecured Covered bond rating Outlook
Leef H Dierks
Ratings table
Moodys Aa2 Aaa Stable S&P A+ AAA Stable Fitch AAAAA Stable
The purpose of Cassa Depositi e Prestiti (CDEP) is to deploy financial resources for public investments, infrastructure projects for the delivery of public services, large-scale public works of national interest and other public-interest projects. CDEP was originally founded in Turin in 1850 to receive deposits from private and public entities. In 1863, a new institution whose task was to grant loans to Italian local governments for financing infrastructure projects and offering borrowers financial assistance for debt restructuring was established in Rome. In 2003, legal adjustments (ie,, Article 5 of Law Decree 239/2003) transformed CDEP from a public administration entity to a joint stock company. Whereas before the transformation, CDEP was wholly owned by the Republic of Italy, its share capital is now 70% owned by the Italian state, with the remaining 30% being held by 66 Italian banking foundations. Note that by law, CDEP must remain majority owned by the Italian state.
Risk weighting
Covered bonds issued by CDEP carry a 20% risk weighting by the Bank of Italy.
Strengths
Business model: Domestic public-sector lending is CDEPs core business where it benefits from a dominant market position, with a market share of 41% in the case of lending to public entities. By 2011, CDEP plans to increase this share to 44%. Overall, as at yearend 2009, lending to local and regional governments accounted for 69.9% (111bn) of all lending, up from 66.8% (107bn) a year before. Total lending amounted to 164bn at year-end 2009. Lending to the central government stood at 53bn and thus slightly below the 56bn recorded in 2008. More market-oriented infrastructure lending activities represents only a minor percentage of CDEPs entire lending operations. Federal guarantee: The Republic of Italy explicitly guarantees the borrowing CDEP requires (ie, the traditional postal savings and CDEPs 20bn covered bond programme, among others) to refund its GS business activities. Asset quality: As a result of its lending profile, CDEPs net loan-loss provisions amounted to a low 1.2mn in 2009, sharply down from 23.9mn in 2008. Governmental support: With the Italian state closely involved in CDEP as a result of holding a 70% stake of CDEPs share capital, supervising CDEPs public-interest activities and its explicit and unconditional guarantee on postal savings products, rating agencies expect support from the Italian state to be highly likely in case of distress. Also, given the close links between the Republic of Italy and CDEP, rating agencies have assigned the same ratings to CDEP and the Republic of Italy (Aa2/A+/AA-). In this context, it is also worth noting that the Republic of Italy is legally required to maintain the majority ownership of CDEP (it currently holds 70% of the share capital). Minority shareholders that currently hold a 30% stake in CDEPs share capital can only be banking foundations, banks and other supervised financial intermediaries. None of these entities can own more than 5% of CDEP's share capital.
Weaknesses
Market liquidity: In light of the relatively modest volume of covered bonds outstanding (6bn) and the fact that no new covered bond had been issued since September 2006 (instead, a 2bn issue matured in 2009), liquidity in the hitherto issued covered bonds is becoming increasingly low. Portfolio exposure: Given the nature of its business model, CDEPs loan portfolio is limited to domestic entities with no diversification to jurisdictions outside Italy. With the high level of decentralisation in Italy, with the responsibility for public-sector finances being steadily transferred to local and regional administrations from the central government, we expect the structure of CDEPs lending to remain geared towards the countrys municipalities, thereby exposing the lender to potential (macro-) economic headwinds in the case of lower-thanexpected economic growth. Involvement of the Republic of Italy: As a result of its 70% ownership and the explicit and unconditional guarantee on postal savings products, the Republic of Italy is closely involved in CDEP. Therefore, all major rating agencies have assigned the same rating to CDEP as to the Republic of Italy, with support from the Italian State expected to be extremely likely in the case of need. At the same time, any potential rating migration of the sovereign would immediately leave its mark on CDEP, too.
Note: At the time of writing, CDEP had a total of three EUR-denominated benchmark covered bonds with a nominal total volume of 6bn outstanding. The latest issuance dates back to September 2006.
Key points for 2010

In light of potentially rising funding needs for the Republic of Italy, the development of CDEPs future volumes needs to be monitored. Net funding through the issuance of bonds and passbooks increased by 12.6bn in 2009. 10 June 2010 Over-collateralisation: The volume of segregated assets, which, among others, back the covered bonds issued by CDEP, amounted to 16.4bn at year-end 2009.
636

Flow of new loans, 2009
Other public entities 26%
Cassa Depositi E Prestiti (CDEP)

Structure of lending, 2009
Local authorities 58%
Central government 32%
Regions and autonomous provinces 16%

Source: CDEP Source: CDEP
Local and regional authorities 68%
10 June 2010
637
Intesa Sanpaolo (ISPIM)

Description
% Index 0.245 % Index 0.151 Total assets 625bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table
Moodys Aa2 Aaa Stable 15.1 S&P A+ NR Stable Fitch AANR Stable -
Intesa Sanpaolo (ISPIM) was created on 1 January 2007, through the merger of the Italian banking groups, Banca Intesa and Sanpaolo IMI. With total assets of 625bn at year-end 2009, down 1.6% y/y from 636bn in 2008, ISPIM is Italys second-largest bank in terms of assets. ISPIM provides universal banking and asset management services to around 11mn clients through more than 70,000 employees in nearly 6,000 branch offices in Italy. Its presence in Central and Eastern Europe (CEE) and the Mediterranean rim amounts to nearly 33,000 employees in 1,900 branch offices, serving 8.5mn retail and commercial banking customers in 13 countries, among them Ukraine, Croatia, Hungary, Serbia, and Slovakia. In 2009, non-Italian operations accounted for 13.3% of ISPIMs net income.
Risk weighting
As Italian Obbligazione Bancarie Garantite are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Market position: With market shares of 16.4% in customer lending, 17.8% in deposit taking, 26.4% in asset management, and 26.5% in pension funds, ISPIN benefits from a sound position in its domestic market where approximately 66% of all customer lending was concentrated. Despite its increasing presence in CEE markets as well as Egypt, which accounted for an aggregate 13.3% of 2009 net income, ISPIM remains geared towards its domestic market. Collateral pool: The collateral pool of ISPIMs hitherto issued 2.00bn public-sector covered bond exclusively consists of claims against the Italian sovereign (34%) and claims against Italian regions (57%), with a certain bias towards Campania (34%) and Piemonte (18%). The cover pool volume of 3.6bn implies a relatively high over-collateralisation of 180%.
Weaknesses
Net interest income: Over the course of 2009, ISPIMs net interest income fell 9% y/y, largely due to the low interest rate environment. The net interest margin fell 26bp to 178bp in 2009, from 204bp in 2008. Still, this development might be (partly) reversed in the case of higher interest rates. As we do not expect the ECB to start hiking the main refinancing rate before Q1 11, however, this effect is unlikely to materialise in 2010. Still, in 2009, ISPIM increased its net income as a result of a marked recovery in its trading income. Overall, ISPIMs net interest income grew 9.5% y/y to 2.9bn in 2009, from 2.7bn in 2008. Capital market reliance: At year-end 2009, ISPIMs customer deposits accounted for a relatively moderate 56% of all lending, making the lender reliant on the capital market for refinancing purposes. As interbank lending fell by more than 8bn over the course of 2009, however, the proportion of wholesale funding to total funding stood largely stable at about 52%. Non-performing loans: Over the course of 2009, the proportion of doubtful loans increased to 1.4% of all loans from 1.0% a year before. This corresponds to c.5.4bn, up 35.2% y/y. The coverage ratio stood at 67.4% in 2009, slightly down from 69.6% in 2008. These levels, in our view, are relatively sound but overshadowed by a sharp increase in so-called substandard loans (+5.1bn y/y), which amounted to 13.0bn (gross) at year-end 2009. Thus, at year-end 2009, NPLs were up both in gross terms (+52.2% y/y) and net of adjustments (+77.4% y/y). This led to a higher incidence of NPL on total loans to customers, increasing from 2.9% in 2008, to 5.5% in 2009. Coverage of non-performing assets came to 40.6% in 2009, versus 49.0% at year-end 2008.
Note: At the time of writing, ISPIM had one (public sector) benchmark covered bond outstanding with a nominal amount of 2bn.
Key points for 2010

In light of the lenders exposure to the CEE economies, the further evolution of ISPIMs NPLs need to be monitored.
10 June 2010
638

Financial summary
mn 2007 2008 Income statement summary Net interest income 10,166 12,349 5,922 5,327 Net fees & com's 165 - 1,329 Trading income 16,704 17,051 Operating income 9,310 10,474 Operating expenses 7,394 6,577 Pre-provision income 577 365 Loan loss provisions Pre-tax profit 4,860 839 7,356 2,682 Net income Balance sheet summary Total assets 572,959 636,133 Customer loans 335,273 395,189 38,830 of which public sector of which mortgages 168,876 Customer deposits 206,592 217,498 Debt funding 139,891 188,280 of which OGB 52,349 50,054 Total equity Profitability (%) 1.3 0.4 Return on assets 14.1 5.2 Return on equity 55.7 61.4 Cost/Income ratio 60.9 72.4 Net int inc/Op inc Asset quality (%) 7.8 5.5 LLPs/Pre-prov inc 0.0 0.7 LLRs/Gross loans 0.0 1.0 Prob loans/Gr loans 69.6 Coverage ratio Capital adequacy (%) 7.1 Tier 1 ratio 10.2 Total capital ratio Equity/Assets ratio 9.1 7.9 2009 11,237 4,955 855 17,526 9,615 7,911 330 3,455 2,938 624,844 374,033 40,890 164,620 210,814 185,243 53,771 0.5 5.7 54.9 64.1 4.2 1.0 1.4 67.4 8.4 11.8 8.6
Intesa Sanpaolo (ISPIM)

75 50 25 0 2007 Cust deposits/loans 2008 2009 50.1 61.6 55.0 56.4 50 52.5 52.0 55
45 Wholesale funding/Tot. funding
Efficiency
3 2 1 0 2007 Cost/Avg assets 2008 2009 Cost/Income 1.6 55.7 1.7 61.4 54.9 50 1.5 70
60

3 2 1 0 2007 NIM 1.8 1.28 0.1 0.44 0.1 2008 RoAA 0.47 0.1 2009 Credit costs 2.0 1.8 0.3 0.5
0.0
Asset quality
300 200 100 0 2008 Coverage ratio 2009 Prob loans/Gross loans 1.0 70 1.4 1 67 0 2
10 June 2010
639
Unicredit Group (UCGIM)

Description
% Index 0.239 % Index 0.114 Total assets 928.8bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table
Moodys Aa3 Aaa Stable 6.5 S&P A AAA Stable Fitch A AAA Negative 16.2 -
With total assets of 929bn at year-end 2009, down a strong 9.7% y/y from 1,045.6bn in 2008, Unicredit Group (UCGIM) is Italys largest bank, providing universal banking and asset management services to around 40mn clients through more than 166,000 employees in more than 10,000 branch offices in 22 countries, of which more than 4,750 were located in Italy. UCGIM is the result of the 1998 merger of nine of Italys largest banks. As a result of its previous acquisitions, UCGIM has a clear focus on Austria, Germany and Italy. In 2009, Italian retail banking accounted for 26% of the groups revenues, followed by UCGIMs Central and Eastern European (CEE) operations where it is market leader with a 17% market share, its Polish (7%%), German (5%), and Austrian (4%) operations. Corporate and investment banking accounted for 34% of the UCGIMs 2009 revenues.
Risk weighting
As Italian Obbligazione Bancarie Garantite are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Market position: UCGIM benefits from a strong position in its core markets with an average market share of 14% in Italy and 16% in Austria. In Germany, however, UCGIMs market share stands at a markedly lower 4%. With regards to its operations in the CEE markets (CEE), UCGIM benefitted from a sound market share of 24% in Croatia, 12% in Poland and 8% in Turkey. Overall, in terms of market share, UCGIM ranks among the top five players in ten CEE countries. Asset structure: UCGIMs total assets contracted by 11.2% y/y in 2009, mostly due to a sharp reduction (-34.7%) in assets held for trading, which amounted to 133.9bn at year-end 2009, from 204.9bn a year before. Overall, customer lending accounted for 61% of total assets in 2009, whereas trading assets fell to 14.4% of all assets from 19.6% at year-end 2008. Revenue split: Despite Italian operations accounting for 40% of all revenues in 2009, UCGIMs revenues benefit from a geographical diversification with CEE countries accounting for 24% of all revenues, followed by Germany (18%), and Austria (8%). Funding profile: Over the course of 2009, UCGIMs funding profile improved with customer deposits accounting for a relatively sound 68% of all lending, up from 64% a year before. At the same time, wholesale funding as a percentage of total funding declined to 46% in 2009, from 49% in 2008. This development is further supported by a 31% y/y decrease in deposits from other banks, which plummeted to 107bn in 2009, from 178bn a year before.
Weaknesses
Profitability: Owing to loan-loss provisions more than doubling to 8.2bn in 2009, from 3.6bn in 2008, UCGIMs net income virtually halved to 2.0bn in 2009, from 4.5bn in 2008 and 6.6bn a year before. Operating income, however, slightly increased 2.7% y/y to 26.6bn which still could not offset the 127% y/y surge in loan-loss provisioning. On a related note, an interest rate hike on behalf of the ECB (which we do not expect before Q1 11) could possibly improve UCGIMs profitability, as with regards to mortgage lending, which accounted for 36% of all lending in 2009, the lender calculates an 500mn impact from a 100bp interest rate shift. Increase in impairments: In 2009, mostly due to developments in the CEE countries, UCGIMs total impaired loans experienced a sharp 57% y/y increase to 31.1bn from 19.8bn a year before. The coverage ratio of total gross impaired loans at year-end 2009 stood at 46.1%, which reflects a coverage ratio of 61.3% of the NPLs and a coverage ratio of 26% of other problem loans. In Italy, UCGIMs NPLs were centralised in a new entity, ASPRA, which recovered 1.5bn of NPL. Slightly mitigating this weakness, however, is that the growth of loan-loss provisions started moderating in Q4 09 when it fell 4.4% q/q versus Q3 09, ie, the second consecutive quarter in a row. In Q4 09, write-offs amounted to 2.1bn. Yet, over the course of 2009, the net writedowns of loans surged 125% y/y to 8.3bn. As at year-end 2009, total impaired loans amounted to 31.1bn, up 57% y/y from 19.8bn a year before. At end-2009, the ratio of net impaired loans to all customer lending amounted to 5.5%, sharply up from 3.2% at year end 2008.
Note: At the time of writing, Unicredit had a total of three EUR-denominated benchmark covered bonds outstanding in the aggregate amount of 5.5bn within the scope of its 20bn covered bond programme.
Key points for 2010

Particularly in light of the lenders exposure to the CEE economies, further developments of UCGIMs NPLs, which increased markedly over the course of 2009, need to be monitored closely.
10 June 2010
640

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which OBG Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 13,965 9,430 538 24,989 14,201 10,787 2,141 9,207 6,618 1,021,835 575,063 2008 18,044 9,093 -2,872 25,930 16,084 9,846 3,582 4,995 4,529 1,045,612 612,480 21,777 209,070 388,831 202,459 4,000 58,240 0.4 7.5 62.0 69.6 36.4 3.2 63.6 6.8 10.6 5.6 2009 17,034 7,781 1,251 26,639 14,761 11,878 8,152 2,923 2,035 928,760 564,986 25,038 204,819 381,623 214,773 6,000 62,892 0.2 3.4 55.4 63.9 68.6 5.5 61.3 8.6 12.0 6.8
Unicredit Group (UCGIM)

Efficiency
100 62.0 56.8 50 1.5 1.6 55.4 1.5 1.5 1.0 2007 2008 Cost/Income 2009 Cost/Avg assets 2.0
Asset quality
100 64 50 3.2 5.5 61 4 6
390,400 239,839 62,397 0.7 12.6 56.8 55.9 19.8 0.0
0 2008 Coverage ratio 2009 Prob loans/Gross loans

2 1.5 0.8 1 0.7 0 0.2 2007 NIM 0.3 0.4 2008 RoAA 0.2 2009 Credit costs 0.0 0.5 1.7 1.7 1.0
10.1 6.1
Collateral pool regional distribution

Others 26% Campagna 7% Veneto 7% Toscana 4% Lazio 16%

70 50.6 60 Lombardia 24% 49.4 67.9 63.5 67.5 45.7 50 2007 2008 2009 Customer deposits to loans Wholesale funding in % of total funding 40 50 60
Sicilia 5%
Piemonte 11%
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641
UBI Banca (UBIIM)

Description
Leef H Dierks
Ratings table
Moodys A1 Aaa Stable 7.9 S&P A NR Stable Fitch A+ AAA Stable 17.6 -
With total assets of 122.3bn at year-end 2009, largely unchanged from 122.0bn a year before, Unione di Banche Italiane Scpa (UBI Banca - UBIIM) was the fifth-largest bank in Italy with a market share of approximately 6%. UBIIM, which is a co-operative banking group that includes nine different network banks, was created in April 2007 from the merger between Banche Popolari Unite (BPU) and Banca Lombarda e Piemontese. Headquartered in Bergamo, UBI Banca provides retail, private and commercial banking services to more than 1mn clients (mostly smaller- and medium-sized enterprises - SME) through more than 1,900 branch offices, of which more than half (1,125) are located in Lombardy and Piemont.
Risk weighting
As Obligazzione Bancarie Garantite bonds are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Cover pool quality: At the time of writing, UBIIM had a total of two benchmark covered bonds in the aggregate amount of 2bn outstanding. With the corresponding collateral amounting to a nominal value of 3.5bn and an asset percentage applied of 78.4% the covered bonds benefit from a sound overcollateralisation of 133%. The weighted average LTV stood at 43.7% with 73% of all mortgage loans in the collateral pool being secured on property located in Lombardy, one of Italys strongest regions in economic terms. As 98% of all loans in the collateral pool were subject to a floating interest rate, however, we caution that potential rate hikes on behalf of the ECB (which we do not expect to occur before Q1 11, however), need to be watched with regards to the further development of UBIIMs asset quality. Regional operations: In 2009, a high 69% of UBIIMs overall loan book consisted of loans granted to clients located in Lombardy. Generally, the lender was heavily geared towards the northern parts of Italy where more than half of its branch offices were located. At the same time, roughly half of all lending consisted of residential mortgage loans.
Weaknesses
Net interest income: With the net interest margin falling by 42bp to 204bp in 2009 from 246bp a year before, UBIIMs net interest income (NIM) fell 17% y/y to 2.5bn in 2009, from 3.0bn in 2008, recording steady quarterly declines to 558mn in Q4, from 736mn in Q1, mostly due to a further decline in the EURIBOR. Despite a rate hike being potentially detrimental to UBIIMs asset quality, the lender reports a sensitivity of its net interest income of 115mn to a 100bp rate increase. Doubtful loans: Over the course of 2009, the amount of loans characterised as doubtful nearly doubled to 6.4bn, from 3.6bn a year before. Gross non-performing loans (NPLs) increased to 2.8bn as per year-end 2009 from 1.9bn in 2008. The most pronounced increase could be observed in gross past due loans, which surged to 934mn in2009, from 214mn in 2008. Overall, in Q4 09, the latest date for which data were available, NPL increased at a pace of 12.1% q/q. On the basis of Banca dItalia instructions, as from December 2009, mortgage-backed loans that have been past due for more than 90 days have been added to past due exposures for an amount of approximately 569mn. Net loan-loss provisions were up 55% y/y to 862mn in 2009, from 557mn in 2008. Despite the overall NPL lying below the domestic average, the above development, in our view, could start leaving its mark on UBIIMs hitherto sound asset quality and therefore needs to be monitored carefully.
Note: At the time of writing, UBIIM had a total of two EUR-denominated benchmark covered bonds totalling 2.0bn outstanding within the scope of its 10bn covered bond programme.
Key points for 2010

Monitor the further development of UBIIMs NPL ratio, which has increased over the course of the past few quarters but still remains below the national average.
10 June 2010
642

Financial summary
mn 2007 2008 2009 Income statement summary Net interest income 2,572 2,996 2,496 1,216 1,188 1,130 Net fees & com's 32 260 11 Trading income 3,903 3,996 3,625 Operating income 2,489 2,581 2,416 Operating expenses 1,414 1,415 1,210 Pre-provision income 357 1,070 914 Loan loss provisions Pre-tax profit 1,134 356 519 982 148 287 Net income Balance sheet summary Total assets 121,492 121,956 122,313 Customer loans 92,941 96,368 98,007 na na na of which public sector of which mortgages na na na Customer deposits 50,164 54,151 52,865 Debt funding 40,818 43,441 44,349 2,000 of which OBG 12,898 12,264 12,350 Total equity Profitability (%) 1.0 0.1 0.2 Return on assets 10.7 1.2 2.3 Return on equity 63.8 64.6 66.6 Cost/Income ratio 65.9 75.0 68.8 Net int inc/Op inc Asset quality (%) 25.2 75.6 75.6 LLPs/Pre-prov inc na 0.0 0.0 LLRs/Gross loans na 2.5 2.8 Prob loans/Gr loans na 0.0 0.0 Coverage ratio Capital adequacy (%) 7.4 7.7 8.0 Tier 1 ratio 10.2 11.1 11.9 Total capital ratio Equity/Assets ratio 10.6 10.1 10.1
UBI Banca (UBIIM)

Efficiency
4 2.5 2 63.8 64.6 0 2007 2008 2009 Cost/Income Cost/Avg assets 2.0 60 2.1 66.6 65 70

4 2.6 2.5 2 2.0 1.00 0.4 2007 Credit costs RoA 0.9 0.7 0 0.12 0.23 2009 NIM 3 2 1 0

75 49.2 46.7 50 54.0 25 2007 Cust deposits/loans 2008 2009 56.2 53.9 40 Wholesale funding/Tot. funding 48.4 50
45
10 June 2010
643
10 June 2010
644
OTHER COVERED BOND PROFILES
10 June 2010
645
ABN AMRO (ABNANV)

Description
% Index 0.03 % Index 0.011 Total assets 469.3bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table
Moodys Aa3 Aaa Negative 6.6 S&P A+ AAA* Negative Fitch A+ AAA Stable 16.7 -
ABN AMRO (ABNANV) was originally created by the 1991 merger between ABN Bank and Amro Bank whose individual histories date back to 1824. In October 2007, ABN AMRO was acquired by the consortium of Fortis, RBS and Santander. In the wake of the global financial crisis, in October 2008, the Dutch state announced that it had bought Fortis, including its interests in ABNANV. In April 2010, ABN AMRO was transferred to a new holding, ABN AMRO Group, which is wholly owned by the Dutch State and also holds the latters shareholding in Fortis Bank. Owing to the break-up following the takeover, ABNANVs total assets more than halved to 469bn in 2008, from 667bn in 2008 and 1,025bn in 2007. In the Netherlands, ABNANV remains one of the largest commercial banks, focusing on private banking and providing banking services to larger SMEs. In 2009, ABNANV ranked among the top three in consumer and commercial banking in terms of market share in its domestic market.
Notes: * Rating Watch Negative. As at 7 June 2010.
Risk weighting
Dutch covered bonds, which are registered with the Dutch central bank (De Nederlandsche Bank) carry a 10% risk weighting under the Standard Approach since 19 May 2009, this applies to the covered bonds issued by ABNANV.
Strengths
Capitalisation: As at year-end 2009, ABNANV reported a rather high Tier 1 ratio of 19.9% (2008: 10.9%) with the total capital ratio standing at 25.5%, up from 14.4% in 2008. This is largely due to a 4bn increase in the Tier 1 capital to 23.4bn in 2009, from 19.2bn in 2008 and the sharp decline in risk-weighted assets, which fell to 117.5bn in 2009, from 176.0bn in 2008. Still, the high capital ratios also reflect remaining amounts to be repatriated to Santander (SANTAN), as well as the capital actions undertaken by RBS and the Dutch State to enable legal separation. Collateral pool: At end-March 2010, the latest date for which data were available, ABNANV had a total of 15.2bn of covered bonds outstanding. At the same time, the total outstanding current balance of mortgages in the portfolio amounted to 21.8bn, bringing the over-collateralisation to a sound 143%. The applicable asset percentage stood at 77.3%, with the weighted average indexed LTV standing at 71%. The collateral pool consisted exclusively of mortgage loans secured on property in The Netherlands and is strongly biased towards Zuid-Holland (21.9%) and Noord-Holland (20.3%), as well as Noord-Brabant (15.1%), and Gelderland (11.3%). Market share: ABNANVs Dutch mortgage business benefited from a sound 13% market share in its domestic market at yearend 2008, the latest date for which data were available.
Weaknesses
Strategic development: On 1 April 2010, the business areas of ABNANV, which were acquired by the Dutch state, were legally separated from the businesses acquired by RBS, transforming ABNANV into an independent bank, which is meanwhile whollyowned (100%) by the Dutch government and under the supervision of the Dutch Central Bank. In order to comply with the European Commissions (EC) requirements for competition, ABNANV had to sell its Dutch commercial clients activities and selected regional branch offices before the merger with Fortis could happen. Profitability: In 2009, ABNANV generated a net loss of 4.4bn, mostly owing to the 4.5bn loss from continuing operations. Despite this being a marked improvement over 2008 when the respective figure amounted to 12.9bn, the lenders future profitability (particularly in light of the strategic re-alignment) needs to be carefully monitored. Non-performing loans: The ratio of loans classified as nonperforming (NPLs) sharply increased over the course of the past year, growing to 4.1% in 2009, from 2.4% in 2008 and 1.4% in 2007. Consequently, the coverage ratio dropped to 66% in 2009, from 77% in 2008. This development needs to be carefully monitored as, in light of potentially rising write-offs, it is likely to have a further impact on the lenders profitability.
Note: At the time of writing, ABNANV had issued mortgage covered bonds in the nominal amount of 10.9bn. At the same time, another 2.4bn of covered bonds backed by assets other than mortgages had been issued within the scope of its 25bn covered bond programme.
Key points for 2010

The future strategic alignment of ABNANV needs to be monitored, particularly as the loss from continuing operations amounted to a high 4.4bn and could be affected by further write-downs over the course of 2010.
10 June 2010
646

Financial summary
mn 2007 Income statement summary Net interest income 4,595 Net fees & com's 3,852 Trading income 1,119 Operating income 15,998 Operating expenses 11,184 Pre-provision income 4,814 Loan loss provisions 717 Pre-tax profit 496 Net income 954 Profit from discounted operations 9,021 Profit for the year 9,975 Balance sheet summary Total assets 1,025,213 Customer loans 398,331 of which public sector 5,739 of which Mortgages 121,763 Customer deposits 255,796 Debt funding 190,611 of which Covered Bonds 7,000 Total equity 29,575 Profitability (%) Return on average assets 0.1 Return on average equity 3.4 Cost/Income ratio 69.9 Net int inc/Op inc 28.7 Asset quality (%) LLPs/Pre-prov inc 14.9 LLRs/Gross loans 0.7 Prob loans/Gross loans 0.0 Coverage ratio 0.8 Capital adequacy (%) Tier 1 ratio 12.4 Total capital ratio 14.6 Equity/Assets ratio 2.9 2008 5,783 3,641 -9,324 -458 9,306 -9,764 3,387 -15,474 -12,894 16,489 3,595 666,817 270,507 8,786 109,298 202,951 124,845 7,000 17,123 -1.4 -53.3 na na na 1.6 0.0 0.8 10.9 14.4 2.6 2009 4,648 2,221 1,562 6,694 7,605 -911 2,793 -4,914 -4,499 99 -4,400 469,345 218,246 2,722 107,341 192,608 110,204 9,000 18,916 -0.6 -20.6 na 69.4 na 2.5 0.0 0.7 19.9 25.5 4.0
ABN AMRO (ABNANV)

Geographical structure collateral pool, 2010
Flevoland Drenthe Zuid-Holland 23% 2% 2% Zeeland Friesland 2% 3% Utrecht Gelderland 9% 11% Groningen Overijssel 3% 5% Limburg 5% NoordBrabant 15% NoordHolland 20%
NIM, credit costs, and RoAA

1 0 -1 -2 2007 NIM 2008 Credit costs RoAA 2009 0.46 0.09 0.07 0.65 0.38 -1.44 0.65 0.39 -0.62

100 80 60 40 20 0 2007 2008 2009 Cust deposits/Loans Wholesale funding/Tot. funding 64.22 62.70 49.70 43.76 75.03 88.25 80 70 60 50 40 30 20

500 400 300 200 100 0 2007 2008 2009 Cost/Income Cost/Avg assets 1.11 69.91 1.04 1.06 113.61 2.0 1.5 1.0 0.5 0.0
Domestic Asset Quality

0.05 0.04 0.03 0.02 0.01 0.00 0.010 2007 2008 2009 Coverage ratio 0.021 0.66 0.038 0.78 0.77 0.8 0.8 0.7 0.7 0.6 0.6
Prob loans/Gross loans
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647
Achmea Hypotheekbank (ACHMEA)

Description
Leef H Dierks
Ratings table
Moodys NR Aa2* NR 5.3 S&P AAAA* Stable Fitch NR NR NR -
Achmea Hypotheekbank (ACHMEA) was founded in 1995 to centralise the funding activities of the groups different mortgage businesses. It provides mortgage loans to private customers under the Centraal Beheer Achmea, FBTO, Avro Achmea and Woonfonds labels, which all secure their lending exclusively on owner-occupied residential properties in the Netherlands. ACHMEA is an authorised bank, which itself is subject to the regulation and supervision of the Dutch Central Bank (DNB). All shares in ACHMEA are held by Achmea Bank Holding, which in turn is wholly owned by Achmea Holding. The latter is a wholly (100%) owned subsidiary of Eureko. The parent company, Achmea, is the largest insurance company in the Netherlands.
Note: * Rating Watch Negative. As at 7 June 2010
Risk weighting
Dutch covered bonds, which are registered with the Dutch central bank (De Nederlandsche Bank) carry a 10% risk weighting under the Standard Approach. As this does not apply to covered bonds issued by ACHMEA, they are subject to a 20% risk weighting.
Strengths
Asset quality: ACHMEA benefited from sound asset quality with virtually no non-performing loans (NPLs) at year-end 2009. The amount of past due but not impaired loans stood at 103mn as at year-end 2009, slightly up from 99mn at year-end 2008. This translates into a past-due ratio of only 0.07%. There were no impairments attributed to counterparty risk in 2009. The covered bonds over-collaterlisation stood at a comfortable 121%. Interest income: Despite the adverse developments in the Dutch mortgage market, ACHMEA could increase its net interest margin (NIM) to 79bp in 2009, from 65bp in 2008 and 58bp in 2007. This is largely due to that fact that in 2008, several foreign mortgage lenders had exited the Dutch market. Net interest income, which accounts for 93% of the operating income, increased by 28% y/y to 126mn in 2009, from 99mn in 2008. Net income nearly doubled to 50mn in 2009, from 29mn in 2008. Despite the improvement, the overall NIM remains on relatively low levels. Parent company: All shares of Achmea Hypotheekbank are held by Achmea Bank Holding, which in turn is wholly owned by Achmea Holding. The latter is a wholly-owned subsidiary of Eureko, which is a personal financial services provider based in the Netherlands and operating in another 11 European countries. With a 55% stake, Vereniging Achmea is the largest shareholder in Eureko, followed by Rabobank, which holds 39% of the shares. Eurekos capital management and treasury department assists ACHMEA with respect to its funding and coordinates its wholesale funding transactions. In addition, Achmea Group provides the bank with subordinated loans and capital.
Weaknesses
Capital market dependency: ACHMEA heavily relies on capital market funding with debt funding accounting for a high 12.2bn and thus 76% of all liabilities in 2009. Debt securities issued amounted to 8.0bn, up from 7.0bn a year before. Market exposure: The collateral pool of covered bonds issued by ACHMEA exclusively consists of loans secured on Dutch residential mortgages. Despite benefiting from a sound 121% over-collateralisation as at year-end 2009, the asset quality faces an exposure to a further downturn in the Dutch housing market. According to the Dutch Land Registry Office, in 2009, new mortgage lending in The Netherlands fell by 33% y/y to 66bn y/y, from 98bn in 2008. The total outstanding mortgage debt in The Netherlands fell by 2.1% y/y to 377bn in 2009, from 385bn in 2008. Impairments: ACHMEAs allowance for losses on loans and advances sharply increased by 46% y/y to 14.6mn in 2009, from 10.0mn in 2008. Despite the absolute level being moderate, we think the pace of further development should be monitored.
Note: As at year-end 2009, ACHMEA had a total of 4.2bn of EURdenominated covered bonds outstanding within the scope of its 10bn covered bond programme. With the collateral pool amounting to 5.1bn, the overcollateralisation ratio stood at a comfortable 121%.
Key points for 2010

In the case of funding conditions becoming less favourable, ACHMEAs strong reliance on the capital markets needs to be carefully monitored.
10 June 2010
648

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating Income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which Mortgages Customer deposits Debt funding of which covered bonds Total equity Profitability (%) Return on average assets Return on average equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 54 2 0 56 44 12 1 6 2 14,493 13,632 38 13,595 3,508 9,334 0 264 0.0 0.8 78.1 96.1 8.2 0.0 na na 7.4 10.9 1.8 2007 84 8 0 92 34 58 6 35 27 14,595 13,595 0 13,595 1,321 11,926 4,719 380 0.2 8.3 36.9 91.4 9.9 40.1 na na 10.1 14.0 2.6 2008 99 10 0 109 35 74 10 38 29 15,672 14,613 56 14,557 2,335 11,406 5,267 427 0.2 7.1 31.9 90.7 13.5 37.8 0.04 na 9.6 12.8 2.7 2009 126 11 0 136 36 100 14 67 50 15,999 14,137 250 13,887 1,235 12,183 4,200 484 0.3 11.0 26.4 92.2 14.0 0.0 0.07 na 10.4 13.1 3.0
Achmea Hypotheekbank (ACHMEA)

Cost/income ratio
100 75 50 25 0 2006 2007 Cost/Income 2008 2009 Cost/Avg assets 0.3 0.2 0.2 0.2 0.3 36.9 31.9 26.4 0.0 0.5
78.1

1.0 0.58 0.5 0.39 0.18 0.01 0.0 0.01 2006 NIM 0.04 0.19 0.07 0.09 2009 0.65 0.32 0.79
2007 2008 Credit Costs RoAA

30 20 10 0 2006 2007 2008 2009 Cust Deposits/Loans Wholesale Funding/Tot. Funding 25.7 9.7 16.0 8.7 72.7 90.0 83.0 90.8 100 75 50 25 0
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649
BAWAG P.S.K. (BAWAG)

Description
Note: * In %
Fritz Engelhard
Ratings table
Moodys Baa1 Aaa Stable 4.7 S&P NR NR Fitch NR NR -
BAWAG P.S.K., the fifth-largest bank in Austria, is the result of a merger between Bank fr Arbeit und Wirtschaft (BAWAG) and the sterreichische Postsparkasse (P.S.K.) in 2005. Through the merger, a total retail network of 157 outlets and 1,300 post offices was created. The banks focus is on its core domestic market. It primarily provides retail and commercial banking facilities to small and medium-sized corporate clients and public sector entities. The banks exposure to Refco, the US brokerage firm that filed for bankruptcy in 2006, unveiled weak corporate governance. This triggered the support of the Austrian government and finally the sale of the bank to the US investment company Cerberus and its Austrian partners Generali, Wstenrot and a private group of industrialists in May 2007.
Risk weighting
Austrian covered bonds carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Repositioning: Following the change of ownership in May 2007, the bank embarked on a substantial restructuring programme. New management addressed the banks weak corporate governance and damaged reputation by introducing tighter controls and guidelines. In addition, the bank started to implement a new strategy aimed at improving the profitability of the banks core Austrian business and managing its risk positions more pro-actively. Over the past three years, the bank could materially improve its liquidity position through rebuilding its deposit base and the disposal of non-core assets, such as its activities in CEE (Slovakia, Czech Republic). Mid-2009, BAWAG launched an initiative to provide a total of 1bn of funding for Austrian sub-sovereigns. Support and improved capitalisation: In 2006/07, BAWAG benefited from substantial institutional support. On 8 May 2006, the Austrian Government provided BAWAG with a 900mn guarantee, which expired on 1 July 2007. In addition, a number of major Austrian banks and insurance companies have injected 450mn of capital into the bank. In April 2009, BAWAG agreed to increase Tier 1 capital by 755mn, of which 205mn were contributed by existing shareholders and 550mn were contributed by the Republic of Austria. In addition, a 400mn risk shelter on certain assets was provided by the Republic of Austria. Final EU approval for these state aid measures is expected until mid-2010. They helped improve the banks capitalisation. The Tier 1 ratio increased from 6.6% at YE 08 to 10.0% at YE 09. Pure Austria exposure of covered bond investors: BAWAG covered bonds are unique, as they are based completely on claims against the Republic of Austria and Austrian sub-sovereigns.
Weaknesses
Earnings volatility and weak profitability: Following a net loss of 715mn in FY, BAWAG reported a 173mn net profit in FY 09. The banks 11.8bn (YE 09) securities portfolio contains 1.5bn of structured credit exposures. Valuation losses as well as writeoffs on these exposures were largely responsible for the weak performance in FY 08. BAWAG managed to unwind some of these exposures and realise some gains on the back of the lowered valuations at YE 08. However, in FY 09 it still needed to write-off 48mn from structured credit exposures booked under the held-to-maturity account. Furthermore, bottom-line results suffered from a 13.5% decrease of the bank net interest income, which was largely due to margin pressure on savings deposits combined with a low interest rate environment. Exposure to cyclical downturn: The economic development in some of the banks core markets remains fragile. This exposes BAWAGs strongly growing corporate exposures, which totalled 10.8bn at YE 09, or 44% of total loans and receivables exposures, to an increase in NPLs and write-downs. Event risk: BAWAGs management team has quite ambitious growth and profitability targets and indicated that it will seek opportunities for acquisitions. While the bank has built up its capital and liquidity position through the sale of non-core activities and a number of capital measures, any purchase of new businesses may have a negative effect on the banks credit profile and/or ratings and, thus, exposes investors to a certain degree of event risk.
Key points for 2010

Track the EUs decision on state aid for BAWAG. Watch the development of the corporate credit environment and its effect on asset quality.
10 June 2010
650

mn Income statement summary Net interest income Net fees & com's Other net income Operating income Operating expenses Pre-provision income Provisions Pre-tax profit Net income Balance sheet summary Total assets Customer financing of which public sector Customer deposits Debt funding of which covered bonds Total equity Profitability (%) Return on average assets Return on average equity Cost/Income ratio Cost/Avg Assets Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gross loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2006 606 152 65 823 647 175 179 19 68 50,806 25,022 8,993 23,194 12,209 3,760 1,673 0.1 4.1 78.7 1.2 73.7 102.1 2.3 na na 9.2 12.5 3.3 2007 603 146 -1 748 656 92 758 -566 -465 44,847 20,023 9,293 22,080 10,328 2,827 1,752 -1.0 -27.1 81.9 1.4 80.6 827.5 3.6 6.2 57.8 8.3 11.8 3.9 2008 653 144 -596 201 705 -504 281 -804 -715 41,578 20,697 3,263 22,585 10,116 2,533 1,138 -1.7 -49.5 77.3 1.6 325.3 -55.8 3.3 5.8 57.0 6.6 9.8 2.7 2009 564 155 326 1,045 598 447 237 232 173 41,225 21,066 3,141 22,674 9,279 2,177 1,919 0.4 11.3 57.2 1.4 54.0 53.0 3.9 6.7 57.8 10.0 13.6 4.7
BAWAG P.S.K. (BAWAG)

Capital ratios
16% 14% 12% 10% 8% 6% 4% 00 01 02 03 Tier 1 ratio 04 05 06 07 08 09 Total capital ratio
Loan exposures (24.9bn) by type of counterparty

Other 13% Financials 15%
Central Govt. 2%
Retail 27%
Corporates 43%
Net interest margin and credit cost

2.0% 1.5% 1.0% 0.5% 0.0% 00 01 02 03 04 05 06 07 08 09 Net interest margin Credit costs
7 5 3 1 -1 05 06 07 Restricted assets Over-collateralisation (RS) 08 09 Covered bonds 1.09x 3.3 3.0 1.18x 4.4 3.8 bn 1.21x 3.4 2.8 1.27x 1.29x 1.40 1.30 1.20 3.2 2.5 2.8 2.2 1.10 1.00

120% 110% 100% 90% 80% 70% 00 01 02 03 04 05 06 07 08 09 Cust. deposits to loans Wholesale funding % of total funding (RS) 70% 50% 30% 10% -10%
Cover pool: exposure by type of counterparty, April 2010

Republic of Austria 41% Federal States 3% Austrian Municipalities 40%
Efficiency
100% 90% 80% 70% 60% 50% 1.6% 1.4% 1.4% 1.2% 1.2% 1.1% 1.1% 1.1% 82% 79% 77% 73% 71% 75% 66% 57% 68% 68% 1.4% 1.4% 00 01 02 03 04 Cost/Income ratio 05 2.0% 1.5% 1.0% 0.5%
0.0% 06 07 08 09 Cost/Assets ratio (RS)

651
10 June 2010
Bank of America (BAC)

Description
% $Index 0.985 % Index 0.339 Total assets USD2,333bn
Jonathan Glionna, Miguel Crivelli

Ratings table
Moodys LT senior unsecured ST Outlook A2 P-1 Stable S&P A A-1 Negative Fitch A+ F1+ Stable
Bank of America is the largest US bank, as measured by assets. The company offers a broad selection of financial services products, including deposits, consumer loans, corporate loans, mortgage banking, capital markets, investment banking and wealth management. Bank of America acquired Countrywide Financial in 2008 and Merrill Lynch in 2009. In December 2009, Bank of America redeemed $45bn of TARP-preferred stock.
Risk weighting
In the absence of UCITS compliance, US structured covered bonds are treated in the same way as senior bank debt under the CRD.

Business profile: Bank of Americas retail banking footprint covers more than 80 percent of the US population, serving approximately 60mn consumers and small business relationships through more than 6,000 branches and 18,000 ATMs, as of December 2009. The company ranks #1 in the US in deposit market share at 13%. In addition, the company operates strong wealth management, investment banking, and capital markets operations that were enhanced with the acquisition of Merrill Lynch in 2009. Asset quality: Bank of Americas asset quality has stabilised following significant deterioration since 2007. Non-performing assets (NPAs) fell 5% in Q1 10 after increasing by 96% in 2009. NPAs over loans are currently at 4.1%, with charge-offs reaching 4.4%. Provisions for credit losses fell $3.6bn in Q110 when compared to Q109, pointing to an improved asset quality outlook. Trends were stronger in credit card loans where Bank of America released $2.3bn of reserves during the quarter. Overall, reserves for loan losses are $47bn, which equates to 120% of non-accrual loans. Profitability: Bank of Americas net income was $3.2bn during Q110, reflecting strong trading results and lower loan-loss provisions compared to Q4 09. This was the first profitable quarter since Q2 09. The companys net interest margin dropped 9bp during the quarter reflecting lower loan balances and elevated cash holdings. This continues the trend that started in 2009 as banks held deposits in cash and securities, enhancing liquidity but lowering net interest margins. We expect to see continued pressure on margins until lending activity resumes. Further, regulatory reform could impact revenue on some lines of business especially those related to trading activities. Similarly, implementation of the 2009 CARD Act is expected to have a $900mm after tax effect on earnings, as per company estimates. Capitalisation: Bank of Americas tangible common equity ratio was 5.6% as of Q1 10, which is a significant improvement compared to Q4 08, when the ratio was 3.3%. During 2009, Bank of America raised over $50bn in capital to comply with the requirements of the stress test and to repay $45bn of government TARP-preferred stock.
Strengths
Asset quality metrics are improving. Capital is adequate following substantial increase in 2009. Diverse operations generate significant revenue to offset loan losses.
Weaknesses
Financial regulatory reform could reduce revenue in some business lines although it is still early to calculate the full effect. Financial regulatory reform could also prompt credit rating downgrades as rating uplift due to government support is reduced.
Key points for 2010

Confirm improving trends in asset quality Financial regulatory reform
10 June 2010
652
Commercial banks
Financial summary
$ million Net Income Pre-Tax Pre-Provision Income Assets Deposits Total Shareholders Equity Tangible Common Equity Profitability Return on Assets (ROA) (%) Return on Equity (ROE) (%) Net Interest Margin (NIM) (%) Noninterest Inc. % Total Revenue Efficiency Ratio (%) Pre-tax Pre-Provision Income / Net Chargeoffs Capitalization Tangible Common Equity % Tangible Assets Total Equity % Assets Tier l Capital Ratio (%) Total Capital Ratio (%) Avg. Loans % Avg. Assets Loans % Deposits Asset Quality Loan Loss Provision % Average Loans Net Chargeoffs % Average Loans Loan Loss Reserve % Loans Loan Loss Reserve % Nonaccrual Loans Loan Loss Reserve % Nonperforming Assets Loan Loss Reserve % Net Chargeoffs (years) Nonperforming Assets % Total Assets Nonperforming Assets % Loans & OREO Nonperforming Assets % Equity + Res. Loan Loss Provision Net Charge Offs Loan Loss Reserve Nonaccrual Loans Other Nonperforming Assets Total Nonperforming Assets 5.38 2.79 2.97 100 94 1.05 1.33 3.02 11.47 $13,380 6,942 29,048 29,086 1,729 30,815 5.54 3.60 3.59 95 90 0.97 1.66 3.75 12.93 $13,375 8,701 33,785 35,554 1,801 37,355 5.03 4.14 3.92 92 88 0.93 1.81 4.25 13.85 $11,705 9,624 35,832 38,740 1,911 40,651 4.46 3.72 4.13 90 85 1.10 1.96 4.61 16.22 $10,110 8,421 37,200 41,375 2,205 43,580 3.96 4.36 4.80 120 113 1.08 1.77 4.07 14.93 $9,805 10,797 46,835 38,988 2,308 41,296 3.55 10.32 10.1 14.0 41 107 5.08 11.32 11.9 16.0 42 102 5.21 11.45 12.3 16.5 41 98 5.95 10.41 10.4 14.7 39 95 5.59 9.85 10.2 14.5 41 104 0.67 7.00 2.68 65.05 45.41 2.70 0.53 5.58 2.64 64.51 47.08 1.81 -0.17 -4.54 2.63 56.12 60.35 1.01 -0.03 -2.46 2.63 53.90 61.37 1.03 0.51 5.66 2.91 56.99 52.41 1.31 Q1 09 Q2 09 Q3 09 9,729.0 974,899 257,683 112,834 Q4 09 Q1 10 $4,247.0 $3,224.0 -$1,001.0 18,756.0 15,754.0 953,508 239,549 79,362 970,742 255,152 110,246 -$194.0 $3,182.0 8,691.0 14,194.0 991,611 231,444 127,222 976,102 229,823 125,554
Bank of America (BAC)

Option adjusted spread senior debt
700 600 500 400 300 200 100 0 Oct-06 May-07 Dec-07
2,321,963 2,254,394 2,251,043 2,223,299 2,333,200
Jul-08
Feb-09 Sep-09 Apr-10
Portfolio composition, December 2009

Other, 8.3% Consumer Loans, 18.2% Constuction , 3.8% Mortgages, 33.9% Home Equity, 12.3%
C&I, 17.2% CRE, 6.3%
Provisions and addition to reserves

$15,000 $10,000 $5,000 $0 ($5,000) Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Loan Loss Provision Addition to Reserves
Tier 1 Tangible common equity ratios / Tier 1 capital

15 % 10 % 5% 0% Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Tangible Common Equity % Tangible Assets Tier l Capital Ratio (%) 8.3% 7.6% 9.2% 10.1% 11.9% 12.3% 10.4%10.2%
Portfolio quality metrics

5% 4% 3% 2% 1% 0% Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Nonperforming Assets % Loans & OREO Nonperforming Assets % Equity + Res. 20% 15% 10% 5% 0%
3.7% 3.2% 3.3% 3.6%
5.1% 5.2% 6.0% 5.6%
10 June 2010
653
Bank of Montreal (BMO)

Description
% Index 0.015 % Index NA Total assets CAD388bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table
Moodys Aa2 Aaa Stable S&P A+ AAA Stable Fitch AAAAA Stable 18.1 -
Bank of Montreal (BMO) is Canadas fourth-largest bank in terms of total assets, which stood at CAD388bn at year-end 2009. It provides retail, corporate, investment banking and wealth management services in Canada, and, through its wholly-owned Chicago-based Harris Bankcorp subsidiary, to the US, where operations are geared towards retail and corporate banking services. Harris operates 280 branches in Illinois, Indiana and Wisconsin. At year-end 2009, BMO had more than 36,000 employees in 1,195 branch offices of which 900 were located in Canada. BMO, which served more than 10mn clients, was originally established in 1817 and thus is Canadas oldest bank. In 1984, Harris Bankcorp was acquired.
Risk weighting
Canadian covered bonds are treated as Senior Bank Debt and thus carry a 20% risk weighting under the Standardised Approach of the EU Capital Requirements Directive (CRD).
Strengths
Funding structure: With customer deposits growing by a strong 9% y/y to CAD99.5bn in 2009, from CAD91.2bn in 2008 and total customer lending falling 10.2% y/y to CAD167.8bn in 2009, from CAD187.0bn in 2008, BMO could increase its reliance on customer deposits as a refinancing instrument. Accordingly, the customer deposit to loan ratio jumped to 59.3% in 2009, from 48.8% in 2008. At the same time, wholesale funding as a percentage of total funding fell to 60.8% in 2009, from 65.0% in 2008, driven by a CAD8bn y/y decline in interbank liabilities. Collateral pool: BMOs covered bonds benefit from a comfortable over-collateralisation of 133%, as covered bonds issued totalled CAD1.5bn at end-March 2010 and the collateral pool amounted to CAD2.0bn at the same time. The weighted average LTV stood at 64%, with 85.2% of all loans secured by mortgage loans granted on owner-occupied property. Whereas 55.1% of all loans were subject to a variable interest rate, the remaining 44.9% were fixed-rate mortgage loans. Also, all (100%) mortgage loans included in the collateral pool are CMHC-insured residential loans with insurance having the full support from the Canadian government. In consequence, mortgages have a 0% risk weight (RW) for regulatory capital requirements for Canadian banks. Capitalisation: Over the course of 2009, BMO could further increase its Tier 1 ratio, which stood at 12.2% at year-end 2009, up from 9.8% in 2008. This is due to a CAD2bn increase in the lenders Tier 1 capital in combination with a CAD25bn reduction in total risk-weighted assets over the same period. The total capital ratio increased to 14.9% in 2009, from 12.2% in 2008.
Weaknesses
Non-performing loans: In 2009, BMOs loan-loss provisions increased by 21% y/y to CAD1.6bn from CAD1.3bn a year before. Spurred by a CAD700mn y/y increase in the gross impaired amount of loans granted to corporates, BMOs gross nonperforming loans (NPLs) amounted to CAD3.3bn in 2009, up a strong 38% y/y from CAD2.4bn in 2008. The coverage ratio fell to 58% in 2009, from 73% in 2008, accordingly. US exposure: By geographic region, in 2009 a high CAD2.2bn of impaired loans was attributed to the United States (2008: CAD1.5bn) where BMO features a sizeable exposure through its fully-owned Harris Bankcorp subsidiary. Overall gross lending in the US amounted to CAD38.bn in 2009, sharply down from CAD52.3bn in 2008. Asset quality: For the second consecutive year, BMO experienced a pronounced increase in its available for sale portfolio, which grew to CAD50.3bn in 2009, from CAD32.1bn in 2008 and CAD26.0bn in 2007. Further developments need to be carefully monitored. Over the course of 2009, total risk-weighted assets were reduced to CAD167.2bn, from CAD191.6bn in 2008.
Note: At the time of writing, BMO had a single EUR-denominated benchmark Canadian covered bond outstanding in the nominal amount of 1bn within the scope of its covered bond programme.
Key points for 2010

The last years steady increase in NPLs, largely due to BMOs US operations, needs to be carefully monitored as provisions could leave their mark on the lenders profitability.
10 June 2010
654

Financial summary
CAD mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Covered Bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset Quality (%) LLPs/Pre-prov income LLRs/Gross loans Problem loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 4,843 1,145 -487 8,996 6,442 2,554 353 2,395 2,131 366,524 189,854 na 52,429 76,202 117,776 0 15,298 0.7 14.5 71.6 53.8 13.8 0.2 0.4 146.5 9.5 11.7 4.2 2008 5,087 1,105 546 8,875 6,902 1,973 1,330 1,981 1,978 416,050 186,962 na 49,343 91,213 139,076 1,500 17,904 0.5 12.3 77.8 57.3 67.4 0.7 1.3 73.2 9.8 12.2 4.3 2009 5,570 973 723 9,461 7,391 2,070 1,603 2,080 1,787 388,458 167,829 na 45,524 99,445 130,955 1,500 20,197 0.5 10.0 78.1 58.9 77.4 0.9 1.9 57.7 12.2 14.9 5.2
Ontario 43%
Bank of Montreal (BMO)

Efficiency ratios
100% 90% 80% 70% 2005 97.9% 2.1% 2.1% 2.0% 71.6% 2006 2007 77.8% 1.9% 2008 78.1% 1.9% 1.8% 2009 2.0% 96.9% 2.2%
Cost/Income ratio
Cost/Assets ratio
Over-collateralisation, 2010
Over-collateralisation (x) CAD bn 5.8 5.4 6 5 4.7 4 3.9x 3.6x 4 3.1x 3 2.0 2 1.3x 1.5 1.5 1.5 1.5 2 1 0 0 Jun-08 Sep-08 Mar-09 Mar-10 Covered bonds Mortgages Over-collateralisation
Covered bond collateral, 2010

Other 9% Quebec 17% Alberta 15% British Columbia 16%

2% 1.6% 0.8% 0.1% 0% 2005 2006 2007 Net interest margin 1.5% 0.9% 0.7% 0.1% 0.1% 0.5% 0.4% 2008 Credit costs 0.5% 0.4% 2009 RoA 1.5% 1.4%

60% 1.4% 62.3% 50% 59.2% 44.8% 40% 2005 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 41.3% 40.1% 48.8% 59.3% 66.6% 65.0% 60.8% 68% 64% 60% 56% 52%
1%
10 June 2010
655
Canadian Imperial Bank of Commerce (CM)

Description
% Index NA % Index NA Total assets CAD336bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table
Moodys Aa2 Aaa Negative S&P A+ AAA Stable Fitch AAAAA Negative 21.2 -
Toronto-based Canadian Imperial Bank of Commerce CIBC (CM) is Canadas fifth-largest bank in terms of total assets, which amounted to CAD336bn at year-end 2009. CM was originally created through the merger of The Canadian Bank of Commerce (established 1867) and the Imperial Bank of Canada (established 1875) in 1961. Through its more than 41,000 employees in its retail markets and wholesale divisions, CM provides a full range of banking products and services to c.11mn individual, small business and commercial banking clients. Services include personal, business banking and wealth businesses, as well as credit, capital markets, investment banking, and merchant banking operations. In addition to its Canadian operations in more than 1,050 branch offices, CM offers financial services in 17 regional markets in the Caribbean through its subsidiary FirstCaribbean International Bank.
Risk weighting
Strengths
Collateral pool: With the nominal amount of covered bonds issued totalling CAD4.297bn as at January 2010 and the respective collateral pool amounting to CAD7.565bn at the same time, covered bonds benefit from a comfortable overcollateralisation of 176%. The weighted average current LTV stood at 52.2%, with 90.3% of all mortgages being secured on owner-occupied homes. All (100%) loans were subject to a variable interest rate. Also, note that all (100%) mortgage loans included in the collateral pool are CMHC-insured residential loans with insurance having the full support from the Canadian government. In consequence, mortgages have a 0% risk weight for regulatory capital requirements for Canadian banks. Funding profile: In 2009, CMs customer deposits accounted for a high 82.2% of all funding, up from 74.4% in 2008. At the same time, wholesale funding as a percentage of total funding fell to 42.2%, from 47% a year before. This development was driven by an 8.9% y/y increase in customer deposits to CAD108.3bn in 2009, while customer lending fell at a pace of 1.4% y/y at the same time. In our view, this strong deposit base should hep CM position itself accordingly in the case of a less benign funding environment. Capitalisation: At end Q1 10, the latest date for which data were available, CMs Tier 1 ratio stood at a relatively high 13%, up from 9.8% a year before. The average Tier 1 ratio of CM domestic peers stood at 12% at the same time. Market position: Being second on the Canadian mortgage market and third in terms of deposit taking, CM benefits from a relatively sound market position in its domestic market.
Weaknesses
Loan-loss provisions: In 2009, CMs allowances for credit losses climbed to CAD1.96bn, up 36% y/y from CAD1.45bn in 2008. Provisions for credit losses more than doubled to CAD1.65bn in 2009, from CAD773mn in 2008. Despite CMs net income recovering to CAD1.2bn in 2009, from a loss of CAD2.1bn in 2008, further development of the lenders credit losses need to be closely watched. The net impaired loan ratio (NPL) stood at 1.4% in 2009, doubling from 0.7% in 2008. Since Q3 09, loan losses (and new impaired loans) have been subject to gradual declines. Mortgage market: With nearly two-thirds (65% or CAD86bn) of all loans granted (CAD132bn) being residential mortgage loans, CM faces a significant exposure to the domestic housing market. This is somewhat mitigated by the low-risk nature of the mortgage lending business. Note that overall mortgage lending declined at a pace of 5% y/y in 2009. Trading income: For the second consecutive year, in 2009, CM generated a trading loss (CAD531mn). Despite being markedly lower than in 2008 (CAD6.8bn), further developments need to be monitored. Overall, securities held for trading fell to CAD15.1bn in 2009, from CAD37.2bn in 2008, whereas assets categorised as available-for-sale (AFS) surged to CAD40.2bn in 2009, from CAD13.3bn in 2008.
Note: At the time of writing, CM had one EUR-denominated, benchmark Canadian covered bond with a nominal amount of 2bn outstanding within the scope of its 8bn covered bond programme. In early June 2010 CM issued its inaugural USD dominated benchmark covered bond.
Key points for 2010

The further development of provisions made for credit losses need to be carefully monitored as they more than doubled over the course of 2009, thereby potentially affecting the lenders near-term profitability.
10 June 2010
656

Financial summary
CAD mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which mortgages Customer deposits Debt funding of which Covered Bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset Quality (%) LLPs/Pre-prov income LLRs/Gross loans Problem loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007 4,558 4,609 328 12,066 7,612 4,454 603 3,327 3,296 342,178 129,998 91,664 91,772 77,018 0 13,489 1.0 25.5 63.1 37.8 13.5 0.5 0.2 340.3 10.5 15.4 3.9 2008 5,207 3,882 -6,821 3,714 7,201 -3,487 773 -2,042 -2,060 353,930 133,648 90,695 99,477 86,537 3,599 13,831 -0.6 -15.6 193.9 140.2 -22.2 0.6 0.7 147.1 10.5 15.4 3.9 2009 5,394 3,690 -531 9,928 6,660 3,268 1,649 1,195 1,174 335,944 131,829 86,152 108,324 78,928 6,423 14,275 0.3 8.5 67.1 54.3 50.5 1.2 1.4 102.6 12.1 16.1 4.2
Canadian Imperial Bank of Commerce (CM)

90% 80% 70% 70.1% 60% 2006 2007 2008 70.6% 45.3% 45.6% 46.5% 74.4% 42.2% 2009 82.2% 52% 48% 44% 40%
Cust. deposits to loans Wholesale funding % of total funding
Efficiency ratios
200% 150% 100% 50% 2006 2007 Cost/Income ratio 2.5% 66.0% 2.4% 2.3% 63.1% 2.2% 67.1% 1.9% 1.8% 193.9% 2.8%
2008 2009 Cost/Assets ratio

2% 1% 0% -0.6% -1% 2006 2007 2008 Credit costs 2009 RoA Net interest margin 1.5% 0.9% 0.2% 1.4% 1.0% 0.2% 0.2% 1.6% 1.6% 0.3% 0.5%
Regional structure of collateral pool, 2010

Other 7% Alberta 18%
Over-collateralisation, 2010
CAD bn 8 6 4 3.6 1.5x British Columbia 33% 2 0 Sep-08 Covered bonds Mar-09 Mortgages Mar-10 Over-collateralisation 5.3 3.6 7.5 2.1x 4.3 Over-collateralisation (x) 7.6 1.8x 3 2 1 0
Quebec 5%
Ontario 37%
10 June 2010
657
Danske Bank (DANBNK)

Description
% Index 0.214 % Index 0.125 Total assets DKr 3,099bn LT senior unsecured Covered bond rating Outlook Discontinuity factor** Collateral score**
Leef H Dierks
Ratings table
Moodys Aa3 Aaa Stable 11.6 S&P A AAA* Negative Fitch A+ AAA Stable 16.6 -
Danske Bank (DANBNK), which resulted from the 1990 merger between Den Danske Bank, Handelsbanken, and Provinsbanken, is Denmarks largest financial institution. At the same time, with total assets of DKr3,099bn as atyear-end 2009, down almost 13% y/y, the institution ranks among the largest players in the Nordic region. With its market share of more than 28% of all lending, DANBNK benefits from a strong position in its domestic market. Meaningful franchises also exist in Sweden, Finland (Sampo Bank), Norway, the Baltics, Ireland and Northern Ireland. DANBNK, which at year-end 2009 had 22,100 employees, provides universal banking services, ie, retail and wholesale banking, mortgage finance, leasing, real-estate brokerage and asset management, as well as insurance services to more than 5mn clients. Attributed to raising DKr 26bn of hybrid capital from the Danish state, DANBNKs Tier 1 and solvency ratios markedly increased over the course of 2009.
Note: * Watch Negative. As at 7 June 2010. ** International cover pool, in %.
Risk weighting
As Danish Realkreditobligationer (covered bonds) are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach, but may qualify for lower risk weightings in the IRB Approach.
Strengths
Market share: In terms of total assets, DANBNK is the largest bank in Denmark. Danish operations accounted for 36% of the groups total income in 2009 and DANBNK benefits from a market share of 28.2% in lending (2008: 30.5%) and 29.6% in deposit taking (2008: 30.2%). Domestic lending, which includes mortgage and repo lending, accounted for 59% of all lending. Asset quality: The collateral pool behind the outstanding benchmark EUR-denominated covered bonds (including the two former SAMPO bonds) consists of the so called Cover Pool I, ie, of mortgage loans backed by Swedish (48.1%) and Norwegian (51.9%) properties. Thereof, 75% were owneroccupied. The WA LTV stood at 59% with a WA seasoning of 2.6 years. Domestic capital market: DANBNK benefits from its access to a strong domestic, ie, DKr-denominated, capital market with a sound investor base. Danish mortgage lending, for example, is entirely refinanced on the DKr market. This, in combination with an average wholesale funding ratio of around 57% since 2006, enabled DANBNK to limit its reliance on the international capital market and also helped reduce the need for state aid in 2009. Capitalisation: Attributed to raising DKr 26bn of hybrid capital from the Danish state in 2009, DANBNKs Tier 1 and solvency ratios surged to 14.1% and 17.8%, respectively. This is markedly higher than as at year-end 2008, when the ratios stood at 9.2% and 13%, respectively. We understand this measure to result from DANBNKs high market shares and its systemic importance for the Danish (and Nordic) market. In our view, DANBNK therefore is likely to receive further federal support in the case of economic distress.
Weaknesses
Impairments: Gross non-performing loans NPLs (ie, those characterised as rating categories 10-11 by DANBNK) surged 70% y/y to DKr55.5bn in 2009, from DKr32.6bn in 2008. This sharp increase is largely attributed to DANBNKs banking activities in Denmark (+131% y/y to DKr10,049mn), Ireland (+208% y/y to DKr5,238mn) and the Baltics (+823% y/y to DKr2,725mn). In the Danish market, which accounts for 59% of all lending, the quarterly loan impairment charges featured a declining trend throughout 2009. The risk arising from DANBNKs exposure to the Baltics, however, is somewhat mitigated by a relatively modest overall exposure, which accounted for 1.3% of all lending. We thus judge the development of impairments related to the Irish market to be more crucial as the latter in particular stem from the negative trend in the countrys property market. Earnings: Owing to a 200% y/y surge in trading income to DKr18.2bn in 2009, DANBNK generated an operating income of DKr 56.5bn in 2009, up 43% y/y from DKr 39.5bn in 2008. Despite this favourable development, net profit only increased to DKr1,700mn in 2009, up 65% y/y from DKr1,036m in 2008. As this is largely attributed to the above-mentioned impairment charges, net profit might not recover again in 2010.
Note: At the time of writing, DANBNK had a total of six EUR-denominated benchmark covered bonds outstanding. Among these are two former SHAMPO covered bonds. The covered bonds are secured on Norwegian and Swedish collateral. In January 2009, DANBNK issued a 3bn Danish government-guaranteed debt instrument (GGB), which will mature in September 2010.
Key points for 2010

The further evolution of DANBNKs NPLs (rating categories 10-11), which increased by 70% y/y in 2009, needs to be carefully monitored, particularly as the potential recovery of net profits has been overshadowed by this development.
10 June 2010
658

Financial summary
DKr mn 2006* 2007* 2008* 2009* Income statement summary Net interest income 19,501 24,260 27,005 27,524 Net fees & com's 7,301 8,877 8,110 7,678 Trading income 6,631 7,887 6,076 18,244 36,443 43,722 39,458 56,529 Operating income Operating expenses 19,485 25,070 28,726 28,907 Pre-provision income 16,958 18,652 10,732 27,622 Loan loss provisions -496 687 12,088 25,677 Pre-tax profit 18,497 19,306 2,229 4,755 Net income 13,545 14,870 1,036 1,713 Balance sheet summary Total assets 2,938,035 3,349,530 3,543,974 3,098,477 Customer loans 1,519,554 1,700,999 1,785,323 1,669,552 of which public sector 17,823 of which mortgages 602,584 627,809 667,181 688,473 Customer deposits 693,142 798,274 800,297 803,932 898,929 980,109 1,064,000 1,111,658 Debt funding of which Covered Bonds Total equity 95,172 104,355 98,247 100,659 Profitability (%) Return on assets 0.5 0.4 0.0 0.1 Return on equity 16.0 16.3 1.0 1.7 Cost/Income ratio 53.5 57.3 72.8 51.1 Net int inc/Op inc 53.5 55.5 68.4 48.7 Asset Quality (%) LLPs/Pre-prov incom -2.9 3.7 112.6 93.0 LLRs/Gross loans 0.7 1.5 Problem loans/Gr loans 1.8 3.3 Coverage ratio 45.0 58.9 Capital adequacy (%) Tier 1 ratio 8.6 6.4 9.2 14.1 11.4 9.3 13.0 17.8 Total capital ratio Equity/Assets ratio 3.2 3.1 2.8 3.2
Note: * Figures with an asterisk were prepared according to IAS/IFRS.
Danske Bank (DANBNK)

1.0% 0.7% 0.6% 0.5% 0.2% 0.0% -0.2% 2005 0.0% 2006 0.5% 0.4% 0.0% 2007 0.3% 0.0% 2008 0.1% 2009 RoA 0.7% 0.7% 0.8% 0.9% 0.8%
Net interest margin
Credit costs

4 1.8 62% 63% 0 2005 2006 2007 2008 2009 Gross NPLs/Loans* Reserve coverage 60% 3.3 70%
65%
Efficiency ratios
80% 0.7% 0.6% 60% 55.0% 53.5% 0.7% 57.3% 0.8% 72.8% 51.1% 0.5% 0.9% 1.0%
40% 2005 2006 2007 Cost/Income ratio
0.0% 2008 2009 Cost/Assets ratio
10 June 2010
659
DnB NOR Boligkreditt (DNBNOR)

Description
% Index 0.201 % Index 0.102 Total assets NOK1,824bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table*
Moodys Aa3 Aaa Stable 6.7 S&P A+ AAA Stable Fitch NR AAA Stable 18.9 -
DnB NOR Boligkreditt is a wholly-owned subsidiary of DnB NOR Bank (DNBNOR) for which it operates as a vehicle for the issuance of covered bonds. Its sole business purpose is to provide residential mortgage loans and to refund the latter through the issuance of covered bonds out of its 40bn covered bond programme. Parent company DnB NOR, in which the Norwegian state holds 34%, is the countrys largest financial services group. In addition to insurance and asset management, DnB NOR provides universal banking and real estate services, benefitting from a market share of c.30% in the retail market and of roughly 35% in the corporate market. Despite operating in the Nordic region and in the Baltic countries (through joint venture DnB NORD with German Landesbank Nord/LB), more than 80% of the groups income is generated in Norway.
Note: *Ratings refer to DnB NOR Bank. As at 7 June 2010.
Risk weighting
Despite Norway not being an EU member state, Norwegian Obligasjonsln med portefoljepant (covered bonds) technically fulfill the EU Capital Requirements Directive (CRD) and thus carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Parent company: DnB NOR Bank, which wholly owns (100%) DnB Nor Boligkreditt, is Norwayss largest bank in terms of assets (NOK1,824bn as per year-and 2009), with market shares of 28% in lending and 32% in deposit taking on the Norwegian retail market where it served 2.3mn customers, making its distribution network by far the largest within Norway. DnB NOR Boligkreditt, with only 15 employees, operationally is fully embedded into DnB NOR Bank where it is responsible for obtaining long-term funding through the issuance of covered bonds. As, according to the Annual Report 2010, during the financial market turmoil, covered bonds have proved to be a more robust and considerably lower priced funding instrument than ordinary bonds. Over the next few years, DnB NOR will thus seek to cover a large share of its long-term funding requirement through the issue of covered bonds. Asset quality: As at end-February 2010, covered bonds issued within the scope of DNBNORs 40bn covered bond programme benefitted from an over-collateralisation ratio of 140%. The collateral pool consisted exclusively of Norwegian residential mortgage loans with a regional bias towards the Oslo and eastern parts of the country. Owner-occupied dwellings accounted for about 88% of the collateral pool. Support measures: The combination of DnB NOR being 34% owned by the Norwegian government and its systemic importance to the Norwegian financial sector, where it benefits from market shares of between 30% and 35%, makes potential government support in the case of distress highly likely, in our view. In Q4 09, DnB NOR completed a NOK13.90bn equity issue. Capitalisation: In 2009, DnB NORs Tier 1 ratio climbed to 9.3% from 6.8% in 2008.
Weaknesses
Impairments: Spurred by a sharp increase in the amount of impaired loans to the international shipping and manufacturing sectors, DnB NORs total impaired loans recorded a 70% y/y surge to NOK19.5bn in 2009. Write-offs more than doubled (+120% y/y) to NOK7.7bn in 2009, from NOK3.5bn in 2008. As DnB NOR reacted accordingly, however, and increased loan-loss provisions by 93% y/y to NOK18.9bn in 2009, from NOK9.8bn in 2008, the coverage ratio effectively improved to 97% in 2009, from 86% in 2008. DnB NORD: DnB NORs exposure to Denmark, Finland, Estonia, Latvia, Lithuania and Poland is channelled through its joint venture DnB NORD. The latter in which DnB NOR has a 51% ownership, was established in 2006 with German Landesbank Nord/LB, which owns the remaining 49% stake. Whereas the exposure in terms of DnB NORs total loan book is relatively modest (DnB NOR fully consolidates the lender on its balance sheet), the planned complete takeover is likely to increase DnB NORs exposure to the Baltic rim where the increase in writedowns in 2009 was most pronounced. Geographical concentration: The collateral pool backing DNBNORs covered bonds consists exclusively of residential mortgage loans granted on Norwegian property. This exposes investors to developments in the countrys housing market. The combination of sound collateral quality, a stable situation on the property market, and a rather benign economic outlook mitigates this potential risk.
Note: At the time of writing, DNBNOR had a total of five EUR-denominated benchmark covered bonds outstanding, totaling 8.5bn. DNBNOR also issues registered covered bonds.
Key points for 2010

Following a 70% y/y increase in impaired loans, the development of the asset quality of DnB NOR needs to be closely monitored. We do not expect this to have any impact on the composition or the over collateralisation of the covered bonds issued by DNBNOR, however.
10 June 2010
660

Financial summary (DnB NOR Bank)
NOK mn 2007* Income statement summary Net interest income 17,866 Net fees & com's 9,476 Trading income 2,149 29,491 Operating income Operating expenses 16,450 13,041 Pre-provision income Loan loss provisions 220 Pre-tax profit 17,409 Net income 15,022 Balance sheet summary Total assets 1,473,919 Customer loans 970,504 of which public sector of which mortgages 538,151 Customer deposits Debt funding 405,010 of which Covered Bonds 75,976 Total equity Profitability (%) Return on assets 1.1 Return on equity 22.4 Cost/Income ratio 55.8 Net int inc/Op inc 60.6 Asset Quality (%) LLPs/Pre-prov income 1.7 LLRs/Gross loans 0.0 Problem loans/Gr loans 0.5 Coverage ratio Capital adequacy (%) Tier 1 ratio 7.8 Total capital ratio 9.0 Equity/Assets ratio 5.2 2008* 21,919 6,894 3,931 32,744 16,503 16,241 3,509 12,170 8,918 1,831,699 1,191,635 439,000 597,242 651,447 127 81,275 0.5 12.0 50.4 66.9 21.6 0.3 1.0 85.7 6.8 11.0 4.4 2009* 22,633 6,655 5,938 35,226 16,701 18,525 7,710 11,302 7,026 1,823,453 1,114,886 477,001 590,745 532,783 231 101,403 0.4 8.1 47.4 64.3 41.6 0.7 1.7 97.0 9.3 12.4 5.6
DnB NOR Boligkreditt (DNBNOR)

Efficiency
60% 55% 1.2% 50% 45% 40% 2005 2006 2007 Cost/Income ratio 2008 2009 Cost/Assets ratio 1.2% 55.8% 50.4% 47.4% 0.0% 58.5% 57.3% 1.2% 1.5% 1.0% 0.9% 1.0% 0.5%

80% 44.7% 47.5% 48.3% 58.2% 54.6% 65% 55% 45% 58.9% 40% 2005 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 57.3% 55.5% 50.1% 53.0% 35% 25%
60%
Collateral pool: Regional distribution, 2010

Southern Norway 14% Western Norway 16%
Northern Norway 6%
Note: * Figures were prepared according to IAS/IFRS.
Eastern Norway 39%
Mid Norway 5% Oslo 20%

1.5% 1.0% 0.5% 0.0% -0.5% 0.01% -0.02% 0.02% 1.08% 1.10% 1.08% 1.26% 1.27% 1.28% 1.33% 0.54% 1.24% 0.38% 0.42% 0.21% 2009 RoA
2007 2008 Credit costs
10 June 2010
661
Erste Group Bank AG (ERSTBK)

Description
% Index 0.114 % Index NA Total assets 202bn LT senior unsecured Covered bond rating* Outlook Discontinuity factor*/** Collateral score* **
/
Fritz Engelhard
Ratings table
Moodys Aa3 Aaa/Aaa Negative 15.0/5.4 S&P A -/Negative Fitch A -/Stable -
Erste Group Bank AG is the largest bank in Austria, with total assets of 202bn as of YE 09. It was founded in 1819 as the first Austrian savings bank and since going public in 1997 has developed into one of the largest financial services providers in Central and Eastern Europe. Currently, Erste Bank is mainly (42.9%) owned by institutional investors. Erste Bank Foundation and Austrian savings banks still hold 26% and 6%, respectively. With its 50,488 employees, Erste Bank is one of the leading financial providers in CEE, serving 17.5mn clients in more than 3,000 branches in eight countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). To efficiently manage its international operations, in August 2008, it changed its corporate structure, with Erste Group Bank AG becoming the holding company and Erste Bank der Oesterreichischen Sparkassen AG the operational unit of the groups Austrian banking activities.
Note: *Mortgage/Public sector **In %
Risk weighting
Austrian Pfandbriefe carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Strong franchise in core markets: With its retail operations in Austria and CEE countries, Erste Bank has built up a solid franchise. Within its core markets, it occupies high market shares in terms of retail loans and deposits: Austria 19% loans and deposits; Czech Republic 27% loans and 29% deposits; Slovakia 26% loans and 28% deposits; and Romania 20% loans and 23% deposits. The strong deposit base allows the bank to expand its loan book with particular focus on mortgage lending. In recent years the banks deposit-to-loan ratio has remained stable at c.90%. Growing net interest margins and tight cost control allowed the bank to more than double its pre-provision income from 1.4bn in 2004 to 3.8bn in 2009, and reduce its cost-income-ratio from 65% to 50% over the same period. Support and improved capitalisation: Although Erste Bank is a joint stock company, largely owned by institutional investors, it benefits from the mutual protection scheme of the Austrian savings bank sector. On 26 September 2001, a joint liability agreement (Haftungsverbund) between Erste Bank and the Savings Banks was signed. Under the agreement, financial support will be funded by the member banks with a cap of 1.5% of risk assets and 75% of the expected pre-tax profit of each institution. The 1.2bn of participation capital which was injected into the group by the Republic of Austria in early 20096 highlights strong public sector support and together with the 540mn of capital placed to private investors and the 1.7bn of capital raised in November 2009 it helped strengthen the banks capital base. In January 2009, Erste Bank signed a framework agreement for 6.0bn of bond issues guaranteed by the Republic of Austria. In 2009, it issued three such bonds with a total volume of 4bn. Over-collateralisation: As of 28 February 2010, the banks mortgage Pfandbriefe had an over-collateralisation of 130% and public sector Pfandbriefe had an over-collateralisation of 170% on a nominal basis. With respect to the mortgage cover pool, we note the high (53%) exposure to multi-family loans, which is mainly due to the financing of social housing associations in the city of Vienna.
Weaknesses
Earnings volatility from structured credit exposures: In FY 08, Erste Banks results suffered from write-offs on exposures to Icelandic banks (288mn) and Lehman Brothers (33mn), revaluations in the banks structured credit portfolio (158mn), as well as write-downs of 570mn on the goodwill of some of the banks CEE investments. Whilst most of these items were non-recurring and due to the low valuations at YE 08 the bank could realise some profits on unwinds, the group still owned a total of 1.9bn of ABS/CDS exposures. In FY09, 33mn of realised losses and 42mn of write-downs led total of 75bn of losses. On the positive side, these losses appear manageable due to the banks overall good earnings. Furthermore, it is worth noting that the bank has written off 130mn of its 138mn (YE 09) exposure to Icelandic banks. Exposure to CEE markets: As of YE 08, exposure to CEE countries made up 89bn, or 40%, of total credit risk exposures. In 2007 and 2008, more than half of the groups operating profits came from CEE countries. The challenging economic environment in these economies, and the slowdown of investment activity in the region puts pressure on the groups asset quality and bottom-line results. In 2009, NPLs of CEE units increased from 2.0bn to 4.3bn, or by 113%. On the positive side, Erste Bank wrote off goodwill on its operations in the Ukraine, Serbia and Romania already in 2008; thus, at least there has been no further fallout on this front in 2009. Competitive domestic market environment: The Austrian banking market is highly competitive and rather mature. In FY 09 the banks net interest income from its Austrian operations decreased 4.8%, or 48mn. This is in some contrast to groupwide net interest income, which increased 6.3%, or 308mn.
Key points for 2010

Monitor provisioning needs in the banks CEE operations.
6
Track the management of legacy ABS/CDS positions.
As private investors also took part in this capital measure, the participation of the Republic of Austria did not trigger EU state aid procedures.
10 June 2010
662

mn 2006 2007 2008 Income statement summary Net interest income 3,189 3,946 4,913 1,446 1,858 1,971 Net fees & com's Trading income 278 351 115 4,913 6,155 6,999 Operating income Operating expenses 2,945 3,642 4,002 1,968 2,513 2,997 Pre-provision income Provisions 439 455 1,071 1,522 1,893 576 Pre-tax profit Profit from discontinued operations 28 640 Net income 932 1,175 860 Balance sheet summary Total assets 181,703 200,519 201,441 Customer financing 97,107 113,956 126,185 Customer deposits 90,849 100,116 109,305 27,024 36,667 36,530 Debt funding of which covered bonds 2,288 3,289 5,730 7,979 8,452 8,079 Total equity Profitability (%) Return on assets 0.56 0.61 0.43 Return on equity 15.5 14.3 10.4 Cost/Income ratio 59.9 59.2 57.2 Net int inc/Op inc 64.9 64.1 70.2 Asset quality (%) LLPs/Pre-prov inc 22.3 18.1 35.7 LLRs/Gross loans 0.4 0.4 0.8 Prob loans/Credit Exposure 2.3 2.2 2.9 Coverage ratio 73.4 70.6 61.6 Capital adequacy (%) Tier 1 ratio 6.6 7.0 7.2 Total capital ratio 10.2 10.1 9.8 Equity/Assets ratio 4.4 4.2 4.0 2009 5,221 1,773 585 7,579 3,807 3,771 2,057 1,261 903 201,710 129,134 112,042 35,760 6,540 12,709 0.45 8.7 50.2 68.9 54.5 1.5 4.1 58.3 10.8 12.7 6.3
Erste Group Bank AG (ERSTBK)

Net interest margin and credit cost
6% 5% 4% 3% 2% 1% 0% 2004 2005 2006 Net interest margin 2007 2008 Credit costs 2009 RoA
Efficiency
80% 60% 40% 20% 0% 2004 2005 2006 Cost/Income ratio 2007 2008 2009 Cost/Assets ratio (RS) 1.9% 1.8% 65% 7% 62% 60% 3.5% 59% 3.8% 57% 4.0% 50% 3.8% 5% 3% 1% -1%

100% 95% 90% 85% 80% 75% 43% 45% 42% 55% 42% 39% 36% 87% 45% 35% 88% 87% 25% 15% 2004 2005 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding (RS)
94%
91%
94%
Geographical split mortgage cover pool, Feb 2010

Vienna 38% Tyrol 7% Lower Austria 21%
Asset quality
12% 10% 8% 6% 4% 2% 0% 73% 75% 73% 71% 80% 62% 58% 60% 40% 2.9% 2.6% 2.3% 2.2% 2.9% 4.1% 20% 0%
Germany 10% Other Austria 24%
2004 2005 2006 Prob loans/Gr loans
2007 2008 2009 Coverage ratio (RS)
Geographical split public sector cover pool, Feb 2010

Austria 95%
Breakdown by loan type: mortgage cover pool, Feb 2010

Mixed Use 2% MulitFamily 53% Retail 13% Other 13% SingleFamily 19%
EU 5%
10 June 2010
663
ING Bank (INTNED)

Description
% Index 0.386 % Index 0.076 Total assets 1,164bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table
Moodys Aa3 Aaa Stable 4.8 S&P A+ AAA Stable Fitch A+ AAA Stable 16.2 -
With total assets of 1,1642bn at year-end 2009, down from 1,331bn in 2008, ING was the 19th largest European financial institutions in terms of market capitalisation, providing banking, investments, life insurance and retirement services through more than 107,000 employees. Yet, in order to gain EU approval for the October 2008 issuance of 10bn of core Tier 1 securities to the Dutch State and the agreement with the Dutch State on an Illiquid Assets Back-up Facility (IABF) covering 80% of INTNEDs 30bn portfolio of Alt-A RMBS, ING has had to accept a number of commitments, among them the spin-off of its US and insurance operations. As a consequence of these agreements, INTNED will have halved its total assets by 2013.
Risk weighting
Dutch covered bonds, which are registered with the Dutch central bank (De Nederlandsche Bank) carry a 10% risk weighting under the Standard Approach since 12 September 2008, this applies to the covered bonds issued by INTNED.
Strengths
Funding profile: At year-end 2009, INTNED benefitted from a sound funding structure with customer deposits accounting for a high 81% of all lending. Wholesale funding accounted for 31% of all funding, thereby enabling INTNED to partly weather adverse effects in the capital markets in terms of refinancing. Still, the customer deposit to loan ratio has steadily declined in recent years, falling to 81% in 2009, from 84% in 2008, 95% in 2007 and 105% in 2006. Also, the spinoff of selected operations might further reduce the respective ratio in the years ahead. Lending profile: In 2009, mortgage lending (321bn), which usually is considered to be relatively low risk, accounted for a high 81% of INTNEDs entire lending (589bn). The better part (164bn) of INTNEDs mortgage lending was secured by Dutch operations where INTNED benefited from a market share of c.20% as at late 2008, the latest date for which data were available. Collateral pool: With the collateral pool amounting to 15.4bn and the nominal value of covered bonds issued by INTNED standing at 11.8bn at January 2010, over-collateralisation stood at a comfortable 131%. The asset percentage applied stands at 82% with 89.7% of all loans included in the cover pool being subject to a fixed interest rate. 9.5% of the loans granted are pegged to the 1m Euribor. A high 90.0% is secured on homes, followed by apartments, which accounted for 10.0%. Overall, the collateral pool is geared towards Noord-Holland (19.8%), Zuid-Holland (19.7%), and Gelderland (15.0%).
Weaknesses
Strategic alignment: In the future, INTNED will concentrate on its position as an international retail, direct and commercial bank. Therefore, its insurance operations will eventually be spun off. First steps towards an operational split of the group came into effect in June 2009, when separate management boards for banking and insurance were installed. The decision to formally separate INTNED into two new entities was approved by shareholders in November 2009 after the European Commission had signalled its consent earlier that month. INTNEDs restructuring measures are expected to result in a proforma balance sheet reduction of about 600bn by 2013 ie, almost half of today balance sheet. This will be achieved through divestments and a further deleveraging of the bank balance sheet. INTNED expects that by year-end 2013, total assets will have shrunk by approximately 30%. Proceeds from divesting the insurance operations will be used to eliminate double leverage and further repay the Dutch State. Still, in our view, these events (theoretically) should be of subordinated importance for INTNEDs covered bond programme. Loan-loss provisions: Loan-loss provisions within INTNEDs bank operations more than doubled to 3.0bn in 2009, from 1.2bn in 2008, thereby leaving its mark on the lenders profitability. At the same time, write-offs related to real estate revaluations and impairments climbed to 2.2bn in 2009, from 1.2bn in 2008. Public sector exposure: Over the course of 2009, INTNED exposure to the public sector almost doubled to 51.1bn, from 26.4bn in 2008. This was driven by a 12bn y/y increase in public sector lending to Dutch authorities to 28bn in 2009, from 16bn in 2008 and 13bn y/y in international public sector lending to 23bn in 2009, from 10bn in 2008. In light of the potentially increasing funding needs of sovereigns in the years ahead, this development and particularly INTNEDs international exposure need to be monitored.
Note: At the time of writing, INTNED had a total of six EUR-denominated benchmark covered bonds with a nominal value of 9.5bn outstanding within its 30bn covered bond programme.
Key points for 2010

Monitor the impact of the strategic alignment on the banking operations of INTNED, particularly with regards to the Dutch mortgage operations and the potential effect on its covered bond-related funding needs.
10 June 2010
664

Financial summary
mn 2006 2007 2008 Income statement summary 9,192 8,976 11,042 Net interest income 4,316 4,827 4,965 Net fees & com's 46,835 46,818 43,812 Gross premium income 10,907 13,352 4,664 Investment income 1,172 1,119 -749 Trading income 73,531 76,717 63,734 Operating income Operating expenses 63,551 65,421 66,034 9,980 11,296 -2,300 Pre-provision income 103 125 1,280 Loan loss provisions Pre-tax profit 9,940 11,043 -1,487 Net income 8,033 9,508 -766 Balance sheet summary Total assets 1,226,307 1,312,510 1,331,663 Customer loans 474,437 552,964 619,791 25,953 23,639 26,387 of which public sector 236,085 291,232 319,544 of which mortgages Customer deposits 496,680 525,216 522,783 84,147 74,320 106,769 Debt funding of which covered bonds 0 0 6,795 41,215 39,531 28,928 Total equity Profitability (%) Return on average assets 0.7 0.8 -0.1 20.2 23.9 -2.1 Return on average equity Cost/Income ratio 86.4 85.3 103.6 12.5 11.7 17.3 Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc 1.0 1.1 -55.7 LLRs/Gross loans na na na Prob loans/Gr loans na na na na na na Coverage ratio Capital adequacy (%) Tier 1 ratio 7.6 7.4 9.3 11.0 10.3 12.8 Total capital ratio Equity/Assets ratio 3.36 3.01 2.17 2009 12,375 4,613 30,492 3,342 1125 51,947 45,749 6,198 2,973 -1,525 -1,053 1,163,643 578,946 51,082 320,594 469,508 130,080 11,788 39,778 -0.1 -2.9 88.1 23.8 48.0 na na na 10.2 13.5 3.42
ING Bank (INTNED)

Geographical structure of the collateral pool, 2010
Zuid-Holland 19% Brabant 12% Overijssel 8% Drenthe 3% Groningen 2% NoordHolland 19% Zeeland 2%
Flevoland 3%
Friesland 3% Limburg Utrecht Gelderland 5% 8% 15%
Structure of the collateral pool, 2010

/Flats 10% Houses 90%

1.0% 0.6% 0.2% -0.2% 2005 2006 2007 Net interest margin 0.8% 0.6% 0.0% 0.8% 0.7% 0.0% 0.8% 0.7% 0.0% 0.9% 0.1% -0.1% 2008 Credit costs 2009 RoA 0.2% -0.1% 1.0%

Investment 21% Insurance 11% Annuity 1% Credit 1% Interest Only 66%
Efficiency
110% 100% 90% 87.8% 80% 2005 86.4% 2006 85.3% 2007 2008 3.6% 2009 5.4% 5.3% 103.6% 5.3% 5.1% 88.1% 4% 3% 6% 5%
Cost/Income ratio
Cost/Assets ratio

120% 100% 80% 60% 2005 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 106.0% 104.7% 30% 95.0% 84.3% 81.1% 25% 31.0% 29.2% 33.1% 31.5% 31.3% 35%
10 June 2010
665
JPMorgan (JPM)
Description
% $Index 0.895 % Index 0.194 Total assets USD2,136bn
Jonathan Glionna, Miguel Crivelli

Ratings table
Moodys LT senior unsecured ST Outlook Aa3 P-1 Negative S&P A+ A-1 Negative Fitch AAF1+ Stable
JPMorgan Chase the second-largest bank in the US provides a wide array of services to both retail and corporate customers. With operations in more than 60 countries, the company offers a broad selection of financial services products including deposits, consumer loans, corporate loans, mortgage banking, capital markets, investment banking and wealth management. JPMorgan acquired Bear Stearns in March 2008 and Washington Mutual in September 2008.
Risk weighting
In the absence of UCITS compliance, US structured covered bonds are treated in the same way as senior bank debt under the CRD.

Business profile: JPMorgan Chase & Cos primary businesses are retail banking, credit cards, investment banking, commercial banking, treasury and securities services and asset management. The company operates 5,000 branches in 23 states and has the third-highest deposit market share in the US at 9%. In investment banking, JPMorgan ranks among the top providers of debt and equity underwriting and trading and financial advisory on a global basis. Asset quality: JPMs asset quality has begun to improve following significant deterioration in 2008 and 2009. In 2009, non-performing assets (NPAs) grew 55%, reaching $19.7bn by Q4 09 (3.1% of loans). In Q1 10, non-performing assets declined for the second consecutive quarter (-3.6% in Q1 10; -3% in Q4 09), signalling sustainable improvement. NPAs over loans are 2.7% as of Q1 10 with net charge-offs at 4.4%. Reserves over NPAs reached 201%, which puts JPMorgan in third place on this metric within our 25-bank aggregate. In line with this, JPMorgan released $0.9bn of reserves during Q1 10 and said in its outlook that if current trends continue, loan losses in home equity, subprime, and prime mortgages will be below previously released expectations. Profitability: JPMorgan reported strong Q1 10 earnings driven by excellent results in its investment bank, particularly fixed income capital markets. Net income was $3.3bn, up from $2.1bn in Q1 09 (contrary to most US banks, JP Morgan remained profitable in every quarter during 2008-09). We believe JPMorgan has strong earnings potential. Recently, the company stated it targets $2224bn per year in earnings when credit costs return to normal. That considered, as a large financial institution, it could be subject to revenue pressure resulting from financial reform. In addition, the Credit Card Act is expected to reduce revenues by $500-750mn per year, Capitalisation: Tangible common equity was 5.2% of assets as of Q1 10, up from 4.4% as of Q1 09. The Tier 1 capital ratio was 11.5%, staying relative flat when compared to Q1 09. JP Morgan was not required to raise capital following completion of the stress test as regulators deemed it strong enough to withstand the embedded losses in its portfolio. It paid back $25bn of TARP preferred shares in June 2009, issuing $5.8bn of common stock at the time.
Strengths
Earnings and diversified business mix. Asset quality metrics are improving with losses likely to be below initial expectations.
Weaknesses
Regulatory reform could create revenue pressure in certain business lines. It is still early to assess the full impact.
Key points for 2010

Confirmation of asset quality trends. Impact of regulatory reform on business model.
10 June 2010
666
Commercial banks
Financial summary
$ million Q1 09 Q2 09 Q3 09 Q4 09 Q1 10
JPMorgan (JPM)
Option-adjusted spread senior debt
$2,141.0 $2,721.0 $3,588.0 $3,278.0 11,652.0 12,103.0 13,167.0 11,160.0 906,969 170,194 90,000 0.41 4.72 3.25 46.59 52.62 2.65 4.43 8.19 11.4 15.2 35 78 4.79 2.45 3.92 240 187 1.56 0.70 2.06 7.42 $8,596 4,396 27,381 11,401 3,253 14,654 866,477 154,766 98,326 0.53 6.38 3.06 50.55 49.57 2.01 4.97 7.64 9.7 13.3 34 79 4.66 3.49 4.31 197 166 1.21 0.86 2.56 9.53 $8,031 6,019 29,072 14,785 2,732 17,517 867,977 162,253 105,767 0.72 9.17 3.12 52.16 50.15 2.07 5.31 7.95 10.2 13.9 33 75 4.91 3.86 4.73 172 150 1.20 1.00 3.11 10.56 $8,104 6,373 30,633 17,767 2,595 20,362 938,367 165,365 108,856 0.66 7.96 3.04 46.56 51.69 1.81 5.49 8.14 11.1 14.8 32 68 4.57 3.88 5.03 180 160 1.28 0.97 3.11 10.02 $7,284 6,177 31,602 17,564 2,177 19,741 $3,326.0 11,547.0 925,303 164,721 108,210 0.65 8.11 3.27 50.45 58.27 1.46 5.18 7.71 11.5 15.1 36 77 3.87 4.36 5.35 224 201 1.21 0.89 2.66 9.37 $7,010 7,910 38,186 17,050 1,969 19,019
Net Income Pre-Tax Pre-Provision Income Assets Deposits Total Shareholders Equity Tangible Common Equity Profitability Return on Assets (ROA) (%) Return on Equity (ROE) (%) Net Interest Margin (NIM) (%) Noninterest Inc. % Total Revenue Efficiency Ratio (%) Pre-tax Pre-Provision Income / Net Chargeoffs Capitalization Tangible Common Equity % Tangible Assets Total Equity % Assets Tier l Capital Ratio (%) Total Capital Ratio (%) Avg. Loans % Avg. Assets Loans % Deposits Asset quality Loan Loss Provision % Average Loans Net Chargeoffs % Average Loans Loan Loss Reserve % Loans Loan Loss Reserve % Nonaccrual Loans Loan Loss Reserve % Nonperforming Assets Loan Loss Reserve % Net Chargeoffs (years) Nonperforming Assets % Total Assets Nonperforming Assets % Loans & OREO Nonperforming Assets % Equity + Res. Loan Loss Provision Net Charge Offs Loan Loss Reserve Nonaccrual Loans Other Nonperforming Assets Total Nonperforming Assets
500 400 300 200 100 0 Dec-07 Jul-08 Feb-09 Sep-09 Apr-10
2,079,188 2,026,642 2,041,009 2,031,989 2,135,796
Portfolio composition, December 2009

Other, 11.6% Consumer Loans, 19.9% C&I, 17.3% CRE, 8.6% Constuction , 1.1% Mortgages, 25.4% Home Equity, 16.1%
Provisions and reserve additions

$10,000 $8,000 $6,000 $4,000 $2,000 $0 ($2,000) Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Loan Loss Provision Addition to Reserves
Tier 1 Tangible common equity ratios

15 % 10 % 5% 0% Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Tangible Common Equity % Tangible Assets Tier l Capital Ratio (%) 9.2% 8.9% 10.9% 11.4% 11.1% 9.7% 10.2% 11.5%
Portfolio quality metrics

4% 3% 2% 1% 0% Q2 08 Q3 08Q4 08 Q1 09Q2 09 Q3 09Q4 09 Q1 10 Nonperforming Assets % Loans & OREO Nonperforming Assets % Equity + Res. 5% 0% 15% 10%
4.7% 4.2% 4.1% 4.4% 5.0% 5.3% 5.5% 5.2%
10 June 2010
667
Kommunalkredit Austria (KA)

Description
% Index 0.077 % Index NA Total assets 18bn LT senior unsecured ST Outlook Discontinuity factor* Collateral score*
Notes: * In %
Fritz Engelhard
Ratings table
Moodys Baa1 Aaa Stable 6.5 S&P NR NR Fitch A NR Stable -
Initially, Kommunalkredit Austria (KA) was established in 1958, with the goal of creating a specialised bank supporting local authorities in Austria through the provision of long-term finance. Between 1992 and 2008, the bank had strong ties with the French Dexia Credit Local, which from 2001 held 49% of the banks shares. In H2 08, the bank suffered from the stress in the financial system and a liquidity gap that represented 25% of its assets. On 3 November 2008, the Republic of Austria for the symbolic price of 1 acquired a 99.8% stake in Kommunalkredit, with the remainder being held by the Austrian association of municipalities (Gemeindebund). A total of 372mn of unsecured claims of the former stakeholders was converted into capital. About one year later, on 28 November 2009, the bank was split into two entities. All strategic activities were transferred to Kommunalkredit Depotbank AG, a former 100% subsidiary of KA, which was renamed Kommunalkredit Austria AG (KA new). Non-strategic assets were kept in the old entity, which was renamed KA Finanz AG (KF). Within this process, a further 250mn of capital was injected into KA new. The banks covered bonds were transferred to KA new, together with the attached cover assets. Outstanding government guaranteed bonds (GGBs) were largely (5.5bn) kept in KF, as only 1bn remained with KA in order to help refinance the debtor warrant structure (see below).
Risk weighting
Austrian covered bonds carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive and may achieve a lower risk weighting under the IRB.
Strengths
Ownership support: The take-over of Kommunalkredit by the Austrian government underlines the substantial systemic support for the bank. On 30 December 2008, Kommunalkredit received a commitment from the Austrian government to help it achieve a Tier 1 capital ratio of 7% as of 31 December 2008, through acceptance of a guarantee on troubled financial assets. As of 24 April 2009, the guarantee was closed with a volume of 1.2bn. Through the guarantee the bank was able to continue to value its troubled assets at cost and thus avoid making provisions for these exposures. The guarantee was reduced to 1bn and assigned to KF. The Austrian government also injected 250mn into KA new. At the same time KA waived its claim against KF for repayment of 1bn of money market deposits against issue of a debtor warrant. KF will, from its future annual surpluses, make payments to KA equal to the amount waived, plus market interest rates. In addition, KA entered into a put arrangement with a special purpose vehicle, granting KA the right to sell the debtor warrant to it by the end of the exercise period of the put option (28 November 2012) at a price equal to the amount waived, plus accrued interest, minus payments made under the debtor warrant. Over-collateralisation: As of 31 December 2009, the public sector covered bonds (fundierte Bankschuldverschreibung) issued by Kommunalkredit benefited from nominal overcollateralisation of 26% (YE 08: 21%).
Weaknesses
Business model: KA new was recapitalised and freed from the burden of its legacy assets. This enables it to reposition itself in the banking market. However, in our view, its narrow business focus on providing financing to Austrian municipalities and infrastructure project loans limits its capacity to get on to a path of sustainable profitability, as competition from domestic banks in this area has increased, interest rate margins are rather small and funding costs are comparatively high on the back of the banks high reliance on capital markets funding. Imposed business restrictions: The substantial support Kommunalkredit received from the Austrian government is subject to approval by the EU and Austrian regulatory authorities. Usually such approval is subject to certain limitations, which may include the necessity to wind down and/or dispose of certain operations, and reduce risk exposures and restrictions relating to the competitive behaviour. On 10 June 2009, the Austrian government transferred the banks restructuring plan to the EU. While the European Commission has approved the split of the bank, final approval is expected in the course of 2010. At this stage it is not clear to what extent the respective restrictions may hamper the ability of Kommunalkredit to recover. Ownership: Following the spin-off of the banks non strategic assets and the subsequent recapitalisation, KAs business plan foresees a profit target of 32mn, which shall be reached in 2012. According the banks management, this increase in profitability should be the basis for a privatization of the bank.
Key points for 2010

Track EU approval for state aid. Monitor progress in repositioning the bank and discussions surrounding the planned privatisation. 668
10 June 2010

mn Income statement summary 2008* 2009
Kommunalkredit Austria (KA)

Structure of assets, YE 09
HtM fin. assets 3% AfS fin. assets 3% Other 10% Claims vs. banks 24%
Net interest income Net fees & com's Trading income Operating Income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income
Balance sheet summary
590 876 357 1,846 923 923 0 923 719 58 0 46 0 0 7 -
5867 2202 -1790 7,364 4834 2,530 690 3,219 2,916 18,283 7,669 1,043 13,284 7,270 421 14.3 17.7 2.3
FV fin. assets 18%
Claims vs. customers 42%
Structure of liabilities, YE 09
Equity 2% Other 9% Interbank liab. 12% Customer liab. 6% Covered bonds 39%
Total assets Customer loans Customer deposits Debt funding of which PS Covered Bonds Total equity
Capital adequacy (%)
Other debt securities 32%
Tier 1 ratio Total capital ratio Equity/Assets ratio

*Kommunalkredit Depotbank

bn 18 1.48x 12 6 0 2004 2005 2006 2007 2008 2009 Restricted Assets (bn) Covered Bonds (bn) Over-collateralisation (x) 2.0 1.5 1.0 0.5 0.0
1.42x
1.25x
1.35x 1.21x
1.26x
Security type public sector, Q3 09

Securities 26%
Geographical split public sector, Q3 09

Others 14.0% Germany 7.0% Italy 6.0% Switzerland 12.0% Austria 61.0%
Loans 74%
Rating split public sector, Q3 09

AAA 23.0% A 15.0% AA 62.0%
10 June 2010
669
National Bank of Greece (ETEGA)

Description
Leef H Dierks
Ratings table
Moodys Baa2* A1* Negative 17.3 S&P BB+ NR Negative Fitch BBB-* A-* Negative 39.3 -
Founded as a commercial bank in 1841, National Bank of Greece (ETEGA) is the oldest of the Greek banks and, with total assets of 113.4bn at year-end 2009, the countrys largest financial institution. ETEGA enjoyed the right to issue banknotes until the establishment of the Bank of Greece in 1928. Nowadays, ETEGA provides private, corporate, retail and investment banking services, brokerage, insurance, asset management, leasing and factoring through more than 575 branch offices to 7mn clients in Greece where ETEGA benefits from an average market share of 22%. In recent years, ETEGA has increased in presence in Central and Eastern Europe (CEE) by acquisitions of the United Bulgarian Bank in Bulgaria (2002), Banca Romanesca in Romania (2003), and Finansbank in Turkey (2006), where ETEGA now operates through more than 450 branch offices.
Note: * Watch Negative. As at 7 June 2010.
Risk weighting
As Greek covered bonds are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Market position: ETEGA is well positioned in its domestic market where it benefits from a sound average market share of 22%. More precisely, in deposit taking, the domestic market share stood at 24% which compares with a high 33% market share in savings accounts. This also applies to ETEGAs Turkish operations, Finansbank, which benefited from an 11% market share in mortgage lending in Turkey. The overall market share in consumer credit in Turkey stood at 4.7% at year-end 2009. Funding profile: With customer deposits up 5.2% y/y to 71.2bn in 2009, from 67.7bn in 2008, and customer lending largely growing at the same pace (+6.9% y/y) to 74.8bn in 2009, from 59.9bn in 2008, ETEGA benefitted from a relatively sound funding profile with a customer deposits to loan ratio of 95%. Yet, owing to a sharp 46% y/y increase in interbank liabilities to 21.6bn in 2009, from 14.8bn in 2008, the proportion of wholesale funding to total funding increased to 25% in 2009, from 20% a year before. Still, in Q1 10, customer deposits markedly declined. Capitalisation: in 2009, ETEGAs Tier 1 ratio climbed to 11.3% from 10.0% in 2008. Over-collateralisation: The covered bond issued by ETEGA benefits from a sound 140% over-collateralisation.
Weaknesses
Loan-loss provisions: Over the course of 2009, ETEGAs loan-loss provisions more than doubled to 1.1bn, from 520mn in 2008. Accumulated provisions amounted to 2.5bn at year-end 2009 which correspond to 3.4% of all lending. The coverage ratio stood at 64%. Overall, ETEGAs non-performing loan (NPL) ratio stood at 5.4% at year-end 2009, with loans in arrears accounting for 6.4% of the entire loan book. This development has meanwhile started to leave its mark on ETEGAs profitability, with the net profit attributed to domestic operations falling by 57% y/y to 398mn in 2009, as provisions for domestic NPLs surged to 618mn in 2009, from 322mn in 2008. The recognition of impairment losses on bonds and shares jumped to 237mn in 2009, from 18mn in 2008. In light of the recent austerity measures implemented in Greece, the NPL ratio could eventually be subject to further rise, particularly in light of ETEGAs 5bn exposure to the countrys smaller and medium-sized enterprises (SME). Net loan growth in Greece accounted for 4.5bn in 2009, which corresponds to a 10% y/y increase. Lending to the Hellenic Republic amounted to 5.6bn in 2009, up from 5.4bn a year before. In terms of geographical distribution, lending to Greece accounted for 71% of all loans, followed by Turkey, which accounted for 15% in 2009. Rating pressure: At the time of writing, the senior unsecured ratings of ETEGA stood at Baa2 (Watch Negative) (Moodys), BB+ (S&P), and BBB- (Watch Negative) (Fitch). In light of the currently challenging economic environment in Greece and continuous rating pressure on the sovereign, ETEGAs ratings remain subject to ongoing pressure. With regards to the covered bonds, following a downgrade of ETEGA below Baa3 (Moodys)/BBB- (Fitch), the issuer will no longer be entitled to withdraw the amounts credited on the transaction account. Pressure on sovereign debt market: Greek government bonds suffered from rising pressure in European sovereign debt markets. The pressure on Greek government bonds and the Greek economy leads to a rather restrictive management of country exposure to Greece by many investors and other counterparties. This limits the ability of Greek banks to fund themselves abroad and also restricts their ability to reduce reliance on central bank emergency funding operations.
Note: At the time of writing, ETEGA had a single EUR-denominated, benchmark covered bond outstanding with an aggregate nominal amount of 1.5bn within the scope of its 10bn covered bond programme.
Key points for 2010

In light of the economic situation in Greece, the further development of ETEGAs asset quality needs to be carefully monitored, particularly in light of the increase in NPL, which have left their mark on the lenders profitability. 10 June 2010 670

Financial summary
EUR mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Covered Bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset Quality (%) LLPs/Pre-prov income LLRs/Gross loans Problem loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2008 3,580 772 427 4,803 2,219 2,584 538 1,937 1,585 101,323 69,898 22,279 67,657 1,814 8,267 1.6 19.2 46.2 74.5 20.8 0.8 2.4 92.9 10.0 10.3 8.2 2009 3,940 686 428 4,982 2,303 2,679 1,295 1,252 963 113,394 74,753 24,482 71,194 1,860 1,500 9,828 0.9 10.6 46.2 79.1 48.3 1.7 4.1 78.1 11.3 11.3 8.7
National Bank of Greece (ETEGA)

Efficiency ratios
60% 2.2% 2.1% 2.2%
50%
46.2%
2.0% 46.2% 1.8%
40% 2008 Cost/Income ratio 2009
Cost/Assets ratio

4% 3% 2% 1% 0% 2008 Net interest margin Credit costs 2009 RoA 1.6% 0.5% 1.2% 0.9% 3.5% 3.7%

100% 96.8% 95.2% 24.8% 19.8% 75% 2008 2009 Customer deposits to loans Wholesale funding in percent of all funding 10% 30%
20%
Over-collateralisation of covered bonds, 2010

Over-collateralisation (x) 1.5 5.5 5.3 1.0 0.5 0.0 Jun-09 Covered bonds 2.0 2.0 7.0 5.2 3.5 EUR bn 1.4x 8 5.0 6 4 2
Structure of covered bond collateral pool, 2010

Attica 44%
Thessalonik 9% Dodekanisa 2%
0 Sep-09 Dec-09 Mar-10 Mortgages Over-collateralisation
Other 41%
Achaia 4%
10 June 2010
671
OP Mortgage Bank (OPMBK)

Description
Leef H Dierks
Ratings table*
Moodys Aa2 Aaa Negative 2.7 S&P AAAAA** Stable Fitch AANR Negative -
OP Mortgage Bank (OPMBK) is a fully-owned (100%) subsidiary of the OP-Pohjola Group; Finlands largest financial services provider. Among others, the latter comprises OP Mortgage Bank and 220 member cooperative banks, which are local deposit banks that are engaged in retail banking. In addition to retail banking, the group provides insurance services to 4.1mn domestic and 200,000 clients in the Baltic region through c.12,600 employees in more than 600 branch offices. The sole purpose of OPMBK is to raise funds for the member banks of the OP-Pohjola Group by issuing mortgage covered bonds. The history of the group dates back to 1902, when OKO Bank, which in 2005 acquired a majority stake in insurer Pohjola, was founded. The current structure of OP-Pohjola Group was established in 2007.
Note:* Ratings refer to Pohjola Bank As at 7 June 2010. ** CreditWatch negative.
Risk weighting
Finnish Covered Bonds carry a 10% risk weighting under the Standardised Approach of the EU Capital Requirements Directive (CRD). They may qualify for lower risk weighting in the IRB Approach.
Strengths
Asset quality: At the time of writing, OPMBKs covered bonds benefited from a very high over-collateralisation. At 4.00bn, the collateral pool amounted to almost twice the volume of covered bonds outstanding (2.25bn). As per year-end 2009, the weighted average LTV of the collateral pool stood at 47% with all mortgages being secured by properties in Finland ie, there not being any exposure to the Baltic countries. Overall, regarding OP-Pohjola Group, net impairment losses on loans and receivables surged to 179mn in 2009, from 58mn in 2008, thereby remaining at modest levels. Also, as the majority of credit losses derived from corporate exposure, we do not expect this to have any effect on the collateral pool of the covered bonds issued. Market share: OPMBKs parent company, OP-Pohjola Group, benefitted from a market share of 32.7% of all lending in Finland as at year-end 2009, up from 32.0% a year before. At the same time, its market share in deposit taking stood at 33.2%, slightly down from 33.8% in 2008. New home loans, in which OP-Pohjola Group enjoyed a high market share of 35.9% in 2009, thereby being the largest player on the Finnish mortgage market. New mortgage lending increased to 5.7bn in 2009, down from 7.0bn in 2008. Parent company: As OPMBK is fully-owned (100%) and integrated into OP-Pohjola Group, Finlands largest financial services provider, where it operates as the exclusive refinancing vehicle with respect to residential mortgage loans originated by its member banks, we understand it to be a strategically crucial entity of the group. This makes support in the event of financial distress appear probable, in our view. Considering the groups large domestic retail franchise, we believe there is a high likelihood that support from the Finnish state would be granted in the case of financial distress.
Weaknesses
Regional concentration: The cover asset pool backing the covered bonds issued by OPMBK is exclusively collateralised by first ranking mortgages secured on Finnish property, of which 47% are located in southern and 33% in western Finland. Despite this concentration in a relatively small market with a population of 5.2mn and 2.7mn dwellings, respectively, we believe the clustering risk to be sufficiently mitigated in light of the expected recovery of the Finnish economy with a potential GDP growth of 1.4% y/y in 2010. In 2009, the countrys GDP contracted 7.8% y/y. Interest rate risk: More than 95% of the collateral pool consisted of mortgage loans with a variable interest rate (mostly the 12month Euribor). In the case of ECB rate hikes (which we do not expect to occur before Q1 11), this might leave its mark on the asset quality. Yet, this interest rate risk, in our view, is fully mitigated by hedging agreements.
Note: At the time of writing, OPMBK had three benchmark covered bonds outstanding with an aggregate volume of 3.25bn within the scope of its 10bn EMT Covered Note programme.
Key points for 2010

Monitor the possible impact of a rate hike on the asset quality of OPMBK as more than 95% of the mortgage loans in the collateral pool are pegged to a variable rate such as the 12-month Euribor.
10 June 2010
672

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector Customer deposits Debt funding of which covered bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007* 2008* 2009*
OP Mortgage Bank (OPMBK)

Mortgage lending by region, 2010
Lapland 2% Oulu 13% Eastern Finland 5%
1,048 422 -30 1,617 883 734 13 288 288 65,716 44,776 na 31,224 15,687 5,638 0.49 5.57 54.61 64.81 1.8 0.0 0.1 11.1 12.2 13.8 8.6
1,189 433 -5 1,794 1,238 556 58 372 -365 75,746 51,708 na 34,533 17,747 2 5,215 -0.54 -6.85 69.01 66.28 10.4 0.0 0.4 0.0 12.6 12.6 6.9
1,070 496 208 1,951 1,247 704 179 464 1,140 80,430 52,992 na 34,617 18,595 3 6,187 1.54 20.07 63.92 54.84 25.4 0.0 0.4 0.0 12.6 12.6 7.7
Southern Finland 47% Western Finland 33%

80% 76.0% 70.0% 36.1% 69.7% 50% 66.8% 35.1% 65.3% 34.9% 30%
60% 30.8% 40% 2005
34.8%
10% 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding
Distribution of mortgage book by LTV ratio, 2009

<10% 1% 10-20% 4% 20-30% 9% 30-40% 14%
Note: * Figures with an asterisk were prepared according to IAS/IFRS.
50-60% 53%
40-50% 19%
10 June 2010
673
OTP Mortgage Bank (OTP)

Description
% Index 0.015 % Index NA Total assets HUF9,775bn LT senior unsecured Covered bond rating Outlook
Leef H Dierks
Ratings table
Moodys Baa1 A2 Negative S&P BB+ NR Stable Fitch NR NR NR
OTP Mortgage Bank (OTP) is a wholly-owned subsidiary of OTP Bank, which is the largest financial services provider in Hungary. In 2001, OTP Bank established OTP Mortgage Bank as a special banking institution operating under the Hungarian Act on Mortgage Banks and Mortgage Bonds. Its business aim is to provide its clients with both state-subsidised and non-subsidised mortgage loans, land mortgage loans, and home equity loans through OTP Banks domestic network of more than 400 branch offices. As at year-end 2009, the latest date for which data were available, 73.5% of OTP Banks share capital was held by foreign investors, down from 75% in 2008 and 85% in 2007. Domestic investors, among them the Hungarian government with a 0.5% stake, held the remainder. Among the largest stakeholders is French financial services group Groupama, which held 9.2% as at year-end 2009.
Note: Ratings refer to OTP Bank As at 7 June 2010.
Risk weighting
As Hungarian covered bonds are compliant with the EU Capital Requirements Directive (CRD), they carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach.
Strengths
Market position: OTP Bank benefits from a strong position in the Hungarian mortgage market, which at the time of writing, was dominated by only three mortgage-lending institutions. OTP Bank (ie, the parent company) is the largest financial services provider in Hungary with a market share of c.23.5% in terms of total assets, c.25.1% by customer deposits and c.20.7% by customer lending. Funding profile: As at year-end 2009, customer deposits corresponded to a high 89% of OTPs lending, up from 78% in 2008. At the same time, wholesale funding in percentage terms of total funding had fallen to 30.5% in 2009, from 34.0% in 2008. Parent: OTP Mortgage Bank benefits from its close integration into OTP Bank, Hungarys largest financial services provider, which provides universal banking services to almost 11.9mn clients in nearly 1,500 branch offices. OTP Mortgage Bank is an integral part of OTP Bank's franchise and the mortgage bank is managed as a proper division of OTP Bank. The ratings of OTP Mortgage Bank are also based on its strategic role as the exclusive refinancing vehicle for OTP Banks Hungarian mortgage loan portfolio, as well as its high operational integration into OTP Banks retail operations. OTP Mortgage Bank is dependent on its parent for credit origination, selected treasury activities, as well as financial reporting. In addition to the Hungarian market, OTP also operates in eight Central and Eastern European (CEE) countries through subsidiaries: in Bulgaria (DSK Bank), in Croatia (OTP Banka Hrvatska), in Romania (OTP Bank Romania), in Serbia (OTP Banka Srbija), in Slovakia (OTP Banka Slovensko), in Ukraine (CJSC OTP Bank), in Montenegro (Crnogorska komercijalna banka), and in Russia (OAO OTP Bank).
Weaknesses
Loan-loss provisions: Spurred by loan-loss provisions which more than doubled (+124% y/y in 2009) to HUF249bn in 2009, from HUF111bn in 2008, OTPs net income sharply contracted by 38% y/y to HUF150bn in 2009, from HUF241bn in 2008. The sound growth in OTPs net interest income, which, over the same period increased by 35% y/y to HUF590bn in 2009, from HUF437bn in 2008, could not offset this development. Market exposure: Given Hungarian covered bond legislation, the collateral of Hungarian covered bonds consists exclusively of Hungarian real estate. Consequently, Hungarian covered bonds have direct exposure to the Hungarian residential housing market. As several mortgage loans granted are denominated in foreign currencies such as CHF or JPY, for example, but secured on Hungarian real estate, exclusively, in light of a potentially depreciating Hungarian forint, this might well lead to an increase in non-performing loan ratios and thus potentially put a strain on the collateral pool, as well as on the banks earnings. Rating agencies have expressed concerns about the likelihood of severe repercussions on OTP's financial profile in 2009 and 2010 as a result of accelerating economic contraction and industry risk in Hungary and other parts of CEE, where the bank has expanded significantly in recent years. Covered bond liquidity: With merely one larger (750mn) EURdenominated covered bond outstanding at the time of writing, liquidity was comparatively modest.
Note: At the time of writing, OTP had a 750mn covered bond outstanding within the scope of its 3.00bn Mortgage Securities Programme for the issuance of Hungarian Mortgage Bonds and Mortgage Notes.
Key points for 2010

Loan-loss provisions, which more than doubled over the course of 2009 to one-third of operating income, need to be carefully monitored, particularly as they have started to have some effect on OTPs profitability.
10 June 2010
674

Financial summary
HUF bn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset Quality (%) LLPs/Pre-prov income LLRs/Gross loans Problem loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio
Note: Numbers refer to OTP Bank.
OTP Mortgage Bank (OTP)

2007 452 133 6 631 254 377 58 249 209 8,461 5,582 na na 5,038 1,286 896 2.7 24.8 40.3 71.6 15.4 1.0 na na na na 10.6 2008 437 135 1 601 284 317 111 274 241 9,379 6,730 na na 5,219 1,843 1,049 2.7 24.8 47.3 72.8 35.2 1.6 na na na na 11.2 2009 590 133 8 797 266 531 249 170 150 9,755 6,413 na na 5,689 1,691 1,192 1.6 13.4 33.4 74.0 46.9 3.6 na na na na 12.2
2006 356 113 8 502 232 270 29 219 142 7,097 4,347 na na 4,232 1,120 788 2.3 21.3 46.2 70.9 10.6 0.6 na na na na 11.1
8% 6% 4% 2% 0% 2005 2006 2007 2008 Net interest margin Credit costs 5.7% 2.3% 0.5% 5.8% 5.8% 4.9% 2.3% 0.5% 2.7% 0.7% 2.7% 1.2% 1.6% 2.6% 2009 RoA 6.2%
Efficiency
70% 60% 50% 40% 30% 2005 2006 2007 2008 2009 Cost/Income ratio Cost/Assets ratio 46.1% 46.2% 40.3% 47.3% 33.4% 2% 0% 3.7% 3.8% 3.3% 3.2% 2.8% 6% 4%

110% 100% 90% 80% 70% 2005 2006 2007 2008 2009 Customer deposits to loans Wholesale funding in % of total funding 107% 25.4% 29.6% 97% 29.3% 90% 34.0% 30.5% 40% 35% 30% 78% 89% 25% 20%
10 June 2010
675
Royal Bank of Canada (RY)

Description
% Index 0.126 % Index NA Total assets CAD654.9bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table
Moodys Aaa Aaa Negative S&P AAAAA Stable Fitch AA AAA Stable 18.1 -
RBC Royal Bank of Canada (RY) is Canadas largest bank in terms of total assets, which amounted to CAD655bn at year-end 2009, down 10% y/y from CAD724bn in 2008. At end-January 2010, RY ranked among the 15 largest banks globally in terms of market capitalisation in USD. RY was originally founded as The Merchants Bank in Halifax in 1864, before rebranding itself as The Royal Bank of Canada in 1901. It provides retail and commercial banking as well as wealth management and insurance services to more than 18mn clients in Canada and 53 other countries through more than 77mn clients. In its domestic market, RY benefits from high market shares (ranking first or second) for most retail products and has the largest branch network (1,197 offices). RY also benefits from a branch network comprising 438 offices in the southeastern US.
Risk weighting
Strengths
Asset quality: With regards to its domestic operations. RY benefits from a sound asset quality with gross impaired loans as a percentage of net loans and acceptances standing at a low 0.5%. Overall, RYs total assets fell 10% y/y (CAD69bn) to CAD655bn in 2009, from CAD724bn in 2008, with approximately half of the decrease due to the impact of the stronger CAD on the translation of mainly USD-denominated assets. At the same time, the decrease in the fair value of derivatives also contributed to the decrease. Interest-bearing deposits with banks fell CAD11bn y/y as a result of significantly lower levels of interbank lending over the course of the past year. With regards to the balance sheet composition, RYs total liabilities fell 11% y/y (CAD75bn), again, with approximately half of the decrease attributable to the impact of the stronger CAD on the translation of mainly USD-denominated liabilities. Customer deposits decreased 9% y/y (CAD40bn) over the same periods, largely due to lower business and government deposits as a result of lower funding requirements, the stronger Canadian dollar and decreases in personal term deposits resulting from the historically low interest rate environment. The proportion of customer deposits to all loans increased 6pp y/y to 54.2% in 2009, from 48.0% in 2008, thereby gradually reducing the lenders reliance on wholesale funding. Over-collateralisation: With covered bonds outstanding totalling CAD6.3bn and the respective collateral pool amounting to CAD17.0bn at end-March 2010, the latest date for which data were available, the covered bonds issued by RY benefitted from a very high over-collateralisation of 269%. The WA LTV stood at 62% with 93.2% of all mortgage loans being secured on owner-occupied property; 70.3% of mortgage loans are subject to a fixed interest rate. Capitalisation: In 2009, RYs Tier 1 ratio climbed to 13.0%, from 9.0% in 2008.
Weaknesses
Loan-loss provisions: Largely due to a trebling of the provisions for credit losses in its US operations, which surged to CAD1.8bn in 2009, from CAD643mn in 2008, RYs total loan-loss provisions more than doubled to CAD3.4bn in 2009, from CAD1.6bn in 2008. As this development has started to leave its mark on the lenders net income, which fell 15.3% y/y to CAD3.9bn in 2009, from CAD4.6bn in 2008, further development of RYs (US) operations needs to be closely watched. Still, we believe that the lenders overall profitability sufficiently mitigates that risk as total revenues were up almost CAD8bn to CAD29.1bn in 2009, from CAD21.6bn in 2008. Overall, gross non-performing loans (NPLs) amounted to CAD5.5bn in 2009, up 87% y/y from CAD2.9bn in 2008. The coverage ratio fell to 60.5% in 2009, from 78.7% in 2008. US operations: RYs US operations, which focus on North and South Carolina, Virginia, Alabama, Florida and Georgia need to be monitored as they suffered the sharpest increase in loan-loss provisions in 2009. At the same time, the operations generated a net loss of CAD1.1bn in 2009, after a net profit of 152mn in 2008. Overall, RY operates through 438 branch offices in the US. We highlight that the lenders exposure in the US market is mitigated as Canadian banking, with a net income of CAD2.7bn, generated 69% of RYs net income in 2009.
Note: At the time of writing, RY had a total of two EUR-denominated, benchmark Canadian covered bonds outstanding with an aggregate nominal amount of 3.25bn. At the same time, two USD-denominated covered bonds totalling $1.6bn were outstanding.
Key points for 2010

Monitor further development of RYs loan-loss provisions and the net income growth in US operations.
10 June 2010
676

Financial summary
CAD mn 2006 Income statement summary Net interest income 6,796 Net fees & com's 1,243 Trading income 2,574 Operating income 20,637 Operating expenses 11,419 9,218 Pre-provision income Loan loss provisions 429 Pre-tax profit 6,204 Net income 4,728 Balance sheet summary Total assets 536,780 Customer loans 208,530 of which public sector na of which mortgages 100,800 Customer deposits 114,040 Debt funding 167,678 of which Covered Bonds 0 Total equity 22,123 Profitability (%) Return on assets 0.8 Return on equity 22.5 Cost/Income ratio 55.3 Net int inc/Op inc 32.9 Asset Quality (%) LLPs/Pre-prov income 4.7 LLRs/Gross loans 0.2 Problem loans/Gr loans 0.1 Coverage ratio 317.1 Capital adequacy (%) Tier 1 ratio 9.6 Total capital ratio 11.9 Equity/Assets ratio 4.1 2007 7,702 1,353 1,999 22,462 12,377 10,085 791 7,025 5,492 600,346 237,936 763 113,200 116,557 207,519 2,844 24,439 1.0 24.8 55.1 34.3 7.8 0.3 0.1 324.8 9.4 11.5 4.1 2008 9,048 1,377 -96 21,582 12,216 9,366 1,595 6,005 4,555 723,859 289,540 1,767 122,991 139,036 250,755 4,727 30,758 0.7 17.7 56.6 41.9 17.0 0.5 1.0 78.7 9.0 11.1 4.2 2009 11,506 1,358 2671 29,106 14,096 15,010 3,413 5,526 3,858 654,989 280,963 2,245 122,130 152,328 216,313 6,327 36,906 0.6 12.6 48.4 39.5 22.7 1.2 1.9 60.5 13.0 14.2 5.6
Royal Bank of Canada (RY)

Efficiency ratios
70% 60% 50% 40% 2005 2006 2007 2008 Cost/Income ratio 58.9% 55.3% 55.1% 1.8% 48.4% 2009 1.5% 2.4% 2.3% 2.5% 2.2% 56.6% 2.0% 2.0%
Cost/Assets ratio

2% 1.4% 1% 0.7% 0.1% 0% 2005 2006 2007 2008 Credit costs 2009 RoA Net interest margin 1.4% 0.9% 1.4% 1.0% 0.1% 1.4% 0.7% 0.2% 0.6% 0.5% 1.7%
0.1%

60% 55% 50% 45% 40% 2005 2006 2007 2008 2009 Cust. deposits to loans Wholesale funding % of total funding 59.9% 61.0% 54.7% 49.0% 48.0% 56% 64.6% 67.0% 66.8% 54.2% 61.3% 68% 64% 60%
Over-collateralisation of covered bonds 2010

Overcollateralisation (x) 15.7 8 16.6 5.9x 14.3 4 2.8 0 3.3x 4.7 4.7 17.0 13.7 3.0x 4.7 12.9 2.9x 4.7 12.3 2.7x 4.7 2.6x 12 6.3 6 CAD bn 18
Structure of covered bond collateral pool, 2010

Other 14% Alberta 14% British Columbia 18% Ontario 39%
Quebec 15%
0 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Mar-10 Covered bonds Mortgages Overcollateralisation
10 June 2010
677
Sparebank 1 Boligkreditt (SPABOL)

Description
% Index 0.064 % Index NA Total assets NOK84.2bn LT senior unsecured Covered bond rating Outlook Discontinuity factor Collateral score
Leef H Dierks
Ratings table*
Moodys A1 Aaa Negative 2.7 S&P NR NR NR Fitch A AAA Negative 15.3 -
SpareBank 1 Boligkreditt (SPABOL) was established in 2006 as a mortgage company whose business purpose is to secure parts of its owner banks refinancing requirements by acquiring loan portfolios and refunding them through the issuance of covered bonds. Therefore, a 10bn covered bond programme was set up out of which 5.75bn had been issued at the time of writing. SPABOL is owned by the so-called SpareBank 1 Alliance, which comprises 22 independent savings banks, among them SpareBank 1 SR-Bank, SpareBank 1 SMN, and SpareBank 1 NordNorge, which together own 69% of SpareBank 1 Boligkreditt. Roughly two-thirds of these institutions combined loan books consists of retail lending (mostly mortgages) with the remainder being lending to SMEs. In their local markets, the savings banks typically are market leaders with an average market share of roughly 40%. As per year-end 2009, SpareBank 1 Alliance was the second-largest retail mortgage lender in Norway.
Note: *Ratings refer to SpareBank 1Gruppen as at 7 June 2010.
Risk weighting
Despite Norway not being an EU member state, Norwegian Obligasjonsln med portefoljepant (covered bonds) technically fulfill the EU Capital Requirements Directive (CRD) and thus carry a 10% risk weighting under the Standard Approach. They may qualify for lower risk weightings in the IRB Approach, however.
Strengths
Asset quality: In 2009, lending to customers doubled (+105% y/y) to NOK74bn from NOK36bn in 2008. The loan book consists exclusively of first-lien residential mortgage loans with an average loan-to-value (LTV) of around 49% and no (0%) non-performing loans (NPLs). All mortgage loans in the collateral pool backing the covered bonds were subject to a floating interest rate and were owner-occupied. As a result of SPABOL being owned by several regional savings banks, its loan portfolio is diversified across Norway, with the main concentration being the Rogaland (28%), Sr-Trndelag (11%), and Troms (6%) regions. The loan transfer from the alliance banks to SPABOL is a true sale in that all credit risk transfers are reflected on SPABOLs balance sheet. Parent companies: SPABOL is owned by a total of 22 independent savings banks, which together constitute SpareBank 1 Alliance. With an average market share of retail lending at c.19.3% and c.17.0% in deposit taking, the alliance benefits from being the second-largest bank in Norway. In the case of the three largest entities in terms of assets, retail lending was up 9.1% y/y in 2009, with the average depositto-loan ratio standing at 63%, thereby illustrating the rather moderate capital-market dependency of the savings banks involved. With only seven employees, SPABOL operationally is fully embedded into its parent companies; a clear indication of the potential intra-group support, in our view.
Weaknesses
Geographic exposure: As the collateral pool backing the covered bonds issued by SPABOL exclusively (100%) consists of floating rate mortgage loans secured on Norwegian property, the asset quality is potentially exposed to further rate hikes on behalf of Norges Bank, as well as the overall economic environment in Norway. As the latter has markedly improved as of late with our GDP forecasts pointing towards a 2.5% y/y growth in 2010 and as 100% of the dwellings in the cover pool are owner-occupied, we believe that the clustering risk is sufficiently mitigated.
Note: At the time of writing, SPABOL had a total of five EUR-denominated benchmark covered bonds outstanding, totaling 5.75bn. The most recent deal was issued in March 2010. SPABOL also issues registered covered bonds.
Key points for 2010

With the collateral pool consisting exclusively (100%) of Norwegian residential mortgage loans, further developments in the countrys housing market need to be monitored carefully. As the collateral pool exclusively (100%) consists of floating rate mortgage loans, further rate hikes on behalf of Norges Bank need to be monitored.
10 June 2010
678

Financial summary
NOK mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which Covered Bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset Quality (%) LLPs/Pre-prov income LLRs/Gross loans Problem loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2007* 33 na na 33 14 18 na 13 10 15,977 14,165 na 1 13,940 13,940 1,036 0.1 1.3 43.8 100.0 na na na na 17.8 6.5 na na 10.4 3.1 2008* 104 na na 69 16 53 na 44 32 53,326 36,200 na 1 51,626 44,785 1,678 0.1 2.3 23.8 150.2 na na na na 10.8 4.4 2009* 108 na na 137 15 121 na 117 84 84,233 74,354 na 57,615 2 80,621 74,246 3,683 0.1 3.1 11.2 79.0 na na
Sparebank 1 Boligkreditt (SPABOL)

Collateral pool: Regional distribution, 2010
Others 38% Nordland 5% Troms 6% Sor Trondelag 10% Ostfold 3% Akerhus 6% Oslo 4% Rogaland 28%
Note: * Figures were prepared according to IAS/IFRS.
10 June 2010
679
SNS Bank (SNSSNS)

Description
Leef H Dierks
Ratings table
Moodys A3 Aaa Negative 4.2 S&P ANR Stable Fitch AAAA Negative 15.4 -
Dutch registered covered bond issued SNS Bank is part of the SNS REAAL Group, which is a Dutch-based provider of insurance and banking services. SNS REAAL was created in 1997 from the merger of SNS Groep and Reaal Groep with further acquisitions since including Zrich's Dutch life insurance portfolio, Nieuwe Hollandse Lloyd, Bouwfonds Property Finance, Route Mobiel, as well as Regiobank, Axa NL, Winterthur Verzekeringen, DBV Holding, and Zwitserleven. SNS REAAL primarily targets retail and SME clients in the Netherlands and confines itself to mortgages and property financing, asset management (ie, savings and investment) and insurance services (life, non-life, disability and pensions). At yearend 2009, SNS REAAL had more than 7,500 employees.
Risk weighting
Dutch covered bonds, which are registered with the Dutch central bank (De Nederlandsche Bank) carry a 10% risk weighting under the Standard Approach since 13 October2009, this applies to the covered bonds issued by SNSSNS.
Strengths
Market position: Over the course of the past year, SNSSNS domestic market share with regards to mortgage lending has steadily increased. Whereas in 2007, SNSSNS accounted for 7.7% of all new mortgages granted in The Netherlands, the respective market share had increased to 8.2% in 2008 and 9.1% in 2009. This comes despite a marked contraction in the Dutch mortgage market. Still, in 2009, SNSSNS generated an interest income of 2.7bn of which a high 68% was related to mortgage lending. Despite this sound development, this strong reliance, in our view, needs to be watched. Collateral pool: At end-March 2010, the latest date for which data were available, SNSSNS had issued mortgage-backed covered bonds in the nominal amount of 2.7bn. At the same time, the total outstanding current balance of mortgages in the portfolio amounted to 4.7bn, bringing the overcollateralisation to a sound 174%. The applicable asset percentage stood at 72.5% with the weighted average indexed LTV standing at 75.9%. The collateral pool consisted exclusively of mortgage loans secured on property in The Netherlands and is strongly biased towards Limburg (23.8%), Noord-Brabant (15.3%), and Gelderland (13.4%). Covered bonds accounted for a low 2% of SNSSNS total funding at year-end 2009.
Weaknesses
Profitability: Despite markedly recovering from a net loss of 498mn in 2008 to a (small) profit of 22mn in 2009, SNSSNS profitability needs to be monitored, in our view. The recovery is largely due to the lower negative impact of volatile financial markets on the equity portfolio of the lenders insurance activities. SNS Property Finance: Profits attributed to SNSSNS property financier SNS PF fell to a loss of 219mn in 2009, from a profit of 28mn in 2008. In view of recent macroeconomic developments, SNS REAAL does not expect sales on the Dutch residential property market to increase but expects valuations in the Dutch office and retail markets to be under pressure with rental income continuing its downward trend []. As prospects for Germany, Belgium, Luxembourg, France and Denmark largely mirror those for the Netherlands, SNSSNS does not expect any improvements in 2010 in the other US property markets, SNS PF aims to phase out its international operations in three to five years. There will be limited new loans in the Netherlands in 2010 and those will be subject to strict risk return requirements. Impairment charges surged 260% y/y to 418mn in 2009, from 116mn in 2008.
Note: At the time of writing, SNSSNS had issued mortgage covered bonds in the nominal amount of 2.7bn within the scope of its 15bn Dutch registered covered bond programme.
Key points for 2010

Interest income related to mortgage lending accounted for a high 68% of all interest income in 2009. In light of recent developments in the Dutch mortgage market, the lenders reliance on this source of income needs to be further monitored.
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680

Financial summary
mn Income statement summary Net interest income Net fees & com's Trading income Operating income Operating expenses Pre-provision income Loan loss provisions Pre-tax profit Net income Balance sheet summary Total assets Customer loans of which public sector of which mortgages Customer deposits Debt funding of which covered bonds Total equity Profitability (%) Return on assets Return on equity Cost/Income ratio Net int inc/Op inc Asset quality (%) LLPs/Pre-prov inc LLRs/Gross loans Prob loans/Gr loans Coverage ratio Capital adequacy (%) Tier 1 ratio Total capital ratio Equity/Assets ratio 2008 850 202 0 1,052 814 238 1,020 -728 -498 125,359 68,649 na 52,640 30,216 34,804 0 4,892 -0.4 -10.2 77.4 80.8 na na na na 10.5 14.0 3.9 2009 733 188 0 921 761 160 847 51 22 128,938 70,457 na 54,757 32,489 34,938 2,000 5,062 0.0 0.4 82.6 79.6 na na na na 10.7 13.9 3.9
SNS Bank (SNSSNS)

Geographical structure collateral pool, 2010
Limburg 20% Gelderland 15% NoordBrabant 16% NoordHolland 11%
Others 26% ZuidHolland 12%
Structure of collateral pool, 2010
House 90%
Farm 1% Others 1% Apartment 8%

2 1 0 -0.40 -1 2008 Credit costs RoA 2009 NIM 0 0.7 0.8 0.7 0.6 0.02 1

50 60.0 45 44.0 40 2008 Cust deposits/loans Wholesale funding/Tot. funding 46.1 50 58.6 60 70
Efficiency
4 82.6 2 77.4 0.6 0 2008 Cost/Avg assets 2009 Cost/Income 0.6 90 85 80 75 70
10 June 2010
681
UBS (UBS)
Description
% Index 0.272 % Index 0.194 Total assets CHF1,341bn LT senior unsecured Covered bond rating Discontinuity factor* Collateral score* Outlook
Note: *In %.
Fritz Engelhard
Ratings table
Moodys Aa3 Aaa Negative S&P A+ NR Stable Fitch A+ AAA 21.9 Stable
With total assets of CHF1,341bn as of 31 December 2009, UBS group (UBS) is a large global firm providing services to its clients through its wealth management and Swiss banking businesses, as well as investment banking and asset management. In Switzerland, UBS AG focuses on retail and commercial banking and as of YE 09, it had a total mortgage lending portfolio of CHF141bn. In September 2009, it launched its covered bond programme backed by Swiss residential mortgages.
Risk weighting
UBS covered bonds carry a 20% risk weighting under the Standardised Approach of the EU Capital Requirements Directive (CRD) and may achieve a lower risk weighting under the IRB.
Strengths
Government support: Being the largest Swiss bank, UBS benefits from substantial support. In October 2008, the Swiss National Bank (SNB) reached an agreement with UBS to take over $38.6bn of illiquid high-risk assets (US sub-prime, US reference linked notes, CMBS) from UBS. Furthermore, in December 2008, the Swiss Confederation injected CHF6.0bn of new capital in the form of mandatory convertible notes (MCNs) into UBS. These measures highlight the strong commitment of Swiss authorities to lend support to UBS in case of need. Repositioning: In order to cope with the significant impact of the financial market crisis on the banks liquidity and solvency position, UBS started a number of initiatives with a focus on stabilising the group, strengthening the capital position, enhancing funding sources and reducing costs. The respective measures already show good results. Between YE 08 and YE 09, the group reduced its interbank liabilities by CHF60bn and its outstanding debt securities by CHF66bn. On the cost side, in the 12 months to December 2009, expenses were reduced by CHF4bn, or 15%. Improved capitalisation: The CHF6.0bn capital injection of the Swiss Confederation in October 2008 was followed by a CHF3.8bn capital increase through a share offering to institutional investors in June 2009. Furthermore, in August 2009, the conversion of the Swiss Confederations MCNs resulted in an overall capital increase of CHF 6.7bn. Finally, the de-leveraging of the groups balance sheet led to a CHF95bn or 31% reduction of risk-weighted assets. The combination of these measures resulted in an increase of the banks Tier 1 ratio from 11% at YE 08, to 15.4% at YE 09.
Weaknesses
Fall-out from the financial market crisis: Like some of its international peers, UBS suffered from its historically strong reliance on wholesale funding as well as its exposure to a number of highrisk asset classes. In order to stabilise its liquidity and solvency position, UBS made use of a number of emergency facilities. The costs for using these facilities combined with the pressure to reduce and/or exit some of its businesses and the subsequent loss in market share have had a negative impact on bottom-line earnings. Furthermore, at this stage it is not clear to what extent the transfer of high-risk assets to SNB has been sufficient to isolate UBS from ongoing volatility in financial markets. Pressure on asset and wealth management: Following the prosecution by US authorities in connection with the banks cross-border private banking services provided to US clients, UBS reached an agreement with US authorities and settled the case in February 2009. However, final approval by Swiss authorities is still pending. In addition, these events, combined with the significant negative impact of the financial markets crisis on the banks bottom-line performance, dented the banks reputation and standing in asset and wealth management. While the groups invested asset base stood at CHF 2.2bn at YE 09 and thus was in line with YE 08 figures, it suffered from significant outflows in the course of 2009, which reflected in the fact that average invested assets in FY 09 were 20% below levels in FY 08. In Q1 10 however, outflows of clients assets appear to be stabilising. At this stage, it remains to be seen whether the CHF1.5bn of cost reduction achieved in FY 09 in this segment will not impede the banks ability to restore its market position. Exposure to regulatory changes: A range of planned regulatory changes will require more capital to be held against investment banking activities. In particular, the calculation of market-related risk-weighted assets may increase by approximately 200% to 300%. This could have a significantly negative impact on the groups capital ratios and bottom-line profitability.
Key points for 2010

Monitor the evolution of the banks asset quality and bottomline performance. 10 June 2010 Track the development of the groups invested asset base.
682

Financial summary YE
CHF mn 2006 2007 2008 2009 Income statement summary Net interest income 6,521 5,337 5,992 6,445 Net fees & com's 25,456 30,634 22,929 17,712 Trading income 13,743 - 8,353 - 25,820 324 47,328 31,959 3,793 24,432 Operating income Operating expenses 31,973 33,944 26,760 22,791 Pr e-provision income 15,355 -1,985 -22,967 1,641 Loan loss provisions 156 238 2,996 1,832 Pr e-tax profit 14,119 -3,742 -27,758 -2,561 Net income 12,020 -4,708 -20,724 -2,125 Balance sheet summary Total ass ets 2,346,362 2,274,891 2,014,815 1,340,538 Customer loans 297,842 335,864 340,308 306,828 of which Mortgages* 153,114 141,381 141,328 140,671 Customer deposits 555,886 641,892 465,741 410,475 Debt funding 190,143 222,077 197,254 131,352 of which covered bonds Total equity 55,775 43,826 40,533 48,633 Profitability (%) Return on assets 0.55 -0.20 -0.97 -0.13 Return on equity 22.4 -9.5 -49.1 -4.8 Cos t/Income r atio 67.6 106.2 705.5 93.3 Net int inc/Op inc 13.8 16.7 158.0 26.4 Asset quality (%) LLPs/Pre-prov inc 1.0 -12.0 -13.0 111.6 LLRs/Gross loans 0.4 0.3 0.7 0.8 Pr ob loans/Gr loans 0.8 0.6 1.8 2.0 Cover age ratio 50.7 48.7 39.4 39.0 Capital adequacy (%) Tier 1 ratio 11.9 9.1 11.0 15.4 Total capital ratio 14.7 12.2 15.0 19.8 Equity/Assets ratio 2.4 1.9 2.0 3.6
Note: UBS AG.
UBS (UBS)
1.0% 0.5% 0.0% -0.5% -1.0% -1.5% 2005 NIM 2006 2007 2008 Credit costs 2009 RoA
Efficiency
120% 100% 80% 60% 40% 20% 0% 106% 66% 1.4% 68% 1.5% 1.5% 1.2% 93% 3.0% 2.6% 2.2% 1.8% 1.4% 1.0% 0.6% 0.2% -0.2%
1.4%
2005
2006
2007
2008
2009
Cost/Income (LS)
Cost/Avg assets (RS)

250% 200% 150% 100% 50% 0% 2005 2006 2007 2008 2009 Cust deposits/Loans (LS) Wholesale funding/Tot. Funding (RS) 167% 187% 191% 137% 134% 50% 40% 30% 20% 10% 0%
Asset quality
4% 3% 2% 1% 0% 2005 1.8% 1.1% 0.8% 2006 0.6% 2007 2008 2009 2.0% 52% 51% 49% 39% 39% 60% 50% 40% 30% 20% 10% 0%
Capital
21 16 11 6 2005 2006 Tier 1 ratio 2007 2008 2009 Total capital ratio 14.7 12.8 11.9 14.1 12.2 9.1 11.0 15.0 19.8 15.4
Prob loans/Gr loans (LS)
Coverage ratio (RS)

15 10 5 0 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 Outstanding Covered Bonds Adjusted Cover Assets Overcollateralization (RS) 2.00 1.80 1.60 1.40 1.20 1.00
Development of LTV % seasoning mortgage ACS pool

3.40 3.35 3.30 3.25 3.20 3.15 Nov-09 55% 50% 45% 40% Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 Seasoning in years (LS) Weighted average indexed LTV (RS)
683
10 June 2010
10 June 2010
684
APPENDIX
10 June 2010
685
Overview on covered bond frameworks

Name of debt instrument(s) Canada Structured covered bond Special banking principle No Substitute collateral Up to 10% Voluntary overMandatory over- collateralisation collateralisation is protected Subject to asset coverage test Yes Fulfills UCITS 22(4) No
Supervision Financial Services Authority and independent trustee
Protection against mismatching Exposure to interest rate and currency risk is neutralised. In addition, downgrade triggers for swap counterparties, and various tests ensure cash-flow adequacy. Balance principle strongly restricts market and liquidity risk. To be determined. Net-present value cover required.
Denmark
Realkreditobligationer SRO/SDO
Yes License required No
Finanstilsynet Finanstilsynet
Up to 2% Up to 15%
No No 102%
Yes Yes Yes
Yes Yes Yes
Germany
Hypothekenpfandbriefe, ffentliche Pfandbriefe, Schiffspfandbriefe Greek Covered Bonds
Bundesanstalt fr Finanz- Up to 10% dienstleistungsaufsicht and an independent trustee Bank of Greece and an independent trustee Up to 15%
Greece
No
Contractual obligation to neutralise interest and currency risk. Also, downgrade triggers for swap counterparties and different tests to ensure adequate cash flows. Coverage by nominal value.
Subject to asset coverage test.
Yes
No
Spain France
Cdulas Hipotecarias (CH), Cdulas Territoriales (CT) Obligations Foncires (OF) CRH bonds
No Yes Yes
Banco de Espaa Commission Bancaire and special supervisor Commission Bancaire and special supervisor Commission Bancaire and special supervisor
Not applicable Up to 15% Not applicable Up to 15%
125% (CH)/ 143% (CT)
Yes Yes Yes
Yes Yes Yes
Not compulsory; but all OFs benefit No from additional contractual features. Cash flows from mortgage notes are 125% generally matched with payments on CRH bonds. Contractual obligation to neutralise interest and currency risk. Also, downgrade triggers for swap counterparties and different tests to ensure adequate cash flows. Exposure to interest rate and currency risk is neutralised. In addition, downgrade triggers for swap counterparties, and various tests ensure cash-flow adequacy. Net-present value cover required. Net-present value cover required; in addition, duration matching and limitation of liquidity risk. Subject to asset coverage test.
French Common Law Covered Bond
Yes
Yes.
No
Italy
CDEP Covered Bonds
Specific legislation
No
Not applicable
115%, with Yes reference to every future payment date No 103% (legal minimum) Yes Yes
No
Ireland
Obbligazioni bancarie garantite Mortgage and public asset covered securities (ACSs)
No Yes
Banca dItalia Central Bank of Ireland and a special supervisor
Up to 15% Up to 15%
Yes Yes
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686
Barclays Capital | AAA Handbook 2010 Special banking principle Yes Voluntary overMandatory over- collateralisation collateralisation is protected No No
Name of debt instrument(s) Luxembourg Lettres de gage hypothcaire/ publique Jelzloglevl Dutch Covered Bonds
Supervision
Substitute collateral
Protection against mismatching Net-present value cover required.
Fulfills UCITS 22(4) Yes
Comission de Surveillance Up to 20% du Secteur Financier and independent trustee Hungarian Financial Supervisory Authority Up to 20%
Hungary Netherlands
Yes No
Net-present value cover required. Exposure to interest rate and currency risk is neutralised. In addition, downgrade triggers for swap counterparties, and various tests ensure cash-flow adequacy. Net-present value cover required.
No Subject to asset coverage test.
Yes Yes
Yes Yes
De Nederlandsche Bank Up to 10% and independent auditor
Norway
Obligasjonslan med Yes portefoljepant, obligasjonslan sikret ved pant Hypothekenpfandbriefe, No ffentliche Pfandbriefe, fundierte Bankschuldverschreibungen (FBS) Obrigaes Hipotecrias , Obrigaes sector pblico Kiinteistvakuudellinen / Julkisyhteis-vakuudellinen joukkovelkakirja Skerstllda Obligationer UBS Covered Bonds Optional Yes
Kredittilsynet and independent trustee
Up to 20%
No
Yes
Yes, as Norway is an EEA member. Yes
Austria
Finanzmarktaufsicht and Up to 15% special supervisor
Net-present value cover may be stipulated in the company act of the issuer. Net-present value cover required; in addition, limitation of liquidity risk. Net-present value cover required; in addition, limitation of liquidity risk. Net-present value cover required; in addition, duration matching. Exposure to interest rate and currency risk is neutralised. In addition, downgrade triggers for swap counterparties, and various tests ensure cash-flow adequacy. Exposure to interest rate and currency risk is neutralised. In addition, downgrade triggers for swap counterparties, and various tests ensure cash-flow adequacy. Exposure to interest rate and currency risk is neutralised. In addition, downgrade triggers for swap counterparties, and various tests ensure cash-flow adequacy.
102% (FBS: subject to company act) 105% No
Yes
Portugal Finland
Banco de Portugal Rahoitustarkastus
Up to 20% Up to 20%
Yes No
Yes Yes
Sweden Switzerland
No No
Finansinspektionen and independent inspector
Up to 20% Up to 15%
No Subject to asset coverage test.
Yes Yes
Yes No
UK
UK Covered Bonds
No
Financial Services Authority and independent trustee
Up to 10%
Subject to asset coverage test
Yes
Yes
US
US Covered Bonds
No
Financial Services Authority and independent trustee
Up to 10%
Subject to asset coverage test
Yes
No
10 June 2010
687
Covered bond collateral scores

Name BAWAG Erste Group Bank Erste Group Bank Hypo Alpe-Adria-Bank HYPO Investmentbank Kommunalkredit Austria UniCredit Bank Austria Vorarlberger Landes- und Hypothekenbank Danske Bank. Domestic Danske Bank, International Aktia Real Estate Mortgage Bank Plc OP Mortgage Bank Sampo Housing Loan Bank Banque Federale des Banques Populaires BNP Paribas Covered Bond Programme BNP Paribas Public Sector SCF CIF Euromortgage, Obligations Foncieres CM-CIC Covered Bonds Compagnie de Financement Foncier Crdit Agricole Dexia Municipal Agency GCE Covered Bonds GE SCF Socit Gnrale SCF Bayerische Landesbank Bayerische Landesbank Berlin-Hannoversche Hypotheken Bank Berlin-Hannoversche Hypotheken Bank Bremer Landesbank (grandfathered) DekaBank Deutsche Girozentrale Deutsche Bank Deutsche Hypothekenbank Deutsche Hypothekenbank Deutsche Kreditbank Deutsche Kreditbank Deutsche Pfandbriefbank Deutsche Pfandbriefbank Deutsche Postbank Deutsche Postbank Hamburger Sparkasse HSH Nordbank HSH Nordbank Kreissparkasse Kln Landesbank Baden-Wuerttemberg Landesbank Baden-Wuerttemberg Landesbank Berlin Landesbank Berlin Landesbank Berlin - Daheim Nr 1, Series 1 Landesbank Berlin - Daheim Nr 1, Series 2 10 June 2010 Pool type Public Sector Mortgage Public Sector Public Sector Public Sector Public Sector Public Sector Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Public Sector Public Sector Mortgage Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Shipping Mortgage Mortgage Public Sector Mortgage Public Sector Mortgage Mortgage 6.2% 9.2% 5.0% 13.1% 4.2% 13.0% 9.8% Collateral score 4.7% 15.0% 5.4% 8.1% 7.4% 6.5% 7.4% 7.5% 10.9% 11.6% 4.0% 2.7% 2.4% 7.4% 6.4% 8.1% 0.0% 6.1% 7.4% 6.9% 4.8% 6.6% 9.5% 3.9% 12.2% 7.4% 14.4% 5.4% 12.4% 3.5% 13.0% 12.6% 2.1% 12.2% 4.3% 20.6% 4.8% 2.4% 4.3% 8.1% 7.5% TPI High Probable High High High High High High Probable Probable Probable n/d Probable Probable Probable Probable-High n/d Probable Probable-High Probable Probable-High Probable Probable Probable-high Probable-High High Probable-High High n/d High Probable Probable-High High Probable-High High Probable-High High Probable-High High Probable-High High Improbable Probable-High Probable-High High Probable-High High Probable Probable Country AT AT AT AT AT AT AT AT DK DK FIN FIN FIN FR FR FR FR FR FR FR FR FR FR FR GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER GER 688
Barclays Capital | AAA Handbook 2010 Name Landesbank Hessen-Thueringen Muenchener Hypothekenbank Muenchener Hypothekenbank Norddeutsche Landesbank Norddeutsche Landesbank SEB AG SEB AG Sparkasse KoelnBonn Sparkasse KoelnBonn WestLB Alpha Bank Marfin Egnatia Bank National Bank of Greece FHB Mortgage Bank OTP Mortgage Bank AIB Mortgage Bank Anglo Irish Anglo Irish Mortgage Bank ACS Bank of Ireland Depfa ACS Bank EBS Mortgage Finance WestLB Covered Bond Bank Banca Carige Banca Popolare di Milano Cassa depositi e prestiti Intesa Sanpaolo UBI Banca UniCredit Mortgage and Land Bank of Latvia ABN AMRO Achmea Hypoteekbank ING Bank SNS Bank DnB NOR Boligkreditt SpareBank 1 Boligkreditt Sparebanken Vest Boligkreditt Storebrand Boligkreditt Terra Boligkreditt Banco BPI Banco Comercial Portugues Banco Espirito Santo Banco Santander Totta Caixa Geral de Depsitos Caixa Geral de Depsitos Banca March Bancaja Banco Pastor Banco Popular Banco Sabadell Banco Santander Pool type Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Public Sector Mortgage Mortgage Public Sector Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Collateral score 5.2% 9.7% 5.2% 15.6% 3.1% 8.5% 5.2% 15.4% 4.0% 4.5% 13.1% 11.2% 17.3% 11.7% 15.1% 6.6% 50.2% 36.4% 6.8% 4.9% 9.5% 5.2% 6.7% 7.5% 12.4% 15.1% 7.9% 6.5% 37.5% 6.6% 5.3% 4.8% 4.2% 6.7% 2.7% 6.9% 4.0% 1.8% 3.6% 4.5% 4.6% 4.1% 3.7% 5.8% 37.0% 32.2% 25.5% 22.2% 26.6% 21.0% TPI High Probable-High High Probable-High High Probable-High High Probable-High High High Probable Improbable Probable Improbable Improbable Probable-High Probable Probable Probable-High Probable-High Probable-High Probable-High Probable Probable Probable-High Probable Probable Probable n/d Probable n/d Probable Probable Probable Probable-High High High High Probable-High Probable-High Probable-High Probable-High Probable-High High Probable Probable Probable Probable Probable Probable Country GER GER GER GER GER GER GER GER GER GER GRE GRE GRE HUN HUN IRE IRE IRE IRE IRE IRE IRE ITA ITA ITA ITA ITA ITA LAT NED NED NED NED NO NO NO NO NO PT PT PT PT PT PT ES ES ES ES ES ES
10 June 2010
689
Barclays Capital | AAA Handbook 2010 Name Banco Santander Bankinter Banco Bilbao Vizcaya Argentaria Banco Bilbao Vizcaya Argentaria Bilbao Bizkaia Kutxa Caixa Catalunya Caixa Catalunya Caixa Galicia Caixa Galicia Caja de Ahorros del Mediterrneo Caja de Ahorros del Mediterrneo Caja Insular de Ahorros de Canarias Caja General de Ahorros de Canarias Caja Madrid Caja Madrid Caja Municipal de Burgos Cajamar CajaSur CCM Dexia Sabadell Ibercaja La Caixa La Caixa Unicaja Lansforsakringar Hypotek Nordea Hypothek Stadshypotek Swedbank The Swedish Covered Bond Corporation Abbey National Treasury Services Bank of Scotland Bank of Scotland Barclays Bradford & Bingley Britannia Building Society Chelsea Building Society Clydesdale Bank Coventry Building HSBC Leeds Building Society Lloyds TSB Nationwide Building Society Newcastle Building Society Northern Rock Plc Norwich & Peterborough Building Society Principality Building Society Skipton Building Society The Co-operative Bank Yorkshire Building Society
Source: Moodys
Pool type Public Sector Mortgage Mortgage Public Sector Mortgage Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Mortgage Mortgage Public Sector Public Sector Mortgage Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Social Housing Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage
Collateral score 5.0% 21.2% 23.6% 6.3% 16.6% 33.1% 11.6% 24.2% 13.4% 38.1% 10.7% 13.9% 18.6% 20.8% 14.1% 30.1% 21.0% 25.6% 12.4% 9.7% 22.7% 21.0% 7.6% 14.3% 3.6% 6.1% 7.6% 7.3% 9.0% 10.5% 5.1% 8.5% 4.9% 17.7% 6.6% 3.3% 10.0% 11.1% 7.1% 8.3% 5.4% 5.0% 2.2% 14.0% 4.1% 7.0% 2.6% 4.9% 6.0%
TPI Probable-High Probable Probable Probable-High Probable Probable Probable-High Probable Probable-High Probable Probable-High Probable n/d Probable Probable-High Probable Probable Probable n/d Probable-High Probable Probable Probable-High Probable Probable Probable Probable Probable Probable Probable Probable-High Probable Probable Probable Very High Probable High Probable-High Probable Probable Probable Probable Very High Probable Very High Very High High High Probable
Country ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES ES SWE SWE SWE SWE SWE UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK
10 June 2010
690
Covered bond discontinuity factors

Name Aareal Bank Aareal Bank Abbey National ABN AMRO AIB Mortgage Bank Alpha Covered Bond Anglo Irish Bank BA Covered Bond Issuer Banca Carige Banca Popolare di Milano Banco BPI Banco Comercial Portugues Banesto Banco Espirito Santo Banco Guipuzcoano Banco Popolare Banco Popular Espanol Banco Santander Totta Banco Santander Bank of Ireland Bank of Montreal Bank of Scotland, Intelligent Finance Bank of Scotland Bankinter Barclays Bank Barclays Bank Bayerische Landesbank Bayerische Landesbank BHH BHH BNP Paribas BNP Paribas Bradford & Bingley CRH Caixanova Montepio Caixa Geral de Depositos Caixa Geral de Depositos Cajastur Caja de Ahorros de Murcia Caja Madrid Caja de Ahorros y Monte de Piedad de Navarra Canadian Imperial Bank of Commerce Cassa Depositi e Prestiti CIF Euromortgage Clydesdale Bank CM-CIC Covered Bonds CM-CIC Home Loans FCT Co-Operative Bank, Britannia Programme Co-Operative Bank CFF Corealcredit Corealcredit Coventry Building Society 10 June 2010 Pool Type Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Guaranteed Mortgages Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Other Collateral Mortgage Public Sector Mortgage Long Term IDR AAAAA+ D-Factor 24.6% 5.6% 14.4% 16.7% 14.0% 20.1% 16.7% 39.6% 13.7% 16.5% 14.9% 14.9% 41.5% 14.9% 41.9% 17.0% 41.3% 14.9% 40.8% 19.6% 18.1% 6.9% 18.4% 41.2% 15.1% 11.2% 19.0% 8.3% 17.4% 7.3% 20.3% 11.8% 37.9% 41.9% 14.9% 32.0% 15.3% 40.8% 41.0% 41.5% 40.8% 21.2% 9.8% 7.3% 19.8% 9.4% 6.7% 18.5% 12.9% 18.1% 6.1% 6.6% Country GER GER GBR NLD IRL GRC IRL US ITA ITA PRT PRT ESP PRT ESP ITA ESP PRT ESP IRL CAN GBR GBR ESP GBR GBR GER GER GER GER FRA FRA GBR FRA ESP PRT PRT PRT ESP ESP ESP ESP CAN ITA FRA GBR FRA FRA GBR GBR FRA GER GER GBR 691
AA A A+ A+ AA A+ AAAAAA AA AAAAAAAA+ AAAAA+ A+ A+ A+ AA A+ AAA+ A+ A A+ A+ A AAAAAA-
AABBBBBBA
Barclays Capital | AAA Handbook 2010 Name Credit Agricole Covered Bonds Danske Bank, Domestic Danske Bank, International DEPFA ACS Bank Deutsche Genossenschafts-Hypothekenbank Deutsche Genossenschafts-Hypothekenbank Deutsche Pfandbriefbank Deutsche Pfandbriefbank Deutsche Postbank Deutsche Postbank Dexia Municipal Agency DnB NOR Boligkreditt Duesseldorfer Hypothekenbank DZ Bank EBS Mortgage Finance Eurohypo AG Eurohypo AG Eurohypo Europische Hypothekenbank SA FCT Red & Black Guaranteed Home Loans HSBC Bank HSH Nordbank HSH Nordbank ING Bank Landesbank Baden-Wuerttemberg Landesbank Baden-Wuerttemberg Landesbank Berlin Landesbank Hessen-Thueringen Landesbank Hessen-Thueringen Leeds Building Society Lloyds TSB Bank Marfin Egnatia Bank National Bank of Greece Nationwide Building Society Newcastle Building Society NIBC Bank Northern Rock Norwich & Peterborough Building Society NRW.BANK Principality Building Society Royal Bank of Canada Skipton Building Society SNS Bank Societe Generale SCF SpareBank 1 Boligkreditt SpareBanken Vest Boligkreditt UBS UniCredit Bank UniCredit Bank Unicredit UBI Banca WM Covered Bond Program Wuestenrot Bank AG Pfandbriefbank Wuestenrot Bank AG Pfandbriefbank Yorkshire Building Society
Note: as at 20 May 2010. Source: Fitch Ratings
Pool Type Mortgage Mortgage Mortgage Public Sector Mortgage Public Sector Mortgage Public Sector Public Sector Mortgage Public Sector Mortgage Public Sector Other Collateral Mortgage Mortgage Public Sector Public Sector Mortgage Mortgage Mortgage Public Sector Mortgage Mortgage Public Sector Public Sector Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage Mortgage Mortgage Mortgage Public Sector Mortgage
Long Term IDR A+ A+ AA+ A+ AAA+ A+ A+ A+ AA+ BBBA A A AA A A A+ A+ A+ AAA+ A+ A AABBB+ BBBAABBBBBB A+ BBB+ AAA BBB+ AA AAA+ A A+ A+ A+ A A+ BBB+ BBB+ A-
D-Factor 22.2% 15.0% 16.6% 9.5% 15.5% 7.3% 25.2% 6.8% 9.9% 13.7% 13.2% 18.9% 6.1% 27.9% 12.1% 21.8% 6.6% 13.8% 18.8% 15.5%
Country FRA DNK DNK IRL GER GER GER GER GER GER FRA NOR GER GER IRL GER GER LUX FRA GBR GER GER NLD GER GER GER GER GER GBR GBR GRC GRC GBR GBR NLD GBR GBR GER GBR CAN GBR NLD FRA NOR NOR SUI GER GER ITA ITA US GER GER GBR
16.2% 7.4% 7.0% 20.7% 6.6% 15.0% 14.1% 38.3% 39.3% 14.6% 6.5% 12.7% 18.5% 7.1% 6.7% 18.1% 6.5% 15.4% 16.6% 15.3% 16.4% 21.9% 17.1% 11.9% 16.2% 17.6% 100.0% 14.6% 4.7% 13.7%
10 June 2010
692
Index
Agencies and supranationals Covered bond Covered bond ratings* ratings* (mortgage) (public sector) NR/NR/AAA Aaa/AAA/AAA Aaa/AAA*/AAA Aa2/AAA*/NR Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/NR/AAA Aaa/NR/AAA Aaa/NR/NR Aaa/NR/NR Aaa/AAA*/AAA Aaa/AAA*/AAA Aaa/NR/NR Aaa/NR/AAA Aaa/NR/AAA Aaa/NR/NR Aaa/AAA/AAA Aaa/NR/AAA Aaa*/AAA/AAA Aaa/NR/AAA Aaa/NR/NR Aaa/AAA/AAA Aa2/AA/AA Aaa/AAA/NR Aaa/AAA/AAA Aaa/NR/AAA Aaa/AAA/AAA Aaa/NR/AAA Aaa/NR/NR Aaa*/NR/AAA Aa1/NR/AA+ Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/NR/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/NR/NR Aa1/NR/AAA Aaa/AAA/AAA Aaa/NR/AAA Aaa/NR/AAA
Name Aareal Bank Abbey National ABN Amro Achmea Hypoteekbank African Development Bank Agence Franaise de Dveloppement Allied Irish Mortgage Bank Asfinag Asian Development Bank AyT Cedulas Cajas Banca Carige Banca Popolare di Milano Bancaja Banco Bilbao Bizkaia Kutxa Banco BPI Banco Espirito Santo Banco Pastor Banca Popolare Banco Popular Banco Sabadell Banco Santander Banco Santander Totta Banesto Bank fr Arbeit und Wirtschaft AG Bank Nederlandse Gemeenten Bank of America Bank of England Bank of Ireland Mortgage Bank Bank of Montreal Bankinter Banque Federative du Credit Mutuel Bayern LB Banco Bilbao Vizcaya Argentaria BCP Millenium Berlin-Hannoversche Hypothekenbank BNP Paribas Covered Bonds BPCE Group Caisse d'Amortissement de la Dette Sociale Caisse de Refinancement de l'Habitat Caisse des Dpts Caisse Nationale des Autoroutes Caixa d' Estalvis de Catalunya Caixa Econmica Montepio Geral Caixa Geral 10 June 2010
Ticker AARB ABBEY AAB ACHMEA AFDB AGFRNC AIB ASFING ASIA AYTCED BANCAR PMIIM CAVALE BILBIZ BPIPL BESPL PASTOR BPIM POPSM BANSAB SANTAN SANTAN BANEST BAWAG BNG BAC BOEN BKIR BMO BKTSM CMCICB BYLAN BBVASM BCPPL BHH BNPPCB CMCICB CADES CRH CDCEPS CNA CAIXAC MONTPI CXGD
Analyst Fritz Engelhard Michaela Seimen Leef H Dierks Leef H Dierks
Page 470 590 646 648 379 380 580 381 332 520 630 634 522 538 616 620 534 632 530 532 528 622 536 650 334 652 382 582 654 526 558 472 524 618 474 560 562 336 564 383 384 540 624 626 693
Huw Worthington Aaa/AAA/AAA Fritz Engelhard Fritz Engelhard Leef H Dierks Michaela Seimen Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Fritz Engelhard Michaela Seimen Jonathan Glionna Huw Worthington NR/AAA/AAA Fritz Engelhard Leef H Dierks Leef H Dierks Fritz Engelhard Fritz Engelhard Leef H Dierks Leef H Dierks Fritz Engelhard Fritz Engelhard Fritz Engelhard Michaela Seimen Fritz Engelhard Fritz Engelhard Fritz Engelhard Leef H Dierks Leef H Dierks Leef H Dierks
Barclays Capital | AAA Handbook 2010 Covered bond Covered bond ratings* ratings* (mortgage) (public sector) Aaa/NR/NR Aaa/NR/NR Aaa/NR/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA* Aaa/NR/Aaa Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA*/AAA Aaa/AAA/NR Aa2/AA/AAA Aaa/AAA/NR NR/AAA/AAA Aaa/NR/NR Aaa/NR/NR Aa3/NR/AA+ Aaa/AAA/AAA Aa2/AA-/NR NR/AAA/NR Aaa/AAA/AAA Aaa/AAA/AAA NR/AAA/AAA Aaa/NR/NR Aa1/AA+/AA Aa1/AA-/AAA Aaa/NR/NR Aaa/AAA/NR Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AA/AA+ Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/NR Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AA/AA+ Aaa/NR/NR NR/AAA/AAA Aaa/AAA/NR Aaa/NR/NR Aaa/AAA/AAA
Name Caja Ahorros del Mediterraneo Caja de Ahorros de Galicia Caja Madrid Canadian Imperial Bank of Commerce Cassa Depositie e Prestiti Cedulas TDA CIF Euromortgage Compagnie de Financement Foncier Council of Europe Development Bank Credit Agricole Danske Bank Dekabank DEPFA ACS Bank Deutsche Bank Deutsche Genossenschafts-Hypothekenbank Deutsche Hypothekenbank Deutsche Kreditbank Deutsche Pfandbriefbank Deutsche Postbank Development Bank of Japan Dexia Kommunalbank Deutschland Dexia Municipal Agency DnB NOR Boligkreditt Dsseldorfer Hypothekenbank EBS Building Society Eksportfinans Erste Abwicklungsanstalt Erste Bank Eurofima Eurohypo European Bank for Reconstruction and Development European Investment Bank European Union Fannie Mae Federal Farm Credit Banks Funding Corporation Federal Home Loan Bank Fondo de Reestructuracion Ordenada Bancaria Freddie Mac German Postal Pensions Securitisation HSBC HSBC France HSH Nordbank Infrastrutture SpA ING Bank NV Instituto de Credito Oficial
Ticker CAJAME CAGALI CAJAMM CIBC CDEP CEDTDA CIFEUR CFF COE ACACB DANBNK DEKA DEPFA DB DGHYP DHY DKRED HYPORE DPB DBJJP DEXGRP DEXMA DNBNOR DUSHYP EBSBLD EXPT ERSTAA ERSTBK EUROF EURHYP EBRD EIB EEC FNMA FFCB FHLB FOBR FHLMC GPPS HSBC HSBC HSHN CDEP INTNED ICO
Analyst Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Fritz Engelhard Fritz Engelhard Michaela Seimen Fritz Engelhard Leef H Dierks Fritz Engelhard Fritz Engelhard Fritz Engelhard Fritz Engelhard Fritz Engelhard Fritz Engelhard Fritz Engelhard Fritz Engelhard Joseph Huang Fritz Engelhard Fritz Engelhard Leef H Dierks Fritz Engelhard Fritz Engelhard Michaela Seimen Fritz Engelhard Fritz Engelhard Michaela Seimen Fritz Engelhard Michaela Seimen Michaela Seimen Michaela Seimen Rajiv Setia Rajiv Setia Rajiv Setia Michaela Seimen Rajiv Setia Leef H Dierks Michaela Seimen Fritz Engelhard Fritz Engelhard
Agencies and supranationals
Page 544 542 548 656 636 550 568 570 338 566 658 476 584 478 480 482 484 486 488 432 490 572 660 492 586 340 385 662 342 494 344 346 386 410 419 413 388 416 391 574 594 496 393 664 348
Huw Worthington Aa2/A+/AALeef H Dierks Michaela Seimen
10 June 2010
694
Barclays Capital | AAA Handbook 2010 Covered bond Covered bond ratings* ratings* (mortgage) (public sector)
Name Inter-American Development Bank Intermoney Cedulas International Finance Corp International Finance Facility for Immunisation Intesa Sanpaolo Japan Bank for International Cooperation Japan Expressway Holding & Debt Repayment Agency Japan Finance Organisation for Municipalities JPMorgan Chase Bank Kfw Bankengruppe Kommunalbanken Kommunalkredit Austria KommuneKredit Kommuninvest I Sverige La Caixa La Poste Landesbank Baden-Wrttemberg Landesbank Berlin Landesbank Hessen-Thringen Landeskreditbank Baden-Wrttemberg Frderbank Landwirtschaftliche Rentenbank Lnsfrskringar Hypothek LCR Finance Plc Lloyds Banking Group Mnchener Hypothekenbank Municipality Finance National Bank of Greece Nationwide Building Society Nederlandse Waterschapsbank Network Rail New South Wales Treasury Corporation Norddeutsche Landesbank Nordea Hypothek Nordic Investment Bank NRW.BANK Oesterreichische Kontrollbank OP Mortgage Bank OTP Mortgage Bank Queensland Treasury Corporation Radio Television Espanola Rede Ferroviaria Nacional Regie Autonome des Transports Parisiens Reseau Ferre de France Royal Bank of Canada
Ticker IADB IMCEDI IFC IFFIM ISPIM JFC JAPEXP JFM JPM KFW KBN KA KOMINS CAIXAB FRPTT LBBW LBBER HESLAN LBANK RENTEN LANSBK LCRFIN LLOYDS MUNHYP KUNTA ETEGA NWIDE NEDWBK UKRAIL NSWTC NDB NBHSS NIB NRWBK OKB OPMBK OTP QTC RTVE REFER RATPFP RESFER RY
Analyst Michaela Seimen Leef H Dierks Michaela Seimen Michaela Seimen Leef H Dierks Joseph Huang Joseph Huang Joseph Huang Jonathan Glionna Michaela Seimen Michaela Seimen Fritz Engelhard
Agencies and supranationals Aaa/AAA/AAA
Page 350
Aaa/NR/AAA* Aaa/AAA/AAA Aaa/AAA/NR Aaa/NR/NR Aa2/AA/NR Aa2/AA/NR Aa2/AA/NR AAA*/AA+/AA+ Aaa/AAA/AAA Aaa/AAA/NR Aaa/NR/NR
552 352 354 395 638 426 428 430 666 356 358 668 396 397
International Bank for Reconstruction and Development IBRD
Huw Worthington Aaa/AAA/AAA
KOMMUN Huw Worthington Aaa/AAA/NR Huw Worthington Aaa/AAA/NR Leef H Dierks Fritz Engelhard Fritz Engelhard Fritz Engelhard Fritz Engelhard Michaela Seimen Michaela Seimen Leef H Dierks Huw Worthington Aaa/AAA/AAA Michaela Seimen Fritz Engelhard Huw Worthington Aaa/AAA/NR Leef H Dierks Michaela Seimen Michaela Seimen Michaela Seimen Gavin Stacey Fritz Engelhard Leef H Dierks Michaela Seimen Michaela Seimen Leef H Dierks Leef H Dierks Leef H Dierks Gavin Stacey Leef H Dierks Leef H Dierks Fritz Engelhard Michaela Seimen Leef H Dierks Aa1/AA+/AA+ NR/NR/NR Aa2*/A-/NR Aaa/NR/AAA Aaa/AAA/AAA Aaa/AAA/AAA Aaa/AAA/NR Aa1/AA-/AAA Aaa-AAA-NR Aaa/AAA*/NR A2/NR/NR Aaa/AAA/NR Aaa/NR/AAA Aaa/AAA/NR Aaa/NR/NR Aaa/AAA*/NR Aaa/NR/NR A1*/NR/A-* Aaa/AAA/AAA Aaa/AAA/AAA Aaa/NR/NR Aaa/NR/NR Aaa/AA+/AAA Aaa/AAA/AAA Aaa/AAA*/NR NR/A/AA Aaa/AA+/NR Aaa/NR/NR Aaa/AA/AAA Aaa/AAA/AAA Aaa/NR/AAA Aaa/AAA/AAA Aaa/AAA/NR
546 398 498 500 502 360 362 602 400 592 504 401 670 596 364 366 438 506 604 368 370 402 672 674 440 403 404 404 372 676
10 June 2010
695
Barclays Capital | AAA Handbook 2010 Covered bond Covered bond ratings* ratings* (mortgage) (public sector) Aa1/NR/NR Aaa/AAA/AAA Aaa/NR/NR Aaa/NR/AAA Aaa/AA+/AAA Aaa/AAA/AAA Aaa/AAA/NR Aaa/NR/AAA Aaa/NR/NR Aaa/AA+/AAA Aaa/AAA/AAA Aa1/NR/AAA Aa1/NR/AAA NR/AA/AAA NR/NR/AAA Aa1/AA-/AAA Aa1/AA-/AAA NR/NR/AAA Aaa/AAA/NR Aaa/AAA*/NR Aa1/AA+/NR Aaa/AAA/AAA NR/AA/NR Aaa/AAA/NR Aaa/NR/AAA Aaa/NR/AAA Aaa/AAA/AAA Aaa/NR/NR Aa1/NR/AAA Aaa/AAA/AAA NR/AAA/NR Aaa/AAA/NR NR/AAA/NR Aa1/AA+/AAA NR/AAA/NR NR/AAA/NR Aaa/AAA/NR Aaa/AAA/AAA Aa1/NR/NR
Name SEB Bank AG Societe de Financement de l'Economie Francaise Skandinakisva Enskilda Banken SNS Bank Societe Nationale des Chemins de fer Franais Socit Gnrale South Australian Finance Authority Sparebanken Boligkredit Stadshypotek AB State of Baden Wrttemberg State of Bavaria State of Berlin State of Brandenburg State of Hesse State of Lower Saxony State of North Rhine-Westphalia State of Saxony-Anhalt State of Thringia Swedbank Hypotek Swedish Covered Bond Corporation Swedish Export Credit Tennessee Valley Authority Tokyo Metropolitan Govt Treasury Corporation of Victoria UBI Banca UBS Unedic Unicaja UniCredit Bank Unicredit Westdeutsche Immobilienbank AG Westdeutsche Landesbank AG Western Australia Treasury Corporation WL-Bank Yorkshire Building Society
Ticker SEBAG SFEFR SEB SNSSNS SNCF SOCGEN SAFA SPABOL SHBASS BADWUR BAYERN BERGER BRABUR HESSEN NIESA NRW SACHAN THRGN SPNTAB SCBCC SEK TVA TOKYO TCV UBIIM UBS UNEDIC UNICAJ HVB UCGIM WESTIB WESTLB WATC WLBANK YBS
Analyst Fritz Engelhard Fritz Engelhard Leef H Dierks Leef H Dierks Michaela Seimen Fritz Engelhard Gavin Stacey Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Leef H Dierks Michaela Seimen Rajiv Setia Joseph Huang Gavin Stacey Leef H Dierks Fritz Engelhard Fritz Engelhard Leef H Dierks Fritz Engelhard Leef H Dierks Fritz Engelhard Fritz Engelhard Jason Rogers Fritz Engelhard Michaela Seimen
Agencies and supranationals
Page 508 406 606 680 576 374 442 678 608 460 462 450 464 452 466 458 454 456 612 610 376 422 434 444 642 682 407 554 510 640 514 512 446 516 598
Note: Rating outlook and Watch status are provided with the individual profiles. * Moody's/S&P/Fitch.
10 June 2010
696
AAA RESEARCH & MARKET STRATEGY ANALYSTS

Barclays Capital 5 The North Colonnade London E14 4BB Larry Kantor Head of Research + 1 212 412 1458 larry.kantor@barcap.com Julian Callow Chief European Economist +44 (0)20 7773 1369 julian.callow@barcap.com Theresa Chen US Economics Research +1 212 526 7195 theresa.chen@barcap.com Fritz Engelhard German Head of Strategy +49 69-7161 1725 fritz.engelhard@barcap.com Joseph Huang Credit Research +65 6308 3518 joseph.huang@barcap.com Peter Newland US Economics Research +1 212 526 3153 peter.newland@barcap.com Rajiv Setia US Fixed Income Strategy +1 212 412 5507 rajiv.setia@barcap.com Huw Worthington European Strategy +44 (0)20 7773 1307 huw.worthington@barcap.com Laurent Fransolet Head of European Fixed Income Strategy +44 (0)20 7773 8385 laurent.fransolet@barcap.com Miguel Crivelli US Credit Research +1 212 412 5231 miguel.crivelli@barcap.com Jonathan Glionna US Credit Research +1 212 412 5184 jonathan.glionna@barcap.com George Karvounis Fixed Income Strategy +44 (0)20 7773 8578 george.karvounis@barcap.com Jason Rogers Credit Research +65 6308 3283 jason.rogers@barcap.com Gavin Stacey Fixed Income Strategist AUS and NZ +61 2 933 46128 gavin.stacey@barcap.com Ajay Rajadhyaksha Head of US Fixed Income Strategy +1 212 412 7669 ajay.rajadhyaksha@barcap.com Leef Dierks Fixed Income Strategy +49 69-7161 1781 leef.dierks@barcap.com Simon Hayes UK Economics Research +44 (0)20 7773 4637 simon.hayes@barcap.com James Ma US Fixed Income Strategy +1 212 412 2563 james.ma@barcap.com Michaela Seimen European Strategy +44 20 313 40134 michaela.seimen@barcap.com Stuart Urquhart Fixed Income Strategy +44 (0)20 7773 8410 stuart.urquhart@barcap.com
10 June 2010
LAST PAGE
Analyst Certification(s) We, Fritz Engelhard, Leef Dierks, Michaela Seimen, Huw Worthington, Simon Hayes, Peter Newland, Theresa Chen, Larry Kantor, Stuart Urquhart, Rajiv Setia, James Ma, Gavin Stacey, Joseph Huang, Jonathan Glionna, Miguel Crivelli, Jason Rogers and Julian Callow, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgibin/all/disclosuresSearch.pl or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.
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RESEARCH

THE AAA HANDBOOK 2010

Barclays Capital | AAA Handbook 2010

Larry Kantor Head of Research Barclays Capital

Barclays Capital | AAA Handbook 2010

Barclays Capital | AAA Handbook 2010

Barclays Capital | AAA Handbook 2010

Dj-vu feelings but this time is different

Concerns about USD funding of European banks

Barclays Capital | AAA Handbook 2010

Figure 1: USD Libor fixings increase

Figure 2: Moves in EURUSD basis

1.5 1.0 0.5 0.0 Jan-09

USD LIBOR 3M (R)

Jul-09 Jan-10 EUR-USD 1yr basis

Moderate spread widening more driven by financials than corporates

Focus on sovereign debt markets

Figure 4: Credit spreads of financials at their widest versus non-financials

iTraxx 5yr Europe: Financials - Non Financials

Barclays Capital | AAA Handbook 2010

Sweden The 2.8% Netherlands 3.2% Ireland 3.2% UK 7.6%

Source: Markit, Barclays Capital

High weight of European core countries in the SSA market

Barclays Capital | AAA Handbook 2010

4Y Agency Swap Spread

iBoxx Euro Covered 5-7 iBoxx Euro Sub-Sovereigns 5-7

4Y Sovereign Swap Spread Spain Germany France The Netherlands

Source: Markit, Barclays Capital

Thinking beyond the rating letter

Barclays Capital | AAA Handbook 2010

Drawbacks of using ratings as strict investment criteria

Beyond the rating letter the benefits of a qualitative approach to ratings

Barclays Capital | AAA Handbook 2010

CENTRAL BANK COLLATERAL SCHEMES

Broadening the scope

Collateral at the ECB

A wide range of EUR debt is eligible

Shift to a single list at the start of 2007

Barclays Capital | AAA Handbook 2010

Figure 9: New categories of eligible marketable collateral

Category 3 Traditional covered bonds Corporate/other

Category 4 Credit institutions

Eligible assets include marketable and non-marketable assets

There was c.EUR13.1trn of eligible collateral in 2009

Barclays Capital | AAA Handbook 2010

Figure 12: Breakdown of assets put forward as collateral by asset type

Barclays Capital | AAA Handbook 2010

Collateral at the Fed

Collateral at the Bank of England

Barclays Capital | AAA Handbook 2010

Term and size

Barclays Capital | AAA Handbook 2010

SECONDARY MARKET CONDITIONS

Happiness makes up in height for what it lacks in length 2

Significant improvement of market conditions in H2 09

Pronounced tightening of bid/ask spreads in some covered bond instruments

Figure 13: Bid/offer spreads on secondary covered bond market

0 Pfandbrief early 2009

Multi-Cdulas mid 2009

Cdulas early 2010

UK Covered Mid May 2010

Mid April 2010

Robert Frost (American Poet)