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Real Estate Slowdown in Spain May Cut Sales of `Covered' Bonds

Sept. 29 (Bloomberg) -- Sales of bonds backed by home mortgages in Spain may drop for the first time in five years as prices of apartments in Madrid and villas on the Costa del Sol rise at the slowest pace since 2001.

Banks in Europe's fifth-largest economy probably will reduce sales of bonds to finance mortgages by 23 percent next year to 50 billion euros ($63 billion), said Avelino Abellas, a capital markets director in Madrid at Calyon, the biggest underwriter of Spanish debt last year. The banks raised 59 billion euros this year with so-called covered bonds, debt backed by mortgages and guaranteed by the seller, almost as much as in all of 2005 and the most in Europe, according to data compiled by Bloomberg.

Mortgage lending fell for three of the past four months as borrowing costs for home buyers rose to the highest since 2003, the Spanish Mortgage Association said. Fewer bond sales may boost returns for investors, according to Pacific Investment Management Co., which runs the world's biggest bond fund.

``The real-estate market and mortgage lending seem to be slowing down,'' said Luis Sanchez-Guerra, the capital markets director at Madrid-based Grupo Ahorro Corporacion, Spain's largest seller of covered bonds. ``That will reduce some pressure.''

Ahorro may cut borrowing by as much as 3 billion euros to 10 billion euros next year, Sanchez-Guerra said.

Yield Premium

Investors demand 4 to 5 basis points in extra yield to purchase Spanish mortgage debt rather than similar securities in Germany, partly because of the higher amount being sold, said Ted Packmohr, a credit analyst at Dresdner Kleinwort in Frankfurt. The covered market in Spain, which started in 1998, now has 190 billion euros of bonds.

Holders of Madrid-based Banco Popular Espanol SA's 2.5 billion euros of 3 percent covered notes due in 2012 lost 0.5 percent so far this year, Citigroup Inc. prices show. That compares with a 0.1 percent loss on similar securities sold by Munich-based Muenchener Hypothekenbank AG. Moody's Investors Service rates both notes Aaa.

The premium on Spanish covered bonds compared with similar- maturity government debt rose 10 basis points to 29 basis points this year, according to the International Index Company's iBoxx indexes. In Germany, spreads widened by 2 basis points to 17 basis points.

Housing Bubble

Home prices will increase 4.5 percent next year, down from an annual 10.8 percent in the second quarter of this year, according to Madrid-based Banco Bilbao Vizcaya Argentaria SA, Spain's second-biggest bank. Economic growth is likely to slow to 3.2 percent in 2007, from an annual pace of 3.7 percent in the second quarter, according to the government.

The last time home values rose more slowly was in 2001, when they gained 8.8 percent, according to Sociedad de Tasacion SA, a Madrid-based property valuation firm.

``In Spain we've had bubble-like conditions for some time,'' said Vishal Pathak, an interest rate strategist at BNP Paribas SA in London. ``If you get reduced volumes of supply, that will help'' bond performance, he said.

Covered bonds typically get AAA ratings by requiring borrowers to set aside assets that can be sold to ensure repayment. Buyers range from central banks to money managers such as Newport Beach, California-based Pimco. About 70 Spanish lenders sell the debt, according to ABN Amro Holdings NV, the market's biggest underwriter.

``A slowdown in issuance could be good for spreads,'' said Felix Blomenkamp, who helps manage 100 billion euros of fixed- income assets at Pimco in Munich.

Better Than U.S.

Spain's slowdown is nowhere near the slump in the U.S. housing market, where mortgage applications dropped last week by the most since June. Prices of new homes in the U.S. fell 1.7 percent in August from the same month last year.

The average lending rate for mortgage loans for periods of more than three years has risen to 4.23 percent, the highest since 4.25 percent in January 2003, according to Spanish Mortgage Association data. The rate has risen from 3.19 percent in August, 2005, the lowest in at least 15 years.

Some Spanish banks expect to boost lending. Caja Madrid, Spain's second-biggest savings bank, may increase sales of bonds next year by as much as 1 billion euros, to 7 billion euros, said Carlos Stilianopoulos, the director of capital markets.

Santander Central Hispano SA, Spain's biggest bank, hasn't completed borrowing plans for 2007, said Antonio Torio, the director of financial management. The bank sold 7.7 billion euros of the notes so far this year, up from 7.2 billion euros in 2005.

Holiday Homes

Declining purchases of second homes by U.K. and German citizens is causing the slowdown in Spain. Foreigners reduced their investments in Spain by 21 percent last year to about 400 million euros a month, according to the latest figures from the Bank of Spain.

Holiday homes account for about 30 percent of residential properties being built in Spain, according to DCM Securities, a London-based broker that finances property development. Half the holiday homes are for foreigners, with U.K. residents making up 52 percent of overseas sales, DCM's data show.

``The Spanish market definitely can't go at the speed we've seen in recent years,'' said Max Beinhofer, who helps manage the equivalent of $15 billion of covered bonds at Deutsche Asset Management in Frankfurt.

To contact the reporters on this story: Charles Penty in Madrid at cpenty@bloomberg.net or Sebastian Boyd in London at sboyd9@bloomberg.net

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