Eu35bn of redemptions of cédulas hipotecarias (CH) this year are credit positive for Spanish banks, Moody’s said yesterday (Thursday), as issuers redeem high coupon bonds and potentially replace them at new, compressed levels – although issuance is expected to fall.

Including retained issuance, some Eu35bn (16.5% of outstandings) of Spanish mortgage covered bonds fall due in 2017, according to Moody’s. These are the heaviest redemptions in any covered bond jurisdiction this year, and are likely to be the highest volume of redemptions in the Spanish single cédulas market in any year over the next decade.

One-third of these cédulas were issued between 2011 and 2013, when spreads were significantly wider than current levels in the midst of the European sovereign debt crisis, Moody’s said. As an example of the more attractive funding levels now on offer to Spanish banks in the prevailing low and negative rates environment, the rating agency noted that the average spread of the Spanish single cédulas iBoxx index in 2011-2013 was 268bp, compared with the recent index value of 34bp.

The rating agency estimates that Spanish banks could achieve a reduction of 15%-20% in their wholesale funding costs as a result of the redemptions. This could provide Spanish banks a welcome boost, with their net interest income having declined sharply since 2014, Moody’s said.

“With little prospect of an interest rate hike in the next two years, the redemption of costly liabilities will help banks offset margin compression, in a context where loan spreads are constrained by subdued demand and intense competition and yields on treasury investments remain at historic lows,” the rating agency said.

“We understand that several covered bond issuers will opt to replace, at least in part, maturing CH using European Central Bank funds from the TLTRO II operation scheduled for March 2017, as acknowledged by the most recent ECB bank lending survey from January 2017. This would lead to a further reduction in wholesale funding costs, as banks may be able to borrow TLTRO II funds at a negative rate.”

Moody’s said the redemption of high coupon issuance will also be credit positive for the Spanish covered bonds that remain outstanding, because the maturities will result in lower interest payments on remaining bonds and reduce any potential mismatch with the cover pool’s cashflows, thereby reducing interest rate risk.

However, Spanish benchmark issuance is widely expected to fall in 2017 from the Eu13.25bn issued last year, on the back of the availability of the TLTRO funding and a decline in issuers’ funding needs. Most analysts forecast between Eu9bn and Eu12.5bn of cédulas supply this year.

Only one benchmark Spanish covered bond has been issued this year, a Eu1.5bn 10 year issue for CaixaBank on 3 January. The deal was priced at 60bp over mid-swaps and with a coupon of 1.25%.

“Banks that issue new CH may do so to obtain funding at tight spreads and with longer maturity than is available from the ECB, as can be observed in those CH most recently issued,” said Moody’s.

In a report published on Monday of last week, Moody’s said that “solid, albeit slower” economic growth will underpin robust performance of Spanish covered bonds this year. The rating agency expects that a slight recovery in house prices and mortgage lending will drive an increase in loan credit quality for new and old loans across the banking system in 2017.