EBA has deemed covered bonds backed by aircraft loans to be LCR-ineligible in a surprise interpretation some market participants say undermines the eligibility of certain Luxembourg and Danish issues, but others have questioned the opinion’s importance ahead of the forthcoming Directive.

The European Banking Authority (EBA) on 22 September answered a question submitted via its “Q&A Tool” in March 2016: Are aircraft loans eligible as collateral and as a consequence credit quality step 1 in the case explained in the background or do they not receive the preferential treatment or otherwise are they non-eligible for LCR in every case?

The question cited two then Aa3 rated aircraft Pfandbriefe, which are understood to have been issued by NordLB.

EBA deemed aircraft covered bonds ineligible for Levels 1, 2A and 2B in its response, citing the ineligibility of the collateral under conditions for preferential treatment under CRR.

The answer surprised many market participants, who had previously understood that – according to LCR rules – covered bonds would be eligible for the key Levels 1 and 2A if meeting either CRR or UCITS requirements. Analysts said EBA appears to have misinterpreted the relevant text and introduced CRR compliance as a prerequisite.

As well as affecting otherwise-eligible NordLB Flugzeugpfandbriefe, the opinion could have implications for other covered bonds that meet UCITS but not CRR requirements, such as some Luxembourg lettres de gage and Danish ROs (Realkreditobligationer). Commerzbank analysts cited NordLB Luxembourg Covered Bond Bank issuance, noting that the issuer had told them that it continues to consider its issuance LCR-eligible.

“Based on the EBA’s interpretation, however, Luxembourg paper could be considered ineligible for LCR purposes in general, as the cover assets do not fully satisfy the requirements of Art. 129 CRR,” they said. “Such an interpretation could well have an impact on the market. After all, banks – for which LCR-eligibility is likely to be an important criterion – accounted for a substantial part of the allocated volumes in NordLB Lux’s most recent benchmarks deals.”

They were among several market participants to highlight that the EBA’s opinion “has no binding force in law”, although a covered bond banker cautioned against playing down the importance of the regulator’s answer.

“People just need something to point at, so I think they do end up using the EBA stuff even if they don’t have to,” he said, “because who wants to be the guy internally who says: ‘This is the EBA’s opinion, but you know what? Never mind what they said.’”

The aircraft opinion follows an earlier EBA answer, on 4 August to a July 2016 question, when it said the eligibility of third country (i.e. non-EU/EE) covered bonds for LCR Level 2A would have to be assessed “on a case-by-case basis of the equivalence of the third country by the bank and its supervisor”. This opinion was also deemed surprising, with the impracticality of conducting such reviews cited, particularly given the lack of a clear benchmark framework to compare them with.

Another market participant lamented the confusion caused by such Q&As, saying that the questions are answered by EBA personnel not involved in the regulator’s ongoing work on covered bonds, and sometimes asked by covered bond market participants who should know better.

“If you ask your mother if you can go out and come back late in the evening, she will always say no,” he said. “Where the wording may be unclear, they are obliging EBA to give a response, which just causes more of a mess. I hope that no-one else will ask any more questions, but in the end this will be addressed in the Directive.

“When LCRs were negotiated, the UCITS stuff was clearly supposed to be in,” he added. “I think there is now some kind of question mark around their eligibility in the Directive.”

Comments from Commission officials have indicated that the Directive will focus on mortgages and public sector collateral. Back in July 2014 EBA advised the European Commission that aircraft covered bonds should not receive preferential risk weight treatment, although it did not include recommendations on collateral eligibility criteria in its December 2016 three-step approach.

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