Covered Bonds

The covered bond market is set to experience one of the steepest declines in issuance on record this January. Yet, despite a poor start, bankers still expect a resurgence in the primary market, although extended lockdown restrictions are creating uncertainty.

A double-digit spread over mid-swaps is still possible in covered bonds from Poland, Slovakia and Dutch conditional pass-though deals, suggesting scope for performance is strongest in these markets, said bankers on Wednesday.

Sparebanken Sør Boligkreditt’s covered bond drew more demand than competing deals issued by Berlin Hyp and Royal Bank of Canada on Tuesday, thanks to its more generous spread, shorter duration and favourable liquidity treatment.

Levels of asset encumbrance increased sharply in the first half of 2020, the European Banking Authority said in a report this week. It warned that roughly half of the assets eligible as collateral for central bank funding schemes are now encumbered.

Royal Bank of Canada issued a tightly priced €1.25bn 10 year covered bond on Tuesday. While it only attracted just enough demand for it, the long tenor, investor diversification, cost of funding and deal size were positives for the borrower.

Korea’s KEB Hana Bank attracted a €2bn order book for its €500m debut covered bond on Tuesday, boosting hopes for an improvement in the secondary market performance of similar deals from South Korea that offer outsized spread pickups.

Even though technical factors are highly supportive for covered bonds, traders say they are unwilling to lift offers, reflecting increased anxiety about limited performance potential and an underlying concern that credit market sentiment is less sure-footed that at the start of this year.

Credit Suisse issued a two-part covered bond in Swiss francs on Monday, choosing to limit the deal sizes in order to ensure a tight spread and low yield.

BPCE found good demand for a two-part covered bond on Monday with the bonds pricing almost flat to its curve. Even so, the near term outlook has become less certain as German lockdowns are expected to be tightened amid renewed concern over the impact on commercial mortgages secured in some Pfandbrief.

Muenchener Hypothekenbank (MuHyp) sold the longest covered bond of the year so far this week, and bankers expect more long end deals to follow.

This week’s burst of covered bonds was exceptionally well received and boosted supply hopes. But even though the funding was cheap and deal execution certain, the supply outlook remains grim.

Tight valuations in euros are making it difficult for banks to impress investors with new senior trades. Issuers may have to pay up or switch focus to other asset classes to make the most of the January market.