Covered Bonds

Faced with shrinking yields, covered bond investors have been deserting the market. Unless the ECB moves out of the way and switches to sovereign purchases fast, there is a real risk that these buyers will not be there when the extraordinary stimulus measures now being delivered are taken away.

The covered bond market was on hold on Monday, awaiting developments in Greece after the anti-austerity party, Syriza, won a near majority in Sunday’s elections. Though the result was in line with expectations, the market is sensitive to the risk of negative headlines. One or two deals could emerge this week, but there is unlikely to be much until next week, when many issuers emerge from blackout.

A majority of covered bond investors polled by Fitch in December 2014 say the market’s greatest challenge is decreasing secondary market liquidity. The rating agency expects the most pronounced illiquidity from June 2016, which could feed through to the credit quality of covered bond programmes, as refinancing becomes more difficult.

The larger than expected quantitative easing programme announced by the European Central Bank on Thursday has turbo-charged the well-established bull flattening trend in covered bonds and trading volumes have tripled from earlier in the week. With the long end of French market now offering a tempting spread to OATs, real money buyers are set to return. And with Bonos and BTPs rallying hard, relative value between covered bonds and sovereigns should soon be restored in the Cédulas and Obbligazioni Bancarie Garantite markets.

NordLB will start engaging with investors from mid-February regarding plans to sell its Lettre de Gage Publique. The issuer may also update investors about its merger plans, which could ultimately result in a wider pool of assets being financed under the Luxembourg covered bond law. Around the same time Goldman Sachs is likely to be reconsidering how to approach the market with its FIGSCO deal. The two issuers’ very different approaches show there is still great scope for innovation in dual recourse instruments.

Five covered bond borrowers issued benchmark deals in the first half of this week, fearing potential volatility from Thursday's European Central Bank announcement on its sovereign quantitative easing programme.

NordLB Covered Finance Bank (NORD/LB CFB) is set to revive the sedentary Lettre de Gage (LdG) market and plans to issue its first benchmark sized covered bond. The issuer, which will take advantage of the recently updated Luxembourg legal framework, mandated leads for a European roadshow on Tuesday.

Moody’s upgraded 12 Italian and Spanish covered bonds into “Aa” territory after the close on Wednesday, taking the bonds from category 2A to 1B in the liquidity coverage ratio (LCR). Though this should theoretically improve bank demand, last week’s LCR impact study published by the European Banking Authority (EBA) showed most banks had already met their minimum LCR requirement, suggesting scope for an improvement in appetite will be limited.

If Wednesday’s leaks prove true, and the Eurosystem buys €50bn of sovereign bonds per month from March 2015 to December 2016, the total €1.1tr package is larger than expected. Government bonds should therefore outperform and this will restore relative value by making covered bonds look comparatively cheap, said analysts.

Canadian Imperial Bank of Commerce opened books for the third Canadian benchmark issued in euros this year. The transaction priced tighter than its peers with no new issue premium, though it was still comfortably oversubscribed. The strong result suggests potential for spread narrowing between eurozone and non-eurozone covered bonds.

The European Commission wants credit ratings left out of financial regulation — a great move, if it can find something good to replace them. But it’s making the right decision for the wrong reason. Upset at the presence of sovereign rating caps the EC has thrown a hissy fit in its final version of the Liquidity Coverage Ratio, and suggests that jurisdiction should not be a part of the credit quality of covered bonds — a view that will come as a big surprise to anyone investing in them.

NordLB Covered Finance Bank (NORD/LB CFB) has mandated leads for a European roadshow to sell its first benchmark sized covered bond under the recently amended Luxembourg legal framework. Though this deal will be backed by public sector assets, the law allows for a much wider pool of movable assets, suggesting there is potential for more innovative deals to follow.