Covered Bonds

The covered bond market is in danger of losing a swathe of real money investors who have been put off by low returns and declining issuance. But a rich new stream of demand from bank investors looking to fill their liquidity buffers could fill the vacuum in time. However, these buyers should be more interested in looking at the nascent floating rate format and not the fixed rate market that until now has prevailed.

National Australia Bank opened books on Wednesday for its first euro benchmark of the year, deciding to follow the well-worn route of others with a seven year tenor, the eighteenth such maturity this year and the fifth this month. Though NAB took advantage of being alone in the market, underlying credit sentiment remains jittery.

Standard and Poor’s positive rating action on Depfa plc on Monday, and an expected rating upgrade from Moody’s that has yet to materialise, have had barely any impact on the issuer’s Irish covered bond spreads. The outlook should become clearer when further details of its ownership structure have emerged, bankers told The Cover on Tuesday.

After a long string of syndication success stories this year, the covered bond market finally saw some investor pushback on Tuesday when Landesbank Hessen-Thueringen (Helaba) issued a tightly priced two tranche Pfandbrief. The outcome gives ammunition to those that are concerned valuations have become overstretched. However the funding was very cheap, attracted exceptionally strong international demand and was placed with high quality accounts.

Declining Spanish covered bond issuance has resulted in higher levels of overcollateralization, said Moody’s on Tuesday. This is credit positive because bondholders are better protected.

After a weak open covered bond market sentiment began to improve on Monday as sovereign markets showed signs of stabilising. Though the outlook could remain unsettled until this Thursday's European elections, the longer range picture is constructive and the natural bias of flow is to the buy-side, bankers told The Cover on Monday.

Landesbank Hessen-Thueringen (Helaba) mandated leads for a dual tranche triple-A rated public sector Pfandbrief on Monday, for launch on Tuesday.

Spanish bank Kutxabank took advantage of improving conditions after a dismal open on Monday to issue the country’s fourth covered bond of the year. Following Swedbank and Bank of Austria last week with a seven year tenor, the deal is the first such tenor from Spain this year and a clear indication of where the sweet spot on the curve lies.

The covered bond industry looks set to achieve its aim of having highly rated bonds counted as Level 1 assets in the Liquidity Coverage Ratio (LCR). However, the newly drafted rules set a minimum single A rating for Level 2 assets. That will mean peripheral banks are unable to use many of their domestic covered bonds for liquidity purposes. They will therefore be forced to increase their sovereign risk.

With a sizeable portfolio of variable rate mortgages, it makes sense for Stadshypotek to issue floating rate covered bonds, as this minimises interest rate risk and swap costs. Though the investor base for floating format covered bonds is still in its infancy, treatment of the asset class in bank liquidity buffers could soon be improved, and since FRNs are better suited for bank liquidity books, this is a market that could potentially deliver a substantial stream of demand.

Five Portuguese covered bond deals were upgraded on Friday by Moody’s, in a move that had been widely anticipated following the sovereign upgrade. But the upgrades came against an increasingly volatile credit backdrop which saw some peripheral covered bonds soften as their respective sovereign markets came under pressure.

Issuers have started to respond to a shift in asset allocation approaches from money market funds, with highly rated borrowers selling sub-one year covered notes and lower rated names contemplating entering the commercial paper market.