Covered Bonds

The prospect of default hung over the covered bond market this week following the downgrade by Moody’s of two Cypriot covered bond programmes. The new Caa2 ratings imply that investors could potentially suffer impairments — the first in the covered bond market for over 200 years.

Commerzbank’s recently-issued SME structured covered bond has been elevated from liquidity category four to liquidity category three in the European Central Bank’s liquidity framework, thereby attracting a much lower haircut. The move should improve the attractiveness of the asset class and could help spur its development.

The primary market remained dormant this week but there are high hopes that a northern European deal will surface next week.

With the exception of difficult credits like Monte Dei Paschi, the European covered bond market was in good shape at the end of this week, with secondary market demand across a number of names and jurisdictions.

This year’s first quarter net supply of euro-denominated covered bonds — negative €40bn — was the lowest level since the birth of the single currency in 1999. And with a surfeit of central bank liquidity alongside continued balance sheet shrinkage, the trend looks set to continue, suggesting the already measly supply forecasts for the year could be revised even lower.

Commerzbank’s recently issued SME structured covered bond has been elevated from liquidity category four to liquidity category three in the European Central Bank’s liquidity framework, thereby attracting a much lower haircut. The move should improve the attractiveness of the asset class and could help spur its development.

Covered bond ratings are going one way — down. Yet regulators continue to develop rules that would force investors to hold more capital against covered bonds rated AA- and below, and it is not yet clear whether covered will be classed as a top level asset for the Liquidity Coverage Ratio. Are regulators out of touch?

The primary market remained dormant today but there are high hopes that a Northern European deal will surface next week. And, despite the Stadshypotek experience, syndicate bankers believe that with careful execution borrowers could even fund without paying a new issue premium

With the exception of difficult credits like Monte Dei Paschi, the European covered bond market was in good shape on Thursday with secondary market demand being noted across a number of names and jurisdictions.

Stricter capital requirements for Norway’s banks would be positive for the country’s covered bond market, said Moody’s in a report on Thursday.

The European Covered Bond Council has responded to investors’ and regulators’ calls to improve transparency, and in two months since launching its Label Initiative, over half the outstanding covered bond market has signed up. But there is still much work to be done, both in meeting the needs of covered bond investors and protecting the reputation of the asset class.

Moody's downgraded two Cypriot covered bond programmes one notch closer to default late on Tuesday. The new Caa2 rating implies that investors could have potentially suffered losses but, since the bonds are retained and are likely to provide their issuers with emergency liquidity indefinitely, this is an issue that they have not needed to confront.