Covered Bonds

Hopes for covered bond issuance rose on news that a Greek debt swap will go ahead, allowing the EU to provide a second bailout for the troubled sovereign. But supply is not dependent on the market environment – borrowers simply don’t need the funding, said syndicate officials.

Banks that encumber assets by issuing secured funding are at risk of sidelining senior unsecured investors. But senior investors say worries about encumbrance will be eclipsed by incoming draft legislation on crisis management. Senior holders will need to focus more on how big the buffer is below them, and not what sits above them.

Turkey’s Sekerbank confirmed that it has sold another tranche of its SME backed covered bond to UniCredit off the same shelf that was inaugurated last year. The placement follows the sale of two tranches to the European Reconstruction and Development Bank and European Investment Bank in December 2011, and comes ahead of an expected sale to another supra-national agency in the near future. The programme’s success has prompted at least three other Turkish banks to mandate UniCredit and set up similar programmes.

As part of a $4bn rates and credit double-whammy from the issuer, a new covered bond from Commonwealth Bank of Australia this week drew notably more investors than dollar debuts from its domestic peers ANZ and Westpac, according to bankers.

Banks that encumber assets by issuing secured funding are at risk of sidelining senior unsecured investors in the event of a default, especially in the wake of the European Central Bank’s second three year long term refinancing operation (LTRO), Barclays Capital analysts warned this week.

Euro covered bond investors voiced concern this week about the weak outlook for new supply as the currency’s tightest and most oversubscribed benchmark bond in more than a year failed to trigger further deals. Analysts, meanwhile, slashed their euro issuance forecasts following the European Central Bank’s two long term refinancing operations.

The outlook for the senior unsecured market will deteriorate as increasing encumbrance and a draft law on bank resolution dampens the euphoric rush of issuance that followed the European Central Bank’s unprecedented injections of liquidity, according to Barclays Capital. As a consequence, banks may increase covered bond issuance, there could be a third Long Term Refinancing Operation, or bank capital ratios might need to be improved.

Barring a poor outcome from Greece’s private sector initiative, primary supply is poised to pick up, said syndicate bankers, who advised issuers to launch trades while the market remains receptive. Covered bond analysts are lowering their euro benchmark forecasts, however, and investors are concerned about declining issuance.

Increasing encumbrance of balance sheets is at risk of sidelining senior unsecured investors in a default scenario, especially in the wake of the European Central Bank’s second three year long term refinancing operation (LTRO), said analysts at Barclays Capital on Thursday. Bankers said encumbrance was becoming more of an issue for investors, but some senior buyers said it would be eclipsed by incoming bail-in legislation.

A Norwegian issuer – believed to be DnB Nor Boligkreditt is considering a 10 year trade, but is struggling to offer an attractive coupon in such a low yield environment, syndicate officials said on Wednesday. Though real money accounts are long cash and eager to put money to work, they may have to move down the credit curve to hit their targets.

The secondary covered bond rally rolls on, grinding spreads tighter and pushing yields to their limit. But foresight and fundamentals have played no part in the lust for peripheral paper. As lucrative as the carry trade has been for banks, when things turn sour investors could find themselves trapped.

The European Commission’s plan to rotate rating agencies should be scrapped, the European Covered Bond Council (ECBC) and European Mortgage Federation (EMF) have strongly recommended.