Covered Bonds

Santander UK has launched Holmes 2011-3, ending a two month drought in the public European ABS market. Market participants had been begging for a large multi-currency master trust deal to kick off a revived market, and Holmes fits the bill.

Covered bonds have been defended after JP Morgan chief executive Jamie Dimon’s criticism of their privileged status in Basel III regulations. Their preferential treatment stems as much from the degree of regulation inherent in the product as its liquidity, said Florian Hillenbrand, head of covered bond research at UniCredit.

UK bank shares fell on Monday after the Independent Commission on Banking recommended ring-fencing the retail operations of UK banks in its final report. Mortgage lending will be permitted within the ring-fence, as will wholesale funding. However, the ICB proposes a wholesale funding limit, which could address concern that if mortgage backed assets such as covered bonds are included in the ring-fence, asset encumbrance would reach unacceptable levels.

Markets opened poorly on Monday morning and hit record wides in some indices, after concerns about Greece’s ability to meet its austerity commitments dominated weekend headlines. Syndicate bankers touted Tuesday as the day to bring a deal if market conditions were constructive, but the volatility means they expect no primary supply this week.

Two weeks of pressure on French covered bond spreads in the secondary market have pushed Dexia Municipal Agency’s outstanding paper to new wides. In the last two days however, spreads have tightened moderately and settled up to 100bp wider than where they were before the market re-opened on August 25. Fortunately the bank has finished its long-term funding for the year, and even if spread levels make public issuance economically prohibitive, it has developed other funding tools. Covered bond analysts see value for investors in buying their bonds now.

The Cover provides a brief summary of the regular covered bond research notes produced by Deutsche Bank, Société Générale CIB, LBBW, Barclays Capital and DZ Bank. With the covered bond to senior unsecured spread having widened considerably in the recent past, one of the key focuses is on relative value, and in some cases senior is preferred over covered. A couple of houses also look at the Scandinavian region with one highlighting the risk of house price declines on high LTV pools in Denmark and Sweden. Finally, one house looks at rising Spanish NPLs and finds that this should not be a problem – provided there’s a €75bn recapitalisation.

Denmark’s Nykredit on Monday started a 12 day bond auction to refinance its adjustable rate mortgages. After two days of selling, bid-to-cover ratios and spread levels appeared to show that demand has withstood concerns about the bank’s new capital centre for ARMs and wider apprehension about Denmark’s weak housing market.

While the European covered bond market continues to misfire as it struggles to distance itself from the eurozone crisis, the dollar market this week showed its increasing strength and depth with its largest deal yet.

After €20bn of covered bond issuance in just over a week, market volatility and announcements by the ECB and German Constitutional Court were enough to keep European issuers sidelined this week. Although there was no primary issuance, the pipeline continued to grow and three issuers finished roadshows, which means there should be deals when conditions improve.

Prospective issuers stayed out of the European covered bond market on Thursday, ahead of the afternoon ECB interest rate announcement and press conference in Frankfurt. A deal is highly unlikely on Friday, which means the week will probably end without any European supply at all. Looking ahead, Norway’s Terra Boligkreditt finished its roadshow on Wednesday and may be the prime candidate to resume euro supply early next week — as long as weekend headlines don’t spook markets.

Against a backdrop of pervasive hesitancy in the euro market, triple-A rated Toronto Dominion Bank launched the largest ever dollar deal on Wednesday. The $5bn dual tranche trade broke the record held by HBOS, which sold a $3bn 10 year trade in 2007.

A UK based covered bond investor spoke to The Cover about the sovereign crisis. He believes the primary market should still be able to function, though the group of issuers capable of doing a deal will be much smaller. Greece is beyond hope, but he says the rest of Europe can still be saved.