Covered Bonds

Purchases of government debt by the ECB stalled a rise in Spain’s borrowing costs and resulted in its sovereign CDS dropping from over 400bp to 350bp at the end of last week. On Monday morning Spanish and Italian government bonds tightened slightly against Bunds, though Spain’s CDS widened out to 375bp, with market participants concerned over the lack of a long term solution to the sovereign debt crisis.

Covered bond traders and syndicates warned against premature optimism during the relative calm at the start of this week, and it turns out those warnings were apt. But syndicate officials have not given up hope of issuance in the next few weeks even though the possible candidates to reopen the market are down to a select few from Germany, the Nordics and the Netherlands — and those with credit lines to US investors are now even better placed.

With US Treasuries and government-sponsored enterprise (GSE) paper closed to buyers with a dedicated triple-A policy, European covered bonds may enjoy increased interest from US investors in search of assets. Syndicate officials said that in spite of several mandates for investor meetings ahead of euro issuance (see story opposite) it could be a dollar deal that reopens the covered bond market after the August interval.

Austrian, Nordic and French borrowers this week announced roadshows for the end of August, raising hopes for a resumption of primary supply in the covered bond market in September. But with the sovereign debt crisis weighing heavily on investors’ minds, issuance could be more difficult — or at least more expensive — than usual for credits from the market’s most recent target of sovereign scrutiny, France.

The pipeline for issuance continued to build on Thursday, with Austrian, Nordic, and French borrowers scheduling investor meetings ahead of planned transactions. Though all prospective trades are in euros, syndicate officials said it could be a dollar trade that reopens the market.

A steady supply of high quality Germany SSA paper continues to give the covered bond market hope it will be next in line to reopen. Raiffeisen Landesbank Steiermark is understood to be preparing for a covered trade in early September, and syndicate officials said high quality names from several jurisdictions are assured market access. In the secondary, however, peripheral covered bonds still lag the debt of their respective sovereigns.

The focus of attention is on plunging stock markets, a falling Bund yield, worse than expected German growth and a meeting between President Sarkozy and Chancellor Merkel. Well received SSA issuance should bode well for a German or Nordic covered bond reopener but many have their doubts. Nykredit is on the road in Asia, but it’s strictly non-deal related.

Australian covered bond legislation could be passed and enacted by the end of the year, a treasury official said this week in a speech titled: “Understanding the Key Elements of Covered Bonds Legislation”.

EFSF guaranteed covered bonds could be one solution to dwindling access to term funding among Europe’s banks. Even if markets reopen in September, costs are likely to be high across asset classes, particularly senior unsecured, said market participants. Funding constraints may lead banks to shrink their balance sheets, and if unchecked could lead to a grinding credit crunch in the southern eurozone.

After a week of severe fluctuations in all market segments, traders said Monday morning was the quietest day in weeks. Market participants are hoping for a modicum of stability to improve the chances of primary supply at the end of the month and several issuers from core jurisdictions are finalising roadshows in order to come to market, syndicate bankers said. But if new issue premiums are at the top end of expectations, they added, it will reshape the secondary curve — and this may deter some names from returning.

A theoretical 10% or 20% haircut on ECB exchanged Greek government bonds in the public sector cover pools of German banks would have a limited effect on nominal overcollaterlisation (OC). Spanish and Italian pool exposures are much larger and a factor that investors should take into consideration.

Following the US downgrade, the dollar market for triple-A rated bonds has been reduced from around $15,000bn to $136bn, closing the market to dedicated triple A buyers. Covered bonds should benefit, but with up to 40% likely to be downgraded within a year, buyers will need to be selective.