The ECB has shown it is ready to support recent covered deals that should have floundered.
Central banks bought more than half of Caixabank and WL Bank’s deals, up from about 30% in almost every other deal issued this year. This shows the ECB stands ready to step in at a moment’s notice and prevent the normal, if sometimes unpleasant, functioning of the market.
The safety net it has provided has come as a welcome relief for sellers. And for buyers it means they have never been far wrong with their choice of investment.
With that kind of security, the effort that it takes to understand the finer details of an issuer’s credit profile, its country’s legal framework and its collateral pool seem hardly worthwhile. Buyers are certainly not compensated for their work by the spreads on offer, nor will they be for potentially the next 18 months, until the third covered bond purchase programme (CBPP3) is due to end.
But events in Austria have shown that it is worthwhile taking the time to do due diligence even if the pay-off is not immediate.
This doesn’t necessarily mean investors should simply avoid lower rated covered bonds from weaker countries and buy only the highest rated issues from core Europe. It means that understanding which covered bonds are dangerous in which circumstances is more important than ever.
Take for example the recently issued €1bn 10 year Cédulas offered by Bankia, a systemically important bank from a country where covered bonds are a systemically important funding tool. The deal has a split rating of BBB+/A, the institution was one of the worst affected by the crisis and loans more than 90 days past due in its mortgage book stand at an eye-wateringly high 7.67%.
But the €37bn of outstanding bonds are backed by a €74bn pool. In order for a payment disruption to take place, the cover pool would need to be stressed to an almost unimaginable level.
In other words, the 42bp basis points Bankia offered looked extraordinarily generous relative to the 7bp that Hypo Noe offered for its most recently issued triple A rated deal. While Austria is "core Europe", Hypo Noe was exposed to the suspension of payments on Heta Asset Resolution's debt, with a direct writedown of €60m on its €225m exposure and indirect exposure through the Pfandbriefstelle.
The bank has delayed its full year results, and its covered bonds have been among the worst hit by the fall-out from the Heta situation.
In September 2016, CBPP3 comes to an end, but given the forward looking nature of monetary policy, it is possible the ECB could start making noises about pulling back from QE as early as this year.
At that point, credit curves will steepen, the cost of liquidity will rise, and investors will no longer be able to count on covered bonds being a one-way trade.
Investors that have really looked closely into their purchases should have confidence to ride out the storm, while those that have bought everything in the market hoping to flip to the ECB may find themselves selling into a soft market, as credit quality, rather than the central bank bid, reasserts its pricing power.