GlobalCapital: What does the TLTRO mean for spreads? Timo Boehm, Pimco: We expect it will lead to more demand from banks but also on the primary side our expectation is that it may also lead to less issuance which would be supportive to spreads tightening. I suppose that banks themselves will invest in the periphery as, though spreads tightened a lot this year, there is still a decent pick-up there. In addition, we expect less new issuance out of the periphery. We will see a few more peripheral deals this year which pales in comparison to the amount of bonds being redeemed.
Mugat, AGI: The perception of more and more liquidity flooding into the markets will keep investors confident sticking to risk-on strategy. The more interest rates are expected to stay at a very low level, the more investors will chase yields lower. They can do this either by going longer on the curve or by picking up riskier assets.
Coyne, NAB: We expect surplus liquidity to find a way into the investment grade product in the short run, awaiting deployment into the SME sectors that a number of the programmes are focused on supporting. That probably means reduced wholesale funding requirements for European issuers on the whole, further supporting the strong technical backdrop for spreads. The spread relativities between senior and covered might move around a little, but the general trend is going to be tighter.
El Amir, UniCredit: I’m talking my own game, but I do see good performance potential for peripheral covered bonds which trade 70bp-80bp over versus flat to 10bp for core markets.
If you look at the core to peripheral spread contraction in senior, it’s been much more than in covered bonds. So I think that there should be a technical bias for covered bonds in the periphery to tighten by more, especially if people do their homework and look at the default rates and LTVs which in our case average 55% in the cover pool.
Boehm, Pimco: Broadly speaking, there’s more room for peripheral performance and even for core markets below swaps. But the speed of spread compression will be lower. We have already witnessed this trend since June as performance contribution from spread versus yield was much less pronounced than the first half of the year.
Costa, CGD: Absolute spread levels between covered bond and senior unsecured levels are more significant in peripheral countries so they will be more encouraged to issue covered bonds to protect net interest margins.
GlobalCapital: Have spreads tightened too far? Do you think they’re sustainable?
Gotrane, Caffil: I don’t know if there is a spread floor but even compared to the widest level recorded during the crisis, the tightening we’ve already seen has been huge and some may argue too quick. Nevertheless, keep in mind that many covered bond spreads were flat versus swaps in 2005.
Hoarau, Crédit Agricole: Bank treasuries will certainly continue to buy covered bonds at very expensive levels, as demand will be fuelled by the incentive to buy for their LCR liquidity buffers and because of shrinking net covered bond supply.
Everything being equal, Pfandbriefe have been underperforming the rest of the market in primary for one year. The spread compression within core covered bonds will find resistance soon within the investor community. I look forward to seeing the five year spread differential returning between German Pfandbriefe and French covered bonds, though it might not exceed 5bp-7bp.
Sami is right, the covered bond market was trading around flat versus swaps in 2005, but outright yields were much higher. In today’s market, insurers and asset managers are really struggling to reach their targets in the core markets. So, yes, compression, core to non-core, is set to continue but this will be driven by technical factors and liquidity rather than a fundamental pricing for risk.
Pimper, Commerzbank: From a fundamental point of view the question is justified, but fundamentals do not seem to be the driver here. It is more the lack of alternatives and the favourable regulatory treatment that is driving spread compression, which I don’t see ending here. Indeed, I could imagine that peripheral covered bonds reach the same spread level to core covered bonds as they had before the crisis.
Mugat, AGI: From an historical point of view, core covered bonds have appeared expensive versus swaps, even if there are a lot of good reasons to justify current tight levels, such as exemption from bail-in, expectations for favorable treatment under LCR and strong negative net supply. Thinking about further tightening potential of peripheral government debt versus core countries, peripheral covered bonds could continue to follow the same spread tightening path.
Costa, CGD: Spreads of many securities compressed significantly in a relatively short period of time, but in some cases previous spread widening of those same securities was even larger and faster when it occurred. In the case of Portuguese securities we believe there is still potential for further spread compression as the economy recovers. Having said that, there may be pockets of volatility at times caused by specific situations such as the one recently illustrated by BES.
GlobalCapital: How do you see the future of the public sector covered bond market?
Gotrane, Caffill: We all know that covered bond issuance has gone back sharply over the past 10 years. However, a lot of this is due to special factors like the cost of German reunification and the end of guarantees for the German Landesbank sector which led to an initial steep increase and to the subsequent decline in public sector covered bond issuance volumes.
The traditional lending business to municipalities has been much more stable than the overall issuance volumes suggest. When we look at the French market, around 30% of outstanding local authority debt is held by covered bond issuers, which makes covered bonds a key pillar for the financing of the local public sector.
When comparing the public sector covered bond to the mortgage covered bond market, there are huge differences in terms of market size of the underlying assets. In the case of France, housing loans total close to €900bn against local authority debt around €150bn, or roughly a fifth of outstanding housing loans. So, it is not a surprise to see higher levels of mortgage backed issuance.
We should, however, not underestimate the importance of the public sector covered bond market. In France, local authorities are in charge of close to 70% of public sector investments. In that sense, public sector covered bonds make a big contribution to financing the national infrastructure.