Throughout most of this year, all but the highest yielding euro denominated covered bonds at the short end of the curve were trading with a negative yield. This made them impossible to sell, but CFF’s trade has shown that this tenor is now open.
Three year deals were issued by banks such as Nationwide and Bayerische Landesbank this year, but these were denominated in higher yielding currencies such as US dollars or sterling. On Tuesday, the French bank showed that three year euro trades can be done.
The three year mid-swaps rate was 25bp on Tuesday morning which meant that, with a final spread of 11bp through mid-swaps, CFF’s trade was still able to give a reoffer yield of 15.2bp. Earlier this year, the three year mid-swaps rate was around 15bp, and with many bonds trading at or below that level, a new issue would have had to price with a potentially negative yield.
But outright three year yields have almost doubled since April which has paved the way for CFF’s return. And in conjunction with its previous deals CFF was able to build out its curve. “We have been in the market with a 10 year and a five year this year, so it made complete sense for our curve,” said Paul Dudouit , managing director, head of long term funding for CFF.
The choice of tenor was also a response to investor demand. “Central banks have a strong interest in the three year point and we wanted to match investor demand,” said Dudouit . Central banks bought nearly half of the €1.5bn deal.
Leads said CFF was one of the few names able to issue in this tenor in euros. “Most would need to do dollars or sterling at this point in the curve,” said one. So far this year five banks have issued three year covered bonds in sterling, and three issuers have priced three year deals in dollars. As swap yields are higher in these currencies, investors were able to get a positive return.
Though one bank did technically launch a three year covered bond in euros this year, this was HSH Nordbank which issued a higher yielding Pfandbrief backed by shipping loan collateral. The unusual asset pool and weaker credit standing of the issuer, along with the three and a half year maturity ensured a positive return. This is something which was not possible with conventional covered bonds until now.
Although other issuers could now consider euro three year deals, the candidates are limited to specialist mortgage lenders that use covered bonds as their main source of funding. Typically universal banks will reserve covered bonds for longer dated funding and use senior unsecured issuance for shorter funding. CFF does not issue in the senior market.
Leads Barclays, BayernLB, Credit Suisse and Natixis circulated initial price thoughts of minus 6bp for the three year Obligations Foncières benchmark. The leads took indications of interest of €1.3bn before revising guidance to minus 8bp. They then launched the €1.5bn trade at minus 11bp, with 85 investors placing orders of €2.15bn.
The issuer’s 4.5% May 2018s were indicated at 13bp through mid-swaps pre-announcement. Leads also looked at the issuer’s 1.125% 2019s which were indicated at 13bp through, and its 0.375% 2019s which were indicated at 15.5bp through. With fair value around minus 13bp, the final print offered new issue premium of about 2bp.
“Investor feedback was such that they asked for a high new issue premium for longer bonds. In this context we targeted the three year which offers a NIP of between one and two basis points,” said Dudouit . This was considerably less than the 7bp that Toronto Dominion paid on Monday for its €1.25bn five year .
The much lower new issue premium is likely to reflect the fact that demand was driven by the less price sensitive European Central Bank. This stands in contrast to the other five euro denominated covered benchmarks issued this week, none of which were eligible for the central bank’s purchase programme.
Nearly two thirds of the deal was placed with German and Austrian investors and just over a quarter was placed into Switzerland with the remainder distributed throughout Europe. Central banks bought nearly half, with asset managers taking nearly a third and the rest going to banks.