Living with a covered bond shortage and the big QE squeeze

The relative value of covered bonds compared to sovereign bonds has improved, but the pace of European Central Bank buying has not slackened, as had been widely hoped. And even though the ECB has marginally scaled back primary market purchases this year compared to last, it remains an aggressive secondary market buyer.

The unrelenting central bid is therefore set to squeeze the market and displace an ever increasing number of private sector investors. The squeeze has crushed yields, taking them to unprecedented levels that are now becoming negative at the short end. 

The unwavering backstop for any bonds which yield close to nothing will prompt more investor profit taking, but sooner or later offers will dry up and the ECB will have nothing left to buy. At that time yields are expected to crash towards the negative 20bp ECB deposit rate. With the curve likely to flatten and fall even further it is possible that very few bonds will deliver even a positive return. 

So unless issuers are prepared to offer more generous new issue premiums, a negative yielding primary issue is likely. But so far investors have managed to survive the squeeze by buying the outperforming and higher yielding periphery; by switching into covered bonds that are not eligible for the purchase programme; and by turning to other currencies. 

Before this year is out the ECB may own more covered bonds under CBPP3 than was issued in the year as a whole, and by September 2016 it may own as much as 40% of the entire outstanding eligible benchmark market. 

Having displaced so much private demand, which will be slow to come back, the ECB will need to give careful consideration to its exit strategy by ensuring there is enough time to wean investors off the central bank teat. 

GlobalCapital and The Cover invited investors and issuers to a special roundtable discussion in March to talk about the hot topics affecting the covered bond market. 

Participants were:

Florian Eichert, covered bond and SSA analyst, 

Crédit Agricole CIB

Götz Michl, head of funding and investor relations, Deutsche Pfandbriefbank 

Jörg Huber, head of funding and investor relations, Landesbank Baden-Württemberg

Jozef Prokes, fixed income portfolio manager, BlackRock

Mostyn Kau, director group funding, ANZ

Ralf Burmeister, senior portfolio manager, Deutsche Asset & Wealth Management

Timo Boehm, fixed income portfolio manager, Pimco

Vincent Hoarau, head of FIG syndicate, Crédit Agricole CIB

Waleed El-Amir, head of group strategic funding, 

UniCredit

Bill Thornhill, editor, The Cover

GlobalCapital: Do you believe the ECB’s decision to expand its balance sheet with covered bond purchases was the correct thing to do? 

Waleed El-Amir, UniCredit: The ECB was trying to encourage macroeconomic growth in Europe so the basic idea of trying to increase liquidity and develop the capital markets was actually a good thing. 

GlobalCapital: A good idea in theory. But seriously do you really believe it will lead to an improvement in lending?

Jörg Huber, LBBW: I doubt it. The problem is much more to do with regulations, which punish banks for each bit of riskier lending. It costs banks so much capital to do this business, so they would rather not do it. 

GlobalCapital: At the present rate of purchasing, the ECB will become a dangerously dominant player, won’t it? 

Florian Eichert, Crédit Agricole: They’ve already moved from mid-single digit percentage points of holdings of the euro system eligible assets to the mid-teens, and will move to anywhere between 30% and 40% by September 2016, which is quite extreme. We’ve mentioned that to them on a number of occasions via the ECBC as well as bilaterally, and they always agree but at the same time admit that this is accepted collateral damage in the bigger quest to raise inflation expectations and improve economic growth.

GlobalCapital: The ECB is taking food off your plate Timo. Do you blame them?

Timo Boehm, Pimco: Even if I did it wouldn’t help, we need to find value for our clients in the present environment. So of course everything’s tight, and that means investing is not easy. But even though we’re at historically very low yields bonds can perform which we’ve seen in some of the latest new issues which printed at super-tight levels. 

Ralf Burmeister, Deutsche Asset & Wealth Management: I think that is fair to say the ECB doesn’t make our life easier. It’s a different story to what we saw in the first and second buying programmes where the ECB enabled market access. This time it’s all about managing inflation expectations that makes the programme a monetary policy tool.

GlobalCapital:Prized real money investors are being pushed out, how can this be good?

Götz Michl, Deutsche Pfandbriefbank: They’ve played a prominent role in changing our investor base, especially for benchmarks. But the crowding out effect, I would say, is rather a combination of spread tightening which of course was initiated by the ECB but, in combination with the low yield environment, it means these long term real money investors just don’t get their returns anymore.

GlobalCapital:How has issuance changed? 

Eichert, Crédit Agricole: Yields have been pushed to all-time lows, so borrowers tend to issue longer and bank treasuries tend to accept they must invest further out the curve to avoid negative rates. So it’s a matter of trying to escape negative rates. That means the 7-10 year area has been more active and we’re increasingly seeing more treasury type investors piling into that maturity bucket. 

GlobalCapital:What is the main consequence of the ECB’s action in terms of pricing a deal?

Vincent Hoarau, CACIB: The purchase programme provides market participants with a quasi-unlimited backstop bid in the secondary market while it offers a phenomenal momentum in primary. The first obvious consequence is a pricing distortion. And we all know that the ECB is not the pickiest investor around when it comes to price sensitivity. 

GlobalCapital:It’s effectively a one way street then?

Hoarau, CACIB: CBPP3 is adding to the structural bid and massively increases the imbalance between demand and supply, especially when you consider redemptions. Traders can’t afford to go short in secondary, syndicate managers tend to be more aggressive in primary and so do issuers. Since people know it can hardly be a balanced two-way market, we’ve seen accelerated spread convergence and compression across all regions and formats, as well as a curve flattened. 

GlobalCapital:If investors are not rewarded for taking risk, what will they do? 

Hoarau, CACIB: I strongly regret that credit differentiation has faded away and subsequently investors are not paid anymore for the additional bit of risk they are taking. Some investors have already exited the segment and granularity in books has strongly diminished overall. I fear resources allocated to the product may decrease in the future. It has already started on the buyside with asset managers shifting focus to higher yielding assets where they can find the size they search for. 

GlobalCapital:The ECB is in a tricky situation: it’s mandated to buy €60bn per month and at the same time it needs to try and preserve as much of the private market as possible. Do you get the sense it has stepped back a bit — at least in terms of its participation in primary deals this year compared to last?

Huber, LBBW: The ECB was buying up to 60% in the primary to begin with, but following a lot of discussions between members of the ECB and market participants we’ve seen their participation fall by about half and that has helped bring in marginal investors. The overall spread tightening has been helpful for borrowers as well as investors, but it’s a concern that at some point investors could stop participating, or at least become very cautious.

GlobalCapital:The ECB’s actions have made what was already a very technically driven market into something that is so much more squeezed. Have they at least tried to combat their overbearing affect? 

El-Amir, UniCredit: The ECB intervening has exacerbated the imbalance of supply to demand that was already there before the buying programme began. The real issue was around the size of the covered bond orders that they were putting in which was initially north of 50% of the deal size. At the end of last year some private investors felt that it didn’t make as much sense to get involved. But since then, and to the ECB’s credit, they’ve gradually decreased purchases to around 25% so there’s been a little rebalancing.

GlobalCapital: But is a little rebalancing really enough? Does it really make so much of a difference to the clearing price if you have to find a few more marginal private investors to replace the ECB?

El-Amir, UniCredit: If I need to raise €1bn and have €900m at 18bp but the last €100m is at 19bp, I’m going to have to price the deal at 19bp because I need that order. So as a 20% investor, the ECB is not going to be able to change the price. In that sense I would say it’s become a more conscientious investor. The ECB understood when they initially came in that they would have a distortive effect but they’ve since adjusted their approach to ensure primary deals are getting done at the appropriate clearing level.

GlobalCapital: They may have changed a little, but that hasn’t really changed the fact that they are pushing natural investors out of the market, has it? 

Michl, PBB: We have a new investor, which isn’t too bad because the ECB has quite deep pockets. But they are hoovering up everything they can get which means real investors are forced to look at alternative assets to achieve the return they are being asked for by their clients.

GlobalCapital: Do you think the ECB will slow its pace of buying in the next few months?

Eichert, Crédit Agricole: The only reason for the ECB to lower the rate of buying is if they struggle to find bonds and at some point I would expect this to happen. I’m surprised to see they’ve kept up the current pace for five months. At some point they will run into obstacles. 

GlobalCapital:What obstacles are you talking about?

Eichert, Crédit Agricole: Many bonds are sitting with large investors in hold-to-maturity portfolios where you can’t sell them. And many existing holdings are swapped so you have to unwind the swap to actually get the bond and that’s going to present an additional hurdle.

GlobalCapital:Waleed, does Florian have a point here?

El-Amir, UniCredit: The ECB’s committed to purchasing a very significant amount of sovereign assets and at the moment it’s not clear who is going to sell them those assets. If you talk to most bank treasurers, I think, no one is really keen to sell their liquid portfolios. You may realise a positive gain because everything’s trading significantly above par, but then you have to replace those assets in a very, very tight spread environment. 

GlobalCapital:So you believe they are going to hit natural barriers? 

El-Amir, UniCredit: It’s not going to be easy at all for them to meet their targets because, I think, most people are going to be quite reluctant to sell them assets and it will only get harder for them as the programme progresses.

GlobalCapital:Does the onset of the Public Sector Purchase Programme (PSPP) change much? 

Hoarau, CACIB: The size of the PSPP is massive and may accelerate and exacerbate the process I described previously. Excess cash will predominate further and spreads may continue to drift tighter. Logically, technical flows and duration extensions will dominate and investors will tend to be overweight to peripheral spreads. So convergence will continue. This is precisely what the ECB wants to achieve alongside the decrease of all-in costs in global funding. 

GlobalCapital:Do you think the ECB will slow its purchasing rate now it can buy plenty of alternatives?

Burmeister, Deutsche AWM: The ECB is snatching roughly €3bn a week which is amazing and is probably more than the majority of market participants had expected. And even though they started buying government bonds I can’t detect any kind of slowdown in their covered bond buying spree and there’s been no comment even hinting at a slowdown. So my best guess is that, as long as market conditions allow them to continue buying without severely hurting the structural composition of investors, why should they stop? 

Boehm, Pimco: I was also a bit surprised that even after establishing sovereign QE the speed of CBPP3 purchasing didn’t fall. It has happened to a very low extent as they started with €640m a day and we are now at €612m. But if the ECB continues at the same speed it’s potentially going to end up with around €150bn in a year which is more than the new issue market. But since they seem to have been pretty active in the one or two year area this stuff will roll off so that’ll help a bit. 

GlobalCapital:Has PSPP been helpful for covered bonds or not? 

Hoarau, CACIB: One direct impact for covered bonds is that with the start of the Public Sector Purchase Programme, they regained some relative value. But frankly, this has been marginal. 

GlobalCapital:Doesn’t PSPP take pressure off covered bonds even a little bit?

Eichert, Crédit Agricole: To me it doesn’t. Both programmes will run in parallel and I don’t see why the ECB should reduce their covered bond purchases. After all, €1tr of balance sheet expansion is a tall order and we have already seen the distortive effects the current buying pace has had, for example, on SSA markets. They will continue to make use of all options they have in order to try to minimise the distortive effects they have on any individual market.

GlobalCapital:Are you seeing more offers now the ECB has something else to buy?

Boehm, Pimco: Nothing has changed since sovereign QE started as you can see that the speed of purchases is more or less the same as it was when CBPP3 was established, especially on the offer side. Broker inventory is low and even now it’s close to quarter-end when you would expect a little better liquidity in some names, it’s still quite low. In general for most deals I can sell up to €5m and buy on average around €2m-€3m.

GlobalCapital:How do you expect primary volumes to shape up?

Michl, PBB: New issue volumes will stabilise around the current levels, or maybe even improve. We’ll see the trend for longer maturities continue as long as we have this low yield environment. Having said that, I think demand from bank treasuries should remain consistent due to LCR requirements. I would say the most defining factor, or even most interesting thing from my point of view, will be the ECB’s exit strategy.

GlobalCapital:As far as I’m led to believe the ECB has not yet thought about its exit strategy, at least that’s what they told me in Amsterdam. Do you think they might need to do some forward planning on this? 

Mostyn Kau, ANZ: Given the distortion that has occurred, I think the ECB will need to exit in a very well thought out, strategic way, to not cause damage in the medium term.

Eichert, Crédit Agricole: I can’t see them just stepping away from one day to the next, the only sensible way to exit is to taper their purchases. 

El-Amir, UniCredit: When they step back, I think it’ll be gradual. It will go back to the strategy they’ve been pursuing from the beginning of 2015 which is to be a price taker and not a price setter. It should be the private market that makes or breaks a deal which will put some pressure on spreads. You might see a little bit of spread softening. 

GlobalCapital:What’s the biggest risk associated with their exit from CBPP3?

Huber, LBBW: Natural investors, such as pension funds and insurance companies, are facing shrinking returns on the asset side, in terms of lower yields and growing liabilities in terms of an ageing population. There’s little or no return in the triple-A rated product so it probably makes more sense to lend directly. The trouble is that when the ECB tries to come off QE in a year or two’s time these investors may stay away because they’ve found new and better ways to get a return. This is a risk that threatens not just covered bonds, but the banking system itself. 

GlobalCapital:That sounds pretty dire. Surely there will be some sort of hard core covered bond buyers left?

Eichert, Crédit Agricole: There’s a risk of investors potentially moving to other fixed income products. But moving into completely different sorts of product types is something many can’t do and even those who are allowed to can only do so in limited volumes. Everyone’s talking about infrastructure and direct lending, but only the bigger accounts can do that predominantly from the insurance side. But they run into similar issues as we have in covered because supply just isn’t enough to cope with demand. 

GlobalCapital:What are they looking at instead? 

Eichert, Crédit Agricole: Many asset managers are at this point moving to corporate, corporate high yield, or senior unsecured, and, as their covered holdings come down, obviously the product-specific credit lines become re-allocated.

GlobalCapital: So will these investors that have moved to other asset classes be able to just jump back into the covered bond market at a moment’s notice when they see the yield that suits them?

Eichert, Crédit Agricole: By the end of September 2016 investors will be left with far less holdings and their credit lines will have been re-allocated to other products. So for them to re-allocate lines back to covered bonds will take time and they will need spread.

GlobalCapital:Do you believe the desertion of these real money guys is a fait accompli?

Hoarau, CACIB: In covered bonds, we can fear that more and more private sector investors exit the segment and re-allocate resources. I am referring essentially to insurers and asset managers. They just cannot find what they are looking for whether it be size or adequate remuneration. Bank 

treasuries driven by LCR considerations may still enjoy the playground. And there is still capital gain to be done in negative yield territory. We just need to get used to dealing with that.

GlobalCapital:Well, I guess at that point bidside liquidity will completely disappear as the market re-prices. But that process could take months given the thinner investor base that the market is likely to be facing, so it’s probably going to be quite messy isn’t it? 

Huber, LBBW: It’s very difficult to get back into the market again but we’ve had experience of that at LBBW. Not long after the first shock, we were one of the first borrowers to tap the market. Price discovery was horrendous and we ended up paying 75bp for a five year, having started somewhere between 60bp-100bp. 

GlobalCapital:And then presumably over time things begin to get back to normal?

Huber, LBBW: Slowly and surely we got a grip and understood what made sense, before arriving at 75bp. The transaction tightened quite a lot in the following weeks, but it was a necessary step to kick-start the market. A year and a half from now is a long time, but investors and traders will need to be aware they have to look closely into the credit features of different credit entities across the various jurisdictions. 

GlobalCapital: I guess there’s always likely to be a bedrock of demand that will return after we presumably see this short sharp shock?

Jozef Prokes, BlackRock: We’ll always see a dedicated base of covered bond investors in euros. And when the buying stops there’ll be some adjustment, but the second it starts to look interesting again people will be back. The market that’s probably been the most squeezed is the one they’re not buying which is corporate credit. We have seen that unwinding with bonds moving decently wider, but I don’t get any sense of panic, so I think when we start seeing cheaper levels there’s going to be plenty of buyers, including myself, that will go back into the market.

GlobalCapital: Does it concern you that we could be in a situation in a year’s time, where a large chunk of the market that was invested in covered bonds has moved to a different asset class? 

Kau, ANZ: As the ECB can’t buy our bonds, then in theory liquidity should in fact be even better for our bonds. Just because of the relative scarcity of eurozone paper available. 

GlobalCapital: How about you Jörg? Surely the potential risk of a much smaller investor base is much greater? 

Huber, LBBW: When the ECB stops buying I’ll need to be much more in front of investors to explain in an objective way why investors get less yield from our Pfandbriefe compared to others. Two years is a long time and international investors tend to forget these important differences. 

GlobalCapital: How do you see the market evolving from here?

Hoarau, CACIB: There are numerous risk factors to credit spreads which have largely been discounted so far this year: Russia, Middle East, oil price volatility, Grexit. But we all know that the covered bond market should stay immune from negative headlines given the strong technical supports around. 

GlobalCapital:What about the hunt for yield? 

Hoarau, CACIB: Traditional institutional investors will continue to shift focus and re-allocate cash into higher yielding products, or into US dollar denominated bonds where you find an attractive pick up versus euros. Elsewhere, the excess cash resulting from the full scale QE is remunerated at the ECB’s negative 0.20% deposit rate, so moving away from negative yields or low beta QE related securities will be a core theme this year. 

GlobalCapital:How do you see spreads evolving?

El-Amir, UniCredit: Spreads are incredibly tight and with the way rates are going we may even have negative Euribor rates. I don’t see that there’s a tremendous amount of room for spreads to tighten any further, to be honest.

Huber, LBBW: Investors have seen a great performance but I question whether they’ll see much more. So either they stick with what they have and get some yield, or they take profits. But if they do that, it’s difficult to know what they’ll buy instead. 

GlobalCapital: On the other hand, I suppose anything which yields more than the ECB’s negative deposit rate is going to look potentially interesting right?

Burmeister, Deutsche AWM: Looking at statements from the ECB they say they could potentially buy bonds with negative yields up to the deposit rate which is minus 20bp. So technically there’s no automatic stop at 0%, the next stop is minus 20bp. 

GlobalCapital: Don’t you think that at that point they will simply start to drop a few hints about pulling back a bit?

Burmeister, Deutsche AWM: If they were to stop buying five weeks after beginning, it may lead investors to question whether it was ever worth starting. The ECB’s decision-making process is lengthy and given it’s taken them so long to get to this point it’s unlikely they’ll stop on the first occasion.

GlobalCapital:Vincent, what do you think? Are we going to see yields become even more negative over time? 

Hoarau, CACIB: When announcing details of the programme at the end of January, Draghi was asked a question: ‘How negative do we go?’ ‘Until the deposit rate,’ was his answer. This set the tone in terms of flooring the convergence on low beta instruments. 

GlobalCapital:How about the credit curve — is there more room for weaker names to perform a bit more?

Boehm, Pimco: We’ll probably see a further spread tightening between high and low beta names, which is now down to about 40bp. The second thing is there’s likely to be a greater scarcity of bonds. In fact, you already see that most brokers refuse to offer paper because there’s nothing out there. 

GlobalCapital:What about the impact of negative yields from a funding perspective?

Huber, LBBW: Our funding needs are more in the short term, but I can’t issue up to three or four years in euros because I’d need to issue with negative yields and nobody’s buying there. Three year swaps are around 15bp but LBBW would normally issue at minus 17bp or 18bp which means the net yield is negative. In the four year area I might issue around minus 15bp and the net yield is in the region of 6bp which makes it difficult to get investor traction. In that sense I’d have to potentially pay an artificially higher spread.

GlobalCapital:What are the main long term consequences — have we seen the full effect of the ECB’s action yet? 

Hoarau, CACIB: The full scale QE will support low interest rates for some time and put a cap on yields and credit spreads. Negative yields at the front end and low beta products are here to stay. Immediate consequences: investors look at longer maturities, go down the credit curve, increase focus on peripheral names or shift into US dollars or sterling denominated bonds in search of value. This will have major consequences on global markets in the mid-run and I think we have not seen the full effect of the armada deployed by the ECB. Don’t forget that the excess cash resulting from QE-related purchases are placed at a negative deposit rate. This is unprecedented.

GlobalCapital: So the situation is going to get much worse for you by the sounds of things Ralf. Under what circumstances would you buy negative yielding covered bonds?

Burmeister, Deutsche AWM: If you have the feeling that spreads or maybe yields are going up to a certain extent, you might be better off even buying a negative yielding bond and waiting. Obviously a negative yielding bond at the short end will not be heavily affected by a yield rise as, say, a 10 or 15 year bond.

GlobalCapital:Does that mean you will be buying negative yielding bonds?

Burmeister, Deutsche AWM: We try to avoid buying negative yields, though we don’t have a heavy restriction forbidding us. It’s hard to argue that economically it makes sense to go for that bond with a slightly negative yield, but in this environment it’s not too absurd. But talking to institutional clients there is a greater acceptance and understanding of the situation. Our institutional clients will go for a diversified approach in terms of their overall asset allocation, so I don’t think they will withdraw completely from fixed income. Also in terms of regulation I can’t see an insurance company leaving the bond sector completely.

GlobalCapital: How do you cope in such a low yielding spread environment? It feels like it has become a big challenge for most investors.

Boehm, Pimco: Independent of the ECB or someone else that’s buying, this is our day-to-day work. The market prices in that there is a backstop buyer, but if you do your credit work you’ll always have the opportunity to find specific deals which are undervalued, even in the current market environment. We’ve figured out a couple of names which we think, based on the covered pool analysis, the bonds are undervalued. This is homework we should not miss out on.

GlobalCapital:What’s been your strategy to deal with the low interest rates and falling interest rates? Does it have limits?

Boehm, Pimco: We remain underweight in core covered bonds and we’re trying to replace them with higher yielding sovereigns with certain limits and where it makes sense. If you look for opportunities in specific names across different currencies you can add a few basis points. So, for example, the Danish krone market is somewhere where we have been involved for a long time. Due to the basis swap we’ve been able to replace some negative yielding euro covered bonds with Danish krone flex loan covered bonds which still trade with a positive yield after hedging back into euros. There are also limited opportunities in the Swiss franc market where it’s possible to add value by adding one or two names. The long end of the sterling market also offers some interesting pick up. 

GlobalCapital:So you’re not too bothered about low yields as long as you can spot some relative value anomalies?

Prokes, BlackRock: The outright yield is not really a concern in terms of us reaching our target as we usually measure our performance relative to the benchmark. Our strategy was never to buy yield and sit on the position. For us it’s more important to see whether the volatility’s high enough and whether there’s enough relative value opportunities. 

Relative value is less about whether we think Spain looks cheap to France than whether spreads that are usually stable move outside of their band of stability. You can, for example, apply this concept to CBPP3 eligible versus non-eligible covered bonds, and to covered bonds versus their sovereign or the swap curve. We’ve seen decent volatility in US Treasuries and UK Gilts so these are places where you can expect to see more relative value opportunities versus covered bonds in those currencies. Luckily for us covered bonds are not the only asset class we look at.

GlobalCapital:Has QE helped normalise the relationship of covered bonds relative to their governments?

Prokes, BlackRock: I’m a strong believer that one of the effects of sovereign QE is that we’ll see more normalised credit relationships, so I would expect government bonds to trade inside covered bonds at some point in the next 12 months. I still think that we need to go into a more normal type of environment for Europe before we can really expect the whole financial system to function properly again. If everything trades Bund plus zero then we have a slight problem, but I don’t think that is the end-game.

GlobalCapital:How have covered spreads moved relative to government bonds in the core and periphery since the onset of sovereign buying? 

Eichert, Crédit Agricole: We saw French seven to 10 year covered bonds cheapen from on average around flat versus OATs in November 2014 to 15bp-20bp currently. Pfandbriefe spreads likewise widened from around 10bp to Bunds in November 2014 to around 25bp today, while top tier 10 year Spanish and Italian covered bonds traded from as much as 100bp through their sovereign to around the 40bp area through today. 

GlobalCapital: Do you think the onset of sovereign QE has been helpful in terms of improving the relative value of covered bonds?

Kau, ANZ: Relative value has definitely improved and that’s taken away a little bit of negativity around the covered bond purchase programme. It’s obviously still a distorted, strange market and just how it’s going to normalise is the big unknown. But we can only hope that in the medium term that the market remains as broad and strong as it has been in the past.

GlobalCapital:Do you think there’s a point when relative value makes no sense because there’s no absolute value?

Burmeister, Deutsche AWM: You take into account the domestic sovereign and where the covered bond is priced in relation to it. And then of course you look at absolute levels and ask if it still makes sense as, after deducting costs, you could end up in negative territory which doesn’t really make economic sense for our clients. But it’s too harsh to say relative value has become irrelevant. If everything has more or less the same price it’s our job to go for the best quality. 

GlobalCapital:What do you mean by best quality?

Burmeister, Deutsche AWM: We’re not talking purely about credit but also about the choice of maturity, that’s also relative value. You have to ask whether it makes sense to hold a 15 year Australian deal if you get the same yield on an eight year Italian bond. So there is this trade-off between duration, rating and yield. The answer will most likely depend on your investment mandate. 

GlobalCapital:Sovereign QE has been helpful for covered bonds in terms of restoring relative value but since it’s impossible to who know what will happen we could find ourselves back in the situation we were in three years ago at some point in the future. So just how far through would you buy? 

Boehm, Pimco: It really depends on what sort of account you are. If you can only buy covered bonds and if you think that the specific deal has room to perform, even if it’s issued far inside sovereign, you might still buy it. But if your account allows diversification between different asset classes you might refuse to buy and say, ‘I want the sovereign or another asset’. Covered bonds from a relative value perspective might look more attractive now versus sovereigns than before QE began but if you cannot switch outside that sector it doesn’t help you a lot. 

GlobalCapital:Have you also benefited from CBPP3 even though you’re outside the eurozone?

Kau, ANZ: As a non-eurozone issuer who can’t directly be bought by the ECB, we’ve been dragged along with the crowd and our spreads are within 10bp of core eurozone issuers. 

GlobalCapital:Does that mean Aussie issuers are getting cheaper funding?

Kau, ANZ: The trouble is the basis swap has widened considerably for a number of reasons but not least because with euro yields very low and better prospects of higher US dollar yields investors prefer swapping into US dollar assets. So by the time we’ve swapped our proceeds back to US dollars or Australian dollars, we’re left with a net funding disadvantage. At the moment it’s cheaper for us to issue US dollar covered bonds.

GlobalCapital:Why do you think price differentials between eurozone and non-eurozone covered bonds have remained so tight? 

Boehm, Pimco: Price distortion has been lower than many expected, so even non-eligible covered bonds benefited. If there is nothing you can buy or if there’s a lack of covered bonds at the broker side then investors must move to other markets — Australia, US or Canada or other non-eligible stuff. 

GlobalCapital:Do you see any kind of incongruities between different types of credit from within the eurozone compared to those outside?

Burmeister, Deutsche AWM: If you look at the curves between the Spanish national champions and Australian or Canadian covered bonds, they are trading within one basis point. That’s quite an impressive pricing effect, and you have to cope with it.

GlobalCapital:Could we describe this as distortive or is it simply logical that eurozone spread differentials to non-eurozone should be well contained? 

Prokes, BlackRock: I think that’s a perfect example how markets work. Once you saw CBPP3 eligible covered bonds trading at expensive levels people switched and the non-eligible deals tightened, so it is not a price distortion. Price distortion for me would be where, for example, we see EIB trading inside Bunds. CBPP3 gives price leadership which is acknowledging the reality, it’s nothing more or less than that. They’re just part of the market, and that’s something you have to factor in. 

GlobalCapital:But surely a weaker credit should trade wider than a stronger credit so that’s a fundamental price distortion isn’t it? 

Eichert, Crédit Agricole: The differences are not major. If you showed me a Norwegian, Australian or Canadian covered bond and at the same time something from Austria which was trading tighter I would have always picked the non-CBPP eligible deals, so there is a distortive element. But it’s not as big as one would have initially thought. 

GlobalCapital: Why do you think differences have been so well contained? 

Eichert, Crédit Agricole: The overall shrinking market along with the additional CBPP3 demand impacts relative value. Asset managers as well as to an increasing extent bank treasuries have tried to escape the CBPP3 both geographically as well as from a currency perspective.

GlobalCapital:Do you ever conduct relative value analysis between senior and covered?

Boehm, Pimco: If the spread difference between senior and covered is not that high, so let’s say we are talking about 20bp-30bp, then of course we prefer covered over the senior. If it’s in the 100bp-150bp range we might take a look at the senior as being the better investment.

GlobalCapital:What about from the issuer side?

Kau, ANZ: Whenever we’re contemplating any kind of fundraising, we’ll look at the relative values between not only different currencies and different geographies but also senior unsecured and covered bonds. But covered bonds is a limited resource with reasonably tight regulatory limits so we tend to view it as a valuable tool for when access to markets is compromised when the more risk averse investors are likely to be more willing to look at the triple-A product. The spread premia of senior over the triple-A product has definitely contracted. 

Michl, PBB: If we have an unsecured funding need then of course we’re try to achieve the best price, but we’re not really looking at relative value compared to our Pfandbrief. But senior is clearly the harder product to place so we start with that but I wouldn’t say we’re really looking at the levels on a daily or weekly basis.

GlobalCapital:Surely BRRD changes everything. Senior markets have not even started to price in the risk of bail-in yet have they?

Burmeister, Deutsche AWM: It’s too simplistic to say that because of BRRD the senior spread must go wider relative to covered bonds, I wouldn’t subscribe to that view. Banks must hold ever more capital, better quality capital along with subordinated debt that obviously ranks below senior. So this may be one explanation driving spreads tighter, along with, of course, the hunt for yield. 

GlobalCapital: Do you think that the low yield environment is herding investors into riskier bonds and that this could end up backfiring on them?

Eichert, Crédit Agricole: The extra basis points on senior have been enough to incentivise covered bond investors to look at the product. But the Austrian market shows the risks of that type of strategy. After Heta as well as Kommunalkredit, the senior market is effectively inaccessible for Austrian banks at this point. The senior spreads of even the bigger issuers that were not directly affected more than doubled within a few days at the start of 2015 to more than 150bp in three to five years. Covered bonds on the other hand have benefited from the CBPP3 demand that eventually came into the market and only moved 10bp-20bp, with the exception being Kommunalkredit.

GlobalCapital: Has the covered bond to senior spread tightened too far?

Prokes, BlackRock: I don’t think we are too compressed at this stage. You get around 50bp-60bp between senior and covered bonds in France, which for me is probably much wider than the point where I would be even considering selling seniors, to buy covered bonds. But that doesn’t mean I would necessarily sell covered bonds and buy senior. 

GlobalCapital:Are investors adequately compensated for senior risk?

Eichert, Crédit Agricole: A somewhat more distressed market environment can always happen, as we had in Austria. And while higher capital and sub debt buffers do protect senior better than in the past, 50bp carry doesn’t protect you against much volatility. It only takes a few basis points of widening in covered bonds and you’re worse off in the senior space. Also the experience of Heta shows that bailing in senior unsecured is not just a theoretical case but can become very real, very fast. What we hear in many cases is, ‘Yes, we’re aware of these risks but we have to produce yield and covered bonds just don’t cut it’. So it’s essentially a matter of dancing as long as the music’s playing. You’re aware of the risks but you have no choice.

GlobalCapital:Do you think the lack of price differentiation may also be due to the fact that covered bonds are the only form of debt excluded from bank resolutions?

Prokes, BlackRock: I think one real reason we’re seeing flat pricing is not so much to do with the ECB’s buying, but what BRRD’s doing to the market. At the point BRRD became apparent in mid-2012 you could see how the approach to covered bonds as an asset class began to evolve and could somehow begin to trade at more homogenous spread levels, maybe based on country, rating or whatever your views are. 

GlobalCapital:We’ve had a lot of talk about the negative effects of CBPP3, but are there are some positive factors? 

Huber, LBBW: We’ve had investors with €200m-€300m orders and everybody wanted them because they gave momentum to the book. But these investors knew how important they were and there came a time when they changed the strategy and wanted a bid for €100m-€150m, which led to difficulties in the secondary market performance of your transaction. So now we have, for the first time, an investor where you could be quite sure that this won’t happen. This is certainly something which in hindsight is a positive thing. 

Michl, PBB: We do see them as a good investor as long as they stick to their strategy of a buy-and-hold portfolio, meaning they don’t sell the assets again. I also think they’ve changed their strategy from price driver to, say, more or less participating in a deal.

GlobalCapital:But are they really an investor?

Huber, LBBW: You can’t really call them a real investor, as they do not invest, they buy to float the market with cash!

GlobalCapital: And what about the impact it’s had on funding costs and lending? 

El-Amir, UniCredit: It’s clear the ECB has provided a lot of cheap funding, not just through CBPP3, but also through other means like the TLTRO. We could have issued covered bonds but we took €7.75bn of TLTRO liquidity in 2014 at tighter spreads, and that money was fully deployed in the European economy. So there were two benefits: not only have banks been funding at cheaper levels, they’ve put that liquidity to work into the real economy. 

Michl, PBB: The main positive is the lower cost of funding and in general negative yields improve the relative attractiveness and profitability of real estate assets. 

GlobalCapital: Are there any other negatives from the issuer’s perspective? 

Michl, PBB: As a bank we have to hold regulatory buffers and invest in govies or SSAs which incur a negative cost of carry.

Huber, LBBW: I face greater competition for assets. My competitors, who normally had to pay more due to their business model and the structure of their cover pool, now get their funding much cheaper thanks to the ECB purchase programme. 

GlobalCapital:Waleed, you say that you’ve put money to work in the real economy. Are you saying that by lowering the cost borrowing you have increased loan origination?

El-Amir, UniCredit: I was sceptical that lower client rates would lead to more borrowing but the empirical evidence shows demand for credit actually increased. In the March TLTRO we took another €7.9bn which we wouldn’t have done, if we had not been able to deploy the initial €7.75bn. So getting the cheaper funding and actually passing that advantage on to clients and marketing this, which we did very extensively, actually worked. In the fourth quarter there was a significant increase in our origination of TLTRO eligible assets, in fact year-on-year we have seen a 105% increase in new loan origination for corporate clients and a 35% increase for SME clients. 

Michl, PBB: We align our lending and funding activities which means the funding needs are determined by new business. Although I wouldn’t really think that lower funding costs has really translated to an increase in our funding needs it has of course contributed to profitability which has been helpful for us in our present circumstances. 

But when you look at the yield difference between bond markets and real estate assets it has been quite high. So real estate is quite attractive for investors, and as long as there is enough premium for the illiquidity and higher administration costs, real estate assets should be an attractive proposition and, all things being equal, there should be greater mortgage lending.

GlobalCapital: How has mortgage origination shaped up for ANZ? 

Kau, ANZ: Lending is equally dependent on the economic situation and at this time growth has slowed in Australia, so demand for mortgages is slower than normal. On the other hand deposit growth is still reasonably strong, which means our funding gap hasn’t materially increased and our wholesale funding need, including covered bonds, has therefore been fairly constant. 

We’ve also got plenty of funding alternatives, so we’re not necessarily concerned about the basis swap situation in Europe. But these things tend to ebb and flow and there will come a time again where the euro basis becomes more attractive. 

GlobalCapital: Are there limits to the benefit of a lower cost of funding when it comes to SME lending?

Eichert, Crédit Agricole: You can see that in some countries, especially the periphery, the lower cost of funding has to some extent led to lower lending rates, but more so on the SME sector than on the mortgage side. But you’re not going to start lending a whole lot more if you’re not comfortable on the underlying assets. 

GlobalCapital:Do you believe tighter bank regulations are to blame? 

Eichert, Crédit Agricole: Many banks use the IRB advanced approach, but if you limit the scope of these models, obviously you force banks to hold more capital. So that makes the decision to lend harder. The lower cost of funding does help obviously but it’s more of a nice effect that takes place only after you’ve made the decision to lend. 

El-Amir, UniCredit: Capital is much more of an issue than liquidity. Large banks are swimming in liquidity so capital is certainly the more scarce resource.

GlobalCapital: Surely there comes a point where people just say, ‘well, for me to take out this loan it is costing virtually nothing’?

Huber, LBBW: Ten year swaps are around 50bp which is virtually nothing but obviously mortgage borrowers have to pay a margin of 60bp-80bp. So you would need to see swaps fall some way into negative territory before you would see this reflected in actual mortgage borrowing costs. 

GlobalCapital:What’s your view on the process of price discovery during the bond syndication in terms of setting initial pricing thoughts, guidance, possibly refining guidance and then final pricing?

Burmeister, Deutsche AWM: Over time you develop a certain gut feeling. For example, if something is announced in the high 20s, it’s probably not going to end up pricing there but rather in the mid-to low 20s. Other people tell me it’s much more of a civilised and standardised process in covered bonds and not the kind of Wild West you sometimes have in the corporate space. 

Boehm, Pimco: Leads and issuers know there’s a scarcity of covered bonds, on the other side there are still a lot of investors that put in inflated orders. We think there should be more investors like us that put in limited orders and in most cases stick to their limits. We’re not in favour of initial pricing thoughts, but from a game theory perspective it’s a rational thing for issuers to do. 

GlobalCapital:You can complain but it’s not going to change anything is it? 

Prokes, BlackRock: I don’t really look at a deal until it’s been launched. There’s no point, in my view, in getting involved in IOIs. If I’m interested I’ll wait for books to open and formal guidance to be set. There’s not much we can do as investors but complain endlessly about the IPT and IOI process, but we see the same practices in all other markets.

I’ve long stopped trying to make my investment decision based on how much new issue premium I get because by the time the deal is closed, the premium is usually gone. The liquidity to flip deals is not there so it is a useless exercise. The investment decision is basically a view on the asset class, and not necessarily whether it’s a couple of basis point cheap. 

GlobalCapital:Are initial pricing thoughts necessary?

Michl, PBB: It’s always interesting to start with initial pricing thoughts because you just need to get a feeling what the investor demand is for your product and who buys, therefore I think the process is very important.

GlobalCapital:Do you think initial pricing thoughts simply present another pricing iteration with the opportunity to tighten pricing more than would have otherwise been the case? 

Huber, LBBW: I don’t like to come out with initial pricing thoughts and then tighten the spread big time, but I think they can be helpful and we shouldn’t get rid of the process completely. I hardly know an investor who would come out and say ‘this is the right price’. First they don’t want to pay up, but also I think they feel more comfortable when they see others are in on the same pricing basis. That is why they wait until they get the first indication and can see how the book is developing, and know that they’re not alone. 

GlobalCapital:Vincent, as the syndicator you have the final word on this. Are initial pricing thoughts necessary or a redundant legacy from the crisis when price discovery really meant something? 

Hoarau, CACIB: Initial price thoughts were introduced because the market was distressed and price discovery not straight forward. The situation has completely changed and we should review methods. The market will remain issuer-driven for some time, so clarification of the process and transparency will not take away their pricing power. 

Pre-crisis we used to build the book on the basis of fixed spread guidance in a few basis point range and I think we should re-introduce the concept for covered bonds. Investors are annoyed with exacerbated travelling in guidance in some situations. We syndicates generally know where fair value is and the type of new issue premium, if any, that investors are ready to accept. 

GlobalCapital:Do you think liquidity has improved or is it still as bad as it ever was?

Huber, LBBW: Nobody has liquidity. Everybody tries to have some kind of assets, but they know they are better long and not short. And, because you can’t get the bonds back, you end up paying a fortune to borrow them in the market.

GlobalCapital:Is it getting easier? Can you not trade on both sides?

Burmeister, Deutsche AWM: I don’t think there has been a major change after the ECB starting buying government bonds. It was already difficult and hasn’t got any easier. What we do see is the usual quarter-end effects where traders try to get rid of their stock. But that’s just a seasonal effect. There have been times where we saw a real buying frenzy, where no matter what you offered it was taken in a second, which was not a healthy situation. Today it’s better as you can trade on both sides in small size, but it’s not the best I’ve experienced in my career. 

GlobalCapital: OK, so there is some liquidity, but we’re not in a state of paralysis either?

Prokes, BlackRock: The market is functioning as much as it was or wasn’t before. The adjustment period is, in my view, over and we’ve seen the market being affected by the usual forces such as widening into the quarter end which always used to be a normal thing. I don’t really see that I wouldn’t be able to trade that market, it’s not paralysed by the buying and I don’t feel that I get under-allocated in the primary market because of ECB. 

Eichert, Crédit Agricole: Offer side liquidity has deteriorated so people try not to get caught short but in the case of Austria we did all of a sudden see more people trying to sell than add exposure. The ECB weren’t reactive enough to step in and sort of calm the market down. So it’s not all one-sided, event risk can easily push the market the other way as well. 

GlobalCapital: How do covered bonds stack up versus other asset classes?

Prokes, BlackRock: We’re not seeing big dislocations in terms of liquidity between different markets, so I think it’s survivable. For the amount of trading activity I do, covered bonds are actually one of the more easily tradable asset classes. I was surprised with the liquidity in supranationals which I’d always regarded as a bit more liquid than covered bonds, but that’s not the case in my view. Markets can and do freeze up from time to time and it’s not possible to transact, but this is the new reality and it’s here to stay.

GlobalCapital:What can the ECB do to improve liquidity?

Burmeister, Deutsche AWM: The first and obvious step for them is to make all bonds they’ve bought available for repo as it may make life a bit easier for traders. 

Hoarau, CACIB: Correct! This would increase liquidity and ease the distortion effects. It may be part of the exit strategy at some point. 

Prokes, BlackRock: I don’t think it should be really their task to smooth price moves. They’re doing a legitimate thing which is QE and they’ve chosen our asset class as one of the first which goes further to the point that under the new BRRD regime, covered bonds are something very different from senior unsecured or any other type of bond, because they carry much less credit risk.

GlobalCapital:What about non-traditional covered bonds such as Sekerbank’s SME deal or Figsco?

Prokes, BlackRock: I can buy these deals but I don’t compare them to traditional cover bonds. You just analyse it as you would analyse covered bonds by looking at the credit risk of the bank, the protection mechanisms that you have in a deal, and then you make a decision whether you want to buy it or not. I think it’s wrong to push these deals on to traditional covered bond investors and play on the fact that the yield being generated in the covered bond space is too low, that is exactly the wrong thing to do. 

Boehm, Pimco: They offer a further alternative and we also take a broader look at those kind of investments. The Commerzbank SME deal provided a very clever structural alternative and we also took a look at Figsco. For us these alternatives are actually quite a positive development because, as an organisation, you need the skill set to analyse such deals which is something we have to thank the people we have in the US and the UK. If you are able to do your homework then these alternatives can provide diversification which is positive. In general I think it’s healthy and positive to see competition to the established product format.

Eichert, Crédit Agricole: Turkish SME deals are a bit of an outlier, both in terms of the collateral and geography. SME backed covered bonds are something that’s very high up on the agenda in Brussels but I don’t see them becoming a big theme in the covered space just yet as issuers have plenty of liquidity. And with senior trading as close to covered bonds as it is right now many investors and issuers don’t see the need for SME backed covered bonds.

GlobalCapital: What if the credit curve was back to where it was in 2011?

Eichert, Crédit Agricole: Yes, well, obviously at that point it would make sense. But where we are right now and where we will likely continue to be for the next 18 months to two years, there’s just no case to be made. Though it’s a probably a good time to talk about it from a theoretical angle between the European Covered Bond Council, the European Commission and the other interested stakeholders. But for the time being it’s only now a theoretical discussion about a potential market in the future and the actual relevance for investors today is not meaningful.

Burmeister, Deutsche AWM: I’m not a great fan of SME bonds as we do not have, at least here in the covered bond space, the SME expertise to really have a profound feel for the collateral. The other thing is SMEs have lower recoveries than mortgages and a higher probability of default. And why should the senior unsecured portfolio manager look at it? He gets a better rating but he doesn’t need it. He gets a lower spread, yet he has to invest time and intellectual capacity in order to understand what he is buying. There is no benefit. 

GlobalCapital:What are your thoughts about doing an exchange of hard for soft bullet bonds, such as was recently done by Credit Suisse?

Kau, ANZ: I completely understand where Credit Suisse are coming from and the theory behind it is a sound one, and though it made sense for them, it would be different for every issuer. We haven’t issued hard bullets for some time now so the portfolio is small. We would need to undertake a cost benefit analysis to assess the advantage of exchanging the hard bullets and saving liquidity costs. 

Prokes, BlackRock: I don’t see too much difference between soft and hard bullets, I don’t really see much reason for a pricing differential. Soft bullets are trying to prevent payment disruption after the issuer defaults so they are basically trying to fix problem that’s likely to happen when you’re underwater. It doesn’t really change much. For me the conditional passthrough represents a much bigger change because it basically takes away every incentive for the regulator to intervene as the probability of an event of default occurring is almost negligible.

GlobalCapital:Do you see any positive aspects to conditional passthrough covered bonds?

Boehm, Pimco: It’s a market with good growth potential and has some advantages for issuers as well as investors in terms of better rating stability. Though the fact it gets a triple-A is all down to the structure which in a way is window dressing. These deals have extension risk but on the other hand, we think they reduce the structural subordination of long dated covered bond liabilities relative to shorter liabilities. In a hard bullet bond, where the issuer defaults and the cover pool is not sufficient to pay all the liabilities, you don’t know what will happen. But with a conditional passthrough, you know what will happen. 

Huber, LBBW: We are in a very comfortable situation in that we have a huge over-collateralization and a very attractive senior funding level, which enables us to fund that over-collateralization. Other banks, which are much more limited may need to look more closely into conditional passthrough bonds. I understand the updated Polish covered bond law has an option to switch from bullet to conditional passthrough if the borrower goes into insolvency. 

Burmeister, Deutsche AWM: It’s something we have to deal with. I understand it’s very appealing to issuers because it helps them to manage their collateral more effectively. I do not dare say that the buyside has such a market influence that they can prevent those structures coming to the market. I personally do have the freedom to not participate, that’s the only thing.

GlobalCapital:So what you seem to be saying is conditional passthroughs are going to happen whatever so you have to accept them, a bit like soft bullet exchanges?

Burmeister, Deutsche AWM: I’m not forced to participate. But what you see in the latest hard to soft bullet exchange offer from ABN is that they’re paying up a few cent. It’s difficult to know how to measure that risk, but the point is if you say no, they will somehow get approval, and if you’ve already rejected it you get nothing. There used to be times when you got a premium if you get engaged in more complex deals, such as soft bullets or conditional passthrough deals, but obviously those times have gone. 

GlobalCapital:How do you feel about environmental, social governance or green covered bonds? 

Boehm, Pimco: Green bonds are a positive development that should be supported for sure, but from an economic point of view the market is too small right now. Of course green bonds are in competition with established bonds so it’s very hard to justify buying them unless the return is similar to what you would get normally. 

Huber, LBBW: LBBW has got a sustainability rating so I guess the main point is here that you could potentially issue an ESG or green deal but on other side of the balance sheet lend money to a state with a high polluting industry or whatever which would be quite deceitful. So in my opinion it’s much better to have a sound sustainability bank rating which takes into account all your efforts.

GlobalCapital:As things stand for the next 18 months the ECB is going to be backstopping anything and everything. So does it really make sense to undertake due diligence? You may as well just buy the cheapest high beta names and you are certain to outperform the index right?

Burmeister, Deutsche AWM: It’s not just a question of going for the bond with the highest yield in a low yield environment, it’s also important to give consideration to have bonds that stabilise your portfolio. I think covered bonds can do this in contrast to government bonds which in the run up to QE and still now after QE has started, tend to be much more volatile. 

GlobalCapital:But there’s not a pay-off with due diligence so why bother?

Burmeister, Deutsche AWM: I would say skipping due diligence is not the smartest approach to investing and if you consider the latest hiccoughs and spread widening we’ve seen in Austria, I think that shows you it’s still worthwhile undertaking the work. You may not profit immediately, but in the long term if you have a thorough selection approach you’ll get a positive pay-off, as hopefully you’ll avoid the landmines which further down the road could blow up. 

GlobalCapital:Surely BRRD adds another layer of comfort? Why would you bother looking at the collateral pool?

Prokes, BlackRock: For me, the analysis of the cover pool was always step number three. We always started with the bank, and that is something that’s probably changed the most. Thanks to BRRD the bank has decreased slightly in importance relative to the asset class as a whole. The cover pool has rarely driven spread performance, it’s just a safeguard and something that you need to be reasonably sure is there if you need it and is reasonably good quality, unlike an ABS fund.

GlobalCapital:OK, so if you’re not sure about the bank or the jurisdiction that is the time when you might want to take a deeper look into the cover pool?

Boehm, Pimco: It is, and for the really interesting names we stress the cover pools. This needs a bit of work but it gives you a good impression how sufficient the cashflow in the pool is to cover payments under a stressed scenario. With this method you really get a good feeling of how much value there is in specific names. We don’t do this credit-intensive analysis for all bonds, but it’s very helpful for some names where we are less sure and want to see what their relative value is in the broader context of the market. This process can be quite interesting.

GlobalCapital:But in the end, the cover pool you analysed may not be what you end up with. Look at what happened to Kommunalkredit. Local supervisors can scupper everything can’t they?

Prokes, BlackRock: You do need to factor these things in, and they bring you away from the cover pool quality. So for me the supervisory aspect sits within the legal framework. There is a question as to how the regulator should behave which may depend on how important the cover bond market is in that region, and its history. 

GlobalCapital:Do you still have conversations with investors about the quality of your cover pool, your business model and other aspects of your credit?

Kau, ANZ: Absolutely. In most cases, they invest across our various products, but nonetheless credit is the driving factor in not only determining their view of covered bonds but also obviously our senior unsecured and subordinated bonds. And as a mortgage bank, the real estate market is also naturally a key focus regardless of whether we issue covereds. So in that sense nothing’s changed, there’s still as much scrutiny around the mortgage market as there ever was, perhaps even more given the continued appreciation of house prices.

GlobalCapital:Is that the same for you too?

Michl, PBB: My feeling is that investors are still doing a very diligent analysis of collateral and the performance of collateral, simply because I think that’s just part of the traditional credit process. And of course they’re looking at the firm’s overall business model, refinancing operations, capital structure and so on. 

GlobalCapital:What are your thoughts on the macro-economic outlook in Europe — do you see a risk of asset bubbles developing? 

Boehm, Pimco: The task of the ECB is much harder than that of the UK and the US Federal Reserve. We have 19 member states in the eurozone. Seven years after the beginning of the crisis we don’t have a unified tax approach in euroland or a unified employment market. So this makes it very hard for the ECB to act right now. Of course there is the risk that we see asset price bubbles though I wouldn’t say we have a housing bubble. In the big city areas of Germany, France and Scandinavia there is some sign of mispricing which needs to be carefully monitored. But at the moment everything seems to be broadly stable even though we see some warning signs on the horizon. 

Huber, LBBW: Mortgages are so cheap, but we are starting to see signs of price inflation on the asset side. So what investors start to save in terms of debt servicing costs they lose in terms of pay-up on the value of real estate assets they’re buying. We don’t have a bubble in Germany but nevertheless prices have increased a lot.

Burmeister, Deutsche AWM: We’ve had three major boosts to the economy: the ECB stepping in buying bonds, lower oil prices and low yields. So if the economy doesn’t pick up in that environment, what else can be done? 

Hoarau, CACIB: I agree and the inflexion point is behind us. The fall in energy prices and low yields are adding to the broader effect of QE and more importantly the falling euro. And the eurozone will be the first beneficiary of this sweet cocktail. My greatest concerns ahead are the exit strategy and the risk of an asset bubble, as Timo rightly pointed out. 

GlobalCapital:What about the timetable for a US rate hike?

Burmeister, Deutsche AWM: I’ve seen articles suggesting we’ve seen over 20 central bank easing measures around the globe year to date. So being the first one to say, ‘OK, even if all the rest of the world is in an easing mode, I’m going to be the one who starts hiking’, that’s tough. I don’t have a strong opinion on the timing of the US interest rate cycle though it’s fair to expect the Fed will probably be the first to hike.

GlobalCapital:How is the Australian economy looking these days? 

Kau, ANZ: It’s in a transition mode. Things are OK but they’re certainly not bounding along. There are some pockets of stress and business sentiment is still very low. 

The political backdrop could have been more stable as we’ve seen a few changes in government lately. In some parts, particularly the mining intensive areas, like Queensland and Western Australia, house prices have come off a bit. But the two big metropolitan cities of Sydney and Melbourne are still chugging along with HPI of about 10% per annum. 

Interest rate cuts, designed to keep the Aussie dollar competitive, have had a stimulative effect on housing construction and employment has been steady and mortgage performance very stable. The Australian dollar has depreciated about 30% in the last six months so that’s having a stimulatory effect on the non-mining sector. In fact we recently saw the value of Australia’s service exports such as tourism and education exceed iron ore exports. 

Lending is equally dependent on the economic situation and at this time growth has slowed in Australia, so demand for mortgages is slower than normal. On the other hand, deposit growth is still reasonably strong, which means our funding gap hasn’t materially increased and our wholesale funding need, including covered bonds, has therefore been fairly constant.