Covered bonds: Better to go now than sit and wait
The market may not be perfect, but it's open, and borrowers should not waste time watching conditions deteriorate
Borrowers are wasting their time sitting on their hands waiting for market conditions to improve. They probably won’t, so banks must adopt a more flexible approach to the sequencing of their deals and consider bringing forward covered bond funding plans.
National champions gingerly returned to the senior unsecured market this week with defensive short dated deals from BFCM, UBS and Crédit Agricole breaking the hiatus that followed NatWest Market’s five year trade issued on February 23.
The market for subordinated issuance remains closed to all, with the last deal issued by BPCE on February 21, in the form of a 10 year non call five tier two transaction.
Since then, the iTraxx Europe Sub Financials index has widened by 24bp to reach 176bp on Tuesday and the Senior Financials index was 12bp wider at 93bp.
But these levels likely understate the true scale of widening for smaller and lower rated banks, especially in Europe’s periphery.
However, the inability to access the market with deals that qualify for the minimum requirement for own funds and eligible liabilities should not bar issuers from reordering the sequence of their funding programmes this year.
Conventionally, banks prefer to issue their most difficult trades first. Yet markets have been anything but conventional. Even before the Russian invasion of Ukraine, it was clear that global central banks had misjudged the scale and pace of rising inflation.
Soaring energy and food prices will only add to the pre-existing inflationary spiral, giving the European Central Bank a big headache. It is committed to finishing net asset purchases in the third quarter and the market is pricing in a normalisation of rates soon thereafter.
But the risk is that inflation considerably overshoots the ECB’s 2% target for a protracted period, leaving it behind the curve and forced to take harsher action than expected.
Besides which, the terms of the ECB’s Targeted Long Term Refinancing Operation are likely to be tightened in June in a move that is certain to level the funding advantage relative to publicly distributed covered bond issuance.
More menacingly, the complex and challenging situation in Ukraine does not look like it will be easily resolved. As both sides seem determined and resolute in their intentions, a protracted struggle seems to be in the making.
Although the situation looks bleak, covered bonds have managed to provide a meaningful source of funding for banks across the globe — with more than €10bn issued in euros last week and a further €5bn launched so far this week.
More promisingly, last week’s national champions paved the way for smaller names to tap the market this week.
Order books for Monday’s deals from Všeobecná úverova banka (VUB), KHFC and ANZ New Zealand may have been slow to build, but the transactions got done and have since traded steadily.
Though subscription ratios were low, the quality of demand was high as fast money accounts are no longer frothing up order books.
The market is open to most names for now, but the clock is ticking and access at present spread levels cannot be counted on for much longer.