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Time for unconventional thinking in the covered bond market

The tenor is not great for issuers but funding options are limited and investors love it

Le Penseur (The Thinker), a famous statue by French sculptor Auguste Rodin in the Pushkin Museum of Fine Arts in Moscow, Russia.

Covered bonds are typically used to fund long dated mortgage assets and borrowers typically match funding with deals that have a long duration, reserving their shorter duration funding needs for the senior unsecured market.

But these are not typical times.

The 10 year sector of the curve is no longer accessible, seven years is only open to a select few and the five year is also becoming increasingly challenging for some who have more recently plumbed for deals of three to four years.

And, with the yield curve continuing to flatten as Europe heads into recession, this trend can only continue.

That view was highlighted this week after LBBW broke ranks with the first two year covered bond in seven years.

In so doing it secured itself cheaper funding than that provided by the European Central Bank under its Targeted Longer-Term Refinancing Operations (TLTRO), which for years had provided an unbeatable cost of funding.

With terms of the TLTRO likely to be tightened at the ECB’s October 27 policy meeting, a broader group of banks should soon be in a position to beat TLTRO financing with market funding, effectively increasing the incentive to issue shorter.

Well rated banks from outside the eurozone that have sizeable funding needs and never had access to this highly profitable source of cash will have taken note.

Two year euro covered bonds present a more cost effective source of funding compared to sterling and dollar equivalents, not to speak of dollar senior unsecured.

Buying a two year covered bond with a top rating and waiting until it rolls off at par presents an incredible investment proposition for bank treasury investors compared to core European government bonds that pay over 100bp less.

For this reason, issuers with ambitious funding needs should be able to dictate the size they wish to sell, which, thanks to the short duration, does not lock them in for long.

Difficult times call for unorthodox thinking and with investors and issuers winning, what's not to like?