Don't take the short end opportunity just because it's there
While it might not be popular with investors, longer dated paper is what covered bond funders need
Covered bonds are having a stellar short end start to the summer: three year paper is as hot as Saint-Tropez.
Investor interest is clearly focussed on the short end of the curve, at least when it comes to the asset class. Accounts appear more than happy to pledge reams of orders for paper anchored around the three year point.
Aareal Bank, for instance, scored its best bid-to-cover ratio on Tuesday, despite wading into the market during the traditionally quieter month of July. The German firm attracted more than €3bn of orders for its €500m no-grow May 2026 Pfandbrief.
Meanwhile, BayernLB, Crédit Agricole and ANZ New Zealand all secured similarly strong outcomes last week. This rampant demand filtered through into strong secondary market performances, with ANZ New Zealand erasing its concession after only a few trading sessions, for example.
But just because there are amazing opportunities to secure spectacular funding at the short end does not mean that everyone should readying themselves to take the leap.
Sure, there is bumper demand available, but piling on the funding at the short end is not the best fit for maturity management — especially after six months of shorter supply. Bank treasuries will want to avoid exacerbating any current asset and liability mismatches with further short dated funding.
Covered paper has skewed short this year — and borrowers need to venture further down the curve to balance out their average duration. Although excellent, these conditions at the short end are not what borrowers need right now. There needs to be a return to equilibrium.
The share of three year paper in the covered funding mix has more than doubled compared to last year. Three year paper accounts for over 21% of all euro deals issued so far this year, according to Dealogic, compared to almost 10% in 2022.
But of course, not every borrower needs to fund further down the curve. For instance, over three quarters of ANZ New Zealand’s mortgage pool has a rate fixed for three years or less. Meanwhile, in Western Europe pools on average skew towards the longer end.
Instead, secured debt funders are better placed waiting for the market’s post-summer lull resurgence. Sure, it is much more palatable to pay a sizeable concession on a three year bond than a 10 year one, but longer dated paper is likely the better match for most firms’ mortgage collateral.
Bank treasuries are best placed waiting out this brief period of short end success in the hope that the long end returns to the fore when issuance resumes in earnest next month.
Analysts at ING anticipate that the ECB will hit the peak of its rates cycle in September. Meanwhile CME’s Fed Watch tool points towards Largarde’s US counterparts’ hike will reach their own summit later this month.
If this peak is to be reached — and central banks provide firm guidance that this is not a false dawn — then longer dated paper could be back on the table come the autumn, including the elusive 12 year or longer bonds.
And of course, banks are not under pressure to load up on funding when the chance arrives.
Despite the collapse of Silicon Valley Bank and Credit Suisse casting a shadow over the market earlier this year, banks still raised almost €140bn in covered format over the first six months. But supply is expected to slow, with Rabobank researchers forecasting just under €60bn of issuance in the second half.
Yes, a rare July funding opportunity has appeared, but just because a strong short end bid has manifested itself does not mean bank treasuries should take it. Borrowers are best off waiting to print when doing so better aligns with the underlying mortgage pools.
After a first half dominated by shorter — and safer — paper, banks should use their remaining funding needs to mop up at the long end — and balance out their duration.