The covered bond market is humming along nicely at the moment. The deal flow this week (three on Monday, one on Tuesday) is steady, spreads have tightened by 5bp-8bp reflecting bid-to-cover ratios of 1.5 to three times the deal size with Česká spořitelna’s inaugural deal on Tuesday a stand-out with an order book of €2.25bn for a €500m no-grow bond.
Issuers and their lead managers also like the make-up of orderbooks, comprising central banks, bank treasuries and asset managers and, importantly, no fast money.
In this respect, the covered bond market now is very different to how it was just four months ago when the fast money, for which read hedge funds, was piling in, inflating orderbooks and enabling issuers to print with no new issue concessions.
Fast money orders are looked down upon by issuers and their bank syndicates because they are deemed more liable to flip the bonds quickly in the secondary market, risking wider spreads by increasing the supply of bonds to the market compared to so-called buy-and-hold investors — such as the three types named above — which are more likely to sit on the bonds for longer, effectively reducing the volume in circulation.
But is fast money really so bad? As any lead manager will tell you, the art of the bond syndication is partly about managing the optics. A successful trade will often start with an early update disclosing a chunky order book, effectively telling the market to get in while there is still a chance.
Here the fast money merchants can be useful as evinced by Caffil’s blow-out covered bond in early January. Opening at 07:53am UK time with initial price thoughts of 62bp over for a euro benchmark covered, the French issuer was able to issue a first update at 08:35 with an orderbook of €4.2bn including a good proportion of hedge funds.
Just 40 minutes later the French issuer fixed the spread at 51bp and the deal size at €1bn as the orderbook hit €8.7bn before closing later in the morning at €10.1bn.
It is likely some hedge funds left when the price was set but the fact the orderbook continued to grow tells us some other investors joined at this stage, probably after having their heads turned by the early updates.
The fast money label also overlooks an obvious truth about hedge funds: they are not a homogenous group. While some hedge funds might sell their bonds shortly after buying them, others will hold the bonds in expectation of a spread differential versus SSAs for example. Indeed, hedge funds holding paper bought in the primary market for longer has been one of the early themes of the year in the primary bond market. The fast money appeared, temporarily at least, to have slowed down.
As hedge funds increase their exposure to covered bonds, it is also likely their strategies will become more sophisticated and longer-term than the quick-flip approach they have adopted until now.
Of course, hedge fund strategies can change when the economics change. No one is suggesting that they have a structural need for the product in the way, say, bank treasuries might.
But we should also not forget that it was not that long ago that one of the covered bond market's problems — debated at conferences — was its lack of liquidity. This was in the days when the European Central Bank was buying up vast chunks of the market. The lesson should surely be that having some investors that can provide a bit more liquidity to the market is no bad thing.
With hedge funds playing a valuable role in bookbuilding and becoming, perhaps, increasingly important as long-term participants in covered bonds, it may be time to reconsider whether fast money is still an appropriate tag and a negative quality in an investor.