Between June and October last year the yield on 10 year Bunds was mostly negative, which meant covered bond yields were also negative in most core European jurisdictions out to the seven year area. Rather than take the higher execution risk associated with negative yielding deals, most issuers extended the tenor of their deals into the long end where they were able to offer investors a positive return, however slim.
Issuers such as DG Hyp, WL Bank and Commerzbank priced benchmarks in the eight to 10 year area with coupons of as little as 0.05%. French banks followed suit with transactions that were more heavily weighted towards the 10 year. Higher yielding peripheral borrowers could have issued shorter deals but, while demand was strong, they took the opportunity to issue as long as they could.
This meant the average duration of covered bonds issued by euro area banks in 2016 was somewhat longer than seven years, but while this gave investors their much desired positive yield, it also meant the average duration of many their covered bond portfolios was uncomfortably long, and certainly a lot long than the six year duration of the iBoxx Liquid Covered Bond index.
Now, with yields up again, the many investors that follow the index will be desperate to rebalance their duration back to neutral. To do that they need to buy bonds with a maturity of less than six years and fives are ideal. Accounts which fear big US tax cuts and a more hawkish than expected Federal Reserve will want to avoid the prospective mark-to-market pain and be shorter in duration than the index.
Although higher yields have been on offer since December, allowing issuers to execute at the short end, there have only been a handful of covered bond issuers that have launched five year bonds this year. But these offerings have proved among the most successful transactions of the year.
DNB Boligkredditt, Bank of Nova Scotia, Swedbank and Nordea issued by far the largest euro covered bonds so far this year. All the deals were well oversubscribed and placed with a wide group of investors.
These deals, with the exception of Nordea, were issued by banks outside the eurozone, where spreads are a few basis points wider, because they cannot be bought by the Eurosystem. Euro-domiciled issuers can also take advantage of the ultra-cheap four year term financing provided under the European Central Bank’s Term Long Term Refinancing Operation, which has reduced their incentive to tap investors for more expensive market funding that is only one year longer.
But that shouldn’t necessarily stop eurozone covered bond borrowers from hitting the five year. Nordea issued €1.5bn with a €2.7bn order book earlier this week and Aareal Bank looks set to follow on Wednesday with another five year. Helaba also filled €1.25bn of five year demand in the first week of the year. These issuers have shown a commitment to meet the investors’ needs. Other borrowers should follow.