Senior preferred: the new cuckoo in the covered bond nest
Senior preferred could prove a much more enduring threat to the viability of the covered bond market than the targeted longer-term refinancing operation (TLTRO) or the covered bond purchase programme (CBPP3).
CBPP3 has heavily distorted covered bond prices and caused some investors to leave the market. In contrast to the private sector, which is driven by rational price considerations, the European Central Bank’s primary concern is to meet its purchasing target, and so it is moving the covered bond market away from where investors want to buy.
But it gets worse. Price distortions caused by CBPP3 purchases have been exacerbated by the TLTRO. The super-cheap financing facility has
CBPP3’s artificial boost to demand, twinned with TLTRO’s subsidised funding, have considerably affected the demand-supply balance, helping elevate prices and tighten spreads. But since both CBPP3 and the TLTRO are extraordinary and temporary measures, their effect must eventually dissipate.
The ECB conducted its last TLTRO in March and, with the European economy now starting to improve, market participants are slowly coming round to the realisation that the ECB could be set to announce a tapering of its asset purchase programmes in September. The combined impact is sure to cause covered bond spreads to widen.
However, just as these two central bank measures are set to end, covered bonds will face a far more enduring level of competition from what is effectively a new asset class — senior preferred.
The introduction of the French senior non-preferred class this year has effectively provided credit enhancement to old style senior preferred and pushed it up the capital structure. The lower probability of default and
Admittedly, senior preferred does not enjoy the same
NSFR may penalise
On the other hand, proposed rules on the net stable funding ratio are set to penalise covered bonds compared with senior
Banks striving to meet their regulatory capital requirements will initially lean more heavily on senior non-preferred with the result that senior preferred becomes a more rarely used funding tool. As senior preferred becomes rarer, spreads should tighten — just as covered bond spreads widen.
Deals issued on Tuesday by UniCredit’s HVB subsidiary and Crédit Agricole clearly showed the direction of travel.
The French €1.5bn 10
With a big order from the ECB, HVB’s €750m nine
From a regulated investors’ viewpoint,
Covered bonds will always have a place, but taking into account asset encumbrance and the many new regulatory hoops that will need to