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Early mover advantage for peripheral covered issuers

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By Bill Thornhill
25 Jul 2017

Covered bond issuers in Europe’s periphery should wake up to the fact that current spread levels are artificially tight and unsustainable. The first bank that recognises and takes advantage of this will have a distinct advantage over its competitors.

With combined covered bond supply of €5bn, Italian and Spanish banks have only issued a quarter of what they did in 2016. The average of forecasts made by analysts at Crédit Agricole, UniCredit, LBBW and Société Générale suggests they have more than two times that amount to raise over the remainder of year.

With the market practically closed in December, banks in these two regions will need to raise €3.5bn a month over September, October and November. 

While that is perfectly possible, it is highly unlikely that deals will be funded at current spread levels.

That’s because secondary prices have become so distorted by the lack of supply and exceptionally high Cédulas redemptions that they don’t reflect market clearing levels. What they reflect, instead, is the price at which the European Central Bank is prepared to buy bonds.

For example, investors would need to bid 5bp through swaps to buy BBVA 2024s, which is precisely the same bid required to buy Compagnie de Financement Foncier 2024s. In September 2016 CFF issued a covered bond due 2026 at 5bp through mid-swaps and two months later BBVA followed with a deal in the same tenor which was priced at 23bp and widened to 30bp.

But in contrast to 2015 and 2016 when the peripheral covered bond market naturally corrected by up to 50bp, the dynamics are very different this year. The European Central Bank is widely expected to announce a formal plan to taper asset purchases — if not in not in September then in October or maybe even December.

Everyone knows the ECB is running out of bonds to buy and the European economy is showing distinct signs of growth. So while ECB president, Mario Draghi, will undoubtedly want to keep all options open, he will be obliged to offer the market some sort of guide.

Issuers in Italy and Spain that recognise these facts will probably see that it makes sense to issue a summer trade today by paying a possible new issue premium of 10bp, rather than wait until later in the year when they could be looking a paying much, much more.

By Bill Thornhill
25 Jul 2017