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Covered bond supply optimism is misplaced

By Bill Thornhill
14 Jan 2021

This week’s burst of covered bonds was exceptionally well received and boosted supply hopes. But even though the funding was cheap and deal execution certain, the supply outlook remains grim.

The mood was sombre on Monday, as only one €500m covered bond had surfaced during the first full week of 2021. 

But then Caffil priced its €1.5bn 10 year flat to the curve, its most subscribed offer yet, and a flood of other borrowers followed, culminating with DNB Boligkreditt’s €1.5bn 10 year also pricing flat to the curve with record demand.

Against this backdrop, senior unsecured deals from BNP Paribas, LBBW and BFCM offered bigger premiums, yet floundered in the secondary market, underscoring investor reticence and a need for higher concessions that may take spreads wider.

In contrast, covered bond investors, that have €30bn of redemptions and coupon payments to reinvest this January, have only seen €6bn of supply. So it’s tempting to believe that risk aversion will cause more banks to turn to covered bonds and eschew senior unsecured.

Yet, the big picture has not fundamentally changed and that means supply optimism is misplaced. For pure funding purposes, European banks can draw on the Targeted Long Term Refinancing Operation which has an unbeatable cost of minus 1% for three years.

More importantly, deposit inflows have surged across the world. And with new lockdowns once again taking hold, spending will remain anaemic, implying that deposits will balloon even further. 

Borrowers that planned to issue early this year will have probably done so already and with blackout periods looming supply is likely to wane. Even though covered bonds are cheap, they are expensive for banks that don’t need the funding.

On the other hand, regulatory funding is a necessity, but issuers can bide their time.

By Bill Thornhill
14 Jan 2021