Has Brussles got the market covered? | Jumbo liquidity hit by a big freeze | Old product, new law
HENRY FORD KNEW a thing or two about selling. “A market is never saturated with a good product,” he once said. Covered bonds must be a very good product – it’s apparently impossible to saturate the market for them. If you ask the European and Asian investor base as a whole what it wants, the answer appears to be yet more covered bonds.
Investors are unlikely to be disappointed. September was another strong month for primary issuance, with some issuers delaying their deals until later in the quarter to avoid a crowded month. Royal Bank of Scotland estimated that total covered bond issuance in September and October would be worth between €25 billion and €30 billion. Cédulas issuers have been the most fecund this year, contributing €10.5 billion to the new-issue totals in September. Last month, Banco Popular Español issued €2 billion with its first stand-alone cédula hipotecaria.
If 2005 was the year of the cédulas, 2006 could be the year of the Italian covered bond. Cassa Depositi e Prestiti (CDP)’s second benchmark priced on October 13. The €3 billion, seven-year deal priced at mid-swaps plus three basis points, equivalent to 12.8bp over the January 2013 Bund. Investor interest was sufficient to build a book of more than €3 billion in four hours. More than 15% of the deal went to Asia and the Middle East.
As a government-supported funding vehicle, CDP issues under its own legal framework. But private sector borrowers should follow its lead. “We are expecting large issuance from Italy next year. At least four borrowers will join the covered bond club,” says Demetrio Salorio, head of DCM origination for financial institutions at SG CIB. “Bank issuers are just waiting for the complete legal framework.”
But of course the covered bond investor base is not homogenous. Different bits of it want different products at different times. At the moment, issuing in dollars is one of the most effective ways to tap the high-quality Asian accounts that are increasingly active in covered bond deals. Halfway through October, Hypothekenbank in Essen, Bayerische Landesbank and Crédit Foncier de France were all working on dollar issues.
As well as Asia, some central banks from both western Europe and central and eastern Europe bought covered bonds for the first time in 2005. The liquidity position of European investors in particular is huge. Supply can’t keep pace with demand, so spreads keep tightening and there is room for more issuance. Any AAA product that offers a pick-up to governments gets snapped up. “If your job is to outperform, what’s the alternative?” asks one portfolio manager at a European central bank. “New money is still coming in and investors who have any kind of index have to keep buying.”
So in addition to absolute levels of supply in this snowballing market, established covered bond investors are positioning themselves with one eye on the impact that these new buyers are having.
Old and new
Some of the more established covered bond investors want demand to drop off. “I would like to see a little bit more supply relative to demand up to year end, forcing spreads one or two basis points wider,” says the portfolio manager. “But I don’t see that.”
”We definitely want to see more spread, but right now I don’t see how the market can provide it,” says Martina Kocksch, senior portfolio manager at Cominvest.
Old and new buyers don’t have to tread on one another’s toes. Dollar deals are popular at the short end of the curve because they offer an arbitrage opportunity. This has left euro issuers free to concentrate on meeting investor demand at the long end. But while new accounts have bought longer-dated deals, some established investors have shunned them. “I prefer the short end,” says the central bank portfolio manager. “If spreads are going against you, you will be more comfortable in the two-year to 10-year segment. Ten-years plus maturity is a long time to sweat it out. There’s a strong bid in 10 years from new money but I’m not buying.”
Established investors are not priced out of the covered bond market. But new buyers from Asia and elsewhere could take control of pricing as well as demand. “Traditional investors aren’t worried at the moment, but it does mean that these accounts are less able to take charge of the pricing process,” says Martin Weber, executive director, head of covered bond syndicate at Goldman Sachs.
Issuers have responded to these concerns, for example by bringing pot deals, although these in turn create possible problems for buy-and-hold investors. “Recently a lot of covered bond issuers have been coming with pot deals where, of course, book-building could be driven by trading accounts,” says Felix Blomenkamp, who is responsible for European mortgage-backed securities at Pimco. “But we always indicate the spread level where we see value in a bond, so hopefully we can influence issuers and their banks to price at fair levels.”
Trading accounts themselves have to adapt to market conditions. “A lot of the trading accounts are longer-term holders than they used to be,” says Weber. “This is simply because rates are currently so low that they need to hold a bond for longer than before to reach their internal targets across the high-grade credit product range.”