With so many issuers coming to market in January, and with the havoc in other sectors of the debt market prompting investors to swallow such high levels of issuance, some banks that had previously only been considering a covered bond programme have decided to go ahead with one.
In Japan, the feeling among covered bond participants is that while the country’s financial institutions have for a long time had the capacity to issue covered bonds, they didn’t think that there was enough interest in the domestic market to justify doing so. That theory is set to be tested as Shinsei Bank is planning the first covered bond from Japan. The ¥50 billion ($479.9 million) bond will have a maturity of 10 years and is expected to launch in March. As there is no specific covered bond legislation in Japan, the issue is to be a structured covered bond, which allows the issuer a measure of structural flexibility. It would appear that Shinsei has taken full advantage of that opportunity. "This is not a covered bond," says one covered bond head. "There is a lot of risk that investors are expected to absorb. They don’t even have priority over the bank’s other creditors in the case of bankruptcy."
Indeed, a number of structural features of the Shinsei issue could deter traditional covered bond investors. In the unlikely event of default, it is possible that the bondholders will not recoup their investment in full, as there appear to be no measures in place to protect them should the proceeds from the cover pool fall short. Also, although the maximum debt-to-income ratio on the mortgages in the cover pool is 30%, there appears to be no limit on the loan-to-value ratio. Many bankers are very critical of these and other structural features.
"Shinsei has called it a covered bond to attract the investors they want," says one. "But as soon as those investors look at the deal’s structure, they’ll run a mile."
Not so fast
The Shinsei covered bond should not be discounted so quickly though. Although there might be a case for saying that the bank is asking investors to buy what is essentially a bullet bond with a guarantee attached to it, it needs a way of attracting investors. Shinsei has very little in the way of retail deposits, and so relies heavily on wholesale funding. With most other funding avenues closed and a domestic market that might not be ready for a more traditional covered bond structure, Shinsei is just doing what it needs to do to meet its funding targets.
"This is a very specialized form of financing," says Tim Skeet, head of covered bonds at Merrill Lynch. "Investors will buy it simply because it’s a triple-A product from Shinsei Bank."
That said, if this type of structure becomes a more regular feature in the covered bond market, it will serve to increase the dislocation between legislated covered bonds and structured ones.
Indeed, the covered bond market is moving further and further away from its traditional roots in Germany, although the Pfandbrief remains the best-quality product in this rapidly expanding marketplace. Deutsche Postbank priced its debut Pfandbrief, a five-year, €1.5 billion deal, at just two basis points over mid-swaps last month. The order book topped €6 billion in a matter of minutes.
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Core market outperforms |
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Jumbo covered bond spread landscape |
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Source: UniCredit |
The timing of the Shinsei issue might work against the bank. The covered bond market was not immune to the spectacular drop in global stock prices toward the end of January, as negative sentiment hit issuers. With investors becoming more cautious, many issuers are thinking twice about planned deals. "The covered bond market came to a halt when share values fell," says Armin Peter, head of covered bond syndicate at UBS. "Although it has since come back a bit, many issuers who were preparing deals are now holding back."
The volume of covered bond issuance in January surprised many in the market, and the sheer variety in price differences and other deal features has characterized the new, post-crunch covered bond market. One effect of the sub-prime-induced credit crunch on the covered bond market has been that issuers are having to pay a significant premium for mortgage-backed issues over what they are paying for deals backed by public sector assets. Public sector deals have always priced tighter than mortgage issues: before the summer, that spread was about 1bp maximum. Now, though, the aversion to anything related to the housing markets means that that spread is about 15bp. Similarly, the difference in price between covered bonds regulated by legislation and so-called structured covered bonds has also widened, by between 5bp and 10bp, as structures from non-legislated jurisdictions lever more risk on to the investor.
As a result, there is also variety in the success of the new issues. On the one hand, some issuers, such as Banco Espírito Santo, are having to work hard and pay up to issue covered bonds. The Portuguese bank priced its debut covered bond, a three-year, €1.25 billion deal, at 20bp over mid-swaps. Likewise, Bank of Montreal’s five-year debut covered bond came at a significant premium, 24bp over mid-swaps.
Public assets
Some issuers, however, have found covered bond issuance a far easier proposition. BNP Paribas issued a €2 billion, three-year deal at 13bp over and garnered an order book in excess of €3.3 billion. The first covered bond backed by public sector assets this year, a four-year, €1 billion deal, came from Austria’s Kommunalkredit, with great success. It eventually priced flat to mid-swaps, stark evidence of the dislocation between mortgage deals and public sector ones.
So the theatrics in the covered bond market will continue for some time, and the success or not of the Shinsei deal might well have wider repercussions. If investors accept it, then the type of structure that forces investors to hold as much risk as the Shinsei issue could become more commonplace and the dislocation between structured and legislated covered bonds will be wider than ever.