It has been another topsy-turvy month in the covered bond markets. In the first week of June Danske Bank issue a €1.25 billion, five-year mortgage-backed deal at 20 basis points over mid swaps. The Danish bank launched the deal with no pre-sounding, and had it all away within a day. But ECB president Jean-Claude Trichet’s hawkish comments on inflation shortly afterwards brought the market back down to earth, and big hits were taken by many investors, especially those sitting on shorter-dated paper. Except for a few public-sector issues from such names as Dexia and Bayerische Landesbank, the covered bond market has been mostly confined to taps and private placements ever since. It was another month that highlighted the overriding shift in this sector since the credit crunch: a move from a fluid, open market to one confined to sporadic windows of issuance.
But which of the two can be considered a normal market? A mistake that has been made by many is to presume that the environment that preceded the crunch was totally normal. However, it would be foolish to think that the past five years or so are the benchmark and that the situation we’re in now is an anomaly. Until last summer the covered bond market was characterized by tight spreads and very little differentiation between products. Now, though, there is marked differentiation, most notably between public-sector-backed issues and those backed by mortgage assets.
Logically, though, that sort of differentiation between types of covered bond is appropriate. It might be that the benign market was the anomaly, and the situation we have now is the one that most closely resembles whatever normalcy applies in this market. Bankers have been racking up the air miles educating investors on the new way of things but increasingly those discussions don’t end with phrases like "until things get better", because it is far from certain that they will, at least in the near to medium term.
Covered bonds are a 200-year-old product, but most jurisdictions are fairly new to them, and have only ever operated in the pre-crunch bull market. Now that they have seen the vulnerability of covered bonds in hard times, specifically in the context of the flawed mandatory market-making system, many are shunning them and looking at other funding avenues. For example, senior unsecured issuance from traditional covered bond players is on the rise, as there is no longer the 50 to 60 basis point spread difference between the two that prevailed in the good times; they are now, for many names, almost on top of each other.
Traditional covered bond issuers, such as Bank of Ireland and Caja Madrid, have recently been absent from the covered bond market, but must be funding somewhere. Caja Madrid issued a €1.6 billion two-year floater at Euribor plus 65bp last month. A covered bond from the same issuer would likely have come in at around the high 50s, but the execution benefits of unsecured issuance and uncertainty surrounding covered bonds prompted the bank to eschew the latter in favour of the former.
Others are doing the same and, as long as they do so, covered bond issuance will remain confined to sporadic windows. Players now have to think a lot more about strategy and timing, whereas before the crunch that was never an issue; a properly structured covered bond was pretty much a guaranteed success. But that is no longer the case, and covered bonds have retreated back into the plethora of funding instruments from their previous position at the forefront of many issuers’ funding plans. Increasingly they look like staying there for the long term.