Covered bonds: It’s time to get picky, says UBS
Technicals will turn negative and valuations widen this quarter.
Fundamentals remain strong, but supply and demand patterns mean that investors should go underweight covered bonds compared with AAA sovereigns this year, according to UBS.
Although cash-rich investors will soak up this month’s estimated supply of about €17 billion, technicals will turn negative in February.
“After January 2006, new supply will outweigh demand from new money,” UBS said in its covered bond outlook for the year. As yields rise, cyclical demand will fall as investors become more price-sensitive and look for a risk premium from lower-rated issuers and structures.
Covered bond valuations will come under widening pressure this quarter. The bank predicts 10-year swap spreads to increase by four basis points to 14bp by March. Although demand for quality names remains strong, investors are now less tolerant of negative headlines surrounding individual covered bond issuers. “Name selection combined with a market weighting is key,” says the bank.
There should still be plenty of covered bonds that perform well. First-time issuers from this year’s new jurisdictions, such as Sweden, Norway, and Italy, will price at a premium. Limited supply and low event risk among French issuers make obligations foncières attractive.