The European Central Bank’s EUR60 billion program of purchasing
covered bonds to stimulate the economy has the traditional markets
for the bonds, but it is also helping spark issuance in countries
where the bonds were previously unknown and in other markets that
are among the most affected by the global downturn.
Covered bonds are highly rated bonds issued by banks to
refinance residential mortgages or public-sector loans that remain
on the lender’s balance sheet. Banks have to maintain the credit
quality of the pool of loans, sometimes in accordance with specific
legislation, and investors have a claim both on the bank that
issued the bond and the assets underlying it.
Because Europe's biggest markets for the securities were Germany
and France, there were concerns when the ECB program was unveiled
in May that the plan would automatically favor banks in those
countries. But a series of recent deals should put such fears to
rest.
In fact, the ECB's purchase of bonds from those bigger markets
has helped facilitate the issuance of new covered bonds elsewhere
in the euro zone, even in one of the countries that has suffered
the most.
Ireland’s banking and housing sectors have been hit particularly
hard by the crisis, so rebuilding investor appetite for Irish
covered bonds was seen as a tough task.
Nevertheless, Bank of Ireland Mortgage Bank, part of Bank of
Ireland Group (IRE) , sold a EUR1.5 billion, 4.625% covered bond
last week – the first Irish deal since June 2007. It attracted
EUR3.8 billion of orders in 90 minutes.
Some market watchers had assumed that central bank participation
would be key to reopening the Irish market, with central banks
buying a large quantity of bonds directly in the primary market to
encourage other investors to participate.
In fact, their role was more indirect, with central banks from
the euro zone and elsewhere buying just 11% of Wednesday’s
deal.
"The central bank component of the order book was relatively
small, and we attracted EUR3.8 billion of orders, so the success of
the deal clearly wasn't dependent on central bank involvement,"
said Jeremy Walsh, syndicate banker at Royal Bank of Scotland, one
of the lead managers on the transaction.
"But this is precisely the kind of transaction that the ECB
program was designed to help, albeit in a way that is hard to
quantify," he said. "Their buying helped spreads tighten to the
point where an Irish deal was feasible again, and their implied
support of the covered-bond product has also boosted investor
interest."
Attractive Yields
Investors are also searching for bonds that offer decent yields.
Spreads, or the premium that a bond pays investors versus a
benchmark rate, have compressed dramatically since the ECB started
buying, in some cases to pre-crisis levels.
Spreads on German covered bonds, or Pfandbriefe, are now around
10 basis points or less over the mid-swaps rate.
The Bank of Ireland deal, by contrast, priced at 190 basis
points over mid-swaps, so investors get a much higher return.
One banker not involved on the deal even suggested that the
spread was too high, considering that the bonds are rated triple-A
and that Ireland's covered bond law affords investors a high degree
of protection.
But while the deal pays investors more than they would receive
for buying, for example, Pfandbriefe, there are other pricing
points to consider.
"Recent one-year government-guaranteed Irish bank debt issues
have priced at 160 basis points over mid-swaps," said RBS's Walsh.
"To price the first unguaranteed Irish bank debt in any format for
nearly two years in a five-year maturity at 190 basis points is an
excellent achievement."
The difference in spreads between covered bonds from different
markets is striking. In a note published Thursday, Barclays Capital
said that covered-bond markets “have reacted asymmetrically” to the
ECB purchase program, and recommended investors switch into
“markets which are commonly perceived to be weaker than their
peers” including the Irish market.
Other issuers are also taking advantage. Monday, National Bank
of Greece S.A. (NBG) announced its inaugural covered bond, in what
will be the first deal out of Greece to be sold publicly to
investors.
And last week, Italy’s Ubi Banca (UBI.MI) announced its
inaugural covered bond – one of a handful of new deals to emerge
from the country since the ECB’s program was announced.
Both countries have introduced laws on covered bonds, although
the market didn't have time to grow before the financial crisis
struck.
But investor appetite should be good for these new deals,
because central banks are on hand to support prices if
necessary.
The Banca d'Italia, for example, has EUR9.9 billion to spend
under the program, far more than the total outstanding volume of
Italian covered bonds.
That buying power creates a natural issuing opportunity for
Italian banks. Even if the central bank doesn't buy bonds direct
from issuers, it has considerable firepower to deploy subsequently,
when bonds trade in the secondary market.
This gives other investors comfort that prices of covered bonds
won't drop after the bonds are issued, and encourage them to
invest.
-By Mark Brown, Dow Jones Newswires; + 44 (0)207 842 9485,
mark.brown@dowjones.com