Titanic Issuance: Is This The Year Of The Covered Bond?

We have been musing for a while now the impact of new financial regulations on bank funding and how banks will structure their balance sheets going forward. I speculated a couple of months ago that banks would likely begin to fund themselves by issuing a combination of covered bonds and contingent capital. My sense is that the demand for contingent convertible capital in the market is currently pretty weak, which if I am to be believed, leaves covered bonds as the only option for bank funding.

Yesterday I think we got a glimpse into the future. Several European banks came to the market with covered bonds. Already this year (week) we have had €14.25bn worth of supply, and when you consider that the euro covered bond market usually issues around €150bn of paper a year, it does seem as though it’s a level that may be worthy of some note. Even with about 10% of the normal yearly supply already done, sentiment is that there is a lot more still to come.

It has generally been larger banks that have come to market and such is the desire to issue paper, they seem willing to pay up. Santander, for example launched a 5yr cedulas (Spanish for covered bond) which priced at swaps+225 yesterday. A record wide level.

A preponderance of covered bonds is clearly not good news for senior debt holders, because in the event of a bank liquidation you are further away from the top of the capital structure and therefore have a claim over fewer assets than you would have traditionally had. It will be interesting to see how the covered bond market develops and what happens to spreads – what will dominate? Demand or supply?

This Titanic issuance of covered bonds is more than moving the proverbial deck chairs around to fund the banks. In fact senior and subordinated bond holders are being rearranged further from the safety of government and legal lifeboats.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Matthew Russell

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