Peripheral vision proves useful
All eyes have been on the periphery since the market opened this year. Italy has decoupled from and recoupled with Spain, leaving many covered bond participants anxious about the shaky future of peripheral issuers.
Spanish government bonds began the year in a weaker position than Italian BTPs as investors began to fear the country with 20% unemployment would go cap in hand to the EU and IMF as Greece, Ireland and Portugal did.
However, by August the two countries reached a point of parity as market fears were transferred to Italy. By September the situation had completely reversed and saw Italian BTPs quoted as much as 37bp cheap to Spain.
Despite the volatile government market in Spain, covered bond issuers such as La Caixa, Kutxa and Caja Madrid were able to access the market with relative ease in the first half of the year and were looking forward to a year that would see them accessing the public market when necessary.
But a lot has changed in the second half of the year. Covered bond traders now estimate certain Spanish issues that were sold earlier this year as are as much as 150bp wider than the level at which they priced. And it’s not just the second-tier names. By the end of the third quarter of 2011 even the highest quality bank assets are coming under pressure. A poorly received €1bn five-year covered bond issue for Banco Santander highlighted how investor appetite for Spanish names has changed since the country was hit by renewed sovereign concerns.
In what is being viewed as a poorly executed deal, syndicates failed to sell all of the bonds and were long €125m each following the pricing. For the foreseeable future, covered bond bankers are bearish on Spanish names. “Even with as much as a 20bp new issue premium they still aren’t guaranteed the deal will be successful,” said a covered bond banker.
Another syndicate banker echoed this: “If the market is shut you can add on whatever new issue premium you want and it won’t make any difference. I can’t see the likes of Santander and BBVA repricing their curve in order to access the market.”
The failure of the Santander deal has been bad news for second-tier Spanish names in need of refinancing upcoming maturities. Months after the issue was priced, bankers are still concerned that the covered bond market will remain shut to smaller institutions for the remainder of 2011 and beyond.
“The only way we can see an improvement in market conditions is with a common political response from Brussels”
“Santander really disrupted the market,” said a DCM banker. “When you have such a badly managed deal it makes you wonder when we will see a weaker peripheral issuer come to the market.”
Others are less pessimistic about the covered bond market and believe that the structural changes that are being made to the country’s cajas, or savings banks, are far reaching and will allow future issuance.
“Spain is sorting itself out,” said Mauricio Noe, head of covered bonds at Deutsche Bank. “Covered bonds are the most important funding tool available to Spanish banks and I think we are likely to see a Spanish Cedulas issue price through the sovereign in the next 12 months.”
Alvaro Jover, funding director at Bankia, agreed and said: “Spanish banks are fundamentally well capitalised. Speaking with investors, it’s clear that they are more concerned about the Spanish sovereign than they are about banks.”
Over the past three years covered bonds have been an important source of funding for Spanish and Italian banks, particularly for second-tier names that have been priced out of the senior unsecured market.
Since the market opened in January, Italian banks have raised €12.8bn while Spanish banks have sold more than €18bn.
In the Italian OBG market, up until June of this year banks had access to the covered bond market and were considered to be in a better position than Spanish institutions. UniCredit sold two OBG covered bond deals since June with a combined total of €2bn and Credito Emiliano also managed to sell a €500m no-grow in June.
In the secondary market Italian names bucked the widening trend for most of the year but as the market began to focus on the sovereign’s 120% debt to GDP ratio covered bonds spreads began to soften.
UniCredit’s recent 10-year OBG that priced at mid-swaps plus 215bp widened out 17bp which was broadly in line with 10-year BTP yields in the 10-year part of the curve, which had softened by 20bp in the two weeks since it was sold.
Across the board Italian names have widened out 70bp at their most pressurised point ensuring that even the strongest Italian names like Intesa are locked out of the market. And despite Italian and Spanish covered bonds continuing to price through their respective sovereigns, bankers are concerned that negative headlines surrounding their respective sovereign could see them follow in the footsteps of Portuguese borrowers that have been unable to sell a covered bond since April 2010.
Looking at the Portuguese covered bond market it is easy to see why bankers are nervous that Spanish and Italian names could suffer a similar fate.
For names such as Caixa Geral de Depositos, which is seen as the strongest Portuguese issuer, the fact that it has traded as much as 150bp and 200bp through government bonds has made little impact on risk-averse investors that are coupling the fortunes of the Portuguese sovereign with its banks.
“Investor attitudes have changed in the past year and nowadays besides the credit and the collateral, investors focus as well on absolute level and performance of underlying domestic government bonds,” said Torsten Elling, co-head of rates syndicate at Barclays Capital.
Rumours were circulating that a number of Portuguese issuers were looking to enter the market in March this year but a deal never emerged. The market is said to be firmly closed and any mention of an opening is usually enough to draw laughter from covered bond participants.
Running out of options
In the absence of a public market, borrowers have turned to retained covered bond deals to allow them to plug funding gaps.
In one such deal, in July, Banca Popolare di Milano structured a €1bn long two-year (January 2014) OBG which it will be able to use as collateral to obtain ECB funding. The retained deal caused something of a stir when it was announced as many syndicates said the structure is usually indicative of no other funding options.
“This BPM deal is a very bad sign,” said the DCM banker. “This wasn’t a private placement with a strategic investor which means that they have no access to the public markets at all.”
Indeed, Italian banks’ reliance on the ECB has jumped to its highest since the beginning of the year as they struggle to access the bond market as a result of the sovereign crisis.
However a covered bond syndicate official had a different opinion. “I wouldn’t read too much into trade, while I am sure the issuer would have loved to have placed it in the public market, covered bond deals get done and get retained all the time,” he said. “It’s been a function of the market for the last three years. The reason why you’ve seen more retained deals in ABS than covered is because there is more flexibility in terms of what you can use as collateral in a securitisation.”
For the final quarter of this year, issuers are hoping that a supportive market will allow for primary activity and that a political solution will see covered bond and government bonds recouple, giving investors the push they need to enter the market.
One Caja issuer who discussed the market said that the market needed to take its focus off countries like Spain and Italy when much of Europe is under pressure. “Secondary spreads are back to original highs. We need the Greek uncertainty to be solved before investor appetite comes back,” he said. “Today even French are out of the market. Focusing on a single country is a mistake. Spanish problems are the same as Italian or French today, and the only way we can see an improvement in market conditions is with a common political response from Brussels.”
Click here to see the Digital Edition of this report.