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Forging a new identity
The stature of covered bonds as a funding tool continues to grow by leaps and bounds. Developments that will see senior debt become bail-inable by 2018 are adding to their allure; as is their legal robustness and unassailable place in the capital structure in the event of issuer insolvency. In short, covered bonds have offered a funding lifeline, certainly to non-peripheral banks whose access to capital has been ravaged by the effects of the eurozone sovereign debt crisis.
As well as being a beacon in the turbulent eurozone market environment, covered bonds have continued their drive to globalisation – exemplified by the coverage in this Special Report – with Australia and New Zealand coming on stream, and Belgium about to pass its covered bond law. The US remains the major elusive jurisdiction; the upcoming presidential elections in November 2012 will see the covered bond bill run out of time in the current administration as more pressing items gain precedence, but its supporters continue to lobby hard.
On the currency front, crisis-driven sovereign and bank volatility may have reduced the overall proportion of covered bonds sold in euros, but issuers have found a willing reception in the US dollar market, while for domestic issuers, Australian dollars and sterling have proved reliable sources at a good price. In the UK, covered bonds in floating-rate format have been a good market in 2012.
For sure, covered bonds have not been able to insulate peripheral eurozone issuers from distress, and peripherals continue to be shut out of the market. The ECB’s second covered bond purchase programme has had limited impact in this regard and the programme, which is running below target, is widely seen as much less effective this time around. What is as yet unclear, though, is if or how the Spanish bank bailout unveiled at the summit of EU leaders, held at the end of June, will offer Spanish banks renewed access to private capital and on what terms.
Beyond the peripherals, there have been issues to deal with but none are seen as deal breakers. The 3CIF issue caused a hiatus in issuance of covered bonds out of France, far and away the most active jurisdiction in the public market into the first quarter. But while 3CIF caused a degree of confusion at the time, market professionals do not expect it to derail issuance into the medium term.
In Canada, in its quest to deflate a housing bubble, the government passed new legislation in May to stop Canadian banks using CMH-guaranteed mortgages in their cover pools. This, and minimum overcollateralisation levels, will increase the cost of funding through covered bonds, but any wider effects have yet to be seen.
In the German Pfandbriefe market, the incidence of negative yields at the short end of the government curve in the second quarter helped to stir a major resurgence of German issuers in the public benchmark market. Germans had been notable for their absence early in the year, preferring to tap the active private placement market.
In essence, Pfandbriefe private placements offer issuers much better execution. Most had avoided paying up to issue benchmarks. But faced with irresistible underlying yields, the likes of Berlin Hypo, Munich Hypo, HSH, LBBW, Deutsche Bank and others stormed into the public market and were able to lock in funding at such tight levels that the overall consensus was that those levels were absurd. But even though they were optically tight, they still offered a decent pick-up to Bunds. And to a predominantly German investor base, this was deemed to be acceptable.
In terms of roadblocks, excluding the impact of market or country-specific events, the way looks clear for covered bonds. Asset encumbrance, taking into account the aggregate of repos, derivatives and covered bonds, is certainly something to keep an eye on but no one is raising this yet as a major red flag. In short, covered bonds are now viewed as a strategic funding tool and for the foreseeable future they look likely to remain there.