A “whopping” share of sizeable new issues launched year-to-date were for a minimum of Eu500m but less than Eu1bn, according to Commerzbank analysts, with these smaller deals reaching an unprecedented concentration in June.
Twenty-seven new fixed rate public covered bond issues of at least Eu500m but less than Eu1bn were priced in the year to 6 July, according to Dealogic. This represents 26%, by number, of all Eu500m-plus deals (excluding taps).
In June, 14 out of 31 sizeable publicly placed new issues were for less than Eu1bn, as issuers either capped deals at Eu500m from the outset, or priced sub-Eu1bn transactions.
As a result, the average deal size in June was Eu860m, according to Royal Bank of Scotland analysts, with the average year-to-date deal size standing at Eu1.03bn, down from Eu1.14bn in 2009.
The rise of sub-Eu1bn deals has won approval from syndicate bankers and rating agencies. Syndicate bankers have seen them as a sign of issuer flexibility and pragmatism, while the smaller issues have facilitated better asset-liability matching, which is looked on favourably by the rating agencies.
And smaller issuers have naturally welcomed the lowering of a barrier to entry, and one that was made only more awkward by more stringent rating agency requirements.
Sentiment among investors surveyed by The Cover, however, appeared more mixed.
Some accounts were either indifferent to or constructive about sub-Eu1bn deals. One investor said that Eu1bn does not represent an important threshold for him because he is not restricted to deals of that size or greater and because they do not guarantee the liquidity that they used to.
“A smaller well placed deal is much more favourable than a Eu1bn deal with no real demand behind this,” he said.
Another portfolio manager said that she does not view sub-Eu1bn deals as problematic, and that it is important for issuers to be pragmatic and realistic about what deal sizes make sense for them. She said that she would prefer issuers with smaller loan books, for example, to place smaller deals across different maturities than a big jumbo.
“Rating agencies are encouraging laddered maturities, and it makes sense for everybody,” she added. “It shows discipline, too.”
Another investor said that he generally does not invest in sub-Eu1bn covered bonds, but that he does not necessarily have a problem with so-called “jumbolinos”.
“It depends on what’s driving it,” he said. “If it’s because some investors have a specific need for it, that’s fine, but if it’s because you want to save 5bp then that’s not good.”
Technical benefits mask ulterior motives?
Rating agencies’ heightened focus on refinancing risk and asset-liability mismatches has been cited as a contributory factor in the rise of smaller deals, and representatives of Fitch and Standard & Poor’s told The Cover that smaller individual deal sizes can improve asset-liability matching, which in turn can lead to lower overcollateralisation being needed to support a given rating.
Nicholas Lindstrom, team leader for European covered bonds at Moody’s, also identified the benefits of smaller individual issue sizes as facilitating better asset-liability management.
“With small regular covered bond maturities you can to a greater extent rely on the natural amortisation of the assets in the cover pool,” he said.
While acknowledging the rating agency benefits of smaller deal sizes, one portfolio manager expressed scepticism about the authenticity of this rationale, suggesting that at times it masked an ulterior motive.
“I don’t have anything against smaller deals as long as there’s enough benchmark supply,” he said. “But the situation is one where, with a bit more effort and willingness, the smaller deals could be turned into jumbos.
“We need to hold issuers to their stated intentions of wanting to be frequent benchmark borrowers.”
He said that more attention needs to be paid to the timing and maturity of new issues to make sure that they reflect investor demand, and that if this strategy is pursued then more transactions should meet with sufficient demand for a Eu1bn size to be reached.
One investor also distinguished between issuers that communicated maximum and minimum deal sizes from the outset: while an issuer capping its issue at Eu500m is likely to be doing so for rating agency reasons, one pricing a sub-Eu1bn issue after announcing a Eu500m-plus issue is merely doing so as a consequence of insufficient demand.
But some market participants have been encouraged by issuers’ willingness to size smaller deals.
“Obviously it’s preferable to do Eu1bn, but in challenging markets it’s quite often difficult to have the assurance at the outset that you’ll reach that level,” said a syndicate official. “The key is for issuers to be flexible.”
Another syndicate banker, however, said that it was important to heed investor preferences for deal sizes and that important accounts were calling for Eu1bn minimum issues.
“Investors, German ones especially, are saying: ‘No more Eu500m deals – we don’t see them as benchmarks’,” he said. “It’s not across the board, but the the investors who are saying it are sufficiently important.”
Jumbo liquidity: dead or just sleeping?
The star attraction of Eu1bn-minimum deals that used to make them deserved of the jumbo name was the promise of liquidity supported by inter-dealer market-making. But with that presently unfulfilled, many market participants suggested Eu1bn-minimum deals had lost their edge over smaller-sized issues.
“The argument that there is more liquidity in Eu1bn deals is debatable,” said one syndicate banker. “Liquidity isn’t great in any case.”
RBS analysts said that the erosion of market-making has made it easier to issue smaller benchmark deals.
Investors also pointed out that jumbos were not living up to their name in terms of liquidity, but some said that smaller deals were even less liquid.
“Liquidity is already bad, but there it’s even worse,” said one portfolio manager.
This is because sub-Eu1bn deals are bought mainly by buy-and-hold investors, he said, or at least by accounts that do not intend to sell the bonds.
While the advantage of Eu1bn minimum deals over smaller deals has narrowed in terms of liquidity, investors suggested that it is still important to hold on to the promise of liquidity, and concomitantly to Eu1bn-minimum deals.
One portfolio manager said that the success of covered bonds as an asset class was in large part due to the introduction in1995 of the jumbo as a liquid benchmark.
“That shouldn’t be torpedoed only because it’s easy at the moment to do smaller deals,” he said.
And another investor told The Cover that those who hold sub-Eu1bn deals should not have the same expectations about levels of liquidity.
“Jumbos should still only be for Eu1bn, and if we ever get liquidity back people sitting with Eu500m deals can’t expect the same standards,” he said.
An issuer said that the jumbo format had been positively enshrined in the market, but that this did not preclude issuance of smaller deals.
Facing an identity crisis
With smaller deal sizes unlikely to disappear from the market any time soon, market practices in the area of nomenclature and price transparency need to be improved, said Commerzbank analysts.
Indeed, the lack of an established term and definition for these deals-of-at-least-Eu500m-but-less-than-Eu1bn makes debating their merits awkward, and data collection and analysis difficult. The term jumbo is meant to refer only to Eu1bn-minimum deals, although many market participants have said that the lack of inter-dealer market-making – one of the minimum standards defining a jumbo – makes that term irrelevant.
The term “jumbolino” has been used, but few commentators appear enamoured with it. UniCredit analysts preferred to take advantage of the World Cup to refer to a “Jabulani-segment of Eu1bn deals” in a recent research piece.
Meanwhile, the term benchmark appears too ambiguous to serve as useful shorthand for the deal format in question. For some a benchmark covered bond is a Eu1bn-minimum transaction, while for others a benchmark is simply a sizeable, well placed issue.
If sizeable, yet sub-Eu1bn deals continue to make up an increasingly important market segment, it would be at the very least helpful to come up with an industry term for that deal format.
Analysts have also called for sub-Eu1bn covered bonds to be included in indices such as iBoxx’s, which one said has failed to capture Eu58bn of issuance since 2008 because deals of less than Eu1bn are excluded.
“In times when most banks have to reduce balance sheets, are desperate for any kind of term funding, and there is limited market liquidity of old-style benchmark covered bonds anyway, it seems justified to include such bonds in benchmark statistics,” he said.