Natixis has applied to the German regulator for a licence to issue Pfandbriefe. With German banks deleveraging and cutting back on Pfandbrief issuance, the new entrant is likely to be viewed in a positive light.
But, total issuance capacity is likely to be very small — hundreds of millions of euros rather than billions — according to bankers who have heard about the programme. As such, the overall picture of diminishing German supply is unlikely to change.
So far this year, only two German issuers have brought deals with a collective value of just €1bn. By comparison, this time last year, as many as eight German borrowers had accessed the covered bond market, raising a total of nearly €8bn.
On a much broader scale, Eurozone issuance as a whole is also well below last year’s levels, and with few borrowers poised to bring deals, spreads look set to tighten.
“The market is on fire. I expect we’ll see spreads come in by around 50bp-100bp,” a covered bond banker said. Referring to recent Federal Reserve policy statement and the European Central Bank’s Long Term Refinancing Operation, he added “we’re in for a bull market for the next year or so, borrowers will be in no hurry to issue as they’ll be confident of better opportunities around the corner”.
Ostensibly issuance this year has been just as high as last year. Dealogic data indicates that €52.1bn covered bonds were issued in the year to date compared to €51.7bn in the same period last year. But this data is highly deceptive.
Benchmark supply falls by 83%
The true measure of a liquid market is the benchmark supply and in the Eurozone there have been conspicuous differences this year compared to last.
So far in 2012, there have been 19 benchmark deals with a value of €24.25bn issued in euros, of which 10 were from the Eurozone. These 10 deals account for €13bn of supply, or 53% of the total.
By comparison, this time last year 36 euro denominated benchmarks had been issued for a total value of €39.35bn — with 30 deals worth €32.6bn issued out of the Eurozone.
Even more startling is the scarcity of short dated supply. This year Eurozone borrowers have issued only €3.5bn in maturities out to five years, compared with €20.6bn in the same period last year.
Typically these bonds are placed with banks, which tend to trade more than insurance companies and pension funds. As a result, there is a clear message as far as liquidity is concerned.
Seven of the 10 deals from Eurozone borrowers this year were in maturities of 10 years or longer. They had a euro value of €9.75bn, equating to 75% of this year’s Eurozone issuance total.
By comparison, only around one third of last year’s €32.6bn Eurozone supply was issued bonds maturing in 10 years or longer.
Long and well held supply
As a result of these big changes, the majority of this year’s longer dated issuance has been placed with insurers, asset managers and pension funds. And, as every covered bond syndicate banker and trader knows, once placed these bonds are rarely traded.
They are liquid in the sense that a good bid will always be found, but illiquid in the sense that there is virtually no turnover.
It should therefore come as little surprise that dealers are now running short of inventory. It cannot be long before bonds become impossible to source and very expensive to find in the repo market.
At the close of trade on Wednesday, many longer dated deals had shown a very marked performance in the secondary market. With dealers anxious not to get caught short, offers have been extremely defensive.
In a tightening market, it is the offer side that is probably the more pertinent measure of demand. Compagnie de Financement Foncier, which issued a €1bn 10-year deal on January 9 at mid swaps plus 190bp, is now offered at 167bp. Many other 10-year deals are between 20bp-25bp tighter than the reoffer level.
Taps under the radar
This strong performance provides fertile ground for issuers to tap deals. For example, Abbey recently tapped an old 10 year and CFF tapped its October 25s, as well as an old five year.
But these taps will often go under the radar, much to the annoyance of investors, who still have targets to meet and returns to make. In all cases it is understood that had these taps been more publicly syndicated, the increase could have easily amounted to a benchmark size.
But issuers are acutely aware of the current supply/demand dynamics and, despite some concern that the funding window might shut due to a swift escalation of the sovereign debt crisis, they seem more than willing to wait and watch as spreads move inexorably tighter.
Non-Eurozone picks up slack
Investors are therefore reluctantly going to have to park their cash elsewhere. The covered bond market can continue to expect more issuance outside the Eurozone and globally.
Compared to last year, Australian dollar issuance has increased by €3.5bn equivalent, sterling deals are up €5.3bn equivalent and US dollars by nearly €1bn equivalent so far this year.