Covered bond tenders don’t make sense

Subordinated bonds, that are the main target for liability management exercises, will often trade at big discounts to par which means that their potential accretion to core tier one will be higher than a bond that trades close to par.

Despite that, several banks have opted to move up the capital structure and exercise liability management for their outstanding covered bonds. But judging by the paltry take-up of Portuguese borrower’s Banco BPI buy-back they shouldn’t bother.

BPI only managed to convince 7.5% of investors to take part in its buyback of its split-rated, single-A to triple-B, covered bonds. The borrower had hoped to buy €1bn of the three year bonds at 85% of par but ended up getting just €76.65m.

This may have partly been because the bonds were already trading at around 82.50%, so investors were hardly incentivised to take advantage of the offer which didn’t look to generous compared to the 20 or 30 cent premiums usually offered in subordinated debt buybacks, or the 10 cent premium of the National Bank of Greece’s recent covered bond tender.

But the low participation might also suggest a degree of investor confidence in the product itself. It also implies investors are prepared to live with lower covered bond ratings.

As the clock ticks down to the European Banking Authority’s June 30 deadline for banks to raise their core tier one capital ratio to 9%, funding teams should devote their precious time to focusing on managing those liabilities that are going to generate the greatest improvement to their capital position. They should leave their covered bonds alone. At the very least, Frederick would not approve.