The well oversubscribed €750m deal came 100bp through the sovereign curve and the demand from across Europe took even the syndicate leads by surprise. “It’s a groundbreaking and historic trade for the covered bond market, and exceptionally important for Italy and UniCredit,” said Philipp Waldstein, head of group strategic funding and portfolio at UniCredit in Milan. “It’s the first covered bond ever printed inside the government curve and a testament to the supreme quality of Italy’s residential mortgage market.”
The last public covered bond from Italy was UniCredit’s €1bn 10 year trade last August. This was the first covered bond to be priced flat to the sovereign curve, and also carried the highest spread of any Italian OBG (Obbligazioni Bancarie Garantite). But the borrower shattered both these records on Tuesday, pricing a €750m trade at 290bp over mid-swaps and around 100bp inside BTPs.
Crédit Agricole, Natixis, Société Générale and UniCredit opened books on the no grow long five year deal with guidance of the 290bp/295bp over mid-swaps area. The borrower’s closest outstanding comparable was an October 2017 trade that was indicated at around 275bp over on the mid on Tuesday morning, according to one covered bond trader. However, like much of the secondary market, the deal was largely illiquid, with at least 15bp between the bid and offer spreads. Though the premium was difficult to discern, far more significant was the differential to BTPs. Syndicate leads put initial guidance at around 100bp inside the government curve, while RBS suggested 110bp.
Buyers appeared to have no issue with buying a covered bond well through sovereign levels, and orders were above €1bn after only 20 minutes.
“The issuer did a lot of work ahead of the mandate, which explains why we were able to execute so quickly,” said one syndicate banker involved in the deal. With a large volume of interest already secured bookrunners had expected to price the deal very quickly, he added.
Key investors had approached UniCredit asking for more exposure to the Italian sector, said Waldstein. “We had deviating price expectations, but these have since narrowed on both sides and this allowed us to price a trade.”
The 290bp spread also ensured an all important 4% coupon.
German insurance buyers were suggested as likely candidates for key tickets, as the deal would not be reported as Italian risk for accounting purposes among those buyers, said one covered bond investor.
The trio of French lead managers, along with the unusual timing and quick execution, pointed to preplacement into French and German accounts, said RBS analysts.
Syndicate bankers also suggested a UniCredit entity had taken some of the deal, but there had been no internal interest from the UniCredit group, said Waldstein.
“With orders approaching €2bn demand is clearly spread across a very broad market,” he said.
The €750m size was due to collateral constraints, though the borrower expects to be able to increase the issue to jumbo size as it originates new mortgages.
Waldstein also expected the deal to perform well in the secondary market and tighten in line with UniCredit’s secondary curve.
The deal was also only the second single-A rated benchmark sold in the public market. Moody’s is expected to rate the bond A2, Standard & Poor’s AA+ and Fitch A. Norddeutsche Landesbank launched a single-A rated aircraft Pfandbrief on July 10.
Pricing precedent
Waldstein told The Cover in April that the group was waiting for Moody’s rating watches on the Italian sovereign and banking system to be resolved before considering OBG issuance. The differential between OBGs and BTPs — around 70bp through BTPs for 10 years at that stage — would have to narrow to permit fresh supply, he said.
“At that point people thought perhaps the differential was a coincidence or that one market was lagging the other,” said Waldstein told The Cover. “But OBGs have traded inside BTPs for months, and the government curve is just one reference point and not the all important one. Though this deal is 100bp inside the sovereign curve it’s also 30bp above UniCredit’s secondary level and so offers real value in that respect.”
Other covered bond bankers were not surprised that the sovereign floor had been broken.
“Covered bonds are in their own separate world and investors are buying this deal from pure covered perspective, not relative to CDS, government or senior bond levels,” said one.
Nor were bankers surprised that UniCredit had been the borrower to break through.
“UniCredit was the obvious candidate to price the first covered bond through its sovereign. It’s a diversified institution and therefore not purely Italian risk,” said Mauricio Noé, managing director of global markets at Deutsche Bank in London. “The Italian housing market has risen at a glacial pace, which gives confidence on the collateral quality, and historically Italian investors have been able to distinguish between the private sector, where there is a high savings rate, and the public sector with its high levels of indebtedness.”
Waldstein also emphasised the quality of Italy’s mortgage market.
“It’s a sector that isn’t highly indebted, and the bond is backed by a granular pool of residential mortgage with a loan to value ratios in the mid 50s,” he said. “There’s clearly a broad acceptance for this kind of risk.”
Investors would also have taken comfort from the fact that some of the risks that apply to sovereigns don’t apply to covered bonds, added Noé. “Though redenomination concerns are present for some, risks such as restructuring would appear far more remote in the case of a covered bond than a government bond,” he said.
A vote for Europe
Though UniCredit was planning only follow on taps other peripheral issuers could well decide to launch benchmark deals, said syndicate bankers.
“We’ll wait and see what Intesa might do and how other strong peripheral issuers like BBVA and Santander react,” said a syndicate lead.
Though the health of the Spanish mortgage market was not comparable to Italy’s, the reception for the Italian trade had been a vote of confidence in the eurozone, he added.
“If the book had been made up of 10 key Italian accounts and some opportunistic core accounts then it could be misleading to draw broader conclusions,” he said. “But the book was over €2bn with 113 accounts participating, which includes all the usual suspects from across Europe.”