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The year so far

28 July 2014
Richard Kemmish

My friends over at the Cover recently wrote a traditional pre-summer holiday article summarising the first half of the year in the covered bond market. Not a bad first half, with 90 benchmark deals we are well on track to achieve a decent market volume, somewhere between 130bn and 150bn seems to be the consensus view.

But as ever, the details provide some interesting clues about where the market is going.

Before the crisis spreads were mainly about nationality of issuer, with a very small amount of name differentiation within each country. During the crisis this started to reverse. Now we have surpassed pre-crisis levels of parochialism.

There is almost ‘clear water’ between spreads on pfandbrief and spreads on everything else – only 2 Germans had to pay double figure spreads (for sub-10 year bonds), whilst the tightest non-German prints were all in mid single figure spreads. Comparing best to best is even more striking. The tightest Pfandbrief came 18 basis points inside the tightest non-pfandbrief. This is a far greater differentiation than ever before and comes at a time of record low rates (LBBW’s deal had a 20 basis point coupon, an 18 basis point spread difference is a near doubling of absolute yield).
Which is all rather counterintuitive if you look at fundamentals. Firstly the credit worthiness of the German banking system is more heterogenous than most. Quite simply, within Germany the gap from best to worst is greater than anywhere else with the possible exception of Spain. More significantly, Banking Union, in particular the single supervisor and the resolution directive should imply that national specificities, such as willingness to support a failing issuer, or supervision of a covered bond pool, are less important and individual bank credit worthiness more important.
Whenever relative value is odd from a fundamental viewpoint the most likely culprits are technical factors. Step forward the incredible shrinking Pfandbrief market. German investors, long liquidity and increasingly nervous of sovereign risks are driving this particular anomaly.

Another interesting feature of the year to date is over-subscriptions. There is a rule across markets that higher beta deals are more oversubscribed than lower (compare equity IPOs with supranational bond subscription levels). This applies between countries in the covered bond market (Spaniards more oversubscribed than Germans), but not within countries (national champions usually more oversubscribed than weaker banks). Small prize for the first reader to explain that phenomenon. 
Most of the other characteristics that Bill highlights in his article are continuations of existing trends, deals are smaller (not a single €2bn print), more Italians (and plenty more to come with the latest law changes there), distributions are more granular (more investors, smaller tickets. That has to be a good thing for the market, surely?), and Canadians are more conformist than ever (guys, do you really all have to do the same trade at the same spreads at the same time? I know Canadians don’t like to stick out but a bit of diversity would be fun). 
What is in store for H2? As Niels Bohr said, “Its hard to make predictions, especially about the future”.

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