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Go long

15 June 2015
Richard Kemmish

At the Global Borrowers and Investor Forum next week one of the panels will be focussing on the recent rise in long duration issuance, and its implications. This panel isn’t covered bond focussed, in fact covered bonds haven’t really featured in the discussions about the panel at all, which is odd given that we as a market used to have so much more longer dated issuance than any other form of bank funding.

It is several years now since our friends at CFF issued the first fifty year covered bond, but there were plenty of twenty and thirty year bonds issued before the crisis. The crisis dramatically reduced the average maturity of new issues, covered and uncovered alike, but it seems like ultra long dated covered bonds have been slow to recover, in marked contrast to other sectors. Switching from 7 to 5 years, yes. Switching to 30 years, not yet.

There are many factors specific to covered bonds that tend to discourage very long dated issuance, such as the greater importance of asset and liability maturity matching, but liabilities longer than assets is less of a problem than the opposite. To the extent that some covered bond jurisdictions only regulate the average duration of each side of the balance sheet, fifty year covered bonds currently funding twenty year assets facilitates more cheap dated funding. Those jurisdictions that have ‘banded’ asset and liability matching should see less ultra-long dated bonds.

Another specific covered bond factor is the cap on maximum maturities under the ECB purchase programme. But this is the same purchase programme that is driving investors out of covered bonds in a search for higher yields. Wouldn’t the higher coupons beyond twenty years be a better way to keep them in these investors in the asset class?

Other problems for long dated covered bonds – like an absence of meaningful price benchmarks – are just as much of a problem for Mexico or Petrobras, but it didn’t stop either of their recent highly successful century bonds.

Then there are the factors which count in favour of long dated covered bonds. Historically the longer end of the curve has been more accommodating to rates issuers than credit issuers (although the growth of long dated EM somewhat undermines that argument). Holders of 30 year bunds want yield pick up / are easily frightened by credit risk just as much as holders of 2 year shatze.

And the investors who have been buying the long dated bonds in other sectors are those who have historically been long covered bonds – insurers and pension funds.

But one factor more than any other will determine long dated issuance: mark to market risk. Namenspfandbrief used to avoid this risk under German insurance accounting. Will that, or a similar option, be available to insurance investors under Solvency 2 when it brings capital requirements in that industry more into line across Europe? If not, it isn’t just the long end of the covered bond market that will suffer.

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