After the sharp rise in global bond yields that followed the US election, liquidity in the covered bond market had started to become more problematic. But, perhaps lulled by a false sense of security borne out of the almost uninterrupted period of stability seen since the start of this year, covered bond issuers and the banks that serve them have been slow to react.
Issuers and leads were awoken with what seemed like a rude shock as deals this week from BBVA and Australia and New Zealand Bank just scraped by. But even the most successful deals of the week, from Crédit Agricole and Nordea Mortgage Bank, contained seeds of discontent.
The French and Finnish borrowers both chose to issue seven year bonds, a welcome diversification from the plethora of long dated deals that had emerged after the summer and which suited yield hungry investors at that time.
However both borrowers only attracted 60 investor orders, which suggested that despite their large deal sizes and healthy oversubscription levels, a third of the possible buyer base was hesitant about getting involved. Even though Nordea had been out the market for over a year, its latest deal attracted the lowest number of buyers of any of its euro covered bonds for the last five years.
But the biggest wake-up call was undoubtedly BBVA’s €1bn 10 year issued on Monday. Although the spread seemed about right, the deal’s long duration combined with a near 17bp rise in Spanish government bond yields at the time of syndication meant it was lucky to even get subscribed.
Since the end of September rates have been continuously heading north and though covered bonds have barely budged relative to mid-swaps, many of the post-summer 10 year trades are now underwater in yield terms. This factor will have hit investor returns and, along the greater price volatility that is associated with long tenors, the buyer base will have been incentivised to shorten duration as outlined two weeks ago and again last week in GlobalCapital.
What is more remarkable is why BBVA ploughed ahead with its deal despite the certain knowledge that it would be a challenge. Erik Schotkamp, head of capital management and long term funding at BBVA put it this way:
“Its true market volatility has got higher since the US election but we think it may stay around for a while and we anticipate there will be more supply on the way. We were faced with the decision of either waiting or leaning against the market which is what we did in this operation."
In other words he didn’t believe conditions were likely to improve, and while a seven year may have seemed a better choice for investors, it certainly wasn’t the best fit for BBVA's balance sheet. So the bank did a 10 year because they thought demand for such deals would seize up completely in the future.
But a seven year was probably not the best choice for ANZ. Unlike BBVA, its bonds are not eligible for repo with the European Central Bank and can’t be bought for the central bank's covered bond purchase programme. That means a big section of bank buyers are less interested in its deals.
The luckless Aussie issuer was unable to achieve even half the demand for its barely subscribed €750m seven year issued on Tuesday that it gathered for its technically weaker New Zealand subsidiary, which issued a covered bond in the same tenor two months earlier.
The lesson here was that what worked for similar credits in September would not necessarily work today. The fact five year swaps have moved firmly into positive yielding territory for the first time in months, and that there has been no five year covered bond supply in euros since June, was evidently not a good enough reason to shoot for a shorter tenor.
If it wasn’t already evident, this week’s suite of covered bonds have shown that there is a fragile side to demand. It is no longer a sellers’ market and unless lead arrangers want to get stuck with a pile of unsold inventory into the illiquid year end period, they better sit up and take notice.