Berlin Hyp issued the first negative yielding covered bond in mid-March, but until this week no other issuer followed because of misplaced fear that such deals would entail unnecessary execution risk.
But, on July 15, Deutsche Hypo raised eyebrows after it attracted €1.3bn orders for its €250m 6.5 year tap that yielded -0.0771%. The extraordinarily high level of demand showed that the market had firmly busted through the negative yielding threshold without even a blink.
Canadian Imperial Bank of Commerce followed on Monday with the first negative yielding covered bond from a non-eurozone issuer. 90 investors placed orders of €2.5bn for the €1.25bn six year which cost them -0.009% to buy.
Just as Berlin Hyp’s deal benefited from an anticipated easing of ECB policy, pricing just before the discount rate was cut to -0.40%, so both this week’s deals have benefited from an increase in central bank easing expectations.
The European Central Bank is running out of bonds to buy, and is likely to be reluctant to move from the present capital key weighting system for purchases to a total debt weighting system. This is because such a change would favour highly indebted countries, creating moral hazard.
Instead, the central bank is more likely to widen the scope of public sector purchases to include government bonds with a yield below the negative 0.40% discount rate. This should drive loss-making German government debt to yield even less.
The same can be said for covered bonds. As of last Friday little more than 70% of bonds eligible for the iBoxx Euro index issued by banks in the eurozone were negative yielding. But when the ECB signals its intent to buy even more deeply negative yielding paper, possibly this autumn, that universe of bonds guaranteed to lose money will balloon.
Buyers will prefer to buy these principal-damaging covered bonds because they will demolish the value of their portfolios more slowly than parking funds in government bonds or on deposit.
Issuers may find it difficult to accept they are being paid to borrow and many will still try to reach for a positive yield by extending with eight to 10 year deals. But the fact less price sensitive bank treasury and central bank investors are reluctant to extend beyond seven year point suggests this part of the curve may become over-supplied, causing it to steepen.