For a few basis points more: covered borrowers go niche

Banks have turned to the covered bond market as they wean themselves off years of cheap central bank liquidity. In 2022, firms raised €284bn equivalent across all currencies and had placed €209bn equivalent by the end of August this year, data from Dealogic shows.

And although the bulk of this funding was raised in euros, niche markets — like the Swiss franc and Australian dollar — have given issuers a necessary and useful alternative outlet.

“We’ve seen through the course of the year that some trades in G3 [markets], from the higher frequency issuers, have been constrained by line capacity,” says Thomas Lowe, head of FIG DCM for UK, Ireland and Canada, at Nomura in London.

“Given the increasing volume banks are needing to do, with central bank funding schemes rolling off, issuers need to supplement this with demand from elsewhere,” says Lowe. “Even if it does cost a few basis points more than core G3 [currencies], issuers are willing to pay to secure genuine diversification.”

For Wojtek Niebrzydowski, vice-president of global term funding at Canadian Imperial Bank of Commerce (CIBC) in Toronto, the principal reason for accessing non-core markets is funding diversification. “Of course, we can sometimes realise some arbitrage, but this is not an overriding factor,” he says.

Yassir Berbiche, head of treasury at Fédération des Caisses Desjardins du Québec (CCDJ), says funding diversity “is key for us this year”. His firm sold its first Swiss franc and sterling covered bonds — as well as its debut unsecured senior yen trade — this year and is looking to branch out into other markets.

The ever-popular Australian dollar is the next market in CCDJ’s sights. “We roadshowed in Australia last year and might return in the winter with a deal,” says Berbiche. “The Australian and Canadian economies have a lot in common and investors there understand us. Issuing in Australian dollars is also a good way for us to gain exposure to a new investor base in Asia.”

Nomura’s Lowe reinforces this point when he says: “There are certain investors who only buy Aussie dollar assets, so if you want true diversification as an issuer then it’s a good proposition.”

He adds that “the local banks have LCR (liquidity coverage ratio) portfolios to maintain and there’s also a sizeable domestic asset manager community who participate in triple-A transactions. On top of this you also have Asian money from banks in China, Hong Kong and Singapore looking to manage their own LCR portfolios, as well as a pool of asset managers across the region.”

These “LCR portfolios have consistently grown in tandem with bank balance sheets,” says Lowe. “This pick-up in demand has been met by the pick-up in supply.”

Niche markets will “never be the cornerstone of any funding programme, but there is genuine diversification available and meaningful size,” he adds.

On average, offshore banks have raised just over Sfr250m ($283m) in a single Swissie tranche and A$764m ($495m) in a single Australian dollar tranche so far this year, according to data from GlobalCapital’s Primary Market Monitor.

But it is not just diversification that is driving borrowers to tap niche currency markets. After years of central bank supported issuance in the eurozone, the end of quantitative easing has made niche markets an attractive funding proposition again.

“During QE, Swiss supply was not competitive versus euros for most issuers given the combination of negative rates and strong euro market dynamics,” says one Zurich-based syndicate banker. “Since QE in Europe faded out and spreads normalised, the Swiss market gained in relative attractiveness.”

Offshore banks have raised Sfr4.8bn so far in 2023, making it already the busiest year for the market since 2012.

On top of this, the return of positive underlying rates in the Swiss franc market last year has ushered in a raft of covered bond supply.

“When issuing in Swiss francs we used to aim for a minimum yield of 1%, but after rates went negative, the challenge switched to getting a positive yield,” says Niebrzydowski.

“From what we understood, during this time there was a finite amount of funds available for low yielding triple-A paper. But now [rates are positive again], investors are reallocating assets back into fixed income and as a result we are seeing more demand, more issuers, and occasionally larger deals.”

The Swiss franc’s seven year dalliance with a negative policy rate ended in September last year. The Swiss National Bank rate first dipped below zero in January 2015, when it dropped to minus 25bp, before later being slashed even further, to minus 75bp.

This negative rate era is now over, with a succession of increases taking the policy rate up to the giddy heights of 1.75%, as of August.

“With the higher absolute rates, investors now can be a bit more flexible when it comes to spread levels,” says the Zurich-based banker.

The average yield for an offshore covered bond has climbed dramatically in the Swiss franc market over the last few years, rising from 0.1% in 2020 to 0.2% in 2021, 1.07% in 2022 and 1.89% so far this year.

“The market will continue to remain supportive as long as we have higher positive rates,” says the Zurich-based banker. “Swiss francs will enjoy further inflows thanks to the relative attractiveness of the currency compared to others.”

This support is evident in the size available in the Swiss franc market, with funders finding opportunities to bring benchmark sized deals. Lloyds Bank dipped into the market for the first time to raise Sfr440m on August 9.

Large offshore deals followed from Santander UK and Toronto Dominion, which respectively raised Sfr385m and Sfr500m. The latter sale was the largest foreign trade in the format since Nationwide’s triple trancher in 2019, Dealogic data shows. However, unlike Nationwide, Toronto-Dominion achieved its size across only two legs.

Although covered bonds are already a firmly established product for offshore borrowers in the Swiss franc and Australian dollar markets, they are yet to take off in other key non-core currency markets.

“There is technically a market in Canadian dollars, but covered bonds are not a traditional fixed income product in Canada,” says CIBC’s Niebrzydowski. “The question for us as an issuer is to what degree issuance of covered bonds would cannibalise the demand for senior unsecured paper in a market that, most of the time, is the cheapest to issue in on the senior side.”

Only two Canadian dollar covered bonds have been issued in the last three years, according to Dealogic. Laurentian Bank raised C$250m ($185m) of five year paper in April 2021, with the next offering following two years later when Toronto-Dominion priced a C$1.25bn three year floater.

No foreign funder has issued Canadian dollar covered debt since Dexia in May 2007.

A potential Canadian dollar-denominated covered bond would be repo-eligible with the Bank of Canada, and as a result “there is demand from Canadian bank treasuries looking for their HQLA portfolios,” says Niebrzydowski.

However, although “this demand is arguably over and above the demand from real money accounts, access to that market is very sporadic,” he says. “We haven’t issued a public Canadian dollar covered bond but have issued self-retained deals. Although we wouldn’t consider the market, at this time, for meaningful issuance, that doesn’t mean it’s not an option for foreign issuers.”

And although there is a clear bid for Australian dollar covered paper out of Asia, this demand does not translate into home currency interest.

Niebrzydowski says CIBC does “occasionally speak to some of our Japanese coverage banks about yen [covered bonds] but the response we get is that the likelihood of that market developing is next to zero”.

Nomura’s Lowe agrees, saying: “There’s not the same market for covered bonds in yen. There are a handful of investors that can buy the product but because of the low yield environment in Japan the focus is on higher beta senior products where the pick-up is greater.”

The last yen covered bond was issued in 2007, again by Dexia, according to Dealogic.

Meanwhile, Niebrzydowski says CIBC has “also looked at Singapore dollars, but it seems the demand there is for capital products that command a much wider credit spread”.

Issuance in this market “is driven by private banks and high net worth investors — and this demand is for wider spread and higher yielding products than triple-A assets,” adds Lowe.

Banks have had a great time raising capital paper in Singapore dollars this year, placing S$3.65bn ($2.7bn) across seven deals. However, no firm has ever issued senior secured paper in the currency.

But for many bank funders, issuing a niche currency covered bond is not a ‘one and done’ exercise. Many hope to return repeatedly to these markets, drawing upon a recently or newly established investor base.

“You cannot spread your funding around different markets and not commit to returning,” says Berbiche. “Investors don’t like to open and follow a name if you only issue occasionally. When we decide to issue in a new currency, we commit to returning and building out a liquid curve.”

For nascent and returning international funders like CCDJ, covered bonds are the perfect instrument to reintroduce or introduce a name to new investors. “We’ve been advised to open new markets first with a covered bond before looking for opportunities to issue unsecured paper,” says Berbiche.

Although non-core currency covered bonds make up a small portion of the overall market, their importance will continue to be felt and these smaller niche markets will persist as a key part of a bank’s multicurrency programme.

“Issuers have committed to the market, now have a decent amount outstanding, and will continue to use it as part of their global funding mix,” says Lowe.