In recent weeks, there have been a remarkable move in the euro covered bond market, with second tier names pricing almost on top of those from established core jurisdictions.
Just last Wednesday, Portugal’s Santander Totta landed a €500m 2.625% February 2030 mortgage covered bond at a spread of 39bp over mid-swaps. And UniCredit Bank GmBH — the Italian group's German subsidiary — priced a €1.25bn 2.625% February 2030 mortgage Pfandbrief at 34bp.
As of Tuesday, the spread between the two names remained at 5bp in the secondary market, according to Tradeweb data.
It has caused some unease in the market, but for second tier issuers eyeing the market, it is an opportunity. Moreover, they must not miss the chance to jump on the spread compression train before brakes are put on demand.
Such spread compression cannot continue for ever — at some point investors will rebel and turn their noses up at the tightly priced paper on offer.
Historically, the spread between second tier or periphery issuers and the top core jurisdiction peers has tended to be significantly wider.
For example, Totta’s previous outing in February 2024 — a €1bn 3.25% February 2031 note — was priced at 67bp over mid-swaps, 29bp back of where ING Belgium priced a comparable tenor note on the same day, and 33bp back of where Hamburger Sparkasse priced a seven year Pfandbrief later that month, according to GlobalCapital’s Primary Market Monitor.
Over the past few years, such gaps have for the most part been the norm in the euro covered bond market. Investors have demanded a pick-up to account for the lower liquidity or credit differences that arise from second tier names or jurisdictions.
But that differential is evaporating quickly, meaning that, if you are a second tier name or hail from a second tier region, now is the time to go and load up on covered funding. The pricing available for these names is exceptional — it is not every day a second tier name can fund at a single digit spread back of Pfandbriefe.
Of course, covered bond spreads still appear elevated compared to the low levels available during the years of central bank buying. But treasurers should look not at the headline spread, rather they should lock in the slim relative difference between themselves and their (more established) peers.
At some point, covered bond spreads will hit the floor. When this happens, investors will not see as much value in diversifying away from more liquid core names into rarer — or hairier — ones.
Investors have already suggested they might not be as willing to accept such tight differentials. The book for last week’s Totta trade fell from a peak of €2bn to €1.5bn as the leads fixed the spread at 39bp, 6bp inside of initial price thoughts.
At some point, this pushback will translate into more spread pick-up.
For now, there is just enough to keep investors engaged. Second tier names and jurisdictions should look to go while the differential is still tight but there is just enough juice for investors to squeeze out.
There is no guarantee the compression express will stay in the station for long.