In 2016, as the first covered bonds were priced with yields below zero, investors remained — for the most part — unfazed.
Berlin Hyp went first in mid-March with a €500m 0% March 2019 note that yielded minus 0.162%. It still attracted €1.5bn of orders.
After four months of hesitancy, Deutsche Hypo followed, attracting €1.3bn of orders for a €250m negative yielding tap. CIBC unearthed €2.5bn of demand for a €1.25bn note at minus 0.009%.
Now the covered market stands on the edge of a similar precipice: SSA and covered spreads are converging. Banks are getting close to pricing covered bonds flat to or even through top quality agency and sub-sovereign paper.
The spreads of the tightest covered bonds — typically German, Nordic and Dutch paper — over the major European supranationals and German Länder are hovering in the single digits.
It is particularly at longer tenors that covered bonds are coming close to these other very highly rated issuers.
French covered bond issuers have even priced through OATs, such as a €500m 10 year deal by Compagnie de Financement Foncier in February which came 14bp through.
But France is no longer in the top division of European public sector issuers.
Covered bond issuers are hesitant to go further and overtake top quality SSAs in spread.
Pricing covered bonds through SSAs would probably put off plenty of bank treasury investors.
Why should they buy 10% risk-weighted assets at spreads below zero risk-weighted SSAs?
But many of them do not even look at long dated bonds, focusing instead on the belly of the curve.
Although the market’s obsession with spreads and new issue concessions might suggest that is all participants care about, many investors have no interest in the spread, whether over mid-swaps or govvies.
They care about their yield targets, and thanks to this year's rapid rise in rates, covered bonds can now hit these at longer tenors.
That has compressed spread gaps at the long end. The most recent 10 year Pfandbrief issue by Münchener Hypothekenbank is trading just 2bp-3bp back of Länder.
The euro covered market is by all accounts undersupplied — and there is no press of deals waiting around the corner in the second quarter.
Issuers have leverage, especially as the market ponders how much the already high levels of SSA borrowing are likely to go up to cover defence spending.
Covered bonds already price through plenty of sovereigns — plus the European Union itself.
The next rank of SSAs is merely a psychological hurdle.
If issuers have the will, they can overcome it and charge through them.
If the demand is there, banks should be bold and go for it.