ECB to buy covered bonds on primary, secondary markets

FRANKFURT (Reuters) - The European Central Bank will buy euro covered bonds directly in the primary and secondary markets, ECB President Jean-Claude Trichet said on Thursday, indicating it intends to support a broad swathe of the market.

"The ECB is making it very clear that having a healthy covered bond market is necessary for a European economic recovery," said Ted Lord, managing director at Barclays Capital.

"They are going to support both the primary and secondary market, which means they want to help those covered bond issuers that have not been able to come to the primary market yet but have high-quality covered bond programs," he added.

The ECB said it would buy bonds directly but did not specify the mechanism that would be used, such as whether purchases will take place through national central banks or through the ECB itself.

"If they give any details on the mechanism, they limit themselves," said Franz Rudolf, covered bond analyst at UniCredit (HVB). "This leaves them room to adjust to market conditions, to enhance the market without running the show ... without leading to distortions in the market."

Covered bonds are issued by lenders and backed by a pool of assets such as mortgage loans or public sector loans that remain on a bank's balance sheet. They are seen as safer than other bank bonds, because they give investors a claim on the assets as well as the lender itself.

The ECB said in May its Governing Council had made a decision in principle to buy 60 billion euros' worth ($85 billion) in euro-denominated, euro zone covered bonds to support the market.

ALREADY BOOSTED

The May announcement alone has led to a sharp narrowing of spreads and a volley of activity in the syndicated, public primary market, which had seen only a handful of issues since the Lehman Brothers collapse in September. The ECB has already supported the market "without spending a euro," Rudolf said.

New issues have since come from banks including Banco Santander (SAN.MC), Deutsche Bank (DBKGn.DE), Swedbank (SWEDa.ST), Erste Group Bank (ERST.VI), Banesto (BTO.MC) and Aareal Bank (ARLG.DE).

Syndicated jumbo covered bond issuance has totaled at least 20 billion euros in the past four weeks, compared with just 10 billion in the four months prior to that, Mauricio Noe, head of covered bonds at Royal Bank of Scotland, told the Global ABS Conference this week.

Trading declined in the secondary market, however, due to the lack of detail on the bonds likely to benefit. Spreads between bid and offer prices widened, and some prices were difficult to come by, analysts said.

"There are still some things unclear, but it is not a disappointing announcement," said Bernd Volk, head of European covered bond research at Deutsche Bank. The lack of clarity "will help keep speculation and activity going, so it is quite a clever strategy."

Trichet said the ECB would implement the purchase program from July until end-June 2010.

"The bond program will be available until mid-2010. That's longer than expected, but that is probably because the market will take time to digest this," said Jose Sarafana, head of covered bonds research at Societe Generale.

Trichet listed several eligibility requirements for the bonds the ECB will purchase:

* A focus on issues with a double-A rating from at least one of the major ratings agencies, but nothing lower than triple-B.

"That is not a limiting factor," because very few covered bonds are rated below double-A, UniCredit's Rudolf said.

* A size of about 500 million euros but in any case not less than 100 million euros.

That size "means they want to help some of the smaller issuers, not just the larger ones that can issue jumbos," Barclays' Lord said.

* Compliance with the official Directive on Undertakings of Collective Investment in Transferrable Securities (UCITS).

That requirement would bar the purchase of a few French and Dutch issuers and one Italian issuer. "There is likely to be a differentiation in spreads because structured covered bond issues will not be included," Sarafana said.

* The ECB will focus on medium- to long-term bonds with maturities of three to 10 years.

* Bonds can be backed by assets from either private or public entities.

Asked about speculation that the ECB might increase the total purchase amount, Trichet said: "We have decided on 60 billion euros, full stop ... When we decide something, we will tell you so."

The amount is large relative to new issuance, which amounted to 96 billion euros in 2008, according to a Societe Generale note.

But the outstanding market is much higher. The iBoxx euro covered bond index totaled 713 billion euros on May 6, not taking into account illiquid covered bonds, which could increase the size of the market to 2 trillion euros, SocGen analysts estimated in a note to investors.

"We view 60 billion euros as big. And it might get bigger if this proves necessary," they wrote in a note before the ECB announcement.

(Reporting by Jane Baird; editing by David Stamp)