Senior left behind as ECB throws weight behind covereds

LONDON, Oct 7 (IFR) - The ECB's decision on Thursday to throw its weight behind covered bonds risks leaving the senior unsecured market further behind at a time when it is already suffering from a lack of investor appetite and trading at historic wides.

Increasingly covered bonds are European banks' wholesale funding lifeline because the traditional senior unsecured market has been shut for much of the year, and also expensive to sell into with the spread differential well in excess of 100bp even for the better names .

Among the ECB's measures to boost liquidity in the euro zone banking system yesterday is a second covered bond purchase programme (CBPP2) set to start in November. It potentially will see it buy EUR40bn of covered bonds. .

In May 2009 the ECB's CBPP targeted EUR60bn and spreads in the sector narrowed 20bp within a matter of days, prompting a raft of issuance.

"There is scope over the longer term for the ECB covered bond purchase programme to impact senior positively as investors feel more comfortable about banks' funding position," said a head of FIG syndicate.

"However, in the short-term, we might see the gap between the two widen further as the ECB backs covered bonds and for many issuers, if they have the collateral, they will do covereds."

Having sufficient collateral is the key factor, one that will become more critical for as long as the senior unsecured market is shut or too expensive to be efficient.

Regulatory clarity is another cloud hanging over senior unsecured bank debt with investors uncertain of the exact nature of the bail-in requirement, but the recent Vickers Report in the UK supports the view that it will take on the attributes of gone-concern capital [IDnL5E7KG28X].

"There are just so many moving parts," said another syndicate banker.

"If you're buying senior bonds in the European market with post-2013 maturities, it looks like you are going to be subject to a potential bail-in, which in addition to the current volatility is another reason to stay out of that market.

Also, given the explosion of covered bond issuance you also need to know what your encumbrance levels look like before 2013 and what this means for your recovery rates."

News that the ECB is flooding the European banking system with liquidity was welcomed even though it fails to address the long-term issues.

"The revival of the LTROs is a headache relief but doesn't solve the underlying problem," said Roger Doig, credit analyst at Schroders.

"If a Spanish bank needs to lend mortgages for 25-years, getting one-year liquidity from the ECB won't help it much, so while LTROs are perfectly acceptable reliefs, they don't solve the real issues."

"You'd be a fool to think that turning the tap on to full flow is somehow going to help the private funding market recover," added a DCM banker. "Any expansion of ECB repo facilities is an acknowledgment that other avenues to fund are firmly closed."

NEW FUNDING MIX

In the absence of a resolution to the sovereign crisis, few in the market expect investors to opt for senior in large volumes in preference to the comfort offered by covered bonds, where they at least have a claim on some specific assets.

Another syndicate official said for the foreseeable future banks' funding will be provided through central bank facilities and money market funds, some short-dated senior like the Deutsche and ABN deals last week, and covered bonds.

"It'll be one to three years for senior and three to 10 for covered."

The enhanced equity base envisaged under Basel III will, it has been suggested, make the likelihood of a senior bail-in so remote as to negate any impact on pricing.

But with both the hybrid and equity markets in the doldrums investors are unlikely to be satisfied about issuers' capitalisation levels post-2013.

Unsurprisingly the market's hopes rest now on a European-wide recapitalisation of the banking sector, after which investors might feel more comfortable.

"Recapitalisation is the perfect solution, as long as it is big enough," said Robert Kendrick, FIG analyst at L&G.

"If EUR200bn+ was injected into the French/Spanish/Italian/German banks then Greece could safely default and the market would be confident that the banks were strong enough to withstand a default of any of the other PIGS. Clearly recapping the banks to a level that insulates them from sovereign default should be enough to reopen the funding market in a meaningful way." (Reporting by Matthew Attwood and Helene Durand, Editing by Alex Chambers and Julian Baker)