January 11, 2008 / 1:56 PM / 10 years ago

Investors seek safer, shorter covered bonds

LONDON, Jan 11 (Reuters) - Investors took a conservative approach to covered bonds as the 1.7 trillion euro market reopened this week, with short-dated paper from the established German market finding most favour, analysts said.

The covered bond market has moved into sharp focus in recent months as it has faced unprecedented turmoil while also being expected to become an ever more important funding tool for banks eager to raise cash, particularly with the securitisation market effectively shut.

Covered bonds are backed by mortgage or public sector loans which remain on the borrower's balance sheet. They have historically been highly liquid and typically rated triple-A by ratings agencies thanks to the quality of the assets and legal support, making them appear a surrogate for government bonds.

UniCredit (HVB) credit analyst Florian Hillenbrand said there had been clear demand for instance for bonds maturing in 2009 and 2010 from German issuers, the mainstay of the covered bond market.

But the market in general remained caught up in the turmoil that started last year.

"The world did not change just because Christmas is over," Hillenbrand said.

That was acknowledged by the European Covered Bond Council (ECBC) on Friday when it eased trading conditions set at the start of the year, allowing for transactions trading at wider spreads to be quoted at triple the normal bid-offer spreads. [ID:nL11231767]

Only the previous week, the ECBC had recommended that covered bond market-makers should commit to trade between themselves at double the normal bid-offer spread on a deal of 15 million euros minimum for all bonds, an improvement from the triple bid-offer spread requirement set across the market late in 2007.

Analysts at Deutsche Bank said in a note to clients that Pfandbriefe had performed well, but that other sectors had come under pressure.

"Secondary market conditions have worsened, with UK and Spanish covered bonds 5-10 basis points wider," they said in a report published on Thursday, adding that market-making remained vulnerable.

"Only small volumes were enough to put spreads under pressure ... Despite seemingly attractive spreads, we remain cautious and recommend issuer selection."


New issuance, however, fared well, with deals from Deutsche Postbank DPBGn.DE, HSH Nordbank [HSH.UL] and Sweden's SEB (SEBa.ST) coming in at the tight end of guidance.

Deutsche Postbank drew orders of 6.1 billion euros for a five-year 1.5 billion euro ($2.2 billion) mortgage covered bond, said Marcus Guddat, managing director of the covered bonds business at Citigroup one of the banks managing the sale.

That allowed the bond to be priced at mid-swaps plus two basis points versus guidance of two to four basis points over.

"Investors are taking a relatively cautious approach to mortgage covered bonds but there was exceptional demand for the Postbank transaction, which benefited from Germany's stable and transparent housing market," Guddat said.

Meanwhile, HSH issued the first ever jumbo ship Pfandbrief, raising 1 billion euros of two-year bonds priced at a yield equal to mid-swaps, Deutsche Bank's analysts said, versus guidance of one basis point over.

From further afield, Royal Bank of Canada (RY.TO) priced a 1.25 billion euro 10-year covered bond. (Additional reporting by Richard Barley; Editing by Paul Bolding)

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