* Eurozone supply to remain flat as new jurisdictions open up
* Covered bonds to benefit from bail-in threat
* Moody’s warns on issuer, credit quality
By Aimee Donnellan
LONDON, Dec 18 (IFR) - The globalisation of the covered bond market is forecast to gather pace in 2013, making up for the dwindling levels of supply in the European market, bankers say.
The trend - which has seen supply in the euro market shrink from EUR195bn in 2011 to EUR100bn in 2012 - is expected to continue as non-European jurisdictions open up and banks seek to diversify their funding.
According to Barclays, 2012 was the first time in the history of the euro that global covered bond issuance from non-euro area countries exceeded issuance from euro area countries.
A combination of bank deleveraging, improved access to unsecured funding and banks’ desire to preserve assets for cheap ECB funding is driving the decline in issuance from European banks.
The US dollar market and other currencies such as Australian and Canadian dollars and Swiss francs are tipped to reach EUR70bn-equivalent, up from EUR55bn last year, according to Barclays research.
Societe Generale says that US dollar supply - dominated by Australian, Yankee and Canadian issuance - could increase by almost 50% in 2013 to EUR45.5bn-equivalent from EUR31bn in 2012.
“Canadians, who are about to adjust their programmes to the new specific covered bond legislation, and Aussies should remain active and continue to benefit from their safe-haven status,” wrote analysts at the French bank.
Covered bond volumes in many other markets may also be boosted by the new legal frameworks that are being introduced, including South Korea, Panama, Mexico, Morocco, New Zealand, Singapore and possibly the U.S., continuing the relentless advance of the product outside the European market.
But for European banks, many question marks remain. Banks’ reliance on central banks for funding is expected to continue as long as the liquidity taps are kept open.
Bernd Volk, head of covered bond research at Deutsche Bank, said supply from Dutch and UK banks will remain low, partly because of deleveraging pressure and, in the case of the UK, because of alternative liquidity available through the Funding for Lending Scheme.
Meanwhile, retained covered bonds for ECB repo purposes, which reached a record EUR306bn - primarily out of Spain, France and Italy, according to data from Barclays for the twelve-month period ending in October 2012 - are expected to remain a theme.
“An exit from the enhanced liquidity measures is not on the agenda,” wrote Barclays analysts. “In addition, funding from the euro system balance sheet is usually cheaper than capital market funding. Thus, benchmark covered bond issuance from euro area credit institutions may be restricted to a few showcase transactions which will be designed to demonstrate ‘access to capital markets’ rather than to optimise funding.”
As a result, bankers have mixed views on peripheral issuance. Credit Agricole expects peripheral covered bond markets to be the main growth areas, while Deutsche Bank said supply would probably be subdued.
Peripheral banks, in particular, have relied less on covered bonds this year as the unsecured market has opened up for them.
But while central bank liquidity is likely to keep a lid on issuance from European banks, new jurisdictions like Belgium are expected to make the most of their newly set-up frameworks, while issuance from non-European banks will help keep the euro market alive.
In Sweden, a recent change in the basis swap could push the country’s banks - effectively absent from the covered bond market in 2012 - towards the euro market. One banker predicted as much as EUR15bn to be issued out of Sweden next year.
One factor that could tip the scale in favour of banks weaning themselves off central bank liquidity is the strong performance of the asset class and the insatiable investor demand for secured bank paper.
Covered bond spreads have tightened by more than 300bp in certain jurisdictions since ECB President Mario Draghi promised to do whatever it takes to preserve the euro, and they should tighten even further next year as redemptions from Spain, Germany and France skyrocket to EUR156bn-equivalent from EUR99bn in 2012, according to Credit Agricole.
Although covered bonds continue to be considered a safe-haven funding tool for issuers as well as a relatively secure place for investors to park their cash, there could be trouble spots ahead.
According to Moody‘s, ongoing negative pressure on sovereigns and issuers will continue to threaten issuer and covered bond credit quality in 2013.
European covered bond downgrades have increased sharply this year. The quantity of downgrades in the seven months from February was similar to the level seen in the previous four years, the rating agency said.
In relation to bail-ins, although secured liabilities are on the face of it excluded from the scope of the bail-in tool, there is room under the terms of the European Commission’s Crisis Management Directive to allow for a potential carve-out if secured liabilities exceed the value of the assets securing them.
In June this year, the Commission said that member states were allowed to exempt covered bonds from the provision, but this could lead to uncertainty for the asset class, bankers say, as it will be down to the value individual national regulators attach to covered bonds.
Analysts at Barclays warn that from an investor’s perspective this adds another element of uncertainty to the analysis of the risk factors involved in covered bonds.
But despite these upcoming hazards, bankers say investors have never been so willing to invest in covered bonds and the bail-in regime may actually work in the product’s favour.
“The funding balance is likely to shift next year in favour of covered bonds as investors become wary about bail-ins and retreat to the safety of secured funding,” said Richard Kemmish, head of covered bond origination at Credit Suisse. (Reporting by Aimee Donnellan; Editing by Helen Durand and Julian Baker)