Abn amro covered bond watch mid term review

Covered Bond Watch Mid-term review

Group Economics Macro & Financial Markets Research Joost Beaumont +31 20 628 3437 joost.beaumont@nl.abnamro.com

DISCLAIMER: This report has not been prepared in accordance with the legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead. This report is marketing communication and not investment research and is intended for professional and eligible clients only.

23 July 2015  Primary market: Net supply of euro benchmark covered bonds was firmly negative in 2015H1. EUR 61bn of new issues compared to EUR 85bn of redemptions, resulting in negative net supply of EUR 24bn. This amount rises to EUR 36bn when taking into account the primary market purchases of the Eurosystem.  Spanish market shrank by the most: Negative net supply was the largest in Spain, followed by the UK and France. In contrast, the Canadian market expanded by the most.  Supply forecast: We maintain our previous supply forecast and continue to expect EUR 125bn of new euro benchmark issues this year. However, we have made adjustments to the breakdown by country. We were too optimistic on Italy and the UK, but we were too negative on Germany, Canada, France, Sweden, and Belgium.

Overall, net supply is expected to be slightly positive in 2015H2.  Longer maturities: There was a shift towards issuance of longer maturities in the first half of the year, with the 7y being the sweet spot. Currently, we see more demand for 5y or shorter maturities.  More soft and conditional pass-through: Issuers are increasingly enhancing the efficiency of their covered bond programmes, resulting in shifts to soft bullet as well as conditional pass-through structures. We expect this trend to continue in the second half of the year.  Spreads at pre-crisis levels: CBPP3 together with negative net supply remained the main factors behind the ongoing spread tightening of euro benchmark covered bonds. Spreads are now almost back at pre-crisis levels.

Peripheral covered bonds outperformed, while Austrian names underperformed. Furthermore, the French longend as well as Canadian paper also performed well. We still see room for some further performance.  CBPP3 to reach EUR 200bn: The Eurosystem is on track to own as much as one third of CBPP3-eligible benchmarks by year-end. Meanwhile, the overall total of CBPP3 purchases could reach EUR 200bn by September 2016, even if the Eurosystem reduces its covered bond purchases in coming months.  Trade ideas: We see further room for peripheral covered bonds to outperform, given the relatively high spread levels. Furthermore, we see value in switching out of (semi) core covered bonds into (semi) core government bonds. The latter have cheapened versus covered bonds, while they will be supported by the PSPP, and will also benefit from a better regulatory treatment. Finally, crowding out and the search for yield should support senior unsecured paper versus covered bonds.

2

Covered Bond Watch - Mid-term review - 23 July 2015

Taking stock

Canadian market growing fastest

The first half of 2015 is already behind us, while the holidays

At the other side of the spectrum, the Canadian market

are nearing. So, a good moment to provide an overview of

increased by EUR 7bn in the first half of this year. Most

developments on the covered bond market in the first six

Canadian covered bond issuers launched new deals in

months of the year. Are our supply forecasts still accurate,

2015H1. In our view, this reflects that these issuers are still

what covered bonds have out/underperformed, will the ECB be

building their curves, following the introduction of the new

able to sustain CBPP3 at the current pace, and what are our

covered bond legislation in 2012. Looking forward, most

trade ideas? Of course, we will also look ahead at the second

Canadian issuers still have sufficient room to issue covered

half of the year.

bonds before they will reach their limits. Indeed, one issuer already returned to the market in July.

Primary market: net supply firmly negative EUR 62.1bn of euro-denominated covered bonds were publicly

Other jurisdictions that are still growing are Belgium, Australia,

placed in the first half of this year, of which EUR 1.4bn were

and Italy. What is more, issuers from new jurisdictions are

sub-benchmarks. Overall, issuers raised EUR 60.8 bn in 78

expected to enter the market as well. Kookmin Bank from

euro benchmark deals. This compares to EUR 85bn of euro

Korea and DBS Bank from Singapore are expected to launch

benchmark redemptions, resulting in EUR 24bn of negative net

inaugural deals any time soon. Meanwhile, issuance is

supply. So, it seems that 2015 will be the third year in a row

expected from Poland as well as Turkey.

that the euro-denominated covered bond market will shrink.

Supply forecasts: on track to reach EUR 125bn‌ The picture on net supply gets even worse if we take into

Last year, we estimated in our 2015 Covered Bond Outlook

account the amounts that the Eurosystem bought in the

publication that EUR 125bn of euro benchmark covered bonds

primary market. Under CBPP3, some EUR 12bn of covered

would come to the market this year. At EUR 61bn in the first

bonds were purchased at their launch, taking negative net

half of the year, it seems that this forecast is still well within

supply even to EUR 36bn. This is close to the EUR 44bn in

reach. However, the breakdown by country is likely to be

2014 as a whole (also corrected for CBPP3).

different than we previously thought.

Spanish market shrank by the most

ABN AMRO supply outlook 2015 (euro benchmarks)

A breakdown by country (ex-Eurosystem purchases) shows that the Spanish market shrank by the most. Just looking at maturing euro benchmarks and new supply, the Spanish market shrank by EUR 16bn, almost twice as much as the UK market, which came second. Third ended the French market, which declined by around 5bn.

Country

Redem ptions

New issuance (realised 2015H1)

Net supply

AT

3

4

(1.5)

1

AU/NZ

1

7

(3.0)

7

BE

0

4

(3.0)

4

CA

0

13

(7)

13

CH

2

2

(0.0)

0

DE

20

21

(12)

1

Net supply by country

DK

1

2

(1.0)

1

EUR bn

ES

36

12

(7.25)

-24

FI

5

5

(2.5)

1

FR

29

18

(9.5)

-11

20

IE

7

5

(2.5)

-2

10

IT

7

10

(3.75)

3

NL

5

3

(1.0)

-2

NO

4

4

(0.5)

0

PT

2

2

(1.0)

0

SE

7

7

(3)

0

UK

15

6

(2.25)

-9

0

(0.0)

30

0 -10

net supply

BE

CA

IT

AU/NZ

FI

NL

PT

redemptions

DK

AT

CH

DE

IE

new supply

SE

FR

NO

ES

UK

-20

US Total

0 142

125 (60.75)

Figures may not add up due to rounding Source: Bloomberg, Bond Radar, ABN AMRO

Source: Bloomberg, Bond Radar, ABN AMRO

0 -17

3

Covered Bond Watch - Mid-term review - 23 July 2015

…but more from (semi) core and Canada…

Redemptions by month

We have revised upwards our supply forecast for Germany,

EUR bn

Canada, France, Sweden, and Belgium, reflecting that year-to-

30

date supply has exceeded our expectations. German issuers were particularly active, having already issued EUR 12bn so

25

far this year, which equalled our previous forecast for this

20

year’s total. As the German economy and housing market are

15

expected to do well, we have raised our forecast for new euro

10

benchmark Pfandbriefe to EUR 21bn. Furthermore, we were too modest on Canadian issuers, most of which still have ample room to issue, further building their curves.

5 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

…and less from Italy and UK In contrast, we were too optimistic on fresh supply from the

Source: iBoxx, Bloomberg, ABN AMRO

periphery, and Italy in particular. Just before the Easter break, appetite for peripheral names diminished, while the Greek

USD market in favour

crisis also seemed to take its toll. This discouraged Italian

An interesting observation compared to last year is that the

banks to launch new deals (this was also the case in senior

USD-denominated market has become increasingly popular,

unsecured space). Nevertheless, we still expect decent supply

despite the low-yield environment. So far this year, 13 issuers

from Italian issuers, as covered bonds have become an

raised more than USD 13bn, which is already more than twice

increasingly attractive funding instrument for Italian banks.

the total number of deals (USD 9bn) seen during 2014 as a

Moreover, this reflects our view that the banks need to fill a

whole. Furthermore, last year only Canadian and Australian

funding gap due to the expiration of the LTROs, which they

banks issued in USD, while they were joined by German and

can only partly compensate with TLTRO money. We now

Nordic banks this year. Reason to issue is that the basis swap

expect EUR 10bn of new Italian supply (was EUR 14bn).

has made it increasingly interesting to issue covered bonds in USD, while it also diversifies the investor base.

UK new issuance has also not met our expectations. Only EUR 2.25bn has been launched, versus our whole year

Shift to longer maturity profiles

forecast of EUR 9bn. This probably reflects that UK banks can

The long end was clearly in favour at the start of the year.

still access the funding for lending scheme, which will end in

Most new deals had a 7y or 10y (+) maturity, which marked a

January of next year. As a result, we lowered the UK supply

clear shift from the 5y maturity last year. Then, around 40% of

forecast to EUR 6bn from EUR 9bn previously.

all new deals had a 5y maturity. This share dropped to 15% in 2015H1.

Redemptions peaked in June; positive net supply in H2 We expect net supply (excluding Eurosystem purchases) to be

Share in total number of new issuance

slightly positive during the remainder of the year. This is based

2015 share (2015H1) minus share in 2014 (%)

on our view that EUR 64bn of euro benchmarks will be issued

20

in 2015H2, which compares to EUR 57bn of redemptions.

Redemptions will remain relatively modest during the remainder of the year, with September and October seeing

10

0

most bonds redeeming (EUR 19bn and 18bn, respectively).

-10 -20 -30 3-4Y

5Y

6Y

7Y

8-9Y

10Y

>10Y

Source: Bond Radar, ABN AMRO

The 7y tenor has been the sweet spot in the first six months of the year, although we also have seen issuers moving longer

4

Covered Bond Watch - Mid-term review - 23 July 2015

up the curve. Indeed, during February and early March, the

together with CBPP3 were the main driving factors behind

10y and 12y tenors gained momentum, until appetite suddenly

further spread compression. The iBoxx euro benchmark

waned just before the Easter break in March, with some

covered bond index has hovered around 10bps (asw-spread)

longer-dated deals struggling to attract sufficient demand.

recently, not too far away from pre-crisis lows.

After Easter, the 7y became the sweet spot again, although

Spreads at pre-crisis levels

since the start of June most deals have had a 5y tenor. This

iBoxx euro covered bond benchmark index (asw-spread,bps)

likely reflected that covered bonds had become relatively

250

expensive in the 7y+ tenors following the correction on the government bond market as well as less investor demand for

200

longer-dated paper. Looking forward, we expect to see more

150

new issues with shorter-maturities (≼ 5y) in 2015H2. This is

100

also based on our view that we probably are at the eve of a

50

period of rising yields, which will should hit investor appetite at the longer end of the curve. So far in July, more than 80% of new euro benchmark deals had a maturity of 5y or shorter.

0

-50 07

08

09

10

11

12

13

14

15

More soft and conditional pass-through Issuers are increasingly making their covered bond

Source: Markit

programmes as efficient as possible, resulting in issuers changing from hard to soft bullet structures. Credit Suisse,

Room for spread tightening has diminished, as spreads have

ABN AMRO, and Bank of Scotland have asked investor

already tightened by some 11bps so far this year, according to

consent to do so. The first two already got the consent, while

Markit data. Still, we see room for some further performance,

voting of the Bank of Scotland will be on 29 July. Furthermore,

mainly on the back of the Eurosystem, which is expected to

some issuers have amended their programmes to be able to

continue to purchase a significant amount of covered bonds.

issue soft bullet covered bonds (e.g. BPCE SFH), while others

This, in turn, will increase scarcity. Hence, room for tightening

have started to issue soft bullets alongside existing hard bullet

is the largest in countries where spreads are the highest,

bonds (e.g. La Banque Postale). The 12-month extension

which is in the periphery. Covered bonds from the (semi) core

period will in the end result in less OC-needs for a given rating.

are (unsurprisingly) the most expensive, trading in negative swap territory.

Most efficient in this respect is the conditional pass-through structure. In the first half of this year, three issuers have opted

Room for spread tightening has diminished

for this structure. Unicredit restructured a soft bullet

Annual change in asw-spread (bps)

programme that it, initially, only had used for retained issues,

150

into a conditional pass-through structure. It successfully issued a 10y deal at the end of February. Dutch bank Van Lanschot was the second Dutch issuer to set up a CPTCB programme, launching its inaugural 7y new issue at ms +1bps on 21 April.

100 50

97

72

67

0

consent from investors to switch to a conditional pass-through structure, which also induced rating agencies to upgrade the rating of its covered bonds. Looking forward, we think that

-89

-50

want to have two separate covered bond programmes. Having said that, other consent solicitations should not be ruled out.

Spreads almost at pre-crisis low Euro benchmark covered bonds have continued to perform this year. The third consecutive year of negative net supply,

-11

-65

-100

2008

more issuers will opt for this structure. Still, this will probably remain limited to new issuers, as we do not expect that issuers

-33

-36

Meanwhile, Banca Monte dei Paschi di Sienna received

Source: Markit

2009

2010

2011

2012

2013

2014

2015

5

Covered Bond Watch - Mid-term review - 23 July 2015

Peripheral spreads still the highest; core negative

Multi-cedulas best performing individual bonds

ASW-spread level (bps)

Looking at individual bonds, multicedulas performed best. The ES-multi ES-single PT IE IT AUS NZ AT CH UK CAN NO SWE BE DK FR-OF FIN FR-SFH NL DE-publ DE-hyp

-40

-20

0

20

40

60

80

100

spreads of AYTCED 4 1/4 10/25/23 and AYTCED 4 3/4 05/25/27 have tightened for instance by around 40bps since the start of the year. The covered bonds issued by Mediobanca (BACRED 3 5/8 10/17/23) and Banca Monte dei di Paschi performed the best at the individual bank level, with spreads some 25bps tighter year-to-date.

French long-end did well in (semi) core The French long-end outperformed other CBPP3-eligible paper. Spreads of CFF, Caffil, and BPCECB paper maturing in 2024 tightened by roughly 11bps in the first half of this year.

Source: Markit

Hence, Austrian names underperformed, and that of KA in particular (spreads of KA 1 5/8 02/19/21 widened by some 40bps).

Periphery outperforming This year, the same as last year, peripheral covered bonds have continued to outperform. Spreads of Spanish, Italian, and

Canadians best non-CBPP3 paper

Portuguese names have tightened by some 20bps or more,

From the remaining, non-CBPP3 eligible, covered bonds,

which is almost five times more than the average spread

Canadian names performed the best in 2015H1. Paper in the

tightening of other euro benchmarks. Interesting to note is that

belly of the curve of Bank of Nova Scotia and Royal Bank of

Irish paper actually lagged behind, with spreads having

Canada tightened by roughly 7/8bps. In contrast, Nordic paper

remained roughly stable so far this year. This is particularly

at the short-end of the curve widened slightly, likely reflecting

interesting given that the Irish market is expected to shrink

that the Eurosystem is not buying the paper, while it had

relatively the most this year.

become already relatively expensive. Furthermore, these covered bonds are not offering any interesting carry opportunities.

Austrian covered bonds underperformed At the other side of the spectrum, we find Austrian covered bonds, which underperformed on the back of negative news

CBPP3: purchases to slow down

headlines (Heta, KA). Having said that, the worst seems over,

The Eurosystem has bought more than EUR 100bn of covered

as spreads have started to tighten since the end of March.

bonds under CBPP3 so far, and we expect the central bank to

Paper from New Zealand as well as Australia also did less

remain an active buyer. Nevertheless, we stick to our view that

well, probably reflecting that these covered bonds are not

the central bank will slowdown purchases slightly, as paper

eligible for ECB refinancing operations, in contrast to, for

becomes increasingly hard to find.

instance, Canadian covered bonds.

Periphery outperforming; Austria underperformed

CBPP3: breakdown by market type

Change in asw-spread by country in 2015H1 (bps)

EUR bn AT NZ AUS SWE BE NO CH FIN DK CAN UK IE NL DE-publ DE-hyp FR-OF FR-SFH ES-single PT IT ES-multi

-30

-25

Source: Markit

-20

-15

-10

-5

0

5

14 12 10 8 6 4

2 0 Oct-14

Dec-14

Feb-15

Primary

10

Source: ECB

Apr-15

Secondary

Jun-15

6

Covered Bond Watch - Mid-term review - 23 July 2015

Eurosystem on track to own almost one fourth of CBPP3

Trade ideas

eligible paper by year-end

Buy peripheral covered bonds and sell (semi) core covered

The Eurosystem bought EUR11bn of covered bonds a month

bonds

in the first half of this year. In May and June, the total amount

Peripheral covered bonds have strongly outperformed other

was slightly below the average (i.e. EUR 10bn), and we expect

covered bonds, but (as mentioned earlier) we still see room for

a slowdown of purchases starting from August onward.

these bonds to continue to outperform, given relatively high

Assuming that the Eurosystem will buy on average EUR 8bn a

spread levels. The search for yield will also remain a factor

month from August until the end of the year, the central bank

supporting covered bonds in the periphery.

will own a total of EUR 145bn of covered bonds under CBPP3 by the end of 2015 (of which EUR 115bn in 2015 only). This

Peripheral vs core covered bonds

would be around 20% of the total iBoxx euro benchmark index

Asw spread (bps)

(July index) and even 26% of the CBPP3-eligible paper of the index. This excludes covered bond holdings of CBPP1 and CBPP2. Including these, the central bank could even own almost one third of CBPP3 eligible paper.

EUR 23bn of primary market purchases Extrapolating this year’s purchases on the primary market implies that the Eurosystem will have purchased around EUR 23bn of new issuance by the end of the year, leaving EUR

160 140 120 100 80 60 40 20 0 Oct-13

Feb-14

Jun-14

Oct-14

Feb-15

Jun-15

SANTAN 4 04/07/20 minus WLBANK 1 ⅛ 05/29/20

92bn for secondary purchases. The Eurosystem reduced its share in primary deals at the start of the year according to our estimates. While it bought on average 35-40% of the

Source: Bloomberg

transaction size of new deals at the start of CBPP3 last year, it

Buy (semi) core government bonds and sell (semi) core

now buys on average roughly 20-30%.

covered bonds We also stick to our view that (semi) core government bonds

CBPP3 holdings could reach EUR 200bn

will outperform (semi) core covered bonds, especially at the

Looking further forward, we assume that the Eurosystem will

longer end of the curve. The PPSP as well as the fact that

further reduce its presence on the covered bond market in

government bonds have gained relative value versus covered

2016. Paper will become increasingly hard to find, while the

bonds will most likely skew demand towards the government

outlook for growth and inflation should brighten. If we assume

bonds market, also given the lower risk weights and more

that monthly purchases will drop to EUR 6bn from January to

favourable regulatory treatment (e.g. LCR). Although this trade

September 2016, the Eurosystem will add EUR 54bn of

idea has already started to perform, we think there is further

covered bonds to its portfolio next year, bringing the total of

room for outperformance of (semi) core government bonds.

CBPP3 purchases to around EUR 200bn CBPP3 could reach EUR 200bn by September 2016

Government vs covered bonds

EUR bn

Asw spread (bps)

250

20

200

10

150

0

100

-10

50

-20

0 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16

-30 Jul-14

Sep-14 Nov-14 Jan-15 Mar-15 May-15

FRTR 2 ¼ 05/25/24 minus CFF 2 05/07/24

CBPP3 Source: ECB, ABN AMRO

Source: Bloomberg

Jul-15

7

Covered Bond Watch - Mid-term review - 23 July 2015

Buy supranationals and sell (semi) core covered bonds

Looking forward, we still expect senior paper to start

What holds for government bonds also holds for euro area

outperforming covered bonds, as crowding out and the search

supranationals in our view. These bonds will become

for yield will push covered bond investors down the credit

increasingly scarce on the back of PSPP. EFSF bonds are

curve towards senior unsecured paper. Furthermore, senior

most interesting in this respect, as they have been hit by the

paper is likely to be supported by a strengthening outlook for

Greek crisis. As such, a relief rally is likely as the risks of a

the banking sector due to improving economic conditions as

near-term Grexit have been reduced now that negotiations on

well as stricter regulation. In addition, we think that the take-up

a 3y ESM programme have started.

in the TLTRO of (semi) core banks will partly come at the expense of less issuance of senior unsecured paper relative to covered bonds.

EFSF vs covered bonds Asw spread (bps)

30 25 20 15 10 5 0 -5 -10 -15 Oct-13

The voting for The Cover Awards have started. So, if you appreciate our research, please vote for us in the survey (see Feb-14

Jun-14

Oct-14

Feb-15

Jun-15

EFSF 1 ½ 01/22/20 minus WLBANK 1 ⅛ 05/29/20

Source: Bloomberg

Buy senior unsecured paper and sell covered bonds Our long held view that senior unsecured paper would outperform covered bonds did not really play out in the first half of this year, probably reflecting the impact of the implementation of the BRRD into national laws. As a result, the spread difference has risen to more than 80bps in the 7y tenor in the Netherlands. Another reason might be that senior unsecured investors moved down the credit curve, buying into the steady flow of Tier2 notes that were launched by banks to increase capital buffers.

Senior unsecured paper vs covered bonds Asw spread (bps)

140 120 100 80 60 40 20 0 Jul-14

Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 UniCredit senior minus covered 2019s ING senior minus covered 2022s

Source: Bloomberg

link: https://www.surveymonkey.com/r/TheCover2015Awards).

8

Covered Bond Watch - Mid-term review - 23 July 2015

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