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European covered bonds: the success story continues with longer maturities, new issuers and new segments Back  
The European covered bond market prospered in 2005, thanks to improved issuer fundamentals and increasing demand for covered bonds, writes Ralf Grossmann. 2006 has gotten off to a record start, with total new issuance volumes in the first four months of the year reaching €75.8 billion. This is the highest volume issued in the first four months of a year since the start of the benchmark covered bond market. In Ireland, although the market lost some momentum in 2005, with overall issuance down by €9 billion, 2006 has gotten off to a good start, with a new issuer, AIB, entering the market.
2005 was another successful year for the Euro benchmark covered bond market. Spreads between covered bonds and swaps tightened, thanks to improved issuer fundamentals and increasing demand for covered bonds. Spreads between covered bonds and euro government bonds remained stable, but at historically low levels.

While turnover in the secondary market was relatively subdued in 2005, primary market activities in the covered bond market attracted investors demand thanks to investor-oriented issuance policy providing attractive spread premiums over secondary market levels. The positive primary market environment allowed issuers to launch a total volume of €133bn (+13p.c. yoy), of which over 50 per cent had a term-to-maturity of 10 years or longer.

Spain: The largest primary market contribution came from the Spanish C?dulas Hipotecarias segment where issuers launched benchmark bonds in an amount of nearly €54 billion (+48p.c. yoy), overtaking the German Jumbo Pfandbrief segment (€48 billion) for the first time ever.

The very dynamic Spanish mortgage lending market was again the driving force behind the strong growth of C?dulas issuance, whereas new lending business of German Pfandbrief issuers hardly compensated maturing loans. As a consequence, most issuers launched Jumbo Pfandbriefe primarily to maintain their presence in the benchmark segment.

Ireland: On the Irish Asset Covered Securities market, Bank of Ireland Mortgage Bank and DEPFA ACS showed their faces with one Euro benchmark transaction each. While BOI MB continued to build up its yield curve with a €2 billion 10 year issue, DEPFA ACS scaled back its Euro issuance to one €3 billion 7 year benchmark transaction, after total benchmark issuance of €9 billion in 2004. As the third Irish issuer, West LB Covered Bond Bank, refrained from issuing in the benchmark segment, overall issuance volume closed 2005 with €5 billion, after a total of €14 billion in 2004.

France: Similarly, the issuance of French Obligations Fonci?res (OF) lost some momentum in 2005, with total volumes in Euro benchmark OF issuance merely reaching €7.5 billion, the lowest level since the inception of the market in 1999. There are several reasons behind this: (i) the importance of private placements (approx. 40-50 per cent of 2005 issuance programs), (ii) issuance in non-Euro currencies, and (iii) the new EU Prospectus directive which prevented tap issues in H2-05.

UK: Even though Abbey National and Nationwide joined the UK covered bond market as new issuers, with a total volume of €9 billion issuance activity in 2005 could not reach the previous year’s level. HBOS, which initiated the UK covered bond segment and was the driving force in 2004, just launched one ultra-long transaction, and Bradford & Bingley paused completely.

New markets and products
New market segments that joined the covered bond market in 2005 were the Italian public sector lending institution Cassa Depositi e Prestiti, Sampo Housing Loan Bank with the first Finnish benchmark covered bond, and ABN AMRO, with a Dutch covered bond similar to the UK covered bond structure.

In 2006, primary market activities of the covered bond market continued on strong pace and remained innovative, but the overall market direction and spread environment became a bit more difficult. In fact, total new issuance volumes in the first four months of 2006 reached €75.8 billion. This is the highest volume issued in the first four months of a year since the start of the benchmark covered bond market. The average of the last five years was in the neighborhood of €47 billion, which highlights the special situation faced in 2006 even further.

The key driver of primary-market momentum was the C?dulas market, where the total new issuance volume hit a new record level at €32.5 billion. A marked increase in new issuance was also recorded in the Obligations Fonci?res market with €6.5 billion and the UK covered bond market with €8.5 billion.

A breakdown by maturity class shows that the share of issues with maturities of more than 10 years has been 20 per cent so far in 2006, and thus in line with the year-earlier level. By contrast, the significance of 10-year paper has diminished, while the share of medium-term and short-term issues has increased.

With the first 50-year Obligations Fonci?res benchmark issue (E1bn, 3.875p.c., Apr-55), Compagnie de Financement Foncier (CieFF) has again broken new ground in the covered bond market after issuing the first 20-year OF issue in 2001. It goes without saying that the segment of 50-year covered bonds will remain small, because only few issuers, such as CieFF, have cover assets with sufficiently long maturities at their disposal. Demand for the 50-year OF bond was dominated by the UK and Scandinavia, where pension funds and insurance companies used investments in the 50-year OF bond to improve the maturity match of their long-term liabilities.

In the Spanish C?dulas market, Caja Madrid extended the maturity profile into the 30Y area for the first time (€1.5bn, 4.125p.c., Mar-36). In 2005, Caja Madrid was also the first to tap the 20-year C?dulas Hipotecarias segment. Launched at a re-offer spread of E+14, the new 30Y C?dulas Hipotecarias from Caja Madrid was well-distributed in all European countries.

Among the new issuers that joined the covered bond market in 2006 was Allied Irish Bank, which issued two tranches of mortgage Asset Covered Securities: €2.5 billion, 3.5 per cent Apr-09 and €1 billion, 3.75 per cent, Apr-13. Allied Irish Bank will probably pursue a similar issuance policy in the ACS market as Bank of Ireland, i.e. presumably one benchmark transaction per annum plus private placements. Further conceivable issuers in the Irish ACS market could be Irish Life & Permanent and EBS, which used to be active in the RMBS securitisation market.

The other new issuers that launched benchmark covered bonds for the first time were the Spanish Caixa Catalunya (€1.75bn, 3.5p.c., Mar-16) and Santander Consumer Finance (€1.2bn, 3.875p.c., Mar-16), and the German Aareal Hypothekenbank (€1bn, 3,25p.c., Feb-11).

Further down the road, new market segments will probably generate additional momentum in the primary market.

Portugal: The Portuguese government has passed a covered bond law, and as soon as secondary regulation is published by the central bank, issuance may take off. The inaugural Portuguese covered bond, backed by mortgage loans, is likely to be launched by Caixa Geral, the country’s largest mortgage lender.

Italy: In Italy, the election campaign and longer-than-expected discussions between the Bank of Italy and the Banking community have somewhat delayed the implementation of the covered bond legislation. Nevertheless, the process is close to the finish, and covered bond issuance is likely to start in the second half of the year.

Sweden: Things are moving as well in Sweden, where Nordea Hypothek, Stadshypotek and SBAB have received their license and will transform all their outstanding mortgage bonds into new covered bonds. The large majority of Swedish covered bonds are denominated in Swedish Krona, but issuance of Euro benchmark covered bonds is likely if spread levels fit in.

Norway: In Norway, DNB Nor is in the starting blocks to issue the inaugural Norwegian covered bond in the second half of 2006 as soon as secondary regulation is completely finalised.
It goes without saying that new issuers and market segments will be more than welcome in the covered bond market, as investors are seeking diversification. Overall, the primary market activities will push total issuance volume to approx. €50 billion in 2006. As half of it was already launched in the first four months, the market should keep a positive tone for the rest of the year. What is more, following the recent widening of spreads versus government bonds, covered bonds are now more attractive, which should translate into stronger demand from final investors over the medium-term.

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