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Continuing FT Alphaville’s recent collateralised lending focus, we draw attention to the following trend observed in the covered bond market by Barlays Capital.
In their latest Euro Weekly note, the analyst team notes:
Whereas on the French market, two-year covered bonds and senior unsecured bank debt of BNP Paribas trade on largely comparable levels, distortions become particularly evident on the Spanish market where three-year Cédulas Hipotecarias issued by BBVA trade at a c.20bp discount to senior unsecured bank debt.
In the German and Swedish market, in contrast, covered bonds trade at a significant premium to senior unsecured bank debt.
The most pronounced difference between an issuer's covered bonds and its respective senior unsecured debt can be observed in the UK and Italian markets where the obbligazione bancarie garantite (OBG) trade at a premium of 120bp over the senior bank debt (Figure 9 and Figure 10).
And here are the supporting charts:
So the general picture — if you look at it from an interbank lending point of view — is that pretty much everywhere apart from Spain banks can currently access financing more cheaply on a collateralised covered bond basis than on an unsecured senior basis. All of which makes sense, apart from the Spain bit.
In Spain, it currently costs banks more to borrow on a collateralised (with Spanish covered bonds) basis, than it does on a senior unsecured basis.
In other words, the market currently trusts banks like BBVA more than it does its own covered bonds — something of an anathema since it suggests the ‘collateral’ provided via the covered bond is actually worse than worthless.
Meanwhile, if you consider the following chart, which shows the swap spread between the iBoxx Euro Banks Senior and covered rate, you’ll see that the trend towards cheaper unsecured borrowing (versus collateralised borrowing) is actually being observed on a much wider scale than just in Spain:
As BarCap note:
Before the global financial markets crisis peaked in autumn 2008, senior bank debt (as comprised in the iBoxx Euro Banks Senior index) traded at a discount of c.50bp to covered bonds (as summarised in the iBoxx Euro Covered index). When market distortions peaked in October 2008, the difference had grown to a historically unprecedented c.225bp "“ only to then rapidly contract to c.50bp by July 2009 again (Figure 1).
And by discount, they do mean price — so from a financing and interbank lending point of view, this implies that senior bank debt was always more expensive than financing provided by covered bonds. As it logically should be.
The point is that recently this weird paradox, which effectively applies a negative value to the collateral pool backing covered bonds, seems to have evolved. As BarCap observe:
As senior unsecured bank debt proved to be less prone to spill-over effects from the sovereign debt crisis, however, it did not become as strong a subject as the renewed widening pressure seen in spring 2010. Instead, swap spreads continued to stabilise. At present, senior unsecured bank debt trades, on average, at a premium to covered bonds.
Despite the convergence trend, which started at the height of the capital markets' crisis in autumn 2008, doubts regarding the sustainability of the above move remain. From a fundamental point of view, a premium (even if it is as small as outlined in Figure 1), is difficult, if not impossible, to justify as in principle, any such phenomenon assigns a negative value to the collateral pool backing the covered bond. Still, recent observations made on the Spanish market support this paradox.
In which case, we wonder, does this have anything to do with the increasing trend towards quality collateral-backed interbank lending versus unsecured generally?
As we wrote on Monday, government securities now represent about 83 per cent of the European repo market, with the remainder consisting of repo purchases backed with high-quality supranational or covered bond debt, mainly.
The repo market itself, meanwhile, is continuing to grow too.
Now, if you consider that Spanish bonds make up the bulk of the European covered bond market generally, then any shift away from using Spanish covered bonds as collateral (versus other national equivalents) might quickly influence a discount in the price of Spanish bonds over others.
And with other covered bonds more highly sought after than usual, this would naturally preserve their premium to the unsecured lending debt.
Of course, with a general preference for collateralisation with government securities over covered bonds appearing anyway — even that premium might eventually fade if the Spanish discount becomes too overbearing.
What’s more, with senior unsecured deals now few and far between, just how indicative of real borrowing costs is the unsecured rate being compared to anyway?
Related links: The Collateralized Lending Regime: An Under-reported Shift in Capital Structure "“ FT Long Room Developments in repo markets during the financial turmoil "“ BIS Frozen in the Greek repo markets "“ FT Alphaville
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