Buying of covered bonds by investors making the cross-over from the senior unsecured market was the focus of a panel discussion at a Crédit Agricole CIB UK investor seminar on Monday, with investors and issuers describing how this was affecting their strategies.

Philipp Waldstein, head of group strategic funding and portfolio at UniCredit, described the cross-over between those buying covered bonds and those buying senior unsecured debt as huge, but stressed that this was driven more by an increase in the number of investors buying covered bonds rather than vice versa.

He said that the biggest shift from senior unsecured into covered bonds had been among banks, citing as anecdotal evidence of this the case of a German bank that holds Eu40bn of senior unsecured bonds in a liquidity portfolio but is planning to cut this by a half over the next three years.

Paul Dudouit, head of medium and long term funding at Compagnie de Financement Foncier, said that the issuer had seen more and more banks looking at its covered bonds, with Basel III and the liquidity buffer requirements it will be introducing key to this increased demand. He said that bank participation of CFF obligations foncières had risen from 30% in 2010 to 36% so far this year.

Gavin Jackson, executive director, credit trading at Crédit Agricole CIB noted the increased presence of credit funds and hedge funds, and he underlined that the dynamics involved in the changing investor base was not a question of old players dropping out and new ones taking their place, but the universe of investors growing.

He said that this was resulting in new technicals coming into play. An example of this might be Italian or Spanish covered bonds trading through their respective government bonds, with some investors seeing good reason for this but other, more traditional players, taking this as a signal to sell.

UniCredit’s Waldstein noted that a strong domestic bid for the bank’s senior bonds in Italy, where there are tax advantages for retail investors buying such paper, was a reason why the bank’s senior unsecured paper traded so close to its covered bonds. When asked why the bank in this case raised so much through covered bonds – around one-third of its funding – he said that the issuer is taking a long term view of the asset class: “We view it as the essential funding instrument for banks going forward.”

He said that the bank was therefore issuing covered bonds on a strategic basis and in a disciplined manner. He acknowledged that this had “a certain cost”, but said: “We are willing to sacrifice that cost.”

Florian Eichert, CA-CIB

A representative of a traditional, rates oriented fund said that while it continued to focus on covered bonds, the levels at which senior unsecured debt were trading had increasingly come into the equation. She said that structural subordination is increasing as covered bond issuance grows, and that this should be reflected in wider spreads between covered bonds and senior unsecured debt going forward.

But she said that in the meantime sovereign risk was a key factor for covered bonds, adding that this presented buying opportunities when covered bonds were undervalued as a result of their respective sovereigns widening.

An investor from a hedge fund that has recently started buying covered bonds said that the asset class had not previously been able to offer sufficient yield or capital appreciation to make it worthwhile getting involved. But he said that the greater country spread differentiation in the market had created opportunities.

However, rather than looking at covered bonds on an issuer versus issuer or region versus region basis, the hedge fund screens the whole covered bond space for value relative to other parts of banks’ capital structures, he said. He said that once this had been found it was then a question of “drilling down” to examine the covered bond’s legislative backdrop and the issuer in more detail.

Arbitrage opportunities were appearing because “you have a lot of siloed investors”, he said. But he said that while his fund was taking advantage of these by putting on trades such as long covered bonds/short CDS, the borrowing costs involved might be prohibitive if, for example, the covered bond was tightly held by domestic investors. Crédit Agricole CIB’s Jackson said that a result of this was that a common strategy among investors new to the market was to go long a new issue and short CDS.

Florian Eichert, senior covered bond analyst at Crédit Agricole CIB and chair of the panel, ended the discussion by noting that the silos referred to by the hedge fund manager are slowly going away. He said that the market is moving towards a situation where investors pick an issuer they want to get involved in and then choose the place on the capital structure where they want to get involved. With that, he concluded, fundamentals should reassert themselves over technical.