Spreads between senior unsecured issuance and covered bonds have widened to unprecedented levels and although analysts expect this relationship to correct, its long term equilibrium level could differ from previously and in the short term some covered bonds are still considered cheap.

The two asset classes have recently traded at spreads as much as 60bp wider than in mid-August, according to RBS, although by the middle of last week the gap had narrowed to be around 35bp wider than a month previously based on iBoxx indices.

“Clearly at the moment there is this massive concern in the market about senior versus covered spread widening,” said Frank Will, senior analyst at RBS.

“Since last October we have strongly recommended switching out of senior unsecured and into covered,” he added. “I think it some cases we’ve reached a point where the yield give-up of switching out of senior unsecured and into covereds is too high.”

Will noted in names such as Barclays, Santander and UniCredit.

But Deutsche Bank analysts still advocated the switch in particular situations. In a Credit Markets Insights research piece, they recommended investors looking to go long Santander or Banco Bilbao Vizcaya Argentaria do so by means of “cheap” covered bonds, rather than through senior unsecured bonds or CDS.

“Investors already long senior unsecured bonds of these issuers should consider switching to cheap mortgage covered bonds to enhance the risk versus reward profiles of their portfolios,” they said.

They added that cédulas issued by Banco Bilbao Vizcaya Argentaria, for example, were more than 100bp cheap based on a model they created using senior unsecured/CDS levels and recovery values.

According to Crédit Agricole analysts, the UK has the highest spread difference between the two asset classes, at 162.5bp. Austria is second, at 113.0bp, and the Netherlands third, at 110.4bp. Canada has the lowest differentiation, at 4.9bp, with Sweden Europe’s lowest, at 64.1bp.

Analysts generally agreed that whatever current market conditions may be, covered bond and senior unsecured spreads will tighten again and their relationship normalise.

“If you look into history,” said Christian Enger, senior credit analyst at LBBW, “there hasn’t traditionally been such a difference between the two asset classes, so I expect it to get back to normal when market conditions improve.

“I think both will tighten, but senior will tighten more than covered bonds.”

He added that the extent of tightening of each instrument would depend on the jurisdiction.

“So, for example, Germany is quite tight, so there’s not much room for the covered bonds to tighten,” he said.

But José Sarafana, head of covered bond strategy at Société Générale questioned whether spread differences between the two asset classes would return to previous levels.

“Whether it will go back to where it was in the first and second quarter, maybe that’s not likely in the near future,” he said. “Maybe we’re going to end up with a wider spread differentiation between senior and covered going forward, but at the same time I don’t think it’s going to stay at these highs.

“A lot of the movement from the tightening will probably come from the senior unsecured side because that is also what happened with the widening,” he added, “seniors widened more than covered bonds, so they should tighten more than covereds, too.”