Some analysts have recommended switching from government bonds into covered bonds to take advantage of possible spread tightening caused by a second ECB purchase programme. But could a hoped for resolution to the euro-zone crisis mean the opposite switch makes sense in peripherals?

Barclays analysts said on Friday that they expect a second European Central Bank covered bond purchase programme to have a positive impact on covered bond spreads, which would lead to certain jurisdictions looking particularly attractive versus their respective government bonds and sub-sovereign and supranational bonds from issuers domiciled in these jurisdictions. Barclays picked out Dutch and French covered bonds, which they consider likely to outperform their respective government bonds.

“Furthermore,” said Barclays’ analysts, “covered bond spreads compared to spreads of their respective government bonds are currently considerably higher than historical averages.”

In France, the average spread over government bonds is 133bp, more than double the historical average of 62bp, they said, adding that in the Netherlands the difference of 108bp was 30bp higher than the historical average.

But José Sarafana, head of covered bond strategy at Société Générale, last week advocated a different strategy for jurisdictions where covered bonds have outperformed sovereign bonds – mainly peripheral countries – if and when there is progress on resolving the euro-zone crisis.

“When the situation improves,” he told The Covered Bond Report, “investors should sell their covered bonds and buy sovereign bonds.”

For example, the Portuguese sovereign, said Sarafana, trades wider than Portuguese covered bonds. He said this makes sense in a scenario of sovereign stress because it is easier to impose a haircut on a sovereign bond than on a covered bond.

“But, if you think that the sovereign problem is being resolved,” he said, “and as a bondholder you don’t think you’ll get a haircut imposed, then it makes sense to go for the sovereign bond because they are more liquid anyway.

“The key idea is that the moment you as the investor feel that sentiment is turning good, you switch out of covereds and into sovereigns.”

In a presentation last Monday (10 October) at an ABI/AFME securitisation and covered bond conference in Milan Sarafana used the example of Ireland, where “the stress eased and sovereign outperformed”.

Irish government bonds outperform covered bonds on macroeconomic progress
(Source: SG Cross Asset Research)

However, he believes the time for switching has not yet arrived.

“It doesn’t look like the problems will abate yet,” he said, “Once it does, then it’s very clear investors should proceed this way.”

Frank Will, senior analyst at RBS, said that if the economy miraculously improves then the switch Sarafana is advocating seems sensible “if you can actually trade it”.

“The spread differential between sovereign and covered bonds in distressed countries is often not tradable in large sizes,” he explained. “Hence, a lot of the movements in covered bond spreads are based on market makers adjusting their price – or not.”

Will added that investors would have to consider market interventions by the ECB, such as the Securities Markets Programme and CBPP2.

Christian Enger, senior credit analyst at LBBW, acknowledged that sovereign bonds were a preferred asset class from a regulatory point of view, but said the question of when to switch into sovereigns was more challenging.

“I’m not convinced that investors would do this,” he said, “because, for example, I wouldn’t buy Italian govvies now, but then when they are tighter then it’s harder to switch.”

Jörg Homey, head of covered bond research at DZ Bank, said he does not advocate the switch from covered bonds into sovereigns.

“We favour covered bonds,” he said.