Positive market moves and investor feedback encouraged Bank of Ireland Mortgage Bank to tap the public bond market with a Eu1bn three year covered bond yesterday (Tuesday), according to an official at the issuer, who said that the opportunity came sooner than anticipated. Covered bonds were deemed the most appropriate asset class to ensure a sustainable return to wholesale funding markets, he added.

The issuer yesterday became the first Irish financial institution to sell a non-government guaranteed benchmark on the public markets since September 2009.

The transaction was welcomed by market participants as an encouraging development, and one that made sense following declining risk premia on Irish debt as investors warmed to the sovereign and its banking system’s credit story.

Ireland’s finance minister, Michael Noonan, said Bank of Ireland’s transaction marked a “milestone” on what he described as the country’s banks’ “path to full independence”.

“This issuance is further evidence of the strengthening and normalisation of our banking system,” he said. “It is a clear show of confidence in the restructuring of the sector and its viability into the future by international investors.”

Darach O'Leary, Bank of Ireland

Darach O’Leary, head of wholesale funding at Bank of Ireland, told The Covered Bond Report that the issuer had not anticipated returning to the wholesale funding markets this year, with the possibility of successfully selling a benchmark covered bond in 2012 only recently becoming a realistic prospect.

“We started pro-actively re-engaging with the debt investor community in spring of this year,” he said, “with the sole objective of re-educating and updating investors on our credit and to position Irish covered bonds as the long term funding instrument for us, but this was very much with the expectation that 2013 would be the earliest point when Bank of Ireland would return to the funding markets.”

This was based on expectations of investor demand as well on the issuer not having any liquidity needs for 2012, said O’Leary, with Bank of Ireland’s wholesale funding requirements falling as the bank deleverages and increases its deposit base, and redemption flows from wholesale funding being “pretty muted”.

However, strong market moves in the past several weeks and better than expected feedback from investors encouraged the issuer to decide to come to market, he said, with covered bonds deemed the asset class best suited for its return to the capital markets.

“An important consideration for us is ensuring that when we returned to the funding markets we did so in a sustainable way,” he said, “and we feel that covered bonds are the appropriate funding instrument for us to focus on given the strengths of the ACS legislation and the protections it provides to investors.

“We wouldn’t see senior unsecured as offering us sustainable funding levels at the moment, so this is not something we are focussed on.”

Bank of Ireland will use the funding raised via yesterday’s new covered bond to replace monetary authority money, said O’Leary, so the amount of outstanding liabilities will not change as a result.

The issuer is aiming to exit a government guarantee and to make further progress on this in the coming months, he added, and is mindful of the need to strike a balance between different types of funding.

“There are pros and cons to accessing the market with an unguaranteed transaction,” he said, “and the covered bond funding is still expensive compared with costs of other funding, via our core deposit franchises, for example, so that is also a consideration.

“But in this case the positives definitely outweighed the negatives.”

After an investor conference call yesterday morning that attracted more than 200 investors, the issuer opened order books on a Eu500m-plus three year mortgage-backed asset covered security (ACS) via leads Citi, Morgan Stanley, Nomura, RBS and UBS.

Lorenz Altenburg on syndicate at Nomura said that an Irish benchmark covered bond was “the logical next step” after Italian and Spanish issuers had already tapped the market this year, especially after Irish covered bond spreads had tightened some 300bp since the summer.

“There has been strong buying interest in the secondary market,” he said. “Spreads had been tightening for a while, but things really turned in June/July.

“Draghi’s comments in late August helped, but the trend was there before.”

Around Eu2.5bn of orders from around 190 accounts enabled the leads to size a Eu1bn deal at 270bp over mid-swaps, the tight end of guidance of the 275bp over area that followed initial price thoughts of the high 200s over. The deal came with a 3.125% coupon.

Bank of Ireland’s O’Leary said the issuer is pleased with the deal.

“It’s a very strong outcome for us as issuer,” he said, “and I would like to think that the investor community is similarly pleased with the outcome.

“It was a very diversified order book, with 98% of the bonds sold to international investors, which sends a very strong message and should give confidence to investors about the broad-based demand for Irish covered bonds.”

More than 80% of the bonds were allocated to real money accounts, noted a lead syndicate banker. Managed funds took 54%, insurance companies 14%, central banks and official institutions 11%, banks 10%, hedge funds 7%, private banks 4%, and others 1%.

Germany and Austria were allocated 37%, the UK 19%, Asia 11%, France 8%, Nordics 6%, the Benelux 5%, southern Europe 5%, Switzerland 4%, Ireland 2%, US 2%, and others 1%.

A covered bond banker away from the deal said that he does not expect much of a follow-up from Bank of Ireland’s national peers, with Allied Irish Banks perhaps the only other candidate, but agreed that the deal sends a strong signal, not least because it came after the end of the ECB’s covered bond purchase programme (CBPP2).

“In peripheral covered bonds earlier this year CBPP2 had to play a significant role,” he said, “and obviously this was not the case here.”

Market participants said that Bank of Ireland’s new issue offered an attractive spread, coming around 100bp back of Irish government bonds.

“That’s a nice pick-up if you want Irish risk,” said a banker, “and helps explain the big success. Where else would you get 270bp over for three year secured debt?”

Another covered bond banker congratulated the issuer on its deal, and noted that it was bought by traditional accounts, with credit investors buying less than some market participants had expected.

He said that the new issue was cheap compared with Irish government bond spreads, but that it looked very expensive relative to where comparable covered bonds trade, such as from Portugal.

At 270bp over, the issuer’s new ACS came inside the issuer’s secondary market curve, according to Jez Walsh, head of covered bond syndicate at RBS, based on where an illiquid June 2015 Bank of Ireland issue trades – anywhere between 285bp over and 265bp over.

“We felt that a new Bank of Ireland three year covered bond should come tighter to Irish government bonds than the secondary level for their largely illiquid June 2015s suggests,” he said, “given that Irish covered bonds trade wider versus the sovereign relative to other jurisdictions, like Italy, Portugal and Spain.”

Three year covered bonds from these countries, rated three notches higher than the sovereign versus a one notch uplift over the sovereign on Bank of Ireland’s ACS, trade significantly through the relevant government bonds, he noted, in Spain’s case more than 100bp tighter.

The leads also felt that pricing slightly back of ESB was appropriate, according to Walsh. The finance arm of state-owned utility Electricity Supply Board on Monday sold a Eu500m seven year corporate bond at 320bp over, which had tightened to around 290bp over yesterday, with Walsh putting a theoretical new three year in the 245bp over mid-swaps area.