Dollar covered bond issuance will increase in 2016, analysts expect, on the back of
high redemptions, a favourable basis swap and new issuers, while the sterling market is seen remaining driven by UK issuers but could offer possibilities for opportunistic non-domestic banks.

Analysts noted that benchmark US dollar-denominated covered bond supply roughly doubled this year, up from $9.25bn (Eu8.41bn) in 2014 to some $21bn year-to-date. Benchmark sterling issuance was also seen increasing, from £6.8bn (Eu9.41bn) to some £7.9bn year-to-date.

“Other covered bond currencies – namely US dollars and sterling – have significantly gained in importance this year,” said Frank Will, head of covered bond research at HSBC. “Primary market supply in both currencies considerably exceeds last year’s total issue volumes.”

Will said this may come as a surprise, as the ECB’s covered bond purchase programme (CBPP3) should make euro issuance more attractive for issuers this year, but he noted that only 10% of US dollar issuance and no sterling issuance has been issued by CBPP3-eligible banks.

“We expect covered bond issuance in US dollars and sterling to keep playing an important role in 2016, particularly for non-Eurozone issuers as they do not benefit from the ECB purchase programmes,” said Will.

Analysts said dollar benchmark supply should increase next year, to up to $25bn-$26bn. One reason cited for this is a high level of redemptions, seen at $27bn-$31bn.

The analysts said such redemptions, although likely resulting in negative net supply, should encourage new issuance, noting that around half of the bonds redeeming are from Canada, followed by Australia and Norway, with 15%-20% each.

“This should be a key incentive for refinancing, especially for Canadians, in order to maintain a curve in the US dollar covered bond markets,” said Anne Caris, research analyst at BAML.

Another factor that will drive dollar supply is an expected continuation of a favourable cross-currency basis-swap, analysts said, which they cited as restoring the competitiveness of US dollar funding this year.

“The currency basis may play in favour of dollar covered bonds again during 2016, as macroeconomic indicators diverge between the US and the euro area,” said Caris. “Issuers may be incentivised to issue in dollars especially if we continue to see similar new issue premiums in the euro market, while also keeping in mind the rather significant dollar covered bond redemptions.

“In contrast, investors could be attracted by higher dollar yields especially in light of ECB QE2.”

However, analysts at UniCredit said Canadian issuers, as well as those from Australia and New Zealand, might opportunistically choose euro funding over dollar funding next year. They noted, for example, that Royal Bank of Canada can save roughly 11bp on five year covered bond funding this way.

Analysts said the growth of the covered bond market in Asia should also boost dollar issuance next year, noting that Singapore’s DBS chose the currency to make its covered bond debut in July, while Kookmin and KHFC launched $500m issues in October and November, respectively.

“We would expect new issuers from Singapore and South Korea to debut in the US dollar markets, despite the lower liquidity in these markets,” said Michael Spies, covered bond and SSA strategist at Citi.

In the sterling market, Citi analysts forecast £8bn of supply.

“While the majority of new deals should come from UK banks, we think that Nordic issuers as well as Canadian banks will eye the UK market and make use of the attractive cross-currency basis to diversify their funding base,” said Spies.

He said this supply would clearly outpace redemptions of some £2.9bn, a figure that includes FRN issuance and deals of £250m or more.

HSBC analysts said they expect sterling covered bond supply to continue to be primarily driven by domestic issuers. They noted that UK issuers accounted for more than half of sterling supply in 2015, followed by Canadian banks with 27%, and Swedish and Norwegian issuers with 16% and 5%, respectively.

“Non-domestic banks will most likely be more opportunistic in their issuer behaviour and are likely to focus on the cross-currency basis swap development,” added Will.

Photo: Federal Reserve Board building