Despite covered bond spreads being at their most attractive for investors since before CBPP3 began, demand for Eurozone paper has been underwhelming this year. Market participants blame this on a mix of broader weakness, relative value versus CBPP3 outs, heavy supply – and expectations of further widening.

According to DZ Bank analysts, the iBoxx Euro Covered index was at the start of the week trading at an ASW level of 23.17, compared with 13.72 on 20 October 2014 when the European Central Bank’s third covered bond purchase programme was launched, and 28.12 on 4 September 2014 when it was announced.

However, several new issues from core Eurozone jurisdictions launched in the first fortnight of 2016 have achieved only modest levels of oversubscription, even with significant support from the Eurosystem. In contrast, non-Eurozone issuers not eligible for CBPP3 have achieved higher levels of oversubscription on larger deal sizes, and sometimes with lower new issue premiums.

A large covered bond investor cited several reasons for the unimpressive Eurozone start and a widening of some 3bp this week across the asset class.

“I think this widening in covered bonds is caused by a combination of this wider credit market weakness, and there being a lot of issuance in covered bonds, and a somewhat slow pace of ECB purchases on the secondary market,” said an investor.

“The relative attractiveness of the asset class is obviously not strong enough to attract real money investors,” he added. “We have basically only the ECB buying, we have a lot of issuance, and now that the ECB – the big buyer in the market – is focussing more on the primary market, the secondary market becomes very weak.”

CBPP3 figures have in recent weeks suggested a slowdown in secondary buying under the programme.

A syndicate official said that CBPP3 overall remains a negative influence on investor engagement with the asset class.

“This means in order to make people play in this market segment, you need to put some more spread on the table than before,” he said. “If you look at trades over the last two weeks, almost all non-Eurozone bonds have outshone the Eurozone issues.”

And despite citing some improvements in relative value, the investor agreed.

“If you look at where covered bonds trade today compared to where they were a year ago, they look much more attractive relative to underlying government bonds than they did, both in core countries and in peripherals,” he said. “But still, it seems that there are less buyers today than a year ago.

“That has partly to do with the fact that we have this general weakness in the credit markets and equity markets,” he added. “And if the market is anticipating that spreads will keep widening then investors will wait, obviously. Even though the relative value looks better now than a year ago, it might look better one month ahead, and that is worth waiting for.”

The amount of supply has exacerbated this, according to another syndicate official.

“We are only two weeks into the year and we have 11 and a half months to go, so investors can be selective,” he said. “In the first weeks, you have a full menu to choose from, and that means that the demand for new covered bond issues, although levels have corrected a certain amount, is not stronger.

“Maybe we do need to see more correction.”

However, market participants said that investor involvement in the covered bond market should eventually increase if spreads remain more attractive.

“Of course it depends on developments in the credit markets,” said the investor, “but I think that if we can keep spreads at where they are relative to government bonds, or if they widen further, that should eventually attract more buyers, especially if supply decreases so there isn’t as much pressure from the primary market.”

Indeed, Maureen Schuller, head of financials research at ING, said that a critical point for the performance prospects of covered bonds is gradually nearing.

“Once covered bonds spreads start to be quoted around levels that ignore support from CBPP3,” she said, “there seems to be little reason to doubt that this market will start performing again at the moment that the overall bond market sentiment improves.”

Despite covered bond spreads being at their most attractive for investors since before CBPP3 began, demand for Eurozone paper has been underwhelming this year. Market participants blame this on a mix of broader weakness, relative value versus CBPP3 outs, heavy supply – and expectations of further widening.

According to DZ Bank analysts, the iBoxx Euro Covered index was at the start of the week trading at an ASW level of 23.17, compared with 13.72 on 20 October 2014 when the European Central Bank’s third covered bond purchase programme was launched, and 28.12 on 4 September 2014 when it was announced.

However, several new issues from core Eurozone jurisdictions launched in the first fortnight of 2016 have achieved only modest levels of oversubscription, even with significant support from the Eurosystem. In contrast, non-Eurozone issuers not eligible for CBPP3 have achieved higher levels of oversubscription on larger deal sizes, and sometimes with lower new issue premiums.

A large covered bond investor cited several reasons for the unimpressive Eurozone start and a widening of some 3bp this week across the asset class.

“I think this widening in covered bonds is caused by a combination of this wider credit market weakness, and there being a lot of issuance in covered bonds, and a somewhat slow pace of ECB purchases on the secondary market,” said an investor.

“The relative attractiveness of the asset class is obviously not strong enough to attract real money investors,” he added. “We have basically only the ECB buying, we have a lot of issuance, and now that the ECB – the big buyer in the market – is focussing more on the primary market, the secondary market becomes very weak.”

CBPP3 figures have in recent weeks suggested a slowdown in secondary buying under the programme.

A syndicate official said that CBPP3 overall remains a negative influence on investor engagement with the asset class.

“This means in order to make people play in this market segment, you need to put some more spread on the table than before,” he said. “If you look at trades over the last two weeks, almost all non-Eurozone bonds have outshone the Eurozone issues.”

And despite citing some improvements in relative value, the investor agreed.

“If you look at where covered bonds trade today compared to where they were a year ago, they look much more attractive relative to underlying government bonds than they did, both in core countries and in peripherals,” he said. “But still, it seems that there are less buyers today than a year ago.

“That has partly to do with the fact that we have this general weakness in the credit markets and equity markets,” he added. “And if the market is anticipating that spreads will keep widening then investors will wait, obviously. Even though the relative value looks better now than a year ago, it might look better one month ahead, and that is worth waiting for.”

The amount of supply has exacerbated this, according to another syndicate official.

“We are only two weeks into the year and we have 11 and a half months to go, so investors can be selective,” he said. “In the first weeks, you have a full menu to choose from, and that means that the demand for new covered bond issues, although levels have corrected a certain amount, is not stronger.

“Maybe we do need to see more correction.”

However, market participants said that investor involvement in the covered bond market should eventually increase if spreads remain more attractive.

“Of course it depends on developments in the credit markets,” said the investor, “but I think that if we can keep spreads at where they are relative to government bonds, or if they widen further, that should eventually attract more buyers, especially if supply decreases so there isn’t as much pressure from the primary market.”

Indeed, Maureen Schuller, head of financials research at ING, said that a critical point for the performance prospects of covered bonds is gradually nearing.

“Once covered bonds spreads start to be quoted around levels that ignore support from CBPP3,” she said, “there seems to be little reason to doubt that this market will start performing again at the moment that the overall bond market sentiment improves.”