The euro covered bond market could reopen next week should surprisingly supportive conditions prevail, according to bankers, after Santander UK reopened the sterling market today (Friday) and following tentative but encouraging revivals in other markets, with an improvement in relative value deemed conducive.

Following the UK’s vote to leave the EU last week, markets succumbed to volatility last Friday and at the start of this week, and covered bond spreads widened across jurisdictions, albeit only slightly in core countries.

However, after a stabilisation and a series of risk-on sessions in the wider market, bankers noted there had in the second half of the week been a reversal of the widening trend in covered bonds, with most jurisdictions almost back to where they were before last Friday.

Amid this backdrop of improving market sentiment, Santander UK today (Friday) sold the first benchmark covered bond since the referendum, a £500m three year FRN (see separate article).

Although no euro-denominated benchmark financials issuance emerged this week, the German State of Hessen tapped a July 2026 issue by Eu875m on Wednesday. The deal attracted books of Eu2.2bn while, according to bankers, offering little to no new issue premium at a final spread of 7bp through mid-swaps.

Deutsche Bahn Finance then priced a Eu750m 15 year issue at 26bp over mid-swaps yesterday (Thursday), down from initial price thoughts of the 30bp area, offering a premium of around 15bp, according to bankers.

“Life has not yet returned to the euro covered bond market,” said a syndicate official, “but it has been a really good return for risk assets, after a tentative start, and it shows the whole world is not frozen.”

Syndicate officials said the euro covered bond market could reopen next week, as several core issuers are monitoring the market. Bankers were confident that deals good be done following Santander’s sterling reopener, and suggested that investors and issuers could be enticed back into the primary market by the usual increase in demand that typically comes at the start of the new quarter.

Bankers said that covered bonds also look attractive given record low yields following a post-Brexit flight to quality, with the 10 year Bund yield having remained in negative territory since the vote, and with the spread between core covered bonds and their underlying sovereigns having widened.

“There are definitely at least a few issuers looking, and covered bonds should be the instrument of choice,” said one.

However, most syndicate officials said volumes will likely be modest until after the summer period, given the potential for fresh Brexit headlines to cause renewed volatility and with many issuers already well advanced in their funding plans.

“I think we will see one or two deals next week,” said one. “After that we are pretty much in the summer holidays, so I would not expect much.”

Syndicate officials disagreed over the size of new issue premiums that will be required should any issuance emerge next week, with some suggesting that premiums need only be 1bp-2bp higher than those in the first half of June, while others said more elevated concessions will be necessary.

“Deutsche Bahn’s double-A rated deal, which is the most useful comparable this week, looked cheap,” added one. “Deals could be done next week if conditions stay as they are, but most of them are already well funded and no one will be keen to pay that first mover premium in those circumstances.”

Bankers were nonetheless optimistic that normal service will resume for most jurisdictions in the coming weeks.

“It seems to be the consensus that whatever form Brexit may take – if indeed it happens at all, but that’s another question – then it will take some time for the process to get started,” said one. “The world can’t stand still until September, or whenever the new prime minister gets the ball rolling.”

Market participants added, however, that supply will likely be much lighter in the second half of 2016 than the first, as a result of the Brexit referendum, the take-up of the ECB’s new TLTROs, and after many issuers frontloaded their funding into the first two quarters.

Euro-denominated benchmark covered bond supply totalled some Eu91.6bn in the first half of 2016 – up from Eu60.75bn over the same period last year.

Analysts at Société Générale have revised their 2016 euro benchmark covered bond issuance forecast, maintaining their overall expectation of Eu145bn of supply, but reducing their expectations of supply from Ireland, Italy, Spain and Portugal while raising forecasts for Sweden, Norway, the Netherlands and New Zealand.

“As expected, Italian and Spanish lenders were the biggest participants in the ECB’s latest TLTRO II programme, increasing net borrowings by around Eu25bn,” said Cristina Costa, senior covered bond analyst at Société Générale. “We believe peripheral banks will continue to make use of TLTRO II and only larger banks might use covered bonds as a long term funding tool.”

Another analyst said he was standing by his forecast for Eu150bn of supply.

“I don’t see why we should be changing our forecasts,” he said. “The market was closed for a good chunk of last year, and yet we still saw a lot of supply in the fourth quarter.

“The market is quiet for now and issuers aren’t in a rush, but there’s another six months to go.”

Photo: Deutsche Bahn; Source: Steven Lilley