A Eu500m Coventry Building Society deal expected this week is seen as an important test of appetite for UK covered bonds, being the first UK euro benchmark since the Brexit vote, and should put down a fresh pricing marker for a sector whose spreads have experienced countervailing forces.

Coventry Building Society began a roadshow on Friday ahead of a potential Eu500m no-grow seven year covered bond issue. The roadshow will conclude on Wednesday, and a syndicate banker at one of leads Commerzbank, Danske, HSBC and Natixis said the deal could be launched on Thursday or Friday, subject to market conditions.

The new issue will be the first euro benchmark covered bond from the UK since the Brexit referendum on 23 June, with the last having been a Eu500m four year issue for Leeds Building Society in April. Only one benchmark covered bond has been sold out of the UK since, a £500m (Eu589m) three year floating rate note for Santander UK on 1 July.

Bankers suggested that the lack of supply was a result of issuers’ reluctance to print new issues at spread levels that had widened on the back of Brexit concerns, and on anticipated lower demand for UK paper given uncertainty about the direction of the market and the future regulatory treatment of the UK product.

“UK covered bonds have taken quite a ride since the Brexit vote,” said one. “Given the many questions that are yet to be answered about how and when the UK will leave the union, it is also understandable that issuers have not rushed to get involved even as spreads have come back down.

“In that context, Coventry’s deal will be an important test.”

UK covered bond spreads widened substantially in the aftermath of the Brexit result, but by August had already retraced such moves, as spreads from all jurisdictions tightened over the summer on the back of a supply drought.

“As risk markets came to think that things were not as bad as first feared, UK covered bond spreads came back in and tightened in conjunction with other jurisdictions, such as the Canadians, which are probably one of the most sensible comparables for UK names post-Brexit,” said a banker at one of Coventry’s leads.

“This tightening trend lasted until quite recently, when a back-up in spreads began as yields hit new lows and some investors started backing away. With the higher yields we’ve seen in the last few weeks there’s been a general buyer strike, and spreads for all jurisdictions have widened by anything between 3bp-5bp.”

These moves have left UK covered bonds now at slightly tighter levels than pre-Brexit, trading roughly in line with those of Australia, but still wider than peers from Canada and the Nordics.

UK covered bonds are now quoted around 20bp-30bp inside Spanish and Italian covered bonds, having been in line with such peripheral paper until the recent widening that followed the US election result – which saw peripherals hit hardest of all.

Bankers at Coventry’s leads saw the issuer’s November 2021s quoted at 10bp, mid. They also cited as comparables Lloyds April 2023s, at 10.5bp, and Nationwide October 2021s at 8bp, October 2022s at 10bp and March 2027s at 15.5bp.

Furthermore, analysts have played down the potential impact of the UK’s exit from the EU on the regulatory treatment of UK covered bonds.

Analysts at Commerzbank noted that should the UK also leave the EEA, it may lose some privileges according to the UCITS Directive, CRR and LCR. However, they noted that UK covered bonds’ eligibility for ECB repo should be untouched.

“On balance this would be comparable to the regulatory status of Canadian covered bonds, which nevertheless typically benefit from healthy demand,” they said. “In addition we could imagine that, by the time the Brexit negotiations have been concluded, new EU measures for improved mutual regulatory recognition with third countries may be initiated as part of the planned covered bond harmonisation.

“These should also benefit UK covered bonds.”

Michael Spies, covered bond and SSA strategist at Citi, agreed.

“In a worst case scenario we think investors will have to treat UK covered bonds in line with Canadian covered bonds from a regulatory point of view, i.e. slightly superior to Australian covered bonds,” he said. “This was the main reason we viewed UK covered bonds as trading too cheap versus main peers during recent months.”

Spies added that UK cover pools’ credit qualities were substantially higher than the overall market average before the vote, and said that that cover pool risks are limited given that the UK housing market “barely moved” following the outcome and considering GDP growth projections.

Analysts also noted that UK covered bond ratings are expected to be unaffected by Brexit, owing to high rating buffers.

Spies said the upcoming deal could be seen as “a test balloon” for investor demand for UK paper.

“As noted, we continue to like UK covered bonds but the first UK covered bond issuance after seven months in a relatively illiquid market has the potential to reprice the whole segment – to the good and to the bad,” he said.