Sub-benchmark covered bonds can offer an interesting alternative for investors and a sensible option for issuers, according to bankers, with growth in the segment to over Eu30bn of outstandings spurred by factors including declining demand for private placements and LCR criteria.

Supply of public sub-benchmark covered bonds reached a record high last year, and issuance has continued in 2017, with notable deals including a debut social covered bond from Kommunalkredit Austria, record deals from Slovakia, and a variety of issues from the Nordics.

Defining sub-benchmark euro covered bonds as deals with an issuance volume of Eu250m-Eu499m and an investment grade rating, Kai Ebeling, covered bond analyst at NordLB, said the market segment has a volume of Eu31bn outstanding, comprising over 110 issues.

Excluding issuers that have also issued benchmark covered bonds and bonds that were used for repo purposes or bonds for which no bid or offer prices are currently provided on the market, he noted that there have been eight sub-benchmark deals from six issuers over the last 12 months.

These comprise a debut social covered bond from Kommunalkredit Austria, two deals for Slovakia’s VÚB, two for Natixis Pfandbriefbank of Germany, and one apiece from Finland’s Ålandsbanken, the Mortgage Society of Finland (pictured) and Norway’s Møre Boligkreditt.

Outstanding sub-benchmarks (EUR bn)

Source: Bloomberg, NordLB

Marc Just, head of FIG origination at LBBW, said there are various reasons why supply is increasing.

“Firstly, declining demand for private placements leads smaller issuers to the syndicated market in order to satisfy their respective capital market funding needs,” he told The CBR. “Due to LCR requirements, the smallest reasonable size in the syndicated market would be sub-benchmark.

“Secondly, smaller banks prefer the sub-benchmark format because it better matches their ALM needs.”

Under LCR, covered bonds must have an issuance volume of at least Eu250m to qualify as Level 2A assets.

According to Ebeling, such bonds offer an alternative for investors, even if they are generally less liquid.

“Compared with the euro-denominated benchmark segment, the sub-benchmarks we have looked at constitute a niche market,” he said. “Having said that, they can still serve as a diversification from the traditional benchmark for investors and also offer a higher spread in some cases.”

When Møre Boligkreditt sold a Eu250m five year debut euro covered bond rated Aaa in May, for example, it paid a re-offer spread of 7bp over mid-swaps, 7bp more than paid by compatriot Sparebanken Sør Boligkreditt the previous week on a Eu500m deal in the same maturity.

One major covered bond investor told The CBR that his focus is mainly on benchmark covered bonds, but that sub-benchmarks can be of interest.

“These Eu250m deals, if there is enough pick-up, can be a long term investment,” he said, “but it’s a very, very small proportion of our investments.”

The number of investors participating in a Mortgage Society of Finland Eu250m seven year in June was in the mid-20s, with the book over Eu400m, while Kommunalkredit Austria’s Eu300m four year in July attracted some Eu530m of demand with a book including more than 40 investors – around half of which were dedicated sustainable accounts.

Based on experience of five recent sub-benchmark covered bonds, LBBW’s Just confirmed that said the number of investors who participate in such trades is comparably lower than in benchmarks.

He nonetheless noted that oversubscription of sub-benchmarks tends to be in line with benchmarks, with deals 1.8-3.5 times covered, and said the tightening from guidance to final spreads is also comparable, averaging 3bp.

Just added that the issuers’ respective domestic markets and Germany are the main investor countries and that investor types vary depending on the maturity.

According to Ebeling, the universe of sub-benchmark issuers is notably less diverse than that of benchmark issuers: the iBoxx Euro Covered Index, including Eu500m-plus-sized issues, covers 22 jurisdictions, while 16 are represented in the sub-benchmark segment.

Outstanding sub-benchmarks by country (EUR bn)

Source: Bloomberg, NordLB