The covered bond market is becoming an investors’ market, with deeply negative spreads no longer necessarily accepted and increased premiums required, but leads and analysts say it is too early to read into this any fall in ECB orders, while stressing the importance of private demand.

Certain new issues have met unenthusiastic and even insufficient demand this week and last, with a EUR500m long six year Pfandbrief for Aareal yesterday (Tuesday) mirroring the struggles of a WL Bank EUR500m 10 year.

“The market is turning,” said a syndicate banker. “As the tightest trading names in the market, of course, it is the Germans that have been most affected.”

Aareal’s EUR500m no-grow July 2024 issue was launched with guidance of the mid-swaps minus 14bpp area. After around two hours and 20 minutes, the leads set the spread at minus 14bp with books above EUR400m, excluding joint lead manager interest. The final size of the order book was not disclosed, and it is understood the deal was not fully subscribed.

This came after the EUR500m no-grow 10 year issue for WL Bank on Thursday was also priced in the middle of initial guidance, at minus 13bp, and the size of the book was not disclosed.

Following the two deals’ underperformance, and after other issuers have offered more attractive premiums amid increased investor selectiveness, syndicate bankers said the market is becoming an investor’s market.

“People have realised we have bottomed out,” said one, “while investment pressure is not as strong as it was at the start of the year, with lower redemptions, and supply over the last couple of weeks has been heavier than originally anticipated.”

Bankers noted that this trend was reflected in other FIG markets, with investors requiring substantially higher premiums in higher beta markets.

According to some syndicate bankers away from the deals, the Eurosystem requested slightly lower orders for the WL Bank and Aareal trades under CBPP3 than it has tended to request historically.

Market participants note that in the past, the Eurosystem has typically asked for around 50% of a new issue, although its actual allocation has more typically amounted to closer to one-third, unless the deal struggled to find sufficient demand from elsewhere.

According to these syndicate bankers, the ECB’s orders for the deals were closer to 40% (EUR200m). Distribution statistics are not available for the trades, and syndicate bankers at the leads declined to comment on the specific size of the ECB’s orders.

However, a syndicate banker that worked on one of the two German deals said that any change in the size of the CBPP3 bid was not the decisive factor in the deals’ struggles.

“I think it’s purely the valuation of the market rather than the ECB buying EUR50m more or less,” he said. “The ECB have been participating, as the distribution stats show, so you can’t say it is down to the central bank appetite.

“In the end, you need to look at what the real problem is, and the real problem is that current valuations are not attractive enough.”

The syndicate banker noted that the Eurosystem’s approach to the primary market has previously differed depending on the deal and the jurisdiction in question.

“As we saw at the back end of last year, not every deal is the same and central banks make decisions on a deal by deal basis,” he said. “In the end, we are in a tapering environment, so I would expect more differing participation from different central banks.”

Another syndicate banker that worked on one of the German trades also said it is too early to say if the ECB is changing its approach.

“The ECB are not transparent in their behaviour, so we have to wait to see if that’s a general rule for all, or if it’s a specific thing to Germans because they have been very active, and are now over-allocated in the capital key,” he said. “This is speculation, something you cannot confirm or get clarity on.

“In the end it is private demand you need to look at, and you need to be able to build a book without the ECB.”

Analysts and syndicate bankers said further non-German CBPP3-eligible supply is needed before conclusions can be drawn on whether the Eurosystem has substantially changed its approach in all jurisdictions and on the sentiment of other investors towards such deals.

They suggested that the German deals’ struggles were largely caused by heavy supply from the country.

This year, 30% (EUR9bn) of all new, CBPP3-eligible benchmark supply has been from Germany, making it the most active of all eligible jurisdictions.

BNP Paribas Fortis was in the market on the same day as WL Bank, the Belgian issuer printing a EUR750m trade upon a book of over EUR1.2bn with around 45 accounts. Central banks and official institutions were allocated 26% of the deal.

No other non-German CBPP3-eligible deals have been launched since. Non-CBPP3 deals have fared better than the German duo, with a EUR500m issue for Sweden’s LF Hypotek yesterday attracting over EUR650m of orders yesterday and a EUR1.25bn issue for Bank of Nova Scotia attracting EUR1.7bn of orders today, while paying new issue premiums of around 4bp-5bp.

Florian Eichert, head of covered bond and SSA research at Crédit Agricole, said rumours of a change in the ECB’s approach could not be verified, as the ECB has never and will never communicate such details. He added that any smaller orders could also simply be a consequence of heavy supply.

“However, should it turn out to be true, we would understand this to be a sign to issuers, rather than an overall reduction in the pace of CBPP3 refocusing towards the PSPP,” he said.

Eichert said a slight drop in the size of the Eurosystem’s orders, from around 50% of a deal to around 40%, would not represent a seismic shift.

“After all, even those deals that did not go well typically had a CBPP3 share of just above 40% with very few reaching the 50% mark,” he said. “What would be more meaningful is its possible signaling effect; it could create the feeling among issuers that this was just the start and that we could be looking at an even lower target in a month’s time.”

However, Eichert noted that the ECB will still need primary market CBPP3 purchases to reach its QE targets, meaning further falls in orders are unlikely over the coming months, and added that a reduction in CBPP3 primary market purchases could lead to an increase in secondary market purchases.

Syndicate bankers said that most issuers that come to the market will now have to pay an attractive premium that could reprice their curve and the curves of others, potentially prompting more issuers to enter the market in the expectation that spreads will continue to widen from current levels.

“Each new deal must pay an attractive new issue premium that reprices the secondary market,” said one, “then another deal comes along, meaning investors are not focussed on the secondary market and therefore there’s no chances for the deals to perform, and that cycle repeats.”

Syndicate bankers added that a break in new issuance could provide some respite for the market, but were uncertain whether the market will get such a breather before the Easter break at the end of next week.

Eichert said the impact of a reduction of CBPP3 purchases on the primary market – if indeed one takes place – would depend on the reaction of issuers over the coming weeks.

“If they sit back and wait to see how things evolve, the spread impact would be negligible for now,” he said. “In our view, however, issuers would be more likely to react by bringing forward some of the issuance they might have planned for the second quarter, fearing a further decline in CBPP3 order sizes.

“That in turn could, in our view, lead to a re-pricing of 5bp-7bp in core eligible markets and perhaps yet another basis point or two as far as new issue premiums are concerned.”

Gross CBBP3 purchases steady

ECB figures released on Monday show no sign of a substantial change in the Eurosystem’s purchases of eligible deals that settled last week, compared to recent weeks.

The CBPP3 portfolio increased EUR788m, from EUR248.783bn to EUR249.571bn, in the week to last Friday. Figures released yesterday show that around EUR200m of holdings in the CBPP3 portfolio matured last week, implying gross purchases of around EUR988m.

This represents a marginal fall from EUR1.041bn of gross purchases in the previous week, and compares to the average of around EUR1.35bn per week so far this year.

Analysts estimate that around EUR700m-EUR800m of the CBPP3 purchases settled last week were bought on the primary market, out of EUR2bn of eligible primary market settlements. In the previous week, analysts estimated the Eurosystem bought around EUR300m out of EUR1.25bn of eligible issuance.

In recent weeks, analysts had noted that the share of CBPP3 purchases made on the secondary market had increased while primary market settlements had decreased – accounting for over half (EUR2.330bn) of February’s EUR4.381bn gross purchases.

WL Bank’s deal will settle tomorrow (Thursday) and Aareal’s will settle on Tuesday.