CBPP3-eligible issuers have been forced to pay larger new issue premiums than non-Eurozone peers, while issuers have not had to pay up to go long, DZ analysts have concluded after surveying issuance since 2016, with demand deemed the most influential factor on NIPs.

The findings are based on an analysis of new issue premiums (NIPs) paid by euro benchmark deals, including taps, between 1 January 2016 and 17 July 2018.

The analysts found that NIPs paid by euro benchmark covered bonds for which they had sufficient data averaged 4.2bp in 2016, just 1.7bp in 2017, and 3.8bp so far this year.

Jörg Homey, covered bond analyst at DZ Bank, said the difference between 2016 and 2017 could be explained by heavier supply in 2016, when euro benchmark issuance totalled some EUR126bn, compared with EUR112bn in 2017.

“The higher issue volume may have contributed to higher NIPs in 2016, but there were other factors, too, such as the composition of the issuer’s country of origin,” he said. “In 2016, there were far more new issues from banks from Spain than in 2017.”

Issuance has also been relatively high this year, at EUR97.15bn year-to-date.

The findings suggest that the most decisive factor in the size of a deal’s NIP is, perhaps unsurprisingly, the strength of demand, said Homey, with the bid-to-cover ratio inversely correlated with the NIP.

“When assessing the impact of the bid-to-cover ratio on NIPs, the question which arises is the direction of the effect,” said Homey. “There are two possibilities in this chicken-and-egg situation: does high demand for a specific bond which is reflected in a high bid-to-cover ratio influence the NIP?

“If it were the case, then high bid-to-cover ratios would have to go hand-in-hand with lower NIPs, because investor competition would push the NIP down, or, in the case of a lacklustre order book, new issuers would have to offer higher NIPs in order to generate sufficient demand for their new issue. Conversely, high NIPs could mainly attract demand from private [non-central bank] investors, leading to a correspondingly high bid-to-cover ratio.”

If the first explanation is correct, bid-to-cover ratios and NIPs would move in opposite directions, with NIPs going lower when bid-to-cover ratios are higher. If the second explanation is correct, higher NIPs would mean higher bid-to-covers.

Homey said the findings for the years 2016 and 2017 seem to support the first explanation, demonstrating an inversely proportional relationship between bid-to-cover ratios and NIPs. However, in 2018 such a correlation is less clear, with new issue premiums being relatively consistent across deals with bid-to-cover ratios from less than 1 to more than 2.5.

Homey concluded that the NIP is the result of the strength of demand rather than the other way around.

“In the end, we believe that the strength of supply and demand as measured by the bid-to-cover ratio is the most important yardstick for NIPs,” said Homey. “The lower the demand for a bond, the higher NIPs have to be to ensure order books are sufficiently filled.

“Ultimately, it all seems to come down to the bid-offer-ratio.”

Also among Homey’s findings is that the ECB’s covered bond purchases under CBPP3 have not led to a compression of NIPs for CBPP3-eligible covered bonds, and that since 2016 the premiums paid by eligible deals have been systematically above those of non-CBPP3-eligible deals.

The analysis found that NIPs paid by CBPP3-eligible deals averaged 5.0bp in 2016, 2.0bp in 2017 and 4.1bp so far in 2018. NIPs for non-CBPP3-eligible deals averaged 2.5bp in 2016, 1.2bp in 2017 and 3.3bp in 2018.

“Above all, ECB purchases have pushed the swap spreads of CBPP3-eligible euro benchmark bonds in the secondary market downwards significantly,” said Homey. “Although the swap spreads of covered bonds of issuers domiciled outside the Eurozone have also tightened, they have not done so quite as much as bonds purchased by the ECB.

“It appears that issuers from within the Eurozone wanting to place their bonds had to offer higher NIPs in relation to their secondary market curves, which were more distorted downwards by ECB purchases than was the case for issuers from outside the Eurozone, whose secondary market curves benefited less and only indirectly from CBPP3 purchases.”

Another impact of the ECB policy has been an increase in longer-dated covered bond issuance in recent years, due to yields in the Eurozone reaching historical lows.

Homey said that while longer-dated deals offer higher spreads than shorter-dated deals of the same issuer – when curves are behaving normally – there is no clear systematic difference between NIPs for longer and shorter-dated deals, which he said is a surprise, given investors usually expect higher credit spreads for longer paper.

“In the case of new issues with an initial maturity of up to five years, we calculate that a marginally lower NIP is being paid than for new bonds with a maturity of more than ten years,” said Homey. “However, there is no evidence of any very pronounced and systematic difference.

“Generally still strongly compressed swap spreads, as a result of the ECB’s purchase programme, seem to go hand-in-hand with a lack of differentiation of NIPs by maturity segment.”

Issuance uniformity limits rating, structure takeaways

Covered bond ratings also appear to have some influence, the study finds, with investors requiring larger concessions for lower-rated deals. The study found, for example, that double-A rated covered bonds paid on average 3.0bp, 0.7bp and 1.0bp larger NIPs than triple-A rated covered bonds in 2016, 2017, and 2018 respectively. However, Homey said a lack of supply of lower-rated deals – with up to 84% of this year’s issuance being triple-A rated, for example – mean it is difficult to draw a clear conclusion.

Homey added that from the available data it is not possible to discern any clear trends on the influence of different repayment structures on NIPs – due in part to limited supply of conditional pass-through covered bonds and due to many hard bullet covered bonds – which would all else being equal be expected to pay lower premiums – being from Spain.

There is also evidence that mortgage covered bonds pay marginally lower premiums than public sector covered bonds but, Homey said, low issuance of public sector covered bonds limits such takeaways.

Photo: Frankfurt Luminale 2018 at the ECB headquarters