A preference for a long term maturity prompted the UK’s Co-operative Bank to turn to the sterling market to launch its first benchmark covered bond, according to a banker at one of the leads. Meanwhile, analysts noted changing trends in UK issuers’ use of covered bonds.

The UK Regulated Covered Bond issuer on Friday sold a £600m (Eu700m) 10 year issue at 250bp over Gilts, equivalent to around 215bp over mid-swaps, on the back of an order book of £1bn, with more than 70 accounts participating.

Jez Walsh, global head of covered bond syndicate at RBS – which led the transaction alongside Barclays Capital, HSBC, JP Morgan and UBS – told The Covered Bond Report that the issuer was ready to launch a deal on Thursday, but that the market opened in such a poor state that the transaction had to be put on hold. The deal ended up being executed the following day, when US nonfarm payrolls were released.

“I can’t remember the last time I was bookbuilding with nonfarms out and knowing we wouldn’t be able to price until after,” said Walsh, “but we took the view that it was a better option than waiting.

“Nonfarms are not the biggest market mover at the moment, and with Italy hitting 6.6% in 10 years this morning it’s been a very weak opening today.”

Walsh said that a euro issue did not come into consideration.

“The maturity preference was for a longer deal,” he said, “and given that we felt a euro transaction was most likely to be there in the short to intermediate maturity we opted for a sterling trade.”

He said that while euro investors were reluctant to invest in long dated issuance from issuers with lower ratings, the UK investor base was open to such supply even in difficult market conditions. Co-operative Bank is rated A3/A-/A (Moody’s/Fitch/DBRS).

However, Walsh said that with the issuer having done a UK and European roadshow a euro deal is likely to be part of the issuer’s future considerations, with feedback from the UK roadshow indicating there would be leftover demand from some domestic accounts for short dated euro issuance.

The re-offer spread of around 215bp over mid-swaps was difficult to compare with pricing in the euro market, he said, with prevailing sterling spreads generally wider than euro levels and the leads generally of the view that a 10 year deal would have been more difficult in the euro market.

The leads looked at the trading levels of outstanding sterling covered bonds including Abbey April 2021s at 196bp over mid-swaps, Coventry Building Society April 2018s at172bp, and Yorkshire Building Society April 2018s at 178bp. Walsh said that hypothetical new 10 year deals for the two building societies would have needed to incorporate around 25bp for curve extension and 15bp of new issue premium, equating to a level of around 212bp-218bp over mid-swaps and 245bp-250bp over Gilts. The Co-op’s re-offer spread of 250bp over Gilts therefore incorporated a theoretical new issue premium in line with what the building societies would have paid, according to Walsh.

UK investors took 99% of the bonds, with funds allocated 50%, insurance companies 40%, banks 4%, corporates 2%, private banks 1%, and others 3%.

The £600m deal was issued off a newly established covered bond programme (Moorland), with the issuer having terminated another programme (Pioneer) that was set up to access the Bank of England’s Special Liquidity Scheme (SLS). Co-operative Bank merged with Britannia Building Society in 2009 and the LLP and other Moorland entities used in the ongoing programme’s structure are those that were used in a programme Britannia had previously established (they have been renamed). A sole, £1.4bn covered bond was launched off Britannia’s programme and was redeemed in October.

Fitch today (Monday) said that some UK lenders’ use of covered bonds as a source of funding is decreasing with the end of the SLS on 30 January 2012, but that a recent increase in supply from large institutions such as Barclays Bank, Lloyds TSB, Nationwide Building Society and Royal Bank of Scotland can offset the contraction of the size of the UK market caused by the end of the SLS.

HSBC Trinkaus analysts said that a “cancellation wave” is underway of UK covered bond programmes set up to access the SLS. They said that while UK issuers were through this giving a positive sign that they are managing without part of the support packages put in place during the crisis, the cancellations also show that more UK issuers are forgoing covered bond refinancing than initially expected.

They said that eight covered bond programmes have already been terminated, with mergers the main reason for early cancellations in 2009, such as in the case of Alliance & Leicester, and in 2010, such as in the case of Chelsea Building Society and Standard Life. Other issuers, such as Leeds Building Society and Coventry Building Society, have decided to continue using their covered bond programmes and cancel some covered bonds that were launched with the SLS in mind, according to the analysts.

Fitch said that in some cases rather than winding down covered bond programmes UK lenders are restructuring them for market issuance, and cited Co-op’s Moorland programme in this respect.

“Examples of restructuring include shifting from a partial pass-through structure in retained deals swapped at the SLS, to hard or soft bullet repayments in deals that will be sold to private investors,” said the rating agency.

A covered bond analyst said that Fitch’s comment confirms that there is “still no public market for pass-through covered bonds”.

The total nominal value of securities held by the Bank of England as collateral in the SLS – mostly RMBS or mortgage covered bonds – amounted to around £287bn, according to Fitch.