Principality is the UK’s sixth largest building society, with £14.1bn in total assets, with all of its larger peers having already entered the covered bond market, and it sees the additional funding option as supporting its sustainable growth ambitions.

The debut was the culmination of 18 months’ preparations, during which time the building society worked on the programme with the support of joint arrangers BNP Paribas and HSBC and its legal advisors, A&O Shearman, as well as its peers within the UK Regulated Covered Bond Council (UK RCBC).

The programme was approved by the Financial Conduct Authority (FCA) in September, after which Principality held investor roadshow meetings in the fourth quarter. With a prospectus dated 19 December, the groundwork had thus been laid for a potential January debut that could build on this momentum.

Nationwide showed the sterling covered bond market to be in great shape when it reopened the market on 9 January with a dual-tranche trade split into £750m three-and-a-half year FRN and a rare £1bn short seven year fixed rate tranche.

“That enjoyed a fantastic outcome and demonstrated the liquidity that was available,” said James Whetman, managing director, FI DCM at HSBC, “and the Principality team were keen to take advantage of a good window in which to get their name established.”

The mandate for the £500m (€577m) no-grow five year floating rate note was then announced last Monday (12 January), with further investor calls and feedback collected before the deal was launched on Wednesday morning.

Joint leads BNP Paribas and HSBC opened books with guidance of the Sonia plus 55bp area for the January 2031 covered bond, expected ratings Aaa/AAA (Moody’s/Fitch). A first book update put demand above £975m, including £30m of joint lead manager interest, and after close to four hours, they set the spread at 50bp on the back of books above £1bn, pre-reconciliation and excluding JLM interest. The final book was above £1.05bn.

The leads saw fair value for larger peers at around 47bp, with comparable five year FRNs issued last year by Coventry, Leeds and Skipton trading around Sonia plus 45bp-46bp, and the curve extension worth 1bp-2bp.

“On that basis, 50bp was an extremely good result,” said Whetman, “very compressed to the rest of the market, with just a bit of premium to reflect this being an inaugural trade and anything that may be appropriate for the credit.

“UK bank treasuries were delighted to see a solid new name establishing a presence in this market,” he added, “and Principality enjoyed strong interest from this investor community – but also really good asset manager demand.”

The size and price met the issuer’s ambitions for an inaugural benchmark.

“Principality is delighted to diversify our wholesale funding sources through the covered bond issuance, allowing us to establish a broader investor base to build on in the future,” Chris Peters, Head of Balance Sheet Management at Principality Building Society, told The Covered Bond Report.

As well as investor diversification, the building society sees quicker access to markets as a reason for entering the covered bond market. Principality will meanwhile retain its established Friary residential mortgage-backed securities franchise alongside the programme to keep its funding options open – it has £1.025bn of RMBS outstanding.

“Covered bonds offer issuers additional flexibility versus standalone RMBS,” said John Millward, managing director, structured finance group, HSBC. “It allows them to access the market more nimbly and opportunistically, with a shorter turnaround time, wider investor base, and broader range of maturities available.

“The covered bond programme therefore significantly increases Principality’s wholesale funding capacity.”

The last new entrant to the UK covered bond market, Paragon Bank, pioneered buy-to-let collateral in its issuance, but Principality’s is broadly in line with the established programmes of its peers.

While 24% of its mortgage lending is in its home territory of Wales, the balance is spread across the rest of the UK. Its initial cover pool is £965m.

Principality now sees covered bonds as central to its wholesale funding plans and expects to be in the market annually, initially in sterling before exploring different tenors and currencies in the medium term.

The short seven year tranche follow up on a £500m five year fixed rate covered bond Nationwide Building Society issued in October, which was the first fixed rate sterling covered bond of £500m or greater since 2017 and first fixed rate sterling benchmark covered bond from a UK financial institution since 2015.

Richard Merrett, head of secured funding at Nationwide, said that while the shorter dated FRN was a typical trade to consider, the issuer was keen to build on its five year fixed rate issue.

“The October trade set us up for this,” he told The CBR. “Coming into January, we had the funding need, and could have gone to euros, but the euro market was exceptionally busy this week – albeit not on Tuesday with the holiday – and so it made sense to try something different.

“When we spoke to the banks, it was clear that the floating rate worked. But we also received some reverse enquiries for fixed. So we were keen to sponsor that demand and continue the development of fixed rate format to be inclusive of all investor types.”

While fixed rate sterling covered bond supply has been scarce, Merrett’s prior experience on the building society’s HQLA desk had suggested it could make sense.

“We bought SSAs and the like, and the fixed format wasn’t an issue because we could use the swap market,” he said. “Moving to the funding side, I questioned why the sterling covered bond market didn’t offer a fixed alternative. So I’m pleased to have explored this further and brought it back to market.

“We explored it in the October trade and it’s apparent that there are accounts out there who want specifically fixed rate flows in sterling and are happy to buy this, which is great.”

Leads BMO, HSBC, Nomura and RBC opened book on Wednesday morning with guidance for the rare dual-tranche sterling trade of the Sonia plus 47bp area for the July 2029 tranche and the mid-swaps plus 64bp area for the December 2032, with the covered bonds carrying expected ratings of AAA/AAA (S&P/Fitch). After around two hours, they reported combined books above £2.5bn, including £180m of joint lead manager interest, evenly split between the two tranches.

Then after close to three hours, they set the spreads at 42bp and 60bp, respectively, on the back of more than £3.15bn of demand, £1.75bn-plus for the FRN and £1.4bn-plus for the fixed. The deal was ultimately sized at £1.75bn (€2.02bn) – the maximum Nationwide was seeking – with tranches of £750m for the FRN and £1bn fixed, on the back of final books of £1.8bn-plus and £1.4bn-plus.

“It just went really smoothly from start to finish,” said Merrett (pictured). “I don’t see how it could have gone any better.”

“Originally, when we looked at the dual-tranche idea, we would have expected the fixed portion to be perhaps smaller or the same as the FRN,” he added, “so we were incredibly happy with the outcome we got, and the quality of that fixed book was exceptional.”

Of the fixed rate tranche, 80% was allocated to the UK and Ireland, 7% to northern European accounts, 6% to Germany, Austria and Switzerland, 6% to other Europe, and 1% elsewhere. Bank treasuries took 69%, asset managers 20%, and central banks and official institutions 11%.

“There were definitely some rarer names in the seven year who were purely after the fixed,” said Merrett, “and that diversification is great for us, because it increases the number of accounts who will buy us in different formats.”

The UK and Ireland took 85% of the FRN, northern Europe 4%, Germany, Austria and Switzerland 2%, other Europe 5%, Asia-Pacific 3%, and other 1%. Banks treasuries were allocated 69%, asset managers 20%, hedge funds 5%, official institutions and central banks 3%, insurance companies and pension funds 2%, and other 1%.

The FRN was seen pricing with no new issue premium, while fair value for the short seven year fixed rate tranche was put by the leads in the very high 50s to 60bp, based on top tier SSAs coming in five years at around 40bp-41bp and adding around 10bp for the curve extension and 10bp for SSA-covered bond differential.

Anand Somaiya, FIG DCM at HSBC, noted that the December 2032’s pricing at 60bp was 2bp inside where French agency Cades on Wednesday sold a shorter, July 2031 benchmark, underlining the strength of Nationwide’s trade.

“They were very deliberate with their strategy on the fixed rate tranche,” he said, “they didn’t take every basis point out of it as they are keen to support the asset class going forward, and they didn’t oversize it either – we were very comfortable delivering the £1bn there and they got their maximum size across the whole deal. And the proof is in the pudding: both tranches are around 1bp tighter in secondaries.

“So from that perspective, they’ve absolutely nailed it, and overall it was a real masterclass from Nationwide.”

According to Merrett, the short seven year tranche in sterling had been seen as offering an estimated 9bp-10bp saving versus euros, although he acknowledged that the strength of the euro market this week meant that it may ultimately have been a little less. He said a seven year sterling FRN may have come slightly tighter, but noted that the rarity of such trades meant that the differential was uncertain.

With Nationwide having now demonstrated the possibilities in fixed rate sterling covered bond issuance, further supply could be forthcoming, suggested Somaiya.

“I expect that the less frequent issuers will continue to do threes and fives in floating rate,” he said, “because there isn’t arbitrage per se in doing a seven year fixed. But some of the bigger funders, or those who have been more reliant on floating rate, may look at this.”

Nationwide, whose financial year ends on 31 March, is meanwhile unlikely to be active in covered bonds before then, according to Merrett, but will return in its new financial year.

Leads Lloyds, BBVA, BMO, HSBC and TD opened books yesterday morning with guidance of the Sonia plus 52bp area for a sterling benchmark-sized November 2030 floating rate note, expected ratings Aaa/AAA (Moody’s/Fitch).

After around an hour and 20 minutes, they reported books above £1.5bn, and after a little over three hours, they set the spread at Sonia plus 47bp and the size at £1bn (€1.14bn) on the back of books above £1.95bn. The final book was above £1.75bn.

The deal is the tightest sterling benchmark covered bond in over a year, since Yorkshire Building Society issued a £750m five year at 45bp in May 2024. It is also the tightest £1bn or greater deal from a UK issuer and tightest £1bn or greater five year FRN from any issuer since 2021.

“This was a really good trade,” said a banker at one of the leads. “Lloyds benefited significantly from being a UK national champion and reaped the rewards of their rarity cachet.”

The new issue is Lloyds’ first sterling benchmark since November 2022, when it issued a £1bn five year FRN, and its first benchmark covered bond in any currency since January 2023, when it sold a €1bn three year.

Lloyds’ FRN comes on the back of a brisk autumn season in the sterling covered bond market, being the eighth trade of £500m or greater.

“Investors have healthy cash balances,” said the lead banker, “and recent sterling covered bonds have performed well.”

He put the new issue premium at 1bp. The last UK Sonia-linked covered bond was a £600m five year for Coventry Building Society on 12 September at Sonia plus 48bp.

“Lloyds traded 1bp tighter on the break,” he added, “demonstrating the pinpoint pricing.”

The five year maturity enabled it to take advantage of the flat credit curve while extending its maturity profile beyond 2029 into 2030, according to the lead banker.

The covered bond wrapped up a busy week for Lloyds in the capital markets after it announced its Q3 results on Thursday of last week (23 October): on Monday it issued a $1bn (£759m, €863m) 6.625% perpetual non-call 10 year Additional Tier 1 (AT1), and then on Tuesday raised $3.05bn of senior debt in a three tranche issue.

Leads DBS, BMO, HSBC, NAB, Santander and TD opened books on Monday morning with guidance of the Sonia plus 57bp area for the sterling benchmark-sized October 2028 FRN, expected ratings Aaa/AAA (Moody’s/Fitch). After around an hour and 40 minutes, they reported books above £1.6bn, including £250m of JLM interest, then after around three hours, they tightened 5bp to set the spread at 52bp and the size at £1bn (€1.15bn, SGD1.74bn) on the back of books above £2.2bn. The final book was above £2.2bn, including £200m of JLM interest and 49 accounts.

A banker at one of the leads said the book is the largest ever for a Singaporean sterling covered bond, with strong demand from real money accounts across the UK and Europe complementing the traditional UK bank bid, and support from APAC accounts also in evidence.

The sterling benchmark is DBS’s fourth – its debut, a £1bn four year deal issued in November 2021, matures next month.

“Coming in with the new deal gives them a longer point on the curve and maintains their sterling presence at the level they want it to be,” said a banker at another of the leads. “They’ve been pretty clear that they’re committed to being a regular issuer in the sterling market.

“My understanding is that they have some natural sterling needs for their corporate loan book, so while they are obviously going to be looking to get the best pricing possible versus what is available in other currencies, investors like the fact that they have those needs.”

Aside from a limited £300m Korea Housing Finance Corporation debut on 30 September, the last non-UK covered bond issuance in the three year maturity was from Canadians CIBC and Bank of Nova Scotia on 5 and 8 September, respectively, with their £1.25bn and £1.5bn deals priced at 55bp and 54bp. Those were seen at around 51bp when DBS approached the market.

“So this basically pried on top of fair value,” said the lead banker. “We have generally seen more and more investors looking at DBS and Singapore in general now that there has been more supply.

“When you get a new investor on board in this market,” he added, “they’ll look at the Canadians and the Australians, which tend to be the core group of non-UK sterling issuers that people do credit work on. But Singapore is now getting firmly entrenched in that as well.”

DBS’s last sterling benchmark was a £1bn three year in May 2024, while the last Singaporean sterling benchmark was a £750m three year from United Overseas Bank (UOB) in September 2024.

The new issue was seen as offering pricing flat to inside what might have been achieved in euros, according to lead bankers, and inside US dollars.

DBS’s deal takes non-UK sterling supply to more than £5bn since the beginning of September, when new issuance restarted in earnest after the UK authorities in July released proposals that put foreign covered bonds back on a firmer footing. The volume even greatly exceeds the one deal for £600m in non-UK sterling covered bond supply that preceded the regulatory uncertainty sparked by the PRA in April.

The previous such trade was a £500m (€576m) seven year for Lloyds in March 2015, while Nationwide itself had not issued a fixed rate sterling benchmark since 2011, when it sold a £750m 5.625% deal with a maturity date of January 2026.

A banker at one of Nationwide’s leads said the rare transaction was launched off the back of reverse interest in the format.

“For the most part, sterling has been an FRN market, with only the occasional long dated floater,” he noted. “But there were some investors on the bank and official institution side who had a specific fixed rate bid, and had done so for a while – there are a few legacy UK fixed rate covered bonds outstanding, such as a 2029 from Santander UK that was an old 17 year, that people can buy, but they’re really hard to get in the secondary market.”

On the building society’s side, the format offered a different option to its recent funding, added the lead banker.

“Nationwide did a sterling FRN earlier this year and they have another October 2030 maturity in FRN format, which was originally a seven year, while they may be looking to do an FRN early next year as well,” he said. “Most of their RMBS have been issued in the three year bucket.

“So they could have gone shorter or longer, but all that made them more open to the idea of a five year in this format. Their secured funding needs are also relatively modest, so they didn’t need the typical £750m-£1bn size. Overall, this fitted quite well into their needs.”

The deal was also notable for being priced over Sonia mid-swaps.

“All the sterling fixed rate covereds before, even some of the more recent German supply, have been priced over Gilts,” he said, “but we took a page out of the SSA book and just priced over Sonia mid-swaps. The SSA market has been doing that for the last year or so, and it makes it a little bit easier to comp to the FRNs that were outstanding.”

After going out last Tuesday (14 September) with guidance of the mid-swaps plus 55bp area for the £500m no-grow October 2030 transaction, expected ratings AAA/AAA (S&P/Fitch), the leads around one hour and 35 minutes later reported books above £1.5bn, including £100m of JLM interest. After around two hours and 15 minutes, they set the spread at 50bp on the back of more than £1.8bn of demand. The final book was around £1.7bn, with over 60 accounts.

Recent building society FRNs were bid in the context of 47bp-48bp over, according to the lead banker, while SSA paper was in the low-30s over Gilts.

“Fifty-five was a pretty good starting point,” he said, “and they got quite a big book. It was a mix of people who would anyway have bought an FRN and swapped it back, but also quite a bit of fixed-specific demand, either from some of the investors who can buy both but wanted more fixed paper, and also from some investors who have a fixed rate-only mandate and are more active in the SSA space and were happy to have the opportunity to buy some triple-A paper in covered format.”

The 50bp spread against mid-swaps was equivalent to around Gilts plus 27bp.

The lead banker said that a seven year could also have worked, albeit with some banks likely dropping out, but other accounts taking a look.

“If you’re a large UK issuer who’s already got a lot of covered and RMBS outstanding or maybe just the pricing isn’t looking so good, and you want to try something different domestically, this is another tool available to you, even if it’s not going to supplant the FRN market,” he added.

No non-UK benchmark covered bonds had been issued in the sterling market since the Prudential Regulation Authority (PRA) on 8 April made a surprise announcement that such securities would be excluded from banks’ LCRs, even though the process to do so was paused on 17 April in the face of a backlash against the move and the way it was handled.

The initiative was deemed particularly problematic given how it could also affect EU treatment of UK covered bonds, which is currently being considered by European authorities.

In coordinated announcements on Tuesday, the PRA and HM Treasury (HMT), as part of a broader policy update, unveiled a new plan to consult on and potentially introduce “an Overseas Prudential Requirements Regime (OPRR) that could be used to designate overseas jurisdictions in relation to the prudential treatment of UK firms’ exposure to non-UK covered bonds”, according to the PRA’s statement.

HMT will meanwhile ensure that any designation does not create cliff edges in treatment for overseas covered bonds issued prior to the legislation.

The news was greeted positively by market participants.

“We welcome the certainty this brings,” Ian Stewart, executive director, UK Regulated Covered Bond Council, told The CBR, “and the opportunity to participate in the consultation.”

And today Canadian Imperial Bank of Commerce (CIBC) tapped a £800m October 2029 floating rate covered bond for £200m (C$368m, €231m).

Wojtek Niebrzydowski, vice president, corporate treasury, CIBC, said the issuer had been considering such a tap for over a month and had considered it feasible ahead of last week’s UK announcement, but had been focused on other trades, including a US dollar AT1 and Australian dollar covered bond.

However, with these out the way, and renewed impetus behind the sterling market in the wake of the regulatory news, the issuer refocused on the sterling tap. According to Niebrzydowski, the tap was exclusively placed with UK investors, a combination of bank treasuries and real money accounts.

Bankers anticipate new benchmark issuance picking up later in August.

“We’ve had some conversations with investors, asking if they are cool to buy now, and there’s been a really positive reaction, because they feel like they’ve been given a lot of comfort,” said a DCM banker. “There are still some investors who will need to have internal discussions before they begin buying again, but we’ve already seen the secondary market pick up a bit, with the non-UK stuff trading.

“So it seems like we’re back to where we were in March, with the upside of an there being an equivalence regime that would improve the capital treatment at some point in the future.”

While non-UK covered bonds will now continue to be treated as Level 2A-eligible, market participants raised the possibility of their joining UK covered bonds in Level 1.

The timing of any such move is unclear, but should be soon enough that five and even three year paper issued now could benefit, particularly as plans are firmed up.

“There has been a widespread view that the EU will do its equivalence thing and then other countries could use that as a model for what they might do in their own jurisdiction,” said a banker. “But the EU could take four years or so, while there’s a chance the UK could get all this in place first – they mention 2027 as when Basel 3.1 is coming into play.”

HMT’s statement notes that, in parallel with the liquidity requirement developments, it is working on updating the capital framework for UK financial institutions, where non-UK covered bonds similarly face risk weight issues.

Following a mandate announcement on Wednesday, leads Barclays, BMO, HSBC, Lloyds and NatWest opened books yesterday morning with initial guidance of the Sonia plus 62bp area for the £500m (€585m) no-grow January 2030 floating rate note, expected ratings Aaa/AAA (Moody’s/Fitch). After around an hour and a quarter, they reported books above £1bn, and after around two-and-a-quarter hours, they set the spread at 57bp on the back of orders in excess of £1.4bn.

Although some orders dropped, the final book of above £1.1bn with around 40 accounts is at the upper end of what Skipton has achieved on its sterling issuance, according to a syndicate banker at one of the leads – for example, it compares with a book above £700m for its last Sonia-linked deal, a £500m no-grow five year issue in October 2023 that was launched in conjunction with a tender for an outstanding FRN.

The Prudential Regulation Authority’s move earlier this month to curtail eligibility of non-UK covered bonds for UK banks’ LCR portfolios contributed to the greater demand for the sterling paper, according to the lead banker.

“There’s a bit more of a predisposition for UK names, even beyond what we had seen previously,” he said. “There was obviously decent representation of UK treasuries supporting the deal, further motivated by a potential lack of capacity to own international bonds.

Skipton’s more regular presence in the sterling covered bond market was cited as an additional factor in the deal’s reception. Having issued its debut covered bond in sterling in 2018 and followed this up domestically the next year, it did not issue again in its home market until March 2022, but since then has sold four £500m FRNs including yesterday’s trade.

The sterling benchmark came in a week bereft of euro benchmark covered bond issuance, following the Easter weekend, but with markets in general proving more stable following the recent tariff-related turbulence – combining with the PRA announcement to make the timing propitious, according to the lead banker.

“They had been considering the market for a few weeks and didn’t feel overly motivated,” he said. “This week’s been better in terms of credit markets and Trump headlines, but there’s still a reasonable amount of uncertainty, so getting something done in covered bond-land felt like a decent option.

“We announced on Wednesday just as a bit of a heads-up, which in theory means taking some overnight risk, but in this asset class you’re much less concerned about the market moving away from you than in senior or subordinated bank debt.”

Indications of interest were concentrated in the high 50s to 60 area and the lead banker said the final pricing of the 57bp area was “pretty close” to where the leads saw fair value.

Before the global financial crisis, buy-to-let specialist Paragon predominantly funded itself through RMBS, but afterwards established Paragon Bank to build up retail funding, with securitisation contributing a diminishing share. And after drawing £2.75bn of TFSME funding, by last year Paragon had no remaining external securitisation indebtedness – which also lowered asset encumbrance levels that had been a contributing factor in preventing earlier take-up of covered bond issuance. When planning its exit from TFSME, the bank therefore finally made its move into covered bonds.

“When the RMBS market shut in the global financial crisis, we didn’t call a number of deals and had to stop lending,” said Dench, Paragon Bank’s head of markets (pictured). “Covered bonds have always been attractive in offering more stable access to markets, and also how quickly you can access the market in terms of lead time versus RMBS.”

Paragon’s move comes in spite of RMBS conditions improving and in some cases pricing beating covered bonds for UK sterling issuance in the past couple of years.

“It’s good that the RMBS market has been pretty strong,” said Dench, “but we’ve been around the block a few times and were well advanced in our covered bond thinking. We see covered bonds as a medium to long term strategy.”

Given the buy-to-let nature of Paragon’s lending, its programme would inevitably take UK regulated covered bonds into new territory, with such collateral rare across the asset class globally and only in the UK featuring in a Coventry Building Society programme that is not a regulated one.

“When we were looking at establishing the programme,” said Dench, “some banks were questioning whether or not there would be appetite, so there was a slight risk in going down this route, even if we thought it would be well received.

“However, we have a proven track record with the type of buy-to-let collateral that we originate and experience from the RMBS markets, enjoying a good reputation in secured funding, which helped. And we were pleased to see that people were willing to engage and do the work to understand the collateral.”

After flagging its broad covered bond plans in reporting last year, Paragon took soundings from investors at industry events, and then, after establishing its programme on 19 February, stepped up marketing through a non-deal roadshow at the end of February and upon the mandate announcement on 25 February.

“It was helpful for us to have front-run the debut,” said Dench, “rather than just hitting the screens and have people start looking at it from zero, and some accounts needed the time to get credit lines in place.

“Some people knew us very well, so it was more a question of providing an update,” she added, “but for others it was more of a learning curve. We received some really positive feedback, with investors happy to see a new issuer entering the market and interested in looking at something a little bit different.”

Paragon targeted launch the week after its mandate announcement, and went out with the new issue on the Tuesday (4 March).

“Markets were still pretty strong,” said Dench, “but we were mindful of headlines starting to ratchet up on the geopolitical side, so we were keen to hit the screens as soon as we could after the programme was finalised.”

Leads Barclays, BNP Paribas and NatWest opened books with initial guidance of the Sonia plus 65bp area for the March 2028 issue, and were able to tighten pricing 5bp to plus 60bp, with the order book peaking above £1.4bn for the £500m (€600m) issue.

“The outcome was fantastic, at only 10bp-12bp back of three year UK prime paper for what was an inaugural trade and the first buy-to-let UK regulated covered bond,” said a banker at one of the leads, “while it captured a nice saving versus three year RMBS.”

A level of around 65bp for such a securitisation was cited.

“The order book consisted of a number of high quality, consistent and key sterling players,” added the lead banker, “with the biggest account type being bank treasuries, as expected, closely followed by asset managers.”

Dench said the potential for involving bank treasuries was a key advantage of a buy-to-let covered bond versus a buy-to-let RMBS, with the latter not being eligible as HQLA at LCR Level 1.

“We’re clearly ecstatic with how it all went,” she added. “Ultimately, we were able to build a really strong book by following the good advice of our arrangers in terms of being a bit conservative, getting some momentum in the book, and then being able to bring the price a bit closer to where we saw relative value, with demand growing further from that stage.

“We could probably have gotten a deal away with a ‘5’ handle on it, but we took the decision to leave something on the table rather than squeeze every basis point out of the first trade, because we’re establishing a franchise and will be coming back to the market, and we’re anyway delighted about where it priced and the overall demand.”

Dench nevertheless argued that while the pick-up over owner-occupied cover pools is consistent with experience in the RMBS market, investors are receiving twofold compensation for the differences in collateral.

“There was a lot of price discovery involved,” she said, “with people clearly having different views on where it should land. We very much saw it as a question of looking at where more standard covered bonds trade and then adjusting for the collateral difference.

“But while the collateral is different, the rating agencies and the FCA have stressed it to reflect that it’s buy-to-let collateral, so the assessment has already been done. It’s always been quite frustrating for us that buy-to-let RMBS tend to price a bit closer to non-conforming RMBS, because we are a prudent lender and our collateral is really strong.”

The covered bonds are rated triple-A by Fitch and Moody’s, with the latter having assigned the programme a Timely Payment Indicator of “probable” rather than “probable-high”, as is the case for other UK regulated covered bond programmes.

Paragon’s cover pool also features greater maturity mismatches due to its buy-to-let nature and commensurate additional overcollateralisation.

“Whereas an owner-occupied mortgage is typically repayment,” said Dench, “buy-to-let is inherently an interest-only product, so you’ve got 25 year mortgages with no repayment. We managed that somewhat by blending more seasoned loans as well as new origination in the cover pool, which helped.”

With the majority of Paragon’s retail funding being easy access deposits and fixed term bonds, up to five years but predominantly one year, the issuer considered three or five year issuance with the three year maturity ultimately meeting both issuer and investor needs.

“Our thinking was that buy-to-let is exotic enough that we wanted to try to keep everything else as familiar as we could,” she added, “including the maturity of the bond. Either three or five years would have added some good duration on our balance sheet, while the curve looked quite steep between three and five years at this point in time.

“We would consider five years in future as well.”

Paragon’s documentation allows for foreign currency issuance, but a euro covered bond is not on the cards in the short to medium term, according to Dench.

“The sterling market is sufficient for our issuance plans,” she said, “but it’s clearly an option for us and we have issued RMBS in other currencies historically.

“Having gotten the first trade done, we’ll be going away and looking at what that means for our funding going forward. We’ve established the programme to access the market regularly on the covered bond side and once a year would be great.

“We will also look at RMBS from time to time,” added Dench. “It still has its positives – even if it’s more expensive, there’s less credit enhancement – and we need retained bonds on an ongoing basis as collateral for ourselves, so could supplement that with some external bonds if the pricing looks reasonable.

“And maintaining greater access to wholesale markets is something that we are strategically focused on.”

TSB Bank’s covered bond issuance had previously been confined to sterling, where levels for UK banks were comfortably inside euros, and last year the bank issued £1bn and £750m four and five year floaters in February and September, respectively, the latter in conjunction with a tender offer.

However, the UK issuer had for some time been eyeing a euro benchmark covered bond for strategic reasons.

“We did a lot of investor work in 2023, going out and meeting accounts, so we felt that we’d laid the groundwork for a euro debut,” Edward Javan, head of balance sheet management at TSB, told The Covered Bond Report, “but we wanted to make sure that we launched into a good market. And it was clear from other transactions just how strong the euro covered bond market was right now for new issuers, those coming from outside of the core of the Eurozone.

“We also had a consistent messaging from our counterparts at the various banks that for the kind of trade we wanted to bring, it made sense to jump in and do it.”

A syndicate banker at one of the leads supported this.

“You’ve seen issuers – like southern European names and UBS again today – be able tighten 8bp across the curve, and there has been a lot more support from real money investors and some official institutions,” he said. “And between TSB, Novo Banco and UBS, you’ve now got three inaugural deals with just massive books.

“If we look at the beginning of the year, where euro pricing was and how the market was behaving, it didn’t necessarily make sense versus theoretical sterling levels,” he added. “But the market kind of turned over the last few weeks and sentiment is really good right now, so they could take advantage of that.”

The mandate for a €500m (£427m) no-grow five year transaction was thus announced last Wednesday morning, and marketing scheduled through to Friday noon, with a total of 14 investors taking meetings, and indications of interest from 44 accounts received. One focus of discussions was the rationale for TSB’s euro debut.

“Essentially, we want to diversify our investor base,” said Javan. “We’ve got two objectives: one, to support the repayment of drawings under Bank of England’s TFSME scheme; but at the same time and thereafter to have the ability to continually raise funds from the wholesale markets to support the growth of our asset book. The more markets and the more investors we can access, the more flexibility we have to do that.

“It was great to be able to meet all those investors over the three days and to get their feedback,” he added. “That then fed into the good momentum on Monday morning.”

An update at Friday lunchtime teed up launch for Monday, subject to market conditions, and leads ABN Amro, parent Banco de Sabadell, BMO, LBBW and Lloyds yesterday morning duly opened books with guidance of the mid-swaps plus 60bp area for the March 2029 issue, expected rating Aaa. After around an hour and 10 minutes, the leads reported books above €1.75bn, excluding joint lead manager interest, and after around two hours, they set the spread at 52bp on the back of books above €3.4bn, excluding JLM interest. The book grew further and more than €4.25bn of orders, excluding JLM interest, were good at re-offer, with more than 100 accounts placing orders.

Market participants put the pricing at roughly flat to fair value – even if the lack of previous TSB issuance and indeed any recent comparable UK supply necessitated a large degree of price discovery helped by the roadshow.

“If you look at the comps,” said the lead banker, “one that the market was looking at was the Virgin Money trade out there, and they landed pretty much flat to that, so they were able to get a deal done in a good market without really paying up for being a new issuer, which was great.”

According to pre-announcement comparables circulated by the lead, the Virgin Money (Clydesdale Bank) 3.75% August 2028s were at 51bp, mid, while Nationwide 3.625% March 2028s were at 33bp, Coventry Building Society 0.01% July 2028s at 45bp, Yorkshire Building Society 0.01% November 2028s at 51bp, and Nationwide November 2028s at 39bp. The latter, a €1bn five year trade in November, was the last UK euro benchmark covered bond.

“I don’t think we could have hoped for a better outcome,” said Javan. “We’ve been working on it for a long time and are really pleased for it have to have been received so well, with such a wide range of investor classes and distribution across geographies.

“Our expectation is that as we return to the euro covered bond market, investors will hopefully participate again,” he added, “but also that we’ll continue to attract new investors who see that TSB is building out a curve in the euro covered bond market.”

UK accounts were allocated 36%, Germany, Austria and Switzerland 30%, APAC 11%, Nordics 9%, Benelux 9%, and other Europe 5%. Fund managers took 43%, banks 38%, central banks and official institutions 15%, and other 4%.

“You are always going to have the domestic following,” said the lead banker, “given that they’ve been buying them before and will look at this euro versus their home currency, but a lot of the demand was driven by real money accounts from other countries who may not have been involved in the sterling issuance. So they were pretty successful from a diversification standpoint.”

As well as having issued its inaugural euro benchmark, TSB continues to closely monitor sterling secured funding markets in covered bonds and RMBS, amid a revival of the RMBS market for UK issuers.

“TSB has now accessed RMBS, sterling covereds, and euro covereds since it was re-launched in 2014,” said Javan, “and this diversification into euro covereds gives us more flexibility to balance our funding needs across different markets as we work through our funding plans over the next three to four years.”

Please download the roundtable in pdf format here.

Participants in the roundtable, hosted by NORD/LB in London on 7 December (left to right below):

Krishan Hirani, head of secured funding, Nationwide Building Society
Pascale Dorey, debt investor relations and senior funding, Lloyds Banking Group
Paul Millon, AVP analyst – covered bonds, Moody’s
Neil Day, managing editor, The Covered Bond Report, and moderator
Philip Hemsley, head of capital markets, Coventry Building Society
Parul Pujara, wholesale funding manager, TSB Bank
Ana Cortés González, portfolio manager, JP Morgan Asset Management (not pictured)
Frederik Kunze, floor analyst covered bonds/financials, NORD/LB Floor Research (not pictured)

Neil Day, The Covered Bond Report: Frederik, we’re at the end of another busy year in the euro covered bond market. What’s have been the key dynamics and how has the UK fared in this?

Frederik Kunze, NORD/LB: We have not really been surprised at the volume of euro benchmark issuance, more so how this evolved over time. It sometimes felt a little bit like a “stop and go” market. We saw less than expected from Canada, for example, while we saw a little more from other jurisdictions, such as Austria. One of the strongest trends was how many short dated covered bonds we saw, with factors on both the supply and demand side explaining why we rarely saw a 10 year benchmark. But overall we can acknowledge that covered bonds once again earned their keep in the funding mix of issuers, while investors were willing to absorb the supply.

We faced a new situation with the ECB pulling the plug on primary purchases and then quite quickly secondary market buying. For UK euro benchmarks, this does not have a direct impact, of course, but there have been substantial second round effects, and more generally the change in the monetary policy environment led to spread widening, also for UK covered bonds. This can nevertheless carry some good news for UK names, because when spreads widen, investors tend to become more selective — even more so when liquidity is not so abundant anymore — and favour those issues of high credit quality, particularly when they again offer some kind of spread pick-up against, for example, Pfandbriefe. This would very much apply to UK covered bonds.

In terms of volumes, we had forecast around €4bn of UK euro benchmarks, and we saw €3.5bn. This is similar to 2022 but well above the preceding years around the pandemic. So while there are good reasons why euro covered bonds are not the first port of call for UK issuers — notably the attractiveness of sterling, which I’m sure we’ll hear more about — UK covered are still on the menu for euro benchmark investors.

Ana Cortés González, JP Morgan AM: We finished 2022 with historically high euro benchmark covered bond supply of €200bn and expectations for 2023 were around €170bn, but we have reached €190bn, so a little bit more than anticipated. This extra amount was somewhat driven by SVB and Credit Suisse, which meant the market for financials was closed for some time. If an issuer wanted to come to market, the only option was a covered bond, in the sense of having low execution risk and a sensible spread, and indeed the market was reopened with a covered bond. So this uncertainty maybe led some issuers to come with more covered bonds than they had planned.

Regarding the UK, there were only a few euro benchmarks, with the bulk of covered bond issuance in sterling. I can see how that makes sense from the issuers’ perspective and all the deals went very well — there has certainly been demand for UK covered bonds, as well as UK prime RMBS, in sterling — while they may face costs associated with euro issuance. I like UK covered bonds and have no problem investing in sterling, while I will also look at any euro issuance — it’s always a question of relative value, taking into account the structure, the collateral quality and the spreads.

Day, The CBR: Krishan, how have you found market conditions?

Krishan Hirani, Nationwide Building Society: The market has been increasingly challenging as we’ve gone through the year. The market was strong at the beginning of the year, which was a perfect backdrop for our €1bn five year deal in March. That was at mid-swaps plus 24bp with a negative new issue premium. You then compare that to our €1bn five year last month at 41bp, where we paid the going rate of 3bp-4bp of premium in addition to the widening in spreads we have all experienced through the year. That just gives you a sense of how conditions have changed.

It’s been a year dominated by central bank policy and rate expectations, and issuers have above all had to navigate that. There have been periods where the markets have needed time to digest supply and adjust to new rate forecasts, so issuers have had to bide their time, take a view on how things are going to play out, and then decide how to proceed.

That said, markets, and in particular covered bonds, have been surprisingly resilient to geopolitical developments such as the two wars underway. The news flow from these regions has been terrible but it hasn’t had much impact on the functioning of wholesale markets, and we’ve experienced this with other shock events in recent years such as the pandemic and Brexit.

Day, The CBR: Pascale, Lloyds was the first UK issuer into the euro market, with a €1bn (£860m) three year in January. What’s been behind your funding strategy this year and how successful has your issuance been?

Pascale Dorey, Lloyds: We were able to achieve what we planned and complete our 2023 funding plan. On the unsecured side, we issued capital in Q1 and, looking back, that was a great decision, even if there was an element of luck about it. Issuance conditions in the first quarter were clearly strong and we decided to issue then even if we didn’t really need to given the levels we were running at. That put us in a good position for the year, especially as the AT1 market effectively closed for a couple of months afterwards.

On the secured side it’s been an interesting year. Levels were very tight and so although sterling was tighter than euros, we were able to issue in euros probably around 12bp tighter than where we would issue in euros today even if in January there were still technical questions around LCR eligibility, which seem to have faded further into the background now.

But what’s been most interesting for us this year is the resumption of RMBS, which we hadn’t issued for some time. RMBS spreads have been extremely tight, almost inside covereds at some point, which makes it really attractive for us and other issuers. So we’ve issued almost as much RMBS as covereds this year, whereas you would typically see more of a skew towards covereds.

In total, we’ve issued about £15bn this year, which is close to where we were pre-pandemic, pre-TFSME. Our run rate would typically be £15bn-£20bn, and in 2024 we’re looking at closer to £20bn, so really back to pre-pandemic volumes. That takes into account TFSME repayments, where we have maturities in late 2025 onwards.

Day, The CBR: Phil, perhaps we can look back a little further, since your last euro was in September 2022 — how has your activity developed since then?

Philip Hemsley, Coventry Building Society: 2022 was an unusually quiet year for us. We did the €500m deal, which we spent a lot of time and diligence on, making ourselves comfortable there was going to be demand, because the LCR discussion was very much live at that time. It went very well and the reception was probably better than we expected — we’d been anticipating a book of perhaps €750m and it reached €1.3bn. It wasn’t the cheapest trade on earth at the time, but the way the world’s moved since then, we’re glad to have got the euro under our belt.

That set us up nicely for this year, when we’ve been able to focus on sterling. We did have a euro in the plan at various points, but the strength and cost-effectiveness of the sterling market has simply kept us away from that. We did a £500m covered bond and a sterling RMBS in the first quarter, and they were both very well received. We then came back with another RMBS, which chimes with what Pascale was saying about the differential between RMBS and covereds — by some measures, our RMBS was flat to a three year covered. So overall the sterling market has just been super-supportive.

The backdrop to our funding need has been a slower mortgage market and a pretty buoyant savings market, so given that we are mainly retail-funded and only do mortgage lending, what we need to do from a wholesale funding point of view has been squeezed — further explaining why any thoughts of a euro covered fell away.

Besides the secured funding, our most strategic trade was our £400m senior non-preferred deal, which gets us ahead of the future MREL need we’ll face when we go past £50bn of deposits. Again, we got really good support from the sterling market.

Day, The CBR: Parul, how does TSB’s experience compare?

Parul Pujara, TSB Bank: It’s been a relatively busy year for us. We stood back from the covered bond market in 2022, so effectively made up for that in 2023. We issued £1bn in the first quarter because, as mentioned, markets were quite constructive back then, though admittedly very crowded. The timing of our results actually work in our favour because we don’t immediately rush out of the doors in January when it’s already busy and there’s so much competing supply on screens. We typically wait until February, which worked well for us this year as conditions were still supportive at this point. January’s trade was actually our largest ever covered bond: our trades are normally a maximum of £500m in size, but demand in Q1 was strong and we saw that there was an opportunity to upsize to £1bn, so we took advantage of that and took the additional funding whilst it was there. We then accessed the market a second time this year, printing £750m in September, which was another upsized transaction. We also did a liability management exercise alongside this new issue, which was a great way of de-risking the execution by freeing up investor lines. Investors were very receptive to the buyback as it gave them the opportunity to offload their Feb 24s and participate in the new deal, so it worked well for everyone.

Overall, we’ve been broadly on plan with what we had set out for the year, which was to do around two or three trades. We’ve also been monitoring the euro market, but for the reasons already mentioned, that hasn’t really been favourable, so for the time being it’s made the most sense to keep to sterling, whilst levels have remained relatively tight. We’ll continue to monitor that space and hope to issue in euros in 2024.

Day, The CBR: Last, but not least, Krishan, Nationwide has been very active this year across a variety of markets and formats. You mentioned earlier that markets have been increasingly challenging — what has been your strategy this year?

Hirani, Nationwide: We’ve issued more than £5bn of covered bond funding in the calendar year, including five benchmarks and across five currencies, and are on track to meet our funding requirement for the financial year to 4 April. Diversification has been important to us to be able to achieve these volumes. I completely agree with the sterling comments — the sterling market has been fantastic in terms of cost — but if you’ve got aspirations to do five or six billion of secured funding in a year, you can’t do that in a single currency, and especially not in sterling. That’s why we have put a lot of emphasis on not only sterling and euros, but also dollars, Swiss francs, and Norwegian kroner, which have all been interesting at various points of the year and have given us options to access certain markets when others may have been more difficult. It’s been particularly helpful to be able to navigate the challenges I highlighted earlier.

Some of our recent increased level of activity in recent months is explained by our expectations for 2024: we think the trajectory of spreads and overall market backdrop will continue, with potentially more headwinds in the coming year. The rates headlines will continue in 2024 and in addition to that you have central bank refinancing, elections and further geopolitical risks. The impact of all of this combined on both retail and wholesale markets is uncertain and so we have tried to position ourselves for this and frontloaded some of our funding into the last couple of months of this calendar year. Saying that, we expect to still have a similar volume of funding to get through in our next financial year, so we’ll be busy again and expect to access a similar array of markets and currencies.

Day, The CBR: Frederik noted earlier the prevalence of short dated issuance this year in euros — Nationwide has been particularly active at the long end in past years, so how have you coped on that front?

Hirani, Nationwide: Indeed, the headwinds I mentioned have had not only had an impact on spreads and the market windows we’ve had to navigate, but crucially they have had an impact on the availability of duration, particularly in covered bonds. Nationwide historically — and hopefully going forward, too — has seen covered bonds as an opportunity to extend the duration of our wholesale funding base, which is why in the past we’ve done trades like 10 year sterling, and 20 and 15 year euros. We like having those options and we try to use them when appropriate, but this year none of them have been on the table; most of the funding we’ve done has had to be short or mid-dated. We did try to extend to the extent that we could: on that first euro trade we pushed to get the five year tenor, and for the sterling trade we did a month ago, seven years was something that hadn’t been tested for a while so getting that done was fantastic.

I think duration in euros has been the underwhelming story of the year, as Frederik already mentioned. It’s rate volatility that has really killed that market: it’s not so much that rates are rising — higher rates are good for investors, they’re getting much more yield as they extend along the curve; what investors don’t like is the volatility, the risk that they invest in a trade in the morning at an expected yield of x, and then by the end of the day or by the end of the second or third day, the market has completely moved. What we are hoping for next year is stability in rates, which should open up the longer end.

Cortés González, JP Morgan AM: I guess issuers in general would love to print longer-dated covered bonds, because we’ve only seen very strong short term issuance, and this is normally a product used for seven, 10 years and longer funding. But it’s highly dependent on how the market looks. In 2023 there were only very few opportunities for issuers to go longer at a reasonable spread, and I’m not sure whether we will see more long-dated supply, either in sterling or euros.

The sterling market has developed very nicely in three and five years for some time now, but seven years is still not a maturity that is used very often. And from an investor perspective, if you go into maturities where there is not much enough, liquidity can be quite challenging. I would tend to prefer issues in three or five years — assuming I like the relative value in general — simply because market depth is better. If issuers want to go out to seven years, they might have to do more to develop this part of the curve to make it more attractive.

Kunze, NORD/LB: Recently there has been some jeopardy in the market when it comes to new issues, and the longer end of the curve is exactly where we could see a mistake, because it’s really difficult to find the right price when there has been so little supply — the only comparables are lower coupon deals from past years and the situation is now completely different. Meanwhile, it’s not clear how much issuers are willing to pay to extend along the curve. There may be some issuers willing to test the long end at the very beginning of the year, but the appetite is not so high so timing will be crucial. Later in the year, when, hopefully, the swap curve is no longer negative-sloping, the situation could be quite different and we could see more and more longer dated deals. Our economists currently expect the curve to change thus at the end of the third quarter, but you never know — we have renewed volatility when it comes to the question of what the ECB will do. Anyway, if there is little pressure to extend duration, it might not be the best strategy to go to the long end for now.

However, the topic of ALM mismatches is coming back to the surface. We haven’t heard much so far from the rating agencies about what risks these might hold for ratings or overcollateralisation requirements. But if this becomes pressing, some issuers might be willing to take a hit in terms of spread.

Paul Millon, Moody’s: The short term maturities are clearly something we’ve seen from the UK, but also in pretty much every market in 2023. This doesn’t impact our analysis, per se. Although short term issuances increase the maturity mismatch with the assets, in our model we already typically assume that at least 50% of cover pool assets will need to be refinanced following issuer default. So we don’t adjust our modelling in response to real time fluctuations in new issuance maturities.

Day, The CBR: Pascale, how important are duration and the euro market for Lloyds when it comes to covered bonds?

Dorey, Lloyds: Investor diversification is key for us. As mentioned, the sterling market has been extremely strong recently, but it’s really the UK bank treasuries that have supported the market and we’re quite conscious that relying on them is not going to be sustainable in the long run, so there’s definitely a focus on diversifying away from that one investor base. At the same time, it has been a very good market in terms of pricing and overall conditions, which is why we issued two sterling covered bonds this year and only one euro covered bond.

In terms of tenors, we are inclined to issue shorter dated covered bonds given the kind of duration of our assets — that three to five year bracket actually works pretty well. To the extent that we get diversification with longer dated issuance, we’d definitely consider that. But in terms of asset and liability matching, for us the natural issuance would be around five years, and then we get a bit more extension in wholesale funding via other products — at the HoldCo, senior, capital would typically be a bit longer dated.

Day, The CBR: Talking about diversification, is dollars — which Lloyds has used for other formats — something that is of interest for covered bonds?

Dorey, Lloyds: We issue in dollars at the HoldCo, but haven’t done dollars at the OpCo for a long time. Clearly you pay more, while investor diversification is there but only to an extent — you can be selling bonds at a higher spread to the same investors who would buy you in sterling. And we haven’t really needed to go beyond cheapest-to-deliver sterling in issuing £2.5bn of covereds this year — except a Swiss franc issue, but that was inside sterling, and we’d probably look at other currencies like that before dollars because of the aforementioned limitations.

Hirani, Nationwide: Indeed, when it comes to currency diversification, it all depends on the quantum of requirement. Like I said, you cannot do more than a certain amount in sterling even though we’d all love to. Saying that, given our experience in the three markets we accessed in the past month, I do think there is diversification there, and a significant amount of it. You cannot stop investors who have multi-currency capabilities playing in all the trades — they will, and on one level that’s good, as it helps your transaction; what you can do is allocate bonds to the target market that you’re looking to look issue into. Our US dollar transaction had 40% non-European participation and to me that is significant — it was the rationale for doing that. Within the 60% that went to Europe, split across UK and other European investors, yes, there is some crossover with not only sterling, but also euros as well. But the diversification we achieved into North America was the purpose of the transaction.

Day, The CBR: Parul, the same question for you on the importance of duration and euros.

Pujara, TSB: I would echo much of Pascale’s comments. The three to five year bucket has worked well for us too this year, and it’s what investors have wanted, so it ticks both boxes.

As I mentioned previously, we have been monitoring the euro market for some time now. When we do decide to tap the euro market, we’re conscious that it will be our debut trade, so timing and pricing will be crucial. We accept it will be expensive relative to sterling — given it’ll be TSB’s first, we also need to factor in an inaugural issue premium on top of that sterling-euro differential — and we expect to see a lot of the UK buyers of our sterling bonds in the orderbook, given the attractive pick-up, so the first trade will be less about diversification and more about establishing a presence in the euro market. But we’re mindful that the sterling market is small and credit lines get used up really quickly, so the diversification into euros is important.

Day, The CBR: Phil, you mentioned that you will keep an eye out for euros next year — how important is that and duration?

Hemsley, Coventry: The two things we like from euros are the diversification and the fact that you could take a little bit more duration. The two three year trades and the five year we’ve done in the secured world this year work fine, but the preference is more that five to 10 year bucket. Apart from the last euro, in 2022, where the market wasn’t there for a seven year, every euro trade we’ve done has been seven years — it falls quite nicely into that bucket and you’re getting genuine diversification in terms of investors. And the duration is a bit further than you could generally do in sterling. So yes, euros is a key market for us.

To an extent, it plays into what Krishan said about how diverse you need to be depending on the quantum of what you’ve got to do. After 2022, 2023 has been a more typical year for us, and if you’re doing one covered bond and maybe one or two RMBS, then you can probably get away with just playing in sterling. We’re looking at dollars for RMBS and euros for covered bonds, and in the fullness of time could look at other currencies, but for the time being, if we’ve got one deal to do, it’s natural to look at the cheapest to deliver. Next year we expect to do one euro and one sterling, just to be active in both currencies where we have established a presence, but it all depends on demand on the retail side, too. If there isn’t much more mortgage growth and retail savings keep performing well, then one of those could get squeezed, and there’s always a chance that’s going to be the euro if that’s the most expensive option.

Day, The CBR: Let’s focus a bit more on RMBS now. That’s something I believe you are all interested in as an option and now seems to be on the table at levels roughly flat to covered bonds in sterling. What are the dynamics behind that, do they make sense, and are they sustainable?

Hirani, Nationwide: Both markets are important. They coexist, albeit there is some overlap in the investor base. However, there is also a significant portion of the investor base that is bespoke to each asset class or will have specific cash for each product, so you are achieving diversification.

Am I surprised that they are pricing so close to each other at the moment? A little bit. Historically, the average differential between the two markets has been anywhere between 5bp and 15bp, so to see them essentially on top of each other is unusual. However, if you think about the technical side of it, the covered bond market is a lot more supplied than the RMBS market, and it’s supply that’s been the biggest driver of that narrowing differential. As long as that dynamic is broadly there, I think the situation will persist — investors are clearly getting comfortable with buying one close to or on top of the other.

We’ve always argued internally that the assets are the same — both are triple-A rated products — and from a risk point of view some investors argue that they should price very close to each other. So you’re really drilling into some of the structural, technical differences if you want to apply a material differential.

We do expect RMBS supply to pick up next year. TFSME refinancing is going to be a big factor in that. There are a vast amount of TFMSE drawings in the UK, and although it feels like a lot of that can be repaid without too much trouble if you look at LCR ratios, if you look at the list in a granular way, there are a number of borrowers who potentially only have RMBS to go into to be able to fund their repayments. So you should expect to see more supply, which may have an impact on that RMBS-covered differential next year. But we shall see.

Dorey, Lloyds: I would echo those thoughts. They are indeed very close to each other. There are reasons both on the issuer side and the investor side that would argue for RMBS to be slightly more expensive, so as an issuer it makes sense to make the most out of these pricing conditions. As Krishan mentioned, supply is likely to increase. You’re probably not going to get to that 10bp-15bp kind of differential, but you will probably see a bit more differential over the next year or so.

Day, The CBR: Phil, you mentioned dollars as an option on the RMBS side.

Hemsley, Coventry: An expensive option, at the moment.

Day, The CBR: Expensive just because sterling is so good, or actually kind of in itself?

Hemsley, Coventry: A combination of the two. Sterling being so good is definitely a driver. But also the US investors have a huge array of products they can buy, and therefore to look at UK issuers and UK RMBS, they will expect a bit of a premium. It’s an option in the long run and certainly our RMBS platform was set up to ensure we can do dollars when it was established in 2020. Again, it comes down to the quantum of requirement.

On the pricing difference between RMBS and covereds, I remember getting told not so long ago it was 10bp as if that was almost set in stone. Then people seemed to say, oh, it’s 5bp to 10bp. And obviously that’s all gotten thrown out the window. I think there’ll be more issuance on the prime side and that will probably see pricing drift wider and some of that differential reappear. But this year we’ve certainly encountered plenty of demand when we’ve issued, and there’s just not the supply.

It feels logical that covered should be tighter than RMBS because there’s the dual recourse, but the other side of that coin is that with RMBS you’re a bit more isolated from the from the originator, the sponsor, and you’re just looking at the loan book. UK mortgage quality has managed to stay pretty robust and in a world where things can happen to the sponsor bank, maybe just having exposure to the portfolio isn’t a bad thing.

Dorey, Lloyds: You also have extension risk with RMBS.

There’s typically the argument that with a covered bond, you can move a lot more quickly, and that has really made it attractive for issuers, in that you can be more reactive to market conditions. But then again, we’ve now seen Nationwide’s innovative “stock and drop” RMBS, so that’s could be changing, and maybe you will be able to come to market a lot quicker next year.

Hirani, Nationwide: One of the biggest issues with RMBS has always been how long it takes between making a decision to do a transaction to being in the market and able to execute it. A lot of work and process needs to go into it and you can’t avoid that, but it can up to eight to 12 weeks. This means that we as funding officials can’t take a view on the market or be nimble to take advantage of opportunities.

So essentially the idea is, you do all of this work once a year, and then you self-issue an amount of bonds, which we’re calling the “stock”, that is reflective of your upcoming year’s expected funding programme requirement. So Nationwide holds these bonds, but they are real, they’re fully documented, all of the diligence and structuring has been done, and they’re ready to be sold. So if and when you decide that you want to come to market with a transaction, you can do so within days of making that decision. Previously, if we were discussing what our funding options are and what markets are open to us over the coming days and weeks, our Silverstone RMBS programme was never a part of that conversation. Now it is very much part of that conversation alongside covered bonds, alongside senior funding, which puts it on a level playing field. We can use it in a lot more agile, reactive way to market dynamics and conditions, which is hopefully going to be positive for us, mainly, but also for investors, because they’ll probably see more of it from us and benefit from the liquidity.

Day, The CBR: Paul, what’s the view from a rating agency perspective?

Millon, Moody’s: I agree with what Krishan was saying about the assets being basically the same when it comes to prime RMBS and covered bonds. And in fact, we do analyse these in exactly the same way, with the same model and methodology. We do then give some benefits to covered bonds because of not only the dual recourse, but regulations as well, and we expect that in a stress scenario — where in an RMBS the assets are deteriorating — issuers of covered bonds will probably clean the cover pool to maintain their ratings. So investors get some benefit, and from a pure credit standpoint, you wouldn’t expect an RMBS to be priced inside a covered bond. So I would agree that supply and demand is the main factor.

Day, The CBR: Ana, how do RMBS and covered bonds compare from your point of view on the buyside?

Cortés González, JP Morgan AM: I cover RMBS and covered bonds and I’m a big fan of both products. UK RMBS went through the entire financial crisis and, apart from one hiccup, the large UK master trusts behaved exactly how they should have done and emerged pretty much unscathed. So from a structural point of view, I’ve never really doubted this product — it is as sound as it can be. Furthermore, structures have improved since the financial crisis. But then after the financial crisis this floating covered bond market suddenly appeared in the UK, with three and five year issuance, and it has developed since then.

Historically, RMBS traded at a pick-up of roughly 10bp-15bp over the respective covered bond; now, we are seeing RMBS trading more or less in line with the covered bonds. It is true that RMBS has returned this year after there was hardly any supply in the prior two years, as banks did not need the funding. While there is an overlap in the investor bases, with some buying RMBS as well as covered bonds, some do not. This has contributed to all the UK prime RMBS deals going very well.

In terms of the credit quality, there’s not much of a difference between the collateral, especially in prime RMBS. When you go into other RMBS sectors, it’s different, but when you look into the same issuer’s covered bond pool and RMBS pool, there may be differences, but they are only minor, and it’s very hard to put a number on what this might be worth in terms of basis points. And yes, you can argue that from a structural standpoint the RMBS might have more extension risk, and it’s important to acknowledge that these differences are there and can be important, but at this point in time, it’s hard to say from an investor perspective that an RMBS should be paying, say, 5bp more. That could change, but it’s reasonable for RMBS and covered to be trading roughly in line for now.

Kunze, NORD/LB: The UK is quite a good example of a well-functioning blended market, where you have both means of funding.

In general, I would say that covered bonds are for technical reasons more secure for investors, because in a very severe scenario you have various kinds of protection — the exemption from bail-in, for example. And if this plays out differently in the market — as is evident from other comparisons, such as covered bonds and sovereign spreads — it is a question of liquidity, or the desire for diversification, or supply and demand. There could also be an element of the dynamic nature of cover pools being more demanding to monitor than RMBS assets if they are actively managed, for example checking when new loans could be coming into the pool with lower mortgage rates than the interest paid on the covered bonds.

Investors could currently see some kind of appeal in UK covered bonds, with the strong focus on residential mortgages, when cover pools in some other countries like Germany are so dominated by commercial real estate. But then we should perhaps discuss what is on the cards for UK covered bonds with the higher interest rates. We haven’t yet seen all the pain from this yet in the UK. On the other hand, while many households still have large amounts outstanding on their mortgages, it’s not so much when compared with the value of the property. Meanwhile, banks currently have higher profitability thanks to higher interest rates, although when higher risk weights kick in due to the economic cycle, the profitability of banks may not be as strong anymore.

So investors should be doing their homework to understand what’s behind the instrument they are buying, whether it’s a UK covered bond or a Pfandbrief.

Day, The CBR: Let’s stay on that topic of credit quality. We’ve already heard some encouraging words about how the housing and mortgage markets have performed so far, but there have been headlines about “mortgage timebombs” from upcoming resets at higher rates. Is there pain to come?

Millon, Moody’s: These loan resets will be a key theme next year. We expect a little bit of a pick-up in arrears, but nothing significant. For us, the main thing is that unemployment with remain fairly low. As long as you have a job, you pay your mortgage. Unemployment has been low for a while and we expect it to stay low next year too, even if it goes up a bit.

In UK cover pools, most of the loans are short term fixed rate, up to five years. We looked at the fixed rate loans in cover pools, and the average interest rate paid on them has only slightly increased since the end of 2021, by just 60bp, while new fixed rates have rocketed by over 3%. So we estimate that only 20% of the increase in rates has so far been transmitted to fixed rate cover pool loans. 80% of cover pool borrowers have short term fixed loans and many of them are going to be hit by the higher interest rates in the near future. But again, with continuing low unemployment, borrowers will generally be able to tolerate higher mortgage payments, so we expect a moderate increase in arrears rather than a big spike.

In terms of the new borrowers, several factors have so far offset the impact of interest rate hikes. The decrease of the affordability stress from 3% to 1% has helped, while the spread between mortgage rates and benchmark yields has contracted by around 2.5% since 2020, which has softened the impact of higher rates on borrowers. We’ve also seen a steady increase in the duration of new mortgages, with the share of 30-plus year terms increasing from 20% a few years ago to close to 35% of originations, which reduces payments for borrowers. The downside is that longer terms result in higher debt burdens and slower amortisation, which is negative from a credit perspective.

Covered bonds are well placed, as Frederik mentioned. There is a lot of OC in the cover pools, much more than we require for our ratings, and we know the FCA is kind of encouraging issuers to maintain high levels of OC. LTVs are very low. We’ve seen house prices decline recently, but if you look back just a little, even between Covid and last year, house price increases greatly exceed the slight decrease that we’ve seen this year. So a lot of equity has been built up in the pools. Yes, house prices might decline a bit more in 2024, but we did an exercise where we calculated what we call the breakeven house price decline — by how much house prices have to decline before the value of properties is less than the covered bonds that have to be repaid. Accounting for LTVs and OC, the average breakeven decline for UK cover pools is 70%. So there are a lot of structural protections for covered bonds against any potential weakening in the housing market.

Day, The CBR: What are the issuers seeing in their loan books and what are your expectations for the overall market?

Pujara, TSB: Lending criteria have been strong in the UK for a number of years now, helped by a number of regulations, so asset quality has held up well, and that is common to all UK covered bond programmes. The fact that not many borrowers are taking out the provisions of the recent Mortgage Charter evidences that, which is encouraging to see. We could also see more regulations coming in or more support for struggling borrowers from the government, driven by the cost of living.

Dorey, Lloyds: Most of our book is fixed, with about a quarter rolling off every year, and then we have the floating rates as well. We’ve seen over half the book reprice now onto the higher rates, and in terms of cost of risk, we’re still guiding for very low levels, below 30bp, which is around where we used to be in a fairly benign year pre-pandemic. A lot of factors are helping, but clearly the fact that wage growth has been quite significant has helped offset some of the pressures. And when we look ahead, inflation is starting to come down. Famous last words, but I think peak mortgage rates are behind us, and we didn’t see a huge level of activity when mortgage rates were 6%, 6.5%, obviously, because they weren’t attractive to borrowers. So whilst we’re never really going to go back to the ultra-low mortgage rates you had in the pandemic, we are looking at potentially improved conditions into next year, with lower mortgage rates. We still forecast a small decrease in house prices, but that probably makes the market slightly more attractive for first time buyers, and you should hopefully see a pick-up in that activity, while, as Paul mentioned, unemployment remains low and supports repayment ability.

Hemsley, Coventry: Arrears-wise, we’re seeing an increase, but it’s not at all dramatic. We are tracking back to the kind of levels we saw in the early 2010s, which was a relatively benign time. We’re not seeing any higher incidence of arrears in customers that have come off one rate and gone onto a higher rate. The calls that we get in our collections department are still the same flavour they’ve always been: divorce, bereavement, injury, unemployment, the latter being key. They’re not getting a huge incidence of people who are still in their job but are facing problems because everything’s now costing more. About 92% of our book is now post-2014 mortgage market review loans and we have less than 20 repossessions in that part of our book — it does feel like that potentially made the UK mortgage market a lot safer for lenders and we are seeing the benefits of that now.

Day, The CBR: Ana, do you have any concerns regarding UK collateral?

Cortés González, JP Morgan AM: I don’t have any particular concerns, as such, but I’m always vigilant. I would agree with some of the points already made. I look at the RMBS investor reports to get a picture on the covered bond side, too, and they all show very stable performance. I would expect that as people refinance into higher rates, there might be a bit of an uptick in arrears, and potentially a bit of a decline in CPRs, but this is coming from very low levels.

I would echo the point on unemployment, which is the most important aspect. Looking at the period during and after the financial crisis, the performance in UK prime RMBS pools was very good, and a lot has happened since then: banks having tightened their underwriting criteria and met new regulatory requirements. So overall collateral quality has improved and certain products are not available anymore. Additionally, people have jobs. I’ve seen charts showing a strong correlation between the UK unemployment rate and delinquencies, and there is of course a strong link: if you have a job and can pay your mortgage, you pay your mortgage, because it’s the roof over your head — this is not speculation — and once you default, it’s not so easy to get back on your feet, so you only go down that route if there’s literally no other option. But we are talking prime borrowers here.

So net-net, although it’s always worth keeping track of how the situation is evolving, I don’t foresee a significant deterioration of the overall performance.

Day, The CBR: Going back to the LCR issue that was mentioned a couple of times earlier, how has that played out?

Hirani, Nationwide: Pascale mentioned earlier that it’s not really a hot topic anymore and I would agree. We’ve seen proof of that in the four UK euro trades this year — all have had very healthy participation from European bank treasuries, which are the LCR buyers in question. More was made out of the issue than it actually was, and quite positively over the last few months one or two of the investors who may have been the more vocal from the start have revised their internal positions. Only one or two investors — and small ones, at that — mentioned regulatory uncertainty as a reason not to participate on our euro deal last month, so I’d like to think we’re 95% there on the LCR issue so have moved on from it — which is great, because we can focus on other matters and look forward to achieving third-country status under the new directive in the future.

Kunze, NORD/LB: The issue arose from there having been no clear answer from any authority on whether the UK is equivalent in its supervisory regime and other aspects — the answer was that it’s a case by case basis matter. We might get some help on this from future EU or Basel measures, but I’m not 100% certain that any EU bank treasury will get a definite yes when asked if they can treat UK covered bonds as LCR-eligible — this is what we hear from the investors. They need to prove it, and while Canadian and APAC names are on a list, the UK isn’t. However, this has been overcome by many market participants because the LCR treatment is not the only relevant investment factor; it’s more a cosmetic aspect for many, but investors will buy UK covered bonds for other reasons.

Hirani, Nationwide: Yes, when the concerns were initially raised, the solution in the eyes of investors was to seek an official list with the UK on it. It then took some education from a lot of people, including those around this table, explaining to the investors that we’re not going to get a list, that’s not how this is going to work. Therefore, we explained how on a fundamental basis the UK framework is equivalent. Firstly it hasn’t changed from two years ago, but secondly, it is equivalent, if not stronger, than both the existing and the new directive. Finally, investors needed to be aware that they could individually make their mind up, and not have to wait for something official and speak to their regulator. Once investors understood this, that opened the gates.

Cortés González, JP Morgan AM: LCR treatment is not a consideration for us. If we look into a UK covered bond, whether or not we participate is entirely driven by our credit as well as our relative value view. I do monitor the situation, and I can understand how it can be more important for a bank treasurer, and hence that third country equivalence could be beneficial for the issuers. But for me what is important is to understand the structure, the collateral, and the relative value at the point in time if and when a covered bond comes.

Day, The CBR: Fred noted that there could be forthcoming EU moves related to the treatment of UK covered bonds. What are expectations regarding third country equivalence pursuant to the covered bond directive?

Millon, Moody’s: We would definitely it see as a good thing were the UK to be recognised as a third country under the EU directive. But it’s a long way away. It keeps being postponed and the new target date for the EBA to give their feedback to the Commission is June 2025. And then after that, everything needs to be put in place from a legislation standpoint, so it will be a number of years before we see any third country equivalence. The Commission hasn’t even produced a framework of how they are going to look at equivalence. We don’t think it will be necessary for the UK regulations to match the EU directive line by line, but it’s likely that some changes to the regulations will be needed to qualify for equivalence. Then there is the question of reciprocity, that is whether the Commission would ask the UK to recognise EU covered bonds the same way as they will be recognising UK covered bonds. That isn’t the case today so the UK would probably have to change that if it wants equivalence. Ultimately they could then achieve favourable treatment for NSFR, LCRs, under CRR, etc, which would be beneficial among investors.

We did a deep dive into the covered bond laws for all key third countries. We found that UK regulations are more or less aligned with 75% of the directive, second only to Canada. Looking at the implementation of the directive in the EU, some countries took the opportunity to remove aspects of their national laws that exceeded the minimum required standards. In Portugal, for example, they had a strong law and aligning with the directive reduced some benefits. If the UK chooses to do the same, there are areas where we could see a loosening, like the 8% OC requirement that might come down to 5%, for example, while the treatment of exposures to credit institutions is quite strong in the current regulations, so could be softened to be aligned with the directive.

Day, The CBR: Looking again at the year ahead, how would issuers sum up their expectations for 2024 — including potential Pfandbrief issuance when it comes to Lloyds?

Dorey, Lloyds: The German entity has Dutch mortgages and has done securitisations on those, and will potentially look at covered bond issuance next year. That will add to the funding diversification goal we were talking about.

Although there are naturally a number of considerations regarding asset and liability growth to factor in, overall for Lloyds you’ll more or less see a balance sheet in a year’s time that doesn’t look that dissimilar to today — roughly flat on assets, roughly flat on deposits. There’ll be a funding gap coming from TFSME repayments that we are looking at, with a late 2025 maturity for part of the loans and the balance being in 2027. So we expect to be more active than this year — probably stable at the HoldCo level but an increase at the OpCo level, really to pre-pandemic levels. That will mean more covered bonds and us being more active in the funding market overall. As I said, that could be impacted in movements in assets or liabilities, but that’s roughly what we’re anticipating.

Pujara, TSB: Next year will probably be about the same on the covered side. As Pascale said, we are not expecting dramatic change in the balance sheet or funding plan as it’s looking at the moment. The slight nuance is that we’ve got our TFSME repayments as well, and to help support those we would like to be active in RMBS so we don’t have to rely solely on the covered bond market. We’ve not been active in public RMBS since 2016, so it will be good to restart issuance there. There are also some unknowns on the mortgage side that could affect our funding plan next year. The mortgage market is of course very competitive and given some of the macro themes that have already been mentioned, activity could be quite muted next year, but we do have plans to maintain, if not grow, our market share. So we think next year’s funding plans won’t be too dissimilar to this year’s, albeit with some diversification into euro covered bonds and RMBS.

Hemsley, Coventry: We expect to grow the mortgage book next year, but not dramatically, and we’ve got some TFSME to pay off — although we’ve already done a bit of the heavy-lifting in paying some off this year, and we’re going into next year with quite a lot of cash on the balance sheet with the deposit growth. So after having done a covered, two RMBS and a senior non-preferred this year, there’ll be a little more SNP to make sure that we meet the forthcoming MREL need, and I imagine we’ll be active in our RMBS again, because the plan is pretty much to crank that handle and use it every year. And then at the moment we envisage two covered, one euro and one sterling, but if we get a little more deposits than expected, one of those could get squeezed out of the plan. So overall next year will feel a lot more like a typical year, and certainly so if both covereds stay in.

Hirani, Nationwide: We expect it to be another challenging year in terms of markets. TFSME is not going to be the driver of volumes for us — we’ve either already repaid it or it’s been pre-funded and is being held as excess liquidity at the moment. Therefore, it’s going to be the retail market that’s going to drive the funding requirement. I agree with most of the comments, in terms of broadly stable mortgages, but it’s deposits, as I mentioned earlier, that could be the big delta next year and we’ll see how it plays out. That should all lead to a broadly similar funding requirement. The only difference you’ll see is more RMBS in the mix — we’ve already told the market what that number might look like — and therefore probably as an overall mix, slightly less covered and slightly less senior preferred.

Day, The CBR: How do the issuers’ plans fit in with expectations for overall UK and euro benchmark activity in 2024?

Kunze, NORD/LB: We expect €168bn of euro benchmark issuance overall in 2024, with €5.5bn forecast from the UK. There are €8.5bn of maturities next year in the euro benchmark segment from the UK, quite a bit, which means the UK will be one of the very rare markets with negative net supply, minus €3bn. This should support UK spreads relative to other jurisdictions.

I understand why some other currencies are more interesting, but we would not be unhappy to see more from the UK. Despite all the LCR discussion, I think there are investors keen to be able to diversify a little bit away from Austria, Canada, France and Germany, so more UK issuance could be good news for some investors, too.

Cortés González, JP Morgan AM: I would like to see strong supply in general coming into the market again in 2024. We had a couple of years where supply was muted, and — using an analogy from European ABS — there’s always this risk that if you don’t have enough supply, more and more investors will turn away, towards markets with more supply. So the more supply we see in covered bonds, the better it is for issuers, for investors, for the entire market community.