Senior issuance outstrips covered
Source: IFR - International Financing Review

28 February 2012
By Aimee Donnellan, Jean-Marc Poilpre

In an impressive turnaround, senior unsecured primary FIG issuance has outshone covered bonds so far in February, as the positive tone in the market continues to lure banks into selling unsecured debt. European banks issued this month just under 23bn of senior unsecured issuance, across currencies, while covered bond issuance was some 19bn, according to CreditSight analyst Puja Poojara.

The senior unsecured market saw a healthy stream of transactions from an interesting breadth of issuers. Deals ranged from strong names from counties that had fallen out of favour in the past months, such as France and Italy, to tier-two names from challenging jurisdictions such as Denmark, which last year forced senior bondholders to take losses after bank failures.

"The market is definitely not shut for covered bonds. However, our advice to banks is to tap the senior unsecured market while it is open," said a DCM banker.

The thinking is that senior unsecured funding should be favoured by issuers because the covered bond market will prove more resilient than the unsecured one if market conditions deteriorate, and because the cost of funding in senior unsecured debt has fallen dramatically relative to covered bonds.

A syndicate banker pointed to the abundance of cash as one reason for the surge in unsecured issuance. "Investors have money to put to work and they are not getting their fill from the secondary market," he said.

Other bankers feel that a rating review launched by Moody's could be a major drag on covered bond issuance, especially for programmes at risk of falling below Double A. The rating agency two weeks ago put on review for downgrade ratings on 114 financial institutions in 16 European countries.

The ECB may have influenced the funding mix too. "Volumes in the covered bond market are also probably depressed by the fact that the collateral is being used for the ECB [repo] operations," said Eric Cherpion, global head of DCM syndicate at SG.

Risk of petering out

While there are some good reasons for the slowdown in the public issuance of covered bonds, there are also quite a few for the strong run of the senior market to peter out. Cherpion noted that all the issuers that planned to issue senior unsecured debt had now done so.

"Many treasurers felt it was better to issue first in the more difficult market the senior unsecured market and then issue covered bonds later on when market conditions become tougher," he said.

Bankers at the IMN global covered bond conference on Thursday warned that the tide for the senior unsecured market could turn, pointing out, for example, that this market could be derailed at any time by further discussions about bailing in debt.

"Many treasurers felt it was better to issue first in the more difficult market the senior unsecured market and then issue covered bonds later on"

Morgan Stanley analysts echoed that view in a report in which they recommended that investors switch from seniors into selected covered bonds. In their view, the impending publication of the draft law on the EU's resolution regime "may spook" some holders of senior debt.

The analysts also argued that balance sheet encumbrance would "surely catch agencies' eyes sooner or later" and could result in even more downgrades to senior unsecured debt. Fitch warned in December that it might notch down unsecured ratings to reflect below-average recovery expectations if it believed that asset encumbrance was particularly high.

The Morgan Stanley analysts also mentioned the expected depositor preference law that should come through within the next few years and the implications of the UK's ICB for holders of senior bonds.

Striking the right balance between senior debt and covered bonds is not easy. Speaking at the IMN conference, the Swedish Central Bank's Matthias Persson said: "Senior unsecured funding needs to be part of banks' funding or we will run into problems in the future."

"The importance of the covered bond market will increase in the future but it's not the holy grail for funding banks it hasn't been in the past and it won't be in the future," he added.

According to market sources, central banks are encouraging financial institutions to tap the senior unsecured market rather than issue covered bonds. This appears to have been what drove Swedbank to issue this year senior debt when that bank has historically favoured the covered bond market.