Since early March, covered bonds swap spreads have tightened, driven by strong demand in primary market transactions. This has allowed recent new issues to price much tighter than IPTs (on average 8bp), and re-offer levels are pricing through secondary deals. Despite covered bonds spreads going slightly tighter, we still see some room for them to perform (up to 2-3bp) in the coming months, although the rally has stalled somewhat in the last sessions, with strong resistance in covered bond markets for the tightest sectors around MS+20bp in 5Y, 25bp in 7Y and 30bp in 10Y.
Despite the recent tightening and Bund ASW spreads being much tighter than last year, covered bonds still look attractive and offer a good level of yield. Given the still wide-swap spreads (when looked at historically) and tighter SSA markets vs. swaps, we believe covered bonds remain attractive as an asset class, not only vs. senior, but also vs. non-financial corporates.
Overall, we believe that fundamental drivers (jurisdiction of issuer, bank credit quality, cover pool characteristics) as well as relative supply volumes YtD have become more relevant spread drivers.
Deals with a larger credit investor base have outperformed, particularly those deals issued early in January, with generous NIPs and wide credit spread. Deals that priced at higher spreads and NIPs, meaning that they priced-in higher credit/idiosyncratic risk, have actually performed better YtD.
German covered bonds have underperformed YtD vs. other jurisdictions due to the exposure of some issuers to CRE and with investors being cautious about CRE and risks in commercial property markets. French covered bonds due to the high supply volumes offer good liquidity, spread and residential market exposure (i.e. no CRE exposure in cover pools). Dutch covered issuance activity has focused on tapping the longer end, while Norwegian covered bonds have been the best performers YTD.
Australia and Canada are two jurisdictions that look attractive from a relative value point of view, as their spread levels have widened and these jurisdictions have not issued as much as core Euro area ones.
Peripheral covered bonds remain in high demand, given strong demand from spread-driven investors. Italian OBGs offer a high pick-up to other core European jurisdictions, despite trading tight to BTPs. For many investors that cannot invest in the sovereign given the low rating, Italian CBs offer good value, given ratings above the sovereign debt rating. Due to household deposit out-flows thanks to retail sovereign bond issuance, we see another EUR3-4bn of supply from the country, particularly in the 5Y part of the curve unless BTPs tighten vs. swaps.