Bloomberg News

Covered Bonds in Dollars Soar to Fill AAA Vacuum

April 17, 2012

Bank of Nova Scotia and UBS have led $23.5 billion of the mortgage-backed offerings this year, a 43 percent jump from the same period in 2011, according to data compiled by Bloomberg. Photographer: Brent Lewin/Bloomberg

Bank of Nova Scotia and UBS have led $23.5 billion of the mortgage-backed offerings this year, a 43 percent jump from the same period in 2011, according to data compiled by Bloomberg. Photographer: Brent Lewin/Bloomberg

Sales of covered bonds in dollars are surging to a record as investors snap up the secured bank notes amid a drop in supply of AAA rated alternatives, benefiting lenders from Bank of Nova Scotia to UBS AG. (UBSN)

Bank of Nova Scotia and UBS have led $23.5 billion of the mortgage-backed offerings this year, a 43 percent jump from the same period in 2011, according to data compiled by Bloomberg. Investors in the notes earned 2.04 percent in 2012, double the gain in investment-grade debt from Treasuries to corporate bonds, Bank of America Merrill Lynch and Barclays Capital indexes show.

Covered bonds are gaining traction in new markets as the number of top-rated issues in Bank of America Merrill Lynch’s AAA Rated Global Fixed-Income Index shrinks to 3,624 this month from a high of 5,331 in December 2007. Canadian banks rushing to get in before the country tightens its rules for issuing the debt and Australia’s groundwork for its own market are also spurring sales outside the traditional stronghold in Europe.

“The momentum for dollar covered bonds is accelerating as the investor base turns global, so the potential could be huge,” said Armin Peter, the global head of covered bonds at UBS in London. “You can now find about 100 institutional clients in the U.S. looking at the product, which makes it possible to reach issuance of $60 billion this year.”

Shrinking Spreads

The securities, known as pfandbriefe in Germany, typically get higher credit ratings than unsecured debt by requiring borrowers set aside assets that can be sold to pay investors.

The extra yield investors demand to hold covered bonds in dollars instead of government securities has fallen 66 basis points this year to 104 basis points as of April 13, Bank of America Merrill Lynch data show. The spread was 99 basis points on April 2, the narrowest since June 21.

“Banks worldwide are seeking new ways to access the world’s largest investor community,” said T. Nicolas Steinbach, a director in Blackrock Inc.’s fixed-income portfolio management group in New York.

Elsewhere in credit markets, a benchmark gauge of U.S. company credit risk declined for a second day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreasing 3.3 basis points to a mid-price of 98.2 basis points as of 11:51 a.m. in New York, according to Markit Group Ltd.

Rate Swap Spreads

The index typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of bond market stress, declined 2 basis points to 28.09 basis points as of 11:53 a.m. in New York. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

Bonds of Mooresville, North Carolina-based Lowe’s Cos. are the most actively traded U.S. corporate securities by dealers today, with 149 trades of $1 million or more as of 11:56 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The second-biggest U.S. home-improvement retailer issued $2 billion of bonds yesterday in five-, 10- and 30-year maturities in its biggest single-day offering on record.

Covered Bond Sales

This year’s dollar covered bond sales represent about 11 percent of the $217 billion of global issuance of the debt. The $3 trillion market for covered bonds is dominated by European banks, for which the securities have been a source of funding since 1769 when King Frederick the Great of Prussia needed to rebuild the country after the Seven Years War.

Sales in euros slowed 44 percent this year to 70.6 billion euros from a year earlier after the European Central Bank provided banks with more than $1 trillion of cheap loans to forestall a credit crunch. The extra liquidity eased pressure on banks to issue covered bonds, sales of which reached a record in 2011 as investors shunned lenders’ unsecured debt.

Morgan Stanley analysts Leef Dierks and Jason Somerville in London cut their forecast for euro-denominated covered bond sales this year to about 100 billion euros from a November estimate of 190 billion euros.

Triple-A Slowdown

Investor demand for covered bonds outside Europe has been stoked by a slowdown in debt offerings by government-tied issuers including Fannie Mae and Freddie Mac, which are shrinking their balance sheets as part of their government conservatorships.

The amount of unsecured debt outstanding from such issuers was $2.3 trillion last year, down from a record $3.2 trillion in 2008, Securities Industry and Financial Markets Association data show.

Covered bonds tend to offer investors higher yields than agency debt because they aren’t linked to a government. UBS’s $2 billion covered bonds due 2017 yield 2.1 percent, according to data compiled by Bloomberg, compared with 1.02 percent on similar maturity bonds issued by Fannie Mae.

Covered bonds offer a “yield pickup to similar sovereign agency debt, while having an investment backed by tangible residential loans,” said Blackrock’s Steinbach, who manages $20 billion including covered and agency bonds.

Nova Scotia

Bank of Nova Scotia (BNS) raised $5.5 billion from dollar- denominated covered bonds this year, more than any other issuer, data compiled by Bloomberg show. The Toronto-based lender’s top- rated 1.95 percent bonds due 2017 sold in January yield 69 basis points more than U.S. Treasuries, down from a spread of 109 at issue, according to Bloomberg Bond Trader prices.

Toronto-Dominion Bank (TD)’s $3 billion of AAA rated 1.5 percent 2017 covered bonds, the largest deal this year, pay a spread of 71, little changed from when they were sold in March.

Canadian banks accounted for $12.6 billion of covered bond sales this year, more than half the total, data compiled by Bloomberg show. They’re rushing to sell the notes as the government considers proposals to limit what collateral can be used as a way of preventing a housing bubble.

Commonwealth Bank of Australia (CBA) raised $2 billion from the debt this year, making it the fourth-biggest issuer globally. Australian lawmakers authorized the debt market in October to give banks more ways to fund themselves.

Relatively Cheap

The three-month cross-currency basis swap, the rate banks pay to convert euro interest payments into dollars, makes it relatively cheap to issue in the greenback. The cost declined to 46 basis points below the euro interbank offered rate from minus 162.5 basis points on Nov. 30.

“There has been excellent swap opportunities from dollars into local currencies at attractive funding levels for covered- bond issuers,” said Ted Lord, head of European covered bonds at Barclays in Frankfurt.

Sales of covered bonds in dollars may increase to a record $60 billion this year, according to UBS estimates, breaking last year’s peak of $44 billion.

The U.S. Senate is considering a bill to create a covered bond market in the country, though the chances of it being passed are fading as the November presidential elections approach, said Tom Deutsch, the executive director at the American Securitization Forum in New York. Without legislation, investors may require higher yields that would deter issuers.

“Issuance of covered bonds can really jump if U.S. legislation is passed,” said Steinbach. “This would also increase demand as the bonds would be included in the most commonly used indexes such as the Barclays U.S. Aggregate.”

To contact the reporters on this story: Esteban Duarte in Madrid at; Jody Shenn in New York at

To contact the editors responsible for this story: Paul Armstrong at; Alan Goldstein at

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