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June 2009 | ifr special report | 11 GOVERNMENT GUARANTEES Happy co-existence

The meaningful re-opening of the covered bond market in May is the next step in the healing process of the crisis-ravaged markets. The short-term fix of government-guaranteed senior bonds will have to be complemented by the long-term funding mix of covered bonds and senior unguaranteed issuances to rebuild a normal, functioning market, especially when some of the GGB issuance windows are to close by this year end. Malini Menon reports.


or now, there is a happy co-existence of the old and the new. The ECB’s announcement in May that it would purchase up to €60bn of covered bonds sent the moribund market into a catch-up frenzy. The primary market consequently witnessed the busiest session for new jumbo supply since May 2008. Banks made a beeline to welcome the return of this important funding tool and promptly placed €6.5bn through five new benchmark bonds by the end of the week beginning May 11. It was an impressive revival, given that the first four months of this year only brought seven new benchmarks.

"It goes without saying that a powerful

player like the ECB committing to absorb a significant amount of a certain market defines a hard valuation backstop," said Florian Hillenbrand, a covered bond strategist at UniCredit. "The fear of many investors, that every point of time for an investment was second-best because spreads widened with every new issue, is practically off the agenda." Since mid-May, as supply in the covered bonds market has picked up, primary market activity in the government- guaranteed senior bonds space has cooled off. An increase in investor risk appetite has to some extent made market access possible across the credit and capital spectrum. "The use of covered bonds as collateral for repo business with central banks has become more popular and economical, stimulating a major increase in the number of financial institutions issuing covered bonds," said Holger Horn, senior director in Fitch Ratings' covered bond team. The €500m two-year priced by A2/BBB+/A- rated Alpha Bank on May 28th in the senior, unsecured, unguaranteed

market, and the re-opening of the Lower Tier 2 bullet format (10-year trades from Rabobank and Credit Agricole) and callable structures (by insurers RSA and Prudential) and even the Tier 1 (courtesy of Rabobank, again) all demonstrate that the conducive market backdrop has been put to good use by financial borrowers.

There are significant fees associated with government-guaranteed bonds that do not generally apply to covered bonds, except in a few jurisdictions where the guarantees covered them. In the UK, for instance, bonds issued under the HM Treasury's Credit Guarantee Scheme attract a fee of 100% of the institution's median five-year CDS spread in the 12 month period to July 2008 plus 50bp per annum. Such fees have made covered bonds an attractive, long- term and cheaper source of funding. "There is an overall allocation limit on the Credit Guarantee Scheme (£250bn), and the [UK] government does expect issuers to utilise other available sources of

liquidity as well,” said Angela Clist, partner, international capital markets group at Allen & Overy. “Uptake under the proposed ECB scheme will be dependent on the applicable eligibility criteria." Despite the gap between the cost of guaranteed and non-guaranteed issuance, in general, being about 100bp, banks have succeeded in issuing larger amounts with longer maturities without guarantee. This is an encouraging trend.

Not a one-trick pony

The glut of issuance in the two-and-three- year maturity space in the government- guaranteed senior funding market has convinced some market participants there could be pent up investor demand for five- year tenor or longer duration in the covered bond market. Investors have recently shown a preference for relatively short-term risk of up to five years, which is maximum duration for the government-guaranteed

Benchmark GGB issuance per currency (€bn) €bn 90

US$ £ €



0 Source: Barclays Capital

Oct 08



Jan 09





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