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June 2009 | ifr special report | 5 EUROPEAN CENTRAL BANK Back from the brink

The covered bond market had been a serious casualty of increased investor risk aversion in the wake of the banking crisis until a new buyer of assets was announced in early May: the European Central Bank. At a stroke it reversed the widening of covered bond spreads that had characterised most of the previous two years, reinvigorating the new issue market. Mike Winfield reports.

The average weekly issuance volume had risen from about €500m

in the first 17 weeks of the year to almost €5bn in the four weeks after the ECB announcement.

he financial crisis that began in the summer of 2007 did not prevent the Triple A bond market from functioning, though it did transform its terms of reference. The covered bond market, on the other hand, suffered more dramatic consequences, seeing supply reduced to a trickle for most of this year. The intervention by the ECB, with its an- nouncement of up to €60bn of covered bond purchases in the 12 month period starting in July this year at its May policy meeting, provided new support for the market. At a stroke, the supply tap was turned back on. Although shrouded by a lack of clarity over details, the news led to a significant spread tightening, resulting in €16.25bn of jumbo deals being priced during May. After including taps, this "means that the average weekly issuance volume had risen from about €500m in the first 17 weeks of the year to almost €5bn in the four weeks

T Covered bond performance since ECB-announcement, May 7 2009 iBoxx € Spain Covered Pooled Cedulas

iBoxx € UK Covered iBoxx € Sweden Covered iBoxx € Hypothekenpfandbriefe iBoxx € Oeffentliche Pfandbriefe iBoxx € Norway Covered iBoxx € Portugal Covered iBoxx € Covered iBoxx € Spain Covered Single Cedulas iBoxx € Ireland Covered iBoxx € France Covered Legal iBoxx € Netherlands Covered iBoxx € France Covered Structured iBoxx € US Covered

-30 -25 Source: UniCredit Research -20

-15 bp

-10 -5 0

after the ECB announcement," said Frank Will, strategist at RBS. If nothing else, investors at least had a better idea of where fair value lay in the market. The initial ECB statement made no reference to the price at which it intends to buy assets, nor a required minimum rating, making the full impact on spreads difficult to assess. Even after the first stage of clarification a month later, which specified "the covered bonds had to be eligible for use as collateral in the ECB's credit operations", there remained unanswered questions. On the morning of the May announcement, covered bond traders had reported that buying in the sector was at the busiest level they had seen in months – particularly in core covered bond markets of France, Germany and Scandinavia. In the aftermath of the announcement some covered bonds, such as the Spanish multi-cedulas, were quoted around 50bp tighter. Traders in general said they had marked their books about 20bp tighter. But with very few prices and fewer covered bonds available to trade following a prolonged dearth of issuance, bid/offer spreads initially widened signifi- cantly, ahead of the June ECB meeting at which further details were announced. In June the ECB said its "direct" purchases would be made from both the primary and secondary markets. It would target three to 10-year issues that met certain credit rating and size criteria (minimum AA and €500m). Although there remained a lack of clarity over how the purchase operations would be conducted, it transpired that the assets to be acquired were those covered bonds currently eligible to be posted as ECB collateral. Prior to the clarification, Deutsche Bank had already said that "some Germany Pfandbriefe had traded extremely tight again [following the original ECB an- nouncement], with short dated issues at around mid-swaps plus 20 bp. On the other hand, some UK covered bonds were still

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