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6 | ifr special report | June 2009 EUROPEAN CENTRAL BANK

bid at around swaps plus 350 bp …confirming that European covered bonds are very heterogeneous and some sectors lack secondary market liquidity." The notion of covered bond purchases had been mooted for some months by the shadow ECB and, no doubt, the ECB itself, as a means of boosting the Eurozone economy. Jean-Claude Trichet, the ECB president, denied that the decision in principle to purchase covered bonds issued in the euro area amounted to quantitative easing. Instead, he stressed the idea was to revive a market that had been hit very hard by the financial crisis.

"Covered bonds were considered by the governing council as one of the segments of securities . . . that have been particularly affected in terms of impact of the financial turbulence," said Trichet. It was only a matter of days before the dearth of supply was addressed, as covered bond issuers lined up to ride the new wave of post-ECB optimism.

Immediate response

The creation of a valuation floor stabilised (and reversed) the slide in covered bond spreads which had seen German-based issues widen by 92bp year- on-year, according to Unicredit, and by 126bp over the same period for French issuers. "The widening tendencies that never had a fundamental backing but were solely driven by market technicals…will also lose this technical basis," the Italian bank said. The ECB wants to support the covered bond market: it is a vital funding tool in many European countries, including Germany, Spain and France, to finance the real estate market and, to a larger extent, the broader economy. "The purpose of this support is obviously to allow a smooth and sustainable reopening of the primary market which has been shut to most of the issuers during the past year," said a strategist at SG CIB at the time. It was logical to assume the ECB would direct its action at eurozone issuers, but not covered bonds issued by institutions in the UK, Denmark, Sweden, Canada or the US. Following the statement of intent, the first transaction after the ECB meeting was for Banco Santander, which announced a €1.5bn five-year benchmark at mid-swaps plus 125bp area. It was the first jumbo Spanish Cedulas since June 2008 and the books for the deal reached €3bn within

hours of opening, with zero price sensitivity reported. Pricing was therefore set at mid-swaps plus 120bp. Broad interna- tional interest at 75% of the final allocation complemented good domestic support, according to the leads, with Germany, Austria, the UK and Irish investors playing a significant roles.

There was ”

much discussion at the time of the ECB’s covered bond announcement if it was following the path of quantitative easing. In fact, the ECB’s actions are more clearly aimed at repairing the covered bond market.

On the day Santander was priced, Compagnie Financement Foncier followed with a 12-year deal at mid-swaps plus 123bp, taking advantage of the opportunity to extend its liability profile. The leads observed an increase in reverse enquiries from French and German investors for such longer dated paper, despite the terms probably being up to 17bp tighter than it would have seen the previous week. Spanish borrowers saw a more significant improvement, with some analysts suggesting as much as 50bp of spread tightening.

In the following weeks a succession of deals appeared, as issuers sought to take advantage of the re-opening of the market and the improved terms of issuance relative to senior unsecured debt. By the end of May, when Banesto sold a four-year Cedulas Hipotecarias at the same spread as Santander, its parent company, there were still no immediate signs of indigestion from the glut of new supply. For issuers, the pricing differential between covered bonds and Double A

Quantitative easing

There was much discussion at the time of the ECB's covered bond announcement if it was following the lead of the US Federal Reserve and the Bank of England down the path of quantitative easing. In fact, the ECB's actions are more clearly aimed at repairing the covered bond market – essential, given the important role it plays in financing the European economy – via the restoration of the new issue market and the improvement of the liquidity of the secondary market. The effect of its actions will, however, be comparable to those of the other central banks in terms of the target asset class – albeit without the same policy implications.

The size of the covered bond market is estimated to be around €2.3trn. In that context, the size of the ECB's planned in- tervention was relatively modest, although considering that only €96bn of new covered bonds were issued in 2008, the figure looks rather more significant. According to RBS strategist Frank Will, "excluding non-euro bonds and public sector covered bonds (on the assumption that the ECB would focus primarily on mortgage backed bonds given the high real economy impact) it would be more than 10% of total issuance."

The size of the ECB's intervention is consistent with that of the other central banks, according to Bernd Volk, head of European covered bond and agency research at Deutsche Bank. "While €60bn is negligible relative to the [asset purchases] of the US and UK, representing only around 5% of the Eurozone's monetary base and about 0.6% of Eurozone GDP this compares to the Federal Reserve’s and the Bank of England’s asset purchases which correspond to 10% of GDP and more than 100% of the monetary base," he said.

rated, five-year senior unsecured debt might typically have been around 15bp before the summer of 2007. Santander's covered issue at mid-swaps plus 120bp compared with terms at plus 150bp for its two-year unguaranteed senior deal in early April 2009. This suggested a minimum 30bp, and more likely 40bp cost saving for the bank by issuing covered bonds. This helps to explain why the market responded so quickly in anticipation of the details of the ECB asset purchase programme.

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