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4 | October 2010 | ifr special report SSA/COVERED BONDS Learning on the job

The measures employed by the European Central Bank to support both the covered and peripheral bond markets ultimately shared a common objective: providing aid to the ailing European banking sector. The outcome of the two programmes, on the other hand, has so far been mixed, as the performance of the underlying debt markets demonstrates. Michael Winfield reports.

he ECB’s response to the deterioration of the credit market differed from that of other central banks. The UK’s asset purchase programme can be seen as a response to a sharp decline in economic activity. The US response targeted the restoration of confidence in the housing market. The ECB’s priority was to support the European banking sector. One of the immediate casualties of the financial crisis was a heightened credit differ- entiation. At times, the preservation of capital was seen as more important than the return on capital. The senior unsecured and covered bond markets fell from favour, as financial institutions became increasingly reliant on the support of their respective sovereigns. Starting with the offer of state guarantees at the height of the crisis, this soon resulted in the creation of a government guaranteed asset class in direct competition with other debt market participants.

T (€m) 1,500 1,000 500

-500 0

-1,000 -1,500

Jul 09

Source: Barclays Capital Sep Nov

Jan 10

Mar May

30 Jun

“The increase in the debt burden of the sovereign sector, however, ultimately contributed to the sovereign debt crisis which became the next target of ECB policy,” said Emmanuel Smiecench, syndicate manager at SG CIB. “The ability to service much greater debt loads at a time of falling tax receipts, as economic activity declined, shifted investors attention to this sector, which since the inception of the euro had largely been viewed as a homogenous asset class.” The explosion in peripheral sovereign spreads questioned whether all Eurozone members would still able to access the capital market. Ultimately, Greece lost market access and had to rely on an IMF and European Union rescue package in return for strict fiscal reforms. After this the spotlight quickly shifted to others that might suffer a similar fate, leading the ECB to undertake a similar asset purchase programme to support the peripheral bond market.

Covered Bond Purchase Programme (CBPP) and Covered Bond (CB) spreads

CBPP rolling 5-day purchase volume (Lhs) ASW iBoxx Euro Covered 5-7 (Rhs)

100 110 120 130 140 150

50 60 70 80 90

Covered intervention a success The covered bond market, which was seen as a systemically important source for banks raising funds, had suffered a significant widening of spreads. In a number of countries the jumbo market was closed as a source of funding, although there were ongoing private placements and the closure of the market did not last as long as it did for some core markets. By early 2009 the market was dominated by occasional taps of existing deals by French, German and some Nordic issuers which were largely the only jurisdictions to brave new supply until the ECB announced a €60bn covered bond purchase programme in May that year. “The announcement of the purchase programme in itself largely started to address the dysfunctional nature of the market although its operation did not commence until July 2009, with new issue volumes quickly recovering,” said Fritz Engelhard, head of covered bond strategy at Barclays Capital. “Along with the ECB’s LTRO, the covered bond market operation became an important part of the central bank’s strategy to ease credit concerns across the many jurisdictions which had previously functional markets. For the ECB covered bonds were clearly part of the solution, not part of the problem.” In the week after the ECB announcement there was around €7bn of new supply (including two Spanish issues), more than there had been in the preceding five weeks. Although the level of supply subse- quently eased, supply continued until year end and through into early 2010. “Over the course of the year to June 2010 the ECB became a rather active participant in the primary and secondary bond markets which helped restore investor confidence ultimately leading to the market reopening for other more troubled jurisdictions, including the UK and the Scandinavian region which were excluded by the ECB,” Engelhard added.

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