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How many covered bonds next year?

23 February 2018
Richard Kemmish

Predictions of next year’s covered bond issuance volumes, never particularly accurate, aren’t even considered important now. We might be wrong to dismiss them totally.

Is it me or is the round of analyst’s predictions about covered bond issuance volumes next year less of a ‘thing’ than it used to be? Articles used to be written, underlying assumptions analysed, spread implications deliberated over. With hindsight all of that was fairly pointless as the predictions were almost always hopelessly wrong and utterly irrelevant to anything other than the analyst’s egos.

Part of the problem was that a top-down approach and a bottom-up approach always came up with such different numbers. The latter invariably being far higher. After much thought and back-testing of previous years I came to the conclusion that fundamentally client coverage officers are optimists and that research analysts are (perhaps foolishly) prepared to take their DCM colleagues at face value – they see a busy year issuing bonds ahead of them. This is of course a euphemistic way of saying that they had just come out of their budget meetings – a process hopelessly undermined by its concurrence with bonus discussions. Few of those discussions started with the words ‘my clients haven’t got a lot to do next year’. Not if you wanted to keep your job and a sniff of a bonus.

Top-down wasn’t much better. All it took was one central bank policy change – some variation or other on ‘we are going to nationalise the DCM business – to fundamentally stuff up the year’s projections. And central bank policy changes have been pretty frequent recently.

Does it matter?

Perhaps not. We used to worry about the projections because it used to be relevant to an issuer’s funding plans – spreads were once sensitive to supply. The annual race to get bonds on screen on the 2nd January actually mattered when investor capacity was finite and when spreads materially widened as January wore on. Similarly, hitting a month with heavy redemptions made deal execution far safer – it was good to know when they were going to be and to plan issuance around them.

Now of course, thanks to the ECB’s buying programme, the cheap alternative sources of term funding and regulatory imperatives to issue bail-in-able senior bonds the covered bond investor capacity is, for all intents and purposes, infinite, therefore unlikely to show much price sensitivity as the year progresses.

The problem though is that if we start to think that total supply levels – net or gross – are irrelevant to quality of deal execution, then we start to think that investor capacity isn’t mission critical any more. No, it hasn’t been for some years but that doesn’t mean it won’t be for ever. The ECB’s purchase programme is subject to Stein’s law.

It is easy to be sceptical about new jurisdictions – in sheer volume terms they haven’t filled the hole left by ECB policy yet. But they will grow. And positive net issuance will return to the mainstream markets. When that happens investor capacity, currently ignored and dented, will start to become basis point critical again. We need to continue to focus on volumes, even when they don’t influence the price.

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