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Making issuance interesting again

26 February 2018
Richard Kemmish

The recent change in market sentiment has made the jobs of issuers and syndicate desks harder. This isn't necessarily a bad thing.

I do try to read the covered bond new issue reports from GlobalCapital. Honestly, I do. But I have to admit that in recent months the task has, shall we say, dragged a little. Games like: ‘trying to guess the pricing from the headline’ are just no fun with the market like it has been. I’ve resorted to trying to find the best investor complaints about the multiple iterations in new issue talk.

The problem, of course, is the European Central Bank (not the first person to type those words, won’t be the last). Their over generous allocations that they get in each qualifying new issue and their seemingly low price sensitivity have killed the art of the syndicate desk – meaningful price differentiation just isn’t working. There is no point staying up all night arguing the relative merits of a Spanish 5 year from a national champion and an Italian seven year from a second tier issuer when the ECB wakes up the next morning and buys half of both deals at a price level of ‘whatever’.

Similarly, with less bonds to go round the private sector and more buyers who are forced to participate (it’s either this or govvies) price sensitivity in the private sector has also collapsed.

1 basis point through mid-swaps? 10 basis points through? 20? Meh.

In a way its fortunate that the art of syndicate has died out because so have the tools that they most use. The other impact
of the ECB’s actions has been on secondary market liquidity and therefore price transparency – the traditional starting point of the new issue pricing conversation.

2018: Oh Happy Day!
This has of course all changed. The narrative of the year was supposed to be more issuance, less ECB, spread widening, differentiation widening. The first couple of weeks have supported that narrative and I have started reading the new issue reports again.

So why am I a little concerned about this?

Firstly, we have no idea what matters any more. The relative value construct before the ECB became the only game in town was dominated by sovereign spread considerations – the best Spaniard will always be wide of the worst German issuer. Now that the pricing of sovereign risk spreads are less of an issue, what matters? A question complicated by, for example the relative probability of state aid, or of supervisory discretion. These two factors are not correlated to sovereign risk. If anything the risk of state interventions with negative implications for covered bond credits might be greater from better rated countries – the Italian government’s relatively supportive actions towards their banking sector being a case in point.

Secondly, the narrative is only slightly true. Yes, we have seen a lot of issuance and less ECB buying in the first couple of weeks of the year. This may however be because the narrative can be a self-fulfilling prophecy. The traditional DCM mantra – issue early, issue often – was reinforced by the plausibility of the spread widening scenario. The ECB is still buying, both on a net basis and reinvesting maturing bonds, banks still don’t have vast funding needs and a lot of investors have pent up demand that will stymie spread widening.

Finally, the world is a very different place from what it was the last time the new issue market had a semblance of normality to it. Whether it be real estate prices (generally speaking house prices are now less sustainable in those countries with a lower sovereign risk spread – both are correlated to growth rates), covered bond laws or political threats, there are a lot of factors that are different from the last time we actually had to think about pricing.

Perhaps best of all, the notoriously conservative covered bond investor base (sorry, but yes you are) is changing. Different investors have come in as some of the traditional asset managers have dropped out in the face of negligible yields. They bring with them new ideas about how to appraise value.

And secondary market liquidity still isn’t there to help guide us.

For the first time in ages the new issue market is actually quite exciting, isn’t it?

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