Commonwealth Bank of Australia's €1.5bn five-year issue was the third and comfortably the most successful Australian transaction since the country passed supportive legislation for covered bonds in late 2011. Joint bookrunner on the deal, BNP Paribas, put its success down to timing and the choice of currency.

After a moribund end to 2011, the international bond market roared back to life in early January 2012, led by a rush of covered and corporate bond issuance. A surprising number of the covered bonds came from outside the eurozone, including the first euro-denominated Australian issue – from Commonwealth Bank of Australia (CBA). The choice of currency helped it to trade rather better that the two Australian covered issues that preceded it.

One of the joint bookrunners to the CBA issue was BNP Paribas, which counts covered bonds among its specialities. Its covered transactions in the first days of 2012 included deals out of UBS, ING, DNB and Aareal, as well as a sterling issue from Royal Bank of Scotland (RBS).

The first two weeks of January 2012 saw some €24bn ($31bn) in covered issuance – indeed, more supply came to market in the first few trading days than in the whole of the previous quarter. This explosion of activity echoed the start of 2011, which saw a similar release of pent-up demand. That subsided quickly enough, however, and this year’s repeat may do the same.

“The game has changed,” says Heiko Langer, senior covered bonds analyst at BNP Paribas, referring to the impact of the European Central Bank’s long-term refinancing operation (LTRO). “The LTRO has put a lot of liquidity into the market – and investors already had a lot of cash, since they were not buying in the fourth quarter of 2011.”

Covering ground

What the three-year LTRO gives, it also – to some extent – takes away, making participating banks less likely to issue short-dated covered bonds. Indeed, none of this year’s early issues had a maturity of less than four years. On the other hand, renewed support by the Eurosystem with its Covered Bond Purchase Programme 2 is adding to overall demand.

Covered bonds continue to make headway as an asset class and funding option, with global outstanding volumes rising from €1500bn in 2003 to €2500bn in 2010, according to the European Covered Bond Council. Since the end of 2007, the number of banks with benchmark issues outstanding has grown by at least 75%. What was essentially a European phenomenon has become more international, with issuance from Canada, the US, South Korea and New Zealand.

A trend to structured covered bonds without supporting legislation went into retreat once the financial crisis began, and an increasing number of countries have introduced framework laws, or, as is the case with the US, are in the process of doing so. In October 2011, after years of prevarication, Australia became the latest jurisdiction to legislate, and the big Australian banks rushed to make the baptismal issue.

Getting it right first time is absolutely crucial. Getting it wrong can have a lasting impact on pricing, sizing and the issuance volumes

Derry Hubbard

ANZ enjoyed what turned out to be the dubious pleasure of being first to market, in November 2011, with itself, Citi, UBS and, at the last minute, Nomura as bookrunners, It was followed immediately by Westpac, which mandated Barclays Capital, Bank of America-Merrill Lynch and, again, Nomura as joint leads. Both issued benchmark five-year deals in – and this was key – US dollars.

Waiting game

Everyone agrees that the Australian legislation is a model of its kind, combining strength with adaptability. “They have got the right balance,” says Arjan Verbeek, BNP Paribas’ head of asset-back securities flow and covered bond structuring. “They have put a strong legal framework in place, giving comfort that government will support the instrument, with enough flexibility to tailor protection for investors. It is not as prescriptive as some others.”

Nonetheless, thanks to timing and choice of currency – and hence investor base –  the two inaugural Australian transactions fared badly in the secondary market, with rapidly widening spreads. Commonwealth Bank of Australia (CBA) issued a mandate at much the same time and ran a five-day UK and European roadshow in November. Given poor prevailing credit conditions and the fate of its compatriots, however, it had the good sense to bide its time.

“Getting it right first time is absolutely crucial,” says Derry Hubbard, BNP Paribas head of financial institutions group syndicate (he was head of covered bond syndicate until April 2011). “Getting it wrong can have a lasting impact on pricing, sizing and the issuance volumes you can take out of the market going forward.”

The decision to issue in euros was pivotal. Europe remains the covered bond’s heartland, in terms of demand as well as supply. Last year, some 85% of all deals were denominated in euros and even the first US issuers, starting in 2006, chose the currency for their inaugural transactions.

“US investors view the product completely differently,” says BNP Paribas. “They start by analysing the collateral. In Europe they start with [the fact of] the law.”

Regulatory endorsement is all-important to European investors, who take considerable comfort from it. US investors are still getting used to what they regard as a relatively new product and may need to be reminded of just how watertight these structures really can be. “The need for investor preparation is high,” says Mr Hubbard. “They don’t want to be bowled over with a drive-by approach. After deal preparation, effective communication is absolutely crucial.”

Healthy appetite

Joint bookrunners with BNP Paribas for the CBA issue were CBA itself, HSBC and RBS. On January 4, 2012, as a healthy market appetite for the right names became apparent, they announced a transaction in the mid-swaps plus 100 basis points (bps) area. Positive influences on pricing included the strength of the Australian economy and its banks, while negatives included vulnerability to any Chinese travails and the fact that the bonds, as a non-eurozone, non-G10 product, are not eligible as collateral at the European Central Bank.

In the early pfandbrief days there was very little disclosure about the asset. Now there is more focus on disclosure and on how asset-efficient the covered bond is, with changing ratings all the time

Arjan Verbeek

Some of the comparables used to determine the right level were New Zealand covered bonds (trading slightly wider), Nordic covered bonds (somewhat tighter) and new issues of senior unsecured debt (trading about 175 bps over for some Australian banks).

The bookrunners logged orders worth €1.7bn. The deal, with a 2.625% coupon, was finally priced at guidance and sized at €1.5bn, with the issuer opting for a five-year transaction. “We had the full level of flexibility but, at that point, five years provided the greatest breadth in overlap of investor types,” says Mr Hubbard. “We wanted to achieve the greatest level of penetration to those accounts that had put lines in place and supported the name before – from insurance companies to bank treasuries.”

The issue was priced at roughly 50% to 60% of where a senior unsecured deal would have come, Mr Hubbard adds. So far, it has traded consistently tighter in the secondary market.

The takers

Distribution was unusual. Banks took 23%, an atypically small share for this maturity. On the other hand, insurance companies bought 12% and asset managers 43%, unusually high. Central banks took 15% and supranationals 4%. Geographically, Germany (30%) and France (3%) were abnormally under-represented, preferring longer maturities and higher yields. The UK took 28%, highlighting its familiarity with Australian names. Nordic accounts bought 10%, Australasian 6% and Asian 3%.

The CBA deal underscores the growing internationalisation of the covered bond. Sterling issuance is on the rise, as UK banks use the market to term out their liabilities – as with RBS’s £1bn ($1.55bn) 12-year issue in January 2012. “UK banks are further building out their domestic covered bond curves, saying ‘we don’t need to tap the euro market at any cost’,” says Mr Hubbard.

As the investor geography diversifies, so do the ways in which they approach the product. There is, for example, a lot more attention to detail. “In the early pfandbrief days there was very little disclosure about the asset,” says Mr Verbeek. “Now there is more focus on disclosure and on how asset-efficient the covered bond is, with changing ratings all the time.”

The continental view of covered bonds is no longer the only one. “It’s paradoxical,” says Mr Hubbard. “There is a great need for standardisation in covered bonds. Yet the growth of the product is bringing jurisdictional diversity and hence, to an extent, increasing complexity.”

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