Few would deny that the Italian sovereign debt market is in a parlous state. But this fragility was highlighted in August 2012, when UniCredit issued a €750m, five-year covered bond deal, priced a full 100 basis points (bps) below equivalent Italian government bonds.
“It was the first time in the history of the covered bond market that a transaction was priced below respective government bonds so it was truly groundbreaking,” says UniCredit head of funding Philipp Waldstein. “Covered bonds began trading through governments on the secondary market at the beginning of the summer but people thought it was a temporary phenomenon. By August, the trend was confirmed and our deal went one stage further.”
UniCredit is Italy’s largest bank by assets and its covered bond transaction was guaranteed by a pool of extremely stable, residential mortgages with an average loan-to-value of 60%.
“This deal was an important strategic transaction for Italy because it demonstrated that not everything in the country is high risk. People are worried about sovereign risk in Italy but the private sector is very sound. Also, the cover pool for our bond is extremely robust,” says Mr Waldstein.
UniCredit has an annual funding plan and maintains regular dialogue with key investors. Mid-2012, it became clear from these discussions that there was demand for a covered bond transaction.
People are worried about sovereign risk in Italy but the private sector is very sound. Also, the cover pool for our bond is extremely robust
“We discussed the benefits of this product and conversations then centred on price. There were three elements to these discussions. First, we analysed where the secondary market was trading and then added a small premium to it, as an incentive to investors. Second, we looked at where government bonds were trading, and third we were focused on the absolute yield. We came with a 4% coupon, which was an important element of the pricing discussions,” says Mr Waldstein. The five-year sovereign yield at that time was more than 5%.
Holiday season
Timing was an issue too. UniCredit had issued a covered bond in August 2011 so it knew it was possible to launch in what is traditionally a quiet month. Nonetheless, some people expressed surprise at the decision.
“When we spoke to other bankers, some of them were sceptical but we had strong, concrete orders and we had experience from the year before, which gave us confidence. Also, even though Italy and Spain are very quiet in August, the holiday season is more spread out in the UK, France and Germany,” says Mr Waldstein.
In the end, UniCredit’s gumption paid off. The bank worked with three other lead managers – Crédit Agricole, Natixis and Société Générale – and the book was heavily oversubscribed, with orders for more than €2bn of bonds. Pension funds took up 82% of the paper, insurers took a further 11.5% and banks and central banks claimed the rest.
“Demand came from real money investors. It was also well spread geographically, including Germany, Austria, the UK, Ireland, Spain and France,” says Mr Waldstein. “Everyone talks about how difficult it is for banks to raise funding. Fewer people talk about the serious dilemma that investors face of where to put their money. For us, the key lesson was that if you present investors with quality, they will subscribe.”
Maintaining momentum
UniCredit took full advantage of investor demand for quality issues, launching two further transactions within weeks of its covered bond deal. On September 4, 2012, the bank came to market with a €1bn, three-year senior unsecured bond carrying a coupon of 4.365%, compared to three-year Italian government bond yields at the time of 3.12%.
“There have been very few unsecured deals from Italian banks recently so we were very pleased with this transaction. We had interest from more than 250 investors, we priced the deal inside our peers and the bonds have traded well in the secondary market. We wanted to demonstrate that various forms of financing were available to us and this proved our point,” says Mr Waldstein.
Just one week later, UniCredit tapped the market again, this time with a €500m, 10-year covered bond in Germany. “We priced it at 22bps over mid-swaps and it was very well received. We have now virtually completed our funding in Germany for the year,” says Mr Waldstein.
For UniCredit, the success of these three issues is significant on three levels. They highlight the bank’s appeal to investors, they will help lower borrowing costs for customers, and they show that the Italian private sector can raise capital in the markets.
“You cannot lump every bank together. Nor can you lump every Italian credit in the same basket,” says Mr Waldstein.
