The European Central Bank's aggressive covered bond buying strategy is severely distorting valuations and turfing out real money investors from the market, storing up the risk of disenfranchising them and pushing them to look elsewhere.
Order books for new covered bond deals that had been multiple times covered in recent weeks as investors piled into the asset class on the back of the ECB purchase programme have been dwindling recently as real money investors appeared to throw in the towel.
"Valuations for some covered bond are already at stretched levels compared to where they were versus sovereigns eg three months ago - even though the ECB has only just started buying them," said Achim Linsenmaier, head of SSA syndicate at Deutsche Bank.
"We could come to a situation where investors say thanks but no thanks to covered bonds at ultra-tight valuations. They will ask themselves: 'do I have certainty that the ECB will take me out of my position which does otherwise not offer much relative value?'."
This week, Credit Agricole attracted EUR1.3bn of orders for a EUR1bn eight-year, while Helaba drew in EUR1.25bn for a EUR1bn four-year and Belfius EUR700m for a EUR500m five-year. In contrast, a EUR1.25bn five-year priced for Caisse Francaise de Financement Local (Caffil) in early September boasted over EUR4.9bn of demand.
"Just after the ECB purchase programme started, every covered bond deal was a complete riot, but it seems to have died down a bit and accounts have started to push back," said an SSA syndicate banker.
"If you look at order books now, if you take central bank orders out, then there is not that much extra demand and you still need incremental buyers over and above the central banks."
But allocations to central banks, agencies and official institutions are instead shifting ever upwards, sweeping up 63% of Helaba, 55% of Credit Agricole and 47% of Belfius.
"The ECB is not price-sensitive," said one syndicate banker. "They're operating on a mission to increase their balance sheet, so they can't be. They'd rather amend their order than drop out to remain part of the show."
In a note published in mid-November, Barclays analysts warned that covered bond valuations were already heavily distorted. "In order to achieve balance sheet growth, the euro system has pushed yields of some core covered bonds not only through the German government bond curve but also into negative territory," they wrote.
"It seems the main reason the euro system is not alone in its investment activity is that some market participants are placing strong hopes on the CBPP3 staying active for a long period," they said, adding it was not advisable to base an investment strategy on vague assumptions trying to second guess future CBPP3 activity.
Some signs of weakness have started to creep into the market, though, and recent primary deals have widened.
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