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Cyprus Internet Directory [ ECB covered bond plan lends support to spreads ]

ECB covered bond plan lends support to spreads

ECB covered bond plan lends support to spreads
May 08, 2009 - Reuters

Spreads on covered bonds from Spain and Ireland have tightened, pulling government bond spreads with them, after the European Central Bank said it would buy around 60 billion euros ($80 billion) of covered bonds.

The ECB announced the move on Thursday among a series of measures to help support bank lending and the economy.

Countries with weak economies and housing markets, including Spain and Ireland, have suffered the most as spreads have widened over the past year. Now they are seen as most likely to benefit from the ECB support programme.

"The impact on periphery spreads we think is very profound ... This is a credit-easing after all, so we should expect the positive momentum, and that's exactly what we've got," said Harvinder Sian, an analyst at Royal Bank of Scotland, in a call to clients. The premium that investors demand to hold debt issued by euro zone countries other than Germany fell on Friday, with 10-year Italian, Greek and Spanish spreads among those hitting their tightest levels since late last year.

"The idea that the ECB is buying assets now does spread risks across the euro area in terms of the economy and the momentum going forward," Sian added.

Spreads on Spanish covered bonds have tightened by about 30 to 40 basis points on average, said Franz Rudolf, a covered bonds analyst at UniCredit (HVB), while German covered bonds have tightened by about 5 to 6 basis points.

Covered bonds are backed by a pool of assets such as mortgage loans that remain on a bank's balance sheet and are seen as safer than other bank bonds, because they give investors a claim on the bank itself and on the assets as well.

Spreads vary by issuer. A Spanish covered bond maturing in 10 years typically trades at about 200 basis points over mid-swaps, compared to about 300 basis points over mid-swaps for an Irish covered bond and just 60 basis points for a German issue, the analyst said.

"The spread tightening for covered bonds was more of a knee-jerk reaction rather than buying from investors as traders speculated about what countries would most likely benefit," a London-based analyst, who declined to be named, said. "We are in a wait-and-see mode as there are too many unknowns still."

In the government bond market, the 10-year Greek/German yield spread narrowed to as low as 160.3 basis points, Reuters data showed, which is the tightest since early December 2008.

The equivalent Irish/German spread also crunched in to 163.8 basis points -- the narrowest since early January.


Germany, France, Spain and Ireland are the largest issuers of covered bonds in the region.

The ECB will determine the technicalities of how to implement the covered bond decision at its next meeting on June 4.

"The covered bond market was starting to recover," said the London-based analyst said. "We fear that investors will stop buying covered bonds and hold off until they know what exactly the ECB will be buying."

Among the details yet to be revealed by the central bank is whether it will buy new issues or bonds in the secondary market.

"They are more likely to be active in the secondary market, and so the spread tightening we have seen is justified," UniCredit's Rudolf said.

Outstanding euro jumbo covered bonds -- excluding bonds maturing in less than a year and non-euro issuers -- total around 640 billion euros, UniCredit estimates. Adding non-jumbo (non-registered) issues in Germany increases that figure to about 860 billion euros.

The ECB purchases would, therefore, amount roughly to either 7 or 10 percent of outstanding covered bond issues depending on which figure is used for the total.

"That's a significant amount," said Rudolf. "It sends a very positive signal that the ECB knows about the important function of the covered bond market for the whole financial industry and the housing market."

It also means that the investors that hold covered bonds, such as banks, asset managers and pension funds, are likely to see some relief in their portfolio in both prices and liquidity.

(Source: Financial Mirror,

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