The European Central Bank’s plan to buy covered bonds has achieved its aim of revitalizing the market for the debt even before the purchases start today, according to Ciaran O’Hagan, a Paris-based fixed-income strategist at Societe Generale SA.
The extra yield that investors demand to hold covered bonds rather than similar-maturity government notes has plummeted in the two months since ECB President Jean-Claude Trichet announced “in principle” the plan to buy as much as 60 billion euros ($83.7 billion) of securities. The spread has tightened to 85 basis points, from 111 basis points when the ECB announced the purchase program in May, according to Merrill Lynch & Co.’s EMU Pfandbrief Index.
“They haven’t spent a cent yet but they’ve already achieved a big bang,” O’Hagan said in an interview July 3, a day after Trichet reiterated the plan to buy bonds. “The mere threat of spending money has been immensely powerful. It’s a kind of showmanship.”
The ECB said it will purchase covered bonds, which are backed by real-estate or public-sector loans, of at least 100 million euros and with three- to 10-year maturities. The ECB will buy 8 percent of the bonds, with the remaining 92 percent to be purchased by national central banks in the euro system, Trichet said July 2 at a press conference after policy makers held interest rates at a record-low 1 percent.
The yield gap between covered bonds and government debt had widened after the collapse of Lehman Brothers Holdings Inc. roiled credit markets in September, and climbed to a record 130 basis points in March, Merrill index data show. A basis point is 0.01 percentage point.
Investors who held onto the securities when others were selling during the first quarter have no motive to sell now that yield premiums are declining, unless the ECB offers above-market prices, said Heiko Langer, an analyst at BNP Paribas SA in London. The presence of the Frankfurt-based central bank will instead help reassure investors that the selloff won’t be repeated, he said.
The impact of the ECB’s purchase plan “is likely to be mainly psychological,” Langer said. “Their being there gives a sort of backstop to the market. If something goes wrong later this year and there’s another selloff there’ll be someone there ready to buy. Last time there was no one there,” he said.
The ECB said today that it will announce how much money it has spent on covered bonds each day in its market operations notice. This is published daily at about 9:10 a.m. Frankfurt time. Tomorrow’s will be the first to reflect any purchases under the plan, the ECB said.
Covered bonds must be rated a minimum AA by at least one rating company to be eligible for the purchase program, the ECB has said.
The $2.8 trillion covered bond market, which underpins much of Europe’s real-estate lending, had been hurt by the credit crisis, with sales dropping by half to 48.6 billion euros as of May 7, compared with 99.4 billion euros in the same period a year earlier, according to data compiled by Bloomberg. Since then, issuance has reached 52.8 billion euros, compared with 48.9 billion euros in the year-earlier period, the data show.
Issuers of covered bonds and so-called pfandbriefe, the German version of the securities, this year include UniCredit SpA, ING Bank NV and Eurohypo AG, Bloomberg data show.
Covered bonds typically have a higher rating than straight corporate bonds because they’re also supported by a borrower’s pledge to pay.