Singapore's United Overseas Bank (UOB) set a key benchmark for Asian banks in the home of the covered bond market on Wednesday, executing the region's first euro-denominated deal with a €500 million ($542 million) offering.
Covered bonds have been enormously popular in Europe so far this year, with almost €50 billion of issuance, the strongest start since 2012. Indeed, at certain points of the year, when volatility was at its most elevated, they have been the only source of bond funding for European banks, similar to the role they played during the global financial crisis.
The sector has remained open for bank issuers because covered bonds typically command triple-A ratings thanks to the level of overcollateralization in the underlying asset pool (generally mortgages) backing the bonds.
Investors also view them as safe haven assets because they not only have a claim on the bank, which retains the bonds on its balance sheet, but also first claim on the underlying assets.
In Asia, covered bonds have been slow to get off the ground, with just a handful of deals from Korea and Singapore, where DBS executed the city state's first issue last July.
This is now slowly starting to change, with Kookmin issuing its second covered bond in the space of three months this January and OCBC preparing to launch a maiden $1 billion issue of its own later this summer via Barclays and Credit Agricole.
However, DBS attracted a small measure of criticism for its debut deal, which was denominated in dollars and largely placed in Asia. The majority of covered bond investors are European and this is who UOB targeted.
Syndicate bankers said UOB bank spent one-and-a-half years preparing the deal and worked hard with European investors to get them familiar with the Singaporean mortgage market and banking sector.
Oz the main pricing benchmark
Key was always going to be how close UOB could price its triple-A rated deal relative to Australian banks, which have similar covered bond legislation and stand alone ratings.
As non-European countries, both countries are ineligible for the European Central Bank's (ECB) Covered Bond Purchase Programme (CBPP). Since it launched CBPP3 in October 2014, the ECB has hoovered up €156 billion of covered bonds, causing a supply/demand imbalance that has driven pricing of European bank deals to very tight levels.
In Australian banks' favour is the better name recognition they command among European issuers since they have been more frequent issuers.
However, they have a weaker one-notch rating of Aa2 from Moody's compared to the Singaporean banks' Aa1 rating. Fitch and Standard & Poor's rate both sets of banks at the AA- level.
In the end, syndicate bankers argued that UOB priced a couple of basis points wide of the Australian secondary market curve, but through it on a primary market basis when a new issue premium is taken into account.
Initial pricing was marketed in the high 30bp over mid-swaps before being fixed at an issue price of 99.653% and coupon of 0.25% to yield 32bp over mid-swaps.
The final order book closed just over the €1.3 billion level according to syndicate bankers, a similar level of demand to the two other covered bond deals, which were in the market on the same day: an €500 million seven-year deal for Norway's Sparebank 1 and an €500 million six-year deal for Belgium's Belfius.
The former priced at 23bp over mid-swaps on the back of a €1.1 billion order book and the latter at 17bp over mid-swaps on the back of an €1.4 billion order book.
A total of 75 investors participated in UOB's deal of which banks accounted for 36%, central banks 18%, insurers 10% and others 5%.
When UOB priced, Westpac's €1 billion March 2021 deal was trading at 32bp over mid-swaps, while CBA's February 2021 deal was trading at 25bp over.
Bankers estimated fair value for the Australian curve around 28bp. But given that most covered bond issues come with at least a 5bp new issue premium, they argued that UOB has come through its peers’ curve since a new Australian deal would price in the low to mid 30’s over mid-swaps.
“Investors liked this deal because it offers diversification pure and simple,” said one London-based syndicate banker. “It has almost no correlation with their German and French covered bonds.”
The banker added that it was hard to determine fair value since UOB has no outstanding euro-denominated debt, but suggested a new senior deal would price around the 65bp level. This means UOB’s covered bond has come about 33bp inside the bank’s theoretical senior curve.
DBS also provided a third benchmark with its dollar denominated deal, although bankers also argued there is very little correlation between covered bonds denominated in euros and dollars. This $1 billion 1.625% August 2018 transaction was trading on a Z-spread of 67bp on Wednesday.
At 32bp over mid-swaps, UOB came at roughly 74bp over on a Z-spread basis, which means it has paid an additional 7bp for a one-and-a-half year maturity extension.
The DBS deal has not traded particularly well since it was issued last July. Although it is now trading on a much tighter yield of 0.942%, this reflects moves in underlying Treasuries.
On a price basis, it traded below issue price for the whole of November through to February and was quoted Wednesday at 99.92% on a mid-price basis relative to its 99.948% issue price.
The collateral pool
In terms of the underlying collateral pool, UOB's most recent investor presentation said it comprises 7,556 mortgage loans with a total current balance of S$4.9 billion. The weighted average seasoning is 51 months and the weighted average remaining tenor 272 months.
UOB also said the portfolio has a split of 80% owner-occupiers, a loan-to-value ratio of 53.2% and committed overcollateralization ratio of 115.9%. About 75.2% of the portfolio comprises condos.
It also says it has a 0% delinquency ratio. However, UOB does not break it down to the granularity of Australian banks, which publish ratios showing how many mortgages are in arrears of less than three months.
For example, CBA has a delinquency ratio of 2.55% but all those arrears are less than three months. The same is true of Westpac, which reports a delinquency ratio of 0.48%.
Both Singapore and Australia have covered bond legislation, which stipulates a minimum overcollateralization ratio of 103% and maximum loan-to-value ratio of 80%. The main difference lies in issuance limits as a percentage of total assets, with Singapore setting a 4% limit, while Australia allows up to 8%.
In its rating assessment, Moody’s also said that Singaporean covered bond programmes are subject to higher re-financing risk than other developed markets because of the lack of a “liquid secondary loan market in Singapore and the legal requirement relating to the declaration of trust structure.”
Singaporean banks have to adopt a slightly different structure because the country’s Central Provident Fund (CPF) has first claim on many mortgages because its members are able to use their holdings to re-pay their housing loans. DBS and UOB have got round this issue by deploying a trust structure, whereby the trustee will hold a large portion of the bonds in the cover pool for the benefit of the special purpose vehicle they would be transferred into in the event of re-payment difficulties.
Joint arrangers for the covered bond were BNP Paribas and UOB, with bookrunners comprising BNP Paribas, Commerzbank, DZ Bank, HSBC, Nataxis, UBS and UOB.