The comparative yield premiums between covered bonds and senior bank debt don’t reflect the different ways the securities will be treated under new European rules on bank failures, according to BNP Paribas SA.
The extra yield investors demand for holding covered bonds instead of safer government debt is 71 basis points, while the spread for senior bank bonds is 125 basis points, according to Bank of America Merrill Lynch index data. That’s below the 70 basis-point average differential for the past three years, the data show.
“The spread differential between covered and senior is too narrow,” Heiko Langer, a senior covered bond analyst at France’s largest bank, said at a conference in London yesterday. “The hunt for yield keeps a very tight lid on any type of differentiation.”
Covered bonds are to be exempted from a European agreement that makes bondholders share the burden of bank failure by having unsecured debt written off. Regulators will be able to impose loses, or bail in, creditors from 2016 after a new bank resolution framework designed to ensure taxpayers are last in the line to foot the bill comes into force next year.
Credit ratings also do not fully account for the different treatment, according to Julia Hoggett, the London-based head of covered bonds and financial institutions group flow financing in Europe at Bank of America Merrill Lynch.
“There’s a question as to whether the ratings differential between senior and covered should shift,” Hoggett said at the IMN global covered bond conference. “That covereds should be relatively better-rated and better-protected and therefore the differential versus senior should increase.”
Given the privileged ranking of covered bonds, which are backed by mortgages and public sector loans, Moody’s Investors Service suggested in September raising the minimum level at which it grades the notes.