Pimco Shuns Korea to Turkey Covered Debt on Liquidity

Bankers attempting to sell covered bonds around the world are hitting a roadblock as investors including Pacific Investment Management Co. say difficulty trading debt from fledgling markets is driving them away.

More than 90 percent of offerings this year have come from recession-plagued western Europe, where sales of the securities started in Prussia in the 18th century, data compiled by Bloomberg show. The share from other markets tumbled to 7.5 percent from 19 percent a year earlier, even as nations from South Korea to Turkey and Panama encouraged the sale of covered bonds, a form of bank financing backed by mortgages and guaranteed by the issuer.

Initial offerings are failing to turn into regular issuance even as non-European mortgage bonds offer higher yields and support from loans in faster-growing economies. The outlook for further sales hangs in the balance after emerging-market debt slumped last month by the most since 2008 and investors yank money from bond funds following the U.S. central bank’s signal it may start reducing stimulus.

“For new markets, such as South Korea or Turkey, there isn’t sufficient liquidity,” said Timo Boehm, a Munich-based money manager focusing on covered bonds at Pimco, which manages about $2 trillion of assets, including the world’s biggest bond fund. “We recognize every new issue in the market and we think it’s a way to broaden the product, but currently the volume is too slow.”

Issuance Falls

Issuers outside western Europe raised $11.1 billion this year, down from $48.1 billion in the same period in 2012, Bloomberg data shows. Covered bonds draw support from the issuer and a designated pool of assets, meaning they typically have higher ratings and lower yields than unsecured notes, reducing the cost of bank funding.

The financing system contrasts with the U.S. where the government backs about 85 percent of home loans though entities including Fannie Mae and Freddie Mac.

Home loans used to support covered bonds vary across new markets, making it more difficult for would-be investors to analyze the notes, according to Georg Grodzki, who helps oversee $515 billion as head of credit research at Legal & General Investment Management in London.

Securities from Korea Housing Finance Corp. are tied to mortgages where the outstanding loan is about half the house’s value, and less than 1 percent of borrowers are more than 90 days late with repayments, according to Moody’s Investors Service, which upgraded the debt to its second-highest level of Aa1 in March.

Bullish Tone

The assets backing Panama’s first covered bonds, sold by Global Bank Corp. in September, include mortgages to primarily low-and middle-income citizens, with about half the loans serviced using automatic payroll deductions, Moody’s said in a statement. The average loan-to-value ratio was 74.9 percent.

The diverse collateral backing covered bonds in some newer markets is “a bit of a deterrent,” said Grodzki. “You really need a bullish tone in the market, with investors feeling good about the world at large and keen on extra yield, for those markets to gain a sustainable foothold.”

Korea and Turkey are among debt markets handing investors losses since the Fed outlined conditions for reducing its $85 billion of monthly bond purchases on June 19. Investors pulled more than $10 billion from emerging-market equity and bond funds in the week ended June 26, the most on record, according to data provider EPFR Global.

Emerging Markets

Emerging-market debt rated A- or higher lost 2.7 percent last month, the most since October 2008, according to Bank of America Merrill Lynch indexes. Korean covered bonds in dollars declined 2.5 percent last quarter, while Australian notes in the currency fell 1.4 percent, the data show.

Global Bank’s $200 million of 4.75 percent notes backed by mortgages in Panama fell to 99.3 cents on the dollar yesterday from 101.93 at the end of the first quarter, Bloomberg prices show. Korea Housing’s $500 million of 1.625 percent covered debt, sold at 99.3 cents in February, dropped to 91.8 cents today, the prices show.

Sluggish global growth is also holding back covered issuance as fewer borrowers take out mortgages. South Korean home loans increased 3.5 percent last year, down from more than 7 percent for each of the preceding four years, according to data from the Bank of Korea. Housing finance in Australia, where lawmakers passed a covered bond framework in October 2011, fell 0.2 percent in April, data from the statistics bureau show.

Economies Growing

Global growth will be 3.1 percent this year, unchanged from the 2012 rate, and less than the 3.3 percent forecast in April, the International Monetary Fund said today. South Korea and Australia’s economies are both forecast to grow 2.5 percent this year, while the 17-member euro zone is set for a second year of recession, according to analysts surveyed by Bloomberg News.

Spanish mortgage lending had fallen 90 percent from the peak of the credit boom in January 2007 as of March, Spain’s national statistics institute said in May.

“When you have a recession, people don’t necessarily go out and buy a house,” said Ted Lord, head of European covered bonds at Barclays Plc. “A lot of the lending volumes are down because of that,” he said from Frankfurt last month.

Yields on a gauge of global bank debt slumped to 2.31 percent in May, the least on record, according to the Merrill Lynch indexes. The rally, which has since reversed as interest rates jumped as high as 3.03 percent on June 24, held back covered bond sales earlier this year by offering banks an attractive alternative funding source.

Unsecured Sales

Unsecured sales can introduce investors to covered bonds sold by the same lenders, according to Gareth Davies, head of European asset-backed securities research at JPMorgan Chase & Co. in London.

“Future covered issuance from Asia is likely to be easier for investors than Latin American covered bonds, for example, as institutions are likely to be more familiar with pricing points,” he said.

South Korea is readying legislation to facilitate more covered bond issuance, while Singapore is also considering a framework to encourage offerings. Banco Santander Chile plans to sell the first covered bonds in the South American country, finance manager Emiliano Muratore said in an interview in March.

Barclays’ Lord traveled last month to Azerbaijan, Georgia, Ukraine and Kazakhstan to discuss use of the securities.

Risk Sentiment

Covered bonds are often rated AAA, so they’re more attractive when risk sentiment deteriorates. The ability to sell the notes “has been critical in helping our financial institutions weather heavy market turbulence,” Wayne Swan, Australia’s treasurer at the time, said in a speech last year.

That turbulence returned last month after the Fed’s June 19 announcement and as European Union leaders reached a deal on how to handle failing banks and enforce creditor losses.

While the volatility is driving investors away from emerging markets, it could bolster covered bond issuance as asset buyers favor the security of such debt.

“The recent selloff in the market and the EU agreement on bank resolution could reset the balance between senior unsecured and covered bond issuance,” said Grodzki. “It may make investors rediscover their taste for covered bonds.”

Before it's here, it's on the Bloomberg Terminal.