Interview: Allianz Global Investors France

The Covered Bond Report’s Neil Day spoke to Anne-Claire Lacharme and Franck Mugat, fixed income portfolio managers at Allianz Global Investors France, about their views on Nordic covered bonds’ performance, liquidity and more.

Is the performance of Nordic covered bonds this year justified?

Anne-Claire Lacharme

Anne-Claire Lacharme, Fixed Income Portfolio Manager, AllianzGI France: Nordic covered bonds have shown a good performance this year. The total return has been 6.4% YTD according to the Barclays euro aggregate covered bond index.

This performance was driven by two factors: firstly, the good performance of the covered bond asset class over the year, and secondly, the status Nordic banks have gained whereby they are perceived as a safe haven by concerned euro-zone investors.

The tightening of spreads occurred particularly in the first quarter and this summer, with almost 50bp of tightening versus swaps since the beginning of the year in the five year area.

The good absolute performance of Nordic covered bonds has to be put into the perspective of the overall performance of the sector. In the covered bond universe only German Pfandbriefe have recorded a weaker performance than Nordics since the beginning of the year. That means that the Nordics are the second worst performers.

Nordic covered bonds have clearly benefited from the euro-zone crisis and their safe haven status. We can observe this phenomenon for all the non-euro countries, for example the UK, as well as Australia and New Zealand. Finland is in the euro-zone, but it is associated with its neighbours. This trend is justified by the economic strength of these countries compared with the euro-zone — but sometimes this obscures problems they could face in the future. Norwegian house prices are booming and that has generated some concern on the part of the central bank, for example, and this kind of concern has absolutely no impact on spreads.

Franck Mugat, Fixed Income Portfolio Manager, AllianzGI France: During the euro-zone crisis, Nordic covered bonds, especially Norwegian and Swedish covered bonds, have posted a very good performance from a fundamental point of view and in terms of economic prospects much better than euro member countries like France, Italy and Spain.

If we look at unemployment in the Nordic countries the figures are much better, especially in Norway. And the legislation is also quite good — although when we are looking at frameworks across Europe they have become quite standardised.

But, as Anne-Claire mentioned, there are several sources of concern, especially house prices. At the moment, the market only takes into account the safe haven status of these countries.

We are now entering a new period with more support for peripheral countries, so maybe the performance of Nordic countries could reverse a little bit.

Are you over- or underweight any particular sectors?

Lacharme: Our investment process is based on fundamental opinions, which, in the case of the Nordic countries, is good compared with other countries — the peripherals, for example. Our fundamental opinion is stable. In terms of positioning in the portfolio, we prefer to stay neutral — neither overweight, nor underweight — but with a little differentiation between countries, mainly driven by relative value. Tactically we favour Norway, Finland and Denmark versus Sweden, mainly because of the pick-up.

Mugat: There are some Swedish covered bonds that trade very close to German Pfandbriefe, so they are a little bit expensive and we don’t see any additional performance of Swedish covered bonds in that context.

Lacharme: Absolutely. The main objective of investors who are buying Nordic covered bonds today is capital preservation, not performance as spreads have tightened to very low levels. Nordics are close to Pfandbriefe now — it seems that there is not much more potential for performance in the coming months.

Is it justified that Danish credits trade at a premium?

Lacharme: We think that the premium for Danish covered bonds is justified.

Currently, Danish covered bonds trade around 20bp wider than Swedish covered bonds, and around 10bp wider than Norway and Finland in the five year area. A few factors can explain this difference, and we can look at three main factors that we consider when analysing covered bonds, which are the sovereign economy, issuer credit quality, and the quality of the cover pool.

Looking at the sovereign, Denmark faced a more significant slowdown than its Nordic peers in 2008 and 2009. After recovering, Danish GDP was again in negative territory in the second quarter of this year, down 0.9% on a year-on-year basis. In the same period the Norwegian and Swedish economies showed stable and positive growth. Also, housing prices in Denmark have plunged by 25% since the peak of 2007, and they keep on falling: the government expects a 3.5% decline in house prices this year. Denmark has the highest household indebtedness in the world relative to income. The positive aspect is that Denmark continues to rely on its safe haven status, supported by a government debt level that is less than half the euro-zone countries’ average, and a current account surplus. That’s why Denmark is seen as better than the euro-zone countries, but maybe less strong than Sweden and Norway.

Franck Mugat

In terms of issuer credit quality, the rating of Danske — which is the main Danish issuer when we talk about euro denominated covered — is Baa1/A-/A, lower than the main other Nordic banks: Nordea is in the AA- area and DNB Nor is in the A+ area.

In the area of overcollateralisation, levels are quite good in Denmark, quite similar to other Nordics. And in terms of loan-to-values, indexed LTVs are similar but slightly higher.

Regarding these factors, a premium for Danish covered bonds really seems justified given that there are some weaknesses in Denmark compared with the other Nordics.

Mugat: The spread between Denmark and Swedish and Norwegian covered bonds is nevertheless quite thin.

To what extent are the domestic markets some Nordic issuers can rely on a factor in your opinion of the banks in those countries?

Mugat: It’s really interesting for us to know that there are strong domestic markets in these countries, because that means that there are alternative sources of funding. Issuers don’t only rely on the euro covered bond market but have their own well-functioning domestic markets with domestic investors. We take this into account in our analyses, but it’s not a key factor for us.

How does liquidity compare across Nordic covered bonds?

Lacharme: Regarding covered bonds in general: secondary market liquidity has tightened. The low supply and sustained demand for this asset class has dried up the secondary market. This trend is particularly visible for covered bonds from non-euro countries, including the Nordics. We believe that liquidity in general will remain quite poor until the beginning of next year with the reopening of the primary market.

More specifically, regarding Nordic covered bonds, we really see a distinction between the short term and the medium and long term parts of the curve.

Mugat: From speaking with traders about Nordic covered bonds, it seems that it’s much easier to find some liquidity on the short term part of the curve, up to three years, rather than on the long term. Perhaps it’s easier for traders to find these short term Nordic covered bonds in repo and at some point they try to give liquidity, we feel, but it’s really different for the longer bonds.

Lacharme: For the medium and long term, especially on the 10 year area, we see an imbalance between the low number of sellers and a continued strong demand. Offers for size — more than Eu10m — are pretty scarce. We think that investors that are holding these types of bonds aren’t taking profit because they are not sure of being able to buy something else and, as they are quite confident about the fundamentals, they prefer to keep this exposure in spite of the good performance they have had.

Another important point regarding liquidity is that central banks seem to hold quite a lot of Nordic covered bonds in this seven to 10 year area, which they bought during the past two years for diversification purpose. These bonds are not available for repo. Market-makers are reluctant to show short offers to avoid the risk of not being able to deliver at settlement. Liquidity for offers is therefore very low right now for long term Nordic bonds. However, liquidity is good when you want to sell. But, actually, there are not many sellers in the 10 year area.

Are you open to Eu500m deals?

Mugat: We need a minimum size of Eu500m when investing in covered bonds. We know that in terms of liquidity in very stressed periods even large benchmarks with a size above Eu1bn can become very illiquid, but generally we try to invest in Eu500m minimum. We consider that there is less liquidity below this size, so we don’t pay attention to smaller issues. In our benchmark, for instance, there are only bonds with an outstanding size of Eu500m minimum.

Do you have any final thoughts on the outlook?

Mugat: We recognise that there are some sources of concern about housing markets in the Nordics. We know that the FSA in Norway made some warnings and asked for new guidelines for mortgage lending. With our credit analysts we will monitor closely house price developments, especially in Norway, focusing on two factors: house prices, and household indebtedness.

That’s why we are generally neutral on Nordic covered bonds. Up until now there have been quite good fundamentals, but at the same time the pricing is really, really tight, so it is difficult to be overweight in that context.

It will really depend on the development of the euro crisis, and if there are fewer risk aversion trades then these bonds should underperform in the next few months. n