DBS Bank has propelled Singapore into the global ranks of covered bond issuers following the completion of a debut $1 billion issue from its newly established $10 billion covered bond programme.
The city state has taken a number years to get a regulatory framework in place for an asset class that now tops the €2.5 trillion ($2.73 trillion) mark and has proved particularly popular in Europe where it was one of the few forms of debt to remain open to bank issuers during the global financial crisis.
Covered bonds are a type of fixed income security, which are backed by an asset pool (normally residential mortgages) and remain on balance sheet unlike other forms of securitized debt. Their overcollateralization means they attract a higher credit rating and lower cost of funding than senior debt, albeit one that ties up assets.
For DBS Bank this meant an AAA/AAA rating for its three-year deal compared to a stand-alone credit rating of Aa1/AA-. Pricing at 37bp over mid-swaps was also about 23bp inside the theoretical level of its senior debt according to syndicate bankers on the deal.
The deal, which was issued in the name of Bayfront Covered Bonds, was initially marketed at 40bp over. Pricing was fixed at 99.948% with a coupon of 1.625%.
Bankers said the deal attracted an order book of $1.37 billion, with participation from 45 accounts of which Asian investors accounted for 51%, Europe and the Middle East 30% and the US 19%.
By investor type banks took 62%, fund managers 19%, central banks 9%, supranationals 8%, corporates 1% and private banks 1%.
The three-year point of the curve made sense for the bank, since this is where it has very little outstanding issuance. According to bond analysts it has only has about $300 million maturing in 2018 compared to roughly $2.8 billion in 2015, $3 billion in 2016, $1.5 billion in 2017 and $500 million in each of 2019 and 2020.
DBS executed its transaction during an extremely busy month for covered bond issuance although bankers said this made very little difference to end demand. Following a Greece-induced hiatus during May and June, issuers have been back with a vengeance during July, raising €10 billion since the middle of the month.
On Tuesday alone there was a total of $4.17 billion from four issuers (Bank of Nova Scotia, Bank of Montreal, Bankia and LBBW). However, bankers said DBS Bank was able to stand out after opting to issue in dollars rather than euros, which accounts for the vast majority of deals.
In a recent research report Credit Agricole said the focus is starting to switch from euros to dollars as investors begin to mull the likely impact on spreads of CBPP-eligible covered bond debt as the European Central Bank starts to wind down its quantitative easing programme and stop purchasing covered bonds.
As a non-European issuer, DBS is not eligible for the programme.
For the past two years there has been a supply demand imbalance in the covered bond market thanks to the ECB. Analysts estimate it now holds about 32% to 35% of eligible covered bonds thanks to its buy back programme.
This was the main reason why overall outstandings dropped by 4% during 2014 even though issuance rose 6% over the course of the year.
Australian and Canadian benchmarks
The US-dollar denominated pool of covered bonds is much smaller and dominated by Australian and Canadian banks.
According to Credit Agricole research banks such as Westpac, National Australia Bank (NAB) and Royal Bank of Canada (RBC) are respectively showing a 16bp, 26bp and 19bp differential between their senior and covered bond debt.
For example, Westpac has a July 2018 senior bond trading at on an asset swap spread (ASW) of 47bp over and a November 2018 bond at an ASW of 31bp over.
The 23bp theoretical differential DBS offered had closed to 21bp as of Thursday's close in Asia.
Bankers said the main benchmark for its covered bond was slightly lower rated Aa3/A+ National Bank of Canada, which has a triple-A rated April 2018 covered bond trading at 32bp over mid-swaps, 5bp inside of DBS. It is, however, on negative outlook from Moody's.
DBS itself is an infrequent issuer in the international bond markets and has few bonds to accurately benchmark the new issue against.
Its 2.35% February 2017 senior bond is illiquid and was being quoted yesterday at an ASW spread of 15.4bp, while its 3.625% Aa3/A+ rated September 2022 subordinated debt was being quoted at 140.1bp over.
Bankers said investors also looked at Canadian bank Toronto Dominion, which has the same Aa1/AA- rating as DBS. Its three-year senior debt is trading at 53bp over mid-swaps.
In its rating statement Moody's said that new covered bond should provide DBS with a stable and low cost funding source. But it does not believe the deal will presage a large wave of issuance from Singapore, although UOB has said it is considering a bond later this year.
"The credit strength of the three Singaporean banks enables them to raise funds through other low cost channels without offering collateral security and issuance could thus remain well below the regulatory limit of 4%," it commented.
Legislative framework
The Monetary Authority of Singapore (MAS) has ruled that covered bonds can amount to no more than 4% of total assets. Some have criticised the level for being too low, but as Credit Agricole points out, the UK started off at the same level before widening the limit to 20% and then removing the hard limit altogether.
One of the main hurdles getting covered bonds off the ground in Singapore concerned the role of the Central Provident Fund in the mortgage market. Unlike other countries, the CPF has first claim on many mortgages because its members are able to use their holdings to re-pay their housing loans.
DBS got round the issue by deploying a trust structure. Acting as trustee it 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.
The MAS clarified the arrangement in a regulatory announcement in June.
Similar to Australia, the MAS also imposes a minimum overcollateralisation ratio of 103%. In Korea, the regulator has set it at 105%.
In getting its deal to market, DBS has also pipped Kookmin Bank, which has also been roadshowing a covered bond. Both deals were held up by Greece and in DBS' case an earnings blackout before the release of its second quarter results on Monday.
Earnings momentum
These showed a 15.3% year-on-year increase in net income to S$1.117 billion ($812 million), beating analysts' estimates. The bank's net interest margin was one of the main stars, rising 6bp quarter-on-quarter.
Credit Suisse said that DBS remains its top pick because it is "likely to see the best near-term earnings momentum helping by better net interest margins, lower credit costs and resilient, broad-based, non interest income performance."
CIMB added that its outperformance is being driven by market share gains in mortgages in a slow growth environment and cost savings from the upgrade of its digital platform.
Lead managers for the covered bond were DBS, Deutsche Bank, JP Morgan and Societe Generale with Barclays and Citi as joint-leads.
