The wholesale bond issuance strike undertaken by the four major banks in the second half of 2011 is coming back to haunt them. The banks were holding off in the hope that market conditions would be better in 2012. There was also an expectation that covered bond issuance would offer a cheaper wholesale funding alternative, albeit within regulated limits. Now it seems that covered bonds are a funding necessity and the pricing on covered bonds is pushing up credit spreads on unsecured bonds to unprecedented levels. This will leave institutional investors with mark to market losses on their existing bond holdings and may well result in an unanticipated credit squeeze.The start of this month saw CBA and NAB issue €2.5 billion of five-year covered bonds in the Euromarket, at a swapped back cost into Australian dollars of around 220 basis points over bank bills. This suggests a 270 bps credit spread for unsecured bond issuance.Both the banks and domestic market participants were shocked by the credit spread demanded, but took consolation from the fact that the spread represented the anxieties of European investors and 120 bps of the spread was due to unfavourable basis swaps.Moreover, this was seen as the price the banks had to pay to open the Euromarket to Australian covered bond issuance. It was a one-off.Not so. Covered bond issuance has continued into Europe, albeit by private placement, and the CBA is about to launch the first domestic covered bond issue. Covered bonds could be used to replace much of the A$50 billion-plus of AAA-rated government guaranteed bonds (issued during the GFC) due to mature this year.The banks had, of course, hoped to replace the government guaranteed bonds with lower cost term debt, when these bonds reached maturity. This hope may be dashed.Credit spreads on five-year government guaranteed bonds issued in the domestic market peaked at 190 bps, including the guarantee fee. The credit spread on the new CBA covered bond has been set at 180 bps to 190 bps. Outright yields are likely to be higher too. NAB paid only 5.645 per cent on its December 2013 government guaranteed bond, issued in December 2008. Indicative pricing on the CBA covered bond suggests a yield of at least six per cent per annum.As for unsecured bond issuance, if it is possible, the spread for the CBA covered bond implies an unsecured credit spread in offshore markets 270 bps at the lower end of the range. This assumes the two-thirds pricing rule for covered bonds still applies. At these levels, the cost of debt will inevitably rise for all borrowers. The Reserve Bank of Australia may be able to offset this to some degree for mortgage and SME borrowers through downward revisions to the cash rate, if it chooses to do so. Corporate borrowers will have even more incentive to consider bond issuance of their own.