Covered Bonds

Komerční banka (KB), a partially owned subsidiary of Société Générale, has mandated leads for the first fully distributed euro benchmark covered bond from the Czech Republic, paving the way for other major lenders to follow suit.

Financial institution borrowers are expected to concentrate efforts on their more difficult trades at the start of this year, reflecting the view that credit conditions cannot get much better — a prudent approach to funding. But the economic recovery is unlikely to be as smooth as expected, and although central banks stand ready, credit market volatility should revive covered bonds as the rainy day funding product of choice.

Aareal Bank priced the first covered bond of the year flat to its curve and, unusually, the first leg of the swap payment was priced below the European Central Bank’s deposit rate of minus 0.50%. Even so, the bonds attracted good demand.

Sustainable finance specialists are optimistic that the European Commission will make a last minute concession on its proposed rules for green buildings when it publishes its final and binding Taxonomy of Sustainable Economic Activities, expected later this month.

Despite mounting evidence of a second more fatal wave of Covid-19 infections and longer lasting, tighter lockdowns, it seems that very little can unhinge the positive outlook for covered bonds as liquidity is set to remain king.

Aareal Bank mandated leads on Monday for the first new covered bond of 2021. At the same time, market participants have low issuance expectations for the next few days. Even though supply may improve next week, January volumes are expected to be lower than in previous years.

Covered bond issuance from Europe’s peripheral regions is likely to be anaemic in 2021, as issuers will continue to rely heavily on far cheaper central bank funding. Covered bond spreads are very tight, but the cost of senior unsecured bonds has come down faster, and deposits have grown.

The European Central Bank’s gross covered bond purchases sustained strong momentum in November which, in conjunction with wavering supply and high redemptions, caused real investors to be squeezed out — a theme that is bound to continue in 2021.

The three major rating agencies have broadly positive outlooks on the covered bond market next year, but they have underlying concerns about rising unemployment, mortgage payment holidays, sovereign and issuer rating downgrades and Brexit.

Expected euro denominated covered bond supply from the Nordic region looks promising with Norway likely to prove a particularly bright spot. However, more cost-effective domestic funding in the Swedish market is expected to depress euro volumes there.

Germany will remain one of biggest covered bond issuance regions, accounting for up to a fifth of European supply next year. The residential real estate market and economy are expected to remain resilient and, along with robust investor protection built into Pfandbriefe, the market is well buttressed — even when it comes to riskier commercial real estate exposures.

Singapore could prove to be a rich seam of covered bond issuance next year, with bankers suggesting analysts’ expectations are far too pessimistic. Conversely, Australian issuance may prove to be disappointing. Meanwhile, potential new legal developments in Japan and Malaysia will provide a key focus of attention.