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Covered Bonds

Funding diversity is the best hedge for falling deposits

Piggy bank and money balanced HiRes 575

Banks cannot rely on deposit growth

Banks surveyed in the European Banking Authority’s latest Funding Plan Report expect to see double-digit percentage point growth in household deposits and non-financial corporation deposits by 2025.

This flies in the face of more recent data collated by S&P, which said, in its mid-year outlook, that deposits from these two sources were falling faster than loan demand.

The widening gap will require funding, a dilemma that can only be exacerbated by further large repayments to central banks as the ECB’s Targeted Longer-Term Refinancing Operations and the Bank of England’s Term Funding Scheme for SMEs come due.

The EBA and S&P agree that record amounts of wholesale funding will be needed in 2024 and 2025.

Senior unsecured funding offers volume but covered bonds provide the cheapest source of readies. In both cases, the markets’ capacity to absorb record issuance may prove finite, driving issuers to seek more diverse opportunities.

Europe’s national champions have not been active in Yankee covered bonds since 2012-2013 and although access is costly compared with euros, it’s a fraction of what it costs to print dollar senior unsecured paper. Kangaroo, Samurai, sterling and Maple markets seem exotic, but are not far-fetched.

Smaller issuers can’t expect the same name recognition overseas, but have plenty of alternatives. Taps and tailor-made private placements in euros are making a comeback.

Issuers with a surfeit of retained collateral could consider pledging covered bonds for private repo. Added to that, the stars are now aligning in the European securitization market for increased issuance.

More fundamentally, tight labour markets and the drive to net zero emissions have long-term ramifications for inflation and rates, which may stay higher for longer than expected. And it would be complacent to overlook the effect of the war in Ukraine which shows no sign of abating.

Set against the hefty funding outlook, market access cannot be counted on and so FIG issuers with access to a diverse set of funding avenues — and the pragmatic sense to use them — will be more resilient than those that don’t.