The introduction of covered bonds has long been mooted in Asia, with Korean and Singapore leading the charge to bring in a new source of low-cost funding for their banks. To aid the market’s development, Korea passed a Covered Bonds Act in 2013 while Singapore introduced a framework for the product in the same year.
But close to two years down the road, and the only thing that is notable about the asset class is the total lack of issuance. There’s been plenty of talk with painfully little to show for it.
That, however, is finally expected to change with Kookmin expected to launch a covered bond soon, after wrapping up a series of investor meetings last week. DBS, too, is closing in on a deal with its roadshow due to finish on July 3.
On paper, there is great potential for covered bonds in these two countries. A possible S$25bn ($18.4bn) of issuance has long been mooted for Singapore, while Korean volumes could be even greater thanks to its much larger mortgage market.
The country boasts one of the highest levels of household debt in the world and mortgage loans — which make up the bulk of household debt — amounted to W470tr ($418bn) as of March 31, according to the Bank of Korea.
And there is little doubt that Kookmin and DBS will get a good reception when they choose to launch their deals. After all, they are two of the strongest banks in Asia with ratings of A1/A/A and Aa3/AA-/AA-, respectively. Plus they will provide some much needed diversification to a market that is dominated by European issuers.
But anybody banking on this pair of deals to trigger a slew of additional issuance will be in for a rude awakening. There are plenty of reasons why covered bonds have been slow to gain traction in Asia and those same reasons are likely to stymie the market’s growth.
Top of the list is the fact Asian banks have plenty of cash, and run low loan-to-deposit ratios compared with their global peers. Lenders have access to a large and sticky deposit base and cheap onshore funding that means they rarely feel the need to branch outside their home market for funds.
That is one reason why Singaporean banks hardly ever issue senior debt in the international market, selling only three deals totaling $2.05bn in 2014, according to Dealogic.
The situation for Korea isn’t any better. While the country’s banks are more active in issuing dollar debt than their Singaporean counterparts, the narrow spread between government bonds and their senior notes means there is little room for them to slot in covered bonds.
All the administrative work and extra effort needed to issue a covered bond simply does not make sense in relation to the number of basis points they can save, at least not against the backdrop of prevailing low interest rates.
But even that hinges on whether Korean banks can actually even find enough of the right assets to put into a covered bond. Even though the country has loads of mortgage loans, more than three quarters of those are floating rate mortgages. The 2013 Act requires at least 30% of the cover pool to be fixed rate loans.
Korea and Singapore have worked hard to make covered bonds a reality, but a truly vibrant market is years away.