Daily Update: June 26, 2024

Originating in the 18th century, covered bonds have long held a reputation as a safe haven in times of economic distress. More than 250 years later, covered bonds have become a crucial funding strategy in Europe. The European covered bonds market achieved exceptional growth in 2023 and is expected to remain resilient in 2024.

Covered bonds are senior secured debt securities that are backed by high-quality assets such as residential mortgages or public sector loans. The assets are held in a cover pool, which provides protection for bondholders if the issuer, typically a bank, defaults. This additional layer of protection makes covered bonds a highly liquid and safe asset for investors such as pension funds, insurers or asset managers. Since these bonds are offered at lower interest rates than other debt, they are also a relatively cheap funding source.

The low-risk nature of covered bonds, which have no history of defaults, is stimulating capital markets in Europe with record levels of issuance. Between Jan. 1, 2023, and Nov. 26, 2023, banks in the region sold a 10-year high of €171 billion in covered bonds. Covered bonds also got off to a strong start in 2024 and full-year issuance levels are forecast to remain elevated at roughly €160 billion, according to S&P Global Ratings, while year-to-date sustainable covered bond offerings are higher year over year.

The ongoing strength of Europe’s covered bonds market comes at a time when the COVID-19 era of cheap funding has faded. During the peak of the pandemic, ultracheap funding was rolled out under central bank liquidity programs to boost lending and spur economic growth. As these pandemic-era borrowings came due, banks turned to secured lending, particularly covered bonds, to support liquidity levels.

"The main driver for continued issuance strength remains issuers' focus on secured funding following the repayment of borrowings from central bank liquidity schemes," according to S&P Global Ratings’ second-quarter insights on covered bonds. The elevated levels of covered bond issuance also come in the wake of the banking turmoil that started in March 2023, when three US regional banks failed and Swiss lender Credit Suisse collapsed.

For 2024, S&P Global Ratings maintained a stable outlook on Europe’s covered bonds market, despite headwinds such as geopolitical turmoil and market turbulence. “Healthy rating buffers in most covered bond programs continue to support rating performance despite a slowing economic growth outlook,” covered bond analyst Casper Andersen said during an episode of S&P Global Ratings’ structured finance podcast, “Take Notes.”

In the podcast, Andersen shared views on the covered bond markets of Norway, Finland, the Netherlands and Iceland. Mortgage credit performance is likely to remain relatively stable in Norway and Finland due to resilient job markets and growing populations, even as higher interest rates have cooled housing markets. In the Dutch market, higher funding costs are depressing excess spread and expanding asset-liability mismatch, while investor demand for sustainable covered bonds is on the rise. In Iceland, covered bonds are now less reliant on domestic investors, which could mean higher ratings, Andersen said.

Overall, a projected soft landing for Europe’s economy and strong investor appetite for sustainable and long-dated offerings should drive further growth in the region’s covered bonds market, according to S&P Global Ratings.

As a creditworthy asset that has endured for nearly three centuries, one thing is evident: Covered bonds are offering a safe harbor in times of uncertainty for Europe.

Today is Wednesday, June 26, 2024, and here is today’s essential intelligence.