In its Covered Bond Market Insights report, S&P Global Ratings presents the local covered bond market, explains how the relevant legal framework works, provides an overview on the local mortgage market, compares key characteristics of the existing programs, and presents the results of a scenario analysis. In this report, we review the Dutch covered bond market.

Overview: An Established But Dynamic Covered Bond Market

The Dutch covered bond market has seen a gradual but thorough transition over the past 15 years roughly, from a purely structured model to a legislation-enabled framework. The market has shifted more recently toward soft bullet issuances from conditional pass-through (CPT) structures, which enjoyed a period of strong popularity in the market. The Dutch covered bond market comprises 16 residential mortgage-backed programs from nine issuers, representing over €158 billion of outstanding issuance. We currently rate 10 Dutch covered bonds programs, of which two were set up in 2022.

The typical Dutch covered bond displays relatively low credit risk but fairly high asset-liability maturity mismatch risk. While Dutch investor-placed benchmark covered bond issuance increased by 28% in 2022 from 2021, its share within the European market decreased to about 6% compared with 10% one year earlier.

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Effects of the new interest environment

In response to soaring inflation, the European Central Bank initiated a series of interest rate hikes since June 2022, ending a decade of historically low rates. In the years before the change, borrowers in the Dutch residential mortgage market locked in long-term, fixed rate, very low financing costs for their expensive homes. Currently, Dutch cover pools in our rated programs generate about 2.4% interest on average.

The weighted-average interest rate on the outstanding covered bonds in our rated portfolio is 1.3%. Covered bonds in our rated portfolio issued since summer 2022 pay 2.5% on average, reducing part of the traditionally high excess spread in the Dutch covered bond programs we rate.

Furthermore, all the Dutch covered bonds issued in 2021 that we rate were long-term covered bonds and the weighted-average tenor of the rated portfolio exceeded 10 years at issuance. But current market conditions no longer favor long-term issuances. None of the Dutch covered bonds we rated since summer 2022 exceed the seven-year scheduled maturity segment, which further increases asset-liability maturity mismatch risk in the programs. Currently, the weighted-average maturity of the assets in our rated cover pools is about three times longer than that for the rated covered bonds.

Dutch programs benefit from multiple unused notches--the number of notches the issuer credit rating (ICR) can be lowered without resulting in a downgrade of the covered bonds. Considering this, and the availability of credit enhancement exceeding the level required to maintain our ratings, we do not expect the increased required credit enhancement to affect our covered bond program ratings.

The Netherlands implements the European covered bond directive

The legislation to transpose the EU Covered Bond Directive into the Dutch legislation includes a new law (Voorstel van Wet - Memorie van Toelichting or Financial Supervision Act 2022) and a new decree (Besluit prudentiële regels, Wft or Decree on Prudential Rules under the FSA 2022).

The decree (dated May 24, 2022) modifies certain provisions of the Financial Supervision Act. The legislative package became effective on July 8, 2022, and applies to covered bonds issued from that date. Amendments to the previous legal framework were essentially refinements, given the Dutch legislation was already well-aligned to the requirements of the EU harmonization directive.

The main changes include clarifications on the conditions allowing an extension of maturities on soft bullet covered bonds and the application of a 180-day liquidity requirement. Furthermore, under the current legislation, a loan value exceeding the 80% loan-to-value (LTV) limit can no longer contribute to fulfilling the 5% nominal overcollateralization requirement.

Macroprudential measures have reshaped the Dutch lending market

The Dutch tax system, which traditionally encouraged household indebtedness via mortgage borrowing, has shaped the main characteristics of the Dutch mortgage market through high LTV ratios and a large proportion of interest-only loans. From the early 2000s, the Dutch government started to adjust the generous tax deductibility of mortgage interest to curb one of the highest household indebtedness worldwide.

In 2013, the government launched a comprehensive set of macroprudential measures to address both risk factors. Newly originated mortgages now need to amortize within 30 years to benefit from tax deductibility. Furthermore, the extent of tax deductibility is being reduced in incremental steps from the highest marginal tax bracket (52%) to the lowest (37.1%) by 2023. The relatively small initial steps of 0.5% per year were replaced by a reduction of 3% each year since 2020. In parallel, the maximum LTV ratio reduced to 100% by 2018, from 120% in the early 2000s, and loan-to-income limits now cap the borrower's potential interest burden.

As a result, the share of interest-only loans decreased in our Dutch rated cover pools to 43% in 2022 from about 85% in 2010. Also, the cover pools' average current LTV ratio fell to 52% from 69% over the same period. Household debt decreased to 222% of net disposable income in 2021 from its 286% peak in 2010, based on Organisation for Economic Co-operation and Development data. The ratio has constantly decreased over the past 10 years, despite strong house price inflation in recent years.

2021 may have marked a hold on successive measures attempting to cool the mortgage market and strain macroprudential risks attached to the property market. In addition to looser lending conditions for couples, an exemption from stamp duty was introduced for young first-time buyers when purchasing an average home (of up to €400,000). Since 2022, municipalities have the option to support first-time buyers by banning investors from buy-to-let property purchases.

Despite a series of long-term macroprudential steps, house price increases have hit record highs in almost every year since the mid-2010s--until mounting inflation pressure suddenly made the European Central Bank raise interest rates in several stages since the end of summer 2022. These steps multiplied the financing costs of new loans amid the average citizen's weakening purchasing power. Due to strains on affordability from multiple ends, the rate of house price increases decelerated by end-2022.

The Legal Framework: An Overview

Bondholders have a dual recourse to receive payments on their debt: they have unlimited recourse to the issuing bank but also recourse to the cover pool assets if the issuer becomes insolvent. The framework stipulates a clear segregation of the cover pool assets for the bondholders' benefit, who have a senior claim to them. This is achieved by a transfer of assets from the issuing bank to a bankruptcy-remote covered bond company.

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Setoff risk

The Dutch mortgage market contains several products that raise specific setoff risk issues upon issuer insolvency. In addition to construction loans ("Bouwdepot") allocated for home improvement, these products also include savings mortgages ("Spaarhypotheek"), insurance mortgages ("Verzekeringshypotheek"), and investment mortgages ("Beleggingshypotheek"), designed to take advantage of a tax asymmetry that allows the borrower to obtain a cheaper effective interest rate on their mortgage loan. In effect, instead of repaying principal to the lender (the bank), the borrower invests in a savings product provided by an insurance company (the insurer). The return on this investment is tax free up to an applicable exemption amount and is used to repay the mortgage loan.

Following issuer insolvency, setoff risk could potentially arise pertaining to deposits maintained by borrowers with the issuer (whose loan has been included in the cover pool). However, setoff risk can only occur if multiple scenarios materialize simultaneously. Hence, we generally consider this to be a remote risk. Moreover, in certain cover pools showing above-average risk potential, committed credit enhancement levels or participation agreements can mitigate setoff risk.

Soft bullet displace CPT covered bonds

CPT covered bonds were particularly popular in the Netherlands during the second half of the 2010s. Their popularity mainly stemmed from the traditionally high proportion of interest-only loans in cover pools, which considerably increased refinancing costs in more traditional soft bullet structures. As CPT covered bonds structurally eliminate refinancing risk--the risk the pool administrator is forced to liquidate assets to repay a maturing bond--we delink the rating on a covered bond from the rating on the issuing bank when the covered bond's overcollateralization is legally or contractually committed. This allows lower-rated issuers to access a 'AAA'-dominated market.

As of Jan. 1, 2019, the Governing Council of the European Central Bank excluded CPT covered bonds from its reinvestments under the CBPP3 (Covered Bond Purchase Programme 3). While the decision had no effect on the eligibility of CPT programs in the Eurosystem collateral framework, the product lost attractiveness for some investors. By now, all Dutch CPT issuers we rate have established soft bullet programs. Currently, about 90% of all outstanding Dutch covered bonds have soft bullet maturities compared with about a 4% share of CPT covered bonds.

As our analysis of covered bond programs starts with the assumption of the issuer's default on day one of our analysis, for CPT programs we typically model in our cash flows a switch to the pass-through mode and the extension of the bonds to their legal final maturity date. Our rating therefore addresses the timely payment of interest and of principal on the legal final maturity date, and not the scheduled maturity.

Coverage tests

Issuers typically commit to a minimum level of overcollateralization via contractual agreements, including the asset cover and amortization tests.

These tests are designed to not only ensure a minimum ratio of cover pool assets for covered bonds, but also serve to enhance the credit quality of the assets in the portfolio. This is because the tests exclude certain mortgage loans from the amount eligible and therefore create an incentive for issuers to remove them from the cover pool. Noneligible loans can include mortgages subject to setoff risk or impaired assets, among others.

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Mortgage Market Overview: Insiders Have A Safety Cushion While Outsiders Face Thicker Walls

We expect the Dutch economy to slow, but not tumble

The economic slowdown we currently expect in Europe will weigh significantly on the Dutch economy through trade and consumer confidence. Persistent inflation strains the Dutch population's purchasing power. We believe the tight labor market, and measures to mitigate increases in the cost of living enacted in the 2023 budget, should partly cushion the blow on households.

The government's announced purchasing power measures for 2023 include a €17 billion package (1.7% of 2023 GDP) presented in the 2023 budget. This includes further lowering of energy taxes, one-off energy compensation benefits for lower-income households, the continuation of the 21% reduction in excise duty on fuel, and an increase in social allowances. The government also announced a price cap on energy contracts in early October, with an estimated cost of €23.5 billion (2.4% of GDP).

We currently forecast a marginal but positive growth rate in the Dutch real economy and a modest rise in unemployment for 2023 (see "Covered Bonds Outlook 2023: Sailing Through Choppy Waters," published Dec. 6, 2022).

Dutch house prices will fall this year

House price growth seemed to peak in mid-2022 and we expect that house price inflation will have decreased to low single-digit levels for the year 2022. We forecast a slight decline in house Dutch house prices in 2023 mainly due to home buyers facing still expensive house prices coupled with rapidly rising financing costs, heavily weighing on affordability (see "European Housing Prices: A Sticky, Gradual Decline," published on Jan. 11, 2023).

Mortgage borrowers that signed their contracts before mid-2022 are shielded from rate rises on their predominantly fixed rate borrowing until the next refinancing date. In our rated portfolio, the next interest refixing date is in about seven years (on a weighted-average basis).

With reduced borrowing power both in terms of capital and monthly interest payments, the average new borrower has to lower the price segment it can afford, which is a difficult step given worsening housing affordability over the past several years. Based on Dutch official statistics (Central Bureau of Statistics Netherlands; CBS), consumer price inflation had exceeded price increases of owner-occupied dwellings by autumn 2022. Therefore, house prices were already contracting in real terms at the end of 2022. Market participants typically do not expect property prices to significantly drop in nominal terms, due to the still tight supply in the Dutch housing market.

The labor market should stay resilient

In our analysis, unemployment is the best predictor of mortgage performance. Although the rising cost of living and interest rates are negative factors, we expect the labor market to stay resilient and limit residential mortgage deterioration.

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Dutch house prices have shown markedly strong cycles in both directions over the past decades. Following an almost 20% annual increase in the early 2000s, they plummeted by close to double-digits into the negative territory in 2012-2013. After a short catch-up, prices quickly outpaced their pre-crisis levels making housing increasingly hard to afford.

Price-to-income ratios for today's generation have approximately doubled compared with those of their parents. The homeownership rate in the Netherlands (70%) resembles other Western European countries (67% on average) and is lower than most Eastern and Southern European countries (81% on average).

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Dutch cover pool

Even though the Dutch covered bond legislation also contemplates public loans, commercial mortgages, and shipping loans, currently all existing programs comprise residential mortgage-backed covered bonds. Mortgages are typically lent on owner-occupied properties.

Most outstanding mortgages pay a fixed interest rate for a period ranging five to 15 years. At the end of the fixed-rate period, the interest rate typically resets to a new fixed rate (fixed-reset interest rate). Borrowers opted to benefit from low interest rates, fixing rates for typically 10 years until about mid-2022. Loans originated since mid-2022 are typically fixed for five years.

Due to recent macroprudential measures, amortizing structures (linear mortgage loans and annuity mortgages) are becoming more popular. On the other hand, a high stock of interest-only loans remain with a large share in combination with an insurance or savings product to accumulate capital for repayment.

Current LTV ratios have decreased in most Dutch cover pools we rate. In addition to an increasing portion of amortizing loans, this is also the result of rising house prices over the past five years.

NHG guarantee

Owner-occupier borrowers can apply, subject to strict conditions and limitations, to a Nationale Hypotheek Garantie (NHG) from the Homeownership Guarantee Fund (Waarborgfonds Eigen Woningen; WEW), an independent institution that has fallback agreements with the Dutch government and municipalities. The guarantee covers the major part of the losses to a lender.

We equate the creditworthiness of the WEW to that of the Dutch sovereign and give credit to the NHG guarantee in our loss-given default calculation on a case-by-case basis, depending on the historical payout rate from the NHG that the bank can show. The presence of a large proportion of NHG-guaranteed loans in some of our rated programs has by and large led to a below-average weighted-average loss severity (WALS; our measure of loss-given default) for our rated Dutch pools compared with other countries (see "Global Covered Bond Insights Q4 2022," published Dec. 16, 2022).

High social benefit support

The Dutch social security system is one of the most comprehensive in Europe, encompassing sick leave, unemployment benefits, disability benefits, maternity leave, child support, and pensions. As such, it provides a safety cushion for borrowers if personal circumstances change or if the economy takes a downturn. In particular, employees are entitled to unemployment benefits in the Netherlands if they partially or completely lose their jobs, resulting in more stable collateral performance for residential pools throughout economic cycles.

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Green Covered Bonds And ESG Considerations

Dutch issuers generally have a strong focus on environmental, social, and governance aspects in their operations. Due to various challenges on both the asset and liability sides, the issuance of green covered bonds in the Dutch market does not reflect this.

The definition of green mortgages and the environmental characteristics of energy efficient properties still lack clarity, which adds to the challenge of accessing and categorizing relevant data on seasoned loans. On the other hand, new lending already requires energy performance certificates (EPC), paving the way for an easier selection of green collateral in the medium term. As an incentive for borrowers, Dutch banks increased their LTV ratio limits to 106% for green mortgages compared with 100% on nongreen loans.

The revision of the Energy Performance of Building Directive (EPBD) aims to increase the rate of building renovation. The EPBD should introduce EU Minimum Performance Standards, requiring the renovation of worst-performing buildings, and make EPC more clear, reliable, and accessible by financial institutions.

Speeding up the construction of housing and combatting climate change are some of the key priorities in the Dutch government's 2021-2025 coalition. The Netherlands' low elevation (more than 25% of land lies below sea level) translates into unusually high environmental exposure for a highly developed economy. This is offset by a long history of strengthening resilience to flooding, for example by adapting infrastructure such as dikes, dams, and floodgates under the Delta Program. The country's adaptation policy includes a budget of about €1 billion per year.

Ratings Outlook: Covered Bonds Are Protected From Risk Of Bank Downgrades

On top of a solid pool performance, Dutch covered bonds benefit from highly rated issuers, which are the first recourse for bondholders. Moreover, programs with a highly rated issuer, and which are not CPT, can benefit from unused notches of uplift, offering some protection against downgrades of the issuing bank.

CPT programs can benefit from an unlimited number of notches of uplift from the ICR, provided that committed overcollateralization in the program is commensurate with the highest achievable rating.

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Chart 8 shows the breakdown of the average target credit enhancement levels compared with the available credit enhancement across countries. We define the target credit enhancement as the overcollateralization commensurate with the maximum collateral-based uplift.

On average, Dutch programs have both lower credit and market risk compared with those of peer countries. Consequently, the available credit enhancement is also lower relative to peer countries' programs.

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Scenario Analysis: Dutch Covered Bond Ratings Could Withstand House-Price Corrections

We carried out a scenario analysis with large drops in house prices to gauge whether these would affect the overcollateralization commensurate with our rating. In our current credit model, we consider that the Dutch housing market reflects an overvaluation of 25%. We tested the rated programs in a scenario analysis for house-price drops of 30% and 40%, which is more severe than the 20% property price drop seen after the financial crisis between 2008 and 2014. While testing the damage of these scenarios on the credit risk observed in the cover pools we rate, we removed our additional adjustment, reflecting the current overvaluation in the Dutch housing market.

Table 6 shows the effect of the house price decline on our WALS calculation. The overcollateralization in line with the current rating does not increase significantly. This is mainly because Dutch programs typically benefit from low credit risk and relatively high excess spread. Therefore, the hypothetical house price drops also do not affect the achievable rating on any of the programs.

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Editor: Georgia Martin

Related Criteria

• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019
• Covered Bond Ratings Framework: Methodology and Assumptions, June 30, 2015
• Covered Bonds Criteria, Dec. 9, 2014
• Methodology For Assessing Mortgage Insurance And Similar Guarantees And Supports In Structured And Public Sector Finance And Covered Bonds, Dec. 7, 2014

Related Transaction Updates And New Issue Reports

• Transaction Update: AEGON Bank N.V., Jan. 25, 2023
• Transaction Update: Achmea Bank N.V. Soft Bullet Covered Bond Program, Nov. 9, 2022
• Transaction Update: AEGON Bank N.V. Dutch Soft Bullet Covered Bond Programme, July 5, 2022
• New Issue: Van Lanschot Kempen N.V. Soft Bullet Mortgage Covered Bond Program, June 27, 2022
• New Issue: NIBC Bank N.V. Soft-Bullet Mortgage Covered Bond Program, June 16, 2022
• Transaction Update: NN Bank N.V. Dutch Soft-Bullet Covered Bond Program, June 13, 2022
• Transaction Update: Van Lanschot Kempen N.V. Conditional Pass-Through Mortgage Covered Bond Program, June 2, 2022
• Transaction Update: NIBC Bank N.V. Covered Bond Program, May 5, 2022
• Transaction Update: ING Bank N.V. (Mortgage Covered Bonds), March 25, 2022
• Transaction Update: AEGON Bank N.V., Feb. 7, 2022

Related Research

• European Housing Prices: A Sticky, Gradual Decline, Jan. 11, 2023
• Global Covered Bond Insights Q4 2022, Dec. 6, 2022
• Global Covered Bonds Outlook 2023: Sailing Through Choppy Waters, Dec. 6, 2022
• Economic Outlook Eurozone Q1 2023: Reality Check, Nov. 28, 2022
• Netherlands, Oct. 24, 2022
• Global Credit Conditions Downside Scenario: Recession Risks Deepen, Oct. 12, 2022
• Sovereign Risk Indicators, Oct. 10, 2022
• European Covered Bonds Reach Harmonization Milestone As The Journey Continues, July 12, 2022
• ESG Credit Indicator Report Card: Covered Bonds, April 7, 2022
• Asset Price Risks: Inflated Property Values Mean Higher Loss Assumptions In European RMBS And Covered Bonds, March 21, 2022
• Are Covered Bonds Becoming More Sustainable? Sept. 6, 2019
• S&P Global Ratings' Covered Bonds Primer, June 20, 2019
• Glossary Of Covered Bond Terms, April 27, 2018
• An Inside Look At Conditional Pass-Through Covered Bonds, May 25, 2017