In its Dutch 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, and compares key characteristics of its rated programs.

Overview: A Transitioning Covered Bond Market

The Dutch covered bond market has gradually but thoroughly transitioned over the past two decades. The first Dutch covered bonds were structured products defined by documentation. Starting in 2008, a framework inscribed in the Financial Supervision Act regulated Dutch covered bond issuance. The framework was amended in 2014, when it received the status of law, and in 2015. The governing framework has adapted, finally becoming a legislation-enabled framework aligned with the European Union's (EU) Covered Bond Directive in 2022.

Issuance has shifted toward soft bullet maturities from conditional pass-through (CPT) structures. CPT structures were popular in the market as an alternative to then prevailing hard bullet issuances. Cover pools now predominantly comprise amortizing loans instead of the previously prevailing interest-only mortgages. Despite these structural shifts, typical Dutch covered bonds display relatively low credit risk but fairly high, recently rising, asset-liability mismatch risk.

The Dutch covered bond market comprises 14 residential mortgage-backed programs from nine issuers, representing over €169 billion of outstanding issuance. We currently rate nine of these programs.

In 2023, Dutch investor-placed benchmark covered bond issuance increased 15% from 2022 levels, compared with 5% on average in Europe. Dutch issuance within the European market rose to about 6.6% from 6.0% a year earlier.

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Lower excess spread and growing asset-liability maturity mismatch require higher overcollateralization

In response to soaring inflation, the European Central Bank (ECB) has increased interest rates since July 2022. By end 2023, its main lending rate reached an almost 25-year peak. Although real interest rates were mostly negative, rate hikes ended more than a decade of historically low nominal rates.

While covered bond funding costs immediately mirrored market rates, cover pools backing new issuances were much slower to adjust. This owes to Dutch residential borrowers previously locking in long-term, fixed-rate, very low financing costs for their homes in years before the increase in rates. Interest rates on the assets of an average Dutch cover pool will reset in around 2033.

This eliminated a large portion of the traditionally high excess spread that characterizes Dutch covered bond programs. Excess spread halved in the rated programs tapping the market in 2023 compared with 2022. Issuers have attempted to address this challenge by adjusting both assets and bonds.

Cover pool assets now include recently granted loans that pay higher interest rates. Despite leading to somewhat higher loan-to-value (LTV) ratios and lower seasoning after cover pool replenishments in our rated portfolio, in our view, the overall credit quality is stable.

For bonds, the trend toward short- to medium-term tenors started in 2022 and intensified in 2023. Banks issued 40% of Dutch covered bonds with a three-to-five-year maturity, compared with 18% a year earlier. Recent issuances show a renewed interest for longer maturities of up to 10 years, which will reduce asset-liability maturity mismatch (ALMM).

Lower excess spread and higher ALMM led to a 14% average increase in the credit enhancement commensurate with the 'AAA' ratings on the covered bonds that tapped the market in 2023.

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Dutch covered bond programs benefit from multiple unused notches that the issuer credit rating (ICR) can be lowered by 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.

ECB treatment reduces appetite for CPT covered bonds

CPT covered bonds were particularly popular in the Netherlands during the second half of the 2010s. Their popularity primarily stemmed from the traditionally high proportion of interest-only loans in cover pools, which considerably increased refinancing costs in more traditional soft bullet structures.

CPT covered bonds mitigate the mismatch risk between the assets' redemption profile and liabilities. They allow bond maturity extension if the issuer is insolvent, and the cover pool assets proceeds are insufficient to redeem the bonds at the initially scheduled maturity. Thereby, CPT covered bonds structurally eliminate refinancing risk, leading us to 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.

CPT covered bonds lost appeal to many investors when the ECB excluded the product from its reinvestments under the Covered Bond Purchase Program 3 (CBPP3) on Jan. 1, 2019. All Dutch issuers have now established soft bullet programs. CPT programs were either merged into soft bullet or are no longer actively used for issuance. Following the dismantling of two additional Dutch CPT programs in 2023, currently about 93% of all outstanding Dutch covered bonds have soft bullet maturities--compared with about a 3% share of CPT covered bonds.

Will the benefits of macroprudential changes to the local lending market last?

The Dutch tax system traditionally boosted household indebtedness via mortgage borrowing, favoring high LTV ratios and a large proportion of interest-only loans. From the early 2000s, the government adjusted mortgage interest's generous tax deductibility to curb one of the highest global household indebtedness.

In 2013, the government launched a comprehensive set of macroprudential measures to address this risk. By now, newly originated mortgages must amortize within 30 years to benefit from tax deductibility. Furthermore, the extent of tax deductibility has been incrementally reduced to the lowest marginal tax bracket (37.1%) from the highest (52%). In parallel, the maximum LTV ratio reduced to 100% on standard mortgages by 2018, from 120% in the early 2000s, and loan-to-income ratio limits cap the borrower's potential interest burden.

As a result, by 2022, the share of interest-only loans in Dutch residential cover pools decreased to 43%, from about 85% in 2010, and the cover pools' average LTV ratio fell to 52% from 69%. Household debt decreased to 211% of net disposable income in 2022 from its 286% peak in 2010, based on Organisation for Economic Co-operation and Development data.

From 2021 the trajectory of these measures changed. A combination of looser lending conditions for couples, stamp duty exemption for young first-time buyers, increased LTV allowance on sustainable residential investments (106%), and higher debt-to-income limits were introduced.

These steps further pushed the already record-high price increases in the Dutch residential property market, as supply continued to lag demand. The ECB's rate hikes in 2022 further increased the cost of financing these homes.

The partial departure from previously stricter mortgage market regulations, tighter monetary policy measures, and weakened purchasing power due to higher inflation are already visible in the Dutch market. By 2023, the falling trend of interest-only loans halted, and average LTV ratios rose.

The Legal Framework: An Overview

The Financial Supervision Act of 2022 (FSA or Voorstel van Wet - Memorie van Toelichting) together with the Decree on Prudential Rules under the FSA (Besluit prudentiële regels, Wft) transposed the EU Covered Bond Directive into the Dutch legislation. The legislative package became effective on July 8, 2022, and applies to covered bonds issued since then. Amendments to the previous legal framework were refinements, given the Dutch legislation was already well-aligned to the requirements of the EU harmonization directive.

Bondholders have 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 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.

Coverage tests

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

These tests 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 Are Cushioned, Outsiders Are Exposed

Steady economic growth, a healthy labor market, and modest inflation

Following weak economic activity globally in 2023, we expect the Dutch economy to grow from 2024 and then stabilize at rates about in line with the eurozone average in the medium term.

Inflation has peaked, and we expect the ECB to gradually cut rates in the second part of 2024.

Moderating inflation together with still-significant household savings will support consumption, and a tight labor market will further underpin the recovery in household purchasing power.

In our analysis, unemployment is the best predictor of mortgage performance. We expect unemployment in the Netherlands to remain one of the lowest in the euro area during our forecast period up to 2026.

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Dutch house prices will keep falling this year

We project that house prices will still fall moderately this year and stabilize by end 2025. Like most European jurisdictions, lagging housing supply is the main factor behind the relative resilience of Dutch housing prices amid rising lending rates.

Our baseline scenario assumes the ECB will wait until mid-year to start cutting interest rates. Consequently, the adjustment of mortgage rates to the new rates environment is probably not yet over. (See "European Housing Markets: Forecast Brightens Amid Ongoing Correction," published Jan. 25, 2024, on RatingsDirect).

Dutch house prices have markedly fluctuated 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 catchup, prices quickly outpaced pre-crisis levels and made housing increasingly hard to afford.

Even following last year's correction, price-to-income ratios for house buyers have more than doubled compared with those of older generations. Key catalysts for Dutch house price inflation are supply shortages and pent-up demand--challenges for the new government to tackle.

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

With reduced borrowing power in both capital and monthly interest payments, the average new borrower has to lower the price segment it can afford. This is a difficult step given recent worsening housing affordability.

The 71% homeownership rate in the Netherlands is aligned with the 67% EU average.

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Dutch cover pool

Even though Dutch covered bond legislation also contemplates public sector exposures, commercial mortgages, and shipping loans, currently all existing programs only comprise residential mortgage-backed covered bonds. Dutch cover pools predominantly feature mortgages on owner-occupied properties.

Most outstanding mortgages pay a fixed interest rate ranging from five to 15 years. At the end of the fixed-rate period, the rate typically resets to a new fixed rate (fixed-reset interest rate). Until about mid-2022, borrowers opted to benefit from low interest rates by fixing rates for 16 years typically. Loans originated since mid-2022 are usually fixed for five years.

Recent macroprudential measures have increased the popularity of amortizing structures (linear mortgage loans and annuity mortgages). On the other hand, a large stock of interest-only loans remains, and a sizeable share are combined with an insurance or savings product to accumulate repayment capital. Although LTV ratios have significantly decreased over the past two decades, they slightly rebounded over 2023. This mostly reflects the combination of somewhat looser lending conditions and the recent house price market correction.

NHG guarantee

Owner-occupier borrowers can apply, subject to strict conditions and limitations, for 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 most of the losses to a lender.

We 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 the bank can show. Therefore, our analysis includes a relatively lower overall loss assumption on cover pools that have a high share of guaranteed loans.

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 contracts. 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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Sustainable Covered Bonds

Labeled issuance materially increased during 2023, both in nominal and relative terms, although from a low base level. With €2 billion placement in 2023, Dutch sustainable issuance quadrupled and its share within investor-placed benchmark issuances rose to 18% in 2023 from 5% a year earlier.

The definition of green mortgages and the environmental characteristics of energy efficient properties still lack clarity, adding 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 lend up to 106% of the property value for financing energy efficiency investment, compared with a 100% LTV ratio on nongreen loans.

More than 25% of the Netherlands' land lies below sea level, translating 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.

Ratings Outlook: Covered Bonds Are Protected From Bank Downgrade Risk

On top of a solid pool performance, Dutch covered bonds benefit from highly rated issuers, the first recourse for bondholders. Moreover, programs with a highly rated issuer, and which are not CPT, can benefit from unused notches of ratings 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.

Available credit enhancement is sufficient to support not only the overcollateralization commensurate with the 'AAA' rating but also all unused notches of collateral-based uplift, providing a buffer to the rating.

The overcollateralization buffer in Dutch covered bonds ranks about average among the programs that we rate globally.

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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 Research

• European Housing Markets: Forecast Brightens Amid Ongoing Correction, Jan 25, 2024
• Global Covered Bond Insights Q1 2024, Dec. 15, 2023
• Covered Bonds Outlook 2024: Stability Amid Turbulence, Dec. 11, 2023
• Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing, Nov. 27, 2023
• Netherlands 'AAA/A-1+' Ratings Affirmed; Outlook Stable, Oct. 20, 2023
• Asset Price Risks: Overvaluation Persists For Europe's RMBS And Covered Bonds, Oct. 4, 2023
• Banking Industry Country Risk Assessment: The Netherlands, Sept. 29, 2023
• 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