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Banks Issue Record Amount of Covered Bonds Amidst Turbulence in the Sector

Banks have witnessed a record surge in the issuance of ultra-safe mortgage-backed debt known as covered bonds in the first half of the year, as they sought to secure cheap funding amidst a turbulent period for the banking sector. Over €175 billion of covered bonds were sold to investors from January to June, surpassing the previous high set in 2011, according to S&P Global Ratings.

Banks Issue Record Amount of Covered Bonds Amidst Turbulence in the Sector

Covered bonds are highly rated debt backed not only by the issuing bank but also by an underlying pool of assets, typically mortgages. These bonds are considered a low-yielding yet secure form of borrowing for banks and a safe investment for buyers.

The increased issuance of covered bonds occurred amid a tumultuous period for the banking sector, marked by deposit outflows and the collapse of several banks. Joost Beaumont, an analyst at ABN Amro, described covered bonds as a funding tool for banks during challenging times. The issuance level reached in 2023 has exceeded previous records.

The surge in issuance can be attributed to the winding down of central bank support for debt markets and the banking sector, as well as banks' desire to replace cheap central bank funding. The European Central Bank (ECB) stopped purchasing covered bonds in primary markets in March, creating a sense of urgency for banks to issue new bonds. The ECB's withdrawal coincided with the repayment of funds distributed under its targeted longer-term refinancing operation (TLTRO) by Eurozone banks. UK banks are also preparing for the end of a Bank of England funding scheme and are considering covered bond issuance as an alternative source of funding.

As liquidity drains from the financial system due to the reversal of central banks' quantitative easing programs, banks' funding costs are likely to rise. Critics have accused banks of profiting at the expense of savers by being slow to pass on interest rate rises to depositors. UK banks have faced criticism for their net interest margins, leading to pressure to raise savings rates. This intensifying battle for retail deposits may prompt banks to explore other sources of wholesale funding, such as covered bonds.

While covered bonds are considered safe, concerns have emerged about the underlying property assets supporting them as interest rates rise. However, the dynamic nature of covered bonds' asset pools, which can be continuously replenished, mitigates potential risks.

The record issuance of covered bonds reflects banks' pursuit of stable funding sources during a challenging period and their efforts to navigate the changing interest rate environment and regulatory pressures.


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