Offshore banks find new demand in euro covered bonds

For over 250 years the covered bond has been a deeply European instrument. Developed by Frederick the Great in the 18th century as a way of rebuilding Prussia after the Seven Years’ War, covered bonds have evolved to become a cornerstone of European bank funding. However, non-European issuers are increasingly turning to the product — particularly in euros — in search of cheap access to a deep and loyal investor base.

The share of outstanding covered bonds across all currencies from non-European issuers crossed 10% for the first-time in 2023, according to data compiled by the European Covered Bond Council (ECBC). In fact, only 88% of outstanding bonds were issued by European banks, with 8% coming from Asia-Pacific, 3% from North America and the remainder from South America.

Last year, non-European banks issued €30.4bn of covered bond benchmarks, accounting for roughly one-sixth of all euro new issues, according to data from GlobalCapital’s Primary Market Monitor (PMM). So far this year, they have raised €13.4bn, or just under 10% of the total euro volume to date.

“The last 10 years has seen a consolidation of interest in the asset class outside of the EU,” says ECBC secretary general Luca Bertalot.

“As of the end of 2023, we had about 40 issuers from outside Europe, double the number from 10 years ago,” adds Joost Beaumont, ABN Amro’s head of bank research.

“As non-eurozone economies continue to grow, so do their natural funding requirements,” says Richard Sykes, head of treasury markets, Singapore and ASEAN, Standard Chartered.

Marc Freydefont, head of capital markets solutions at Standard Chartered, adds that covered bonds allow banks to transform “typically illiquid [mortgage loan] assets” into “collateral for secured borrowing which increases the efficiency and utility to the bank of those assets.”

For many banks — both in Europe and outside — the cheapest way to use these assets is through covered bonds. These bonds “are by far the tightest bank funding product available,” says Christian Klocke, a FIG syndicate banker at DZ Bank in Frankfurt.

“If you want to tap the euro market, the easiest and most established way to do so is through covered bonds,” Klocke continues. “For many overseas issuers, euro covered bonds are not a key term funding product, but rather an excellent tool for diversification.”

“Covered bonds allow access to foreign currencies through one of the financial markets’ more sophisticated products,” says Sykes.

The appeal of euro covered bonds for many issuers outside Europe lies in the deep and well-developed investor base. For many of these issuers, this investor base — traditionally dominated by bank treasuries — is distinct from the accounts that might buy their domestic or unsecured offerings.

“A covered bond programme offers issuers not just a high quality source of funding, but also access to an expanded investor base via the euro covered benchmark market,” says Sykes, whose firm issued its debut covered bond earlier this year — a €500m 3.324% May 2027 note.

Banks placed €116.9bn of euro benchmark paper in the first half of 2024 compared to £9.3bn in sterling and $3.7bn in dollars, according to PMM and Dealogic data. Meanwhile, last year just under €183bn was raised in euros, with £17.6bn and $17.5bn placed in sterling and dollars, respectively.

“The breadth and depth of the euro covered bond market far outsizes any other currency,” says Sykes. “It is the most active in both primary and secondary.”

As a result, many first-time non-eurozone names opt to make their first covered bond forays in the euro market before branching out elsewhere. “For any new issuer, it is important to develop your offerings in the deepest, most liquid place first, and then build on investor feedback,” says Sykes. “We intend to do our first couple of trades in euros to strengthen our curve, but beyond that we would like to explore other currencies too.”

Though some non-European banks are turning to euros to satisfy natural funding needs, many are not shackled to one market. Alongside the core euro market, non-European banks have found success in US and Australian dollars, sterling and Swiss francs.

However, time and time again, these banks turn to the euro market to raise the bulk of their covered bond funding. “There is a large and loyal investor base in euro covered bonds,” says Beaumont. “What the Canadian banks have shown is that it can be very attractive to do quite a lot of funding in euros,” he adds.

Canadian firms printed €17.75bn of euro benchmark deals last year, making them the third most active group of borrowers in euros after German and French banks. Furthermore, they raised a sizeable chunk of this in multi-tranche transactions, highlighting just how much depth there is available in euros.

Many investors are eager to buy non-European deals, “as they add diversification,” says Beaumont. “These less well-known names will likely offer higher spreads as well.”

Despite being among the largest issuers of covered bonds, Canadian banks have paid an average spread of 47.3bp over mid-swaps for their new issues this year, compared to 38.3bp in France and 34.1bp in Germany, PMM data shows.

For the ECBC’s Bertalot, “these are not one-off transactions”. Setting up a covered bond programme guarantees investors that a name “wants to maintain a longstanding presence in the market,” he adds.

“Our programme is supported by a S$20bn ($15.3bn) mortgage book,” says Sykes. “We have a growing business. We’ve set up and sized our programme with an initial cap of $5bn-equivalent outstanding to indicate where we’d like to grow the programme too.”

Despite the workload, the benefits of putting these programmes together are plentiful. “It is fair to say that because covered bonds are perceived as such a high quality product, it can take a little longer to establish a programme — but this quality is why there is such high demand from investors,” Sykes adds. “We considered the market and proceeded carefully, taking our time to set up the programme, recognising that covered bond investors need to be comfortable as to the provenance and high quality of the end product.”

Setting up a new covered bond programme “takes at least 12 — if not 24 — months to establish one from scratch,” says Klocke.

Issuers from 19 jurisdictions accessed the euro covered bond market in the first half of 2024, including four from outside of Europe, according to PMM data. More are expected to follow.

The four non-European jurisdictions — Australia, Canada, Korea and Singapore — all have national legal frameworks aligned with their European counterparts. Furthermore, many bonds from these countries carry the Covered Bond Label, a quality and transparency label European issuers and the ECBC launched in 2012.

In fact, “some markets, like Singapore or Canada, have almost become traditional established covered markets,” says Bertalot. “We don’t see a discrepancy between Singapore or Canada and Europe — they are now semi-domestic markets.”

Compatible covered bond legislation “is a nice key to open the door for the Euro investor base,” adds Bertalot. “It’s happened to the Canadians, Singaporeans and other markets, and now Japan is looking too.”

Japanese banks have maintained a sporadic presence in the euro covered bond market — none have issued so far this year and only €1.75bn was raised in 2023, PMM data shows. For now, the lack of codified covered legislation is hampering these deals, with Japanese firms instead issuing in the less popular structured covered bond format.

“The question now is how the asset class moves from traditionally developed countries to open access to capital markets in emerging markets,” says Bertalot. For instance, Brazil and Morocco have approved covered bond legislation, meanwhile regulators in Saudi Arabia, Indonesia and the Philippines are in discussions, he adds.

“For markets close to joining the EU, establishing covered bond legislation is a sign of maturity for the financial regulation of a country,” Bertalot continues. “Georgia, Armenia and Northern Macedonia are either developing covered bond market activities or thinking about introducing covered bond legislation that aligns with EU banking standards.”

Bertalot adds that these new, emerging markets are ones “where banks primarily rely on deposits for funding” — markets ripe to benefit from covered bonds.