Covered Bonds Hit Record $356 Billion

Banks have sold a record amount of covered bonds this year, as jittery investors backed the ultra-safe forms of debt, in a trend expected to continue in 2011.

Close-up of a pen on stock price chart
Close-up of a pen on stock price chart

Worldwide issuance of the bonds has reached $356.5 billion this year – up nearly 20 percent from 2009, according to data from Dealogic.

Unlike regular securitisations, where investors have no recourse to the issuing bank, the loans backing covered bonds remain on a bank’s books and are ring-fenced, protecting bondholders even in bankruptcy.

Issuance has been heavily dominated by European banks – the format was developed in 18th-century Germany – but countries elsewhere are beginning to alter laws to give investors the protection the bonds require.

South Korean and New Zealand banks have recently begun issuing the bonds, while Australia is planning to introduce legislation to allow the use of the instrument. Crucially for the market, equivalent US legislation could also be passed next year, allowing US banks to tap a surge in US investor appetite.

“US banks are interested in jumping into this market,” said Ralf Grossmann, head of covered bond origination at Société Générale, which estimates that issuance targeted at US investors by European and Canadian banks will double to about $60 billion next year.

“This growth in their home market should be a real incentive to the US to push through the necessary legislation.”

This extra security has been attractive to investors uneasy about other highly-rated forms of debt, such as government bonds, where politicians have called for forcing losses on bondholders in future bail-outs.

“A lot of investors would rather have the solid assets of a bank backing their bonds than the promise of a sovereign with weak finances,” said Ted Lord, head of European covered bonds at Barclays Capital.

Covered bonds have proved particularly attractive to investors worried about changes to bank resolution regimes in Europe.

Germany passed a law in November that will force bondholders to take losses if a bank fails – but this does not include covered bonds. Other countries are expected to follow suit.

“With more discussion about special resolution regimes, we expect investors to seek assets with some kind of security attached,” said Vinod Vasan, head of European financial institutions’ debt capital markets at Deutsche Bank.

Covered bonds accounted for a third of all European banks’ borrowing this year – the highest proportion in eight years. Straightforward securitisations meanwhile totalled just 7 percent – still a fraction of their pre-crisis 25 percent average.“If banks are trying to re-enter the market, then covered is the most secure form,” said Mr Vasan.

The extra security offered by covered bonds has been particularly helpful for banks in countries shunned by the markets, such as Spain, where it has enabled them to use their loan book to generate funds even as the far bigger senior debt markets have been closed to them.