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CEE covered bond markets set to expand in 2020 despite slowing world economy

posted onDecember 6, 2019

Central and eastern European (CEE) covered bond markets will expand in 2020 as banks look to fund growing mortgage sectors with long-term wholesale funding, Moody's Investors Service said in a report published on Monday (Dec.2).

Covered bond issuance in the region increased notably over the past years with the growth being led by the Czech Republic, followed by Poland and Slovakia. 

The US-based international credit ratings agency expects that an increased willingness to source funds locally, partially due to new ownership structures, will also increase demand for market funding in the Baltic states. 

Meanwhile, in Estonia the government passed legislation to establish a covered bond market while Latvia and Lithuania expected to follow suit.

In Romania, Alpha Bank issued its inaugural covered bond in 2019 -  representing a first for the financial and banking sector in the country. The European Bank for Reconstruction & Development (EBRD) and IFC took almost half of the inaugural issue (EUR40m and EUR50m, respectively). The bank's covered bond is rated Baa2, one notch higher than Moody’s sovereign rating of Baa3.  

The bond  which has a five-year maturity and pays a floating rate coupon, is listed both on the Luxembourg Stock Exchange and on the Bucharest Stock Exchange.

According to the agency’s forecast, the credit quality of European covered bonds will remain strong overall in 2020, supported by positive regulatory changes and a largely stable outlook for issuers and sovereigns.

"Domestic strengths will support European economies, limiting risk for covered bonds, even as slowing economic growth makes the global economy more vulnerable to negative developments," said Miguel Lopez Patron, AVP-Analyst based at Moody's in Madrid. "Our outlook for most banks in most European countries is stable and this will underpin the continued strong credit quality of European covered bonds in 2020."

covered bonds market

(Graph data source: EBRD)

The regulatory environment will remain supportive overall as countries begin implementing new European Union rules for covered bonds. While much regulation in Europe will remain credit positive, measures to protect financially vulnerable people will heighten regulatory risks in some cases. Low mortgage interest rates will support borrowers' abilities to repay loans, a credit positive for covered bonds.

However, Brexit uncertainty in the UK will increase risk. In the UK, issuers will increasingly link new and existing covered bonds to the Sterling Overnight Index Average (Sonia) instead of the London Interbank Offered Rate (Libor).

Green covered bond issuance will also rise, as issuers and investors incorporate environmental factors in their funding strategies, Moody's said.

First introduced by Frederick II of Prussia exactly 250 years ago, covered bonds are debt securities issued by a financial institution and backed by a separate group of assets. This type of derivative investment is viewed as low-risk and is popular in Europe. According to bond-investment giant Pimco "the loans backing a covered bond remain on the balance sheet of the issuing bank."  

In the event the financial institution becomes insolvent, the bond is covered. With over EUR 2,500 billion in outstanding amounts, covered bonds currently represent one of the largest debt markets in the EU and are an important and efficient source of long-term, low-risk funding. 

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