Covered bond issuance continues to thrive in many currencies
With the covered bond market emerging stronger than ever from the financial crisis and countries including the United States, Canada, Mexico, Australia, and New Zealand looking to introduce covered bond legislation TED LORD says that covered bonds are a steady, longer-term winner in newly-evolving financial markets

The covered bond market is emerging from the financial crisis stronger than ever. There is a chance that this year the volume of issuance of covered bonds in the public markets could approach Euro 300 billion in the world's major currencies. Although the Euro dominates issuance, there has been a rapid rise in covered bond issuance in other currencies. US dollar benchmark issuance (minimum size of US dollars 1 billion) has risen rapidly in the 144a market targeted at US institutional investors. Year-to-date public dollar covered bond issuance is approaching US dollars 40 billion. Sterling covered bond issuance has also grown strongly with the emergence for the first time of Jumbo issuance of covered bonds (Sterling 1 billion). Covered bond issuers are also steadily increasing their issuance in Swiss francs and Australian dollars given the investor appetite for high-quality bonds in those currencies.To put this in perspective, this year's issuance could be a three-fold increase from the amount of covered bonds issued in 2008 and one third more than the market's best year ever before the onset of the financial crisis in 2006.
Ted Lord


The amount of outstanding covered bonds in the market is close to Euro 2 trillion equivalent for both public issues and private placements. Covered bonds are securities that are backed by the best assets of a financial institution. The asset pools backing these bonds are either high-quality mortgages or high-quality public-sector assets. Covered bonds are different from the traditional asset-backed security in several ways. Firstly, there is a dual claim by a covered bond investor on a financial institution: the issuer itself and should the issuing financial institution face insolvency, then the high-quality asset pool overcollateralising the bond.

Secondly, the cover pool backing the covered bond issues are dynamic. If an asset in the cover pool should decline in value and not perform, the covered bond issuer is obliged to take it out of the pool and replace it with a performing one. Thirdly, many covered bonds are supported by a government legislation that protects the priority claims of the covered bond investors (often ahead of government tax authorities in some countries) and has been immune from the recent bail-in actions by several European governments. Several Irish financial institutions have issued covered bonds since the Irish covered bond legislation, known as the Irish Asset Covered Securities Act, was passed in 2001. Investors all around the world have been reallocating their investment portfolios towards covered bonds over the past few years. Several indexes used by large institutional investors have increased the covered bond component. One central bank has increased the covered bond weighting in its tailored investment index from 7 percent to over 25 percent.

This reweighting of the covered bond component has helped fuel the rapidly-rising investor demand for covered bonds. Now many investors finding themselves more "off index" if not investing in covered bonds. This is a big change from a few years ago, when purchasing covered bonds was going off index in investment strategies. Covered bonds are continuing to gain acceptance among the largest reserve managers. I calculate that 92 central bank foreign reserve managers around the world are purchasing covered bonds for their investment portfolios. They either do this directly or through their fund managers.

One Asian central bank now has its Euro portfolio invested entirely in covered bonds. Many of the world's major sovereign wealth funds purchase covered bonds on a regular basis. Recent regulatory changes have also helped the growth of investor demand for covered bonds. Pension funds and insurance companies in the Nordic region have been purchasing more covered bonds issued by non-local names due to the Solvency 2, Pillar 2 guidelines. Several Nordic covered bond issuers have seen North American financial institutions purchase large amounts of their recent covered bond issues in US dollars as they prepare for their new liquidity guidelines under Basel 3.

Several central banks are also accepting and many others are looking to allow repo financing from market participants through covered bonds at attractive levels. More countries are looking to establish covered bond legislation to enable their local financial institutions to take part in this growing investor demand globally. The United States, Canada, Mexico, Australia, and New Zealand are at various stages of putting together a covered bond legislation. More financial institutions in South Korea are looking to issue covered bonds. With increasing investor comfort in the asset class and a wider variety of currency issuance, covered bonds are the steady, longer-term winner in the newly-evolving financial markets.


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