Covered Bonds "Soar" and "Roar" in New Year

So far, 2010 is a happy new year for covered bonds, as financial news outlets are reporting with enthusiasm:

• In a column titled "Covered Bonds Set to Roar?" Richard Kemmish of the Wall Street Journal wrote (Dec. 8): "If 2009 was the year of the European corporate bond market, perhaps 2010 will be the year of the European covered bond market."

• A news story from Dow Jones' Mark Brown and Michael Wilson struck a similar note: "The market for covered bonds ... is off to a roaring start in 2010."

• Meanwhile, the headline of a Bloomberg article by Sonja Cheung and Caroline Hyde trumpeted: "Covered Bond Sales Soar to 3-Month High, Lead European Issuance."

Bloomberg pegged covered bond sales so far this year (as of Jan. 8) at about €12 billion (more than USD 17 billion) — about 30 times the volume over the same period in 2009.  It noted that covered bond spreads have tightened, with yield falling by three basis points this week.

The financial writers seemed in agreement on the basic reasons for the covered bond surge, while varying in emphasis:

1.  Investors are back in the market after the holidays, looking for good places to put their money to work.

2.  There is concern that covered bond supply may ultimately outstrip investor demand, so banks are motivated to issue sooner rather than later in order to raise cash.

3.  The European Central Bank has almost reached the halfway mark in its €60 billion (about USD $86.5 billion) covered bond purchase program, so there is an incentive to issue before the program tops out.

Dow Jones cites an estimate from Société Générale that although banks would like to issue some €300 billion (about USD $432 billion) worth of covered bonds in 2010, investors may only soak up more like €168 billion over the course of the year.  Richard Barley cites similar forecasts, with ING predicting €160 billion in total sales and Unicredit predicting €140 billion.

So far, covered bonds continue to be overwhelmingly a European funding tool.  Although Canadian banks engaged in a couple of issuances last year (most recently by CIBC), no U.S. bank has done so since 2007.   Prospects for U.S. covered bonds are widely seen as dependent on possible future enactment of a supporting legal framework by Congress. 

In the Pacific region, the only covered bonds were a USD $1 billion issuance by South Korea's Kookmin Bank in May 2009.   Although covered bond issuance is not currently permitted under Australian government rules, a movement to change this is underway.

Covered bonds are debt obligations that have recourse to a pool of assets — the cover pool — that secures or "covers" the bond if the issuer becomes insolvent.  To date, they have primarily been used for real estate and public sector financing.