Covered Bonds Outlook Midyear 2021: Credit Stable Despite Waning Support - Antonio Farina Marta Escutia Andrew South - S&P Global
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Covered Bonds Outlook Midyear 2021: Antonio Farina
Marta Escutia
Credit Stable Despite Waning Support Andrew South
July 23, 2021Contents
Key Takeaways 3
Economic Conditions 4
Credit Performance 8
Issuance 11
Harmonization 15
Ratings Outlook 16
Related Research 20
2Key Takeaways
We expect investor-placed issuance to stay depressed until 2023 as the unprecedented monetary policy
support aimed at combating the COVID-19 pandemic unwinds.
Economic conditions are supportive and long-term scarring to the economy should be limited by Europe's
coordinated fiscal and monetary policy response, enabling the region to close the output gap by 2024.
Eurozone inflation has spiked since the start of the year due to one-off factors. However, we expect the
momentum to abate through to the end of 2021. The ECB will likely continue net asset purchases through 2023
and refrain from hiking rates before late 2024.
We expect only a limited credit impact on prime residential mortgage loans once this fiscal and regulatory
support wanes, because payment moratoria have already expired in several European countries, and there is
still no evidence of any cliff effects in the labor market from the phasing out of short-time work schemes.
We expect a more severe impact on the performance of commercial real estate assets, especially for the retail
and lodging sectors, but cover pools’ exposures are limited.
Our outlook remains stable, because the credit enhancement available to most of the programs that we rate
significantly exceeds the level required to maintain the current ratings. The presence of unused notches
reduces the risk of covered bond downgrades even if there are limited downgrades of issuing banks.
3Economic Conditions | The Recovery Is Now Moving To Services
– Increasing vaccination rates are allowing European governments to gradually lift social-distancing restrictions.
– Services sectors are catching up with construction and manufacturing, where momentum has slowed due to semi-conductor shortages.
– The main risks stem from the impact of COVID-19 variants and financing conditions when central banks reduce their bond purchases.
Eurozone PMI Highlights Sectoral Rotation From Industry To
Infections Are Low But Rising Again In Parts Of Europe
Services-Led Growth Has Started
U.S. U.K. European Union South America Asia PMI manufacturing PMI services
1,000 70
900
60
800
Index: above 50 = expanding
New cases per million
700 50
600
500 40
400
30
300
200 20
100
0 10
0 10 20 30 40 50 60 70
0
Share of population that received at least one vaccine dose (%)
08/2019 11/2019 02/2020 05/2020 08/2020 11/2020 02/2021 05/2021
Latest data as of July 17, 2021. Source: Our World In Data, S&P Global Ratings. PMI--Purchasing managers' index. Source: IHS Markit, S&P Global Ratings. Economic Outlook Europe Q3
2021: The Grand Reopening, June 24, 2021.
4Economic Conditions | Long-Term Scarring Likely To Be Limited
Next Generation EU: Cumulative GDP Impact By 2026 Under Our
High-Impact Scenario
– We expect eurozone economic growth of 4.4% this year and Percentage point
increase
4.5% in 2022, after a 6.7% contraction in 2020. 20
FINLAND
– External demand remains dynamic as the eurozone's main 15
SWEDEN
ESTONIA
10
trading partners, like the U.S. and China, recover from the 5 North Sea
LATVIA
pandemic and vaccination rollouts continue to pave the 0
IRELAND
DENMARK
LITHUANIA
NETHERLANDS
way for a sustainable reopening of the economy.
Atlantic Ocean
– Long-term scarring to the economy should be limited by BELGIUM GERMANY
POLAND
Europe's coordinated fiscal and monetary policy response, LUXEMBOURG
CZECH
enabling the region to close the output gap by 2024.
REP.
SLOVAKIA
FRANCE AUSTRIA
– The Recovery and Resilience facility could add 1.3%-3.9%
HUNGARY ROMANIA
SLOVENIA
CROATIA
to eurozone GDP over the next five years, marking a shift in Black Sea
the type of fiscal support. PORTUGAL
SPAIN
ITALY
BULGARIA
– While at the start of the crisis governments concentrated
on maintaining household incomes and companies' access Mediterranean Sea
to finance, they are now looking to restart growth through GREECE
large investment programs. MALTA
CYPRUS
CYPRUS
S&P Global Ratings’ estimate of Recovery and Resilience Facility component of the plan. Source: S&P Global
Ratings. Economic Outlook Europe Q3 2021: The Grand Reopening, June 24, 2021.
5Economic Conditions | The ECB’s New Inflation Strategy Signals
Smooth Tapering
– Consumer prices have been rising on the back of higher energy prices, but these effects will likely slow in the second half of this year.
– The ECB’s new strategy addresses shortcomings in how it targets inflation and will likely make it more comfortable about tapering.
– We still expect the ECB to continue net asset purchases through to 2023 and refrain from hiking rates before late 2024.
Headline Inflation Increased Mainly Due To Energy Prices, While Covered Bonds Constitute Almost 10% Of Cumulative Net
Underlying Inflation Remains Subdued Purchases Under The Asset Purchase Program
Headline inflation Core inflation PEPP (left scale) APP (left scale) Covered bonds as % of the APP (right scale)
3 4500 25
4000
Year on year change (%)
3500 20
2
3000
15
2500
Bil.€
%
1
2000
10
1500
0 1000 5
500
(1) 0 0
May 2015 May 2016 May 2017 May 2018 May 2019 May 2020 May 2021 2016 2017 2018 2019 2020 2021
Sources: Eurostat, S&P Global Ratings. European Economic Snapshots, July 9, 2021, and The ECB’s New Sources: European Central Bank, S&P Global Ratings.
Strategy Signals Smooth Tapering And Cautious Greening Ahead, July 9, 2021.
6Economic Conditions | Economic Rebound Supports Housing Market
– Short-time work and furlough schemes, increased savings, and loose monetary policy kept housing demand afloat in 2020 and 2021.
– The expected sustained recovery in the economy and employment will support the housing market beyond 2021.
– Structural changes in a post-pandemic housing world are possible, but we still expect cities to remain attractive to homeowners.
House Prices Are Still Growing Fast In Europe… …Despite Banks Tightening Credit Standards To Limit Credit Risk
Credit standards next quarter Credit standards last quarter
Netherlands 50
Net %age of banks reporting a tightening
40
U.K.
30
of credit standards
Ireland 20
10
Italy
0
Spain (10)
0 2 4 6 8 10 12 14 (20)
%
To May 2021. Sources: National statistical offices, Nationwide (U.K.). Sources: ECB, S&P Global Ratings.
7Credit Performance | Expect A Limited Increase In NPLs
Mortgage Arrears Should Remain Well Below The Levels
Experienced A Decade Ago Unemployment rate Doubtful mortgage rate
Forecast Doubtful loan rate − Collateral performance has been
Spain Greece remarkably stable since the onset of
30 50 the pandemic, with residential
24 40 mortgage arrears generally steady or
18 30
decreasing.
− Short-time work schemes in the
%
%
12 20
eurozone's largest economies have so
6 10
far prevented an unemployment surge,
0 0 and mortgage payment deferral
2005 2008 2011 2014 2017 2020 2023 2005 2008 2011 2014 2017 2020 2023
schemes have prevented borrowers
Italy Ireland from falling into arrears.
− We expect only a limited credit impact
20 20
on prime residential mortgage loans
16 16 once this fiscal and regulatory support
12 12 wanes, because it will happen against
a background of a strong economic
%
%
8 8
rebound.
4 4
0 0
2005 2008 2011 2014 2017 2020 2023 2011 2014 2017 2020 2023
Sources: OECD, National Central Banks, S&P Global Ratings. Covered Bonds Must Adjust To A New Reality After COVID-19, June 30, 2021.
8Credit Performance | Strong Job Market Supports Residential
Assets
– There is still no evidence of any cliff effects in the labor market from the phasing out of short-time work schemes, and only about 2% of
the eurozone's active population was using these schemes during the third wave of lockdowns.
– Payment moratoria have already expired in several European countries, without a meaningful hike in delinquencies.
Only A Small Part Of The Active Population Is Still On Furlough Eurozone Unemployment To Recover To Its Pre-COVID-19 Levels
Employment-equivalent measure By The Second Half Of 2022
Apr-20 Apr-21 Germany France Italy Spain Netherlands Eurozone U.K.
18 18
16 16
14 14
% of active population
12 12
10 10
%
8 8
6 6
4 4
2 2
0 0
Germany France Italy Spain Weighted average 2019 2020 2021f 2022f 2023f 2024f
Source: National Labor Ministries, Eurostat, S&P Global Ratings calculations. f--Forecast. Source: S&P Global Ratings.
9Credit Performance | Commercial Mortgages Under Pressure But
Cover Pool Exposure Is Limited
Eurozone Commercial Real Estate Prices Grew Faster Than
Residential Real Estate Prices Before The Crisis
– Secular trends--such as the rise of working from home and the Residential real estate prices Commercial real estate prices
growth of e-commerce--and commercial real estate prices
outpacing residential prices before the pandemic, have clouded 10
the outlook for segments of the commercial real estate sector. 8
Retail and lodging are more at risk, while it is still early to 6
assess the long-term impact on offices. 4
– That said, the supply-demand mismatch in retail real estate is 2
much more significant in the U.K. than it is in continental 0
%
Europe. And even before COVID-19, many key European office (2)
markets were undersupplied, manifested in low vacancy rates
(4)
and increasing rents, and ever-declining yields.
(6)
– While we believe that commercial real estate asset
(8)
performance may deteriorate, we do not anticipate this
(10)
significantly impairing the credit quality of the covered bonds
that we rate, due to the availability of credit enhancement to (12)
2006 2008 2009 2011 2012 2014 2015 2017 2018 2020
absorb losses and the limited exposure to sectors that we
consider to be more at risk.
Source: ECB, S&P Global Ratings.
10Issuance | Central Bank Funding And Deposit Growth Depress
Issuance
– Non-standard monetary policy measures, such as the ECB’s TLTROs, have partly substituted investor-placed covered bonds as a bank
funding tool during periods of market turmoil.
– European households accumulated excess savings of about 12 percentage points of disposable income, limiting wholesale funding needs.
Eurozone Financial Institutions’ Use Of Term Funding From Central Deposit And Loan Book Growth Are Beginning To Normalize
Banks Has Ticked Higher Once Again 12-month lending and deposit growth, Eurozone real economy
MRO LTRO Loans Deposits
2.5 12
10
2.0
8
1.5
Tril. €
6
%
4
1.0
2
0.5
0
0.0 (2)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
LTRO--Long-term refinancing operations. MRO--Main refinancing operations. Source: European Central Real economy includes households and nonfinancial corporates. Source: European Central Bank.
Bank.
11Issuance | Retained Issuance Likely To Play A Larger Role For Longer
– The ECB may need to stimulate demand at least until 2023, so we expect retained covered bond issuance to play a significant role for the
next few years.
– It is unclear what investor appetite for covered bonds will be once monetary policy intervention wanes.
Retained Issuance Surged In March 2020 At The Expense Of
Strong Take-Up Of ECB Funding Drives Down Issuance
Investor-Placed Issuance
Jan-20 Apr-21 Change in issuance Benchmark, investor-placed Other
-10%
600
+0.8%
500 -2.9%
500
400
-3.5% 400
300
Bil. €
300
Bil. €
-2.8%
200 200
100
100
0
0
Jun-12
Nov-12
Jun-17
Nov-17
Jul-14
Oct-15
Jul-19
Oct-20
Jan-12
Sep-13
Feb-14
Dec-14
Mar-16
Jan-17
Sep-18
Feb-19
Dec-19
Mar-21
Apr-13
Apr-18
May-15
May-20
Aug-16
France Italy Germany Spain Netherlands
Sources: ECB, S&P Global Ratings. 12-month rolling benchmark issuance. Sources: Bloomberg, S&P Global Ratings.
12Issuance | Regulatory Developments Could Spur Sustainable
Covered Bond Growth
Sustainable Covered Bonds Represent A Growing Share Of New
Issuance
18
– Sustainable covered bonds grew to almost 17% of overall
issuance so far in 2021, from less than 5% in 2018.
16
– Despite limited pricing differentials compared with vanilla
issuance, sustainable covered bonds benefit from strong 14
investor demand and a supportive regulatory environment.
12
– The EU has recently approved or amended several regulations,
including the benchmark regulation, the regulation on 10
sustainability-related disclosures in the financial services
%
sector, and the taxonomy regulation for climate change, which 8
establishes the list of activities considered environmentally
6
sustainable.
– These initiatives provide greater clarity for market participants, 4
allowing issuers to plan the necessary investments required to
set up a green or social covered bond issuance program. 2
0
2017 2018 2019 2020 2021 YTD
Based on benchmark investor-placed issuance only. 2021 YTD figures as of July 16, 2021. Source: S&P Global
Ratings.
13Issuance | European Investor-Placed Issuance Volumes Set To
Remain Subdued For The Rest Of 2021
European Investor-Placed Benchmark Covered Bond Issuance
Year to date Rest of year YTD deal count (right scale) – Issuers' continued access to cheap central
160 160 bank funding and strong deposit growth will
continue to substitute for some European
140 140 covered bond issuance in the short term.
120 120
– However, issuers will likely still come to
market occasionally in order to maintain
100 100 investor relationships for the longer term.
No. of deals
– Covered bonds may remain an attractive
Bil. €
80 80
method to fund at longer maturities than
those offered by central bank schemes.
60 60
– There will also likely be increasing interest in
40 40 covered bonds as a platform for sustainable
(i.e., green or social) issuance.
20 20
0 0
2013 2014 2015 2016 2017 2018 2019 2020 2021
Year to date figures as of July 16 each year. Source: S&P Global Ratings.
14Harmonization | Pandemic Has Delayed The Transposition Into
National Legislations
Current State Of Covered Bond Harmonization Transpositions
Law passed
– The legislative package for the harmonization of EU covered bond
Proposal in parliament
frameworks entered into force in January 2020. Member states
Public proposal had until July 2021 to transpose it into national laws, and the new
Non-public proposal measures will apply by July 2022.
Transposition not undertaken – The COVID-19 crisis delayed the process in most countries. At the
Unknown status same time, the transposition into law of certain elements, such
as provisions on extendible maturities and the calculation of
liquidity buffers, has proven difficult. That's because the directive
is principles-based, leaving greater room for interpretation at the
national level.
– To date, only Germany, France, Denmark, and Latvia have enacted
the law, but we still think that most member states will be able to
meet the July 2022 target date.
S&P Global Ratings. Covered Bond Harmonization In The EU Remains A Work in Progress, July 13, 2021
15Ratings Outlook | Ratings Stable Despite Lockdowns And Drop In
Economic Activity
– Since the beginning of the COVID-19 crisis we have not downgraded any of the covered bond programs that we rate. We revised outlooks to
negative on less than 15% of them, and upgraded four of them, due to rating actions on the issuing banks or the related sovereigns.
– Most programs that we rate still have stable outlooks, except those in Spain.
Negative Rating Bias Highest In Non-Core Eurozone, Due To
No Downgrades So Far Due To The Pandemic
Spanish Sovereign Outlook
Upgrades Downgrades Negative outlook Stable outlook Positive outlook
20
Jun-21
Core EU
15 May-20
10 Nov-19
Jun-21
5
Nordics
No. of programs
May-20
0 Nov-19
(5) Jun-21
Non-core
EU
May-20
(10)
Nov-19
(15) Jun-21
Non EU
(20) May-20
Nov-19
(25)
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Note: Core EU: Austria, Belgium, France, Germany, The Netherlands. Nordics: Denmark, Finland, Norway, Sweden. Non-core EU: Greece, Hungary, Ireland, Italy, Spain. Non EU: Singapore, South Korea, U.K. Source: S&P
Global Ratings.
16Ratings Outlook | Overcollateralization Should Cushion Collateral
Performance Deterioration
Available CE Is On Average More Than Six Times What's Required For The Ratings
Q1-2021 Q4-2019 – The credit enhancement available to most of
the programs that we rate exceeds, on
Hungary
Ireland average, more than six times the level
Finland required to maintain the current ratings.
Norway
– We have not recorded any material
Denmark
Italy
deterioration in available credit
Germany enhancement, even when issuers used their
Belgium programs extensively for retained issuance.
France
Spain
– Our rating outlook remains stable, even
Netherl… though we expect mortgage arrears to peak
UK in Europe only in 2022.
Austria
Singapo…
– We expect a more severe effect on the
Sweden performance of CRE assets, but they
Korea generally constitute a relatively small part of
Greece the cover pools backing programs that we
0 2 4 6 8 10 12 14 16 rate.
CE--Credit enhancement. Q--Quarter. Source: S&P Global Ratings.
17Ratings Outlook | Unused Notches Partially Mitigate Bank
Downgrade Risk
Unused Notches By Country
– We continue to expect any potential changes Average
in sovereign or issuer credit ratings to be the FINLAND
most likely trigger for changes to our covered 4 NORWAY
SWEDEN
bond ratings. 3
2
– Currently, rated programs benefit on average 1 IRELAND
North Sea
DENMARK
from 2.4 unused notches--the number of U.K. NETHERLANDS
notches the issuer rating can be lowered Atlantic Ocean
without resulting in a downgrade of the BELGIUM GERMANY
covered bonds.
– French, German, and Dutch programs are
FRANCE AUSTRIA
more protected from the risk of bank HUNGARY
downgrades.
Black Sea
– Spanish and Italian programs have less of a SPAIN
ITALY
buffer to mitigate the effect of bank
downgrades and could be immediately
affected by a sovereign downgrade. Mediterranean Sea
Source: S&P Global Ratings. Global Covered Bond Insights Q2 2021, June 30, 2021.
18Ratings Outlook | Non-Core European And Public Sector Programs
More Exposed To Sovereign Risk
Most Program Ratings Will Be Unaffected By A Limited ICR Or Sovereign Downgrade
4
– Given our current sovereign ratings, covered
bond ratings in most jurisdictions would not
change due to a one-notch downgrade of the
3 60.5% 48.8% 46.5% 32.6%
sovereign, with some exceptions.
– We would expect mortgage programs in
ICR downgrade (notches)
2 75.6% 60.5% 55.8% 39.5% Ireland, Greece, Italy, and Spain, as well as
programs backed by public sector assets in
Belgium, France, and the U.K., to be most
1 88.4% 70.9% 66.3% 44.2%
sensitive to changes in the respective
sovereign ratings.
0 77.9% 70.9% 47.7%
-1
-1 0 1 2 3 4
Sovereign downgrade (notches)
Note: Percentage of covered bond program ratings unaffected by an ICR or sovereign downgrade. Unused notches are the number of notches the ICR can be lowered by, without resulting in a downgrade of the covered bonds,
all else being equal. ICR--Issuer credit rating. Source: S&P Global Ratings.
19Related Research
– Covered Bond Harmonization In The EU Remains A Work in Progress, July 13, 2021
– The ECB’s New Strategy Signals Smooth Tapering And Cautious Greening Ahead, July 9, 2021
– European Economic Snapshots: The Economy Is Responding Quickly To The Grand Reopening, July 9, 2021
– Commercial Real Estate In Covered Bonds: Is It Worth The Risk?, July 8, 2021
– Covered Bonds Must Adjust To A New Reality After COVID-19, June 30, 2021
– Global Covered Bond Insights Q2 2021, June 30, 2021
– Economic Outlook Europe Q3 2021: The Grand Reopening, June 24, 2021
– Covered Bonds In New Markets: Expect Only A Gradual Recovery, March 8, 2021
– Sustainable Covered Bonds: Assessing The Impact Of COVID-19, Dec. 1, 2020
– ESG Industry Report Card: Covered Bonds, Nov. 9, 2020
20Analytical Contacts
Antonio Farina Marta Escutia Andrew South
Head of Structured Finance Research -
Senior Director, Covered Bonds Associate Director, Covered Bonds
EMEA
+34-91-788-7226 +34-91-788-7225 +44-20-7176-3712
antonio.farina@spglobal.com marta.escutia@spglobal.com andrew.south@spglobal.com
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