Covered bond alternative to government bonds? Spread with Bund only 0.2%
Covered bonds are considered by some analysts also useful tools to implement the plandragons on the EU
3' min read
Key points
3' min read
A viable alternative to government bonds, but also to other investment grade bonds (i.e. those considered safe). Covered bonds issued by EU banks would be suitable for investors looking for security and a small additional yield compared to sovereign bonds (the Iboxx euro covered bond index points to a reduction of the spread with the Bund to only 20 basis points), but also a useful instrument to bridge the investment gap needed for Europe's future. But, as always when it comes to investments, attention to credit and market risks is required, as well as an assessment of the specific characteristics of the 'collateral pool'. But let us proceed in order.
What are covered bonds
They are instruments issued by banks and guaranteed by a specific pool of assets (e.g. mortgages or public loans) held separately by the issuer. This mechanism offers a double layer of protection: the direct guarantee of the bank and that of the pool of separate assets to secure payments in the event of default. The other main features are high security (no default has been recorded in over 200 years) and a regulated structure (regulated by EU Directive 2019/2162).
Comparison with government bonds
.Covered bonds are, therefore, often seen as a substitute for EU government debt, given their defensive and high-quality nature. "The supply dynamics in 2024," explains Henrik Stille, European covered bond strategy manager at Nordea, "further strengthen the argument in favour of covered bonds. While the net supply of EU government bonds is expected to increase due to ongoing budget deficits, covered bond issuance is likely to remain subdued. This supply imbalance favours performance over government bonds. They offer,' Stille continues, 'an attractive strategic allocation for risk-averse investors who wish to diversify away from corporate bonds. With comparable yields at lower risk levels, we believe they are an attractive choice in the current market environment'.
"Help" for the Dragon Plan
.There are also those who argue that covered bonds could help fill the investment gap needed for Europe's future: the Draghi report highlights the need for additional annual investments of 750-800 billion (4.5% of EU-27 GDP). Mathias Pleissner, Deputy head of covered bonds at Scope Ratings, says: "There are three key areas where covered bonds could be useful in addressing the challenges highlighted by the Draghi report: closing the innovation gap (they could provide funding benefits for banks and SMEs); helping decarbonisation (green covered bonds could diversify banks' funding sources and promote sustainable energy); supporting economic security and sovereignty (covered bonds offer financial stability and reduce Europe's dependence on external economic influences).
The banking risk
.But how will the recent bank takeovers announced in Europe affect these instruments? 'M&A discussions such as those between UniCredit-Bpm and UniCredit-Commerzbank,' Pleissner replies, 'could benefit investors by tightening the spreads of the perceived weaker party if the transactions go through, which is not a foregone conclusion at the moment. On the credit side, we do not anticipate any negative repercussions. UniCredit,' Pleissner continues, 'is already among the largest issuers of covered bonds, which supports its systemic relevance and the likelihood that its covered bonds will remain outstanding in the event of regulatory intervention. A merger will strengthen its position. This could allow UniCredit to refinance itself at lower costs and increase its competitiveness'.
