There has never been a more urgent need to develop the covered bond markets in central and eastern Europe – before the ECB purchase programme runs out.
The European Central Bank’s recent announcement that their programme of quantitative easing will continue until at least September 2018 was good news for issuers of mortgage covered bonds. These bonds form the back-bone of mortgage finance in many of the countries of Western Europe, most famously Germany, but equally in countries such as Denmark, Sweden and France. These securities are by far the largest private sector component of the ECB’s recent purchases, with €231bn having been purchased so far – in contrast to only €115bn of corporate bonds.
Few would dispute the ECB’s judgement in prioritising this asset class. Covered bonds have an impeccable credit – there is no record of one ever having defaulted – and in many countries investors demand a lower coupon to hold them than they do for government bonds. Recent Greek covered bonds launched at a yield 85 basis points tighter than the yield on equivalent-date Greek government bonds.
Similarly, covered bonds benefit from preferential European Union rules for investors reflecting their high credit and liquidity status.
Largesse not felt
But the benefits of the ECB’s largesse – and the European Union’s prudential treatment of these securities – are disproportionally felt in the west. These funds flow largely into the mortgage markets of Germany, France and Spain – which hardly need more funding - for one simple reason: with a couple of honourable exceptions there just aren’t enough mortgage covered bonds in central and eastern Europe for the ECB to buy.
There are many reasons why covered bonds in the newer states in the European Union have developed too slowly. The mortgage markets are typically smaller than those in western European countries, banks rely less on the wholesale funding markets and more on deposits and funding from western European parent institutions and the legal and regulatory technology has not been sufficiently developed.
The banking systems of central and eastern Europe can be made much more stable with the introduction of term, asset-backed funding options for banks there. It will help to break their reliance on both short-term funding and intra-group liquidity – increasingly a problem as western European banks address their own problems.
An important alternative
Furthermore, mortgages for homeowners in the region can be funded for longer and cheaper when banks have access to the vast western European covered bond investor base. And the workings of the covered bond market – where banks remain fully on the hook for the money that they borrow – will ensure that mortgages are advanced only on a responsible, long-term basis.
Finally, the introduction of highly liquid, high credit quality private sector securities provides an important alternative to government securities for nascent pension funds and bank treasurers in many countries.
With the ECB’s money by necessity being channelled where it is least needed – highly liquid banks lending it into the German and French real estate markets, for example – there has never been a more urgent need to develop the covered bond markets in central and eastern Europe – before the ECB purchase programme runs out.