With covered bonds proving resilient amid the crisis, the industry is not only seeking to track response measures but also to provide solutions, whether via public sector covered bonds, ESNs or energy efficient mortgages, the ECBC’s Boudewijn Dierick and Luca Bertalot told The CBR.

In happier circumstances, we would today have been bringing you follow-up reporting from the latest European Covered Bond Council plenary, which had been due to take place last Thursday. The coronavirus pandemic, of course, meant the industry body’s twice yearly gathering of the covered bond community did not occur in Athens.

The ECBC nonetheless last week held virtual meetings (see image) on both ongoing and crisis initiatives related to issues facing the market and the wider environment, includings of its steering committee on Tuesday.

The Covered Bond Report’s Neil Day caught up with ECBC chairman Boudewijn Dierick, head of flow ABS and covered bond structuring at BNP Paribas, and secretary general Luca Bertalot to hear how the covered bond market is faring in the crisis and how the industry is responding.

Neil Day, The Covered Bond Report: Going straight to the crux of the matter: have covered bonds been hit by the crisis? They’ve been touted as a crisis-proof, resilient product – are they living up to that reputation?

Boudewijn Dierick (pictured): No, they haven’t been affected. The only effect you see is that spreads have widened – but that’s a general market trend reflecting overall market sentiment. In particular, a massive increase in issuance from governments and some SSAs is anticipated and since they are a sort of benchmark for covered bonds, spread widening there affects covered bonds, too. And in line with previous experience, as risk premiums have increased, covered bonds have widened less than other asset classes.

In terms of issuance, there’s not yet been a rush to the market. There are two reasons for that.

Firstly, the central banks acted very rapidly to calm the market, which has meant that new issuance resumed quite quickly in a variety of sectors. Had we not seen such quick action, we would probably have seen more covered bond issuance from banks who needed the funding.

Secondly, banks are looking at the various repo and other facilities that the central banks have in place. In Europe, we have seen the French issuing successfully, showing the market is open, but issuers in some other countries find the levels too wide and would rather take advantage of the central bank alternatives. That is reflected in the issuance we saw from the Canadians, who initially didn’t have the sort of central bank alternatives available to the Europeans.

What’s also different to the previous crisis is that banks have a lot more capital. Last time, people blamed the banks – and securitisation – but today, banks are more seen as possibly supporting the recovery. Governments are asking banks to keep funding businesses, mortgages and consumers, with payment holidays in some countries, for example. There is then a question of how that will affect the asset side – could there be a big spike in non-performing loans? But in terms of collateral quality, covered bonds will be very well protected, so I don’t expect any major issues in that respect.

Luca Bertalot: We feel that covered bonds have respected their history, again representing a safe harbour for investors, but also issuers. They also represent a part of the solution, being a capital market support for the real economy. As Boudewijn said, this is not a financial crisis as in 2008, but a crisis of the real economy, and we believe that – especially within the framework of the Banking Union and Capital Markets Union – the banking sector can help in the post-pandemic recovery plan and covered bonds can represent a part of the solution in a variety of ways.

We reacted immediately to the crisis, reaching out to the European Commission as soon as it emerged around the end of February, and we started creating our strategic Covid-19 task-force covering two major aspects: a retail focus and a funding focus. The aim is to build a common platform where every ECBC member can share their insights into developments and we can, so to speak, map the various problems and responses.

At the same time, this taskforce is preparing a medium to long term recovery plan. We have published a paper on the potential use of covered bonds from the mortgage sector but especially from the public sector, ESNs (European Secured Notes) and energy efficiency mortgages as potential cogs that can help the EU recovery. At the end of the day, the ECBC can mobilise directly or indirectly 2,000 institutions – not only European, but also globally – in the same direction, and that is what we are trying to do.

The establishment of the taskforce should also send a signal to investors that the market is acting as a community to find solutions amid the crisis. If there is a problem, don’t worry, we will tackle it.

Day, The CBR: You have mentioned quite a variety of aspects there, but alongside the usual suspects you mentioned public sector covered bonds. That’s a part of the covered market that has been in decline over many years. What’s your thinking there?

Bertalot: On many occasions in history when public finances have not proven sufficient to bolster the state in the face of an emergency, capital markets have stepped in to provide a solution, often in the shape of mortgage or public sector covered bonds. Public sector Pfandbriefe, for example, played an important role in helping finance the reunification of Germany, providing a nice additional capital markets support to the public sector. Remember, the first jumbo was done in 1995, and for a decade public sector covered bonds constituted the majority of the market. The same logic was followed by Friedrich the Great and by Napoleon III with the French obligations foncières. So it’s very much in the nature of this asset class that when public sector finance has not been enough, capital markets have provided solutions, and using banks to leverage this is a nice idea.

So we are simply re-proposing what over centuries was proposed several times, with public sector covered bonds and on this occasion also ESNs. 80% of European citizens work for SMEs, so if the SME sector does not recover, most of the borrowers who have taken out mortgages or commercial loans could face problems. It’s therefore in the interest of our industry to have a direct impact on the SME sector, too. And – last, but not least – energy efficiency mortgages can really be a flagship initiative to support the green recovery.

Day, The CBR: ESNs were promoted during the process of the EU covered bond legislative package but didn’t get included in any substantive form. Is this potentially the moment when they do become reality and are embraced more sympathetically by the European institutions?

Bertalot: Vice president Timmermans has been very clear in saying that this will be a green recovery. Although it was not captured in the study commissioned into ESNs during the legislative process, they can have a green aspect, and this is being discussed both within the Commission and industry as a possible tool to help green infrastructure, green facilities and green SMEs. Together with green covered bonds – and green securitisation – such a dual recourse instrument could become a driver of the recovery.

This can be implemented in two ways. On the one hand, by implementing a national solution. The Italians, for example, are very advanced in this respect. Bear in mind that minister of finance Gualtieri previously supported ESNs in the ECON committee.

On the other hand, it could take a European form. At the end of the last Commission, Dombrovskis said that ESNs were a priority for the next mandate. Now he is back on the same floor of the Berlaymont building, so the Dombrovskis cabinet will probably look very carefully at ESNs.

Dierick: The advantage of ESNs is that you could incorporate assets that are not necessarily eligible for traditional covered bonds – SMEs, green assets – as Luca mentioned, and for the medical sector. So it could be a lot wider in terms of assets and separate from the traditional covered bonds.

Bertalot: Regarding healthcare, Caffil has issued ESG public sector covered bonds to finance hospitals, most recently in relation to Covid-19. The French issuer was a bit of a pioneer in the ESG world, but this is a path that could be followed by the entire market.

Day, The CBR: One of the issues that was raised in relation to ESNs when spreads were tight and compressed was how much sense it would make for an issuer to go to the trouble of issuing them when there was not necessarily a great advantage over senior preferred funding. Could they make more sense if spreads are elevated for a prolonged period?

Dierick: Indeed, they could. As soon as you see risk premiums and spreads rising, then of course people may turn to covered bonds, but also to ESNs if they don’t have sufficient collateral for traditional covered bonds or face issuance limits.

Bertalot: That was exactly the point Boudewijn raised in the past. When we created the ESN, we said, we don’t need this now, but most probably we will need it for the next crisis, so let’s work on this and keep it in the drawer because one day we will need it. I think that that day has arrived.

Day, The CBR: You’ve already mentioned green quite a few times and the Energy Efficient Mortgages Initiative. Can you expand on what steps you are taking in that respect?

Bertalot (pictured): We are working on five key moves that can support this idea of the green recovery in a concrete way.

We are organising an Energy Efficiency Label that will be announced in September. We have created a new Energy Efficiency Label Foundation under Belgian law and are working on a new platform that will be very similar to the Covered Bond Label concept.

At the same time, we are boosting the creation of national hubs. We are offering support to create a network of European financing at the local level to allow the 60 pilot phase banks to get financial support from the European Commission to develop their pilots. We now have more than 13 national projects in the pipeline and each of them will potentially be eligible for €1.5 million of Horizon 2020 support.

We are working very closely with EeDaPP (Energy Efficient Data Portal & Protocol) on an important study to demonstrate that there is a performance link between credit risk and energy performance.

And we have consulted all the pilot phase banks on the creation of harmonised disclosure templates (HDTs) we are developing, which are more or less a copy of the Covered Bond Label harmonised transparency template (HTT) but for energy efficiency.

Finally, we are developing an input database, called the EeDaPP master template, which will be used by pilot phase banks to input data.

These are five really concrete moves we are putting together during these months to be ready for September.

Day, The CBR: You mentioned that some of this builds on the work you’ve done with the Covered Bond Label. What’s driving the latest Label developments you recently announced?

Bertalot: First of all, I would like to highlight that we have increased the Label’s coverage of the market quite a lot: if you look at covered bonds outstanding, it’s now more than 75%, and in the EEA it’s almost 84%.

We have started a complete revision of the Covered Bond Label website to implement new technological aspects that will be fully disclosed in a few months’ time.

In parallel with this, we have put together a new function that will allow investors and other interested parties to easily check basic key parameters – OC, maturity structure, interest rate hedging or not – in a very simple, standardised way, with charts, so visually it is very clear.

This is a clear response to deal with the heterogeneity of the asset class, which was captured by the recent working paper of the ECB. This heterogeneity is in the nature of covered bond programmes and the nature of the mortgage market, but we are always acting as a driver of harmonisation by proposing solutions that will bring issuers to work under the same kind of framework. Of course, it takes time to implement these solutions, but the HTT reporting tool is very much working towards this end.

Dierick: One of the various topics the Covid-19 taskforce is monitoring is the treatment of payment holidays in terms of asset eligibility, and an initial idea we are working on is the reporting of payment holidays as a potential voluntary option in the HTT template.

Day, The CBR: The last taskforce to be established by the ECBC (ahead of the Covid-19 one) was the implementation taskforce in light of the finalisation of the EU legislative package. What can you tell us about how its work is developing? Is it less of a focus in light of the current crisis and could implementation dates be pushed back?

Bertalot: We are fully on that ball as well. Covid-19 has of course changed the calendar of the Commission – the working group meetings of the member states cannot be organised, so they are reorganising their schedule a bit. But we are following the Commission’s agenda very closely. We want to understand if there could potentially be a delay to the implementation of the covered bond directive. Everything can change with Covid-19. Perhaps countries who are managing other priorities will need more time to implement the directive – that’s something that we want to discuss with the Commission and with national member states. This is all being tracked and discussed by the implementation taskforce.

Dierick: On the one hand, Covid-19 doesn’t change anything specific to the directive, but because governments are focusing on short term issues, they may push this out a little bit in terms of timing and priority. The authorities haven’t yet said, like with Basel, that they will give a year more, but I guess they will be more flexible if countries at some point need more time to implement it.

There are also different views on this. Some countries would like to just go ahead as planned because they were waiting to combine the directive text with other planned changes to national legislation, some of which were already overdue. Others would like to have a bit more time to implement these changes, because they are busy dealing with other crisis-related issues.

Day, The CBR: We are speaking at a time when the covered bond industry would have been gathering in Athens for the ECBC plenary. The Greeks were perhaps the most heavily struck by the past crisis. What can we take away from their experience with covered bonds?

Bertalot: Covered bonds have been an essential capital markets instrument to support the financial sector in Greece. They did what they were supposed to do, in bringing investors comfort, in keeping investors in the country, and in being a solid and liquid instrument – that is what happened during the Greek crisis. The spreads of Greek covered bonds were completely different from the spreads of the government bonds.

Dierick: When Greek banks emerged from the crisis, they began their return to the capital markets by issuing covered bonds. You also saw this in the aftermath of Lehman, when banks hadn’t been able to issue but then began by issuing short-dated covered bonds because that was the product that was the most viable. That is because of their dual recourse nature. In various countries mortgage covered bonds even priced inside their respective government bonds during the sovereign crisis because you have so much security and the credit risk is so low. And they will be able to help again, if needed.

Bertalot: We recently set a new date for the Athens plenary meeting, on 21 April next year. We had to cancel Barcelona, unfortunately, but our plan is to try to organise an extraordinary plenary, maybe in November or December, as soon as conditions will allow us to organise a gathering of the covered bond community. We really feel that there is a need to reassemble as soon as health conditions improve across the continent.