EU banks plan to ramp up covered bond issuance in 2018 and 2019 after below average supply this year, according to a survey by the EBA, which warned this could cause capacity problems post-CBPP3. The EBA is meanwhile not overly concerned by an increase in asset encumbrance.

The European Banking Authority (EBA) published two reports last Monday (31 July), a backward-looking report on asset encumbrance and a survey asking 155 banks from all EU countries about their funding plans for 2017-2019.

The survey found that covered bond issuance is projected to exceed this year’s volumes in 2018 and 2019 in almost all EU markets in which at least Eu1bn of supply is forecast in any of the three relevant years, with many jurisdictions set for increases of well above 50% and in some cases 100%.

Countries where covered bonds are particularly prominent have significant planned issuance volumes, with more than Eu70bn issuance expected in Sweden in 2019, up from just over Eu20bn this year, for example. Substantial increases are also expected in Germany, Denmark, France, Italy and Spain.

The EBA does not in its report specify when the forecasts were made. This is relevant given that the Dutch forecast for 2017, for example, has already been surpassed by banks included in the survey. The full underlying figures for the above chart were also not disclosed in the report. The EBA did not respond to enquiries by The CBR’s deadline.

This mirrors expectations for overall debt issuance. Banks’ funding plans for this year are lower than the average issuance recorded in 2015 and 2016 in most countries, but suggest increasing issuance in 2018 and 2019 – in some cases even exceeding the historical average.

The EBA said these trends could be explained by high volumes of successful issuance last year, abundant central bank funding in 2016 and 2017 – which is expected to be wound-down in the coming years – and by assumed growth in assets such as loans to households in the coming years.

Another factor could be that banks aim to sell most of their required MREL-eligible issues in 2018 and 2019 given that such products are currently more expensive than alternatives, the EBA suggested. Market participants have previously suggested that issuance of covered bonds could be reduced by banks instead focussing on MREL-related issuance.

It said that an increase in the overall issuance of debt securities in 2018 and 2019, coming after a decline this year, could pose additional challenges for banks, as investors may have switched out of bank debt into other asset classes.

“Furthermore, as parts of these issuances are currently eligible for central banks’ asset purchase programmes, it can be assumed that markets are broader than the volume that common investors are willing to buy,” said the EBA. “This means that placed issuances might exceed the volumes that could be placed on the markets before central banks’ asset purchase programmes began.

“Even where such central bank purchases are restricted to secondary markets, they still support the primary markets, as could be seen on the covered bond markets in 2016. This would create an additional risk if central bank purchases were reduced or ended, as banks would then have to demonstrate that they would still be in a position to place their issuances on the market.”

Thorsten Euler, covered bond analyst at DZ Bank, said that while an increase in supply and hence choice is good news for investors, the sharply higher spreads and greater execution risk that may result – particularly for those with lower ratings – could give issuers pause for thought.

“Against this background, we believe it would make sense for issuers to consider whether any new issues planned for next year can be brought forward to 2017,” he added.

‘Modest uptick’ in asset encumbrance

Based on the increased volumes of long term secured funding featuring in banks’ funding plans, the EBA said the share of covered bonds as a source of asset encumbrance is likely to continue a recent rising trend.

The asset encumbrance report found that the ratio of banks’ encumbered assets and collateral received relative to the total assets and collateral received available for encumbrance, measured as a weighted average across the sample, rose from 25.4% in December 2015 to 26.6% in December 2016. The report is based on data from December 2014 to December 2016 and a sample covering 195 banks.

The EBA noted that, as in previous years, relatively high levels of encumbrance are found in countries that have large and established covered bond markets, most notably Denmark and Sweden, as well as jurisdictions with a high share of central bank funding or a high share of repo financing and collateral requirements for over‐the‐counter derivatives.

The report found that the share of covered bonds as a source of encumbrance increased over the sample period to 21% in December 2016.

“Taking into account the limited time series for this report, the modest uptick in the level of total asset encumbrance in 2016 appears not to be a cause for concern,” said the EBA. “Nonetheless, the availability of collateral for central bank funding in particular, as well as the use of central bank funding, should be carefully monitored to investigate the changes in funding structures across the EU as official sector funding is reduced.”