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Covered Bonds In New Markets: Expect Only A Gradual Recovery

While the COVID-19 crisis reaffirmed the role of covered bonds as reliable funding tools in times of financial turmoil in both established and new markets, we expect that the pandemic and the subsequent policy response will have long-lasting effects on this instrument.

In this report, we take a closer look at the key characteristics and outlook for new covered bonds markets.

Ample Liquidity Will Depress 2021 Issuance

Despite extended coronavirus containment measures that pushed the world into the deepest recession since the Great Depression, the covered bond market remained open throughout 2020 and banks were able to find investors even at the peak of market turmoil. Cheap central bank funding partly replaced investor-placed covered bonds, but also supported issuance of retained covered bonds (see "Covered Bonds 2021 Outlook: Policy Intervention Is Reshaping The Role Of Covered Bonds," published on Nov. 25, 2020).

Investor-placed benchmark issuance in 2020 was only slightly down in new markets compared to the year before, bolstered by the strong performance in Korea and Japan.

Chart 1


Chart 2


Ample liquidity will depress 2021 covered bond issuance in new markets, but volumes should pick up again once the economic recovery is well established.

Economic conditions are improving, and economic growth should rebound globally in 2021. However, we expect that the recovery will start supporting mortgage lending only from 2022. When mortgage lending grows faster than customer deposits, lenders typically access the wholesale funding market, and can use mortgage loans as collateral for issuing covered bonds.

Table 1

GDP Growth And Recovery Forecasts
Real GDP growth rates Recovery to end 2019-level
(%) 2019 2020e 2021f 2022f 2023f GDP Unemployment
U.S. 2.2 (3.9) 4.2 3.0 2.1 Q3 2021 >2023
Eurozone 1.3 (7.2) 4.8 3.9 2.2 Q2 2022 Q4 2023
China* 6.1 2.3 7.0 5.0 5.0 Q2 2020 Q4 2020
India§ 4.2 (7.7) 10.0 6.0 6.2 Q2 2021 N/A
Japan 0.7 (5.5) 2.7 1.3 0.9 Q1 2023 >2023
Russia 1.3 (3.5) 2.9 2.7 2.0 Q4 2021 Q2 2023
Brazil 1.1 (4.7) 3.2 2.6 2.6 Q3 2022 Q1 2023
U.K. 1.3 (11.0) 6.0 5.0 2.4 Q4 2022 >2023
World† 3.1 (3.7) 5.0 3.9 3.6 N/A N/A
*China's GDP for 2020 is actual, not forecast. §Fiscal year ending in March. †Weighted by purchasing power parity. e--Estimate. f--Forecast. N/A--Not applicable. Source: S&P Global Ratings, Oxford Economics.

Financing conditions should also remain supportive, backed by ultra-low interest rates in major economies, which push investors to look for better yields outside more established markets. The main risk is that the passage of a more sizeable stimulus in the U.S. is boosting inflation expectations and pushing U.S. yields higher. This in turn could decrease capital flows to certain riskier markets (see "Emerging Markets Monthly Highlights: Despite Vaccines, Normality Still Elusive," published on Feb. 17, 2021).

Cautious Optimism For Issuance Pick-Up Starting From 2022

Loan growth and further legal and regulatory developments should also support covered bond issuance in new markets starting from 2022. EU member states are in the process of transposing the harmonized covered bond framework into their national legislations. The legislative package provides a common definition of covered bonds, defines the product's structural features, and clarifies the responsibilities for supervising the product. It also amends the EU Capital Requirements Regulation to strengthen the conditions for granting preferential capital treatment (see "Harmonization Accomplished: A New European Covered Bond Framework," published on April 18, 2019).

A harmonized framework should boost development of covered bonds in Europe by raising the standards for asset quality, disclosure, and supervision, particularly in some Central and Eastern European jurisdictions. At the same time, the establishment of a European benchmark could encourage legislators and regulators in other regions to align their frameworks to the same standards, further supporting the developments of new markets.

Central And Eastern Europe

Covered bond issuance is growing rapidly in Central and Eastern Europe (CEE), especially in Slovakia, where new legislation became effective in 2018, and in Poland, which saw the first green issuance in the region. In Estonia, where new legislation became effective in early 2019, Luminor Bank AS and LHV Pank AS entered the market in 2020 with benchmark and sub-benchmark issuances, respectively. In addition, in 2020 Luminor Bank added Latvian and Lithuanian mortgage loans to its initial cover pool of only Estonian assets. Estonia, Latvia, and Lithuania are also setting up a pan-Baltic covered bond framework.

Chart 3


Demand for housing in the region has been strong, driven among other factors by falling unemployment, rapidly rising incomes, and a shortage of dwellings. This resulted in a solid increase in mortgage lending, which issuers in the region have largely funded with deposits. In a few countries, banks had also relied on parent support from foreign banks to meet their funding needs. However, following changes in banks' ownership and regulatory initiatives in recent years, banks have become self-financed. In this context, covered bonds have become an important funding tool for issuers to better match their funding profiles, diversify their investor base, and optimize their cost of borrowing.

Despite our expectation for an economic recovery through 2021, we believe that covered bond issuance in the region will remain subdued this year. An increase in loan loss provisions, and caution amid economic uncertainty should reduce the appetite for granting new loans, while cheap and stable retail deposits are still funding banks in CEE. In addition, we understand that many CEE banks have received the minimum requirement for own funds and eligible liabilities (MREL) targets in 2020 and have until the end of 2023 to achieve them. Therefore, we expect that they will prefer issuing MREL-eligible debt rather than covered bonds until they meet their MREL targets.

Table 2

Growth Picks Up In 2021 But Deposits Cover Most Funding Needs
Real GDP growth (%) Customer deposits / domestic loans (%) Nonperforming assets / systemwide loans (year end; %) Loan growth (%)
2021f 2022f 2021f 2022f 2021f 2022f 2021f 2022f
Bulgaria 4.0 3.3 127.0 129.2 12.9 13.1 5.2 5.2
Croatia 5.6 3.5 92.2 90.1 9.6 8.3 0.2 2.2
Czech Republic 4.9 2.8 123.4 123.2 3.7 2.7 5.5 6.0
Estonia 2.6 4.1 65.4 66.3 N/A N/A 4.0 4.0
Hungary 4.5 3.5 79.3 79.1 4.3 4.5 6.8 6.3
Latvia 2.8 4.8 100.9 101.8 8.7 N/A 0.7 0.8
Lithuania 2.5 3.5 65.6 66.0 2.8 3.3 4.0 5.0
Poland 3.8 4.2 97.8 97.2 9.0 7.5 5.8 7.0
Romania 4.0 3.0 114.9 117.0 9.1 6.9 4.7 4.9
Slovakia 4.3 2.8 79.2 79.8 2.8 2.6 6.7 7.5
Slovenia 5.0 3.5 106.4 101.8 3.8 3.9 3.5 4.0
Turkey 3.6 3.5 69.3 65.4 10.2 10.9 15.0 15.0
f--Forecast. N/A--Not available. Source: S&P Global Ratings.

In the medium term, we believe that covered bond growth will resume, lifted by a pick-up in loan origination and legislative and regulatory developments. Mortgage debt in the region is still below the European average, and we believe that it could converge toward the level of Western European countries.

Chart 4


The transposition of the EU harmonization directive should also prove a supporting factor for covered bond issuance, by either introducing new dedicated legislations or aligning existing local frameworks to the best practices of more established markets. With four months left for the transposition of the directive into national frameworks, it is not entirely clear where each country stands in the process. We understand that in Hungary discussions between the Hungarian Banking Association and the Ministry of Finance are progressing, but a draft law has not been submitted to Parliament yet. The Latvian government introduced to parliament a legislative framework for covered bonds in October 2020, while in Estonia and Lithuania work is in progress but no draft law is yet in parliament. In Croatia where reforms were on hold, the existing working group has been reactivated and is developing a covered bond legal framework and the implementation of the directive is in progress. We currently have no visibility on the situation in the Czech Republic, Poland, and Slovakia.

While we still think that some member states will be able to meet the July 2021 target date, we see an increasing risk that at least some of them may miss it.

Chart 5


The issuance of mortgage covered bonds in Hungary is governed by Act No. XXX of 1997 on Mortgage Banks and Mortgage Bonds (Mortgage Bank Act; see "Hungarian Mortgage Covered Bond Framework Allows For Rating Covered Bonds Higher Than The Issuer," published on Aug. 24, 2018).

Even though Hungarian banks are mostly deposit-funded, covered bonds have become an important tool to diversify funding sources and reduce the banks' asset liability maturity mismatch. The Central Bank of Hungary (Magyar Nemzeti Bank; MNB) supported domestic issuance by establishing two mortgage bond purchase programs and by introducing the mortgage funding adequacy ratio (MFAR) regulation, which requires that banks finance at least 25% of outstanding household mortgage loans with mortgage-backed bonds. As of year-end 2019, about 28% of Hungarian residential mortgage loans were financed with covered bonds, up from up from about 16% at year-end 2016. In November 2020, the MNB stopped its covered bond purchases on the primary market pending announcement of the details of its green mortgage bond purchase program, which should be established later this year.

We expect modest covered bond issuances in the first half of 2021, while market participants await the details of MNB's green mortgage bond purchases and the qualification criteria for green bond status. We do not expect new market entrants, as the five major banks have already set up their mortgage programs.


Amendments to the 1997 Act on Covered Bonds and Mortgage Banks, which became effective in January 2016, created adequate conditions for the development of the Polish market (see "A First Look At How Poland Might Amend Its Covered Bond Framework," published on Nov. 13, 2014). Since then, a supportive macroeconomic environment and the desire to diversify funding costs and reduce asset liability mismatch have fueled covered bond issuances. The largest banks have already set up mortgage banks and increasingly issue covered bonds, especially euro-denominated notes.

In 2019, Polish issuers pioneered the first green covered bond issuances in CEE. PKO Bank Hipoteczny S.A. issued its first Polish zloty (PLN) 250 million green covered bond that June, followed shortly by a second issuance. ING Bank Hipoteczny S.A. followed suit with a PLN400 million green bond issuance.

Polish residential mortgage loans account for about 20.5% of GDP, a low percentage compared to other European countries, so there is a strong potential for further mortgage loan growth. At the same time, only about 5.6% of residential mortgages are funded with covered bonds, leaving plenty of collateral for further issuance.

Czech Republic

On Jan. 4, 2019, an update to the Bonds Act (No. 190/2004 Coll., on Bonds; as amended by Act No. 307/2018 Coll.) became effective (see "S&P Global Ratings Comments On The Czech Republic's Revised Covered Bond Framework," published on March 5, 2019). While Czech banks benefit from a strong core customer deposit base, they have used covered bonds to diversify their funding sources. As a result, the local covered bond market is the largest in CEE, with a total outstanding amount of €14.2 billion as the end of 2019. Since May 2020, the Czech National Bank accepts Czech koruna-denominated (CZK) mortgage bonds as collateral for short-term liquidity operations. Given banks' strong liquidity buffers in domestic currency, we do not expect this to have a material effect in driving CZK-denominated domestic covered bond issuances.

In recent years, many Czech banks have increased euro-denominated lending to corporate entities. The Czech banking system is largely foreign-owned and therefore banks could get foreign currency funding from the parent if needed. However, as banks have become self-financed, some are looking to use covered bonds for euro funding and optimize their borrowing costs. The first euro denominated benchmark transaction under the amended law was launched in January 2021 by Komercní banka, a.s., with a €500 million bond issued under its newly established €5 billion mortgage program.

We expect covered bond issuances to be flat in 2021 due to a slowdown in loan growth and banks taking a more cautious stance amid economic uncertainty, before picking up in 2022.


The updated covered bond legislation adopted in January 2018 already reflects the European Banking Authority's best practices. With the amended legislative framework in place, Slovakian issuers have provided a rich supply of benchmark covered bonds and even dominated the CEE issuance market in 2019. In June 2020, Vseobecna uverova banka a.s. (VUB) issued its third €500 million benchmark covered bond, having launched two in 2019. Additionally, both Prima banka Slovensko, a.s. and Slovenská sporitl'na, a.s. made their benchmark debut issuances in 2019.

Slovakia's banks posted solid credit growth in recent years. Loan growth has been driven primarily by mortgages funded through predominantly low-cost customer deposits. However, covered bonds are becoming increasingly important for banks to match their long-term mortgages with long-term funding.


Korea and Singapore pioneered covered bond issuance in developed Asia. As local banks are mainly funded by customer deposits, their primary motivation in establishing covered bond capabilities was to manage asset liability mismatch risk and diversify their funding sources. In 2018, the first covered bond program was set up in Japan. Because there is no dedicated local covered bond legislation, the program was based on a contractual structure.

Ample liquidity has recently dampened issuance from Singapore, but overall volumes have been partially compensated by issuance from Japanese and Korean banks.

Chart 6


Despite the expected rebound in economic activity, we believe that 2021 issuance in the region will be similarly restrained by the availability of customer deposits and limited funding needs in foreign currencies.

Table 3

Economic Conditions Are Expected To Improve In Major Asian Economies
Real GDP growth (%) Customer deposits / domestic loans (%) Nonperforming assets / systemwide loans (year-end; %) Loan growth (%)
2021f 2022f 2021f 2022f 2021f 2022f 2021f 2022f
China 7.0 5.0 79.9 79.9 2.7 2.9 11.8 10.2
India 10.0 6.0 114.1 114.1 8.3 7.5 10.5 11.0
Indonesia 5.4 5.2 102.8 98.1 4.0 3.8 5.0 7.0
Japan 2.7 1.3 152.7 155.7 1.4 0.9 0.0 2.0
Korea (the Republic of) 3.6 3.2 75.3 73.2 0.9 0.9 2.7 3.5
Malaysia 7.5 5.2 65.6 67.0 3.9 2.8 6.2 6.0
Singapore 6.0 3.0 82.1 82.5 3.0 2.5 3.0 5.0
Thailand 5.0 3.9 73.6 73.6 6.0 5.7 6.0 6.0
f--Forecast. Source: S&P Global Ratings.

In the medium term, we believe that Asian covered bonds should grow further, with new Asian banks benefiting from the funding diversification that they provide. We expect that housing finance needs will grow substantially, and covered bonds could become an important instrument for mobilizing private capital toward mortgage financing, especially in emerging Asia.

Chart 7


Despite the success of the Japanese issuers, we don't expect that many financial institutions outside Japan will establish programs based entirely on a contractual framework. Most new issuers will either wait for the approval of a dedicated covered bond legal framework, or at least an appropriate supportive regulatory framework, in our view.

The approval of the harmonization directive could spur legislative initiatives even outside the EU, since it established a blueprint for covered bond legal frameworks that will be considered by legislators globally. A stricter alignment with the provisions of the directive could also favor the achievement of an equivalent regulatory treatment of covered bonds issued by credit institutions located outside the European Economic Area.

South Korea

Covered bonds in South Korea can be issued through the Covered Bond Act and the Korea Housing Finance Corp. Act. The Korean Housing Finance Corp. (KHFC) has issued covered bonds since 2010, joined by Kookmin Bank in 2015 (see "How We Rate Korean Covered Bonds," published on May 20, 2019). Since then, KHFC issued the first social covered bond from Asia and the first Korean euro-denominated covered bond in 2018, and KEB Hana Bank established its own program and inaugural euro-denominated issuance in January 2021.

The Korean Financial Services Commission has also recently adopted several measures to encourage covered bond issuance, including reduced registration fees for bond issuances and lower capital requirements for covered bond investors. These measures incentivized the issuance of South Korean won (KRW) denominated bonds, and since 2019 five financial institutions, including KHFC, have issued covered bonds in the domestic market.

We expect Korean issuers to continue using covered bonds, both domestically and internationally, to diversify their funding base and mitigate asset-liability risk.


The regulatory framework for the issuance of covered bonds by banks incorporated in Singapore was established on Dec. 31, 2013, and refined on June 4, 2015, through the Monetary Authority of Singapore (MAS)'s Notice 648 (see "Singapore's Covered Bond Framework Supports Higher Ratings On Covered Bonds Than on The Issuer," published on Feb. 23, 2016).

With the legislative framework in place, the three major domestic banks have already set up their programs and cumulatively issued the equivalent of approximately €9 billion as of the end of 2020. Issuance could be further stimulated by the MAS' recent increase of the asset encumbrance limit to 10% from 4% of the issuer's total assets. This could lead to an increase in existing programs' size and might incentivize other banks to set up covered bond programs. However, the overall supply will likely be limited because banks in Singapore are mostly funded by depositors and have limited funding needs in foreign currencies.


Covered bond issuance is possible according to a dedicated legal framework--legislation-enabled covered bonds--or through contractual means--structured covered bonds (see "S&P Global Ratings' Covered Bonds Primer," published on June 20, 2019). Since there is no dedicated legal framework in Japan, when Sumimoto Mitsui Banking Corp. (SMBC) issued the first Japanese covered bond in November 2018 it based its program on a contractual structure. Likewise, Sumitomo Mitsui Trust Bank (SMTB) launched its inaugural covered bonds in October 2020 with a structure similar to SMBC's. Given the availability of domestic deposit, it appears that the main reason for establishing covered bond programs is to attract cheap foreign currency funding.

The Japanese covered bond market has the potential to grow quite considerably: local lenders are already using collateralized lending, such as residential mortgage-backed securities (RMBS), and they have now started adding covered bonds to their funding mix; outstanding mortgage loans are about Japanese yen (¥) 200 trillion, of which only 15%-20% is currently used as collateral for RMBS, leaving ample capacity for covered bond issuance; Japanese banks have considerable assets denominated in foreign currencies and covered bonds could constitute a competitive source of funding for these assets; and from a risk and regulatory perspective, covered bond issuance can reduce the duration mismatch between the assets and liabilities (see "How We Rate Japanese Covered Bonds," published on Sept. 6, 2019).

However, the current lack of a dedicated legal or regulatory framework could be a restraining factor for further issuance, especially for regional banks.


Issuers in China have expressed increased interest in dual-recourse issuance in the past few years. Since larger banks in China benefit from abundant liquidity and strong deposit bases, the appetite for covered bonds mainly reflects increasing risk awareness--specifically, the importance of having alternative tools for banks to plan for rainy day funding, rather than current funding needs. Aside from limited issuers' supply, there are several other legal and regulatory questions that should be considered. The incumbent asset issue is a primary challenge for covered bond issuance. China has regulations on the protection of depositholders, and the arrangement to ringfence specific banks' assets to benefit covered bondholders could be complicated without a dedicated legal framework. Moreover, legally, depositholders enjoy a very high ranking in the allocation waterfall after banks' liquidation in the region. Because these assets' ringfencing and deposit ranking relate to the sovereign banking laws, regulators may find it difficult to have flexibility, even if they support the development of covered bond issuance. Finally, it is unclear whether an on-shore special-purpose vehicle could validly provide a guarantee for payments. So, while banks in China are likely to investigate covered bond options, it will probably take regulatory and deal-arranging efforts to see issuance in the near future.


India has a significant shortage in affordable housing and a young and growing population. Moreover, household debt as a percentage of GDP is below that of other emerging markets. These factors suggest there could be significant growth in the housing finance sector in the future. Currently, customer deposits predominantly fund banks in India, but issuers and regulators are considering alternative sources of wholesale funding, including covered bonds. The Reserve Bank of India (RBI), for example, had constituted in 2019 a Committee on the Development of Housing Finance Securitisation Market, which recommended, among other things, an enhanced role for the National Housing Bank and further amendments to reduce the transaction costs for securitizations. Like other Commonwealth countries such as Australia and the U.K., India does not have specific legislation governing securitization. Rather, the legal framework for India's securitization market is based on existing trust, contract, and property law, and a series of guidelines issued by the RBI. We anticipate that if covered bonds are issued in India, they may, at least initially, be issued under a general-law framework with an appropriate supportive regulatory framework. In our view, key clarifications required will include whether the issuance of covered bonds is permitted under Indian legislation generally, whether existing securitization guidelines can be applied to covered bonds, how asset segregation can be achieved, the treatment of assets in an issuer insolvency scenario, and whether there are any challenges from a tax perspective, including stamp duty and withholding tax (see "India's Pathway To Establishing A Covered Bond Market," published on Sept. 12, 2017).

Latin America

Covered bonds in this region have a short and limited track record. Panama was the first country to see a covered bond issuance in October 2012. Since it does not have a dedicated legal framework, covered bonds were based on contractual agreements. Chile also saw limited and locally distributed covered bond issuance in the past.

One factor preventing financial institutions in the region from issuing covered bonds is the lack of a dedicated legal framework. However, things are changing thanks to the legislative developments in Brazil. If covered bonds prove successful there, we may see other countries in the region follow its lead.


In October 2014, Brazil enacted Provisional Measure No. 656, which outlined a framework for Brazilian local covered bonds ("letra imobiliária garantida"; LIGs), and which became Law No. 13,097 in January 2015. From the standpoint of the legal protection afforded to covered bondholders by the Brazilian framework in case of issuer insolvency, we believe the new regime could allow a covered bond program to be rated above the issuer credit rating under our covered bonds criteria (see "A Closer Look At The Brazilian Covered Bond Framework," published on Dec. 6, 2016).

Banks only began issuing LIGs after the presidential election of 2018, with private domestic placements. At the end of 2020, the Brazilian Securities Exchange Commission allowed public placements for LIGs, which could further support domestic issuance. The market is still waiting for legal and regulatory clarification on how international issuances could be done. Once this clarification is obtained, we believe that Brazilian banks will try to issue offshore LIGs targeting foreign investors.

Chart 8



Morocco was the first country in the region to release draft covered bond legislation (see "Morocco Looks To Covered Bonds To Support Housing Finance," published on May 8, 2013). However, it has not yet approved the final law, which is a testament to the difficulties encountered in the legislative process.

Similarly, in 2015, South African regulators considered allowing banks to issue covered bonds, in the context of a broader discussion regarding resolution regimes and the anticipated introduction of retail depositor guarantees. However, domestic investors remain resistant to the idea of covered bonds, due to their concerns about the potential pressure on the pricing of their senior unsecured debt, the losses if an issuer becomes insolvent, and what could happen to the ratings on this debt. As of today, banks are still not allowed to issue covered bonds, and we don't expect any market development in South Africa in the near future.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Antonio Farina, Madrid + 34 91 788 7226;
Natalie Swiderek, Madrid + 34 91 788 7223;
Secondary Contacts:Jerry Fang, Hong Kong + 852 2533 3518;
Yuji Hashimoto, Tokyo + 81 3 4550 8275;
Leandro C Albuquerque, Sao Paulo + 1 (212) 438 9729;
Calvin C Leong, Melbourne + 61 3 9631 2142;

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