Bumper GSS covered bond growth seen easing as asset constraints bite

Growth in sustainable covered bond issuance is expected to moderate this year after a doubling of such issuance in 2021, with constraints on appropriate assets holding back growth, and regulatory developments a mixed blessing for issuers hoping to tap into investor enthusiasm for such bonds.

Last year’s growth represented the fifth consecutive year in which issuance of green, social and sustainable (GSS) covered bonds has increased. Moreover, the pace of growth picked up sharply on the previous three years, with €17bn in euro benchmark (€500m or greater) covered bonds more than double the €8bn of 2020, while the 18% share of issuance accounted for by GSS supply was a new high as overall euro benchmark issuance plateaued.

“As confirmed by each new ESG launch, the ESG segment is not the passing fad some expected it to be but is progressively becoming one of the market’s main drivers,” said Jennifer Levy, senior analyst at Natixis.

LBBW analysts said investors can now choose from 28 benchmark issuers from nine jurisdictions and 31 programmes – 20 green, eight social, and three sustainability (green and/or social). While according to S&P, the number of sustainable covered bond issuers overall (in euros and other currencies) increased from 13 in 2018 to 47 in 2021.

Green bonds represented 73% of euro benchmark GSS covered bond supply, while the share accounted for by social and sustainable issuance fell from 37% in 2020 to 27% in 2021, according to Natixis.

The largest ESG countries in terms of outstandings are France with a 31% market share, Norway with 22%, and Germany with 21%. Norway represents 22% of the ESG market despite only representing 9% of the global covered bond market, noted Natixis, with South Korea also enjoying a disproportionately high share of ESG issuance, at 11%, given that all euro benchmark supply from the country’s issuers has been in GSS formats. In contrast, major covered bond jurisdictions such as Canada remain absent from the ESG segment.

Levy noted that green covered bonds have benefited from stronger investor appetite, as reflected in higher bid-to-cover ratios.

“It was especially true in 2021, where the average subscription ratio for ESG deals outperformed those of conventional peers (x2.4 vs. x1.9),” she said, “while issuers offered little to no NIP for their deals (c. 0.6bp vs. 1.5bp for conventional covered bonds).”

According to Levy, ESG covered bonds also tend to tighten faster than conventionals, c. 1.6bp vs. 0.2bp in a 30 day period after issuance, while a greenium of 1bp-2bp is in evidence in the longer run, especially in jurisdictions with high ESG volumes.

But in spite of last year’s growth and the potential execution benefits of GSS covered bonds, growth in issuance is expected to moderate in 2022.

Natixis sees the share of ESG supply rising to at least 20% in 2022, while ING analysts expect sustainable covered bond issuance to rise to some €20bn. Crédit Agricole is expecting the share of sustainable issuance to stay relatively stable versus 2021, at 15%-20%, with absolute volumes depending on the level of overall supply.

“With the share in overall issuance distorted upwards in 2021, we don’t see this number grow further in 2022,” said Crédit Agricole’s covered bond analysts.

Market participants said regulatory developments will be key to the magnitude of sustainable covered bond supply, by affecting the amount of identifiable and appropriate loans that can be used as collateral for GSS covered bonds and incentives for banks to source these.

“The lack of data availability, standardisation and disclosure are also limiting factors,” said Fitch Ratings. “Although some lenders have started to incentivise sustainable mortgages, offering interest rate discounts, cash bonuses or increased financing for green properties, the limited number of energy efficient properties within the housing stock remains a constraint for green issuance in most countries.”

Crédit Agricole analysts echoed this, saying that the main challenges for issuers continue to be a lack of eligible assets that are in line with their covered bond programme rules as well as their sustainable frameworks.

“There is a lot of focus on the green asset ratio (GAR), which will come into force in 2022 for a first set of detailed reporting templates in 2024, and we could also see lower capital charges for energy efficient mortgages,” they said. “Until then, however, growth will be mainly from new loan origination.”

S&P was more positive on incoming regulatory developments, saying that while the EU Taxonomy and the proposed EU Green Bond Standard may increase the burden on issuers and investors in terms of transparency requirements, it will also provide greater clarity for banks planning green or social issuance.

Crédit Agricole analysts meanwhile noted that the 18% share of covered bond supply accounted for by GSS issuance was lower than its roughly one-quarter share of supply in other bank bond issuance last year.

“Besides the issue of identifying eligible assets on banks’ balance sheets, banks have until now often used green assets for senior preferred or senior non-preferred issuance, not covered bonds,” they said. “The added value was simply deemed higher in those asset classes further down the capital structure than for low risk covered bonds.”