In recent years, the ECB’s ultra-loose monetary policy had ensured that risk premia on Pfandbriefe and other covered bonds were low. In addition, issuers hardly had to worry about selling new bonds. After all, with its third Covered Bond Purchase Program (CBPP3), the central bank stood ready to absorb up to 50% of a new issue at peak times. There were also constant purchases on the secondary market.
These times have been over since July 2023 with the end of CBPP3 purchases. The covered bond market now needs to find a new balance without the major anchor investor from Frankfurt’s Ostend. The ECB is currently still commanding a gigantic covered bond portfolio of around EUR 285bn. However, this is to be gradually reduced over many years in a market-friendly manner and without active sales.
There will again be significant market growth (net new issue volume) in 2024
In 2023, euro benchmark covered bonds with a volume of some EUR 185bn were newly issued. German Pfandbriefe accounted for EUR 35.8bn of the overall number. In our view, the new issue volume of euro benchmark covered bonds in 2024 is likely to be slightly lower at EUR 170bn, taking into account various positive and negative factors. Among the factors that will have a positive impact on the volume of new issues is the increased refinancing requirements of banks via the capital market. The credit volume should increase slightly next year. On the liabilities side of banks’ balance sheets, we anticipate a decline in deposits, which should increase banks funding needs. The refinancing advantage of covered bonds over unsecured bank bonds should continue to be attractive for issuers and work in favour of issuing covered bonds. Another positive factor for us are the upcoming maturities of the last targeted longer-term ECB loans (TLTRO-III). In 2024, the banks yet have to repay around EUR 390bn to the central bank. We assume that some banks will refinance part of the repayment via covered bank bonds.
In contrast, at around EUR 116bn, slightly fewer covered bonds in the euro benchmark format will mature in 2024 than in 2023. Issuers’ need to replace maturing covered bonds with new ones would therefore be somewhat lower and thus a limiting factor for the volume of new issues. However, the decisive limiting factor is likely to be the expected strained absorption capacity of private investors. Until July 2023, the ECB had reinvested the nominal from maturing covered bonds from its CBPP3 portfolio back into covered bonds itself. In 2024, lacking ECB demand private investors will have to absorb this, too. With a new issue volume of euro benchmark covered bonds of EUR 170bn forecast by us for 2024, this would mean net purchases (or portfolio increases) of a high EUR 87bn for private investors. The structural shift from an ECB-induced seller’s market to a buyer’s market that has already begun will make life more difficult for issuers in 2024. In our view, this argues against an even higher volume of new issues. Issuers will be more reliant than ever on private investors willing to buy next year anyway.
Against this backdrop, issuers will once again have to make greater efforts to win the favour of investors. This means, among other things, that it will be important for issuers to keep an eye on investor preferences and not be too ambitious when pricing new bonds. Otherwise, order book volumes could suffer. Some issuers already made this experience in the fall of 2023. Investors were already able to stock up sufficiently on covered bonds in the first half of 2023, meaning that investment pressure had eased considerably by the end of August. As a result, investors recently only bought bonds that offered the right overall package for them in terms of maturity, risk premium and rating.
This selective approach is unlikely to change much in view of the high volume of new issues we are forecasting for the new year. Instead, new issues should offer a premium over secondary markets (NIP) in order to attract investor interest. The size of the NIP is also likely to depend on the tenor of the new issue. Last year, the sometimes elevated NIPs already led to an increase in risk premia on the secondary market.
In this context, the continued weak economy and the longer-than-expected high interest rate levels (“higher for longer”) should also have a negative impact. Together with increased geopolitical risks, these uncertainties have led to a widening of covered bond swap spreads in recent weeks. Even though DZ BANK’s economists expect a moderate economic recovery in 2024, bank markets are likely to remain tense next year. In particular, the high (mortgage) interest rates should continue to burden borrowers and lead to economic challenges. In this market environment, the ECB’s previously supportive CBPP3 purchases will be noticeably absent in the coming months. In the past, these have ensured solid demand in such difficult market situations.
If NIPs remain high, the secondary market curve should continue to follow the primary market at the start of 2024. In January 2024, the usually lively primary market activity at the start of the year is likely to exert additional pressure on spreads. Looking ahead to the second quarter, the asset swap spread of the iBoxx € Covered Index should peak at 40 basis points. It should subsequently narrow again towards its November level of around 30 basis points.
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