Covered bonds retain favoured status in Europe, but investors watchful on collateral quality

As the cost of issuing debt via the senior unsecured market has risen substantially since the financial crisis, banks have turned increasingly to the covered bond markets for low cost funding. But will this surge in issuance lead to a deterioration in quality of the assets being pledged; reducing one of the main attractions of the product to investors?

Haircuts under the ECB’s €60bn covered bond purchasing programme were 10% lower than for ABS

For a long time, covered bonds were viewed as the unglamorous, steady-Eddie of the bond markets, particularly when compared with their off-balance sheet cousin, securitisation. Issuance levels were solid and predictable from year to year, and because the assets underlying the transactions were generally high-quality residential mortgages, there was little in the way of complexity or innovation – prized commodities in the pre-crisis boom years – to get investors excited.

Yet if one asset class