Close to EUR 30bn of benchmark issuance in the first three weeks of January marked the second-highest in a decade, exceeding the volumes for the same period of 2022, which turned out to be a record year.

“A key factor in terms of primary activity is the end of TLTRO and the extent to which it was really needed hence needs to be replaced with market funding, or whether it was opportunistic,” said Karlo Fuchs, Scope’s head of covered bonds. “With the ECB phasing out its market activity and yields turning positive, real-money investors will return to the fray in covered bonds,” Fuchs added.

Cover-pool credit quality will remain stable. Even though mortgage borrowers face pressuresfrom higher interest rates and a higher cost of living, the risk of large-scale mortgage defaults is remote under our base case. Banks have the capacity and willingness to allow for payment deferrals or re-mortgaging, which will limit pressure on borrowers. Non-performing loans will remain moderate; issuers have the capacity to replace and maintain very low levels of NPLs in their cover pools..

One factor to watch is house prices. “The trend reversal in prices will continue in 2023, squeezed by higher mortgage rates,” said Mathias Pleissner, deputy head of covered bonds, “although we do not expect negative impacts from lower house prices on stressed recovery rates for covered bonds. Our rated universe is well protected against expected and stressed scenarios.”

Several countries will see marked setbacks in house prices, although the extent will vary. Norway, Sweden and Luxembourg show the highest structural vulnerability to mortgage risks arising from affordability shocks and value declines. Denmark, the Netherlands and Portugal also show high structural risks. Spain, Italy and Greece look most resilient. Prices in Sweden and Norway also appear elevated comparing average annual house-price growth with long-term GDP growth, as do Austria, Luxembourg and the Czech Republic.

Risks to residential mortgage prices

Source: Eurostat, Scope Ratings

Pleissner is confident the market is prepared for a downturn, however. “For a start, borrowers are less exposed to rising interest rates as the share of floating-rate mortgages has decreased significantly in the last 10 years,” he said. Only 16% of new European mortgages were floating rate in 2022 as borrowers took advantage of ultra-low interest rates to switch into longer reset products. “Banks haven’t diluted their underwriting standards despite much higher volumes of mortgage lending in the low-rate period. This to some extent reflects the series of macroprudential measures introduced by supervisors throughout Europe,” Pleissner added.

Regulators have not – for now – tightened their grip on ESG disclosures and standards, so ESG-themed covered bonds remain a small albeit growing niche. “A gentle tug from the ECB could make them more mainstream, though. For issuer discipline around transparency, a similar wish proved to be the necessary catalyst,” Fuchs said.

Download the 2023 Covered Bond Outlook.