Secured bonds: banks run for cover

Secured bonds: banks run for cover

When Captain Cook first reached Australia, Prussia had just created the forerunner of today’s covered bonds. This month, Australian banks became the latest to issue the bonds, a safer cousin of the securitisations made infamous in 2007 during the onset of the global financial crisis. US lawmakers may also allow US banks to tap the market.


Don’t all rush at once. What makes covered bonds safer for investors poses risks to other bank creditors. Bondholders get securities backed by loans that stay on banks’ books and carry a bank guarantee, and they are protected even in bankruptcy. But covered bonds encumber bank assets, leaving less for other creditors. The long-term reliance on covered bonds or other secured borrowing threatens to leave all other creditors, including governments extending deposit guarantees, with no security.
Australian regulators have imposed a cap of 8 per cent on the amount of a bank’s domestic assets that can be tied up in cover pools. In Europe, regulators have differing limits; some have none, and all are aware that the banks they supervise are relying on covered bonds because unsecured borrowing is too expensive.
Issuance of senior unsecured bonds, the bread and butter of bank funding, dropped to 38 per cent of the total borrowed in the second half of this year, says Dealogic, against an average since 2000 of 51 per cent. Covered bonds accounted for 45 per cent of funding in recent months, from an average of 29 per cent.
Growing use of secured borrowing risks becoming a vicious circle: if investors charge more for unsecured borrowing because of rising asset encumbrance, banks will be forced to tie up even more of their very best loans to raise funds.
Unless the unsecured markets reopen, Europe’s governments must consider some support of bank bonds as they did in 2008 and 2009. This carries dangers – governments are weaker now.
But letting this trend grow is in no one’s interest.