UK banks are issuing record amounts of sterling covered bonds to diversify their funding options and to meet demand from investors keen to avoid onerous new capital rules.
Issuance of sterling covered bonds soared during the first quarter to over £11 billion, compared with £3 billion in the first quarter of 2011, according to data compiled by RBS and Dealogic. This is already more than full-year volumes for 2011 or any other year.
Covered bonds have long been established as the safest type of debt, offering the highest level of protection to investors in the event of an issuer's bankruptcy. They are commonly issued by banks in Europe and, given that investors are shying away from senior unsecured debt, have become more popular as a funding tool.
Sterling bond issuers are primarily UK banks and building societies such as Barclays, Abbey and Nationwide, said Michael Michaelides, covered bond strategist at RBS. The investors snapping up covered bonds include pension funds, insurers and bank treasuries. “Insurers are keen to invest in long-dated sterling assets, such as sterling covered bonds, because they will be treated more favourably compared to senior bank debt and corporate debt under Solvency II regulation”, said Michaelides.
Solvency II sets the amount of capital that insurers across all EU states must hold against different risks. In most cases, insurers will need to hold less capital against covered bonds than other credit investments, said Michaelides.
Banks themselves are also keen to invest in covered bonds to satisfy regulators under forthcoming capital requirements regulation, Basel III. “Banks are keen to invest in covered bonds because these will most likely be eligible in liquid buffer rules under Basel III regulation”, said Michaelides.
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