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That time of year again (3)

03 August 2016
Richard Kemmish

In my previous post I mentioned two of the four categories that I put countries in to based on the latest ECBC market size statistics – ‘coming of age’ and ‘old but still growing’. There are two more worth considering.

Most of the larger countries in Europe – Germany, France, UK, Spain – fall into the category that I would call ‘gentle decline’, on average roughly 5% smaller than they were last year. Germany I have already discussed, but if you were to omit the technical change to public sector covered bonds they would easily be recharacterised into my second category of ‘old but still growing’.

I suspect that in most of these countries you have two factors working against each other. Overall mortgages books are increasing as a result of house price inflation and low interest rates. But on the other hand the proportion of the increase that is funded via covered bonds is decreasing. These are the same two factors that drive growth in the ‘old but still growing’ category. It is just that the latter factor has the upper hand in these countries.

It is worth noting that, except the UK, these countries are all in the Eurozone and therefore potential beneficiaries of the ECB’s very generous TLTRO funding, whilst the countries in the ‘old but still growing’ category are mainly outside the Eurozone and have central banks that feel less of a need to offer such generous funding. TLTRO funding is most obviously a substitute for covered bonds given its maturity.

The future size of the covered bond markets in these countries seems to be almost entirely a function of ECB bank funding policies, with a secondary factor of house price inflation.

My final category is ‘massive reduction’ countries. In particular Greece, Cyprus and Ireland – spot a common thread there? These are perhaps the least relevant countries in the statistics from an investor standpoint as the reduction in bonds outstanding has been mainly in the form of bonds that only ever existed for central bank funding purposes. As funding conditions have normalised in these countries the bonds have matured and, by and large, not needed to be replaced.

It is a pity that the bonds for central bank repo haven’t been replaced by bonds for third party investors. But I genuinely believe that this is only a matter of time.

A categorisation of such an heterogenous market into four broad groups in the interest of predicting future growth patterns is flawed. It is a generalisation and it is limited to the numbers as reported by the ECBC. The idiosyncratic outliers may be significant but have to be excluded from such a broad brush approach. Sorry, Romania, Iceland, Slovakia, Poland and others – you don’t fit into broad categories. But for all of the right reasons.

On the back of this year’s ECBC statistics I’m going to predict a 7% growth by this time next year. Anyone care to make a bet?

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