Banks and insurance companies have placed far greater emphasis on ESG targets through their funding programmes this year, with green and social bonds now taking a much larger proportion of overall supply.
GlobalCapital data show that FIG borrowers printed €17bn of ESG paper in the euro senior market last year, which made up roughly 12% of the annual total in volume terms.
This year to date, the financial sector has rolled out €36bn of labelled issuance, representing some 25% of all proceeds raised.
The figures are even more striking when viewed in terms of the individual number of transactions. Banks and insurers applied green or social tags to one in every six euro senior bonds in 2020, while in 2021 they have labelled almost one in three deals.
Armin Peter, EMEA global head of DCM syndicate and EMEA head of sustainable banking at UBS, said he thought the expansion of ESG issuance could continue through 2022 and beyond.
“I’m not surprised about the jump following last year’s net zero commitments, given the willingness of issuers to follow with tangible deals on the back of these promises,” he said.
“My expectation is a continuation of the trend, but not another doubling up next year. I expect more banks to define their climate and transition plans, which then creates opportunities for labelled products.”
Transition ambition
Many large banking groups have promised vast sums of sustainable investment, much of which could be financed in the capital markets using dedicated “use of proceeds” bonds.
During the COP26 conference this week, the Glasgow Financial Alliance for Net Zero (GFanz) said in a statement that its 450 members had committed to providing more than $130tr of capital to fund transition plans over the next three decades.
GFanz was launched earlier this year by former Bank of England governor Mark Carney, with the aim of establishing a consolidated set of net zero guidelines for banks, insurers and asset managers.
Referring to the recent surge in ESG bond issuance from the financial sector, a head of FIG debt syndicate said: “Climate change awareness and political pressure are supporting the trend — it’s as simple as that.”
But market participants have also stressed the idea that green and social bonds bestow clear advantages on borrowers, particularly in the senior market.
GlobalCapital data show that the average new issue premium on an ESG-labelled senior deal works out at around 2bp in euros so far this year. The average concession on ordinary euro senior transactions is just under 5bp.
Similarly, the average coverage ratio for ESG senior bonds in euros is 2.25 in 2021, versus 1.93 times for their unlabelled equivalents.
“There is no doubt that green labels help,” said a FIG syndicate banker, who worked on a €500m five year green preferred senior bond for SR-Bank this week, sold at 33bp over mid-swaps.
“Without a green label, I don’t think we would have been able to push the spread in to 33bp. We would have been stuck at 36bp/37bp.”
Green growth
The recent trends in sustainable bank funding were encapsulated perfectly by a deal from NatWest Group on Tuesday.
The UK bank sold a £600m seven year non-call six senior bond through its holding company — its first ever green sterling transaction.
NatWest has committed to issuing a quarter of its holdco senior debt using its green, social and sustainability (GSS) framework this year.
“With a £600m deal this week, we are just under 45% — well in excess of our target,” said Scott Forrest, head of treasury DCM at NatWest.
“We are now looking at our forecasts for the next five years from a budget perspective and will assess our target for 2022 as part of that.”
Last month, the lender announced that it was looking to deliver £100bn of sustainable financing by the end of 2025, as part of the push towards a net zero economy.
It will use the proceeds from its latest deal to finance more growth in its green mortgage business, which it set up in October 2020.
NatWest offers green mortgages against properties with Energy Performance Certificates of ‘A’ or ‘B’. Eligible borrowers are able to benefit from a reduced interest rate on their loans.
“We cut a green mortgage pool of £455m at the end of August and will use £300m of the net proceeds to refinance that,” Forrest explained. “Given that we have been originating new green mortgages at a rate of about £60m on average each month this year, I would expect to have the other £300m utilised within the next five to six months.”
The bank proved popular with investors, which put £1.2bn of orders behind its £600m seven year non-call six senior bond.
Lead managers ABN Amro, Goldman Sachs, JP Morgan, NatWest Markets and RBC Capital Markets were able to pull the pricing in from initial thoughts of 140bp-145bp area over Gilts to land at a final spread of 127bp — via guidance of 130bp plus or minus 3bp.
A banker on the deal said NatWest had probably paid about 3bp-5bp of new issue premium at final terms, which compares favourably with the 5bp-10bp seen on other recent sterling transactions.
Forrest said there had been a clear advantage in choosing to issue a labelled deal. “We saw larger indications of interest than we would have expected, which was mainly driven by the green angle of the transaction,” he said. “It attracted a good number of prime UK and European asset managers.”
ESG covered bonds look forward to a bright future
The outlook for ESG covered bond supply remains equally compelling, particularly in the wake of this year’s astounding growth.
Thirteen banks have launched their first ESG covered bonds in 2021, taking the total number of issuers to have done such deals to 31. The number of debutants was almost the same as in the preceding three years combined and has bolstered supply by almost €7bn to well over €15bn so far this year, or 17.2% of this year’s total supply of €90bn.
A further ramp-up in issuance seems probable, as borrowers that have set up ESG frameworks and issued their first senior deals aim to diversify into covered bonds, where they can expect to attract different pockets of investor demand.
“It’s difficult to imagine the drive behind ESG covered bond issuance not growing,” a senior banker told GlobalCapital on Thursday, noting that mortgages make up the largest component of assets on most issuers’ balance sheets, making covered bonds the natural asset class to fund these with.
Issuance prospects may also be enhanced with an improvement in regulatory treatment. Given that buildings account for 40% of the European Union’s energy consumption and 36% of greenhouse gas emissions, it’s probable that that regulatory inducements, designed to encourage origination of green mortgage assets and loans for refurbishment, will follow.
“I would be surprised if we didn’t see greater regulatory incentives for borrowers to originate green mortgage loans,” said the same person. His views chimed with those of the head of the European Mortgage Federation and European Covered Bond Council, Luca Bertalot, who told GlobalCapital this week that regulatory treatment of green and ESG mortgages was likely to improve.
Banks involved with the EMF-ECBC’s energy efficient mortgage initiative are building an empirical database which shows that such borrowers typically have a higher disposable income and they live in properties that have a higher resale value. This means that the probability of default and loss given default on such mortgages is usually lower than vanilla loans, implying less risk than would justify a lower capital charge.
Apart from requiring less expensive capital to originate and hold energy efficient mortgages, green covered bonds could soon offer a cheaper cost of funding compared with vanilla transactions. At present the funding advantage is a paltry 1bp and this has probably stymied supply.
Green difference
But, as the European Central Bank starts to withdraw its extraordinary monetary stimulus measures, credit spreads should widen, introducing a greater degree of differentiation between green and vanilla mortgages. A survey of 40 market participants undertaken by GlobalCapital this week showed that the majority of respondents expected a spread widening of more than 5bp next year.
As of today, green Bunds and senior unsecured financial transactions price 4bp-6bp tighter than vanilla deals, so there is no reason covered bonds shouldn’t too. “If spreads widen, we expect to see a greater covered bond greenium,” said a second banker, who thought this would encourage issuers that have ESG frameworks in place to bring their first covered bonds.
In light of this year’s strong trajectory in ESG covered bond supply, the improving regulatory backdrop and an improved cost of funding, the first banker thought covered bond supply had the potential to rise from around 17% this year to about 25% of annual supply over the medium term.
However, others are less sanguine, reasoning that higher overall supply will make a further proportional jump in ESG issuance harder to achieve.
Assuming covered bond supply rises by €30bn next year to €120bn, ESG covered bond issuance would need to rise by €5bn to keep the proportion of ESG supply steady at 17.2%. A €15bn increase in ESG supply to €30bn would be needed to reach 25% of total issuance.
