LCR: From Compliance to Balance Sheet Performance
With an average LCR of 158% (versus a 100% regulatory minimum), European bank liquidity is no longer a concern. In the current context, the focus has shifted to investing for performance. This is reinforced by a change in perception whereby, today, the strength of a balance sheet is no longer measured by the size of its liquidity reserves, but by the intelligence of its composition. Holding an inert cash position or near-zero yielding securities is no longer a prudent strategy. Instead, it represents an opportunity cost that directly weighs on ROE (Return on Equity).
The challenge, therefore, is to construct an LCR portfolio that achieves a triple objective: impeccable liquidity to satisfy regulators, low capital consumption to preserve equity, and a positive return to contribute to overall balance sheet performance (through interest income). Yes, the equation is complex and also increasingly demanding considering the new Basel 3 Endgame directives.
This is precisely where fundamental credit analysis comes into play. While an instrument like a Covered Bond could provide the necessary diversification, not all Covered Bonds are created equal. At Ostrum AM, our Credit & Sustainability research team does not merely analyze the issuer. We delve into the heart of the instrument: its legal framework, the granularity of its cover pool, and its structural protections.
This fundamental approach is essential. It equips our managers in their decision-making, aiming for the optimal combination of liquidity, yield, and capital efficiency. For us, the goal is precisely to go beyond issuer ratings to assess the intrinsic risk and potential of each instrument, ensuring that every asset in our LCR portfolios actively contributes to its performance.
Covered Bonds : premium value between sovereigns and credit
Covered Bonds are a differentiated asset class to consider for Liquidity Coverage Ratio (LCR) management, offering a unique combination: attractive yields (higher than sovereign bonds), enhanced quality (dual recourse from the issuer and collateral, valuation stability relative to swaps, lower regulatory haircut), and solid liquidity (stemming from a significant outstanding stock and regular issuance: in 2025, 25 jurisdictions and 110 issuing banks).
Although LCR portfolios invested in Covered Bonds are managed with specific constraints, portfolios are still managed dynamically. Depending on client specificities (e.g., OECD or Eurozone universe), we actively adjust directional exposure, country allocation, and bond picking to generate yield superior to the ECB's deposit rate, while limiting the regulatory haircut.
Ostrum AM has been managing LCR portfolios of Covered Bonds since 2015, with a dual objective: to optimize the yield of our clients' portfolios and ensure their LCR regulatory compliance.
The management of Covered Bonds requires specific know-how. This is why we apply a multi-factor approach to navigate its complexities. Our approach relies on our in-house market views, a deep understanding of this asset class's behavior, rigorous monitoring of each issuing country's fundamentals, and a precise analysis of the issuing bank as well as the quality of the collateral (cover pool).
Finally, we highlight the resilience of Covered Bonds in the face of increased market volatility. They can offer protection during sovereign debt crises or country-specific risks (such as France's situation during the dissolution of the National Assembly), as well as relative to credit risk. More recently, in March, for example, Covered Bond spreads resisted better than those of senior preferred bonds, which experienced notable widening
A dynamic approach, individual or combined asset classes
Ostrum AM is recognized for its LCR management expertise. Here, the objective is to guarantee credit institutions that delegate their LCR management to Ostrum with the availability of a sufficient stock of High-Quality Liquid Assets (HQLA), allowing them to cover their cumulative net cash outflows over a 30-calendar-day crisis period. There are several types of LCR management, distinguished by the quality of the underlying assets selected.
Ostrum proposes single asset strategies and/or strategies that aggregate different underlying assets. This allows, on one hand, for risk diversification, yield optimization, and also for controlling and optimizing 'haircut' levels for banks' balance sheets.
Expertise in managing LCR Covered Bonds and LCR Corporate Credit has been developed in collaboration with our numerous clients. LCR credit management allows for investments in high-quality Corporate issuers, which, followed by our Credit & Sustainability analysts, offer additional yield and interesting diversification.
Our in-depth knowledge of regulatory constraints allows us to invest effectively while scrupulously respecting the framework established by the various banking institutions. A dynamic approach also offers flexibility, allowing, as the case may be, for the allocation or reallocation of assets between different underlying assets, depending on market conditions and balance sheet constraints.
LCR mandates have demonstrated their robustness by the way they navigated recent market crises, such as Covid or, more recently, the conflict in the Middle East. This is why they are in high demand from banking institutions.
*LCR : Liquidity Coverage Ratio
