Fitch still upbeat on covered bonds despite issuer wobbles

Covered bonds had a very strong year in 2009 and this should continue into 2010, despite some concerns, particularly about commercial real estate and bank stability, says Fitch Ratings.

At Fitch’s annual European Credit Outlook conference, held in London on 19 January, Fitch’s Suzanne Albers said: “Covered bonds were in style in 2009 and should be in 2010. Following the European Central Bank’s May announcement [that it would buy up to €60bn of bonds to boost bank liquidity], the jumbo market re-opened and there was a total of €120bn of public issuance last year.” This took primary issuance in 2009 back to 2003/2004 levels (see chart, page 14) after a drop in 2008 and the temporary closure of the market in Q4 2008, following the collapse of Lehman Brothers.

Fitch publicly rates 109 different covered bond programmes. Albers, a senior director in Fitch’s covered bonds team, said: “The number of issuers is still growing, mainly in existing jurisdictions and during 2009 we rated 16 new programmes. The big news was in Germany, where some issuers face uncertainty over their future ownership and there was government intervention; Hypo Real Estate (now Deutsche Pfandbriefbank) was nationalised.” Duesseldorfer Hypothekenbank is also still for sale, she noted.

Another highlight last year, she said, was the introduction in Germany of the 180-day mandatory liquidity rule. “There was less impact on downgrades than we would have seen without this new regulation,” she said. Albers said Fitch had updated its analysis in several ways in 2009. One was placing greater emphasis on monitoring the risk of issuer default (the issuer default rating, or IDR) as well as the covered bonds rating, to indicate how far the two might differ.

Fitch then modelled the 109 issues on a probability of default basis and found 18 would be downgraded if there was a one notch downgrade in the IDR (see top graph). Fitch also looked at liquidity risk – issuers’ ability to sell assets to make payments on bonds – and its effect on ratings in the period after issuance. “We thought there

was less certainty, in particular in the given time frames most programmes allow,” said Albers. But Fitch found that issuers were willing to increase the levels of over-collateralisation and as a consequence took no negative rating action (see bottom graph).

New focus for 2010

In 2010 Fitch will focus on commercial mortgage cover pools, because of falling property prices in some jurisdictions and rising arrears and defaults. Albers said this need not have an impact on ratings as long as “the support we saw for over-collateralisation in 2009 continues in 2010”.

Fitch rates some German and Spanish issues as stable/negative rather than stable. “Commercial real estate is probably the main concern,” Albers said. “In Germany, all but two we rate have commercial real estate exposure and we have asked issuers for more information on rents etc. As a result, we have put nine programmes under analysis.” Exposure to eastern European assets is also under analysis. One issuer has 12.5% of collateral in this region. The outlook for the UK market, which is fairly small compared with those of France, Germany and Spain, is stable for most programmes.