Covid-19: covered bonds holding steady

Scope does not expect the safe-haven status of covered bonds to change, “although as differences in the credit risk of issuers and their cover pools emerge over time, covered bonds will reposition as a credit product,” Fuchs said, “especially as bank ratings deteriorate.” Banks will have to weather higher provisioning. The significance of asset-quality deterioration in their core corporate and retail lending activities will ultimately determine the impact on their ratings and ultimately on covered bond ratings.

“Mild one or two-notch bank downgrades will support covered bond ratings at current levels,” added Mathias Pleissner, a director in Scope’s covered bonds team and co-author of today’s report. “But significant asset-quality erosion could impact covered bond ratings if the ratings already rely on cover-pool support. The ability of a bank to generate sufficient liquidity to buffer against government-imposed or voluntary payment moratoriums or similar disruptive and system-wide events will be an important credit factor.”

The impact of missing repayments due to moratoriums is less relevant for covered bonds than for securitisations. The bank issuing the covered bonds must provide first recourse and make-whole payment delays. Unless a bank is close to regulatory intervention or a BRRD-like bail-in scenario, the share of loans subject to moratorium or payment holiday only serves as a traffic light for potential replenishment needs and potentially higher levels of over-collateralisation.

“Banks are able to increase protection available to their covered bonds, which allows them to mitigate deteriorations in their own ratings and/or changes to the credit quality of cover pools. A correction of sovereign ratings will not uniformly impact the credit quality of covered bonds. Rather, changes to the credit quality of the first recourse for covered bonds – the bank rating – will drive the extent of potential rating changes,” said Fuchs.

Encumbrance levels are still low and most issuers have ample additional cover assets, allowing them to replenish if and when needed. At the same time, moratoriums might require more active liquidity management by issuing banks as scheduled payments for cover assets might be delayed.

The full report can be downloaded here.