Prime cover assets, strong issuers underpin neutral covered bonds 2024 outlook

December 08, 2023 (MLN): Strong issuer credit profiles, multiple notches of buffer above bank ratings and substantial overcollateralisation (OC) cushion support the neutral covered bonds sector outlook for 2024, Fitch Ratings says in its global covered bonds outlook 2024.

This is despite our expectations of lagging asset performance deterioration in some jurisdictions, as well as an increase in asset-liability mismatches in some covered bond programmes.

Banks still benefit from high-interest rates, with the positive impact on profitability outweighing related asset quality concerns.

In Southern Europe, a primarily floating-rate mortgage market, strong profitability from higher net interest margins has contributed to bank upgrades.

Downside pressure from bank Issuer Default Ratings (IDRs) is limited, as 99% are on Stable or Positive Outlook.

Rated programmes benefit from an average of 3.6 notches of buffer against issuer downgrades.

The higher interest rate environment will continue to squeeze excess spread for some programmes, especially for countries with longer-term fixed rate assets originated pre-2022 (Belgium, France, Germany, the Netherlands).

Coupled with greater maturity mismatches resulting from the recent trend of shorter-dated covered bond issuance, this could increase.

Fitch’s break-even overcollateralistion (OC) for some ratings. The entity expects this to be temporary, as higher-yielding assets are added to cover pools and existing assets reprice.

In addition, the vast majority of programmes have ample OC cushions to absorb potential mismatches, and interest rates have peaked in most countries.

The rating outlook is stable for 99% of covered bond programmes rated on the international scale at the beginning of December 2023, with 75% rated ‘AAA’.

The average total notches of uplift granted by Fitch above bank IDRs was 8.5 notches, of which 4.9 were used.

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