European investors are concerned about an increased use of covered bonds, according to a survey conducted by Fitch, although the rating agency said that it believes that for the majority of “sound banks” there should be no material threat to unsecured creditors from the trend.

In its latest quarterly European senior fixed income investor survey, released today (Monday), Fitch found that 87% of respondents were concerned about an increased use of secured funding by banks, which could lead to structural subordination.

“Within this sample 16% described themselves as ‘very concerned’ as higher asset encumbrance increases the loss given default for unsecured creditors,” said Monica Insoll, managing director in Fitch’s credit market research group.

Fitch said that it believes covered bond issuance will only continue to grow, citing investor risk aversion and regulatory incentives as the primary reasons for the trend. It noted that planned resolution regimes would make structural and legal subordination an even more important issue.

“Holders of bank senior debt are understandably concerned about the growing use of covered bonds, given that these have a preferential claim over selected bank assets,” said Bridget Gandy, co-head of Fitch’s EMEA financial institutions group.

However, Fitch said that legal constraints limit how high much issuance can rise, referencing “regulatory limits on banks’ use of secured funding and availability of qualifying assets”. It also said that broad risk aversion should fall as economies recover, which would make unsecured funding cheaper relative to secured funding.

“Fitch would expect to see an equilibrium being reached, which, for the majority of sound banks, is unlikely to be a material threat to the status of unsecured creditors,” said Gerry Rawcliffe, managing director in Fitch’s financial institutions group.

The rating agency said in a report in March that although in extreme cases covered bond issuance could be a “curse”, it was in general benign, and well below levels that might give cause for concern.

“There is an argument that a potential spiralling effect exists, whereby growing covered bond funding could gradually crowd out appetite for senior unsecured debt,” said Fitch. “Certainly, increased issuance of secured funding in a redoubled bank may become more a curse than a choice for treasurers seeking investors for unsecured issues.

“Apart from such extreme cases, the risk of covered bond funding reaching a level that acts as a deterrent to potential senior unsecured debt investors is still small for the majority of issuing banks.”

The survey was conducted from 31 March to 2 May.