Full implementation in 2013 of Solvency II rules as they currently stand could reduce the appeal of covered bonds on the basis of their capital-adjusted returns and thereby render them more expensive to issue, but the security they offer means they will remain attractive to insurers, said Fitch in a report yesterday (Thursday).

This dynamic would be one among many, such as a shift from long term to shorter term debt and an increase in the attractiveness of higher rated corporate debt and government bonds, that would occur as a result of insurers, the largest investor group in Europe, making significant changes to their asset portfolios to optimise their capital positions, said the rating agency.

In a summary introducing the report Fitch said that an increase in the attractiveness of covered bonds would be one of the main impacts resulting from insurers adjusting their asset portfolios to optimise their capital positions.

However, in a section dedicated to covered bonds further on in the report the rating agency said that although triple-A rated covered bonds have a lower capital charge than other corporates, “the charge is relatively punitive compared with the risk and returns currently available, making them less attractive than other bonds on a pure return-on-capital basis under the (credit) spread module”.

It compared the return on equity provided by a triple-A rated covered bond with that of a BAA infrastructure bond and a shorter dated Tesco corporate bond, with the covered bond generating the lowest return (see chart below).

With banks under pressure to increase funding, a reduction in demand could increase covered bond pricing, the report added.

However, Fitch ended its assessment of the impact on covered bonds on a positive note, saying that the asset class is likely to remain attractive to insurers because of their “very safe nature”.

“Over the past 18 months, Fitch has seen an uptick in demand by insurers in some regions for covered bonds, with more investments being made as insurers seek out instruments with higher security.”