The ratings outlook for peripheral European covered bonds in 2012 is negative, according to Fitch, but for other regions stable. The outlook for public sector assets is also more uncertain than for mortgages for the first time, noted the rating agency.

A total of 21% of Fitch’s covered bonds ratings are on Rating Watch Negative (RWN), mainly those in peripheral Europe. Further sovereign downgrades in Cyprus, Greece, Italy, Portugal, or Spain are considered by the rating agency to be likely to cause covered bond downgrades, in certain cases by several notches. Fitch noted that crises in Greece, Ireland and Portugal led to multi-notch covered bond downgrades in 2010 and 2011.

“The outlook for covered bonds is driven by the risk of systemic crisis,” said Suzanne Albers, senior director in Fitch’s covered bond team. “Covered bond ratings are stable as long as the sovereign is stable, but if a systemic crisis occurs, a domino effect will likely lead to multi-notch downgrades on the covered bonds.”

Italian ratings have been the least affected among peripheral European covered bonds, with Italian mortgage covered bonds remaining on RWN because of an ongoing recalculation of overcollateralisation levels consistent with ratings. Should the sovereign be downgraded by more than one notch, Fitch is likely to downgrade the covered bonds by several notches.

Although Spain is the strongest sovereign in the region (AA-), the negative covered bond outlook reflects cédulas’s bullet redemptions and a lack of liquid assets in cover pools. Single notch downgrades of most issuers would cause downgrades of the covered bonds, said Fitch.

Covered bond programmes outside peripheral Europe have significantly more cushion before a bank downgrade would cause a covered bond downgrade.

The 13 programmes in Australia, Canada, and New Zealand Fitch rates are supported by high sovereign ratings with stable outlooks, and high ratings for all issuers.

“The picture is less stable in the US, where the two dormant programmes were downgraded in 2011,” said Fitch, “following issuers failing to manage committed OC levels in line with higher OC levels supporting the ratings.”

Fitch does not expect covered bonds issued out of France, Germany, Luxembourg, and the Netherlands to be critically exposed to worsening cover asset liquidity.

The rating agency noted the contagion risk is lower outside the euro-zone, in Denmark, Norway, Switzerland, and the UK.

Fitch added that 2012 would mean greater uncertainty for public sector covered bonds.

Hélène Heberlein

“Decreasing sovereign and sub-sovereign credit worthiness may cap the ratings, increase the default risk within the cover pools and lead to increased refinancing costs for such assets,” said Fitch. “The euro-zone crisis is also increasing these costs for public sector assets, with higher ratings and stable outlooks.

“This will increase the overcollateralisation supporting the rating of programmes with historically low levels of overcollateralisation and some issuers may not have the willingness and/or ability to increase overcollateralisation levels to such a degree.”

However, Hélène Heberlein, managing director in Fitch’s covered bond team, said that provided that issuers actively manage their programmes and have additional eligible assets available, the rating agency does not expect such a trend to translate into a negative outlook on covered bonds.