Covered bond ratings were less affected by issuer downgrades than Standard & Poor’s would have expected based on scenario analysis from last year, the rating agency said yesterday (Thursday), noting that most issuers, in particular in the past six months, have shown a high commitment to maintaining or upping OC levels commensurate with a maximum potential rating.

The conclusions emerged from a comparison of findings of a 2011 scenario analysis with actual changes in covered bond ratings since October that were linked to issuer credit rating (ICR) downgrades.

At the time of its 2011 scenario analysis, the rating agency had expressed its expectation that many of its covered bond ratings would be resilient to moderate stress in the banking sector (see here for more), and S&P yesterday said the recent rating performance of covered bond programmes confirmed this expectation.

“Over the past six months, an unprecedented combination of sovereign rating pressures, credit market turmoil, and the introduction of our new bank rating criteria has led us to lower our issuer credit ratings by one to three notches on nearly 40% of the covered bond issuers that we rate.

“However, we’ve lowered our ratings on only 16% of the corresponding covered bond programmes over the same period.”

It said that that the average unused ratings uplift between the ICR and the covered bond rating decreased from 1.84 notches to 1.69 notches during the past six months due to the issuer downgrades.

While S&P cut the ICRs of 13 issuers by one notch, it added, it only lowered the rating of one of 17 related covered bond programmes (6%).

“Therefore, we have observed less covered bond rating migration than we would have expected last year,” said the rating agency.

Its latest scenario analysis took into account factors that affected covered bond ratings that were not considered in the 2011 analysis, said S&P: country risk, the rating agency’s opinion of asset-liability mismatch (ALMM) risk, and any changes in programmes’ overcollateralisation.

Most covered bond programmes that S&P downgraded by two or more notches were exposed to multi-notch issuer cuts as well as some of the factors mentioned above, such as an increase in ALMM risk or market value risk and constraints due to heightened country risk.

“Indeed, covered bond issuers in countries where we have recently lowered our sovereign ratings – such as Portugal, Spain, and Italy – were most affected,” said S&P.

In France and the UK the rating agency carried out a relatively large number of issuer downgrades, it said, but made no corresponding covered bond downgrades, while in Germany and Spain, the lowering of three ICRs did not lead to downgrades of the related covered bond programmes as the ratings of the 17 programmes in these countries could withstand what were one notch downgrades of 13 issuers.

S&P also said that during the observed six month timeframe since October, some French and Swedish covered bond issuers in its view actively lowered their programmes’ ALMM risk, which allowed the programmes to maintain or even increase their maximum potential ratings uplift above the ICR by one notch, compensating for any further issuer downgrades.

The most imminent factor that is most likely to put pressure on covered bond issuers and therefore may affect the stability of covered bond ratings, according to S&P, is programme-specific changes in the level of overcollateralisation.

Such changes typically arise from increased credit and ALMM risks, it said.

“We believe that the high degree of covered bonds maturing over the next three years may put pressure on the level of overcollateralisation commensurate with the maximum potential rating,” said S&P. “That said, we have seen most covered bond issuers – particularly in the past six months – show a high commitment to maintaining or increasing this level of overcollateralisation.”