A “remarkable” 91% of investors participating in a Fitch end-of-year survey do not consider a triple-A rating to be essential for covered bonds, according to the rating agency, which also highlighted other trends showing investors to be more flexible.

[This article has been amended to reflect corrections made by Fitch to its release regarding pass-throughs.]

Fitch, Canary Wharf

The survey took place in December 2012, with 97 investors participating. Of these, 10% have more than Eu20bn of covered bonds under management, 30% have between Eu5bn and Eu20bn, and 61% have less than Eu5bn in their portfolios, said Fitch. All but three of the investors are based in Europe, the Middle East, or Africa.

“Although not exhaustive, Fitch deems the sample to be a fairly representative cross-section of European covered bond investors,” it said.

According to the rating agency, the results show that the relevance of triple-A ratings is declining, with the proportion of investors signalling that they can buy non-AAA covered bonds rising from 83%, already a high figure, in 2011 to a “remarkable” 91% as at the end of last year.

“The portion of respondents that either have no rating limit or can buy down to BBB has also increased, to 56% from 49% in 2011,” said Fitch. “Investors are increasingly looking directly at the Issuer Default Rating (IDR), which is becoming a more important driver of investment decisions: 53% of respondents consider the IDR to be more than or equally important to the covered bond rating.”

Fitch also highlighted that a growing number of respondents – 79% compared with 71% and 62% in December 2011 and 2010, respectively – are prepared to buy covered bonds with a soft bullet redemption profile.

However, the percentage of investors willing to buy pass-through covered bonds was unchanged at 47%. [Corrected from an increase to 79%.]

Investors also appear to be increasingly willing to innovate in terms of other bond characteristics, such as cover assets, according to Fitch, with accounts displaying flexibility in this context. It cited in support of this a decline from 64% to 60% in the proportion of respondents feeling only comfortable buying covered bonds secured by mortgage loans or public sector debt.

“It could be a consequence of their propensity to adapt that investor appetite remains,” added Fitch, “with 86% of respondents planning to either maintain or increase their current holdings of covered bonds, consistent with last year’s figure of 88%.

“However, and akin to last year’s figures, the euro-zone crisis is still impacting investment decisions, with a notable differentiation between peripheral and non-peripheral countries.”

Scandinavia, Belgium and the UK are the jurisdictions of choice, according to Fitch’s survey, with respondents most likely to decrease their exposure in Spain.

The survey also asked investors for their views on peripheral covered bonds being priced inside their respective government bonds, and whether they think covered bond spreads are likely to widen or government bond spreads tighten.

With respect to pricing inside government bonds, the vast majority of polled investors (68%) consider this to be the new norm, according to Fitch, and that the trend will continue. Some 76% expect government bond spreads to tighten and thus reduce the gap between covered bond and government bond pricing.

The survey indicates that sovereign risk is still the main concern for investors, but that “anxiety” about this is receding, according to Fitch. Compared with 59% of investors in the year-end 2011 survey citing this as the main challenge facing the covered bond market, the figure in December last year stood at 43%. This is still higher than the 37% Fitch recorded in December 2010, however, noted the rating agency.

The second biggest challenge cited by investors is the health of the banking sector, which was selected by 21% of respondents.

A majority of respondents (58%) stated that asset encumbrance is either an overrated concern or that other forms of secured funding are a bigger source of encumbrance than covered bonds, according to Fitch. The remaining 42% of participating investors are concerned about it and would welcome regulatory initiatives to limit it, added the rating agency.