Estimated cover pool losses for public sector covered bonds are on average higher than those of mortgage covered bonds for the first time since 2009, according to Moody’s latest report on European programmes.

Figures from Moody’s European Covered Bonds Monitoring Overview Q3 2012, released on Monday, show a declining trend in the credit quality of public sector cover pools relative to mortgage ones.

Under Moody’s methodology, cover pool losses are estimated taking into account collateral risk and market risk. In the third quarter of 2012, collateral risk was 8.3% for public sector cover pools and 8.1% for mortgage ones, and market risk scores were 18.4% and 18.3%, respectively, giving expected cover pool losses of 26.7% and 26.4%.

Although the difference between the figures for the two asset classes is low, according to Moody’s this is the first time since 2009 that cover pool losses are on average higher for public sector covered bond programme rather than for mortgage programmes.

According to some 2009-2012 historical figures provided in the report, the declining trend in credit quality for public sector cover pools started in the second quarter of 2011. Weighted average market risk grew from 13.3% in Q2 2011 to 17.2% in Q3 2011 for public sector cover pools, while the increase was more modest for mortgage ones, 15.8% to 18.1%.

Weighted average collateral risk has also been rising for public sector cover pools in the past three years, growing from 4.1% in Q2 2011 to 8.3% in Q3 2012, while it was almost flat for mortgage cover pools, oscillating between 8.5% and 7.8%.

Hadrien Rogier, covered bond analyst at Moody’s, told The Covered Bond Report that the rise in the average collateral risk for public sector programmes is mainly due to sovereign downgrades in 2011 and 2012, which directly impacted cover pools’ quality.

“Most of the programmes are exposed to public sector entities of their respective country,” he said, “therefore creating a link between the credit quality of the sovereign and of the cover pool.”

He noted that in Spain the average public sector collateral score has increased from 17% in Q3 2011 to 35%.

“Even though this phenomenon has also been observed in other countries,” he said, “the high number of public sector Spanish programmes drives the public sector collateral score average up.”

As a result, public sector covered bonds have on average a higher collateral score than mortgage ones – 15.8% and 12% respectively – reflecting lower cover pool quality. Moody’s collateral risk figures are derived from the collateral scores.

According to the 2009-2012 historical figures, the average collateral score of public sector cover bonds has been lower than for mortgages, but in the second quarter of 2011 it rose sharply and surpassed mortgages in the first quarter of 2012 for the first time.

In its latest quarterly update, Moody’s also highlighted that two new features have been included in the report: two new collateral scores, one including and one excluding the impact of minimum portfolio level credit enhancement; and two TPI charts, one showing the distribution of TPIs across all programmes, and one showing the stability of Aaa-rated covered bond programmes in EMEA based on their TPI Leeway and level of surplus overcollateralisation.

Average collateral score by country: public sector backed covered bonds

Source: Moody’s Monitoring Overviews