Covered bond ratings could withstand a two notch issuer downgrade on average because updated rating criteria from Fitch, which takes into account the BRRD, have provided an additional uplift on issuer ratings, the rating agency said on Friday – although the proportion of IDRs on negative outlook has increased from 16% to 42% due to weakening state support.

Fitch implemented updated criteria in March to take into account the exemption of covered bonds from bail-in under the EU Bank Recovery & Resolution Directive (BRRD).

As a result of BRRD and its new criteria, Fitch has assigned additional notches of uplift to covered bonds that it rates, and it noted a reduced sensitivity of covered bond ratings to potential Issuer Default Rating (IDR) downgrades, and a lessening of the likelihood of an enforcement of the security against the cover pool in the event of a bank default.

The rating agency said that it has incorporated an aggregate 109 notches of IDR uplift into its covered bond analysis. It said 40 programmes have been provided an IDR uplift of two, and 29 have been provided an uplift of one.

“Despite this larger cushion, the perspective for covered bond ratings has only improved modestly, with 11 ratings on positive outlook, as the potential downgrade of a support-driven IDR is not always compensated by IDR uplifts,” it said.

The vulnerability of covered bond ratings to an IDR downgrade of one notch has fallen from 45% last quarter to 27%, while those vulnerable to a two or three notch IDR downgrade have dropped from 20% to 13% and 15% to 8%, respectively.

A well as the 11 covered bond programmes that were placed on positive outlook following the implementation of the new rating criteria, one was placed on Rating Watch Evolving and another on Rating Watch Negative.

In contrast to the positive impact for covered bond ratings under BRRD, the proportion of IDRs on negative outlook has increased from 16% earlier this year to 42%, noted Fitch, reflecting the rating agency’s belief of reduced state support for banks in the event of issuer default.

Fitch rates 132 covered bond programmes from 21 countries, with 59% rated AAA.