Improving sovereign credit quality in mainly peripheral European jurisdictions is a credit positive for many covered bond programmes going into 2015, Moody’s said yesterday (Tuesday), with average TPIs having improved in the past year and a sovereign ceiling RFC underway.

In a report on its outlook for 2015 Moody’s noted that, because of slight economic improvement in the euro area and the stabilisation of some macroeconomic fundamentals in certain countries, sovereign risk is lower today than at the beginning of 2014.

Expecting improving sovereign credit quality to support a continuation of strong collateral performance, the rating agency also said authorities and stakeholders will in the future have greater opportunities to avoid covered bond defaults.

It cited this as a reason why it has upgraded Timely Payment Indicators (TPIs) for many programmes accordingly. From 30 October 2013 to 30 October 2014, the proportion of covered bond programmes assigned TPIs of “probable” increased from 19% to 39%, noted Moody’s, while the proportion of programmes with TPIs of “improbable” decreased from 25% to 5%.

These improvements mainly occurred in countries that have benefited most from lower sovereign risk, according to Moody’s. Spanish and Italian mortgage and public sector covered bonds received a median TPI improvement from “improbable” to “probable”, while Irish and Portuguese mortgage covered bonds were upgraded from “very improbable” to “probable”.

Moody’s added that, reflecting a lowering of concern about elements of country risk, it has also issued proposals to raise its country ceilings. The rating agency began consulting in November over whether it should widen the notches between euro area country ceilings and government bond ratings, to up to six notches.

“If implemented in its proposed form, the change will result in higher country risk ceilings for some non-Aaa euro area countries,” Moody’s said. “The Request for Comment reflects the fact that the experience of the sovereign debt crisis, together with measures taken by the euro area authorities to address contagion, suggests that the risk of a country exiting the euro area has generally diminished.”

Moody’s meanwhile expects positive new regulatory developments – such as an exemption from bail-in that covered bonds will enjoy under the Bank Resolution & Recovery Directive and preferential treatment in terms of Liquidity Coverage Ratio requirements – to outweigh a likely weakening of government support for failing banks in 2015.

The solid record of performance of covered bonds throughout the financial crisis will also increase their appeal, the agency added.

“While our banking system outlooks, predominantly negative in Europe, imply a negative credit view for covered bonds, the paradigm shift in regulation towards resolution regimes that partly drives these outlooks is broadly credit positive for covered bonds,” Moody’s said.

However, despite these factors, the rating agency cautioned that market forces will not favour a significant growth in covered bond issuance in 2015, compounded by moderate funding needs of banks, continued amortisation of existing collateral levels, and a predominance of other sources of funding.