An investor survey conducted by Fitch found decreasing secondary market liquidity to be the greatest challenge facing the asset class, the rating agency said yesterday (Monday), with 58% of respondents expecting to switch to other assets in response to ECB measures such as CBPP3.

The year-end survey – to which 52 investors responded, 60% from the Eurozone – asked investors to pick from 11 options the three that are among the biggest challenges facing the covered bond market and decreasing secondary market liquidity was picked by more investors than any other, with 53% putting it in the top three.

Fitch said it believes the risk to secondary market liquidity to be greatest after the conclusion of the European Central Bank’s third covered bond purchase programme (CBPP3) and targeted longer term refinancing operations (TLTROs).

“Because of the medium term nature of the programmes and the substantial lowering of covered bond spreads that have occurred, many market players are concerned that investors may be pushed out of the market and may not be willing or able to readily return after June 2016,” said the rating agency.

Fitch said that decreasing liquidity could ultimately have a credit impact in its rating analysis if lower demand led to widening spreads.

“This would likely lead to more conservative refinancing spreads within Fitch’s cashflow analysis and higher breakeven OC levels in line with the same ratings,” it said. “At this stage, it’s unlikely that lower primary issuance would lead Fitch to take a more conservative view of liquidity gap and systemic risk in its discontinuity caps (which reflect payment interruption risk), which would tie programme ratings to a greater degree to banks’ IDRs.”

The survey identified sovereign risk (47%), the health of the banking sector (38%) and regulatory treatment of covered bonds (34%) as the next highest ranking challenges for covered bonds. These were the top three concerns when Fitch conducted a survey a year previously, although on that occasion decreasing liquidity was not offered as an option to respondents.

The survey also found that 58% of covered bond investors expect to switch to other assets as at least one of their reactions to the impacts on the market of factors such as the TLTROs, CBPP3 and sovereign QE. However, 37% said they would instead buy covered bonds from outside the Eurozone and 19% covered bonds with longer maturities, while 25% said they would not change their investment behaviour in response to these factors.

Fitch also noted that 43% of respondents expect to increase their covered bond holdings – up from 29% in the previous survey – while 28% expect them to stay roughly the same, versus only 24% that expect their holdings to decrease somewhat and 6% that expect them to decrease substantially – against 12% and 0% one year ago, respectively. Fitch noted that the changes relative to the previous year’s survey could be partially caused by a substantially changed respondent base.

Assessing demand by jurisdiction, the survey found that those polled are most likely to increase their investments in the UK (36%), the Netherlands, Ireland and Scandinavia (each 29%). Regarding aggregate intentions – the proportion of respondents likely to increase their exposure to the jurisdiction, minus the proportion likely to decrease it – the UK again ranks highest, followed by Belgium and the Netherlands. France, Germany and Greece ranked lowest.

“Of the markets facing the worst aggregate intentions, Fitch has differing views with a neutral status and outlook market evaluation for France, a strong assessment for Germany and a very weak assessment for Greece,” noted Fitch. “For France and Germany, it is likely that supply and pricing considerations are impacting the investment intentions along with mortgage market predictions.”

Investors’ attitudes towards less traditional amortisation and collateral types were more resistant than previously. One-third said they would buy covered bonds with a conditional pass-through redemption profile versus 39% at end-2013, while 17% would be willing to buy those that amortise on a full pass-through basis against 24% at end-2013.

While respondents still see covered bonds backed by traditional cover assets, such as residential mortgages and public sector debt, as the most attractive, there was a strong showing for mixed mortgages, commercial real estate (CRE) mortgages and infrastructure loans, which are new to Fitch’s survey this year. Interest in unsecured SME loans was down by 4% to 25%, however.