Positive developments in the credit quality of covered bonds will continue in 2016, according to upbeat reports from Fitch, Moody’s and Scope, with the rating agencies citing factors such as stable and positive outlooks for issuers and sovereigns, preferential regulation and tightening spreads.

In reports on their outlooks for covered bonds next year, Fitch, Moody’s and Scope also listed improving mortgage markets and new structures as being credit positive, noting that developments this year had been largely positive for asset class.

Fitch said it expects greater stability in covered bond ratings next year, after a “sharp turnaround” in covered bond outlooks this year.

It noted that as of 1 December, 94% of the 127 covered bond programmes it rates had a stable outlook, while 15% of 47 non-AAA rated programmes were on positive outlook – a record amount – and only one was on Rating Watch Negative.

“This contrasts markedly with 2011 to 2014, when around 20% of all Fitch-rated covered bonds were on Negative Outlook or Rating Watch, mostly those issued out of peripheral Eurozone countries,” it said.

One reason for its forecast, Fitch said, is that 76% of covered bond issuers it rates had an Issuer Default Rating (IDR) on stable outlook and 12% on positive outlook as of 1 December, while only 37 programmes would be downgraded upon a one-notch downgrade of the issuer’s IDR.

Sovereign influence on ratings is also expected to be limited, Fitch said, as sovereign ratings in the Eurozone have also generally gained stability or have positive trends. The rating agency added that after it factored reduced sovereign support expectations into banks ratings’ this year there is greater delinkage between bank and sovereign ratings, which should contribute to greater rating stability for covered bonds, provided banks’ intrinsic financial strength is preserved.

Fitch also said that the levels of breakeven overcollateralisation (OC) it requires for a given rating could potentially decline in several jurisdictions in 2016, due to economic and market developments. These include decreasing spread levels in European countries, improvements in some housing and mortgage markets, total-loss absorbing capacity (TLAC) requirements, and an increase in the use of soft bullet and conditional pass-through covered bonds.

However, it said a trend of issuers removing privileged swaps hedging their cover pool or covered bonds could lead to increases in breakeven OC requirements.

Moody’s said it expects the credit quality of European covered bonds to remain strong with stable underlying factors during 2016.

In particular, Moody’s cited a “dramatic shift” in bank creditworthiness. The rating agency noted that as of November 2015, 58% of its senior unsecured ratings were stable (up from 18% in 2014) and 16% were positive (up from 3%), and that the majority of its European banking system outlooks are now stable, whereas almost all had been negative 12 months ago.

It added that a consolidation of the credit quality of sovereigns for key European markets will also be supportive for covered bonds in 2016, although stalling growth in Europe means its asset quality outlook is stable rather than positive.

Moody’s said the regulatory environment will be mostly supportive for European covered bonds next year, and that it in particular it expects the credit strengthening impact of the Bank Recovery & Resolution Directive (BRRD) to continue as it is implemented by more jurisdictions. The rating agency updated its covered bond methodology in March to reflect the impact of BRRD, and said the covered bond anchors for programmes it rates have increased by 1.7 notches on average, while 86% of programmes have a covered bond anchor higher than a year ago. It said BRRD also reduces covered bond rating volatility for stronger issuers, whose higher covered bond anchors allow for increased leeway against the deterioration of the issuer’s creditworthiness without affecting covered bonds’ ratings – measured by its Timely Payment Indicator (TPI) leeway.

Moody’s said the implementation of LCR this year is also positive, as it lowers refinancing costs, but that Basel proposals for the Net Stable Funding Ratio (NSFR) are credit negative for covered bonds. It said the proposed requirements would incentivise a reduction of the levels of covered bonds’ collateral and make covered bonds less attractive than other types of stable funding.

The rating agency also expects that soft bullet and conditional pass-through (CPT) covered bond programmes to become more common in 2016. The rating agency said it expects such structural changes to programmes, or the establishment of new programmes, to slightly improve the composition of the TPIs of covered bonds it rates, but said it does not expect this to affect enough programmes to warrant a significant change to the split of its TPI categories during 2016.

Scope said its base case for 2016 is a continuation of a credit positive development for covered bonds, their issuers, and the sovereigns in which they operate. It expects the credit quality of European cover pools to develop favourably, thanks to a continued turnaround in core credit indicators for its collateral analysis, such as lower unemployment or house price indices for mortgage backed cover pools.

Tightened refinancing spreads for covered bonds will also be a positive factor, Scope said, as lower discounts are applied when it models refinancing risk.

Scope expects the credit strength of the banking sector to remain stable to mildly positive thanks to stronger balance sheets, regulations and supervision, while low rates and a flat yield curve will continue to pressure profitability and put pressure on traditional bank business models. Positive rating changes for banks rated by Scope outpaced negative rating developments in 2015, the rating agency said, reflecting the positive impact of receding macroeconomic stresses in banks’ financials, adjustments of business models gaining traction and improved capitalisation.