Generous overcollateralisation (OC) levels maintained by covered bond issuers support an already well-regulated instrument, according to Fitch, which notes that OC in most programmes exceeds proposed minimums. However, issuers may not be so generous in harder times, an analyst suggested.

While publishing its latest quarterly covered bonds surveillance snapshot yesterday (Thursday), Fitch said OC available in the vast majority of covered bond programmes it rates “generously exceeds” the rating agency’s breakeven OC for the programmes’ given ratings and are also well above regulatory minimums required by respective legislative frameworks.

“In general, issuers maintain safe OC buffers to facilitate management of their assets and liabilities, for instance registering extra assets in their cover pool in anticipation of future issuance,” said the rating agency. “In Fitch’s view, this reflects market discipline behind an already highly regulated instrument.”

According to Fitch, weighted-average nominal OC for Fitch-rated programmes ranged between 20% and 60% in most markets.

It noted these levels are much higher in Spain – where cédulas are backed by the issuer’s entire mortgage book – and Singapore and South Korea – where issuers are building up collateral for future issuance.

“At the other extreme are the Canadian and Australian programmes, whose capacity to distribute voluntary OC to covered bondholders is limited by regulation,” added the rating agency.

However, Jörg Homey, covered bond analyst at DZ Bank, questioned whether current OC levels are a useful indicator of how issuers would act in harder times.

“It was proven in the crisis that when push comes to shove, issuers will do what is legally permitted,” he told The CBR. “Rating agencies look at actual OC at a certain point in time, and of course that can be helpful, but I think it is more informative to look at the legal minimum requirements.

“I would even expect that if times of crisis would return, issuers would do whatever they could to drive OC requirements down with structural enhancements, like switching to conditional pass-through structures, for example.”

In December, the Basel Committee published amended risk weights for covered bonds, effective from 2022, which rule that covered bonds must meet a minimum 10% nominal OC requirement to be eligible for 10% risk weight treatment, among other requirements.

Fitch noted that of the 108 covered bond programmes it rates, only 15 had available OC of or below 10%, as of 1 January. All European programmes exhibited OC above 5%, the minimum level put forward by the European Banking Authority (EBA) in proposals expected to inform the European Commission’s awaited Directive to create a harmonised EU covered bond product.

In its year-end survey, Fitch found that 42% of respondents believe regulatory OC is sufficient to cover all credit risk.

“This is contrary to our view that mandatory minimum OC set by most legislative frameworks is too low to sustain large stresses, including cover pool losses and maturity mismatches, as well as interest rate and currency mismatches,” said the rating agency.

DZ’s Homey is sceptical of the effectiveness of a “one size fits all” OC requirement.

“We have in different countries different credit profiles, so to set a regulatory OC requirement that fits the credit profile you would have to analyse country by country, and even issuer by issuer,” he said. “It is a moving target anyway, because there are credit cycles and at one time 5% might be appropriate and at another time not.

“It is not a bad thing to implement, but it is not a silver bullet.”