Cuts to sovereign or issuer credit ratings resulting from a deterioration in economic conditions caused by the coronavirus could hit covered bond ratings, according to S&P, but it said short-lasting mortgage forbearance initiatives are unlikely to lead to downgrades.

While the rating agency acknowledges that there is a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak, it is working on the assumption that the pandemic will peak between June and August, as estimated by some government authorities.

S&P said that due to the measures put in place by governments to contain the virus, it believes the global economy has been pushed into recession, and that subsequently employment levels and housing markets could be affected.

On Tuesday it updated its forecast for the US economy, for example, to predict that GDP in the second quarter will decline at least double a 6% contraction forecast it made only last week, on top of a first quarter contraction.

“Europe’s GDP decline for the first half of the year looks to be similar to the US’s,” it added, “but with a somewhat larger decline in the first quarter than the second because the shock started earlier there.”

Any impact on an issuer’s credit rating (ICR) resulting from the pandemic, such as a downgrade, may directly affect the ratings of its covered bonds if it does not have unused notches of uplift under S&P’s methodology, the rating agency noted.

“Currently, most issuers in most countries have unused notches available, which may be utilized should the ICR deteriorate,” it said yesterday (Wednesday). “Programmes without unused notches are spread across jurisdictions, and are mainly a result of relatively low ICRs or limits to the jurisdictional or collateral support elements of our ratings analysis.”

Average number of unused notches by country in Q1 2020

Note: chart does not include pass-through programmes, programmes with no rating on the issuer, and GE SCF S.C.A.; Source: S&P

Some 95% of the covered bond programmes S&P rates have stable outlooks, reflecting the unused notches of ICR, with only 3% on negative outlook (and 1% on positive outlook).

Given S&P’s current sovereign ratings, a one-notch downgrade would for most jurisdictions not lead to changes in the covered bond ratings of the respective issuers.

The rating agency noted that it considers mortgage loans to have low to moderate sensitivity to the sovereign’s performance, and therefore rates transactions backed by such assets up to six notches above the sovereign rating. It nevertheless highlighted that programmes in Ireland, Greece, Italy and Spain are expected to be most sensitive to changes to sovereign ratings among mortgage-backed covered bonds.

The ratings of programmes backed by public sector assets are constrained to two notches above a sovereign rating and S&P noted that in some cases are (weak) linked to them. Programmes backed by public sector assets in Belgium, France and the UK were also flagged as being likely among the most sensitive to changes in the respective sovereign ratings.

Short term reductions in collections due solely to forbearance on mortgage instalments – following initiatives introduced by various governments and financial institutions – will have limited impact on S&P’s covered bond ratings, it said, noting the dual recourse nature of covered bonds.

“We expect issuers to have access to sufficient balance sheet liquidity – especially given increased central bank support – to offset such lower collections,” said S&P.