More public sector covered bond programmes becoming “dormant”, issuers becoming more reluctant to increase OC to obtain top ratings, and less reliance on privileged swaps are some of the trends highlighted by Fitch in its outlook for 2013 yesterday (Monday).

The rating agency said that more public sector programmes will become dormant or enter into wind-down in 2013 because of a decrease in profitability of lending relative to funding costs. The outstanding amount of public sector Pfandbriefe, which make up the greatest share of public sector covered bonds, will continue to decline as a result of a lack of eligible assets following the abolition of guarantees for German Landesbanks and savings banks in 2005, it added.

The rating agency said that from 2013 public sector Pfandbriefe will be encouraged to limit their cover pool exposure to lower rating countries “by implementing voluntary ratings-based haircuts”. This is a reference to an initiative by the Association of German Pfandbrief Banks (vdp) to introduce a new model for the valuation of public sector assets in Pfandbrief cover pools.

The rating agency said that, following some market consultations, it will soon publish an updated version of its public sector covered bonds methodology, having proposed tighter criteria taking into account modelling of material contagion risk among euro-zone countries.

In terms of overcollateralisation (OC), Fitch said that it expects that more issuers will prefer to use lower rated covered bond programmes than increase cover pools’ OC levels to maintain higher ratings. This is because OC breakeven levels have become “increasingly onerous”, as the demand for collateral for purposes other than covered bonds has become “more pressing”, said the rating agency.

Another trend Fitch flagged for 2013 is a decrease in the use of privileged swaps. The rating agency noted that while these may have some benefits, such as protection against interest or currencies mismatches between assets and liabilities, they can also have some “unintended consequences”. For example, their pari passu ranking with covered bonds means termination payments may cause liquidity shocks to a programme.

It said that privileged swaps “may cause more concerns than relief” in covered bond programmes, and that the prospect of accounting for potential collateralisation amounts in a bank’s liquidity coverage ratio contributes to a decreasing pool of available counterparties.

“Fitch has already seen swaps being partially unwound in existing programmes, such as in Italy, and new programmes being set up without privileged derivatives, such as in Belgium,” it said. “The agency expects this trend to continue in 2013.”

Fitch noted that nearly all covered bonds ratings in peripheral Europe have a negative outlook, while the outlook is stable for 86% of programmes established by issuers elsewhere.