22. Nov 2016 Scope research  – Covered bonds

Covered bond Outlook 2017: Credit contraction unlikely to unravel

The end of the ECB’s purchase programme will not unravel existing differences in credit quality across European covered bonds. Improvements in bank fundamentals and further harmonisation will remain supportive, but cannot conceal the products credit DNA.

Scope Ratings' expects in its 2017 outlook that the credit performance of covered bonds will continue to improve, thanks to the enhanced regulation and supervision that is strengthening European bank credit fundamentals, the anchor point for this asset class’s credit quality. The improvements are leading not only to safer business models for issuers, but to stronger capital and liquidity profiles as well. At the same time, the ECB’s quantitative easing continues to support financial stability in Europe and benefits borrowers’ asset quality, and ultra-low interest rates are prompting issuers to lengthen the maturities of new covered bonds, thereby reducing their main risk – the asset-liability mismatch.

Scope believes that base line credit quality for covered bonds will improve, helped by changes in covered bond frameworks. Fundamental support factors for covered bonds will remain supportive, and the protection provided by the cover pool could further improve due to the harmonisation of covered bond frameworks.

However, covered bond investors cannot really benefit from these positive aspects, as new issuance remains meagre. The covered bond market continues to shrink, driven by high redemptions of covered bonds and soft credit demand on the supply side. Banks continue to deleverage their balance sheets, while investors stand on the sidelines because of the often-negative yields of covered bonds that destroy value.
The ECB continues to crowd out investors, as it is siphoning supply from both primary and secondary markets through its third covered bond purchase programme. Also, the ECB is now the largest single investor in the market. Even if investors are willing to bite the bullet and invest in bonds with negative yields, they might be unable to maintain their covered bond holdings.

Existing covered bond investors should re-visit their investment policies, as credit quality could again become more volatile. A more pronounced credit differentiation of the asset class could be prompted by the end of the ECB’s third purchase programme, a potential rise in interest rates, and the socio-political risk emanating from Brexit or the 2017 elections in various European countries.

Download the full report: 'Credit contraction unlikely to unravel'.

Analyst Conference Call

Scope Ratings discusses its European covered bond outlook for 2017 in a telephone and web conference call on Wednesday, 30 November 2016, 2:30 pm CET. Following a brief presentation, Scope analysts will be available to take questions.

When: Wednesday, 30 November 2016 at 2:30 pm CET
How: Conference call and web presentation
Analyst: Karlo Fuchs, Head of Covered Bond Ratings

Please register here.


Scope Ratings AG    Phone: +49 30 27891-0
Karlo Fuchs    k.fuchs@scoperatings.com
Guillaume Jolivet    g.jolivet@scoperatings.com
Oliver Müller    press@scopegroup.com