Covered bond investors are taking a more flexible view of the ratings and other characteristics of these investments, according to a survey conducted last month by Fitch Ratings. Yet they are discriminating about which jurisdictions they want exposure to.

In fact, sovereign risk remains the primary concern for covered bonds investors for the third year running, according to Fitch, which surveyed 97 investors during the month of December 2012.

However, only 43% of respondents consider sovereign risk the main challenge facing the covered bonds market, down from 59% a year earlier. The second biggest challenge cited is the health of the banking sector, which was selected by 21% of respondents.

Continuing a trend discovered during the previous survey, the results also reveal that investors are increasingly willing to innovate, not only in terms of bond characteristics, but also in terms of rating.

Ninety-one percent of investors declared that a 'AAA' rating was no longer essential to invest in a covered bond, a response Fitch termed “remarkable.” By comparison, in the survey Fitch conducted a year earlier, 83% of respondents said an ‘AAA’ rating was no longer essential.

The trend bodes well for the covered bond market, since downgrades of sovereign and bank ratings are putting downward pressure on ratings of these instruments themselves.

Furthermore, a growing number of respondents -- 79% compared with 71% in December 2011 -- indicated they are prepared to buy covered bonds with a soft-bullet redemption profile. The response to pass-through covered bonds is also much more positive, with a total of 79% of investors responding to the survey stating they would buy them, compared with only 48% a year ago.

Another consequence of investors' propensity to adapt to changing market conditions is the fact that 86% of respondents plan to either maintain or increase their current holdings of covered bonds, consistent with last year's figure of 88%.

However, the eurozone crisis is still impacting investment decisions, with a notable differentiation between peripheral and non-peripheral countries. When asked in which geographic areas their exposures will most likely increase, Belgium -- which enacted its covered bonds legislation in late 2012 -- the U.K. and Scandinavia scored the highest. Not surprisinglu, respondents are most likely to decrease their exposure in Spain.

While the survey was far from comprehensive, Fitch considers it to be representative of covered bond investors. The ratings agency said 10% of the respondents have more than €20 billion of covered bonds under management, 30% have between €5 billion and €20 billion, and 61% have less than €5 billion in their portfolios. All but three are based in Europe, the Middle East and Africa.

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