Next year there will be a worsening of covered-bond issuer credit quality and a continued deterioration in the sovereingns' financial condition.

Both events will serve as key threats to EMEA covered bonds's credit quality, Moody's Investors Service said in a new outlook report released today.

The rating agency thinks that the worsening financial conditions of certain European sovereigns will still negatively impact covered bonds' performance in the next year.

This deterioration will exert downward pressure on issuer credit quality directly and will thus spur refinancing risk with the price of government debt serving as a floor for refinancing costs across a jurisdiction.

Additionally, in the rating agency's perspective, sovereigns are currently less able or willing to directly or indirectly support the refinancing of assets and/or covered bond programs during a covered bond issuer's default.

With the European sovereign crisis and other market pressures, specifically funding, current banking system outlooks are mostly negative, according to the rating firm. 

Moody's said that issuers in peripheral European countries are at most immediate risk of experiencing deteriorating credit quality, specifically in Spain and Italy.

The banks elsewhere in Europe also face considerable challenges such as direct exposures to the peripheral euro area, which is a harder operating environment created by the crisis, and increased
regulation and reduced government support in their own countries.

The Europeann Union's (EU) bail-in proposals for creditor burden sharing are probably going to continue in 2012, Moody's stated.

The bail-in rules will in all likelihood exclude covered bonds from burden sharing, which should increase demand for covered bonds and promote them by creating a deeper and more liquid market. In the rating agency's perspective, this is a credit positive to limit refinancing risk, although the proposals are not yet finalized by the EU.

The rating agency said that regulatory changes at the national and pan-European levels are still improving safeguards and increasing transparency for covered bond buyers. These enhancements will continue as negative sovereign and banking system outlooks are still feeding through to deteriorating issuer credit quality. There will also be a continued reliance on repo funding, specificaly in peripheral Europe.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.