Multi-issuer Spanish covered bonds are benefiting from an ongoing shift in the composition of assets in cover pools, according to Fitch Ratings.

Covered bonds are a form of corporate debt with recourse to both the issuer and a pool of assets on the balance sheet of the issuer, which is typically a bank.

Covered bonds issued by Spanish banks, known as cédulas hipotecarias (CH), are backed by a mix of residential mortgages, commercial mortgages, and loans to real estate developers.  Since the financial crisis, most Spanish banks have actively managed these portfolios, increasing the portion of residential mortgages, which have performed better than either commercial mortgages or loans to real estate developers.

This shift has been “gradual, but significant,” according to a report Fitch published this week. At the close of the first quarter this year, residential mortgages comprised nearly 75% of cover pools of multi-issuer cédulas hipotecarias (MICH). That’s up 17 percentage points from 2012.

Partly as a result of this shift in portfolio composition, the average non-performing loan ratio has fallen to 11% from 11.8%. Residential loans tend to default less than commercial mortgages and real estate developer loans.

However the decline in the average non-performing loan ratio is also due to improving conditions in Spain’s macro-economic and housing environments, according to Fitch.  The rating agency expects Spanish gross domestic to rise 2% by the end of 2015 and 2.3% in 2016. It also anticipates that housing prices will stabilize after declining for the past seven years.  

The stable credit profile of the MICH transactions has been a contributing factor to a decreased in supporting overcollateralization ratios, and prompted Fitch to upgrade 12 MICH transactions by one notch in May. The highest rating that resulted was an ‘A-‘ for a deal called IM Cedulas 7.

Fitch also revised the outlook of five MICH deals to stable, and now all MICH transactions have a stable outlook. Fitch cited macroeconomic improvement, along with progress in the housing market and banking sector, as driving factors for the upgrades.

The upgrades also reflect Fitch’s affirmation of its ‘BBB+’ rating for the Spanish sovereign in April 2015.

Investors in covered bonds have a preferential claim on the assets in the cover pool in the event of default. This dual recourse to both the pool and the issuer, along with a historically safe nature and relatively high returns, make cover bonds attractive to investors. Additionally, the credit institution, which is regulated by a public entity, is obligated to maintain sufficient assets in the cover pool to continually satisfy bondholders’ claims. 

Spanish banks also must comply with terms set by legislation that require issuers of covered bonds to keep a very complete register of their loans and credits. Covered bonds assets remain on the issuers consolidated balance sheet, and investors favor the transparency of these deals. 

Covered bond issuance also increased dramatically in 2010, 2011, and 2012 following the housing and financial crises, although it fell off in 2013, according to the European Covered Bond Council. Over €100 billion of covered bonds were issued in 2012, compared to just over €40 billion in 2009.

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