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​Fitch: Southern Europe Taps Covered Bond Funding for the Long Run

Fitch Ratings observes Italian, Portuguese and Greek banks are taking advantage of the positive market momentum and investors' hunt for yields to place longer-dated covered bonds. Issuers are either pre-funding future needs, locking-in cheaper funding for the long run, or building up their yield curves after a market shutdown, mainly in Greece.

A general lengthening of the weighted average (WA) maturity of bonds, coupled with a stable cover pool amortisation profile, can potentially reduce refinancing needs in a covered bonds programme. This positively impacts breakeven over-collateralisation (OC) for a given rating, as long as maturity mismatches decrease.

At the same time, longer-dated liabilities could put pressure on issuers' ability to originate eligible mortgage loans and preserve OC; this is particularly true in countries where mortgage origination remains subdued (Greece) or where deleveraging is still offsetting new loan issues (Portugal). Most programmes rated by Fitch in these countries include an amortisation test, which is performed once the issuer is no longer the source of payments, to protect investors from OC depletion and time subordination risk. Once the test is breached all bonds become immediately due and payable, preventing longer-dated bonds from suffering larger losses than earlier maturing bonds.

The WA maturity of publicly placed benchmark covered bonds (at least EUR500 million) has lengthened year-on-year since the launch of the Covered Bonds Purchase Programme 3 (CBPP3) by the European Central Bank (ECB) in October 2014. As an example, Italian issues have now a WA tenor of 9.6 years compared with 7.2 years as of end-2013; in addition 60% of Italian covered bonds issued in 2017 have a maturity of 10 years or more (20% in 2013). Portuguese programmes followed the same pattern with a WA maturity moving to 6.9 years (from five years in 2013); the share of 10-year bonds issued in 2017 accounts for 20% versus none in 2013.

Market dynamics may change following the recent ECB decision to stop buying conditional pass-through (CPT) covered bonds of non-investment grade issuers. Out of the 20 CPT programmes rated by Fitch, four will become non-eligible to new CBPP3 purchases starting from February 2018 (two Greek, one Portuguese and one Italian programme). The choice of redemption type has currently no rating impact on Greek programmes (see "Fitch: Liability Profile Rating Neutral for Greek Covered Bonds" dated 1 December 2017 available at www.fitchrating.com). 

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