Growing Diversity And Complexity Of European Covered Bonds

The increasing diversity of European covered bonds means that investors should take a close look at the risks to which they are exposed, according to a report published today by Standard & Poor’s Ratings Services.

“While the default risk of two seemingly similar covered bonds may allow both to be rated ‘AAA’, investors must now be aware of other, often changing, risks that have resulted from the market’s expansion,” explained credit analyst Karlo Fuchs.

This is because the covered bond franchise is growing, and fast.

Mr. Fuchs noted that within the past two years more new issuers have arrived and more new legislation has been enacted than in the whole of the previous decade.

“The new arrivals have been drawn to the market by a number of advantages that covered bonds bring. For most these are funding advantages, but the changing risk weighting of the underlying assets under the Basel II framework is another key benefit,” he added.

“Further positives include the stability of covered bond credit ratings, with no defaults or losses in its 200-year history, higher secondary market liquidity than other products, and an outstanding volume of covered bonds that is expected to reach about €2 trillion at the end of 2007,” Mr. Fuchs said.

“While these new features may differ markedly between covered bonds they may all support the same—usually ‘AAA’—rating. We must stress, however, that investors should not be mistaken that two covered bonds with similar default risk are similar in all other respects. The risk profile of a cover pool may change without the default risk—and hence the rating—changing,” he concluded.