Portugal

Unless sovereign debt market volatility subsides, it seems likely that publicly placed covered bond financing could remain shut for peripheral issuers in 2012, potentially forcing Spanish and Italian banks into the same category as Portuguese and Greek banks which were unable to access the market at all last year.

Fitch has downgraded mortgage backed covered bonds issued by three Portuguese banks, highlighting the risk of peripheral covered bonds falling below the rating threshold for ECB repo eligibility. Issuers still shut out of the market are heavily reliant upon repo funding, and further downgrades could force the ECB to adjust its criteria, though DBRS has offered a lifeline to at least one Portuguese bank.

Stress in bank funding markets, exposure to troubled eurozone sovereign bond markets and moves away from implicit government support have affected the creditworthiness of many global banks. But Standard & Poor’s approach to covered bond ratings means they should remain resilient compared to other agencies.

The concept of liquidity has changed over the course of the financial crisis. Where once it may have been viewed as a free ticket, it is now highly valued — for without liquidity there cannot be a market. Covered bonds are comfortably at the most liquid end of the credit spectrum, but the way they are traded has completely changed since the onset of the financial crisis.

Markets opened poorly on Monday morning and hit record wides in some indices, after concerns about Greece’s ability to meet its austerity commitments dominated weekend headlines. Syndicate bankers touted Tuesday as the day to bring a deal if market conditions were constructive, but the volatility means they expect no primary supply this week.

A UK based covered bond investor spoke to The Cover about the sovereign crisis. He believes the primary market should still be able to function, though the group of issuers capable of doing a deal will be much smaller. Greece is beyond hope, but he says the rest of Europe can still be saved.

A theoretical 10% or 20% haircut on ECB exchanged Greek government bonds in the public sector cover pools of German banks would have a limited effect on nominal overcollaterlisation (OC). Spanish and Italian pool exposures are much larger and a factor that investors should take into consideration.

Core European investors are much more pessimistic than two months ago, according to Crédit Agricole’s latest sentiment index, which showed an even greater decline in issuer sentiment. Investors expect further deterioration in Spanish and Italian covered bonds, but at a slower rate than over the last two months.

After digesting the details of a rescue plan for Greece, traders have marked back Spanish and Italian sovereign debt following a brief relief rally on Friday. Secondary market activity was subdued on Monday, and though covered bond spreads have lagged sovereign tightening, making them look relatively cheap, traders said it was never enough to be market moving.

High yields and certain structural attributes have attracted faster money buyers to Portuguese mortgage covered bonds. While traditional investors have left Obrigações Hipotecárias (OH), buyers with high minimum yield requirements have found OH’s structure sound and rates compelling.

Covered bond practitioners say the release of Capital Requirements Directives IV is positive for the sector and broadly similar in outlook to the draft version of Basel III that sealed a structural bank bid for the sector. There have been changes in the way covered bonds are treated by the Liquidity Coverage Ratio, and potentially in the way the Net Stable Funding Ratio is applied. Underlying market sentiment remains negative, as many believe that the sovereign debt crisis is only just beginning.

Moody’s cut the covered bond ratings of five Portuguese issuers on Friday, following a downgrade of the issuers’ senior unsecured ratings on the same day. The senior unsecured cuts, said Moody’s, were prompted by the downgrade of Portugal’s sovereign debt rating on April 5.