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European covered bond market risks continue to rise

Publication Date: 22 Nov 2018 - By ReachX Team By ReachX T.

Environmental, Social & Governance Macro Fixed Income/Credit Multi Asset UK EU Financial Services


Europe's regulatory and market environment will remain supportive for covered bonds in 2019, but a number of potential risks are building, including the possibility of a 'no-deal' Brexit, according to Moody’s.

In a note to its clients, the rating agency said regulatory developments – particularly efforts to harmonise covered bond laws across Europe – will be mostly positive for European covered bonds and will support continued strong credit quality in 2019. 

"But political risks, including the possibility of a no-deal Brexit, will be an important credit theme for European covered bonds in 2019 and beyond," warned John Hogan, Vice President and Senior Analyst at Moody's.

While Moody's expects the UK and EU to eventually reach an agreement to preserve most of their existing economic relationships ahead of the UK's withdrawal, the possibility of a no-deal Brexit has become more likely in recent months. 

“This would be negative for UK covered bonds because it would be negative for the UK economy and UK banking sector. A no-deal scenario would also raise legal and regulatory issues for both UK and EU covered bonds.”

Market conditions, on the other hand, will remain supportive despite rising interest rates, according to Moody's.

"We expect interest rates to increase at a modest pace in 2019 as the European Central Bank gradually unwinds the stimulus provided under its quantitative easing policy," says Greg Davies, Vice President and Senior Research Analyst at Moody's. "However, the possibility of a sharp and sudden rise in interest rates is a risk, particularly for banks in countries with high levels of debt."

Mostly stable sovereign and bank outlooks will also underpin covered bond credit quality in 2019.

The rating agency expects continued growth in green and social covered bonds, as well as covered bonds that reference alternatives to LIBOR interest rates.


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