Fitch Ratings says in a new report that the covered bonds market continued to grow over the last year, whereby the typical covered bond is moving away from a standard public sector Pfandbrief, issued under German legislation, to become a more international secured debt instrument, funding pools of mortgage loans and issued outside any dedicated legislation.

In the comparative study, Fitch discloses statistics about the cover pools' credit quality, the extent of maturity, interest rate and currency mismatches between cover assets and covered bonds, as well as levels of over-collateralisation (OC). The report also provides an overview of the Discontinuity Factors (D-Factors) assigned by the agency as part of the roll-out of its covered bonds rating methodology.

The analysed sample represents a Fitch rated outstanding debt of over EUR1trn at August 2007, increased from EUR975bn as of July 2006. The main driver for this expansion is the arrival of newcomers from the US, Portugal and Norway, so that the proportion of German issuers drops to less than half of the 48 institutions included in this study. Among the 61 covered bonds programmes monitored by the agency, 36 are collateralised by mortgage loans and 25 by public sector debt. Contractual covered bonds programmes are increasingly popular, and accounted for six out of 10 new entrants. A new development is that some financial institutions have preferred to set up contractual covered bonds programmes in countries like France, which have a domestic legislative framework for the issuance of covered bonds.

The study confirms expectation that public sector pools generally fare better in terms of average cumulative expected loss than mortgage pools (1.5% vs 6.2% in a 'AAA' scenario). Maturity mismatches between cover assets and covered bonds are particularly high for recent issuers, as they have yet to build a smooth liability curve. On average, variable rate cover assets exceed variable rate liabilities, since covered bonds are traditionally issued at a fixed rate of interest. Likewise, the currency of the cover assets does not exactly match that of the covered bonds. Out of 61 covered bonds programmes, only 28 implement privileged swaps to reduce exposure to adverse interest or currency movements in the event of an issuer insolvency. Average available nominal OC - the ultimate mitigating factor against credit and market risks - stands at an impressive 30.3% and is, on average, higher for mortgage than for public sector covered bonds.

Fitch's covered bonds' D-Factors measure the likelihood of an interruption of payment on covered bonds in the direct aftermath of an issuer event of default. They indicate how far the probability of default of the covered bonds may differ from that of the debtor of recourse, on a scale of 0% (for perfect continuity) to 100% (worst). The D-Factors assigned by the agency so far range from 6.4% to 31.6%. Public sector covered bonds' D-Factor is 7.6% on average - only half the level as mortgage covered bonds. At the same time, contractual covered bonds tend to achieve lower D-Factors (10.5%) than legislative based mortgage covered bonds (15.4%).