OREANDA-NEWS. Negative interest rates and the end of hard bullets are among the topics that Fitch Ratings analysts will discuss at the Euromoney/ECBC covered bond congress 2016 that takes place in Dusseldorf tomorrow. These issues are representative of the changes which financial markets at large and the covered bonds segment in particular are facing.

Following similar trends first witnessed in euro-denominated money market funds and global sovereign debt, covered bonds are also witnessing the effect of negative policy deposit rates.

"Fitch cash flows modelling for covered bonds tests the programmes' resistance to prolonged period of negative interest rates in countries where short-term rates are already in negative territory," says Helene M. Heberlein, Managing Director in Fitch's covered bonds analytical team. The breakeven overcollateralisation for a given rating published by the agency results from the worst case between low and high interest rates stress scenarios.

Once predominantly offering hard-bullet redemptions, covered bonds programmes have gradually embraced maturity extensions upon certain conditions, generally for a 12-month period (so-called soft-bullets), or increasingly, for longer than the maturity of all cover assets (so-called conditional pass-through covered bonds). Conditional pass-through covered bonds are designed to eliminate maturity mismatches between assets and liabilities. They are popular with issuers since they attract a higher rating uplift than other covered bonds, up to a maximum 12 notches above the issuer rating under Fitch's methodology.

However, protection against payment interruption is not uniform among these pass-through programmes, according to Cosme de Montpellier, Senior Director in Fitch's covered bonds analytical team. In particular, Fitch's view on the effectiveness of reserves to cover interest payments upon an issuer event of default and over potential grace periods before the enforcement of the recourse against the cover pool may lead to a higher discontinuity risk assessment and a lower rating uplift. These aspects tend to be more strictly defined in programmes where a special purpose vehicle holds the cover assets, similar to structured finance transactions.

Fitch publicly rates 127 programmes, of which 52 have a soft bullet redemption profile, 33 have a hard bullet redemption profile, 22 have a conditional pass-through redemption profile and 20 have covered bonds outstanding with a mix of redemption types.