Moody’s would view any inclusion of covered bonds in Level 1 assets for liquidity coverage ratios as credit positive, the rating agency said yesterday (Monday), after a German finance ministry representative was reported as saying that covered bonds meeting certain criteria should be treated as high quality liquid assets for the purposes of LCRs.

The rating agency said that the article in Recht der Finanzinstrumente quoting state secretary Jörg Asmussen (pictured) supports an initiative by the Association of German Pfandbrief Banks (vdp) and Association of Danish Mortgage Banks (Realkreditrådet) aimed at gaining better treatment of covered bonds under Basel III. This would remove the 40% cap and minimum 15% haircuts that Level 2 assets – which covered bonds fall under according to the Basel Committee on Banking Supervision’s proposals – for covered bonds meeting certain criteria.

(Please see this article from January for a full discussion of the initiative.)

Moody’s said that, if implemented, the initiative would be credit positive for covered bonds as it would reduce investor losses arising as a result of refinancing risks.

“If some covered bonds have the benefit of an exemption from the 40% cap, this exemption will materially increase and stabilise the potential investor base for these covered bonds and reduce yields,” said the rating agency. “Prospective covered bond issuers with access to a strong investor base, able to fund at low yields, will be more willing to refinance the assets of a troubled issuer meaning that access to, and costs of, refinancing for existing programmes is reduced.

“Refinancing risk is a very significant risk for most programmes due to material longer dated asset/short dated liability mismatches and the difficulty of estimating the price at which a pool can be liquidated.”