Moody’s yesterday (Monday) downgraded five Greek covered bonds because of an increased likelihood and severity of Greece defaulting on its debt and the implications of such a default for Greek covered bonds.

Covered bonds issued by Alpha Bank under its direct issuance programme, mortgage bonds issued by EFG Eurobank Ergasias (EFG) off programme I, mortgage covered bonds issued under programme I of National Bank of Greece (NBG), and covered bonds issued off NBG’s programme II were cut from Ba3 to B1. EFG’s programme II covered bonds were cut from B1 to B2.

Moody’s said that in the event of a disorderly default by Greece, “the functioning of the banking system and the state would be materially impaired, and the economy would very likely experience a further sharp contraction”. It would also increase the likelihood of Greece exiting the euro area, accompanied by a return to a deeply devalued national currency, according to Moody’s.

The rating agency noted that while such an event is not its central scenario, the probability of a default occurring is rising. In that event, the ability of Greek borrowers to repay their debts would weaken significantly, beyond that already assumed. Moody’s has concluded that no Greek covered bond could be rated higher than B1 even taking into account the low likelihood of this scenario.

Moody’s noted that Greek covered bond documentation is governed by UK law and that in the “remote” event of a redenomination in Greece, the underlying assets backing the covered bonds could be converted into a new national currency while the rated notes remain in euros.

“In this scenario, and for a given asset performance level, notes will suffer different levels of losses arising from the redenomination risk, depending on the credit enhancement levels,” said the rating agency.

The programmes were downgraded to B1 or B2 depending on the amount of non-euro denominated assets in the cover pool. EFG’s programme II covered bonds were downgraded to B2 as the vast majority of the loans are denominated in Swiss francs. The rating agency noted there is a limited share of these loans in the other cover pools, explaining the B1 ratings on the other four programmes.

The Timely Payment Indicator (TPI) assigned to Alpha’s covered bonds, EFG’s programmes I and II and NBG’s programme II is “improbable” and the TPI assigned to NBG programme I is “very improbable”.

The TPI leeway for all five programmes is limited, meaning a downgraded of the issuer ratings may lead to a further downgrade of the covered bonds.