Moody’s has published an update to its covered bond rating approach to explain in more detail areas of its methodology that have played a greater role in an environment of lower issuer and sovereign credit strength, such as how it applies its TPI analysis to sub-investment grade rated issuers.

The rating agency on Monday published an updated covered bonds rating methodology, which it said does not contain any changes to its global approach to rating covered bonds as currently applied and will not affect any ratings. The report supersedes a 2010 version, itself an update of an original report first published in 2005 to provide more information on certain aspects of Moody’s methodology.

However, a rise in prominence of certain aspects of Moody’s methodology “following credit developments in recent years”, in its words, prompted the rating agency to amend its report to provide more information on these areas.

These areas include: overcollateralisation (OC), Timely Payment Indicator (TPI) analysis with reference to sovereign and financial system risks and lower rated issuers, and assessment of cover pool credit quality in jurisdictions where a Aaa rating cannot be achieved.

According to Moody’s these areas have recently played a greater role in its analysis as its methodology has increasingly been applied in an environment of lower issuer and sovereign credit strength.

LBBW senior credit analyst Alexandra Hauser said that although Moody’s is not making any fundamental changes to its methodology minor adjustments and explanations give the rating agency more room for observations and ratings on a case-by-case basis.

“Ratings in peripheral countries are likely to have been one of the main drivers for this move,” she said, “in particular as many covered bond programmes in these countries remain under high rating pressure.”

The first area that was updated in its report, said Moody’s, is OC, in particular committed versus uncommitted OC, with the rating agency in its report explaining the role of OC in its analysis, how it determines whether OC is committed or uncommitted, and the circumstances where the rating agency may give full, some or no value to uncommitted OC.

Given an increase in the number of issuers rated Ba1 and lower, Moody’s has also amended the report to include rating bands in its TPI table to clarify the range of likely rating outcomes for these issuers’ covered bonds.

Moody’s TPI table (article continues below)

According to Moody’s the bands reflect the possible need for a more detailed and flexible case-by-case analysis to determine the final position of the TPI cap achievable for issuers rated below Baa3.

“A reason for this is that, for lower rated issuers, we may conclude that they are less able to manage the credit risks in a covered bond than higher rated issuers,” said Moody’s. “As a result, our analysis for lower rated issuers relies more on the credit position of a covered bond in its current circumstances.”

It said that the rating agency in general seeks to apply an analysis that is sufficiently flexible to take account of any relevant factors, and that the bands indicated by the TPI table give guidance but, as with all ratings indicated by the table, are not definitive.

Moody’s also noted that the application of its TPI analysis to sovereign and financial system risk has played an increasing role in covered bond rating actions, and that it therefore updated its report to discuss in more depth how these risks impact its TPI analysis. According to Moody’s, the report explains that in jurisdictions where sovereign credit weakens, the government may be less willing or able to extend support for covered bonds, while the country’s financial institutions may also be weakened and less able to provide support. Together this presents a potential threat to timely payment of the covered bonds if they need to be refinanced following an issuer default.

Another area that was updated concerns cover pool credit quality, with Moody’s saying that it clarified the meaning of a collateral score where the highest achievable covered bond rating in a country is lower than Aaa.

“Where the highest achievable rating in a country is capped below Aaa, collateral scores will be calculated by reference to the theoretical expected loss that is consistent with the maximum achievable rating in the relevant jurisdiction,” it said.

The credit quality of the assets in the cover pool is one of the main inputs into Moody’s expected loss (EL) model, which forms step one of the rating agency’s covered bond rating process, followed by a TPI analysis. A collateral score based on several assumptions and considerations captures the cover pool quality.

The Moody’s report can be accessed here (log-in required).