In jurisdictions with stronger sovereigns the credit strength of covered bonds has become less dependent on that of the bank supporting the bonds since the beginning of the crisis, but the linkage has increased in weaker sovereigns, Moody’s said yesterday (Tuesday).

The development is reflected in covered bond ratings’ increased average uplift over supporting banks’ ratings in stronger sovereigns, and a fall in the uplift for covered bond ratings in weaker sovereigns. This is in turn captured by the rating agency’s Timely Payment Indicators (TPIs), which improved slightly in stronger sovereigns and fell markedly in jurisdictions with weaker sovereigns over the same period.

TPI categories in stronger and weaker sovereigns “diverged significantly” since Q3 2009, according to Julie Ng, assistant vice president, analyst at Moody’s

“Over the course of the crisis the improvement in TPIs in stronger sovereigns has had a countercyclical effect, as it has moderated the negative impact on covered bonds of the deteriorating credit quality of the supporting banks,” she said. “Conversely, for weaker sovereigns, the falling TPIs have exacerbated the effects of supporting banks’ deteriorating credit quality.”

Moody’s distinguished between sovereigns rated Aa and higher and sovereigns rated Baa and below, noting that although TPI leeway – the degree to which the credit quality of a covered bond can exceed that of the issuer – fell across both, it shrank only slightly in sovereigns rated Aa and above, in contrast to the situation in weaker sovereigns.

“In weaker sovereigns, the TPI leeway contracted materially as the banking sector and sovereign credit quality worsened more dramatically,” said Ng. “As a result, there are no longer any covered bond programmes in these jurisdictions with a TPI leeway of more than one notch, compared to 75% having a TPI leeway of more than one notch in Q3 2009.”

She pointed out that covered bond ratings’ resilience to issuer downgrades fell suddenly on two occasions, in Q3 2011 and Q1 2012, mainly due to a deterioration in Spain’s creditworthiness.

In countries with stronger sovereigns, such as Germany, France, and Sweden, Moody’s raised the TPIs for covered bond programmes partly because covered bond laws were strengthened and previously contractually-based programmes were brought under the scope of covered bond laws, said Ng.

In weaker sovereigns, Moody’s lowered TPIs due to the reduced capacity of governments to support covered bonds, with the dramatic fall in TPI leeway also fuelled by issuer downgrades.

Source: Moody’s