Moody’s upgraded 15 European covered bonds programmes yesterday (Wednesday) alongside other positive rating actions triggered by the introduction of a new anchor point for ratings to reflect potential benefits from pending bail-in frameworks.

Volker Gulde, Moody's

The rating agency also placed nine European covered bond ratings on review for upgrade and confirmed three ratings that had previously been on review for downgrade. (See below for a list of the affected programmes.)

Additionally, a further 55 [corrected from 58] covered bond transactions now benefit from a covered bond anchor that is higher than the senior unsecured deposit/deposit rating that was used as a reference point before the criteria change. These covered bonds were not upgraded largely because they were already rated Aaa, or because the ratings were at the respective sovereign ceilings, according to the rating agency.

Bernd Volk, head of covered bond research at Deutsche Bank, said that Moody’s new approach and the related rating actions are generally positive.

“Besides numerous upgrades, OC requirements also went down and buffers in relation to unsecured ratings went up,” he said. “However, given that the new anchor approach was widely expected and given the strong spread tightening in the past 12 months, it is unlikely to have a specific short term market impact.”

The rating agency has amended its covered bond rating methodology by introducing a new departure point for rating covered bonds to reflect that differing treatment of senior unsecured debt and covered bonds under the draft EU directive on bank resolution, the Bank Recovery & Resolution Directive (BRRD). Its new, final approach is consistent with that proposed in a Request for Comment (RFC) initiated in September.

“The current approach is driven by our knowledge that covered bonds, as opposed to senior unsecured debt, will be exempt from bail-in, which allows us to give benefit to the effects this will have,” Volker Gulde, vice president and senior credit officer at Moody’s, told The Covered Bond Report. “While the impact on senior unsecured debt will be detrimental if the probability of default goes up, where there is an adequate level of bail-in-able debt the knock-on effect on covered bonds is positive because the probability of an issuer that is in trouble remaining a going concern increases.”

The uncertainty still surrounding bail-in and other aspects of the resolution directive prompted the rating agency to limit the scope of its criteria update.

“We listened carefully to the feedback but the current approach is driven by the limitations of what we actually know,” said Gulde. “Right now we don’t know what other drivers may appear in due course within the directive and/or respective national legislation to determine what will happen to covered bond programmes, so we kept a relatively narrow focus.”

Moody’s new reference point for covered bonds, the covered bond anchor, will be based on the higher of the issuer’s adjusted baseline credit assessment (BCA) plus up to two notches, or the senior unsecure/deposit (SUR) rating plus up to one notch.

This new approach will be applied across the EU and Norway, but in other jurisdictions the SUER/deposit rating will remain the anchor, according to Moody’s.

The degree of uplift aver an issuer’s adjusted BCA or SUR mainly depends on the amount of bail-in-able debt of an issuer/issuer group (see chart below), with three debt ratio thresholds applied by Moody’s: a debt ratio of less than 5% does not earn any uplift; a debt ratio of 5%-10% generates one notch uplift; and a debt ratio of more than 10% leads to two notches of uplift. The debt ratio is the amount of bail-in-able debt to total liabilities.

“The debt ratio does not impact the covered bond anchor in cases where the SUR already incorporates material levels of government support,” said Moody’s.

In addition to setting out its final rating criteria in response to the treatment of covered bonds under the BRRD, Moody’s yesterday provided more details on how it calculates hedging of interest rate and foreign exchange risks, and on its approach to assigning covered bond ratings delinked from the covered bond anchor.

Citi covered bond analyst Michael Spies said that, as expected, some second tier Italian and Spanish issuers benefited from the introduction of a new departure point for covered bond ratings, but that many of the programmes upgraded by Moody’s were from core jurisdictions.

“We don’t think the rating actions will have a substantial impact on spreads,” he said. “We feel vindicated with our recommendations to prefer Italian Tier 2 names like Banco Popolare and continue to like these names.”

He added that he expects Moody’s to act on Spanish multi-cédulas within the next few days “as a main uncertainty within Moody’s covered bond rating methodology has now been resolved”.

The programmes upgraded by Moody’s are:

The programmes that were placed on review for upgrade are:

The programmes whose ratings were confirmed are:

Debt ratio determines notching

Source: Moody’s