S&P is set to join Fitch and Moody’s in revising its covered bond rating methodology to reflect the EU bail-in framework, a move analysts expect to be positive for the asset class even as issuers come under pressure from less assumed sovereign support.

Standard & Poor’s announced its intention to change its covered bond rating criteria yesterday (Tuesday), citing developments such as the introduction of an EU bail-in framework as the impetus for the move. It did not disclose proposed new criteria, but said that it “expects to publish in the near future a request for comment describing our proposed criteria changes”. It expects that the new criteria may lead to some covered bond rating actions, it added.

S&P is the last of the three major rating agencies to modify its covered bond rating methodology to reflect the pending implementation of the European Bank Recovery & Resolution Directive (BRRD). Moody’s was the first to do so. The BRRD provides for the possibility of senior unsecured debt being written down to avoid a taxpayer bail-out of a bank in difficulty, and exempts covered bonds from a so-called bail-in.

S&P had been expected to join the other rating agencies in making changes to reflect this preferential treatment, and yesterday’s announcement therefore did not come as a surprise to analysts.

“It was clear that they were going to have to move in line with Moody’s and Fitch,” said one. “To me it was a matter of ‘when’ rather than ‘if’.

“There have been fundamental changes in the environment for covered bonds and they have to reflect that.”

While Moody’s and Fitch were happy to move earlier on criteria changes despite the BRRD not being finalised, S&P’s decision to proceed with a revision of its covered bond criteria appears to have been triggered by the approval of the BRRD by the European Parliament on 15 April.

In addition to giving advance notice of the planned covered bond criteria change, S&P yesterday announced various rating actions on European banks following a review of government support, and in this context referred to the parliamentary vote as “a key milestone”.

“European regulators have been working to implement resolution frameworks for some time,” said S&P. “However, we consider that a key milestone in this process was the European Parliament’s approval of the EU Bank Recovery & Resolution Directive on April 15, 2014.

“Importantly, the bail-in power for senior unsecured liabilities and associated requirement to mandatorily bail-in a minimum amount of liabilities will be implemented on January 1, 2016,” it added. “This is within our two year rating horizon for investment grade companies.”

The issuer rating actions are a consequence of S&P taking the view that European banks are less likely to receive extraordinary government support given these resolution frameworks.

The rating actions taken as a result of S&P’s changed view of government support are: outlooks on 15 banks revised from stable to negative, upgrades of two banks, negative outlooks on 38 banks maintained, stable outlooks maintained on 15 banks, and five banks remain on CreditWatch with negative implications.

Limited impact from sovereign support flux

Maureen Schuller, head of covered bond strategy at ING Bank, said that the removal of government support from issuer ratings by S&P will have limited impact on covered bonds given the rating agency’s intention to modify its covered bond rating criteria.

“Even if government support is going to be removed from the issuer credit rating, acknowledgement of the preferential treatment of covered bonds under a bail-in scenario and going concern consequences of such a bail-in may form a future additional rating cushion against negative rating changes for the issuer,” she said.

Another analyst came to the same conclusion, saying that most of the 15 banks whose outlooks were changed to negative still have leeway built into the ratings of their covered bonds.

“Only Deutsche Pfandbriefbank is at the maximum uplift, so even if S&P were to reduce the sovereign support somewhat most of these programmes wouldn’t be directly impacted,” he said.

Schuller also noted that of the 15 bank entities put on negative outlook yesterday by S&P, only five have covered bond programmes rated by S&P: ABN Amro, Barclays, ING, Deutsche Pfandbriefbank and Swedbank.

The Dutch covered bond programmes have a one notch cushion against an issuer downgrade, which matches the one notch uplift in the issuer credit ratings for sovereign support, according to Schuller.

She noted that although S&P indicated that the removal of government support expectations could lead to a downgrade of Swedbank by one notch by the end of 2015 but that Swedbank Mortgage covered bonds’ S&P rating “have ample protection against such a removal” given a three notch buffer.

Barclays’ covered bond programme, meanwhile, could withstand a one notch downgrade of the issuer rating before its rating would be affected, according to Schuller.

“Deutsche Pfandbriefbank benefits from a one notch sovereign support uplift in its issuer credit rating and would consequently be immediately affected by a one notch downgrade as a consequence of a removal of this one notch uplift,” she added.

Danske Bank was one of two European issuers upgraded by S&P yesterday, from A- to A, and Schuller said that its covered bond rating is also protected from any negative rating action stemming from changes in S&P’s future sovereign support assumptions.

“This underscores that even if the aforementioned programmes would not benefit from the upcoming proposed changes to S&P’s rating methodology with respect to covered bonds, a forthcoming removal of the sovereign support assumptions from the issuer credit ratings ahead of 2016 is unlikely to have significant rating implications for the covered bond programmes of these issuers.”