Standard & Poor’s could cut 15% of the covered bond programmes it rates and raise 10% after having finalised threefold changes to its methodology, which take into account, among other developments, BRRD, and which alter the way jurisdictional differences are reflected.

The changes to S&P’s criteria, announced on Tuesday of last week (9 December) come after the rating agency launched three RFCs in June, on: covered bond criteria; methodology and assumptions for assessing portfolios of international public sector and other debt obligations backing covered bonds and structured finance securities; and updated cashflow assumptions for modelling certain covered bonds.

The rating agency said that it expects 25% of its covered bond ratings to change upon the joint application of the three updated criteria, assuming that issuing banks take no mitigating action, with 15% being lowered, by an average of 1.5 notches, and 10% raised, by an average of 1.6 notches.

A key change in the covered bond criteria is the introduction of a reference rating level (RLL), which revises the starting point of S&P’s analysis and the maximum achievable covered bond rating — a move driven by the introduction of the Bank Recovery & Resolution Directive (BRRD) in the EU in April.

The RRL is the greater of S&P’s issuer credit rating (ICR), and the ICR minus notches of uplift incorporated in it to reflect extraordinary government support (the adjusted ICR) plus one or two notches, depending on the systemic importance of the respective covered bond programmes.

“This notching recognises that resolution regimes such as the BRRD increase the likelihood that the issuer could still service covered bond liabilities without reverting to a sale of assets in the cover pool, even after writing down or stopping payments to senior unsecured obligations,” said S&P, adding that in jurisdictions without BRRD-like regimes the RRL is equal to the ICR.

S&P will then factor in jurisdictional support to arrive at a jurisdiction-supported rating level, and, further, analyse support from the collateral to arrive at the maximum achievable covered bond rating.

The rating agency in September published preliminary assessments of jurisdictional support – which range from Weak, through Moderate and Strong, to Very Strong, and associated zero to up to three notches of uplift – for different covered bond frameworks, and it said that it will publish an update on this to reflect the final criteria. The new jurisdictional support levels replace S&P’s previous country classifications, which ranged from 1 to 3.

Up to four notches of uplift above the jurisdictional support rating level can be given to arrive at the maximum achievable covered bond rating, depending on the coverage of credit risk and of refinancing costs and the jurisdictional support uplift applied. This collateral-based uplift can, however, be notched down up to two notches depending on whether short term liquidity risk is covered and upon the level of commitment to maintaining overcollateralisation.

The covered bond rating will then be arrived at after factoring in counterparty risk and country risk.

The updated criteria are effective on 1 January and S&P said that it intends to complete its review of affected ratings in the following six months.