Scope released a first covered bond rating methodology today (Thursday), with the asset class’s exemption from bail-in cited as the rationale for six out of a potential nine notches of uplift over issuer ratings being accounted for by an analysis of legal and resolution frameworks.

The rating agency published its first bank ratings in April last year and hired Karlo Fuchs (pictured), former senior covered bond analyst at Standard & Poor’s, as head of covered bond ratings in October.

Scope said today that its proposed methodology reflects the enhanced credit protection available to covered bonds compared with other financial institutions debt issuance following the implementation of the EU Bank Recovery & Resolution Directive (BRRD) and similar regimes in other European countries.

“The chain of events leading to recourse to the cover pool is extremely improbable under a post-crisis resolution regime,” the rating agency said. “Covered bonds have not defaulted over the last centuries and the bail-in framework further enhances the likelihood of ongoing performance.

“Scope nevertheless recognises that the credit quality of cover pools differs significantly from one issuer and covered bond type to another,” it added. “In addition, the management of risks varies according to the issuer’s degree of management discretion.”

The anchor point for the rating agency’s analysis will be banks’ Issuer Credit Strength Ratings, and Scope will then allow up to two notches of uplift based on its analysis of legal frameworks and up to a further four notches for the resolution regime, and then up to three extra notches based on its cover pool analysis.

Given the potential nine notches of uplift, banks rated BBB- or higher would therefore potentially be able to achieve AAA ratings with their covered bonds subject to satisfying Scope’s requirements.

“The proposed methodology reflects our fundamental view that the new regulatory environment provides sufficient support for investment grade banks to issue covered bonds up to the highest rating levels,” said Fuchs.

“Analysis of the covered bond issuer and assessment of the resolution framework applicable to it are the lynchpin of Scope’s covered bond analysis,” he added.

The established rating agencies have been updating their bank and covered bond rating methodologies to take the BRRD into account and Fuchs told The CBR that in this respect Scope has benefited from only entering the rating business more recently.

“The difference to the other rating agencies is that when we started doing our bank ratings last year we had the benefit of starting with a blank slate and already having the resolution regime not only on the horizon but close to being signed, so we could already incorporate that,” he said. “We didn’t have all the legacy issues about systemic support to deal with and really were able to start with a fresh look.”

The rating agency said it will not take a “mechanistic” approach to country and counterparty risks, and hence there will not be sovereign rating caps – although it noted that it will factor in dependency on key counterparties and sovereign credit fundamentals into its cover pool analysis.

“While macroeconomic factors play an important role in Scope’s rating analysis, the agency believes that the credit quality of a sovereign is not a suitable basis for imposing a rating cap, particularly in Eurozone countries, as it does not allow for an adequate relative ranking of covered bonds’ credit quality,” it said.

Scope said it plans to issue subsequent documents providing further details on the assumptions and stresses applicable to assess various types of cover pool and other structural risks. It has asked for comments on the proposed covered bond rating methodology released today by 3 April.

“We offer market participants a different and fresh analytical view,” said Fuchs. “We provide a European perspective to investors and aim to be the European rating alternative.”