A UniCredit Bank Austria move to implement a zero floor on its floating rate mortgage loans means there is a lower risk that interest income from cover assets will fall below the amount owed to covered bondholders, Moody’s has said, with an analyst citing several factors that could influence the extent to which negative rates might be an issuer for others.

Moody’s on Thursday said UniCredit Bank Austria’s (UCBA) clarification to its mortgage customers in February that all its floating rate mortgage loans are floored at zero improves the covered bond programme’s cashflow, ensuring that the cover pool generates sufficient income to pay covered bond investors in an environment where some reference interest rates have turned negative.

“The share of floating rate assets (85%) in UCBA’s cover pool is higher than that of floating rate covered bonds (30%),” Moody’s noted. “Without the zero floor, there would be gradually less interest income from the assets in the cover pool as interest rates decrease below zero, eroding the margin buffer available to ensure interest payments on the covered bonds, if the issuer is unable to pay the interest.”

Moody’s analysts said that Bank Austria’s announcement will mostly affect Swiss franc-denominated loans, noting that of its cover assets 20% are Swiss franc-denominated, and the relevant reference index is already below zero. It is also relevant to the remaining euro-denominated 80% of collateral –as most of these loans are also floating rate linked to Euribor.

Among other Austrian issuers, the level of risk presented by negative rates varies depends on many factors, Alexander Zeidler, senior analyst at Moody’s, told The CBR.

“One difference is the extent of exposures to loans in Swiss francs,” he said. “For now, when you look at the Swiss Libor versus Euribor, it is simply already more negative. This exposure varies from one country to the next as well.

“What also makes a difference is the composition of cover pools and the margins on the loans,” he added. “If you have a loan which is overall more risky, that has a higher margin initially, then at least in this respect it is actually better, because it takes longer for it to become negative. So overall when you have a cover pool which has for example a lot of commercial, there’s probably a higher margin overall than a pool comprising public sector or residential debt.”

Other differentiating factors include differences in loan contracts, in AGBs (general terms and conditions), and in the actions taken by issuers to tackle the risk, said Zeidler.

Outside Austria, the level of risk varies depending on the quantity of loans linked to other reference rates, he said, citing Portugal, Spain and Italy as jurisdictions where Euribor-linked loans are common.

“The topic itself you would think should be very homogenous, because you have the Euribor and that’s it, it should always be the same,” he added. “But actually, it is quite different. For example, it would depend on the time frame that the Euribor is actually fixed at. At least when you look at it now, one month Euribor is different from 12 month Euribor.

“I think it also a bit of a question of the vintages – for example, in Austria, Swiss franc loans are more directly affected, but these loans have stopped being originated. And then there is the question of how much freedom banks have in individual countries, or under individual loan contracts, or individual regulations, to reset either completely away from Euribor or maybe to reset the margins.”

Moody’s also noted that, because UniCredit Bank Austria’s zero floor was not explicitly specified in initial loan contracts, borrowers could challenge in court the legal validity of the action, meaning a degree of implementation risk remains, even if legal arguments support its move.

The covered bonds are rated Aa1, on review for upgrade, while UniCredit Bank Austria’s Baa2 deposit rating is on review direction uncertain, and its ba1 adjusted Baseline Credit Assessment on review for downgrade.