In the event that Greece exits the Eurozone, holders of Greek covered bonds would be protected from redenomination to an extent, according to Moody’s, but it said that uncertainties remain as a result of collateral redenomination and bail-in risk.

Although the rating agency’s base case is that efforts to hold the Eurozone together will succeed, the risk of Greece leaving the euro area and returning to a Greek currency have increased, it said yesterday (Thursday).

In this scenario, investors would be protected from redenomination as all Greek covered bonds it rates are governed by English law and an English court would be unlikely to recognise an attempt to switch payments into a new Greek currency, Moody’s said. By virtue of the country remaining in the EU, Greek courts would be expected to uphold such a decision.

While Greek covered bonds would be likely to remain euro-denominated, mortgage loan repayments would be redenominated into the new Greek currency, Moody’s added. This would likely lead to a sharp fall in the value of cover pool collateral relative to the euro-denominated bonds, meaning the assets may not be sufficient to meet coverage requirements.

Mortgages would also likely be re-indexed to Greece’s new base interest rate, with a resulting spike in interest rates potentially increasing the default rate of mortgage borrowers, the rating agency said. Over 90% of collateral for Greek covered bond programmes carries a floating-rate, according to Moody’s figures.

An average overcollateralisation level of 51% gives the Greek covered bonds rated by Moody’s some protection, it added, meaning a devaluation of the Greek currency against the euro of 34% on average would be required to wipe out current overcollateralisation levels.

Further protection would come from issuers adding assets to cover pools to ensure they meet the required euro equivalent value to avoid default.

“Generally, we consider that issuers would add collateral to avoid default where possible,” Moody’s said, “although we acknowledge this may be difficult in a stressed environment following redenomination.”

However, Moody’s noted that banks’ credit quality would likely be negatively affected by a Greek exit from the euro, increasing the risk of issuers entering resolution.

While the rating agency expects Greek covered bonds to be exempted from bail-in in a resolution scenario, it warned that if the collateral value is lower than the amount of the outstanding covered bonds, the shortfall could still be bailed in.

“If a resolution occurs,” it said, “the relevant issuer will likely have no discretion as to whether to support the covered bonds by adding more collateral; the resolution authorities would then have to make the decision whether to bail-in any collateral shortfall.”