A Bank of China “green covered bond” being marketed by the state-owned institution has been awarded one notch of uplift over the issuer by Moody’s, which assigned it a provisional Aa3 rating today (Wednesday), noting several weaknesses versus traditional covered bonds while providing details of the structure and collateral.

Announced on Monday of last week (24 October), the deal is the first from China to be touted as a covered bond, with the country having no special legislation for the product. A roadshow was held last week for a planned three year US dollar Reg S issue off a new $5bn MTN programme.

Bank of China (BOC) has a Counterparty Risk (CR) assessment of A1 and this was cited as a key strength of the transaction alongside the dual recourse nature of the bond and its collateral.

According to Moody’s, the provisional collateral backing the bond is 97.7% comprised of climate-aligned bonds of two issuers, China Railway Corporation and Shanghai Pudong Development Bank Co. Overall, 11 bonds from six issuers are included as collateral.

The provisional cover pool value, based on par value, is RMB6.79bn ($1bn, based on an exchange rate of RMB6.79/USD that Moody’s uses, or Eu909m) and overcollateralisation is 100%, implying a deal size of some $500m. The rating agency modelled a “relatively high” stressed level of collateral losses of 36.85%, saying this is “because the portfolio is highly concentrated, the credit quality of the issuer and that of the collateral pool can be highly correlated, and the characteristics of the collateral pool can change within a relatively short period of time”.

The lack of covered bond legislation or true sale of collateral to a separate entity to support segregation of assets from the issuer’s bankruptcy estate were cited by Moody’s among legal uncertainties around the enforcement of the collateral pool.

The above negative aspects of the collateral and weak ring-fencing were cited among key weaknesses alongside potential reduction in the value of the collateral relating to various factors including currency, set-off, commingling, present-value and refinancing losses. For example, there is no liquidity reserve, there is no hedge to mitigate the mismatch between the renminbi collateral and US dollar issuance, and the enforcement of security can be suspended in case the bankruptcy or reorganisation process of the issuer has begun.

“The rating of the secured notes will be highly linked to the long-term counterparty risk assessment of BOC because of the weak asset ring-fencing protection when compared with traditional covered bonds,” said Moody’s, “and in view of the various risks in the transaction as explained in the preceding paragraphs.”

It limited the uplift from BOC’s A1 CR assessment to one notch, with the Aa3 rating in line with the foreign and local currency ceilings. The Timely Payment Indicator (TPI), which does not constrain the rating, is “very improbable”.

Photo: Shanghai Pudong Development Bank offices in the HSBC Building, Shanghai; Credit: Dan Lundberg/Flickr