Some covered bond issuers are choosing to buttress current covered bond ratings rather than committing collateral to achieve higher ones, says Moody’s, with senior credit officer Alexander Zeidler explaining that cost is not the only consideration as investors focus on downside risks.

In a report published on Tuesday, Moody’s said some European covered bond issuers have over recent years managed their programmes with a view to consolidating the credit strength of their covered bonds at current rating levels rather than progressing to higher, achievable rating levels. By doing so, issuers have developed more robust ratings for their programmes, said Moody’s.

“Some European covered bond issuers appear to have favoured a lower covered bond rating that is less sensitive to a weakening of the issuer’s credit strength over a higher rating that would be more tightly linked to the issuer’s credit strength,” it said.

Moody’s said considerations relating to collateral management may have led some issuers to do this. An issuer that chooses not to push for a higher rating will not need to add as much collateral to its cover pool to maintain the covered bonds’ credit strength in the event of a deterioration in the issuer’s credit strength.

“This may be a consideration for issuers that are subject to limits on asset encumbrance or a requirement to maintain a stock of unencumbered assets against which secured funding can be raised in times of market stress,” the rating agency said.

It also acknowledged that issuers weigh the costs and benefits of progressing the highest achievable rating, with the costs steeper at the top of the rating scale.

“Such decisions may particularly be an issue when considering the progression from Aa1 to Aaa, because the reduction in the expected loss rate is materially greater than the reduction associated with other single-notch progressions,” said Moody’s.

Using hypothetical examples, the rating agency noted that for a programme with a CR assessment of A3, a one notch upgrade to Aa1 would involve a collateral cost of 1.5%, while a one notch upgrade to Aaa would cost 9.5%.

Alexander Zeidler, senior credit officer at Moody’s, said cost was not the only consideration that issuers are taking into account.

“We have the impression that issuers and investors are still very often looking at downside scenarios, and it’s not only about the cost of, for example, going from a Aa1 to a Aaa rating,” he told The Covered Bond Report. “Rather, the question for issuers and investors might be that if there is another downside scenario in the future and the issuer rating is under pressure, how difficult is it to defend the covered bond rating?

“What we have found talking to investors is that if a covered bond is rated double-A, for example, they still find it quite attractive if it means it is a more resilient rating level, against these kind of downside scenarios. I think that is because the financial crisis is still on people’s minds.”