Support for covered bonds has so far outweighed credit negatives that issuers’ discretion over their programmes could imply, according to a Moody’s official, who also said that it is too early to determine what impact bail-ins could have on its methodology.

Nicholas Lindstrom

In a Q&A prefacing a new covered bond compendium publication released on Monday, Nicholas Lindstrom, senior vice president – covered bonds, at Moody’s, was asked how the rating agency takes into account the large amount of discretion issuers enjoy over the credit quality of their programmes.

“The short answer is that we penalise the programme’s rating for certain actions that could be detrimental to the pool, but give limited uptake for positive actions,” said Lindstrom.

He highlighted several ways in which the rating agency has to reflect worst case scenarios into its analysis and said that an issuer’s discretion could therefore be seen as a credit negative.

“But an important benefit of a covered bond programme is that the issuer can support the covered bond programme if it wants to,” he added. “And to date the positive credit impact of issuers adding further support to their covered bond programmes has more than outweighed any potential negative credit impact stemming from issuer discretion.”

Lindstrom also addressed the question of whether bail-in frameworks being developed might make Moody’s reconsider whether it is appropriate for senior unsecured ratings to be the correct reference point in determining the likelihood of investors having to rely on a cover pool to be repaid.

“The argument you’re referring to is that, in a post-bail-in world, the likelihood of a default of the issuer supporting the covered bonds won’t reflect the likelihood that investors will need to rely on the assets in the cover pool,” he said. “This is because after a bail-in, the issuer can continue to service the covered bonds.

“This assumes that secured debtors won’t be bailed in, and most of our discussions so far suggest that secured debt will be excluded from bail-ins. So it may not be right to assume that a default of the issuer supporting the covered bonds is the point at which investors have to rely on the cover pool.”

But Lindstrom said that it is not yet known what the final details of all resolution regimes that incorporate burden-sharing will be.

“What’s crucial is that we’ve seen little guidance on whether the covered bond programme of a distressed institution will be allowed to continue as part of a potentially functioning post-resolution entity,” he said. “In those cases, we’d consider how to give credit for that in our analysis.”