Covered bonds from downgraded sovereigns have been on average cut by 10 times as many notches as those from stable sovereigns, according to data in a Moody’s study of how the rating performance of covered bonds compares with those of sovereigns and issuers.

Moody’s found that in countries where sovereigns have been downgraded covered bonds suffered an average 4.2 notch downgrade, whereas in countries that had remained stable they had only fallen by an average of 0.4 notches (see charts below for distribution). The respective average issuer downgrades were 5.6 notches for those from downgraded sovereigns and 2.0 for those from stable countries.

“In contrast to the performance of covered bond ratings in downgraded sovereigns, bond ratings in sovereigns whose ratings have remained stable have experienced an equivalent migration that is less than half a rating notch,” says Volker Gulde, senior analyst, Moody’s.

“Sovereign downgrades may affect covered bond ratings both directly and indirectly. The direct relationship acts to lower the TPIs, thereby limiting the uplift from which a covered bond rating may benefit, over and above the issuer rating; whereas, indirectly, sovereign downgrades typically lead to issuer downgrades.”

Moody’s noted that a weaker sovereign implies that the government and financial institutions of that country may be less able and/or willing to provide or obtain funds to support the refinancing of covered bonds after an issuer default.

Covered bond ratings were much more stable than issuer ratings in countries where sovereigns were not downgraded, with only 22% of covered bond programmes facing downgrades compared with 80% of issuers, and only 1% of covered bonds being cut by four notches or more versus 15% in the case of issuers.

In countries that faced sovereign downgrades, 65% of covered bonds were downgraded. Half were cut by four notches or more, compared with 83% of the sovereigns suffering such downgrades and 61% of issuers.

The analysis covers those covered bond programmes Moody’s rates and rating changes from 1 January 2008 to 6 February 2012.

Ratings migration of covered bonds and issuers in sovereigns with stable ratings

Includes covered bonds from Austria, Denmark, Finland, France, Germany, Netherlands, Poland, Sweden, UK

Ratings migration of covered bonds and issuers in downgraded sovereigns

Includes covered bonds from Hungary, Iceland, Ireland, Italy, Latvia, Portugal, Spain

Source: Moody’s