Eichert, CA-CIB: Covered bonds should be anchored to the issuer rather than the unsecured rating. The link to the issuer exists because covered bonds need a sponsor that is there to support the programme. With bail-ins of senior unsecured becoming possible we could have the situation where senior is bailed in but the bank continues to support the covered bonds. Unsecured is therefore not the correct starting point anymore. Rating agencies will have to rethink the way they award bank ratings with de-linkage between senior and issuer rating, and covered bonds being linked to the issuer rating.
This should mean that covered bonds don’t move as drastically as they are moving at the moment. The problem is simply that agencies are not going to move before they have a final resolution framework text. Some peripheral bonds could thus be downgraded to junk only to be upgraded again later when the agencies eventually get round to changing their methodology.
EUROWEEK: Are the rating agencies too strict?
Juhasz, World Bank: You can argue it both ways but from an investor’s perspective, I prefer stricter scrutiny from the agencies.
Denger, MEAG: Stricter rating methodologies are more justified on the unsecured side given the impact of bail in regulations than they are on the covered bond side given their exclusion from bail-in.
Heberlein, Fitch: Our latest criteria change was in September 2012, it became not so much stricter, but more specific. We’d been downgrading covered bonds in line with the sovereign crisis for systemic reasons, but the criteria were initially developed at a time when European sovereigns were very stable. So when this was no longer the case, the criteria had to be clarified. In a way it’s not so much that the criteria became stricter, it became more explicit regarding the influence of systemic risk.
Systemic risk is perverse because it affects several parameters at the same time. Bank ratings go down, interbank liquidity dries up, and as macroeconomic conditions deteriorate, cover pool performance worsens both from a probability of default and loss given default perspective. This means there is downward rating pressure on the covered bonds from several sources.
Lavastre, CDC: The credit rating agencies take account of the covered bond market’s dual recourse structure in their rating methodologies and use the issuing financial institution’s unsecured liabilities rating as the starting point and floor for their covered bond ratings. So without an implicit support from the sovereign, banks should be downgraded.
Cortazar, BBVA AM: I would like to see rating agencies become more transparent and believe they should try to simplify their rating methodologies, not just in covered bonds but across other asset classes such as MBS. The fact you often see very different ratings for the same deal shows just how complex ratings have become. I would like the agencies to co-ordinate their approaches and try to qualify why they arrive at different ratings.
Eichert, CA-CIB: S&P views multi-Cédulas like a CDO and prefers to see a bigger liquidity line the greater the concentration of underlying entities. But what they’re completely ignoring is that the bigger entities are actually better rated than the smaller ones which are more likely to default. They look pretty closely at the biggest individual exposure and assess how large the liquidity line needs to be relative to that. It doesn’t make any sense.
On the swap counterparty side the outcome could have been a lot worse than it actually has so the market may have dodged a bullet there. But they’re still overdoing it as counterparty risk is something that should be dealt with through OC and not through linking covered bonds to another entity.
Heberlein, Fitch: We do differentiate between the swap provided within the banking group and that which is provided by a third party. Because covered bond swaps tend to rank pari passu with covered bonds, investors could be at risk should a termination payment be due post issuer default. Termination payments could put a drag on liquidity, as the cover pool would need to pay the market value of the swap at a specific point in time, or else this would cause a cross default.
But it’s notable that Spanish programmes never had privileged swaps. The two recent Belgium programmes also have no registered swaps. They have fixed and floating rate assets and fixed rate covered bonds — but no swap in between. That makes it easier for issuers, but it also means there is more interest rate risk, which leads to comparatively higher break-even overcollateralisation for a given rating.
EUROWEEK: The rating agencies regularly update and tweak their assumptions but do you think they should change their methodologies that often?
Juhasz, World Bank: They definitely have to because the market is dynamic. We have new asset classes, for example, these SME covered bonds, we have new regulations and the market landscape is always changing. So the agencies have to follow these developments. They shouldn’t be behind the curve but I’m not sure that they have to be ahead of the curve either.
Burmeister, DeAWM: We are in a difficult economic environment and therefore ratings are likely to go down, that’s fair enough. But I sometimes find it difficult to understand some rating actions, especially when agencies don’t keep to their own methodology. For example, we have seen occasions where Spanish covered bonds were not downgraded to the extent they should have been in the aftermath of the sovereign’s downgrade. And in the case of the UK’s Co-operative Bank, Moody’s raised its Timely Payment Indicator so the bank’s covered bonds would remain investment grade even though they downgraded the bank to Caa1.
Heberlein, Fitch: Formally we review our criteria annually but that does not necessarily mean we decide on changes, though we are always considering adjustments in terms of stressed assumptions, such as for cover assets default and recovery expectations. Larger changes in the framework are less frequent. For example in 2009 we reassessed liquidity risk and gave more weight to the liquidity gap section of the Fitch discontinuity factor.
This was tweaked in September 2012 when we replaced the discontinuity factor with a discontinuity cap. The D-factor gave the impression it was a very scientific measure, whereas in fact it was a qualitative judgement expressed in a quantitative way. Now we say the same thing in the form of notches. But this was more of a cosmetic change, the main change was the integration of systemic risk consideration as part of the liquidity gap assessment.
Lavastre, CDC: We need stability in methodologies as otherwise it means investors don’t have the possibility to make investments with ratings evolving continually.
Prokes, BlackRock: Many rating moves can be anticipated though some are surprising and sometimes even in a positive way. And if you are holding a covered bond that is prone to go down to sub-IG, it’s daft to say you didn’t see it coming. Sometimes the moves are surprisingly positive, sometimes they are surprisingly negative, but the volatility is quite well defined.
Denger, MEAG: If the market shows significant change then methodologies should be updated to mirror the current picture. But downgrading unsecured bonds due to the increased risk of bail-in and not reflecting these changes in covered bond ratings, which are excluded from bail-in, is not a good thing. Agencies should think of the anchor for covered bond ratings.
Prokes, BlackRock: Rating agencies should update their methodologies as often as they like, I have no problem with that. They are a useful resource for investors, but that’s where it, many times, stops. There is a value when I look at a core market in terms of the information I get between a triple-A and a double-A rated covered bond but when I look at sub-investment grade covered bonds, I don’t think there is any new information that I can get from the rating.
The way bail-in seems to be playing out, it should make some rating agencies consider ways of delinking the covered bond rating from senior rating. One way they could achieve that is to look at the deposit rating of the institution, or if they don’t want to change their methodology completely, adjust some assumptions behind the senior to covered rating uplift.
What bail-in tells me is that you should see a wider notching for a very distressed institution such as a peripheral bank which is rated single-B on the senior side and double-B on the covered bond side.
But for large systemically important banks in Europe’s core there should be much less of an impact because the probability of the issuer defaulting is likely to be low.
Burmeister, DeAWM: Agencies need to update their methodology from time to time but on the other hand they need to show comparability and consistency over time and over the rating cycle. If the methodology changes often it’s difficult to make a dependable assessment over a period of time. I don’t mind if they change some parameters, such as the assumption with regard to loan losses, but you have to start questioning what happens to consistency and comparability when the methodology is changed again and again.
Lavastre, CDC: Some countries are more affected than others by the European crisis. The peripheral countries are likely to struggle with high unemployment which is not sustainable. They will have to reform their labour market and find new ways to stimulate growth.