Northern Rock Covered Bond Program At Risk
—Daniel Flatt & Hugh Leask
The threat of a ratings downgrade on Northern Rock could potentially spell the end of future covered bond issuance for the beleaguered bank, which derives 18% of its funding from covered bonds. Moody’s Investors Service placed the bank’s Aaa covered bond program on watch for potential downgrade following the agency’s decision to do the same on its 'Aa3' long-term bank deposit rating. A downgrade could force the bank to cough up more collateral for its £8.6bn ($17.7 billion) covered bond program, money it may be hard-pressed to raise. “Until there’s clarity, Northern Rock won’t be back. If they can keep their Aaa rating they might be able to keep doing their covered bonds, but the covered bond rating is dependent on the unsecured rating,” said one official who declined to be named.
Northern Rock’s covered bond program is sensitive to its bank rating because the bank acts as a basis and interest rate risk swap counterparty for the program. Any downgrade on the bank’s unsecured rating would force the bank to find another guarantor or cough up collateral as protection on the pool.
It is unclear how much collateral the troubled bank would have to put aside but with £24 billion ($49.4 billion) in loans from the Bank of England, many market participants believe Northern Rock may struggle to do so. “They need assets on balance sheet to put into the covered bond program. I’d imagine borrowing from the Bank of England will be backed by assets, so they could theoretically run out of assets to put into a covered bond program,” an industry source remarked.
Northern Rock officials declined all comment.