February 4, 2009 / 4:51 PM / 10 years ago

Covered bonds face rating pressure from S&P plans

LONDON, Feb 4 (Reuters) - Credit ratings for more than half of Europe’s covered bond programmes could come under pressure from proposed changes to the way Standard & Poors rates these securities, the rating agency said on Wednesday.

S&P wants to put more emphasis on the ability of covered bonds to gain access to liquidity to repay investors in the event of a default by the issuer.

“If implemented, we estimate that approximately 60 percent of the programmes by number would not meet the proposed minimum rating guidelines for covered bond issuers,” S&P said.

A large number of the bonds would have to increase their “overcollateralisation” (assets in excess of liabilities) to maintain current ratings, S&P said. Failure to do so could result in further negative rating pressure.

“Going forward, if the proposals are implemented, the covered bond ratings would be more linked to the issuers rating,” said Karen Naylor, head of European covered bond ratings at S&P. “So should the issuer ratings come under pressure, the bond ratings may come under pressure too.”

S&P has not downgraded any covered bonds so far, she said.

Covered bonds typically get higher credit ratings than the banks issuing them, because they are backed by assets that stay on the issuer’s balance sheet.

This means investors have a claim on the bank itself and a priority claim on the assets as well. For this reason, more than 80 percent of these bonds are rated at triple-A.

If there is a default, the bonds have to be repaid from the assets backing it.

In current market conditions, however, S&P is concerned about the ability of these bond programmes to sell assets if there is a default.

“We will heighten our focus on the ability of covered bond structures to access liquidity to repay investors when we assume the bank becomes insolvent,” Sabrina Miehs, S&P credit analyst, said in a statement.

Most covered bond programmes may have a mismatch between the maturities of assets and liabilities. Those with greater maturity mismatches would have to rely more heavily on asset sales, S&P said.

Germany is the biggest market for covered bonds, but new issues have dried up following the bankruptcy filing of U.S. investment bank Lehman Brothers in September last year.

There have been a small number of new deals since then, but analysts are not expecting the market to regain its original size.

This year, covered bonds will be competing with increased government bond sales and state-guaranteed bank bond programmes, Commerzbank said in a recently published research note.

Last month, Moody’s Investors Service warned that ratings of European banks’ covered bonds programmes were likely to come under pressure this year as ratings fall for the banks themselves.

S&P has requested feedback on its proposed new system, which was prompted by turmoil in the capital markets as a result of the credit crisis. (Reporting by Jane Merriman; editing by Simon Jessop)

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