Friday, July 31, 2009

S&P’s covered bond flip-flop?

Posted on the FT's Alphaville by Tracy Alloway:

What’s this? Another flip-flop — albeit a more protracted one than that on CMBS — on the horizon from ratings agency Standard & Poor’s?

Recall that the agency announced in February that it wanted to change its methodology for rating covered bonds. The announcement caused more than a bit of consternation in the market since, according to S&P, the envisaged changes would result in about 60 per cent of covered bond programmes being downgraded.

S&P’s proposals were focused on linking the covered bond rating more closely to that of the issuer. At the moment, covered bond ratings are linked primarily to the asset quality and structure of the programme, and only tangentially to the issuer credit rating. That means that the bonds usually get higher ratings than the banks issuing them since, unlike in securitisation, the assets stay on the issuer’s balance sheet and are ring-fenced to give investors some protection in the event of the issuer’s bankruptcy. Beyond the ring fenced pool, investors also have priority claim on the rest of the issuer’s balance sheet, thus investors are meant to be doubly protected - from default on the underlying collateral and from the default of the issuer.

Changing the rating methodology as suggested would therefore result in downgrades — as above — and probably a requirement for more overcollateralisation. Thus the industry was understandably roiled, and S&P was forced to extend its initial five-week request for public comment period by an additional two weeks.

S&P announced on Monday that its new ratings criteria would now not be ready for publishing until September.

That’s fine — except that the market is already interpreting that delay as meaning the agency has gone soft on its original proposals. From Structured Finance News:

The new approach was largely viewed as negative by covered bonds market participants in Europe but analysts at Dresdner Kleinwort say that the fact that S&P is taking so much time over its revision could be a sign that the agency is making corresponding, significant corrections.

We already expected the eventual rating effects to be a good deal milder,” said analysts. “This could also be supported by the fact that that the agency could harm its long-term standing by adopting an overly aggressive stance - since early June two German issuers already asked for their S&P Pfandbrief (covered bonds) ratings to be withdrawn.”
Sure — being overly aggressive. That’s what will destroy S&P’s reputation.

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