Thursday, January 21, 2010

Covered bond consequences for S&P

Here’s a good illustration of the tightrope-walk often faced by the ratings agencies.

Having opted to stick with its proposed revised ratings methodology for covered bonds, first announced in February last year, S&P is now experiencing the consequences of having tougher ratings criteria.

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 issuer bankruptcy.

This was S&P’s thought process:

The proposed methodology reflects our heightened focus on the ability of covered bond structures to access liquidity to repay investors under stress scenarios where the bank becomes insolvent or halts payments on unsecured obligations. This liquidity need arises as most covered bond programs have a maturity mismatch of assets to liabilities. While the covered bond issuer is solvent, repayment of covered bonds should be addressed by the bank’s general debt service capabilities. However, if the issuer is no longer solvent, debt service and the redemption of the maturing covered bonds depends firstly on cash flow generated by the cover pool’s assets. If this cash flow from the cover assets is insufficient to service the covered bonds, the program must obtain the necessary liquidity either from third-party financing, if permitted within the program, or through the sale of assets.

Nevertheless, the proposed changes prompted plenty of howling by covered bond issuers and Pfandbrief-players — enough that some people thought S&P might opt to water down its new criteria.

But, the rating agency more or less stuck to its guns, and (albeit a belatedly) released its new methodology on December 16th, simultaneously placing 98 covered bond programmes on credit watch.

And, late on Wednesday, the agency published the following:

FRANKFURT (Standard & Poor’s) Jan. 20, 2010–Standard & Poor’s Ratings Services said today that it had affirmed its ‘A-’ long-term and ‘A-2′ short-term counterparty credit ratings on Germany-based Landesbank Baden-Wuerttemberg (LBBW). The ratings were subsequently withdrawn at the bank’s request. The outlook was negative before the withdrawal.

At the same time, various issue ratings on LBBW’s debt were affirmed and then withdrawn, including those on debt that benefit from grandfathered guarantees provided by LBBW’s owners, including its key owner, the State of Baden-Wuerttemberg (AA+/Stable/A-1+), which owns 40.5%.

Coincidence? Maybe.

But that’s not what’s implied by coverage from covered-bond specialist, The Cover:

Standard & Poor’s will no longer rate Landesbank Baden-Wurttemberg’s Pfandbriefe or other debt after the German bank ended its contract with the rating agency. The covered bond issuer is believed to be the first to have done so since S&P announced its controversial new rating methodology on December 16.

The question for S&P is — will there be more to come?

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