Moody's Investors Service today placed on review for downgrade the ratings of various covered bonds issued by Austrian, Danish, Dutch, Finnish, French and German banks.
The decision was prompted by the negative effects on the Moody's covered bond analysis stemming from the rating agency's recent review for downgrade of the senior debt ratings of the banks supporting the covered bonds.
Any downgrade of these senior debt ratings would negatively affect the covered bonds through their effect on both the expected loss method and the timely payment indicator (TPI) framework.
S&P Hosts Seminar
In a panel discussion on covered bonds on Jan. 25 Standard & Poor's seminar panelists said that when it comes to defaults, RMBS transactions benefit from more built in protections that would shield issuers and investors from taking too hard of a hit.
"If it was a Doomsday scenario, I'd definitely rather be in the RMBS camp than in the covered bond camp," said Rob Ford, a partner at TwentyFour Asset Management who spoke at the event last January. "A failing bank could take assets from its covered bond pool, reducing overcollateralization to levels that would cause covered bond downgrades. Once that happens, the bank is never again going to be able to fund using covered bonds or senior debt, and it would suggest to me that it was in wind-down mode."
For investors the choice between which instruments comes out as a winner depends on the jurisdiction. According to Gareth Davies, head of European ABS and covered bond research at JPMorgan, who also spoke at the event, Irish covered bonds pay out at maturity because of the public-sector support but RMBS from that jurisdiction only relies on the support of the structure's collateral pool with 10% of borrowers more than 180 days in arrears.
"It comes back to the frequent argument over whether covered bonds are a credit product or a rates product," Davies said. "In Germany, you're a rates buyer. In Ireland — at the other extreme of collateral credit quality — you're also a rates buyer. You're saying you believe in the government and the [European Central Bank or ECB]. In the middle — like in the U.K. — you're a credit buyer. When you buy a U.K. covered bond, you should consider the bank and its loan pool."
The panel warned that credit investors shouldn't focus on the long history of the covered bonds product and should instead look at how the structure would hold up to a wider banking system crisis.
"We should ask: What happens in a tail event?," Davies said. "We now have some good examples of RMBS and ABS broadly performing in line with the documentation, whereas in a covered bond you would have to work out day-by-day how an institutional default would actually affect the program."
However, preferential regulatory treatment for covered bonds has brought both new jurisdictions and new investors to the table, while the European RMBS investor base has remained fairly static.
Davies said that any product that has such a "strong consensus view associated with it" must be handled with care.
"If there was a disruption in the covered bond market and we lost access to that particular investor group, then Europe's banks would lose funding without the ECB's support," he said. "Both covered bonds and RMBS have advantages, and we should consider a more varied approach to bank funding. We may be over-promoting covered bonds to the detriment of the European banking system."