Moody's Investors Service today commented on how it evaluates the effect of global and bank credit deterioration in Europe on structured finance securities.
This comes after the agency's Feb.15 announcement that it had placed on review for downgrade the ratings of 114 European banking groups and non-European firms that have large capital market franchises.
According to Moody's, a deterioration in banks' credit quality negatively affects these securities given the different roles that banks play in structured finance deals.
The credit linkage between these structured finance securities and the counterparties comes into the picture because of the risk that a bank will fail to perform its role and cause a payment disruption or permanent losses on the securities.
The degree of credit linkage would also depend on the banks' roles, the applicable jurisdictions, the transactions's nature and the presence of protection mechanisms.
Moody's already placed on review securities from 249 structured finance deals because of indirect linkage after the aforementioned Feb.15 announcement. These securities included mostly ABCP where the affected bank acts as a key liquidity or credit provider and repackaged deals where the impacted bank is one of the key support providers.
The rating agency will downgrade securities that rely heavily on the performance of any banks that it downgrades unless issuers and their agents have told the agency about plans to implement protection mechanisms that limit the credit linkage.
The rating agency will also place on review for downgrade other securities that also rely strongly on the performance of affected banks, while monitoring the implementation of the different protection mechanisms. These include those institutions relying on cross currency swaps, large cash accounts, or low-rated servicers that do not have back-up arrangements, Moody's stated.
If the deal parties do not effectively and timely use protection mechanisms, these offerings' strong linkage to affected banks will probably cause the highest-rated securities to be downgraded, Moody's warned.
The rating agency is not anticipating taking any immediate rating actions on securities that have indirect exposures to downgraded banks if it concludes these exposures have a small effect on the securities' credit quality. It wil also consider if the likelihood of the timely implementation of effective structural protection mechanisms is high.
Specifically, Moody's will consider the timing and details of the implementation of protection mechanisms. However, the agency will consider downgrading these securities if the deal parties do not implement the protection mechanisms.
Any negative rating action will rely on the extent of payment disruptions the agency is anticipating given the increased counterparty risk, the the counterparty downgrade's magnitude and the exposed security's rating.