Section 2 - FTSE

“bullet bonds”, the natural amortisation of the assets
cannot be relied on to repay the bonds. This means that
funds need to be raised against the assets backing the
covered bond – possibly through the firesale of the assets.
The discount on the price achieved to complete such a
firesale of the assets, in the potentially stressed
environment following the default of the bank that
originated these assets, is referred to as refinancing risk.
Because of the uncertainty surrounding this “refinancing
risk”, Moody’s does not believe that there is a very high
certainty that a“bullet”covered bond would receive full and
timely payment following the default of the bank supporting
the covered bond. This is the primary reason that if the
supporting bank falls below a certain rating level, then a
Moody’s covered bonds rating will usually start migrating.
Moody’s has published the rating levels of the supporting
banks which are expected to constrain the rating level of the
covered bonds.
Some markets do not suffer such material refinancing
risks. For example, in Denmark, the majority of covered
bonds are pass-through bonds, which means that following
the default of a bank supporting a covered bond, the covered
bonds should be able to rely on the natural amortisation of
the assets to pay them back – i.e. the requirement for a
firesale of assets into an illiquid market is much more remote.
Will these challenges be the same across all types of
covered bonds? Or are Jumbo bonds, or bonds with
cross-border pooled assets, for example, different?
NICHOLAS LINDSTROM: Refinancing risks vary deal by
deal and jurisdiction by jurisdiction. The extent to which
refinancing risk is dealt with tends to be different under
different covered bond laws. Further, refinancing risk varies
deal to deal, for example based on the average life of the
assets, and the type and quality of assets included in a cover
pool. Some markets do not suffer such material refinancing
risks. For example, in Denmark, the majority of covered
bonds are pass-through bonds, which means that following
the default of a bank supporting a covered bond, the
covered bonds should be able to rely on the natural
amortisation of the assets to pay them back
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Are there instances of covered bond ratings delinking
from the issuer and other categories of its
debt exposure? Is this feasible going forward?
NICHOLAS LINDSTROM: Currently Moody’s does not
rate any covered bond as delinked. However, if a covered
bond structure was sufficiently sound, a delinked rating
could be assigned. It is easier to envisage a structure
without refinancing risk achieving a“delinked”rating than
a structure that suffers from“refinancing risk”.
How might approaches to ratings change going
forward?
NICHOLAS LINDSTROM: The current extreme climate has
also highlighted the volatility associated with “refinancing
risk”, a risk that the vast majority of covered bonds are
exposed to. In response to this risk Moody’s has updated
some of the refinancing stresses it applies to covered bond
programmes.
Looking forward, given the nature of the product, do
we anticipate an early revival?
TIM SKEET: The key question remains as to when the
covered bond market will revive. A general expectation is
that it will be amongst the first of the asset classes to revive,
although precise timing will depend heavily on the passage
of the government guaranteed bonds and success of the
financial bail outs.The second quarter of 2009 appears to be
the current hope. Investors will also be seeking assurances
on the supply situation as the risk of substantial supply in to
a shrinking investor base was at least one factor that
penalised some parts of the sector previously. Supply will
need to be carefully handled, and market participants will
have to be attentive to the conflicts of interest that will arise
between competing issuers. Contracting bank balance
sheets, de-leveraging and economic slowdown present
macro-economic constraints on supply, but investors will
need to understand how these influences translate into
numbers. Still, regulatory pressure on banks to raise and
maintain liquidity and push out maturities, combined
favourable treatment of the covered bond as an asset for
those additional liquidity reserves, bringing more of this
group of product buyers back to the game, should provide a
solid basis for the return of the asset class.
CARLOS STILIANOPOULOS: We have to go a step at a
time. Currently the appetite is for Government Guaranteed
Bonds, and I am afraid this will last for at least the first six
months of 2009. Probably the next asset class to come back
to the market, in a substantial enough size, will be the
Covered Bond market. However, the question is in what
form will it come back? Will it be mainly in jumbo deals or
small targetted placements? What will hapen with the
market making commitments? There will be too many
questions and it is still too soon to know the answers.
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