Covered Bond Bail-in Benefit Prompts Moody’s Ratings Proposal

Moody’s Investors Service is proposing changes to the way it rates covered bonds to reflect the debt’s preferential treatment under new European rules governing bank failures.

The ratings company is responding to an agreement that calls for bondholders to share the burden of a bank’s failure by having unsecured debt written off, or bailed-in, while exempting covered bonds. Given the privileged ranking of the securities, which are backed by mortgages and public sector loans, Moody’s suggests raising the minimum level at which it currently grades these bonds.

“It does seem fair enough to reduce the linkage with senior unsecured, which will be bail-inable, while covered bonds are not,” said John Raymond, an analyst at CreditSights Inc. in London.

If the proposals are adopted, the majority of European covered bonds rated below the highest level of AAA could be upgraded by as many as two steps, according to Moody’s. The new guidelines could also extend beyond the European Union to other jurisdictions that introduce bail-ins for unsecured debt, according to Moody’s.

“The rating of covered bonds is a big topic so it is good to see Moody’s start the discussion,” said Frank Will, head of covered bond, supranational and agency research at Royal Bank of Scotland Group Plc.

The European Union’s bail-in rules, agreed on June 27, are subject to final negotiations and could be adopted as law by member states by 2018.

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