Early last month, the association of German Pfandbrief banks (Verband Deutscher Pfandbriefbanken – VDP) met to discuss the ratings agencies’ methodology for rating covered bonds. The members of the VDP feel that the type of data asked for by the agencies, specifically that relating to the cover pools, is overly constricting in terms of the amount of time and investment required to provide it.
The role of ratings agencies in the covered bond market has become increasingly central as the product has grown away from its German roots. For issuers to position their covered bond programmes as an alternative to government debt, a triple-A rating is essential. This gives the ratings agencies an extraordinary amount of power. "With covered bonds, additional over-collateralization requirements are set by the ratings agencies, which gives them a quasi-regulatory role in covered bond structures," says Rob Robinson, covered bond analyst at Merrill Lynch. "Although there is room for covered bonds that are not rated triple-A, the core of the market is triple-A paper that can be used as a rate product substitute."
As covered bonds have developed, so has the methodology used for rating them. The VDP has been outspoken in its disapproval of unregulated, structured covered bonds, especially those issued in countries that have regulated frameworks in place, such as the recent Landesbank Berlin issue. The success of the structured covered bond markets, such as in the UK, has led to a more Anglo-Saxon-style securitization methodology, similar to that used for structured finance loans. Standard & Poor’s, for example, uses a covered bond monitor similar to its evaluation systems for the CDO and ABS markets.
It is interesting to note that while many covered bond issuers from outside the Pfandbrief market have commented on the stringent requirements of the ratings agencies, few are bemoaning them. Most seem to feel that the ratings agencies are only asking for what is necessary to ensure the safety of the product. "The need to provide information on cover pools is just the nature of the beast," says one. "You have to be in a position, system-wise, to cooperate with the agencies."
It is possible that issuers in newer covered bond markets are better equipped to cater to modern rating methods. In Ireland, for example, the ACS market is only a few years old, and so has the benefit of being structured around contemporary methodologies. "We are in a slightly different position," says one ACS issuer. "The ACS bank is a new beast. We have comprehensive, easily developable data."
The Pfandbrief, of course, is a much older product. According to market participants, some issuers of the product are ill prepared to meet ratings agency demands. "Pfandbrief issuers are always incredibly reluctant to provide information to ratings agencies," says a covered bond head. "The methodologies require a lot of information disclosure, and some Pfandbrief issuers have pretty poor data systems."
Pfandbrief issuers will have to adapt to the rating methods. The only way to instigate a change would be for the market as a whole to stand up and demand it. But the Pfandbrief no longer leads the covered bond market, and although it is more than 200 years old, the rating methodologies are not.
According to one Pfandbrief issuer, the VDP meeting was inconclusive. It will discuss the issue further at another meeting later in the year.