Moody's invites comment on sub bank debt ratings

LONDON, June 17 (Reuters) - Moody's Investors Service on Wednesday invited feedback from market participants on proposed changes to the way it rates lower quality subordinated bank debt.

An assumption that governments and central banks would offer some protection to subordinated bondholders has been tested in recent weeks, with support contingent on banks suspending interest payments on this capital in some cases.

That fear has driven down subordinated bond prices, with some Tier 1 debt trading at about 40 percent of face value.

A removal of this government support assumption would result in further reduced ratings for subordinated bank capital, including hybrid debt and preferred securities, Moody's said.

"It's good that Moody's is communicating with the market and taking into account what the professionals think about how they should be rating these entities," said Gary Jenkins, head of fixed income research at Evolution Securities.

"What we could see now are more bank debt buybacks or exchanges. From a reputation point of view a bank will probably not want a rating deep into junk on any of its debt so this might accelerate the exchanges into senior or higher-rated subordinated bonds," he added.

Twenty-five percent of hybrid ratings are likely to remain unchanged, 40 percent will be lowered by one to two notches, 25 percent by three to four notches and the remainder by five or more notches, added Jenkins, quoting Moody's figures.

The rating agency referred to the recent distressed exchanges of Citigroup's (C.N) non-cumulative preferred securities into common equity and conditions set by the European Commission on payments on Commerzbank's CKKG.DE hybrid capital in return for state aid.

"We have already downgraded or placed under review for downgrade the subordinated debt and preferred securities of a number of banks for which government support did not benefit, and in some cases even hurt, the holders of those instruments," says Moody's analyst Barbara Havlicek.

"Our proposed change in methodology would base most subordinated capital ratings on this observed behaviour," she added.

Market participants have until July 10 to submit their comments to Moody's. Once finalised, the changes in methodology will lead to rating actions on a county-by-country basis, the ratings agency said. (Reporting by Natalie Harrison; Editing by Greg Mahlich)