CORRECTED-Peripheral banks at risk as S&P plans to slash ratings
(Corrects S&P's Portugal structured finance rating cap to A- from BBB+, in 11th paragraph)
* S&P to reduce ABS ratings' uplift over sovereign
* Move could force Portuguese collateral out of ECB
* Harsher treatment for swathe of peripheral collateral
By Owen Sanderson and Anil Mayre
LONDON, Oct 16 (IFR) - Portuguese and other peripheral banks' access to central bank liquidity could be at risk if Standard & Poor's goes ahead with proposals to slash structured finance and covered bonds ratings.
S&P announced on Monday that it was seeking to change the way it rates structured finance and covered bond deals in relation to sovereign ratings. Such a move could mean that up to half of Portuguese structured finance would stop being eligible central bank collateral, while other peripheral issuers could see higher funding costs, whether in the market or at the ECB.
In order to receive central bank liquidity, which they came to rely on during the depth of the financial crisis, banks have had to pledge assets such as covered and structured finance deals.
But once any debt security is rated below BBB-, it can no longer be presented to the Eurosystem for repo financing. With structured finance, the rule is that the "second-best" rating applies - each bond needs two ratings, and the worst rating determines the collateral treatment. The reverse is true for all other collateral categories (that is, the best rating determines the treatment).
As well as up to half of Portuguese structured finance deals, S&P proposes downgrading 95% of Italian covered bonds, 50%-60% of RMBS, ABS, SME CLOs, cedulas and multicedulas in Spain, 60%-70% of RMBS, ABS and SME CLOs in Italy, and 20% of RMBS in Ireland.
S&P is seeking to change its methodology as a result of "evolving views on the effect of country risk and related tail risk across asset classes", the agency said.
Structured finance deals can usually be rated above the rating of the sovereign, because they are backed by large pools of financial assets that ought to pay off even if the sovereign defaults.
People will continue to pay mortgages even if the sovereign does not pay bonds (although a sovereign default is usually associated with severe economic distress). Other protections are built into the structures, such as reserve funds and credit enhancement.
S&P says it has observed a "greater degree of tail risk, that is, low probability but high severity event risk associated with sovereign distress and default scenarios that are not captured by the stress scenario (such as risk of a monetary union exit, which in our view reached significant levels in Greece, or in the imposition of a deposit freeze and capital controls, which occurred in Cyprus), when a country is experiencing severe economic stress or upon a sovereign default."
It is therefore capping structured finance ratings at four notches above sovereign ratings, rather than six notches as before.
Under S&P's current criteria, Ireland, Spain and Italy benefit from a six-notch uplift, with maximum achievable structured finance ratings of AA+, AA- and AA (sovereigns currently rated BBB+, BBB- and BBB). Portugal has a five-notch uplift, allowing deals to be rated A- versus the sovereign rating of BB.
Greece is currently rated B- and its structured finance ratings are capped at the same level by S&P due to specific concern about the country.
Portugal has EUR39bn of securitisations outstanding, according to the Bank of Portugal, of which EUR10.6bn is already placed in the market, according to JP Morgan research.
This leaves EUR28.4bn "retained" for central bank liquidity purposes. Some 40 tranches of Portuguese securitisations are ECB eligible, according to IFR calculations. S&P estimates that 60% of RMBS, ABS and SME CLOs (the only important structured finance asset classes in Portugal) will be affected.
S&P said: "We expect about half of the RMBS and ABS ratings and all of these SME ratings that are affected by this proposed criteria in Portugal will be lowered below BBB-".
A eurozone central bank can still choose to offer financing against non-investment grade collateral under the Emergency Liquidity Assistance programme, but must choose to do so at its own risk, not that of the Eurosystem.
Even downgrades where collateral remains ECB-eligible can still be hugely damaging to bank balance sheets. A securitisation which is downgraded from A- to BBB+ attracts a 22% haircut instead of a 10% haircut, which could drain a large volume of liquidity from the system. The ECB had EUR347.5bn of ABS collateral pledged at the end of the second quarter of 2013.
The agency is introducing a sensitivity-based analysis for deals. S&P's proposals define high sensitivity deals as those backed by corporate or government assets (banks, most regional and local governments) and susceptible to a combination of economic volatility and potential changes to the legal and regulatory frameworks.
Moderately sensitive deals include RMBS, CMBS, ABS and CDOs backed by corporate loans or bonds.
For high sensitivity deals the maximum differential is two notches, rising to four for moderately sensitive deals. Deals from countries rated AA- or higher will not be subjected to a separate sovereign test, but will still have to adhere to the sensitivity notching.
Some deals will still be able to achieve a six-notch uplift (two in addition to the standard four) if they meet certain criteria reiterating their high quality and low risk (moderate sensitivity risk, no refinancing risk for bullet assets, liquidity support to cover one debt service payment, the sovereign is rated BBB- or better, the portfolio is seasoned portfolio and current credit support can withstand losses at 1.3 times S&P's Triple A loss projection).
S&P is consulting on the changes until November 14. (Reporting By Owen Sanderson and Anil Mayre, editing by Helene Durand, Alex Chambers and Matthew Davies)
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