Moody’s Investors Service says it’s prepared to start rating securities designed to absorb losses when banks are close to failing, and is requesting comment on its proposed approach.
Back in February 2010, Moody’s established a moratorium on rating contingent capital securities where loss absorption is subject to regulatory discretion and/or the breach of regulatory capital triggers. It says its hesitation to rate these securities was based on the difficulty in predicting when loss absorption would be triggered, due to the rapidly changing regulatory and political environments.
Since then, it says that it has seen greater regulatory and political will to impose losses on creditors as a precondition of public sector support. And, this additional visibility around the trigger points for loss absorption allows it to consider assigning ratings to certain types of contingent capital securities, it says.
In particular, it’s seeking comment from the market on its proposed approach for rating contractual non-viability securities, which are typically junior securities that absorb losses either through converting to equity, or a principal write-down, that is triggered when a bank is on the verge of failure.
“The issuance of bank contingent capital or CoCos, which have triggers linked to the point of non-viability when a bank is in deep distress, as well as the global regulatory push toward burden sharing by creditors, provides us with the confidence that we can now rate these instruments,” says Moody’s senior vice president, Barbara Havlicek.
The rating agency describes its proposed framework for rating these securities, and explains how it fits into its existing approach for rating subordinated debt and hybrid securities. It is also seeking market feedback on whether it should establish a cap on the ratings for such contractual non-viability securities.
Additionally, Moody’s notes so-called “high trigger” contingent capital securities remain subject to a rating moratorium. However, it also invites public comment on whether a rating would be useful for such securities, and what such ratings should address, given the potential that loss absorption could be triggered early in a bank’s financial distress, and may not honour the traditional priority of claim in a bank’s capital structure.
The rating agency is also seeking comment on its approach for incorporating support in bank subordinated debt ratings. “The regulatory and political willingness to impose losses on ‘plain vanilla’ subordinated creditors has also led Moody’s to re-examine its systemic support assumptions for bank subordinated debt,” it says. As a result, it is proposing a revised methodology that does not assume systemic support for bank subordinated debt and instead uses judgment on a country-by-country basis to identify those instances where there may continue to be a willingness and ability to support subordinated debt.