International Financing Review March 7 2020 21People
&Markets
Tier 2s set for downgrades under new Fitch criteria
Banks’ Tier 2 bonds could face a raft of
downgrades from FITCH RATINGS on the back
of a criteria update and some could drop out
of indices, while a raft of ratings on
!DDITIONALû4IERûûBONDSûCOULDûBENElTûFROMû
performance-boosting upgrades.
The new criteria, published on February 28
AFTERûAûREQUESTûFORûMARKETûFEEDBACK ûREmECTû
changing assumptions on the likelihood of
losses for AT1 and Tier 2 bondholders and
developments in bank resolution plans.
About 230 ratings, mostly of subordinated
debt, could potentially be downgraded and
about 260 ratings, mostly of AT1 and senior
debt, could be upgraded.
4HEûMOSTûSIGNIlCANT ûANDûNEGATIVE û
impact will be for Tier 2 bonds.
Fitch’s baseline notching for Tier 2 debt
has changed from one notch below the
issuer’s anchor rating to two notches below.
&ITCHûCITESûAûHEIGHTENEDûRISKûOFûSIGNIlCANTû
losses for Tier 2s in the event of default.
“In Tier 2 the concern is for issuers that
previously had two IG ratings may no longer
have them,” said Kapil Damani, head of
capital products at BNP Paribas.
Analysts say the Tier 2 bonds of issuers
such as UniCredit and Virgin Money could
fall out of indices as a result.
Affected Tier 2 bonds may now have a
narrower investor base.
“Fitch’s Tier 2 ratings were generally
higher than S&P and Moody’s. In cases
where Fitch was the only IG rating or in
cases where the average rating goes down to
sub-IG, the new methodology will have a
detrimental effect in the primary market,”
said Charles-Antoine Dozin, EMEA head of
bank capital structuring at Morgan Stanley.“It is not that those deals won’t get done,
of course, but it is likely to have an adverse
impact on price.”AT1 UPSIDE
In contrast, AT1 bonds’ baseline notching
HASûIMPROVED ûCHANGINGûFROMûlVEûNOTCHESû
below an issuer’s viability rating to four
notches below.
The base case notching for non-
performance on AT1s has been reduced,
narrowing the gap between Tier 2 and AT1
instruments.
“By our estimates, this proposed change
could dramatically transform the structure
of the coco universe by improving the
composite rating of approximately 20% of
the outstanding coco universe to investment
grade, which would mean the overall
volume of IG-rated cocos in the universe will
rise from 30% to just over 50%,” said James
Macdonald, senior portfolio manager and
%UROPEANûlNANCIALSûANALYSTûATû"LUE"AYû!SSETû
Management.
Analysts said the AT1s of Lloyds and
Nationwide Building Society might be among
THEûBIGGESTûBENElCIARIES ûASûTHEYûCOULDûNOWû
have two investment-grade ratings.
Deals from issuers including Societe
Generale, Danske, ABN AMRO, Nykredit and
Standard Chartered are also in line for
upgrades.
However, Damani said the market impact
of the changes on AT1 is likely to be less
meaningful than for Tier 2 as investors
generally pay less attention to ratings and
indices in the AT1 space.
h4HEREûISûSOMEûBENElT ûITSûJUSTûHARDûTOû
quantify,” he said. “There will be some investorsthat look at the ratings, and particularly having
two IG ratings will help for sure.”
Fitch aims to implement any rating
changes within six months.MOODY’S REWORK
MOODY’S, meanwhile, is looking to revamp its
loss given failure analysis, and the resulting
change in the methodology could affect
around 10% of the banking groups it rates.
The agency is responding to the US$230bn
of senior non-preferred debt issued by
Moody’s rated banks over the past few years,
and what could be its overly conservative
approach to the notching in its LGF analysis.
3PECIlCALLY û-OODYSûSAIDûITSûAPPROACHû
MIGHTûPLACEûINSUFlCIENTûWEIGHTûONûFAILUREû
scenarios where losses are low. The existing
metrics make little or no distinction
between ratings on more junior instruments
despite real economic differences.
“While there have been only a few
resolution cases against the backdrop of a
benign environment of recent years, there is
evidence that authorities will favour
resolution approaches that minimise losses
through private sector takeovers or other
means,” Moody’s said.
It said the proposed changes would result
in greater distinctions in the ratings of more
junior instruments and hence confer a more
realistic measure of relative credit risk.
If the methodology is updated as proposed,
Moody’s expects some instrument and issuer-
level ratings of around 10% of rated banking
groups will be affected, principally in the
operational resolution regimes in Western
Europe, North America and Hong Kong.
Tom Revell, Robert HoggUS SOFR index, averages make debut
The NEW YORK FEDERAL RESERVE last week
launched its index and term averages on the
Secured Overnight Financing Rate, which a
&ED
BACKEDûlNANCIALûINDUSTRYûGROUPû
endorsed as the alternative to the London
interbank offered rate.
The SOFR index - as well as averages for
30, 90 and 180 days - are tools for market
participants to move away from the scandal-
ridden benchmark rate Libor for US$200trn
OFûDOLLAR
DENOMINATEDûlNANCIALûPRODUCTS
“Market participants should use them to
create new SOFR-based contracts, instead of
precariously growing Libor exposures and
waiting for the development of a forward-
looking term SOFR,” said Tom Wipf,
Alternative Reference Rates Committeechair and vice-chairman of institutional
securities at Morgan Stanley.
There has been some reluctance among
market players to embrace SOFR, even as
the clock ticks down for the elimination of
Libor after 2021.
A main hurdle in the adoption of SOFR is
the fundamental difference between the
two interest rates.
SOFR is seen as a near risk-free interest
rate based on prior day’s trades in the
repurchase agreement market, where banks
borrow overnight cash using mostly
Treasuries as collateral.
Libor gauges the unsecured borrowing
costs between banks overnight and beyond.
The US dollar market is lagging behind itssterling counterpart in the Libor transition,
&ITCHû2ATINGSûSAIDû)TûSAIDûTHATûREmECTEDû
“greater regulatory fragmentation in the US
and less emphatic regulatory statements
initially, compared with UK regulators”.
Fitch expects a “relatively smooth” move
among large banks to switch to SOFR in the
derivatives market. But smaller banks,
which have large exposure to cash products
and worry about the shortcomings of SOFR,
might seek alternatives to SOFR.
US money market rates fell sharply last
week in step with an emergency 50bp rate-
cut from the Fed on Tuesday. The 30-day
SOFR average stood at 1.57630% on
Thursday, lower than 1.58731% last Monday.
Richard Leong5 IFR PM 2323 p 15 - 24 .indd 21 06 / 03 / 2020 19 : 22 : 45