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Happy Birthday

09 July 2014
Richard Kemmish

Happy 10th birthday to the Fitch rating team. In a seminar yesterday they mentioned that it is 10 years since they were founded (always a bit sad when you have to remind your friends that its your birthday. I didn’t even get them a card).

Of course Fitch rated covered bonds before that, but as Helene Heberlein, head of the covered bond team, said previously they had rated some covered bonds in their structured finance team, some in their banks team. Which was odd. In another agency covered bonds had previously been part of structured finance, then were taken over by the banks team (you thought Putin’s annexation of the Crimea was controversial?). But nowhere else was the product actually split between the two approaches.

But the distinction is the important thing. Do you rate covered bonds as being enhanced forms of bank credit, first look at the bank then see how much value the structure and the assets add? Or do you rate covered bonds as being structured finance, like a securitisation but with different structural features and support from / reliance on the bank?

Where Fitch were smart was that they realised that this was very jurisdiction specific, in some countries bank+X is the right model, in others structured finance was the right model. Where they were less smart was that this created a huge inconsistency, can we talk about a unified market with comparable ratings when two covered bonds ae analysed in totally different ways?

Their brainwave all of those years ago was to take the need for different methods in different countries and reduce it to a variable within the model – the famous discontinuity factor. A discontinuity factor of 1 meant the structured finance mindset prevails, a discontinuity factor of 0 meant that Banks+X is the way to rate this. Of course they realised that no covered bond is either 0 or 1 but somewhere in between (in fairness there were a few but not many and usually special cases). As a result both approaches were relevant but of more or less importance to the final rating outcome.
At the time this was radical and resulted in all three agencies having totally different approaches (Moody’s always had a more bank+ mentality, S&P were more structured finance minded).

The methodologies have hugely converged since then of course. Sometimes it looks like they are copying each other, to take an example, when thinking about the rating uplift due to the bail-inable nature of senior debt protecting covered bonds, both Fitch and Moody’s start to give value if the bank has 5% loss absorbency capacity between capital and covered.  Coincidence? 

10 years ago, Fitch were clearly ‘the third agency’. Partly due to smart thinking like the discontinuity factor they have significantly improved their market share and are now the second largest in our market. But as the big three agencies covered bond methodologies converge, and they all respond to the tectonic changes in credit worthiness of the banking system in broadly similar ways, is there a role for fresh thinking again?

Don’t dismiss the new kids on the block like DBRS and Scope too readily. You might start celebrating their birthdays too soon.

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