Moody's Downgrades Bank of America's Covered Bonds

A few months ago (March 31), Moody's Investor's Service placed on review for possible downgrade the Aaa ratings of the covered bonds sponsored by Bank of America, N.A.  On Friday (July 10), Moody's downgraded the covered bonds to Aa1, on review with direction uncertain.

As noted here previously, the root of the agency's ratings concerns about the BA Covered Bond Program is identified as the level of "committed" overcollateralization (OC)—that is, the amount of OC that the program sponsor is "legally bound to maintain" and "cannot be withdrawn in the future under stressful circumstances."  

On March 31, Moody's wrote that although the total OC then reported for BofA's covered bonds was about 37%, the agency considered the committed amount to be more like 4%.  In Friday's announcement, the rating agency repeats the 4% figure as the amount it considers committed.

Friday's announcement does not mention the total OC currently reported.  But the agency indicates that even converting the current total OC to committed status might not be sufficient to justify a Aaa rating.

The heart of the problem is the structure of BofA's program, which could require all assets in the cover pool to be sold within 120 days in the event of sponsor insolvency.  Quite reasonably, Moody's believes that could result in fire sale prices.  And the lower the OC, the more likely the proceeds would be insufficient to compensate bondholders.

BofA's program contrasts with covered bond structures containing "pass-throughs" and other provisions—gaining favor in more recent times—that potentially can provide much more flexibility to preserve assets in case of insolvency.

Moody's states that the direction of (further) review is uncertain because BofA still could make changes, including an increase in committed OC.   If not, a downgrade to Aa2 is "likely."

Of the two U.S. covered bond programs, at least BofA's program still has a Moody's rating.  As reported here previously, last month Moody's withdrew its rating on Washington Mutual's covered bond program, which is now sponsored by JP Morgan.

This commentary should not be relied upon as a substitute for the text of Moody's rating action.  To read the rating action, "Moody's downgrades Bank of America's covered bond ratings to Aa1, on review with direction uncertain," log on (free) at www.moodys.com, then click on the following link:

http://www.moodys.com/moodys/cust/research/MDCdocs/10/2007400000626372.asp?namedEntity=Rating+Action&doc_id=2007400000626372&frameOfRef=structured