Moody's Reviews BofA Covered Bonds--Update #1

[On April 3, Moody's published a correction to the text of its March 31 announcement that the agency was placing Bank of America's covered bond ratings on review for possible downgrade.  This updated story incorporates the corrected information into the sixth paragraph below.]

The other shoe has dropped.

The first shoe was the decision (March 25) by Moody’s Investors Service to downgrade Bank of America, N.A.'s long-term senior unsecured ratings and bank financial strength rating.

Now, Moody’s has placed on review for possible downgrade the Aaa ratings of the covered bonds issued by BA Covered Bond Program (March 31).  The covered bonds were issued by a “special purpose vehicle” (SPV) rather than directly by Bank of America, N.A., so the bank is referred to as the “sponsor.”

The likely ratings outcome will not exceed two notches below the current rating (i.e. not lower than Aa2), according to an announcement by Moody’s.  The statement also made it clear that future enhancements (if any) to the cover pool could play a notable role in the agency’s decision-making.  

“The ultimate rating outcome will be dependent upon any change that the sponsor may make to the program structure which may include an increase in level of committed overcollateralization,” Moody’s stated.

Although the total overcollateralization currently “reported” is about 37%, Moody’s gives “full credit only to the level of committed overcollateralization” (italics added).  Moody’s considers that level to be more like 4%, "which is the minimum overcollateralization level specified in the program documents."  That figure is down from about 7.5% on the dates of issuance.

Here are some of the considerations that Moody’s cited for its action placing BofA’s covered bond program on review:

• A premise of the agency’s decision-making is that “[t]he dependence of the rating on the value of the cover pool increases as the strength of the sponsor decreases.”

• Under the terms of the BofA program, in the event of the sponsor’s default, the entire cover pool might need to be sold in fewer than 120 days.  (Although the announcement does not say so, this arrangement contrasts with the terms of some new covered bond programs, which can be set up to allow more flexibility after default.) The size of the cover pool is enormous—more than $10 billion in mortgage loans. “Under current market conditions, such a sale may obtain an exceptionally low price or not be completed at all.”

• Moody’s has now assigned a Timely Payment Indicator (TPI) of "improbable" to the  Program, meaning it assesses as improbable “the likelihood that covered bond investors will be paid timely interest and principal following a default of the sponsor of a covered bond program.”

Moody’s stated that during the review period, its focus would be “refining our estimate of the realization value of the cover pool in a highly unlikely event of the sponsor defaulting.”

To read the whole text of this rating action by Moody’s including the April 3 correction, log on (free) at www.moodys.com, then look under “RATINGS news” for April 3.