Moody's: Romanian covered bond draft legislation reduces collateral and refinancing risks; currency risks could remain

According to Moody’s Investors Service, the Romanian government’s draft legislation on covered bonds is credit positive, particularly in addressing collateral risk and mitigating refinancing risk. However, Moody’s notes that covered bond investors could be exposed to significant currency risk, it said in a statement.

“We expect that Romanian covered bonds would be exempted from bail-in in application of the BRRD and benefit accordingly, like covered bonds in other countries of the European Union”, said Alexander Zeidler, Moody’s Vice President and Senior Analyst. “The Romanian banks’ will likely benefit from a successful implementation of the law in the long-term because it will allow them to diversify and extend their funding sources. An active covered bonds market will also help banks increase mortgage lending and as a result improve their revenue generation”, added Mr Dallakyan.

Moody’s notes that under the terms of the draft legislation, Romanian banks will issue covered bonds, which will be backed by a portfolio of real estate loans and ring-fenced from the bank’s balance sheet upon insolvency. Because of this structure, covered bond investors will have two layers of protection should the issuing financial institution become insolvent. In common with other jurisdictions, investors will have a first recourse through the issuer’s credit strength and then, in case the issuer ceases to make payments under the covered bonds, through the cash flows from the segregated pool of real estate mortgage loans. This second layer of protection likely supports a higher rating on the covered bonds than on the bank’s unsecured debt.

Moody’s regards the draft legislation as credit positive, particularly in addressing collateral risk and mitigating refinancing risk. However, Moody’s considers that covered bond investors could be exposed to significant currency risk if no effective hedging arrangements are in place. The proposed legislation, if enacted, will revise the current Mortgage Bonds Law from March 2006 and strengthen the legal framework for Romanian covered bonds in several aspects.