Scope Ratings has released the finalised versions of the updated methodologies on (i) bank ratings and on (ii) bank capital securities ratings. Earlier versions of these two methodology updates, with a request for comment (RFC) by 29 April 2016, were published in March 2016. Following several comments from market participants there are no material differences in the final versions published today when compared to the March 2016 RFC versions.

The methodologies were first published in 2013 and 2014, respectively, with updates in 2015. Currently Scope assigns public ratings to 26 large banking groups in 11 European countries – including capital securities ratings for 19 banks.

Bank rating methodology
In light of evolving regulatory and legal developments in Europe, Scope said that when appropriate it plans to notch down the ratings of senior unsecured debt specifically allocated to, or eligible for MREL and/or TLAC from the bank’s Issuer Credit-Strength Rating (ICSR). According to the rating agency, this will occur via a one-off uplift of the respective banks’ ICSR. “We base this approach on the belief that going forward the ICSR should benefit from the protection of a materially more ample capital structure in a default-like scenario”, said Sam Theodore, head of Scope’s bank rating team who authored the methodology.

Such rating actions would be implemented after the publication of the final version of this methodology update later this spring and when national rules are clarified. The first related rating actions are expected to be on rated banking groups which issue or will issue MREL/TLAC-eligible senior debt out of holding companies. Scope has added that it plans to continue later with debt subject to statutory or contractual bail-in.

Importantly, the agency highlighted that none of the proposed adjustments and clarifications will lead to any shift in the fundamental approach underpinning its bank rating methodology. Scope also pointed out that its bank rating methodology has had the bank resolution regime as a central element from its first version in 2013.

Bank capital securities rating methodology
Commenting on this methodology update, its author Pauline Lambert, senior bank analyst at Scope, pointed out that recent market and regulatory developments concerning Additional Tier 1 (AT1) and Tier 2 (T2) securities have brought a sharper focus on these credit products. In this context, Scope highlighted the fact that the main risks of principal conversion/write-down and coupon repayment risk for AT1 securities have been flagged and analysed in detail from the first version of its methodology in 2014.

The current update notes that the notching down of the ratings of AT1 and T2 securities will have as anchor the respective banks’ senior unsecured debt ratings and not the ICSR (as has been the case until now).

The above adjustments will not affect the exiting ratings on capital securities, according to Scope.

Scope’s ratings reflect probability of regulatory action
Looking at the track record of bank defaults across Europe and beyond, rare as they have been historically, Scope notes that they were the consequence of regulatory action and not of commercial insolvencies or bankruptcies like in non-regulated credit sectors. Such regulatory action could be in the form of early supervisory intervention (including preventing payments on capital securities), resolution-related debt bail-ins, or insolvency proceedings (for banks not subject to resolution).

Scope points out that these scenarios make a strong case for market participants to have a firm grasp of the credit fundamentals of the banks they invest in or do business with. This is all the more important since regulators’ goals are to protect depositors and preserve financial stability, rather than to specifically shelter investors from losses. Scope’s ratings and analyses aim to address these challenges.

The following methodology reports (final versions) were published.

• Bank rating methodology
• Rating methodology for bank capital instruments

The reports are available at www.scoperatings.com.