DBRS Releases Methodology for Rating Bank Preferred Shares and Equivalent Hybrids

DBRS has today released its methodology for rating Bank Preferred Shares and Equivalent Hybrids.

This methodology addresses the level of notching for preferred shares and equivalent hybrid instruments (collectively, preferred shares) relative to issuer ratings for banks and other financial institutions that are highly leveraged relative to the leverage seen in most corporate issuers. For simplicity, we will refer to banks, but the methodology applies to certain other financial institutions that fit this profile. The combination of high leverage and the importance of adequate capital for a bank’s viability increase the risk of nonpayment of preferred share dividends and/or adverse exchange offers of common equity for preferred shares relative to the risk for similarly-rated corporate issuers. These actions provide ways for a bank to quickly build up loss-absorbing common equity. The inclusion of “equivalent hybrid” denotes that this methodology also applies to hybrid securities that either convert into preferred shares rather than into junior subordinated debt or have other characteristics whereby DBRS would treat the instrument in the same fashion as it would preferred shares.

In summary, there are two major changes occurring in this methodology relative to the prior DBRS methodology for rating bank preferred shares.

(1) For those banks that benefit from support, the starting point for notching preferred share ratings will now be based on the intrinsic assessment (IA) rating rather than on the final senior debt rating. The DBRS support assessment methodology means that the IA is usually lower than the final senior debt rating for such banks. This change reflects the view that external support should provide no rating uplift for equity-type securities.

(2) The degree of notching from the IA rating to the preferred share rating has been widened to reflect our perception that the risk in these capital instruments has increased, although there is some flexibility to make adjustments to reflect the position of individual banks. This extends the long held core principle of rating more junior securities at lower levels. In addition to the implied higher risk of default, this also in part recognizes that there is a higher expected loss for junior securities that default than for more senior ranking securities.

The methodology providing DBRS's processes and criteria is available by contacting us at info@dbrs.com. It can also be found on www.dbrs.com under Methodologies.