DBRS Addresses Ratings for Bank Subordinated Debt & Hybrid Capital Instruments with Contingent Risks

DBRS has today clarified its approach to rating a subset of hybrids and other debt capital instruments whose features include principal write-downs or conversions to lower positioned instruments, if certain trigger events occur. See DBRS Methodology, “Rating Bank Subordinated Debt and Hybrid Capital Instruments with Contingent Risks” April 2010.

Within the relatively limited subset of debt capital instruments with these contingent risks, DBRS draws an important distinction in its ratings between those instruments where these adverse events are reversible if a bank survives, and those instruments where these adverse events, once triggered, are irreversible, even if a bank survives. Accordingly, instruments with reversible contingent events are generally rated like other debt instruments that otherwise have similar characteristics. Instruments with the elevated risk from irreversible contingent events, however, are generally rated lower with notching driven by DBRS’s preferred rating scale for banks. This clarification primarily addresses instruments already issued by European banks, but also lays out the framework for rating other instruments in the future.

DBRS’s approach to rating these instruments focuses on the extent to which their distinctive features elevate the risk for debt investors above the normal risk of loss from a bank becoming insolvent, bankrupt, or seized by regulators. Risk for debt holders involves both the likelihood of insolvency or other adverse events and the expected loss incurred if triggers are tripped and these adverse events occur. To explain our approach, we discuss first the nature and potential for loss that investors are exposed to and then consider the likelihood of the triggers being tripped.

This clarification builds upon DBRS’s action in December 2009 that explained DBRS’s treatment of sub-debt and hybrids instruments whose features include discretionary payments, as well as the impact on the ratings when deferrals occur. The details of this action can be found in DBRS Methodology, “Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments”. Also relevant in rating bank capital instruments is the action DBRS took on the 20th of April, 2009, by downgrading most preferred shares to better align the ratings with the risks inherent in these instruments. The details can be found in DBRS Methodology, “Rating Bank Preferred Shares and Equivalent Hybrids.”

Note:
The related methodologies are Global Bank Methodology for Rating Banks and Banking Organisations, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under methodologies.