Banks could see a large swathe of their debt downgraded if Moody’s Investors Services, the rating agency, pushes ahead with plans to reform how it rates the hybrid securities that became so popular during the boom years, according to a report in the Financial Times.

Hybrids, or subordinated debt, have characteristics of both equity and debt. This has until now allowed the rating agencies to consider them debt – and rate them more highly, lowering banks’ borrowing costs – while allowing bank regulators to consider them as part of a bank’s equity-based capital cushion and, as such, ready to absorb losses.

Moody’s stated that it had previously considered the securities to be generally more debt-like, on the assumption that any official support given to a bank would also cover subordinated debt. But several subordinated instruments have been allowed to suffer losses during the crisis, leading the rating agency to reconsider its stance.

In the UK, the government has the power to avoid paying interest when it steps in to restructure banks.

Moody’s said it expected the changes to leave only a quarter of hybrid securities with their ratings intact. Two-fifths would see a downgrade of between one and two notches, and a further quarter would be weakened by three or four notches. The remaining 10 percent could drop five or more notches.

Tagged with: 2009, press, ratings agencies