Irish banks face a huge new hurdle in their battle to remain solvent. New plans will make fund raising significantly more expensive on the capital markets if the major credit rating agencies proceed with plans to change the way they rate covered bonds.

The two biggest agencies, Standard & Poors (S&P) and Moody's, have said they are considering using the overall bank rating - known as the issuer rating - to help determine the creditworthiness of the bonds, which are usually judged solely on the basis of their high-quality collateral.

The move would make it harder and more expensive for Irish banks to raise money by using covered bonds in repurchasing arrangements. AIB, Bank of Ireland and EBS have all raised billions in funding through covered bonds in the last year.

Covered bonds are almost always rated AAA on the strength of their asset-backing while the banks themselves have been sinking in the ratings since the financial crisis began. S&P, for instance, downgraded the entire Irish banking system in late January citing tough economic conditions and pressure on profits, which would make it harder for banks to meet their debt obligations.

By contrast, covered bonds tend to maintain very high ratings since banks provide excess collateral and swap in better assets if the underlying mortgages underperform.

"Going forward, downgrades of issuers' ratings are more likely to result in downgrades of their covered bond ratings than has been the case to date," Moody's said last week.

Moody's also said it would consider the sovereign rating as well when considering its scores for covered bonds, another blow for Irish banks as Ireland's rating is on negative watch and under pressure amid intense focus on the debt levels of peripheral EU countries such as Greece.

"At the start of 2010, five countries in which Moody's rates covered bonds face a negative sovereign outlook. These are: Greece, Hungary, Ireland, Latvia and Portugal. Negative rating action on a sovereign may adversely impact covered bond ratings," Moody's said.

Downgrades of sovereign ratings may negatively impact covered bonds directly, as refinancing risk in a market increases, or indirectly, to the extent the downgrade may lead to negative rating pressure on covered bond issuers.