Standard & Poor’s today (Monday) assigned preliminary triple-A ratings to covered bonds issued out of two BRFkredit capital centres that were downgraded by Moody’s last week, highlighting the rating agencies’ different assessments of the risk of ARM loans in Danish covered bonds.

S&P assigned preliminary ratings of AAA, on stable outlook, to særligt dækkede obligationer (SDOs) issued out of BRFkredit’s capital centre E and realkreditobligationer (ROs) issued out of capital centre B.

Moody’s downgrades – which hit the issuance of other Danish mortgage banks, too, in recent months – came after the rating agency revised its view on adjustable rate mortgage loans in the cover pool of Danish covered bonds, as well as resulting from cuts to issuer ratings. Moody’s increased refinancing margins and lowered the Timely Payment Indicator (TPI) assigned to Danish issuances from “very high” to “high”.

S&P said in its rating releases that it has assigned the two BRFkredit programmes to category 1, the best categorisation in its methodology, and asset liability mismatch (ALMM) measures of “low”, allowing potentially for the issuance to be rated seven notches above the issuer rating. S&P assigned BRFkredit an issuer rating of A- last week.

“BRFkredit’s capital centre E is an existing capital centre and has separate programme documentation, which it will use to finance fixed rate, adjustable rate mortgages (ARMs) and floating-rate mortgage loans by issuing SDOs of various maturities,” said S&P in its release on capital centre E. “We expect the majority of new issuance from Capital Centre E to have a one year maturity term.

“We understand that BRFkredit does not currently plan to issue new RO from the capital centre, but may do so at a later date,” said the rating agency of capital centre B. “The issuer will continue to refinance some adjustable rate mortgage (ARM) loans in capital centre B, which due to legal changes, cannot be moved to capital centre E.”

Moody’s change to its methodology in June reflected the growing volume of ARM loans in cover pools and its view that they are more exposed to refinancing risk than traditional mortgage loan products.

S&P noted today that while the long term loans may have to be refinanced on a regular basis, borrowers have to accept the full cost of funding for the mortgage loans.

“Due to the specifics of the balance principle of the Danish mortgage system, we do not model a sale of the cover pool at the first maturity of the bond, but assume that the issuer will refinance the bond at (stressed) market rates,” said the rating agency. “We consider the refinancing of the ARM loans to be a potential credit risk as interest may increase substantially between interest reset periods, and hence expose the borrower to the risk that a loan’s scheduled future periodic payments may increase substantially (a ‘payment shock’).

“We therefore increase our base case foreclosure frequency rate for ARM loans by 20%.”

S&P said that it has not observed any higher refinancing costs for ARM loans.

“Should we observe an increase in funding costs of ARMs compared with other mortgage loan products, we may reflect the different investor perception by adjusting our refinancing assumptions accordingly,” it added.

Moody’s revised criteria for Danish covered bonds had resulted in it requiring higher overcollateralisation levels for issuers to maintain ratings.

S&P said that as of 30 June, the available credit enhancement for capital centre E was 15.33% versus target credit enhancement commensurate with the highest credit rating of 9.86%, and for capital centre B 9.47% and 9%, respectively.

BRFkredit last Monday, ahead of having its covered bonds downgraded, requested that Moody’s withdraw its ratings. A BRFkredit official told The Covered Bond Report that it could seek ratings from Fitch.