Fitch has published a full set of proposed new covered bond rating criteria including more details than in a release two weeks ago, and identified 22 programmes that would likely have their ratings cut by one or two notches if the proposed changes are implemented, with OBGs most at risk.

An exposure draft detailing the changes was published yesterday (Wednesday), marking the start of a six week consultation period ending 12 July. The rating agency expects to publish final revised criteria in August.

Jussi Harju, vice president, covered bond analyst at Barclays, said that the exposure draft provides clarification of the changes Fitch indicated in a press release from 16 May, and noted that the final criteria will be published in August when other criteria changes are also due.

“In August Fitch will come out with multiple criteria revisions, including the counterparty criteria for covered bonds and some additional revisions to its analytical assumptions.” said Harju.

The rating agency said it will by the end of August publish updated counterparty criteria, a criteria report on the analysis of covered bonds secured by public sector assets, a criteria addendum on its mortgage spread assumptions, and an update to the criteria for the analysis of covered bonds secured by commercial real estate loans, and that any proposed revision of criteria may have additional rating impact to that stemming from revisions to its global covered bonds rating criteria.

For Florian Eichert, senior covered bond analyst at Crédit Agricole CIB, said that the exposure draft is largely in line with the changes flagged in Fitch’s earlier announcement.

“With sovereign risk more in focus, Italian programmes still look like the ones that are most in danger,” he said.

But the exposure draft contains new information, for example, about how Fitch will analyse programmes that are in wind-down, said Eichert.

“The main thing that I take away is that Fitch will treat programmes that are in wind-down or not actively used differently, by applying more severe cashflow modelling criteria and being stricter about voluntary OC,” he said.

He also noted that the proposals involve Fitch taking a somewhat stricter stance on voluntary OC in general, thereby moving closer to the approach taken by other rating agencies.

Fitch previously said that it expects the rating impact to be modest, and that the programmes most likely to be affected are non-pass through mortgage programmes of issuers rated BBB+ and below and programmes with weak liquidity gap protection.

It yesterday identified by name those programmes whose ratings would likely be cut by one or two notches, which would result primarily from Fitch implementing a new weak link approach and incorporating explicit sovereign risk factors into new “D-Caps”.

Twenty-two programmes were identified (see below), seven of which are Italian, five Spanish, four German, three UK, two Dutch, and one Irish.

Yorkshire Building Society is one of those with a programme at risk of being downgraded, and Chris Parrish, group treasurer at the UK financial institution, said that this is of course disappointing, in particular when there have been no changes at the level of the issuer or its covered bond programme.

“It’s purely because of the way Fitch is changing how they view things.” he said, “To a degree the situation is therefore out of our hands, but we will work with Fitch to see what mitigants may be possible to implement to safeguard our triple-A rating.”

Moody’s rates Yorkshire’s covered bonds Aa2.

The proposed criteria do not, according to Fitch, represent a change to its rating framework, which will continue to assess the risk of interruption of covered bond payments in the aftermath of an issuer default.

Instead, the proposed amendments represent enhancements intended primarily to simplify Fitch’s discontinuity framework approach, and to better address sovereign and systemic risk issues, according to the rating agency.

One of the main proposals involves the replacement of Fitch’s Discontinuity Factor (D-Factor) framework with D-Cap categories that correspond to a maximum uplift from a long term issuer default rating to the covered bond rating on a probability of default (PD) basis.

In its 16 May press release Fitch referred to D-Caps of between 0 and 8, but Barclays’ Harju said that the exposure draft makes clear that a D-Cap of 8 is reserved only for pass-through programmes that are mainly used to access central bank liquidity, while D-Caps of 0 to 6 notches apply to publicly placed covered bonds with bullet maturities.

The proposed D-Caps are: 0 (Full Discontinuity), 1 (Very High), 2 (High), 3 (Moderate High), 5 (Low), 6 (Very Low), and 8 (pass-through programmes with sufficient liquidity protection).

Fitch said that it considers a D-Cap of 4, in line with moderate risk, should be the best assessment to apply to non-pass through mortgage programmes, and that this will raise the bar for achieving a AAA covered bond rating, from a minimum issuer default rating (IDR) of BBB+ to A-.

“The change is driven by the continued lack of precedents for mortgage liquidations, particularly following an issuer default, and the view that a BBB category IDR can be too volatile to support the expected stability of a AAA rating,” said Fitch.

Fitch is also proposing that the D-Caps be driven by the highest risk component, in contrast to a weighted view of components as is the case under its D-Factor framework.

“This change in criteria will increase transparency by highlighting any perceived weaknesses within the components,” said Fitch. “It will also ensure that a major weakness in any crucial component will become the key driver of Fitch’s rating.”

A key change to Fitch’s prevailing approach is to introduce covered bond rating caps based on sovereign ratings, with a maximum rating of six notches above the sovereign.

Barclays analysts said that this means an issuer must be domiciled in a country that has a rating of at least A- if its covered bonds are to obtain or keep a AAA rating, and that the proposed cap will obviously affect programmes linked to lower rated countries.

Furthermore, they said, under the proposal the sovereign cap gets stricter when sovereign rating is lower. A sovereign rating in the BBB category would result in a D-cap of one notch only, meaning a BBB+ rated issuer domiciled in a BBB+ rated country could at best achieve a A+ covered bond rating (including two notches uplift for recoveries).

For countries with a sovereign rating of BB+ or below (for example, Portugal), the D-cap for a BB+ rated issuer would be most likely 0, meaning the maximum covered bond rating would be ‘BBB’ (assuming two notches uplift for recoveries, although Fitch may grant up to three notches), said Barclays analysts.

“Given the magnitude of the recent sovereign rating downgrades, this can lead to a higher rating volatility for covered bonds,” they said.

Programmes that would likely be cut by one or two notches, according to Fitch:

• Aareal Bank AG, mortgage programme, AAA
• Banca Carige, mortgage, AA Rating Watch Negative (RWN)
• Banca Monte dei Paschi di Siena SpA, mortgage, AA RWN
• Banca Popolare di Milano, mortgage, AA RWN
• Banco Guipuzcoano, mortgage, AA- RWN
• Banco Mare Nostrum S.A., mortgage, AA-
• Banco Popolare, mortgage, AA RWN
• Barclays Bank PLC, public sector programme, AAA
• Caja Laboral Popular, mortgage, AA- RWN
• Cajamar Caja Rural, Socieded Cooperativa de Credito (Cajamar), mortgage, AA- RWN
• COREALCREDIT BANK AG, mortgage, AA-
• Credito Emiliano S.p.A., mortgage, AA+ RWN
• DEPFA ACS Bank, public sector, AAA RWN
• Deutsche Pfandbriefbank AG, mortgage, AA+
• NIBC Bank N.V., mortgage, AAA
• Northern Rock (Asset Management) plc, mortgage, AAA
• SNS Bank N.V., mortgage, AAA
• UniCredit S.p.A, mortgage, AA+ RWN
• Unione di Banche Italiane Scpa – UBI Banca, mortgage, AA+ RWN
• Unnim Banc, S.A., mortgage, A- RWN
• Wuestenrot Bank AG Pfandbriefbank, mortgage, AAA
• Yorkshire Building Society, mortgage, AAA