Standard & Poor’s has cut public sector covered bonds issued by Eurohypo Lux from AAA to AA- because it considered the available credit enhancement insufficient to cover market risk stemming from potential swap termination payments, and subsequently withdrew the ratings at the issuer’s request.

The rating agency cut the lettres de gages publiques to AA-, on negative outlook, after a review of the latest cover pool characteristics and cashflow information as of 31 March. It classifies the covered bonds as a Category 2 programme with “low” asset-liability mismatch (ALMM) risk.

“The downgrade reflects our view on the level of market risk resulting from swap termination payments, potentially due to derivative counterparties, that have led to an increase in the target credit enhancement level,” said S&P.

It considers the target credit enhancement level commensurate with a AAA rating to be 24.34% on a nominal basis, including 11.94% in consideration of potential swap termination payments, and said that its analysis indicates that the available level of overcollateralisation (14.26% on a nominal basis) is commensurate with a AA rating.

This equates to three notches of uplift above the issuer credit rating (ICR), as opposed to the six that is possible under S&P’s methodology given a Category 2 programme and “low” ALMM risk.

RBS analysts said that S&P confirmed that the rating action did not result from any changes in the documentation or the composition of counterparties, and that the rating action was an in-between step on the way towards the application of new counterparty criteria, which have yet to be published.