DBRS has assigned Spain’s cédulas hipotecarias to its lowest category for ranking covered bond legal frameworks, Modest, which compares with scores of Adequate on the Portuguese programmes it has rated and Strong for its rating of a Bank of Ireland programme.

The rating agency published a commentary on the Spanish mortgage backed covered bonds on Wednesday and assigned the Legal & Structuring Framework (LSF) score based on an a review of the legislation and regulations applicable to cédulas hipotecarias. DBRS LSF categories are: Very Strong, Strong, Adequate, and Modest.

“The methodology differentiates ‘moderate LSFs’ from other higher categories of LSFs such that although the covered bond holders are given a preferential claim to the cover pool assets upon the insolvency of the issuer, DBRS considers that there is still a significant linkage to the issuer in the event of the issuer’s insolvency,” it said, “with considerable risks of cross-default and payment acceleration, or a considerable risk of delayed payments on the covered bonds because of a lack of or limited references to, contingency plans prior to an issuer’s insolvency.”

DBRS said that it recognises the unique way in which holders of cédulas hipotecarias have a claim against all unencumbered mortgage assets of an issuer.

However, it said that it views the risk of (short term) disruption of timely payments on the cédulas hipotecarias as high because, in its words:

• Cashflows received on the cover pool assets not being identified as part of the cover pool before the issuer becomes insolvent (in other words, collections received by the issuer from the cover pool assets are commingled with the issuer’s other operating funds up until the time of the issuer’s insolvency). As a result, immediately following the issuer’s insolvency, an insolvency administrator may not be able to differentiate those cashflows received from the cover pool from the general operating funds in the issuer’s account in order to make payments on the CH;
• No pre-appointed CP administrator or replacement servicer prior to issuer insolvency;
• Lack of liquidity test for CH issuers; and,
• Given the current stress to the Spanish economy and the need to recapitalise the banking sector, DBRS has a heightened concern regarding the ability of the Bank of Spain to support outstanding CH following an issuer’s insolvency.

DBRS said that although not a factor in its LSF assessment, it recognises other concerns for CH holders: there being no requirement to update property valuations in order for eligible loans to remain eligible cover pool assets; the lack of an independent cover pool monitor pre-insolvency of the issuer.

The rating agency said that transaction-specific structural features could warrant the assignment of a different LSF to a cédulas hipotecarias.

“The CH LSF assessment outlined in this commentary represents a qualitative DBRS credit-based view regarding the potential de-linkage, if any, between an issuer and a CH rating,” it added.