Fitch has updated its criteria for analysing asset related risks of commercial real estate loans used as collateral for covered bonds, with feedback from German issuers represented by the Association of German Pfandbrief Banks (vdp) contributing to its decision.

The rating agency on Friday announced the changes, which it said are not anticipated to have any rating impact given that only slight reductions in loss rates are expected.

The three main changes cited by Fitch are: the introduction of a benefit for tenant granularity; the consideration of additional securities related to the cover assets; and an adjustment of the default modelling for loans secured by multi-family properties (MFH).

“With the updated methodology, Fitch recognizes the benefit of tenant granularity in its recovery analysis for loans that are assumed to default immediately based on their current property income,” it said. “Whereas previously the assumed property income was adjusted downwards under the assumption that all tenants would default in a stress scenario, now Fitch uses a rating dependent default rate to adjust the property income until lease expiry.

“Additional securities will now be considered in the recovery analysis if they are solely available for the benefit of the bondholders, held in cash or highly rated sovereign bonds, and assumed to have a material impact on the portfolio’s expected loss. For MFH, Fitch will no longer test for defaults at lease expiry for properties which are located in countries where residential lease contracts are open ended.”

Rebecca Holter, senior director, Fitch, told The Covered Bond Report that the changes came about partly as a result of feedback received during discussions with German issuers and the Association of German Pfandbrief Banks. The rating agency in February concluded reviews of several German issuers’ commercial real estate exposure in cover pools that were initiated back in January 2010.

“The feedback that we received then was quite extensive,” said Holter, “and in the last update we hadn’t changed much because we were still in the process of the reviews of the loan by loan data we received, but this year we have made the changes.

“For example, a point the issuer association pointed out was that we don’t reflect benefits of tenant granularity, and that’s something we then incorporated. And they said that we were too conservative on multi-family housing, and we took another look at how we treated it in the model and also there reflected the issuer feedback.”

RBS analysts said that the changes to Fitch’s methodology are sensible.

“In our view, the adjustment for borrower diversification is a step in the right direction,” they said. “This should partly mitigate the difference in the treatment of certain MFH in German pools between the German Pfandbrief Act (use-based definition of commercial mortgage loans) and Fitch’s approach, where loans secured by more than four single residential units are (mostly) classified as commercial mortgages.”