Standard & Poor’s cut Hypothekenbank Frankfurt Pfandbriefe from AAA to A- before withdrawing the ratings on Friday as a result of the implementation of a new framework on counterparty risk. It has also placed on Credit Watch negative obligations foncières of Compagnie de Financement Foncier.

The rating agency updated its methodology and assumptions for assessing counterparty and supporting party risk in March 2012, but no rating action was taken against issuers that presented plans to comply with the new framework by a transition deadline set for 11 January 2013. However, S&P noted that from being in regular contact with the two issuers it now understands that they may not be able to implement the necessary changes before the deadline, despite their willingness to meet the new criteria. S&P warned of impending reviews and possible multiple notch downgrades resulting from issuers’ failure to comply with the new methodology on 26 November 2012 (click here for previous coverage).

The mortgage and public sector covered bond programmes of Hypothekenbank Frankfurt (formerly Eurohypo) were cut by six notches, with S&P saying that although the issuer still aims to address the risks, “to date, no actions have been implemented to mitigate the identified risks, nor is it likely that these planned amendments fully address our criteria or will be implemented by 11 January 2013”.

Using worst case scenario assumptions for sizing commingling risk (which S&P said it did because the most recent cashflow reports it has received are as of 30 September), the rating agency concluded that the available credit enhancement of 20.05% for the mortgage covered bond programme is neither sufficient to cover the target credit enhancement consistent with six notches of uplift over the issuer rating of A- nor a 27.79% level necessary to cover asset default risk that would give the programme a one notch rating uplift over the issuer.

For public sector covered bonds, S&P said that a 6.9% level of available credit enhancement is insufficient to cover the target credit enhancement or a 9.43% level of enhancement commensurate with a one notch uplift above the issuer’s rating.

After the ratings of the two programmes were cut to the issuer rating of A- they were withdrawn upon Hypothekenbank Frankfurt’s request, said S&P.

The covered bond programme of Compagnie de Financement Foncier (CFF) was put on negative review on December 14 also as a result of the implementation of S&P’s new counterparty risk framework, with the rating agency saying that its derivative related risks are still not in line with the updated criteria.

“In particular,” said the rating agency, “termination payments that would arise if a derivative contract ends prematurely and could be due by CFF to the counterparty are not subordinated to the covered bondholders.

“For a significant number of swaps in the transaction this risk of exposure to termination payments is not yet mitigated by a replacement framework according to Standard & Poor’s methodology,” it added.

Unless the issuer takes action to reduce these swaps to represent less than 5% of the outstanding covered bonds, S&P said, CFF’s covered bond programme may be cut by four notches from AAA to A+, one notch above the issuer’s rating.

However, S&P noted that the information provided by the issuer demonstrates “its willingness to address the counterparty risks in its programme through amending some swap contracts, possibly introducing covenants to mitigate the impact of termination payments, and by increasing overcollateralization to cover any unhedged risk in order to maintain the current rating on the covered bonds”.

A covered bond analyst contrasted the situations of Hypothekenbank Frankfurt and CFF.

“As opposed to Hypothekenbank Frankfurt, which is a static programme, CFF has a very vital interest in avoiding a four notch downgrade and should do everything to avoid this scenario,” he said.