Fitch will be taking a closer look at top quality prime residential mortgage portfolios backing covered bonds and RMBS to make sure that “idiosyncratic” risks are adequately mitigated, it said yesterday (Thursday), noting that portfolios with stronger credit profiles could become more common.

The rating agency’s move could lead to downgrades if its supplementary analysis shows that credit protection may be insufficient to support a prevailing rating due to increased idiosyncratic risk, depending on other aspects of asset performance and expectations for the evolution of future credit protection.

Fitch said that prime residential mortgage portfolios with low expected loss levels – described as less than 4% in a triple-A stress scenario – are relatively uncommon but that this could change.

“Although a handful of such portfolios have been seen to date, given tighter post-crisis underwriting limits across the globe, which in some instances have continued to tighten, it is likely portfolios with stronger credit profiles will feature more frequently,” said the rating agency. “This means the 4% loss expectation could be tested more often.”

Fitch will therefore be carrying out supplementary analysis of RMBS and mortgage covered bond portfolios where the expected loss for a triple-A level portfolio is less than 4%, although it may also do this for portfolios with triple-A level loss expectations in excess of 4% if the expected loss is low compared with peer transactions in the same country or for a sector outside prime.

The additional analysis will assess whether there is sufficient credit protection against what Fitch calls “idiosyncratic” risks, which the rating agency did not define outright. However, it said that in spite of apparently strong credit characteristics, a portfolio of loans could experience higher losses than expected overall due to the potential for individual loans unexpectedly defaulting and potentially realising a higher loan severity than expected.

“The specific drivers of these idiosyncratic loss outcomes are difficult to determine in advance,” it added. “For example, the loss may result from unforeseeable factors affecting a property’s value.”

This could be due to servicers choosing to prioritise higher LTV loans for workout, meaning low LTV loans could see a longer workout period and incur greater carry costs prior to security being enforced. Fitch said that it is important that the potential for this risk is assessed and that portfolios contain supplementary credit protection against it where necessary.

Danske Bank analyst Søren Skov Hansen said that only a few issuers’ covered bond programmes are likely to be affected by Fitch’s plans, naming:

• Commonwealth Bank of Australia (loss rate of 3.9%)

• National Australia Bank (3.5%)

• UBS (4%)

• Bank of New Zealand (3.3%)

• DNB Boligkreditt (2.5%)

• SpareBank 1 Boligkreditt (1.7%)

• Sparebanken Vest (2.3%)

“As noted by Fitch, the review may lead to higher collateral requirements,” said Hansen, “but we do not expect the reviews to cause any significant increases. Moreover, we are convinced that any additional requirements will be met accordingly.”