Fitch released an exposure draft on its covered bond sovereign risk criteria yesterday (Wednesday), which in general reflects its prevailing approach but also proposes new criteria for rating multi-jurisdictional covered bonds and which could lead to some cuts.

Fitch, Canary Wharf

The exposure draft explains the rating agency’s prevailing practices with respect to linking ratings of structured finance notes and covered bonds to the credit quality of the sovereign to which they are exposed. In particular it provides detail about Fitch’s approach to assigning structured finance and covered bond ratings that are higher than the relevant sovereign local currency issuer default rating (LC IDR).

Because they reflect Fitch’s prevailing approach these criteria are not expected to affect ratings assigned to covered bonds where the cover pool assets are concentrated in a single jurisdiction.

However, the exposure draft also proposes new criteria for ratings of multi-jurisdictional covered bonds, some of which could be cut if the criteria are implemented as proposed.

“In particular, we have identified 15 to 20 multi-jurisdictional structured finance transactions (out of 85) that could have one or more tranches downgraded, in most of the instances by one or two notches, and two multi-jurisdictional covered bond programmes (out of 15) that could see downgrades by one or two notches on one or more bonds,” said the rating agency.

It said that where a cover pool includes assets from different jurisdictions, it is not possible to peg the maximum covered bond rating achievable to a unique sovereign local currency IDR or country ceiling.

“Due to their diversified country risk exposure, transfer and convertibility risk can become a secondary rating driver for multi-jurisdictional structures,” said the rating agency. “Fitch applies a specific approach where the exposure to sovereigns with a lower country ceiling than the structured finance or covered bond rating is below 20%. Caps may also apply if exposure to macroeconomic and/or event risks is material.”

Maureen Schuller, head of covered bond strategy at ING Bank, said that Fitch does not see transfer and convertibility risk as the major rating driver if the share of assets linked to sovereigns with a lower country ceiling than the covered bond rating is below a materiality threshold of 20% (subject to stress tests). If the portfolio exposure to transfer and convertibility risk exceeds the materiality threshold, that risk is considered to be the major rating driver and the covered bond rating is then capped between the highest and lowest country ceiling of the countries included in the portfolio.

Fitch is seeking feedback on the exposure draft by 28 February.

The consultation comes after Standard & Poor’s in the autumn of last year consulted on new criteria for rating covered bonds above that of the relevant sovereign, which, if implemented as proposed, would reduce the maximum uplift from six for four notches and trigger downgrades of several peripheral covered bonds.

S&P’s consultation was launched in mid-October and closed on 14 November, but final criteria have yet to be released.

Fitch today (Thursday) said that it has amended the stresses applicable to Euribor, UK pound Libor and New Zealand interbank interest rates in covered bonds. It said that the changes concern the parameters applicable to the rates, but that the core principles remain the same and that it does not expect any rating changes from the updated stresses.