Fitch has started to disclose the components of breakeven overcollateralisation (OC) for its covered bond ratings, information it believes will help investors compare risks across programmes, the rating agency announced yesterday (Tuesday).

The move was unveiled yesterday at a covered bond event held by Fitch in London, with a report subsequently released to the wider market.

The rating agency said that it has started publishing the three drivers of breakeven OC, which are credit loss, cash flow valuation and asset disposal loss. It said that these three components are the quantitative factors most likely to affect covered bond performance in the case of an issuer default.

Fitch already published information about the credit loss expectations for a cover pool in a stressed scenario, and said that the breakeven OC components provide extra detail.

“Credit loss is only part of the story,” said Suzanne Albers, senior director of covered bonds at Fitch. “With access to all three components, investors will gain a more complete picture of our view on the risks the programmes face after recourse shifts to the cover pool.”

The rating agency will graphically present the figures in reports for individual programmes and provide them in other published information.

It said that it believes the components will be most useful in benchmarking individual programmes relative to those most similar to them.

Bernd Volk, head of covered bond research at Deutsche Bank, said that the tool provides additional insights into Fitch’s assessment of overcollateralisation (OC), but is unlikely to have much of an impact on the market.

“Given the dominance of macro topics, this is something of a non-event for the covered bond market at this stage,” he said. “However, it increases transparency and conservative investors may focus on covered bonds with a low credit loss component.”

He added that the tool will be of interest for issuers as it will allow them to see how they compare with their peer group.

According to Fitch, the credit loss component reflects the stressed weighted average and recovery rate for assets in the cover pool.

“We previously published the rating loss rate for programmes,” said Fitch. “The figures are similar but credit loss will always slight exceed rating loss rate for the pool because it is calculated as a percentage of the maximum covered bonds that could be issued rather than as a percentage of the total cover pool.”

The cash flow valuation shows if the stressed present value (PV) of the assets is greater than the stressed PV of the covered bonds after considering the impact of swaps, open interest rate and currency positions, third-party costs, and stressed prepayments.

“When the assets have a higher stressed PV, the cash flow valuation reduces breakeven OC,” said Fitch. “So it is presented as a negative figure.”

Asset disposal loss mainly considers the impact of losses resulting from the liquidation of assets to repay covered bonds on a timely basis or the valuation of cover pools after an assumed covered bond default. Fitch said that the higher the portion of cover assets to be liquidated and the refinancing stresses applied, the larger this component will be.

“It may still be large for ratings that only consider recoveries because Fitch uses lower discount in its recovery analysis, but these are applied to the entire pool,” the rating agency said.

A covered bond analyst said that this component is of less concern, noting that central banks will typically reduce the refinancing risk.

Fitch’s breakeven OC for a given rating captures the minimum amount of excess assets, as a percentage of the covered bonds, below which Fitch would expect to downgrade the bonds due to insufficient protection, all else being equal.