Dexia Kommunalbank Deutschland (DKD) has criticised a Standard & Poor’s downgrade of its public sector Pfandbriefe, after S&P on Tuesday lowered the rating from A+ to A citing concentration risks in the issuer’s cover pool relating to Länder debt.

S&P announced the cut to its rating of DKD’s Öffentliche Pfandbriefe from A+ to A, on stable outlook, after applying its new covered bond rating methodology, which led to increased overcollateralisation (OC) requirements for the programme.

The rating agency said it had not assigned any notches of collateral-based uplift from DKD’s jurisdiction-supported rating level (JRL) of “a” because the available credit enhancement of 8.27% is below the level required.

Under its rating criteria, for a notch of collateral-based uplift, the available credit enhancement must exceed the higher of “AAA credit risk plus 25% refinancing costs” – which S&P calculates as 8.74% – and the potential net loss that may arise from debtor default, calculated by new supplemental tests that capture concentration risks in the cover pool.

The supplemental tests calculated the total net loss that would occur assuming the default of a certain number of the largest individual obligor exposures of a similar nature (the “largest industry test”) – in DKD’s case, German local and regional governments (Bundesländer) – depending on their rating, and applying a stressed recovery rate.

In DKD’s public sector cover pool, exposure to the six largest-rated AA+ or below obligors – the Länder – is Eu6.654m, according to S&P. It applied a recovery rate of 60% in this supplemental test, resulting in a net loss of Eu2.662m, or 13.24% of OC.

“In order to cover a AAA credit stress scenario, the available credit enhancement must exceed this net loss result,” said S&P.

In a statement published on Tuesday, DKD said that it disagreed with the reasoning behind S&P requiring more than 4 percentage points of extra OC be registered in its cover pool for its A+ rating to be maintained.

“DKD’s board of directors has decided not to fulfil this request since, due to the outstanding credit standing of Bundesländer, it is not discernible that a considerable concentration risk may result from this borrower group’s stock of debt,” it said.

“Bundesländer debts are among the best quality cover assets which contribute significantly to the special quality of DKD’s Öffentliche Pfandbriefe.”

According to the issuer, it currently has Eu9.1bn of Länder debt in its cover pool, equivalent to a 41% share, and it had nominal OC of 9.1% as of 31 March.

DKD also said that S&P had told it that the procedures used by the rating agency to measure concentration risks from Bundesländer debt are based on methods and data that originate from the market for corporates and US municipal CDOs.

The issuer added that for many years, the nominal overcollateralisation for the pool has been higher than the target value of 8.15% of outstanding Pfandbriefe with only slight changes in the debtor structure, and that the proportion of German loans is higher than 70%.

“When designing the composition of its cover pool for Öffentliche Pfandbriefe, DKD traditionally has pursued a policy of a steady hand and of continuity,” it said.