A downgrade of the UK by Fitch last week does not have a direct impact on the ratings of non-UK covered bonds whose cover pools include assets from the country, according to the rating agency, with rating vulnerability expected to be limited, given the low exposure of most programmes.

On Monday of last week (27 June) Fitch downgraded the UK from AA+ to AA, following the country’s vote to leave the EU.

Yesterday (Tuesday) afternoon, Fitch said that the downgrade does not have a direct rating impact on the 10 covered bond programmes it rates that have exposures to the UK. The rating agency noted that the 10 programmes include six public sector and four mortgage programmes of French, German and Luxembourg issuers, with ratings between AA and AAA.

For the public sector programmes, Fitch said exposure to the UK is low to moderate, ranging from 0.3% to 11.8% of their respective cover pools. While stressed expected losses from UK assets increased slightly based on the increased default risk and lower recovery rate assumptions for such assets following the downgrade of the UK, the rating agency said the maximum increase is below 1 percentage point in AA to AAA scenarios.

Fitch said that for the mortgage programmes – all four of which are German – exposure to the UK consists of loans backed by commercial real estate (CRE) and ranges from 2.6% to 12.7% of cover assets. The stressed expected loss for these loans is derived based on loan and property characteristics, as well as market expectations such as vacancy rates, property yields and rental value declines, the rating agency said, adding that so far, these programmes have been unaffected by the UK downgrade.

“Potential economic, political and regulatory consequences of the Brexit vote could affect the ratings of programmes with high exposure to the UK,” said Fitch. “A weaker economic environment may increase loss expectations for public sector assets linked to the sovereign rating.

“Credit losses modelled in rating scenarios corresponding to the current covered bonds rating could increase if the UK IDR (issuer default rating) is downgraded further.”

Fitch said that loans backed by CRE assets may be subject to higher expected defaults and lower recovery expectations if economic uncertainty and reduced demand lead to downward pressure on UK CRE markets.

However, it said that given strict German mortgage lending valuation guidelines applicable to Pfandbriefe and consequently low loan-to-market value ratios of the UK exposures, market values would have to fall significantly to lead to substantial increases in Fitch’s stressed loss expectation for these programmes.

Depreciation of sterling against the euro would lead to declining cover pool values if not hedged or fully offset by sterling covered bonds issuance, Fitch added, but it said it does not expect a significant increase in the breakeven overcollateralisation (OC) for the assigned ratings, as most of the programmes exhibit only small open sterling positions.

Furthermore, Fitch said it does not currently expect any downgrades to non-UK covered bond programmes given an average buffer between the breakeven OCs for the ratings and the OC Fitch relies upon of more than 8%.