The Pfandbrief 2011 | 2012

The Methodologies of the Rating Agencies
Fitch Ratings’ Covered Bonds (CBs) Rating Methodology | Fitch Ratings methodology mainly addresses
the probability of default (PD) of the debt but also incorporates an element of post-default recovery expectation.
Fitch Ratings defines “default” as failure to make full and timely payments of interest and/or principal
on payments due under the instruments.
The covered bonds rating methodology has been applied since 2007 and covers the following analytical steps:
— Discontinuity: Analyses the risk that payments due on the CB are not met in a timely manner as a consequence
of the insolvency of the issuer. The agency’s view about the likelihood of such an event is
expressed by the discontinuity factor (D-Factor). The Fitch Discontinuity Factor is a percentage between
0% (perfect continuity of payments) and 100% (concomitant default of the issuer and the CB).
— Cash Flow Modelling: Analyses the cash flows in combination with the sustainability of the assets provided
as collateral to investors. In doing so, Fitch also takes into account the available or committed overcollateralisation.
Assuming the issuer defaults, Fitch tests whether cash flows from the cover assets are
sufficient to meet the payments due under the CB.
— Recoveries given Default: After having determined the maximum rating a CB can reach on a probability
of default basis (PD rating), Fitch additionally takes into account expected recoveries in its simulation
runs. The rating scenarios tested go beyond the one corresponding to the PD rating level. Depending on
the expected recoveries the rating of the CB can be lifted by two (or three) notches above the PD rating,
subject to whether the PD rating is in the investment grade (‘BBB-’ and above) range or below.
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As such, the analysis is split into two parts: On the one hand the D-Factor considers the systemic and issuer
specific elements, while on the other hand a quantitative risk analysis is conducted. The D-Factor is computed
as a weighted average score of the following four components:
— Asset Segregation 45%
— Liquidity Gaps 35%
— Alternative Management 15%
— Covered Bonds Oversight 5%
Additionally the D-Factor can be adjusted for counterparty risks dependent on the sensitivity of the investors
to these risks. The rating-dependent stress scenarios used in Fitch Ratings’ quantitative analysis assess
whether the cover pool’s payments (including overcollateralisation) are sufficient to meet the scheduled payments
to the CB holders. Important factors considered are the quality of the cover assets as well as interest,
currency and maturity mismatches between assets and liabilities.
Fitch Ratings’ covered bond methodology is consistently applied since 2007 and has been partially adjusted at
times to reflect market developments. In 2010 / 2011 the following updates were implemented:
— Counterparty Risks: In March 2011 Fitch published its covered bond specific counterparty criteria. This
criteria, inter alia, describes the analysis of payment interruption risks potentially occurring after the issuer’s
insolvency. For a full mitigation of these risks Fitch expects a reserve to cover at a minimum the amount of
expected covered bond interest payments due over the next three months on a rolling basis. Fitch will also
assess the collateralisation of derivatives taking the rating of the issuer into account and the replacement
prospects. For derivatives with internal counterparties Fitch assesses the replacement prospect more critically.
If the counterparty risks are not fully mitigated Fitch will assume a higher probability of default following an
issuer’s default expressed through an increased D-Factor.
— Analysis of commercial real estate: In January 2010 Fitch placed nine covered bond programmes with
a significant amount of commercial real estate exposure in their cover pools and limited data availability
for these assets on Rating Watch Negative (RWN). In the meantime their RWN were resolved for seven programmes.
Following the more detailed pool analysis for all of these programmes the OC supporting the ratings
has increased.
Analytical Contacts:
Rebecca Holter, Director, Covered Bonds CEE (rebecca.holter@fitchratings.com, Tel. +49 69 7680 76 261)
Susanne Matern, Senior Director, Covered Bonds CEE (susanne.matern@fitchratings.com, Tel. +49 69 7680 76 237)
Business & Relationship Development Contact:
Andreas Wagenknecht, Director, (andreas.wagenknecht@fitchratings.com, Tel. +49 69 7680 76 235)