The Pfandbrief 2011 | 2012

The Methodologies of the Rating Agencies
Standard & Poor’s Rating Services rates covered bonds based on its criteria published in late 2009. S&P’s
criteria reflect its belief that covered bonds that exhibit mismatches between the underlying assets and the
covered bond liabilities should be linked to the issuer credit rating. Only if a covered bond can be isolated from
that risk can S&P rate the covered bonds on a de-linked basis from the issuer. When a program is exposed to
asset-liability mismatch (ALMM) risk, the maximum potential rating uplift the covered bond rating can achieve
above the issuer credit rating is seven nothes. Therefore, ‘AAA’ ratings can only be assigned to covered bonds
of highly rated issuers, provided that S&P believes the program has sufficient credit enhancement to cover all
relevant risks.
Asset analysis
The underlying cover pools typically contain residential mortgage loans, public sector bonds and loans, or
some other form of high credit-quality collateral. Thus, in case of a default a high rate of asset recovery can
be expected. However, the cover pool assets may be exposed to payment interruptions and defaults. Therefore,
using jurisdiction- and asset-specific assumptions, S&P analyses these pools to form a view on the expected
stressed credit performance. S&P currently reviews the assumptions applied in the asset analysis of public
sector covered bonds.
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Cash-Flow and Market Value Analysis
In addition to interest and exchange rate mismatches there is an inherent maturity mismatch between the
cover pool assets and the covered bonds. Analysing the degree of this mismatch together with the potential
repayment options is an important step in S&P’s cash-flow- and market value analysis for covered bonds. If the
cover pool fails to generate sufficient cash-flows, S&P models the sale of the remaining cover pool assets by
discounting their cash flows using a stressed discount rate and an asset specific liquidity premium.
We also evaluate the alternatives at the trustee’s disposal to manage ALMM in case of an issuer default.
The broader the range of funding options and the more well-established and systemically important S&P
believes the covered bond market is the higher is the potential rating uplift the covered bond rating can
achieve above the issuer credit rating.
Lastly, S&P determines a rating on the program that reflects the cover pool’s actual level of credit enhancement.
In this step, S&P assesses whether the available credit enhancement in a program is equal to or higher
than the target credit enhancement deemed commensurate to support the maximum potential rating. The target
credit enhancement covers all risks that S&P considers relevant and in our view allows for timely payment
of all covered bond liabilities.
S&P publishes the main indicators of the covered bonds it rates in a quarterly report (see “Global Covered
Bond Characteristics and Rating Summary” on www.standardandpoors.com/coveredbonds).
Legal Risk
S&P typically reviews the following legal aspects when assigning a rating to a covered bond program – with
special regard to the case if the issuing bank fails:
— Is there a clear segregation of the assets and cash flows;
— Does no acceleration of payments to noteholders of the program occur;
— Are covered bonds excluded from the payment moratorium or forced restructuring of the bank;
— Is the provided credit enhancement fully available to covered bond holders;
— Are hedging instruments still available after the insolvency of the bank;
— What options has the trustee available to access liquidity; and
— What options are available to manage the cover pool.
Operational and Administrative Risks
In its rating process S&P also considers the relevant operational and administrative risks. Hereby, we review
the organisational aspects of the bank, as well as the credit life cycle of the respective assets. The issuer’s business
policy, origination and servicing operations, together with recovery following a default are all assessed.
Counterparty Risks
To the extent a program benefits from the use of derivatives to address any interest rate or currency mismatches
S&P reviews the underlying agreements to assess whether they conform with its relevant counterparty
criteria. The covered bond specific counterparty criteria are currently under review.
S&P methodology may change from time to time as a result of market and economic conditions
that would affect our credit judgment. S&P currently reviews its counterparty criteria for covered bonds.
(Editor‘s Note: This article is a summary of the S&P criteria published in late 2009 (“Revised Methodology And Assumptions
For Assessing Asset-Liability Mismatch Risk In Covered Bonds” published on Dec. 16, 2009 and available on RatingsDirect and
www.standardandpoors.com/coveredbonds.)
Contacts:
Primary Credit Analyst: Sabrina Miehs, Frankfurt, (49) 69-33-999-304; sabrina_miehs@standardandpoors.com
Analytical Manager - Covered Bonds: Karlo Fuchs, Frankfurt, (49) 69-33-999-156; karlo_fuchs@standardandpoors.com