TEXT-S&P rates DLR Kredit's Capital Centre B bonds

Fri Nov 23, 2012 11:01am EST

OVERVIEW
     -- We have assigned our preliminary 'BBB+/Positive' long-term rating and 
preliminary 'A-2' short-term rating to DLR Kredit's upcoming issuances of 
"section 33e" bonds (junior ranking mortgage bonds) out of its Capital Centre 
B. 
     -- We have assigned these ratings based on our principles of credit 
ratings. The current approach does not envisage any additional rating uplift 
from that of the senior unsecured debt rating on the issuer, due to the 
specific characteristics of these bonds.
    
     Nov 23 - Standard & Poor's Ratings Services today assigned a preliminary
'BBB+' long-term credit rating and a preliminary 'A-2' short-term rating to DLR
Kredit A/S' issuances of Danish section 33e bonds (DKSE33e; Danish
legislation-enabled junior ranking mortgage bonds) out of its Capital Centre B.
The outlook is positive (see list below).

We understand that DLR Kredit intends to issue section 33e bonds to raise 
funds to replace existing government guaranteed debt and for posting 
additional collateral in its Capital Centre B, which issues "saerligt daekkede 
obligationer" (SDO; Danish senior covered bonds). DLR Kredit's Capital Centre 
B is an existing capital center, which has separate program documentation and 
is specifically set up to allow the issuer to issue SDO bonds. The section 33e 
bonds will be issued under separate documentation for the capital center. 

RATING RATIONALE

We note that section 33e bonds rank junior to the traditional (senior) covered 
bonds in the capital center that they are issued from, but rank senior to the 
issuer's senior unsecured debt for funds from the associated capital center. 
The proceeds from the issuance of section 33e bonds must be placed in 
particularly secure assets, as defined by the covered bond act, which in turn 
are to be placed in separate accounts dedicated to the specific capital 
center. Any surplus of the cover pool after making payments to covered bonds 
and section 33e bonds will be transferred to the bankruptcy estate. Not until 
then will the senior unsecured creditors have access to assets from the cover 
pool.

If the issuer defaults, payments on the section 33e bonds are deferred until 
all respective senior covered bonds have been redeemed, unless the bankruptcy 
administrator is confident that the senior covered bonds can be repaid. The 
bonds are dual-recourse instruments as they are secured by the residual or 
remaining assets within the individual capital center, and will rank pari 
passu with the senior unsecured creditors' claims if not repaid using the 
funds in the capital center. 

In our opinion, section 33e noteholders are unlikely to receive full payment 
of principal and interest and will not receive any interest on deferred 
interest in such an event. As our ratings address timely payment of interest 
and ultimate payment of principal, we believe that our ratings on the section 
33e bonds issued out of DLR's Capital Centre B would be lowered if the issuer 
defaults.

The reason for this is twofold. First, the notes rank pari passu with the 
senior unsecured claims on the issuer in case the cover pool is not sufficient 
to repay the section 33e bonds. Second, we give no benefit to the cover pool 
in our analysis of the section 33e bonds. As a result, we would generally 
expect our ratings on the section 33e bonds to reflect any changes in our 
ratings on DLR Kredit's senior unsecured debt. 

We do not consider the benefit of any recourse to the cover pool in our rating 
analysis as we do not believe that the issuer can commit to or manage levels 
of overcollateralization to support section 33e bonds that are similar to what 
we typically see for standard covered bonds. This is due to the specific 
payment mechanics of the Danish section 33e bonds and their purpose to raise 
funds to provide additional overcollateralization for the senior covered 
bonds. 

Consequently, our preliminary 'BBB+' long-term and 'A-2' short-term ratings on 
the section 33e bonds are directly linked to the ratings on the issuer's 
senior unsecured debt. As a result, the outlook assigned to the long-term 
rating on the section 33e bonds reflects the positive outlook assigned to the 
issuer credit rating on DLR Kredit.

LEGAL CONSIDERATIONS

The 2007 amendment to the Danish covered bond legislation introduced the 
requirement to regularly revalue the collateral securing the mortgage loans in 
order to make certain Danish covered bonds compliant with the Capital 
Requirements Directive. With the amendment, the regulators introduced section 
33e bonds to allow mortgage credit institutions issuing SDOs to raise capital 
in order to maintain sufficient overcollateralization in the event that the 
loan-to-value ratio of the mortgage assets were to increase above regulatory 
limits.

The Danish covered bond legislation refers to section 33e bonds as bonds 
issued with the purpose of funding additional overcollateralization. Some 
mortgage banks refer to section 33e loans as "junior covered bonds" while 
other market participants may refer to them as the "issuance of senior debt in 
pursuance of section 33e of the Act on Mortgage Loans and Mortgage Bonds etc". 

We understand that no acceleration occurs on the covered bonds, derivatives, 
or section 33e bonds if the mortgage credit institution is declared bankrupt. 
However, a bankruptcy administrator may pay back section 33e bondholders if 
the administrator is confident that funds are sufficient to repay all 
remaining issued covered bonds and derivative counterparties registered in the 
specific capital centers.

OTHER CONSIDERATIONS

Should an issuer choose not to refinance the section 33e bonds, this may lead 
to a decrease in the overcollateralization available to a capital center. 
Changes in available overcollateralization may lead to changes in the ratings 
on covered bonds issued out of DLR Kredit's Capital Centre B. 

The issuance of Danish section 33e bonds is only one of the methods that 
Danish covered bond issuers are utilizing to meet the legal requirements of 
additional posting of collateral when property prices decline. If the issuer 
becomes insolvent, all assets in the cover pool secure the preferential claim 
of the outstanding covered bonds. 

The Danish covered bond legislation requires that the proceeds from issuance 
of section 33e bonds are invested in a defined group of high quality assets. 
Furthermore, the legislation states that any assets that are funded by the 
issuance of section 33e bonds must remain in the capital center from where the 
section 33e bonds were issued. This means that the part of the 
overcollateralization in a given capital center that the rating on the 
(senior) covered bonds relies on is in effect, committed to the capital 
center. Furthermore, management cannot remove it at their discretion as long 
as the corresponding section 33e bonds are outstanding.

We currently rate SDO issuances from DLR Kredit's Capital Centre B at 
'AAA/Stable/A-1+'. As of June 30, 2012, Capital Centre B had available 
overcollateralization levels of 14.79%. We expect DLR Kredit to issue DKK4 
billion worth of section 33e bonds with a further amount to be issued in 2013. 
The intended first issuance could potentially increase available 
overcollateralization by 3.91% in Capital Centre B. We expect DLR Kredit to 
continue issuances out of the capital center, albeit at a lower level, as long 
as property prices continue to fall in Denmark.

RELATED CRITERIA AND RESEARCH 

     -- DLR Kredit's Capital Centre B Covered Bond Issuances Assigned 
'AAA/A-1+' Ratings; Outlook Stable, Oct. 24, 2012
     -- DLR Kredit Outlook Positive On Improved Capitalization; 'BBB+/A-2' 
Ratings Affirmed, Off CreditWatch, Sept. 7, 2012
     -- Standard & Poor's Ratings Definitions, June 22, 2012
     -- Ratings Assigned To Nykredit Realkredit's Danish Section 33E Bond 
Issuances, April 18, 2012
     -- European Structured Finance Scenario And Sensitivity Analysis: The 
Effects Of The Top Five Macroeconomic Factors, March 14, 2012
     -- Global Structured Finance Scenario And Sensitivity Analysis: The 
Effects Of The Top Five Macroeconomic Factors, Nov. 4, 2011
     -- Principles Of Credit Ratings, Feb. 16, 2011
     -- Understanding Standard & Poor's Rating Definitions, June 3, 2009
     -- Evolution, Not Revolution-Proposed Changes To The Issuance Of Danish 
Covered Bonds, Jan. 25, 2007


RATINGS LIST
Program/            Rating
Country: Covered bond type

RATINGS AND OUTLOOK ASSIGNED
DLR Kredit A/S - Capital Centre B
Long-term: BBB+/Positive
Short-term: A-2
Denmark: "Danish Section 33e Bonds" (Legislation-Enabled Junior Ranking 
Mortgage Bonds)