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Feb 13 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed Commerzbank AG’s (CBK; A+/Stable/F1+) SME structured covered bonds at ‘AA’ with a Stable Outlook, following a periodic review of the programme.
The rating is based on CBK’s Long-term Issuer Default Rating (IDR) of ‘A+', the Discontinuity Cap (D-Cap) of 8 (minimal) and the contractual overcollateralisation (OC) that Fitch takes into account in its analysis, which is currently 21%.
The unchanged D-Cap is driven by a minimal risk assessment of the liquidity gap & systemic risk component. The cover pool specific alternative management and asset segregation risks are assessed as low. Risks stemming from the systemic alternative management and privileged derivatives components are classified as very low.
The D-Cap analysis reflects the minimal risk of payment discontinuation on the covered bonds post CBK’s insolvency. After CBK defaults, the covered bonds benefit from a switch to pass-through mechanism -if funds to repay the bonds at their expected maturity date are insufficient- and a separate liquidity facility for each bond after a rating trigger breach.
Fitch’s ‘AA’ breakeven OC has increased to 12.5% from 11.3%, primarily driven by the agency’s newly implemented cash flow modelling approach. In a ‘AA’ scenario, Fitch has calculated a cumulative credit loss of 16.8%, confirming last year’s results.
However, the breakeven OC of 12.5% will only sustain the ‘AA’ covered bond rating as long as CBK remains rated ‘A+'. The level of OC supporting the ‘AA’ covered bond rating irrespective of CBK’s IDR is currently 19.0%, well below the current OC and in line with the previous analysis.
With a cut-off date 31 December 2013, CBK’s EUR500m outstanding SME structured covered bonds were secured by a collateral pool of EUR605m, resulting in nominal OC of 21%. The collateral pool consists of 1,610 short-term money market to medium-term investment loans granted to 1,334 German SME borrowers.
The weighted average life (WAL) of the collateral pool has increased to 1.8 from 1.1 years since the previous analysis. However, Fitch has modelled all loans with an extended maturity to account for the increased default risk of short-term bullet loans should CBK be unwilling or unable to refinance maturing loans. The agency assumed a minimum WAL of two years for all loans.
Consequently, the portfolio’s WAL for the credit model increased to 2.5 years.
The covered bonds’ redemption profile does not match the amortisation of the cover pool. The agency assumed a WAL of 2.5 years for the cover assets, while the covered bonds have an expected bullet maturity in 4.2 years. As a result, temporary liquidity surpluses may arise, resulting in significant negative carry for the programme assuming a reinvestment rate of near zero.
All cover assets and the covered bonds are euro-denominated. The cover assets predominantly carry floating rate interest (52%), while the structured covered bonds pay a fixed coupon. Fitch has taken these mismatches into account by modelling the expected cash flows under appropriate stresses, as the existing market risks are not mitigated by privileged derivatives. However, a switch to pass-through of the bonds would also change their coupon payments from fixed to floating, conditional on the cover assets having a longer term than the outstanding liabilities at time of the switch, a significant open interest position could arise.
The ‘AA’ rating would be vulnerable to downgrade if any of the following occurred: (i) CBK’s IDR was downgraded by nine or more notches to ‘B+’ or below; or (ii) the OC that Fitch considers in its analysis dropped below Fitch’s ‘AA’ breakeven level of 12.5%.
The Fitch breakeven OC for the covered bond rating will be affected by, among other factors, the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuances. Therefore the breakeven OC for the covered bond rating cannot be assumed to remain stable over time.
More details on the portfolio and Fitch’s analysis will be available in a credit update, which will shortly be available at www.fitchratings.com.