OREANDA-NEWS. Fitch Ratings has updated its global master criteria for rating covered bonds. The report, entitled "Covered Bonds Rating Criteria," replaces the previous report of the same title, dated 8 August 2014. The amendments are not expected to have any impact on ratings.

The enhancements to the criteria are aimed at providing more clarity and transparency regarding Fitch's covered bonds rating process. Notably, this new version explains in greater detail how Fitch's cash flow model functions and contains a more comprehensive example on it in the appendix.

Fitch's cash flow model, which forms the quantitative part of Fitch covered bonds analysis, determines the breakeven overcollateralisation (OC) or the breakeven asset percentage (AP) for a given rating. This indicates the minimum protection for the assigned rating, based on a combination of tested rating on a probability of default basis and credit for recoveries. The cash flow model is built on stressed net present value calculations. Stresses applied include credit losses, prepayments and fees for the servicing/management of the assets as well as adverse variations of interest and currency exchange rates (if applicable). The result is rounded to the nearest 0.5% as the model is not intended to deliver a greater sense of precision.

The new report also offers more insight into the following aspects: how Fitch takes into account future issuance plans for the purpose of its cash flows modelling; when the agency would depart from assigning a minimal discontinuity risk assessment for pass-through programmes; and for which additional reasons it would apply a limited rating uplift for certain covered bond programmes.

For programmes with a low number of outstanding issuance and where the issuer communicates a future issuance plan or Fitch is of the opinion that there will be future issuance, the agency may test cash flows assuming further bonds have already been issued, reducing the asset and liability mismatches. The approach adopted in these specific cases will be communicated in Fitch's publications.

Pass-through covered bond programmes with three month's coverage of interest and expenses are generally assigned a discontinuity cap (D-Cap) of 8 notches (minimal discontinuity risk). This is as long as the assessment of D-Cap components other than the liquidity gap and systemic risk does not raise any particular issues. For example, Fitch did not assign the maximum D-Cap of 8 notches to a conditional pass-through programme where the systemic alternative management section of the D-Cap was considered to be a weak link. In this case, the agency deemed that certain enforcement events of the asset-owning SPV guarantee resulted in a strong reliance on the issuer's ability to make timely payments on the covered bonds compared with other programmes where the enforcement against the cover pool is expected to take place without such a delay.

Fitch will rate covered bonds at or near the issuing bank's Issuer Default Rating if there are limitations in the available cover pool assets, cash flows or market information. This also applies when an issuer has a limited track record in originating and servicing a certain class of cover assets or if there is limited visibility on its business model, indicating that asset generation may be insufficient to maintain OC in the future. These limitations will result in Fitch assigning little or no rating uplift above the issuing institution's IDR, as adjusted by any applicable IDR uplift.