OREANDA-NEWS. December 08, 2015. Fitch Ratings has affirmed Landesbank Baden-Wuerttemberg's (LBBW; A-/Stable/F1/bbb) outstanding public sector Pfandbriefe at 'AAA'. The Outlook is Stable.

KEY RATING DRIVERS
The rating reflects LBBW's Long-term Issuer Default Rating (IDR) of 'A-', the unchanged Discontinuity Cap (D-Cap) of 5 notches (low risk), an IDR uplift of 2 notches and the 50.2% overcollateralisation (OC) that Fitch takes into account in its analysis, which provides more protection than the 'AAA' breakeven OC of 12%.

LBBW's 'AAA' breakeven OC has increased to 12% from 8%, previously, mainly driven by a greater asset disposal loss component of 7.6% (2.5% previously). In a change from last year's analysis, Fitch tested sensitivity to cash flows prolonged after the interest reset dates. The change drives an enlarged need for forced asset sales to ensure timely payment as in this stressed scenario the weighted average life (WAL) of the assets exceeds that of the Pfandbriefe.

As Fitch currently does not receive loan-by-loan information on final legal maturities, we benchmarked LBBW`s programme against its German public sector Pfandbrief peers that deliver this information.

The credit loss has increased to 6.0% from 4.0%, reflecting a different modelling approach for unrated German municipalities. Fitch applied a 'BBB-'floor for the majority of unrated German municipal assets, which account for about 30% of the cover pool. We previously applied an individual score for single municipalities.

The cash flow valuation component has improved to 1.2% from 3.2%, mirroring the high spread earned on the assets compared to the outstanding Pfandbriefe and a notable open interest rate position of about 19%. This mismatch improved compared with last year's analysis (23%).

The public sector Pfandbrief rating is credit-linked to Germany (AAA/Stable/F1+) as around 45% of the cover assets are either directly exposed to or guaranteed by the German sovereign or its federal states.

Fitch tested for adverse interest rate and currency movements in its cash flow analysis. For residual interest rate risk, Fitch applied its published interest rate stresses. The open foreign currency positions in three different currencies were stressed ranging from 1.4x to 3x the current exchange spot rate in a 'AAA' scenario. These tested scenarios are not intended to conform to exact probabilities of occurrence and do not represent explicit forecasts but rather show the vulnerability of the covered bond programme to changes in foreign currency exchange rates.

RATING SENSITIVITIES
The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) the IDR is downgraded to 'BB+' or lower; or (ii) the combined number of notches represented by the IDR uplift and the D-Cap is reduced to 3 or lower; or (iii) the OC that Fitch considers in its analysis drops below Fitch's 'AAA' breakeven level of 12%; or (iv) the German sovereign is downgraded to 'AA+' or below.

If the OC that Fitch considers in its analysis drops to the legal minimum requirement of 2% on a net present value basis, it would not be sufficient to allow for timely payment of the Pfandbriefe following an issuer default. As a result, the Pfandbrief rating would likely be downgraded to 'AA-', reflecting an IDR uplift of two notches and single-notch recovery uplift.

The Fitch breakeven OC for the covered bond rating will be affected, among others, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore the breakeven OC to maintain the covered bond rating cannot be assumed to remain stable over time.