Transaction Update: Dexia Kommunalbank Deutschland AG Public-Sector Covered Bond Program

Transcription

1 Transaction Update: Dexia Kommunalbank Deutschland AG Public-Sector Covered Bond Program Primary Credit Analyst: Bjoern Schurich, Frankfurt (49) ; Secondary Contact: Antonio Farina, Madrid (34) ; Table Of Contents Program Overview Key Analytical Factors Outlook: Stable Rationale Program Description Issuer-Specific Factors Cover-Pool Specific Factors Additional Factors Related Criteria And Research NOVEMBER 8,

2 Transaction Update: Dexia Kommunalbank Deutschland AG Public-Sector Covered Bond Program Ratings Detail Program Overview Table 1 Based On Data As Of Aug. 30, 2013 Jurisdiction Germany Type of covered bonds Legislation-enabled Underlying assets Public sector Outstanding covered bonds (bil. ) Year of first issuance NOVEMBER 8,

3 Table 1 (cont.) Rating at closing/year Extendible maturities AAA/1998 Target credit enhancement (%) Available credit enhancement (%)* 7.73 *This figure is subject to Standard & Poor's analytical adjustments and therefore does not equal publicly available information on DKD's covered bond program. For details refer to the section "Outlook" below. No Key Analytical Factors Dexia Kommunalbank is in run-off management with no new lending business allowed. Proven track record of managing asset-liability maturity mismatches (ALMM) and credit risk profile. Willingness and capability to maintain the current level of cover pool support. Available credit enhancement that does not allow for maximum potential uplift above the issuer credit rating. Outlook: Stable The stable outlook on Dexia Kommunalbank Deutschland AG's (DKD's) public-sector covered bonds reflects the stable outlook on its parent Dexia Credit Local (DCL). Although DKD's covered bond program is eligible for up to seven notches of ratings uplift above DCL's issuer credit rating (ICR), we understand that DKD does not intend to increase the covered bonds' level of overcollateralization in order to maintain the current covered bond rating even if we were to downgrade the bank. Therefore, all else being equal, any future downgrade of DCL would automatically lead to a downgrade of the covered bond program. The stable outlook also reflects that in our forward-looking scenario the program is likely to remain in the "low" ALMM category. We could raise DKD's covered bond ratings when the available overcollateralization we consider in our cash flow analysis increases further. The available overcollateralization in our analysis is currently lower than DKD's reported overcollateralization. This can arise if an issuer has large shares of zero coupon covered bonds. The regulatory-based reported overcollateralization calculation considers the current accrued amount of the zero-coupon bond while we take into account their final redemption value, explaining the difference between reported and available overcollateralization. When approaching their final maturity date, the accrued zero-coupon balance increases and, therefore, the difference between available overcollateralization and reported overcollateralization diminishes. Since we understand that DKD intends to manage the covered bond program's reported overcollateralization at the current level, we see the potential for a technical-driven increase of the available overcollateralization. All else being equal, this could eventually result in a positive rating action. We would consider a negative rating action on the covered bonds if the ALMM or credit-quality deteriorated or the available overcollateralization decreased, against our expectations. NOVEMBER 8,

4 Rationale From our analysis of the legal and regulatory framework for covered bonds in Germany, we have concluded that the assets in DKD's cover pool are isolated from the risk of a bankruptcy or insolvency of DKD. This asset isolation allows us to assign a higher rating to the covered bond program than the rating on DKD. We determine the maximum achievable covered bond rating by analyzing the cover pool's asset credit quality, payment structure, and cash flow mechanics. According to our ALMM criteria, ALMM risk as of Aug. 31, 2013, is "low," and the program is in Category 1. This combination allows for a covered bond rating that is seven notches higher than the long-term issuer credit rating if available overcollateralization is sufficient to cover target credit enhancement. Since we regard DKD as a core entity of DCL, we apply the uplift to the 'BBB' rating on DCL to derive the long-term covered bond rating. We continue to observe relatively stable asset quality and ongoing active ALMM management. However, as the available credit enhancement is below the target credit enhancement, we believe the provided overcollateralization is only sufficient to support four notches of uplift. In our opinion, counterparty and country risk do not constrain the rating on DKD's covered bond program. Our methodology and assumptions for rating covered bonds are outlined in our criteria "Covered Bond Ratings Framework: Methodology And Assumptions," published on June 26, 2012, on RatingsDirect. Program Description DKD is a midsize German bank specialized in public-sector financing in Germany and Europe. DKD established its public-sector covered bond program in 1997; we assigned our first rating to the program in NOVEMBER 8,

5 DKD issues bearer covered bonds (Inhaberpfandbriefe) under its "Debt Issuance Program" (DIP) and registered covered bonds (Namenspfandbriefe) on a stand-alone basis. All covered bonds that DKD has issued rank pari passu and have recourse to the same cover pool. The majority of covered bonds are issued in euros, while some are issued in Norwegian kroner and U.S. dollars. As foreign exchange and interest rate risk is not hedged with derivatives, we have modeled these risks in our cash flow analysis. In our view, the associated risks with external bank account providers do not constrain the rating on DKD's public-sector covered bonds (see "Counterparty risk" section, below). Table 2 Participants Role Name Rating Rating dependency Issuer Dexia Kommunalbank AG (DKD) NR (DCL; BBB/Stable/A-2)* Yes NOVEMBER 8,

6 Table 2 Participants (cont.) Bank account provider Deutsche Bundesbank NR (ECB; AAA/Stable/A-1+)** Yes Bank account provider Banque Internationale a Luxembourg A-/Stable/A-2 No Bank account provider Skandinaviska Enskilda Banken AB (publ) A+/Negative/A-1 Bank account provider Belfius Bank SA/NV A-/Negative/A-2 No Bank account provider Citibank Japan Ltd. A/Stable/A-1 No *Under Standard & Poor's Ratings Services' group rating methodology, Dexia Kommunalbank Deutschland AG (DKD) is a core entity to its parent Dexia Credit Local (DCL; BBB/Stable/A-2). Therefore, we derive the ratings on the covered bonds by applying notches of uplift to the long-term issuer credit rating (ICR) on DCL. **As long as we believe Germany unlikely to exit the eurozone (European Economic And Monetary Union), we consider the Bundesbank's credit standing to be indistinguishable from that of the European Central Bank (AAA/Stable/A-1+) No Issuer-Specific Factors Legal and regulatory risks We consider that the German covered bond legal framework satisfies the relevant legal aspects of our covered bond criteria. This enables us to assign ratings to covered bonds that exceed the long-term rating on the issuer. The German Covered Bond Act, "Pfandbriefgesetz" (PfandBG) and the secondary legislation providing further guidance on the assessment of the lending value or the cover pools' risk management provide the legal framework for the issuance of German covered bonds, "Pfandbriefe." The current Covered Bond Act was introduced in 2005 and last amended in 2013 (see also "German Covered Bond Law Amendments Improve Framework By Clarifying Use Of Bundesbank Accounts," published May 27, 2013). Under the framework, banks can issue public-sector, mortgage, ship, and aircraft covered bonds. Covered bond investors have a preferential claim to a cover pool of assets which for public-sector covered bonds may comprise exposures to state, regional, and local public-sector authorities of EU/European Economic Area countries as well as exposures to public-sector entities in Canada, the U.S., Japan, and Switzerland. Additionally, the cover pool can also comprise eligible substitute assets. According to the legal framework, the issuer must maintain overcollateralization of at least 2% on a net present value basis for the outstanding covered bonds and ensure 180 days of liquidity needs at all times. An independent trustee is responsible for monitoring the cover pool (cover pool monitor) until an independent cover pool administrator is appointed in case of the issuer's insolvency. BaFin, the German supervisory authority for financial institutions, appoints and supervises the cover pool monitor and cover pool administrator. BaFin also regularly conducts a special covered bond audit, usually every two years (see paragraph 3, PfandBG). We base our analysis of legal risk on guidelines in "Europe Asset Isolation And Special-Purpose Entity Criteria--Structured Finance," published on Sept. 13, Operational and administrative risks As a regulated entity, DKD's cover pool is subject to bi-yearly audits by the BaFin and to the continuous supervision of the cover pool monitor. NOVEMBER 8,

7 In addition, we believe the bank's management is committed to maintaining an adequate level of overcollateralization and limiting ALMM risk for the covered bonds. Since the European Commission's approval of the revised orderly resolution plan of the Dexia Group in December 2012, DKD is in run-off management without new lending business. We are of the opinion that this obligation will not materially impact the issuer's ability to manage the covered bond program at the current rating level and we also expect ongoing new issuance activity, either opportunistic or driven by cover pool management. The strategic importance of covered bond funding and DKD's willingness to support ratings at their current level might decrease over time, but we currently consider this to be an unlikely scenario. Our analysis of operational and administrative risks follows the principles laid out in "Principles Of Credit Ratings," published on Feb. 16, Cover-Pool Specific Factors Asset credit quality In our view, DKD's public-sector cover pool credit quality, as measured by the pool's scenario default rate (SDR), is better than the average rated European public-sector pool (19.39% for DKD versus a 25.74% European average). The vast majority of collateral consists of exposures to Western European local authorities, which typically have a low-risk financial profile. The weighted-average rating of 'A-' is in line with what we typically see in European public-sector cover pools. We expect DKD's cover pool composition to remain stable, and thus asset quality to remain strong. The pool is well diversified by country and borrower type, with 66.83% of total public-sector assets in Germany, 8.87% in Italy, and the remaining assets spread across 14 jurisdictions as of Aug. 31, The concentration metrics for DKD's cover pool are above average for German public-sector covered bonds, with the top 20 obligors representing 53.76% and the largest obligor representing 7.01% of total assets. Although obligor concentration increased somewhat over the past year, SDR results have remained stable due to the reduction in pool weight to low-rated exposures, that is, entities rated 'BB' or lower. The dynamic nature of the cover pool may result in a change in the composition and credit quality of the cover pool assets over time. DKD can in principle include other assets that, despite meeting the eligibility criteria of the German covered bond law, have lower credit quality. We understand, however, that the issuer does not intend to significantly change the pool's composition and that the amortization profile exhibits stable credit development as the cover pool runs off. Furthermore, the issuer has a track record of actively reducing the cover pool's exposure to assets from sovereigns rated speculative grade. We expect the issuer to continue its cover pool management, which should avoid any rapid deterioration of credit quality. Tables 3-7 give an overview on the composition of the cover pool. NOVEMBER 8,

8 Table 3 Cover Pool Composition --Aug.31,2013--(current period) --May 31,2012--(previous period) Asset type Value (mil. ) Percentage of cover pool (%) Value (mil. ) Percentage of cover pool (%) Public-sector assets 27, , Substitute assets Total cover pool assets 27,972 32,174 Table 4 Key Credit Metrics *--Aug.31,2013--(current period) --May 31,2012--(previous period) Weighted-average cover pool asset rating A- A- Weighted-average loan asset maturity Largest obligor (% of the cover pool) Five largest obligors (% of the cover pool) largest obligors (% of cover pool) Credit analysis results: Scenario default rate (SDR) (%) Asset default risk (%) European average metrics: SDR (%) Asset default risk (%) Table 5 Geographic Distribution Of Cover Assets (%) *--Aug.31,2013--(current period) --May 31,2012--(previous period) Germany Italy Austria Belgium Japan Other Total Table 6 Pool Asset Distribution By Borrower Type (%) *--Aug.31,2013--(current period) --May 31,2012--(previous period) Sovereigns thereof: largest 5.47 (Italy) 2.02 (Japan) NOVEMBER 8,

9 Table 6 (cont.) thereof: second largest 1.60 (Japan) 0.85 (Hungary) German states German municipalities Financial institutions thereof: German Landesbanks with statutory guarantee thereof: German savings banks with statutory guarantee Austrian states Italian local and regional authorities Other Total Table 7 Pool Assets By Rating Category (%) *--Aug.31,2013--(current period) --May 31,2012--(previous period) AAA AA A BBB BB B or lower Total We analyze the credit quality of the portfolio using our criteria in "Surviving Stress Scenarios: Assessing Asset Quality of Public Sector Covered Bond Collateral," published on Sept. 30, Payment structure and cash flow mechanics Our analysis of the covered bonds' payment structure shows that cash flows from the cover pool assets would be sufficient, at the given rating, to make timely payment of interest and ultimate payment of principal to the covered bond holders. The covered bonds are exposed to ALMM risk because mismatches are not addressed by structural features, such as pass-through liabilities or committed liquidity arrangements. To assess ALMM risk, we calculate the percentage of the cover pool showing a mismatch between the maturity of the assets and maturity of liabilities. As of Aug. 31, 2013, the ALMM percentage was 2.83%, which we classify as "low" ALMM risk. The level of this indicator is lower than the average ALMM of public-sector covered bonds in Germany and DKD has a track record of effectively limiting ALMM risk. We have classified DKD's public-sector covered bonds in Category 1, reflecting the ability to raise funds through both borrowing and asset sales in a country where covered bonds have a well-established history and high systemic market importance. The combination of covered bonds in Category 1 and "low" ALMM risk allows a maximum seven notches of uplift NOVEMBER 8,

10 above the issuer credit rating. This means we can rate DKD's covered bonds up to seven notches above the ICR if the available credit enhancement is at least equal to our target credit enhancement, and other factors do not constrain the rating. The transaction is exposed to potential foreign exchange and interest rate risk. We observe 7% of assets to be spread over six currencies and 93% in euros, compared with 99.9% of the liability amounts in euros. The interest rate profile exhibits 23% of assets and 7% of liabilities linked to variable rates. We factor currency and interest rate risks into our cash flow analysis, and therefore into our target credit enhancement level. We have determined a target credit enhancement for the program of 10.74% as of Aug. 31, 2013, which is lower than the average of 15.03% for European public-sector covered bond programs, owing to a lower SDR and ALMM risk. After May 31, 2012, target credit enhancement increased from 8.61% mainly due to the implementation of our new counterparty criteria (see section "Counterparty Risk" below). As the available enhancement is below the target credit enhancement, we rate the covered bonds only four notches higher than the ICR on DCL. We analyzed the cash flows according to our criteria in "Revised Methodology And Assumptions For Assessing Asset-Liability Mismatch Risk In Covered Bonds," published on Dec. 16, 2009 and "Assessing Asset-Liability Mismatch Risk In Covered Bonds: Revised Methodology And Assumptions For Target Asset Spreads", published on April 24, Table 8 Asset-Liability Maturity Mismatch (ALMM) Metrics *--Aug.31,2013--(current period) --May 31,2012--(previous period) Asset WAM (years) Liability WAM (years) Maturity gap (years) ALMM (%) ALMM classification Low Low Maximum uplift above issuer rating (notches) 7 7 Target credit enhancement for maximum uplift (%) Target credit enhancement for first notch of uplift (%) Available credit enhancement (%) European average metrics: Target credit enhancement (%) Available credit enhancement (%) WAM--Weighted average maturity. NOVEMBER 8,

11 Additional Factors Counterparty risk We have identified bank account risk and commingling risk as relevant for the program (see "Ratings On Dexia Kommunalbank Deutschland's Public-Sector Covered Bonds Lowered To 'A' And Kept On Watch Negative," published Jan. 11, 2013). While these risks are not structurally mitigated, they do not constrain the ratings as we have taken them into account in the modeling or by introducing a weak link to the German central bank (Bundesbank), one of DKD's account banks (see "Assessing Credit Quality By The Weakest Link," published Feb. 13, 2012 and table 2 for the list of counterparties). We analyzed the counterparty risks according to our criteria "Counterparty Risk Framework Methodology And Assumptions," published June 25, 2013, and "Covered Bonds Counterparty And Supporting Obligations Methodology And Assumptions," published May 31, Country risk Under our nonsovereign ratings criteria, we take into account the covered bonds' exposure to country risk through the related sovereign in the eurozone (see "General Criteria: Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions," published June 14, 2011). We consider that the public-sector exposures in DKD's public-sector covered bonds have a high sensitivity to country risk in Germany. Since the sovereign rating on Germany is 'AAA', country risk does not constrain the covered bond rating. Related Criteria And Research Request For Comment: Methodology And Assumptions For Ratings Above The Sovereign--Single Jurisdiction Structured Finance, Oct. 14, 2013 Europe Asset Isolation And Special-Purpose Entity Criteria--Structured Finance, Sept. 13, 2013 Global Covered Bond Characteristics And Rating Summary Q3 2013, Sept. 11, 2013 Counterparty Risk Framework Methodology And Assumptions, June 25, 2013 Guarantee Criteria--Structured Finance, May 7, 2013 Covered Bond Ratings Framework: Methodology And Assumptions, June 26, 2012 Covered Bonds Counterparty And Supporting Obligations Methodology And Assumptions, May 31, Assessing Asset-Liability Mismatch Risk In Covered Bonds: Revised Methodology And Assumptions For Target Asset Spreads, April 24, 2012 Assessing Credit Quality By The Weakest Link, Feb. 13, 2012 General Criteria: Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions, June 14, 2011 Principles Of Credit Ratings, Feb. 16, 2011 Advance Notice Of Proposed Criteria Change: Methodologies And Assumptions For Rating Certain Covered Bonds And CDOs, Aug. 5, 2010 General Criteria: Methodology: Credit Stability Criteria, May 3, 2010 Revised Methodology And Assumptions For Assessing Asset-Liability Mismatch Risk In Covered Bonds, Dec. 16, 2009 Use Of CreditWatch And Outlooks, Sept. 14, NOVEMBER 8,

12 General Criteria: Understanding Standard & Poor's Rating Definitions, June 3, 2009 German Pfandbrief Framework Further Improved, March 30, 2004 Surviving Stress Scenarios: Assessing Asset Quality of Public Sector Covered Bond Collateral, Sept. 30, 2003 Rating Pfandbriefe--The Analytical Perspective, Jan. 27, 2003 Additional Contact: Covered Bonds Surveillance; NOVEMBER 8,

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