Scope Ratings has today assigned Long-Term Ratings of AAA with a Stable Outlook to Spanish mortgage and public sector covered bonds (Cedulas Hipotecarias and Cedulas Terretoriales) issued by Banco Santander SA (Santander).

The covered bond ratings reflect Santanders Issuer Credit-Strength Rating (ICSR) of A+/Stable/S-1 (Banco Santander Issuer Rating Report published 28 August 2015) which is the analytical anchor point for the covered bond ratings. It also reflects the fundamental credit support of the Spanish legal covered bond framework and national implementation of the European bank recovery and resolution regime. In combination, these elements support a maximum credit differentiation of up to six notches under our methodology. These ratings do not take into account the potential further credit support of up to additional three notches the cover pool analysis could provide.

Fundamental assessment supports a high credit differentiation above the bank’s rating but differs between mortgage and public sector covered bonds

To determine the fundamental uplift we have analysed the Spanish legal and resolution framework based on our methodology. We conclude that mortgage covered bonds can receive a six notch credit differentiation and Spanish public sector covered bonds a five notch differentiation (for more details see the Spanish section in Covered Bond Framework Analysis – Analytical considerations, published 31 July 2015).

Legal framework analysis
In our legal framework analysis we conclude that the Spanish legal covered bond framework meets most of the rating relevant provisions to support a two notch credit rating differentiation. Certain aspects of the framework such as missing updates of LTV’s for cover pool assets or the less pronounced active cover pool risk and liquidity management are no longer best practice in a European context. Changes on the framework that are under discussion and high levels of overcollateralisation available are able to compensate, however.

The ability to make payments after the insolvency rests on the preferential right of Cedulas Hipotecarias (CH) holders on the proceeds of the full mortgage book (not only the registered cover assets) and the recourse of Cedulas Terretoriales (CT’s) to the full public sector book of the insolvent issuer. Both CH’s and CT’s benefit from a generous mandatory overcollateralisation of 25% and 43% but the available overcollateralisation is effectively much larger. The eligible assets only determine an issuance limit and covered bonds have full recourse to the respective (nonsecuritised) mortgage or public sector loan books as per above.There is a regular supervision by both, the Bank of Spain and the Comisión Nacional del Mercado de Valores (CNMV).

There are no rating relevant aspects that materially differ between covered bond types and that are relevant for the assessment of the legal framework differentiation. Both Spanish covered bonds types receive the full rating uplift for the supportive legal framework.

Resolution regime analysis
We conclude that all Spanish covered bond types benefit from a preferential treatment in the Spanish translation of the resolution regime and are both systemically important. Spanish mortgage covered bonds issued by Santander are therefore eligible to receive the full credit differentiation of four notches. Public sector covered bonds receive a resolution based rating uplift of three notches as they are used by a smaller number of issuers and direct public sector lending is of lesser importance than mortgage lending.

Since 20 June 2015 the BRRD is effective in Spain and has been fully translated as the Spanish law ‘Ley 11/2015 de recuperación y resolución de entidades de crédito y empresas de servicios de inversión’. It confirms the preferential status of covered bonds upon insolvency.
Available resolution options in the previous resolution and restructuring framework applicable to Spanish banks already featured most provisions and resolution tools stipulated in the BRRD. All available resolution options were used in the significant restructuring of the Spanish banking sector during the crisis. We note that current practice did not impact holders of covered bonds demonstrating the systemic importance of this product.

Santander in itself is viewed as systemically important in the context of its market. Scope therefore believes it is in the public interest that it would be recapitalised and not placed into insolvency upon resolution . Accordingly, we expect that eligible liabilities which are not excluded by the respective resolution authorities be bailed in towards the recapitalisation process. We view Santander as having a substantial cushion of eligible bail-in-able liabilities – capital securities, other subordinated liabilities, and long-term senior unsecured debt – which represents a reassuringly ample protection for its covered bonds. In our view, a scenario in which bailed-in eligible liabilities are inadequate to stem losses and recapitalise the bank would be highly implausible.

Spanish banks regularly rank among the top five countries worldwide measured by the volume of outstanding mortgage covered bonds. Measuring the share of covered bonds as a percentage of GDP comes to a significant 30%. Spanish covered bonds are widely represented in investor portfolios.

CH’s are used widely for refinancing mortgage loans, but outstanding public sector covered bonds comprise only about 1/10 of mortgage covered bonds in Spain as of end 2014 (CH: EUR 282bn vs CT: EUR 25bn). We believe the lower systemic importance is likely to impact stakeholders’ incentives to support the product.

We believe Spanish stakeholders are highly incentivised to maintain covered bond funding as a refinancing option and observe a proactive regulatory oversight with the view to maintain the issuers as a going concern. We do not expect the use of resolution tools to negatively impact covered bonds.

Covered bond ratings assigned to Santanders Cedulas
Cedulas hipotecarias issued by Santander are secured by a cover pool which comprises the full domestic mortgage book of the bank, any additional substitution assets and the cash flows generated. This differs to other European jurisdictions where only eligible cover assets comprise the cover pool that secures the covered bonds. As a result, Spanish covered bonds often exhibit the highest overcollateralisation levels among covered bonds issued worldwide. Due to the recourse to the full mortgage book Spanish covered bonds also exhibit comparatively high loan-to-value ratios and high levels of non-performing loans and a comparatively higher share of nonstandard mortgage collateral.

The above difference between the cover pool and the eligible assets also applies to Santander’s public sector covered bonds which are predominantly secured by exposures to regional governments and local administrations.

For the unsolicited ratings we have not analysed the cover pools. Both cover pools exhibit differences in credit quality, cash flow structure and protection levels provided (overcollateralisation). These can impact the assessment and potential additional credit differentiation from the rating analysis of the cover pool which could support an additional credit differentiation of up to three notches.

Rating cap on Spanish covered bonds not appropriate
Sovereign risk considerations do not limit the ratings on these covered bonds. The risks of an institutional framework meltdown, legal insecurity or currency-convertibility problems, due to a hypothetical exit of Spain from the eurozone, are not material for these Spanish covered bonds.

Rating change drivers
The Stable Outlook on Santander’s mortgage covered bonds reflects the Stable Outlook on the issuer and an available rating buffer of at least two notches. The fundamental analysis based credit differentiation of six notches means that the currently assigned ratings can be maintained if the bank would be downgraded by up to two notches. Further rating stability could be provided from the cover pool rating analysis which may further enhance the ratings by up to three additional notches.

Santander’s public sector covered bonds also benefit from a buffer against a negative credit development of at least one notch. Similarly, further rating stability could be provided from the cover pool rating analysis which may further enhance the ratings by up to three additional notches.

Currently rating drivers for the covered bonds mirror the rating drivers for the issuer.

We currently do not expect changes that could impact our assessment of the fundamental rating drivers for Santander’s covered bonds.

The following ratings were assigned to Banco Santander’s covered bonds:

- Banco Santander SA, senior secured Spanish mortgage covered bonds (Cédulas Hipotecarias), AAA/Stable
- Banco Santander SA, senior secured Spanish public sector covered bonds (Cédulas Territoriales), AAA/Stable

The ratings assigned to Santanders covered bonds are (i) based on public information, (ii) not solicited by the issuer and (iii) without issuer participation in the process.

Related Research:
Banco Santander Issuer Rating Report published 28 August 2015
Scope upgrades Santander’s Long-Term Issuer Ratings to A+; Outlook Stable published
24 February 2015
Covered Bond Framework Analysis – Analytical considerations, published 31 July 2015

Important information

Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility

The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund.

The rating analysis has been prepared by Karlo Fuchs, Executive Director.
Responsible for approving the rating: Dr. Stefan Bund, Chief Analytical Officer.

The rating concerns financial instruments which were evaluated for the first time by Scope Ratings AG. The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Information on interests and conflicts of interest

The ratings assigned to Banco Santanders covered bonds are (i) based on public information, (ii) not solicited by the issuer and (iii) without issuer participation in the process.

As at the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG or any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of Information for the rating

Available public information provided to investors by the issuer, official publications and data series by the central bank, regulators and research from reputable market participants. Scope Ratings considers the quality of the available information on the evaluated entity to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.

Examination of the rating by the rated entity prior to publication

Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

Methodology

The methodology used for the rating assessment is “Covered Bond Rating Methodology” published in July 2015 as well as “General Structured Finance Rating Methodology” published 28 August 2015. The methodologies are available on www.scoperatings.com.
The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.

Conditions of use / exclusion of liability

© 2015 Scope Corporation AG and all its subsidiaries including Scope Ratings AG, Scope Analysis, Scope Capital Services GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope cannot, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided “as is” without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or otherwise damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party, as opinions on relative credit risk and not as a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings AG at Lennéstraße 5 D-10785 Berlin.

Rating issued by

Scope Ratings AG, Lennéstrasse 5, 10785 Berlin