Rating action

Scope Ratings has today affirmed the AAA rating on Bankia SA’s cédulas hipotecarias (Spanish mortgage covered bonds). The Outlook remains Stable.

Rating rationale

Scope’s rating of AAA/Stable for the EUR 30.2bn (as of March 2018) of cédulas hipotecarias issued by Bankia SA (Bankia) reflect the issuer’s rating (BBB+/Stable, see Scope’s issuer report) enhanced by a seven-notch credit uplift provided by the cover pool.

The entire mortgage book provides 144% of overcollateralisation, fully mitigating identified credit and market risks. Pronounced cash flow mismatch remains a key driver for the rating-supporting overcollateralisation, although available overcollateralisation remains generously above the level needed to maintain the cover pool-based uplift. Fundamental credit factors have not changed since the last annual review, maintaining the six-notch rating uplift and anchoring the additional cover pool-based uplift at AA+.

According to Scope’s cover pool analysis, an overcollateralisation of 34% based on performing mortgage loans supports a seven-notch uplift. The analysis did not incorporate mortgage loans granted to developers or secured by land which would be excluded from an overcollateralisation level the agency takes into account.

Following BMN merger, cover-pool credit quality remains stable but asset-liability mismatch risk increases

In Scope’s view, the cover pool’s credit profile remains materially similar to that from a year ago, even with the issuer’s merger with Banco Mare Nostrum S.A. (BMN), effective on 8 January 2018. As of March 2018, the combined mortgage book (equivalent to the cover pool) increased to EUR 73.7bn, which compares to the EUR 60.1bn from a year before.

The cover pool’s credit quality has improved but, because of the reference to the whole mortgage book, remains weak in an international context. The mortgage book’s average indexed loan-to-value has increased to 58.8% from 57.5% since the last annual review. The BMN merger also resulted in an increased exposure to mortgage loans secured by properties in Andalucía, the Balearic Islands and Murcia. However, the resulting geographical concentration does not materially affect the rating.

Scope’s recovery assumptions have only moderately changed, reflecting two counterbalancing factors. The reduction in recovery assumptions for residential loans (86.6% of total book balance), due to an increase in their loan-to-value to 58.4% from 55.9% a year earlier, was offset by the higher recovery expectations for commercial loans, due to a decrease in the latter’s loan-to-value to 62% from 68.9% over the same period.

The programme remains strongly exposed to market risks, particularly regarding maturity mismatches. According to Scope’s calculations, the weighted average remaining life of the assets is 17.6 years, but only 6.1 years for the bonds. This creates a duration gap of 11.6 years, which compares to the 9.7-year gap before the BMN merger and from a year ago. Scope expects maturity mismatch risk to continue to drive the rating-supporting overcollateralisation. There is also the risk that maturing bonds are not fully refinanced, which would further widen the maturity gap between assets and covered bond redemptions.

Interest rate risk is also material as around 70% of outstanding bonds pay a fixed rate while 95% of cover assets pay a floating coupon. While newly originated fixed-rate mortgages will reduce the mismatch, persistently low interest rates will continue to stress the programme’s excess spread.

Quantitative analysis and key assumptions

Scope has analysed Bankia’s highly granular mortgage book using a normal inverse distribution. Lifetime default rates assumed in Scope’s analysis are 15% for residential loans and 30% for commercial loans (excluding land and developers), with coefficients of variation at 70% and 60%, respectively. Scope’s assumptions are based on mortgage performance data provided regularly by the Bank of Spain and were adjusted for Bankia’s performance. The latter has improved since the last annual review, resulting in a reduction in Scope’s default assumption for commercial loans by 5pp.

Scope has calculated a weighted average recovery rate of 45.1% for residential loans and 40.3% for commercial loans in the stressed scenario. The blended servicing fee was assumed at 25bps and the blended refinancing spread at 250bps. Scope did not apply the highest trading spreads under its methodology because assets would need to be sold continuously for more than 10 years and, in the agency’s opinion, such spreads cannot be maintained throughout the whole term.

In the stressed analysis, Scope has used a low prepayment rate (0%) together with non-converting low interest rates that decrease to 1% after the second year. All bonds are denominated in euro, while 20bps of assets are denominated in other currencies. Scope deems this exposure immaterial and therefore did not apply foreign exchange stresses.

Rating-change drivers

Scope’s Stable Outlook reflects: i) the continuous availability of high overcollateralisation, which provides a significant buffer against a rise in credit and market risks, thereby maintaining the cover pool-based support; ii) Scope’s view that the European covered bond harmonisation will not negatively impact the fundamental support factors relevant for the cédulas hipotecarias; and iii) Scope’s Stable Outlook on Bankia. In addition, a one-notch change in the issuer rating is unlikely to affect the covered bond rating.

The covered bond rating may be downgraded if i) Scope’s rating on the issuer deteriorated by more than two notches, ii) the mortgage book reduced significantly in size; or iii) Bankia issued significant amounts of cédulas hipotecarias, eroding available overcollateralisation below the rating-supporting level.

Stress testing
No stress testing was performed.

Cash flow analysis
In order to determine the cover pool-supported rating uplift, Scope performed a cash flow analysis to establish an expected loss for the covered bonds. The cash flow analysis uses the scheduled cash flows of the cover assets and covered bonds as a starting point. Scope applies rating-distance-dependent stresses to simulate the impact to cash flows arising from increasing credit and market risks. The cash flow analysis also includes the impact of stressed asset sales or other variables such as changing prepayment speeds or servicing costs.

Methodology
The methodologies used for this rating and outlook are: Covered Bond Rating Methodology; General Structured Finance Rating Methodology (for the translation of the expected loss into ratings); and Methodology for Counterparty Risk in Structured Finance (for account banks).
The methodologies are available on www.scoperatings.com.
Historical default rates of Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to 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 definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.

Solicitation, key sources and quality of information
The rated entity participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, third parties and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and rating outlook is issued by Scope Ratings GmbH.
Lead analyst Karlo Fuchs, Executive Director
Person responsible for approval of the rating: Guillaume Jolivet, Managing Director
The ratings/outlooks were first released by Scope on 08.07.2016.

Potential conflicts
Please see www.scoperatings.com. for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2018 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions 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 does not, 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 other 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 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 GmbH at Lennéstrasse 5 D-10785 Berlin.

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