Rating action

Scope Ratings today downgraded to A+ and resolved the review for downgraded initiated on 19 June 2018 on the public-sector covered bonds (Öffentliche Pfandbriefe) of Dexia Kommunalbank Deutschland GmbH (DKD). The Outlook is Stable. Scope subsequently withdraws all ratings and Outlooks assigned to DKD’s covered bonds for commercial reasons and upon the issuer’s request.

Rating rationale

The downgrade is driven by the drop in available overcollateralisation and lack of guidance by the bank regarding its commitment to a sustainable overcollateralisation level. As a result, the rating does no longer reflect the benefit of a strong cover pool. The rating now only reflects the issuer’s credit quality plus five notches from fundamental credit support factors. The latter is comprised of i) two notches from Germany’s unchanged and strong legal covered bond framework, and ii) three notches from the resolution regime and its benefits for German public-sector covered bonds and DKD.

Since Scope placed DKD’s public-sector covered bonds under review for possible downgrade, the issuer has not provided information to assure investors that overcollateralisation will exceed the regulatory required minimum. Combined with overcollateralisation that cannot quantitatively support the cover pool uplift, Scope has removed the cover pool-based uplift.

The issuer has updated its public regulatory reporting as of 30. June 2018. Scope understands that asset quality has remained broadly unchanged and changes to the cash flow profile primarily reflect covered bonds matured during Q2 2018 and selective buy-backs of outstanding and long-dated covered bonds. As broadly unchanged and the issuer has not provided new detailed asset and cash flow information on the covered bond program, Scope has not updated its cover pool analysis. Reported nominal overcollateralisation as of June 2018 has further reduced to 4.3% from 5.2% in March. Based on the net present value, oc has slightly increased to 12.4% from 10.5%.

The Stable Outlook reflects the issuer’s stable credit quality and Scope’s expectation that fundamental credit support factors will be maintained.

Following the downgrade, Scope has withdrawn all ratings and Outlooks on DKD and its covered bonds upon the issuer’s request.

Quantitative analysis and key assumptions

Scope’s previous cover pool analysis is based on data as of 31 March 2018. Scope’s default distribution of DKD’s public-sector cover pool was determined using a Monte Carlo simulation projecting individual exposures’ default. Scope has made asset-per-asset default and recovery assumptions, which result in a weighted average default risk equivalent to a rating of aa-, as well as a weighted average recovery rate of 72% in the rating-relevant stress scenario. Scope has assumed asset correlations between the exposures, reflecting a global correlation factor adding to sector-specific factors reflecting the differing transfer mechanisms, oversight methods and guarantee structures specific to the public sector entities in the cover pool. The correlation assumptions between two given assets range from 30% to 35%. Scope has also considered concentration risk by applying a correlation stress to large obligors exceeding 1% of the cover pool. The resulting non-parametric distribution has a mean default rate of 0.72% with a coefficient of variance of about 283%.

The covered bond cash flow analysis incorporates the default and recovery projections for the cover pool to which market risk and refinancing risk stresses are added. In Scope’s assessment, the programme is most sensitive to a non-reverting interest rate rise to 10%. Scope tested sensitivities to foreign exchange risk reflecting a currency depreciation stresses of up to 77.5%, 35.0% and 88.0%, respectively for JPY-, SEK- and USD-denominated cover assets against the EUR-denominated covered bonds. The agency has also applied an average refinancing spread of 216 bps and a servicing fee of 10 bps. The cash flow analysis is the most sensitive to a low prepayment stress (0%).

Rating-change drivers (not applicable)

Following the downgrade to A+ with a Stable Outlook, ratings have been withdrawn.

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 these cash flows on order to simulate the impact of 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: the Covered Bond Rating Methodology, General Structured Finance Rating Methodology (to translate expected loss into ratings) and Methodology for Counterparty Risk in Structured Finance (for account banks).

For the issuer’s private credit rating, Scope has also applied the principles contained in the Bank Rating Methodology. All 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/or rating outlook is issued by Scope Ratings GmbH.
The rating analysis was prepared by Karlo Fuchs, Executive Director.
Responsible for approving the rating: Guillaume Jolivet, Managing Director.
The rating was first released by Scope on 4 May 2016.

Potential conflicts
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.

Scope Ratings GmbH, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Torsten Hinrichs.