Rating action

Scope Ratings has today affirmed the AAA/Stable ratings on the Austrian covered bonds (Hypothekenpfandbriefe) issued by Salzburg-based Bausparkasse Wüstenrot AG (Wüstenrot). The Outlook remains Stable.
Additional information and research on the issuer and its covered bonds are available on scoperatings.com.

Key rating drivers

Sound issuer rating (positive). Wüstenrot’s sound credit quality reflects its low-risk business profile and adequate capitalisation.

Fundamental credit support (positive). The strength of the Austrian legal covered bond and resolution framework supports up to four notches of uplift above the issuer rating.

Cover pool support (positive). The 117.0% overcollateralisation as of 31 March 2019, based on a whole loan basis, shields the covered bonds from market and credit risks and is well above the minimum 25.0% overcollateralisation that supports the three-notch cover pool-based uplift. The cover pool continues to be of high credit quality, reflecting the fully residential and domestic cover assets. Mismatch risk is moderate, with an open interest rate position of around 25% and a four-year gap on weighted average life. However, the latter figure increases significantly when accounting for potential prepayments.

Rating-change drivers

Scope’s Stable Outlook on the covered bonds reflects: i) the continuous availability of high overcollateralisation, which provides a significant buffer against a rise in credit and market risks, thereby maintaining the three notches of cover pool-based support; ii) Scope’s view that European covered bond harmonisation will not negatively impact the fundamental support factors relevant for the issuer and Austrian mortgage covered bonds in general; and iii) Scope’s Stable Outlook on the issuer.

The covered bond ratings may be downgraded if: i) the issuer’s credit quality deteriorates by one notch or more; ii) risk in the covered bond programme increases and provided overcollateralisation no longer supports a seven-notch rating uplift; or iii) there is a deterioration in Scope’s view on fundamental support factors relevant to the issuer and Austrian mortgage covered bonds in general.

Quantitative analysis and assumptions

Scope’s projections of defaults on Wüstenrot’s mortgage loans use an inverse Gaussian distribution. Scope has derived an effective lifetime mean default rate of 10% and coefficient of variation of 60%, based on internal loan-by-loan risk assessments provided by the bank and benchmarking.

Scope’s recovery rate calculations reflect rating-distance-dependent market value declines as well as its assumptions regarding the Austrian housing market and its unique characteristics. Scope’s stressed security value range between 40.0%-62.5%, depending on the property’s location. This results in recovery rates of 91.3% in the base case and 79.4% in the most stressed scenario. Scope further assumes a recovery timing of 30 months for residential mortgage loans in Austria.

Scope used the resulting loss distribution and default timing to project the covered bond programme’s losses and reflect its amortisation structure. The analysis also incorporated the impact of rating-distance-dependent interest rate stresses. The covered bond programme is most sensitive to a ‘lower for longer’ scenario, in which interest rates drop to negative 1% after two years and remain at that rate until the last bond has been repaid. This reflects the 25% open interest rate position with 100% fixed-rate covered bonds against only 75% fixed-rate cover assets.

To calculate the cover pool’s net present value in the event of an asset sale, a refinancing premium of 150 bps for Austrian residential mortgage loans was added to the rating-distance- and scenario-dependent discount curve.

Scope tested for low (0%) and high prepayments (15%) to stress sensitivity to unscheduled repayments. The programme is most sensitive to high prepayments. As of 31 March 2019, the unstressed gap in weighted average life stands at 4.5 years (weighted average life of 14.3 years for assets and 18.8 years for covered bonds). This, however, increases significantly to around 14 years when accounting for potential prepayments, thus increasing the negative costs of carry.

The analysis applies country- and asset-type-specific servicing fees paid annually by the cover pool. For the residential mortgage loans, Scope assumes a servicing fee of 25 bps.

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-dependant stresses to simulate the impact of increasing credit and market risks on these cash flows. 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 methodology used for the covered bond ratings and outlook is the Covered Bonds Rating Methodology. The methodology is available on www.scoperatings.com.
Historical default rates of the entities rated by 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 definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

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 the issuance of the rating action, the rated entity was given the opportunity to review the rating and outlook and the principal grounds on which the credit rating and 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.
Lead analyst: Reber Acar, Senior Analyst
Person responsible for approval of the rating: Karlo Fuchs, Managing Director
The ratings/outlooks were first released by Scope on 06.04.2017. The ratings/outlooks were last updated on 17.07.2018.

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
© 2019 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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