Rating action

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

Additional information and research on the issuer and its covered bonds is available on www.scoperatings.com.

Rating rationale

Key rating drivers and rating-change drivers are summarised as follows:

Issuer rating (positive). The sound BBB+/Stable issuer rating on Bankia¹ reflects its strong retail franchise in Spain, low-risk business profile and adequate capitalisation.

Cover pool support (positive). Cover pool support² is the primary rating driver and adds at least seven notches of credit uplift, reflecting:

1. Overcollateralisation (positive). Available overcollateralisation of 180.5% shields the covered bonds from market and credit risks and is well above the unchanged minimum of 37.5% that supports the cover pool uplift.
    
2. Sound credit quality (positive). Granular, predominantly residential cover pool with moderate loan-to-value and an ongoing improvement in asset quality.
    
3. Asset-liability mismatches (negative). High asset-liability mismatch risk from the slow scheduled amortisation of cover assets compared to a relatively fast redemption profile for the covered bonds. As is usual for Spanish covered bonds, the cover pool does not include additional, short-term substitute assets, nor does the framework allow the maturity of liabilities to be extended.

Fundamental credit support (positive). The six-notch fundamental credit support uplift reflects the strength of the Spanish legal covered bond framework, the benefits of the resolution regime, and the systemic importance of covered bonds in Spain. This effectively provides a floor against a deterioration in the credit quality of the cover pool.

Rating-change drivers

The 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 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.

The covered bond ratings may be downgraded if: i) the issuer’s credit quality deteriorates by more than two notches; ii) risk in the covered bond programme increases and the overcollateralisation provided 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 Spanish mortgage-covered bonds in general.

Quantitative analysis and assumptions

Scope analysed Bankia’s highly granular mortgage book using a normal inverse distribution. Based on Q1 2020 reporting, Scope’s analysis assumes lifetime default rates of 15% for residential loans and 30% for commercial loans (excluding land and developers), with coefficients of variation at 70% and 50%, respectively. Scope’s assumptions are based on mortgage performance data provided regularly by the Bank of Spain and were adjusted for Bankia’s performance. These assumptions have remained unchanged since the last review, as Bankia’s mortgage pool has largely performed in line with the overall market.

Scope’s recovery assumptions have improved, mainly reflecting the decrease in the mortgage book’s average loan-to-value as well as the ongoing recovery of Spanish house prices leading to positive indexation effects. For residential mortgages, the base case (D0) recovery assumptions have increased to 80% from 76.3%. Recovery assumptions for the commercial segment have increased to 70% from 68.5% a year ago. Scope has calculated a stressed recovery rate (D9) of 48% for residential loans and 42% for commercial loans.

Overall, credit risk accounts for 16pp of the 37.5% supporting overcollateralisation.

The rating agency used the resulting loss distribution and default timing to project the covered bond programme’s losses and reflect the programme’s amortisation structure. Scope also incorporated the impact of rating distance-dependent interest rate stresses in its analysis. 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 fact that 65% of the outstanding bonds pay a fixed rate while around 90% of cover assets pay a floating-rate coupon. Newly originated fixed-rate mortgages will reduce the mismatch over time, but persistently low interest rates continue to stress the programme’s excess spread – which is already at negative levels and thereby adds to supporting overcollateralisation.

Scope tested for low (0%) and high prepayments (up to 25%) to measure the programme’s sensitivity to unscheduled repayments. The programme is most sensitive to low prepayments as the large maturity mismatch would require asset sales in order to make timely payments on the bonds. The mismatch arises from a weighted average life (WAL) gap of around 14 years between the assets’ WAL of 20 years (based on their legal terms) and the bonds’ WAL of only 6 years.

To calculate a net present value for the cover pool in the event of an asset sale, a liquidity premium of 250bps for the residential mortgages and 300bps for the commercial mortgages in Spain were added to the rating distance and scenario-dependent discount curve. Scope derived this liquidity premium by analysing the long-term development of trading spreads for Spain. 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 are not likely to persist throughout the whole term.

All bonds are denominated in euros, with 0.2% of assets denominated in other currencies. Scope deems this exposure immaterial and therefore did not apply foreign exchange stresses.

In total, market risk accounts for 21.5pp of the 37.5% supporting overcollateralisation.

Scope further assumed a recovery lag of 36 months for both residential and commercial loans originated by Bankia. The agency also applied country- and asset-type-specific servicing fees which the cover pool needs to pay annually. Scope assumed a servicing fee of 25bps for residential and 50bps for commercial loans.

Rating driver references
1. Bankia – Issuer rating
2. Confidential quarterly cover pool reportings 

Stress testing
No stress testing was performed.

Cash flow analysis
The cover pool-supported rating uplift is based on a cash flow analysis using Scope’s covered bond model (CobEL version 1.0). The model applies rating distance-dependent stresses to scheduled cash flows to simulate the impact of increasing credit and market risks. The model outcome is the expected loss for a given level of overcollateralisation as well as the impact of stressed asset sales or variables such as changing prepayment speeds or servicing costs.

Methodology
The methodology used for this rating and rating outlook (Covered Bond Rating Methodology, 26 July 2019) is available on https://www.scoperatings.com/#!methodology/list.
The model used for this rating and rating outlook (Covered Bonds Expected Loss Model version 1.0) is available in Scope’s list of models, published under: https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. 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. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
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 and/or its agents participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, 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 or outlook action, the rated entity was given the opportunity to review the rating and 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 are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
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 8 July 2016. The ratings/outlooks were last updated on 12 July 2019.

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
© 2020 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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