Rating action

Scope Ratings has today affirmed its 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 is available on scoperatings.com.

Rating rationale

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

Sound issuer rating (positive). Wüstenrot’s sound credit quality¹ reflects its 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). The 123.5% of overcollateralisation as of 31 March 2020, on an eligible-loan basis, shields the covered bonds from market and credit risks and is well above the minimum 17.0% of overcollateralisation that supports the three-notch cover pool-based uplift.
    
2. Sound credit quality (positive). The cover pool solely comprises residential and domestic cover assets with a low averaged indexed eligible loan to value (LTV) of about 50%.
    
3. Asset-liability mismatches (negative). Mismatch risk is moderate, reflecting a 25% share of floating-rate assets against 100% of fixed-rate denominated covered bond liabilities and a three-year weighted average life gap. The latter increases significantly when stressing for potential prepayments.

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. This effectively provides a floor against a deterioration in the credit quality of the cover pool.

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 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 the agency’s assumptions regarding the Austrian housing market and its unique characteristics. Scope’s stressed security values range between 40.0%-65.0%, depending on the property’s location. This results in recovery rates of 100% (up from 91.3%) in the base case and 90.0% (up from 79.4%) in the most stressed scenario. The increased recoveries mainly reflect the fact that Scope focussed solely on the eligible loan part instead of the whole loan.

Wüstenrot voluntarily limits its eligible LTV to 60%. While this leads to higher recoveries on the one hand, it also reduces the overcollateralisation Scope takes into account on the other.

Credit risk only accounts for 2pp of the 17.0% supporting overcollateralisation. This compares to 3pp in the previous analysis, reflecting the increase in the stressed recovery.

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 interest rate mismatch, 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 150bps 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 2020, the unstressed gap in weighted average life stands at around three years (weighted average life of 14 years for the assets and 17 years for the covered bonds). This, however, increases significantly to around 13 years when accounting for potential prepayments (down from 14 years previously), thus increasing the costs of carry.

Market risk accounts for 15pp of the 17% supporting overcollateralisation, 7pp below the 22pp Scope calculated in its previous analysis. The decrease reflects a smaller stressed asset-liability maturity mismatch and a 20bps decrease in the weighted average interest rate paid on the covered bonds. While the decrease in the average interest rate is small, it compounds over the long remaining life of the covered bonds.

The analysis applies country- and asset-type-specific servicing fees paid annually by the cover pool. For the residential mortgage loans, Scope assumed a servicing fee of 25bps. Scope further assumed a recovery timing of 30 months for residential mortgage loans in Austria.

Rating driver references
1. Wüstenrot – private 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 20219) 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/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is 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 6 April 2017. 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
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