Rating action

Scope Ratings GmbH (Scope) has today affirmed the ratings assigned to the Danish mortgage covered bonds (særligt dækkede realobligationer – SDRO) issued by Realkredit Danmark A/S (Realkredit) out of capital centre S and capital centre T. All ratings have a Stable Outlook.

Key rating drivers

Solid issuer rating (positive)¹. Realkredit has a solid issuer rating of A+. It is a core and closely integrated subsidiary of Danske Bank A/S, which itself has a solid market position. As the second largest mortgage lender in Denmark, Realkredit has reassuring profitability and prudential capital metrics.

Fundamental credit support (positive)². Fundamental credit support is the primary rating driver for both capital centres. It provides the covered bonds with six notches of uplift above the issuer rating. As such, only four notches are needed to raise the covered bonds ratings to the highest achievable level.

Cover pool support (positive)³. The capital centre-specific cover pool analyses support additional rating stability. This is reflected by:

1. Cover Pool Complexity Score (positive). Scope has classified the issuer’s management of the interplay between complexity and transparency provided to investors with a CPC Score of ‘1’, allowing for a maximum additional uplift of up to three notches on top of the fundamental uplift.
    
2. Over-collateralisation (positive). The 5.6% of over-collateralisation as of 30 March 2021 for capital centre S and 7.2% for capital centre T can shield the current AAA ratings against an issuer downgrade of up to five notches.
    
3. Sound credit quality (positive). The cover pools comprise a mix of residential and commercial assets, predominantly secured by Danish mortgages. The cover assets benefit from a low average loan-to-value ratio of about 57.0% for capital centre S and 55.0% for capital centre T.
    
4. Market risks (positive). Aided by the Danish balance principle, market risks (in particular, asset-liability mismatches) are almost fully eliminated.

Rating-change drivers

Scope’s Stable Outlook on the covered bonds reflects a rating buffer of five notches, including three notches of potential cover pool support. Ratings may be downgraded upon: i) an issuer rating downgrade by more than five notches; ii) a deterioration in Scope’s view on fundamental support factors relevant to the issuer and Danish covered bonds in general and on the interplay between complexity and transparency; and/or iii) an inability of the cover pool to provide an uplift in case the issuer rating is downgraded by more than two notches.

Quantitative analysis and assumptions

The cash flow analysis projected cover pool defaults assuming an inverse Gaussian distribution. Scope derived an effective weighted-average lifetime mean default rate of 2.3% for capital centre S and 2.6% for capital centre T after applying a cure rate of 50% and a weighted-average coefficient of variation of 50% and 75%, respectively. Assumptions on the coefficient of variation for capital centre T incorporate a potential increase in borrower defaults if margins increased by up to 500bp – in case a covered bond’s refinancing fails. These assumptions were based on credit performance data provided by the bank, in particular vintage and loss data, as well as benchmarking.

Scope also assumed asset-recovery rates ranging between 92.2% in the base scenario and 73.2% in the stressed scenario for capital centre S and between 91.0% and 77.9%, respectively, for capital centre T. Scope established total security-value haircuts for the properties securing the mortgage loans of 20.0%-65% in the base scenario and 42.5%-80% in the stressed scenario, with the level depending on the location and type of property.

The credit risk analysis of substitute assets accounted for 5.6% of the cover pool of capital centre S and 6.7% of capital centre T’s, using a portfolio-analysis framework. The portfolio’s default and loss distribution did not materially contribute to the credit risk of the mortgage portfolios due to its strong credit quality.

Scope used the resulting loss distribution and default timing to project the covered bond programmes’ losses and reflect their amortisation structures. The analysis also incorporated the impact of rating-distance-dependent interest-rate and FX stresses. Danish balance principle covered bond programmes are not very sensitive to changes of market-risk parameters. Scope used a ‘lower for longer’ scenario in which interest rates drop to a minimum negative 1% after two years and remain at that rate until the last bond has been repaid. In combination with high prepayment scenarios, the programmes were most sensitive to an appreciation of the euro, Norwegian krone and Swedish krona against the base currency – Danish krone – by up to 35% in the most stressful scenario.

Scope tested for low (1%) and high (up to 25%) prepayments to stress the programmes’ sensitivity to unscheduled repayments. Both programmes are most sensitive to high prepayments as these reduce the available excess spread over the transaction’s life.

Recovery lag assumptions were 18 months for residential loans and 30 months for commercial loans and substitute assets. A weighted annual average servicing fee of 27bp was assumed for capital centre S and 32bp for capital centre T.

To calculate the cover pools’ net present value in the event of an asset sale (on the remaining grandfathered bullet bonds or an interest shortfall), a refinancing premium of 150bp for residential mortgage loans and 300bp for commercial mortgage loans was added to the rating-distance and scenario-dependent discount curve.

Rating driver references
1. Realkredit Danmark A/S – public issuer rating 
2. Fundamental support assessment Denmark 
3. Confidential and public quarterly cover pool reporting, complementary annual performance updates 

Stress testing
No stress testing was performed.

Cash flow analysis
The Credit Rating uplift is based on a cash flow analysis using Scope Ratings’ covered bond model (CobEL version 1.0). The model applies Credit 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.

Methodology
The methodologies used for these Credit Ratings and Outlooks, (Covered Bond Rating Methodology, 18 May 2021; General Structured Finance Rating Methodology 14 December 2020), are available on https://www.scoperatings.com/#!methodology/list.
The model used for these Credit Ratings and Outlooks is (Covered Bonds Expected Loss Model version 1.0), available in Scope Ratings’ list of models, published under https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity, third parties and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Mathias Pleißner, Director
Person responsible for approval of the Credit Ratings: Olivier Toutain, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 29 August 2018. The Credit Ratings/Outlooks were last updated on 19 August 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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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