Rating action

Scope Ratings GmbH (Scope) has today affirmed its AAA/Stable rating on the Austrian mortgage-covered bonds (Hypothekenpfandbriefe) issued by Hypo-Bank Burgenland AG (Bank Burgenland). The Outlook remains Stable.

Rating rationale

Sound issuer rating¹ (positive). Bank Burgenland’s sound credit quality reflects its conservative and integrated business model, improving profitability and adequate capitalisation.

Cover pool support² (positive). Cover pool support is the primary rating driver and adds at least six notches of credit uplift, two notches in addition to fundamental support factors. The cover pool uplift reflects:

1. Cover pool complexity score (positive). Scope assigns the interplay between complexity and transparency a cover pool complexity score of 1, allowing for a maximum additional uplift of up to three notches on top of the fundamental uplift.
    
2. Overcollateralisation (positive). The 62.7% of overcollateralisation as of 30 September 2021, on an eligible-loan basis, shields the covered bonds from market and credit risks and is well above the minimum 14.0% of overcollateralisation that supports the three-notch cover pool-based uplift.
    
3. Mixed mortgage pool (moderate). The mixed nature of the cover pool, comprising around 25% of commercial mortgage loans, results in moderate credit risk. Cover assets continue to be fully domestic and of high credit quality, reflected in their low average loan/value ratios.
    
4. Asset-liability mismatches (moderate). Interest rate mismatches are elevated, with 73% of floating rate assets compared to fully fixed rate covered bonds. Further, the gap between the weighted average life of the assets (6.8 years) and the bonds (7.3 years, when accounting for potential call rights) is small. However, the gap increases significantly when accounting for potential asset prepayments.

Fundamental credit support³ (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 mortgage-covered bonds reflects a rating buffer of one notch of cover pool support. The rating may be downgraded upon: i) an issuer rating downgrade by more than one notch; ii) a deterioration in Scope’s view on fundamental support factors relevant to the issuer and Austrian mortgage-covered bonds in general as well as on the interplay between complexity and transparency; and/or iii) an inability of the cover pool to provide additional rating uplift.

Quantitative analysis and assumptions

Scope’s projections of defaults on Bank Burgenland’s residential mortgage loans use an inverse Gaussian distribution. Scope derived an effective lifetime mean default rate of 12.5% and a coefficient of variation of 60%, based on internal loan-by-loan risk assessments provided by the bank and benchmarking.

Scope used a market-standard portfolio analysis to estimate default statistics for the commercial mortgage loans, taking the exposure’s credit quality, its amortisation profile and asset correlation assumptions into account. A default distribution was derived for the cover pool using name-by-name credit assessments. Scope also applied a correlation framework which accounts for geographical, industry and issuer concentration. The resulting non-parametric default distribution has a mean default rate of 8.6% and a coefficient of variation of 72.7%.

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 value haircuts range between 45.0%-70.0%, depending on the property’s location. This results in portfolio recovery rates of 95.0% in the base case and 73.7% in the most stressed scenario. Scope assumed a recovery lag of 30 months for mortgage loans originated by Bank Burgenland, and 48 months for the substitute assets.

In total, credit risk accounts for 7 pp of the 14.0% supporting overcollateralisation. This remains unchanged from the previous analysis, reflecting stable cover pool composition.

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 level until the last bond has been repaid.

Scope tested for low (1%) and high prepayments (15%) to assess sensitivity to unscheduled repayments. The programme is most sensitive to high prepayments increasing the negative costs of carry.

Market risk accounts for the remaining 7 pp of the 14% supporting overcollateralisation, 3 pp below the previous year. This reflects: i) the roughly one year shorter life of the covered bonds when accounting for potential call rights; and ii) a 10 bps decrease in the weighted average coupon on the covered bonds.

Scope applied asset type-specific servicing fees to be paid by the cover pool annually. The rating agency assumed a servicing fee of 25 bps for the residential mortgage loans, 50 bps for the commercial loans and 10 bps for the substitute assets.

To calculate a net present value for the cover pool in the event of an asset sale, liquidity premiums were added to the rating-distance- and scenario-dependent discount curve, of 200 bps for the residential mortgage loans, 400 bps for the commercial loans and 200 bps for the substitute assets.

The programme’s sensitivity was also tested to reinforce the programme’s supporting overcollateralisation, specifically against prepayments of up to 25% and front-loaded defaults.

Rating driver references
1. Bank Burgenland – private issuer rating (confidential)
2. Quarterly cover pool reportings (confidential)
3. Fundamental support assessment Austria 

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 (Covered Bonds Expected Loss Model 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 this Credit Rating and/or Outlook (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 models used for this Credit Rating and/or Outlook (Covered Bonds Expected Loss Model version 1.0; Portfolio Model version 1.0) are available in Scope’s 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 Rating if the Credit Rating 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 Rating: 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 the Credit Rating 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 Rating and/or Outlook and the principal grounds on which the Credit Rating and/or Outlook is based. Following that review, the Credit Rating was not amended before being issued. 

Regulatory disclosures
This Credit Rating and/or Outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Rating and/or Outlook is UK-endorsed.
Lead analyst: Reber Acar, Associate Director
Person responsible for approval of the Credit Rating: Benoit Vasseur, Executive Director
The Credit Rating/Outlook was first released by Scope Ratings on 15 November 2017. The Credit Rating/Outlook was last updated on 19 November 2019.

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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