Rating action

Scope Ratings GmbH (Scope) has today affirmed the AAA ratings assigned to the Danish mortgage covered bonds (særligt dækkede realobligationer) 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.

Governance support (positive)². Governance support is the primary rating driver for both capital centres and is based on Scope’s view on: i) Denmark’s strong legal covered bond framework; and ii) the resolution regime and systemic importance of Realkredit and its covered bonds in the country. Governance support provides the covered bonds with six notches of uplift above the issuer rating. Only four notches are needed to raise the covered bonds ratings to the highest achievable level. (ESG factor)

The legal framework, together with common market practices, ensures i) the cover pool would be segregated from the issuer’s insolvency estate; ii) bond payments can continue after insolvency; and iii) identified risks can be mitigated by overcollateralisation, which generally remains available after insolvency. Danish covered bonds also benefit from specific regulatory oversight and the unique balance principle which largely mitigates liquidity and other market risks allowing for two notches of uplift from our legal framework assessment.

The additional four notches of resolution-regime uplift reflect Scope’s assessment of the Danish resolution regime and systemic importance considerations. These include: i) the implementation of the Bank Recovery and Resolution Directive and the exemption of covered bonds from bail-in; ii) incentives that prevent regulatory intervention in the issuer affecting the covered bonds’ credit quality and performance; iii) product-, issuer- and country-specific aspects relevant to the systemic importance of covered bonds in Denmark; and iv) a pro-active domestic stakeholder community.

One or more key drivers of the credit rating action are considered an ESG factor.

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. The ratings may be downgraded upon: i) an issuer rating downgrade by more than five notches; ii) a deterioration in Scope’s view on governance 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.

Quantitative analysis and assumptions

Scope performed a cover pool analysis to assess the cover pool’s ability to provide additional support should the issuer be downgraded by more than two notches.

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

Cover pool complexity (CPC) category (positive). Scope has classified the issuer’s management of the interplay between complexity and transparency provided to investors with a ‘low’ CPC category, allowing for a maximum additional uplift of up to three notches on top of the governance uplift. (ESG factor)

Overcollateralisation (positive). The 7.4% of overcollateralisation as of 31 Dec 2023 for capital centre S and 7.1% for capital centre T can shield the current AAA ratings against an issuer downgrade of up to five notches.

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 45% for capital centre S and 50% for capital centre T.

Market risks (positive). Aided by the Danish balance principle, market risks (in particular, asset-liability mismatches) are nearly eliminated.

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 2.5% for capital centre T, and weighted-average coefficients of variation of respectively 50% and 75%. The higher coefficient of variation for capital centre T reflects that the floating mortgage loans exposed to increased borrower defaults upon a failure to refinance the covered bonds as margins can be increased by up to 500bp. These assumptions are established based on the bank’s credit performance, in particular vintage and loss data, as well as benchmarking.

Scope also assumed asset-recovery rates ranging between 99.9% in the base scenario and 77.5% in the stressed scenario for capital centre S and between 99.9% and 80.4%, respectively, for capital centre T. Scope established total security-value haircuts for the properties securing the mortgage loans of 10%-45% in the base scenario and 42.5%-55% in the stressed scenario, with the level depending on the location and type of property.

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 foreign exchange stresses. Due to the Danish balance principle, covered bond programmes are not very sensitive to changes of market-risk parameters. The programmes were most sensitive to a ‘lower for longer’ scenario in which interest rates drop to a minimum of negative 1% after two years and remain at that rate until the last bond has been repaid. The programmes were sensitive prepayment scenarios. The capital centre T was most sensitive to a depreciation of the euro, Norwegian krone and Swedish krona against the base currency – the Danish krone – by down 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.

Recovery lag assumptions were 18 months for residential loans and 30 months for commercial loans. A weighted annual average servicing fee of 30bps was assumed for capital centre S and 33bps for capital centre T.

To calculate the cover pools’ net present value in the event of an asset sale, refinancing premiums of 150bp for residential mortgage loans and 300bp for commercial mortgage loans were added to the rating-distance and scenario-dependent discount curve.

Rating driver references
1. Realkredit Danmark A/S – public issuer rating 
2. Governance 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 (Covered Bonds Expected Loss Model Version 1.1). 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 methodology used for these Credit Ratings and Outlooks, (Covered Bond Rating Methodology, 24 May 2023) is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Covered Bonds Expected Loss Model Version 1.1), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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 Ratings: public domain, the Rated Entity 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 and Outlooks 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: Fatemeh Torabi Kachousangi, Associate Analyst
Person responsible for approval of the Credit Ratings: Karlo Fuchs, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 29 August 2018. The Credit Ratings/Outlooks were last updated on 30 June 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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