Scope publishes updated covered bond rating methodology

13 August 2018

On 31 July 2018, Scope Ratings published its updated rating methodology for covered bonds.  

Methodology highlights

The methodology provides for an assessment of covered bonds’s recourse to both the issuing bank and to the cover pool, which enhance covered bonds’ credit quality significantly above the issuer’s rating.

The Methodology reflects the unique status of covered bonds in a bank’s liability structure. Scope’s non-mechanistic approach to rate covered bonds takes into account:

i) the systemic importance of this bank-funding product, and

ii) the covered bond’s significance in both regulatory and supervisory frameworks as well as in central bank monetary policy.

Scope’s cover pool analysis applies a bottom-up approach that reflects the specifics of European markets.

In this update and following a call for comments, Scope further enhances and clarifies the use of the cover pool analysis. In particular, Scope clarifies its approach to assess public sector entities default risk, recovery rates and dependencies. Scope also clarifies its approach to assess the impact of market risk mismatches between the cover pool and covered bond liabilities.

Scope assigns covered bond ratings reflecting the higher of the benefit from the fundamental and the cover pool credit supports available to a covered bond issue.

The methodology therefore features three analytical steps:

  1. Issuer assessment. Scope relies on a credit rating of the issuing bank (the first recourse) as the starting point for the additional rating uplift.
  2. Fundamental credit support assessment. The analysis of the legal and resolution frameworks and other forms of support provides an insight into the likelihood of covered bonds being used as a going-concern funding instrument. A covered bond rating issued by a resolvable bank in a country with a supportive framework can benefit from up to six notches above the bank’s issuer rating.
  3. Cover pool support assessment. This step addresses the benefits of the second recourse to the cover pool if needed. The chain of events leading to recourse to the cover pool is extremely improbable under a resolution regime. As a result, the cover pool analysis may not always be a material rating driver. It generally provides up to three notches of credit differentiation above that from fundamental credit support.

For more information, download the ‘Rating Methodology Covered bonds