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    MBA智库文档 金融 证券投资 债券 J.P.摩根全球债券手册2019-440页.pdf

    J.P.摩根全球债券手册2019-440页.pdf

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    Europe Credit Research 06 September 2019 . Morgan Global Covered Bond Handbook 2019/20 Edition European Credit - ABS & Structured Products Meghan C Kelleher AC (44-20) 7134-2591 @ Suraj Dey, CFA AC (44-20) 7134-1722 @ . Morgan Securities plc See page 442 for analyst certification and important disclosures. . Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.  We launch the 2019/20 . Morgan Global Covered Bond Handbook, providing an overview of the product, a summary of recent market activity, and rating agency approaches to evaluating these instruments, along with a comprehensive overview of benchmark issuers that have accessed the international capital markets. 2 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Table of Contents Product Overview...................................................................10 Covered bonds: a ‘bluffer’s guide’.........................................................................10 What exactly is a covered bond?............................................................................11 Regulatory update .................................................................................................14 Covered bonds vs. RMBS......................................................................................16 Market statistics ....................................................................................................18 Rating agency approaches....................................................21 DBRS ...................................................................................................................21 Fitch Ratings.........................................................................................................22 Moody’s ...............................................................................................................24 Standard & Poor’s.................................................................................................26 Australian Covered Bonds ....................................................30 In pictures… .........................................................................................................30 Legislative snapshot ..............................................................................................31 Australia & New Zealand Bank .............................................................................32 Bank of Queensland ..............................................................................................34 Commonwealth Bank of Australia .........................................................................35 Macquarie Bank....................................................................................................36 National Australia Bank ........................................................................................38 Suncorp Metway ...................................................................................................40 Westpac Banking Corporation ...............................................................................41 Austrian Covered Bonds .......................................................44 In pictures… .........................................................................................................44 Legislative snapshot ..............................................................................................45 BAWAG PSK.......................................................................................................46 Erste Bank Group..................................................................................................48 Hypo Landesbank Vorarlberger.............................................................................50 HYPO NOE Gruppe..............................................................................................51 Hypo Tirol Bank AG.............................................................................................53 Kommunalkredit Austria AG.................................................................................54 Raiffeisen Landesbank Niederösterreich Wien.......................................................56 Raiffeisen Landesbank Oberöesterreich .................................................................58 Raiffeisen Landesbank Steiermark.........................................................................59 Raiffeisen Landesbank Vorarlberg Waren-und Revisionsverband...........................60 UniCredit Bank Austria.........................................................................................61 Volksbank Wien....................................................................................................63 Belgian Covered Bonds.........................................................66 In pictures… .........................................................................................................66 Legislative snapshot ..............................................................................................67 Belfius Bank SA/NV.............................................................................................68 BNP Paribas Fortis SA/NV....................................................................................70 ING Belgium SA/NV............................................................................................72 3 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ KBC Bank NV......................................................................................................74 Canadian Covered Bonds......................................................78 In pictures… .........................................................................................................78 Legislative snapshot ..............................................................................................79 Bank of Montreal ..................................................................................................80 CIBC ....................................................................................................................82 Fédération des caisses Desjardins du Québec .........................................................84 HSBC Bank Canada..............................................................................................86 National Bank of Canada.......................................................................................87 Royal Bank of Canada...........................................................................................89 Scotiabank ............................................................................................................91 Toronto Dominion Bank........................................................................................93 Czech Covered Bonds ...........................................................96 Legislative snapshot ..............................................................................................96 UniCredit Bank Czech Republic & Slovakia..........................................................97 Danish Covered Bonds ........................................................100 Legislative snapshot ............................................................................................100 Danish Ship Finance............................................................................................102 Danske Bank A/S................................................................................................103 Jyske Realkredit A/S ...........................................................................................106 Nykredit Realkredit A/S......................................................................................108 Finnish Covered Bonds .......................................................112 In pictures ...........................................................................................................112 Legislative snapshot ............................................................................................113 SSA comparables ................................................................................................114 Aktia Bank plc ....................................................................................................115 Danske Bank plc .................................................................................................117 Nordea Mortgage Bank plc..................................................................................119 OP Mortgage Bank plc ........................................................................................121 Sp Mortgage Bank ..............................................................................................123 Stadshypotek Mortgage AB.................................................................................125 French Covered Bonds ........................................................128 In pictures… .......................................................................................................128 Legislative snapshots...........................................................................................129 SSA comparables ................................................................................................133 Obligations Foncières..........................................................134 Arkéa Public Sector SCF.....................................................................................134 AXA Bank Europe SCF ......................................................................................136 BNP Paribas Public Sector SCF...........................................................................138 Caisse Française de Financement Local SCF .......................................................140 Compagnie de Financement Foncier SCF ............................................................144 Crédit Agricole Public Sector SCF ......................................................................146 My Money Bank (MMB SCF).............................................................................148 Société Générale SCF..........................................................................................150 4 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Obligations à l’Habitat..........................................................152 Arkéa Home Loans SFH......................................................................................152 AXA Home Loan SFH........................................................................................153 BNP Paribas Home Loan SFH.............................................................................154 BPCE SFH..........................................................................................................155 Crédit Agricole Home Loan SFH.........................................................................157 Crédit Mutuel-CIC Home Loan SFH ...................................................................158 HSBC SFH .........................................................................................................160 La Banque Postale Home Loan SFH....................................................................162 Société Générale SFH .........................................................................................164 Other French CBs.................................................................165 Caisse de Refinancement de l’Habitat..................................................................165 German Covered Bonds ......................................................168 In pictures… .......................................................................................................168 Legislative snapshot ............................................................................................169 SSA comparables ................................................................................................170 Aareal Bank AG..................................................................................................171 Bayerische Landesbank.......................................................................................173 Berlin Hyp ..........................................................................................................175 Commerzbank.....................................................................................................177 DekaBank Deutsche Girozentrale ........................................................................179 Deutsche Apotheker- und Ärztebank ...................................................................181 Deutsche Bank AG..............................................................................................182 Deutsche Hypo....................................................................................................184 Deutsche Kreditbank...........................................................................................186 Deutsche Postbank ..............................................................................................188 DZ Hyp...............................................................................................................190 Hamburg Commercial Bank (formerly HSH Nordbank).......................................192 Hamburger Sparkasse AG ...................................................................................194 ING-DiBa ...........................................................................................................195 Landesbank Baden Württemberg.........................................................................197 Landesbank Hessen-Thueringen ..........................................................................199 Münchener Hypothekenbank...............................................................................201 Norddeutsche Landesbank...................................................................................203 pbb Deutsche Pfandbriefbank ..............................................................................205 Sparkasse Köln-Bonn ..........................................................................................207 UniCredit Bank AG (HypoVereinsbank)..............................................................208 Greek Covered Bonds..........................................................212 In pictures... ........................................................................................................212 Legislative snapshot ............................................................................................213 Alpha Bank.........................................................................................................214 Eurobank Ergasias...............................................................................................216 National Bank of Greece .....................................................................................218 Piraeus Bank.......................................................................................................220 5 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Irish Covered Bonds ............................................................224 In pictures ...........................................................................................................224 Legislative snapshot ............................................................................................225 AIB Mortgage Bank............................................................................................227 Bank of Ireland Mortgage Bank...........................................................................229 Italian Covered Bonds..........................................................232 In pictures... ........................................................................................................232 Legislative snapshot ............................................................................................233 Banca Carige.......................................................................................................235 Banca Monte dei Paschi di Siena .........................................................................237 Banca Popolare di Sondrio ..................................................................................239 Banco BPM ........................................................................................................240 Banco Desio........................................................................................................242 BPER Banca .......................................................................................................243 Crédit Agricole Italia...........................................................................................245 Credito Emiliano.................................................................................................247 Intesa Sanpaolo...................................................................................................249 Mediobanca ........................................................................................................251 UBI Banca ..........................................................................................................253 UniCredit Group .................................................................................................255 Japanese Covered Bonds....................................................257 Legislative snapshot ............................................................................................258 Sumitomo Mitsui Banking Corporation ...............................................................259 Korean Covered Bonds........................................................262 Legislative snapshot ............................................................................................262 Kookmin Bank....................................................................................................263 Korea Housing Finance Corporation....................................................................264 Luxembourgish Covered Bonds .........................................266 Legislative snapshot ............................................................................................266 NORD/LB Luxembourg SA Covered Bond Bank ................................................267 Dutch Covered Bonds..........................................................270 In pictures… .......................................................................................................270 Legislative snapshot ............................................................................................271 SSA comparables ................................................................................................272 ABN Amro Bank NV..........................................................................................273 Achmea Bank NV...............................................................................................275 Aegon Bank NV..................................................................................................277 De Volksbank NV...............................................................................................279 ING Bank NV.....................................................................................................281 Nationale-Nederlanden Bank NV ........................................................................283 NIBC Bank NV...................................................................................................285 Rabobank............................................................................................................287 Van Lanschot NV................................................................................................289 6 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ New Zealand Covered Bonds ..............................................292 In pictures… .......................................................................................................292 Legislative snapshot ............................................................................................293 ANZ New Zealand ..............................................................................................294 Auckland Savings Bank (ASB)............................................................................295 Bank of New Zealand..........................................................................................296 Westpac New Zealand.........................................................................................297 Norwegian Covered Bonds..................................................300 In pictures ...........................................................................................................300 Legislative snapshot ............................................................................................301 SSA comparables ................................................................................................302 DNB Boligkreditt AS..........................................................................................303 Eika Boligkreditt AS...........................................................................................304 Nordea Eiendomskreditt AS ................................................................................306 Sbanken Boligkreditt...........................................................................................308 SpareBank 1 Boligkreditt ASA............................................................................310 Sparebanken Sør Boligkreditt AS ........................................................................312 Sparebanken Vest Boligkreditt AS.......................................................................314 SR-Boligkreditt AS.............................................................................................316 Polish Covered Bonds .........................................................320 Legislative snapshot ............................................................................................320 PKO Bank Hipoteczny SA ..................................................................................321 Portuguese Covered Bonds ................................................324 In pictures… .......................................................................................................324 Legislative snapshot ............................................................................................325 Banco BPI...........................................................................................................327 Banco Comercial Portugues.................................................................................329 Caixa Económica Montepio Geral .......................................................................331 Caixa Geral de Depósitos ....................................................................................333 Santander Totta ...................................................................................................335 Singaporean Covered Bonds ..............................................338 In pictures… .......................................................................................................338 Legislative snapshot ............................................................................................339 DBS....................................................................................................................340 Oversea-Chinese Banking Corporation ................................................................342 United Overseas Bank.........................................................................................344 Slovak Covered Bonds ........................................................346 Legislative snapshot ............................................................................................346 Slovenská sporiteľňa ...........................................................................................347 Všeobecná úverová banka ...................................................................................348 Spanish Covered Bonds ......................................................350 In pictures… .......................................................................................................350 7 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Single-Issuer Cédulas ..........................................................351 Legislative snapshot ............................................................................................351 SSA comparables ................................................................................................352 ABANCA Corporación Bancaria.........................................................................353 Banco Bilbao Vizcaya Argentaria........................................................................355 Banco de Sabadell...............................................................................................357 Banco Santander .................................................................................................359 Bankia ................................................................................................................361 Bankinter ............................................................................................................363 CaixaBank ..........................................................................................................365 Caja Rural de Navarra .........................................................................................367 Cajamar Caja Rural .............................................................................................369 Deutsche Bank SAE............................................................................................371 Eurocaja Rural ....................................................................................................373 Ibercaja Banco ....................................................................................................374 Kutxabank ..........................................................................................................376 Multi-Issuer Cédulas ............................................................378 Legislative snapshot ............................................................................................378 Overview of outstanding multi-cédula series ....................380 Swedish Covered Bonds .....................................................386 In pictures ...........................................................................................................386 Legislative snapshot ............................................................................................387 SSA comparables ................................................................................................388 Länsförsäkringar Hypotek AB.............................................................................389 Nordea Hypotek AB............................................................................................391 Skandinaviska Enskilda Banken AB....................................................................393 Stadshypotek Mortgage AB.................................................................................395 Swedbank Mortgage AB .....................................................................................397 Swedish Covered Bond Corporation ....................................................................399 Swiss Covered Bonds..........................................................402 In pictures… .......................................................................................................402 Legislative snapshot ............................................................................................403 Credit Suisse Group AG......................................................................................405 UBS AG .............................................................................................................407 Turkish Covered Bonds.......................................................410 Legislative snapshot ............................................................................................410 Vakifbank ...........................................................................................................411 UK Covered Bonds...............................................................414 In pictures ...........................................................................................................414 Legislative snapshot ............................................................................................415 Barclays Bank UK PLC.......................................................................................416 Clydesdale Bank .................................................................................................418 The Co-operative Bank........................................................................................420 8 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Coventry Building Society ..................................................................................422 Leeds Building Society........................................................................................424 Lloyds Banking Group PLC ................................................................................426 Nationwide Building Society...............................................................................428 NatWest Bank plc (Royal Bank of Scotland)........................................................430 Santander UK plc................................................................................................432 Skipton Building Society.....................................................................................434 TSB Bank plc......................................................................................................436 Virgin Money......................................................................................................438 Yorkshire Building Society .................................................................................440 9 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ P ro d u c t O v e rv ie w 10 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Product Overview Covered bonds: a ‘bluffer’s guide’ We set out below a cheat-sheet for readers new to the asset class, providing a synopsis of the main characteristics of the product. Table 1: Covered bond cheat-sheet What is a covered bond? Covered bonds are secured, senior, bullet instruments of an issuer (typically a bank), that provide investors with recourse to both the issuing institution and the underlying revolving collateral pool. What types of CB structures exist? There are three broad CB structures: a) CB can be issued directly off the balance sheet of the originator, with the collateral pool remaining with the originator, albeit ring-fenced for covered bond investors (for example, in Austria and Germany); b) a financial institution establishes a limited function subsidiary, which in turn issues covered bonds (for example, France’s OF, Norway, Ireland etc); c) in structured CB jurisdictions, CBs are typically unsecured obligations of the issuer, with funds raised from the issuance of CB lent to a guarantor vehicle (typically a limited liability SPV), which uses the loaned amounts to acquire collateral from the originator. This collateralised entity then acts as guarantor to the unsecured bonds, agreeing to repay bondholders on insolvency of the issuer (for example UK, Canada, Netherlands, Italy). What type of collateral is accepted? CB legislation (or transaction docs, when no CB legislation exists) typically define the list of collateral eligible to be included in the cover pool. The main types of assets used as primary collateral are public sector exposures and residential & commercial mortgages. Shipping, aircraft and SME exposures are also able to be included in some jurisdictions. In some cases, a max LTV is specified. The EC’s CRR also allows senior MBS (both residential and commercial) issued by securitisation entities, where at least 90% of the underlying mortgages comply with the above rules for unsecured mortgage exposures (essentially when securitisation is used for intra-group asset transfer). The MBS must be rated Credit Quality Step 1 (AAA to AA-) and can only form 10% of the collateral pool (self-originated MBS receive a waiver from the 10% cap). Substitute assets up to a given threshold (typically 10-15%) can also be included in cover pools, and typically include public sector or bank exposures (and cash). What type of risk are investors exposed to? Investors are generally exposed to issuer risk until its default, after which they are exposed to the credit risk of the cover pool. If there are CBs outstanding after the cover pool has been extinguished, CB investors will have a residual claim to the bankruptcy estate of the issuer which will rank pari passu with that of senior unsecured bondholders Do cover bonds accelerate upon the issuer’s default? No, CBs do not necessarily accelerate on insolvency of the issuing institution. Only the failure of the programme to make payments as and when due typically results in the acceleration of the obligations. Which jurisdictions are the largest markets? The largest market, by outstanding amount, is Denmark, followed by Germany, France and Spain. As CBs gain popularity with regulators, issuers and investors, more jurisdictions are starting to push for dedicated covered bond legislation. Singapore launched its inaugural benchmark covered bond in July 2015, while Turkey and Poland debuted in April 2016 and October 2016, respectively. Most recently, the inaugural benchmark covered bond from Japan was issued in October 2018, followed by Slovakia in March 2019. How do CBs differ from RMBS? The main differences between RMBS and covered bonds can be summarised as: a) amortisation: RMBS generally have a pass-through structure based on the repayment of the underlying collateral, while CBs generally have a hard (or soft) bullet profile–although ‘hybrid’ instruments, known as Conditional pass-through (CPT) bonds have become increasingly popular; b) credit enhancement: covered bonds have much simpler structures than ABS and rely on over-collateralisation as the predominant form of credit enhancement. This can vary according to the usage of the programme by the issuer but a minimum OC has to be maintained; this is monitored through asset and interest coverage tests typically monitored by third parties, which ensure that the asset pool and its proceeds are enough to match the issuer’s CB liabilities. In senior RMBS, credit enhancement is given by both subordination and structural features and, except for certain structures, it generally increases as the deal de-levers; c) unlike securitisation, where investors benefit from recourse to the collateral pool only, CB investors benefit from dual recourse to both the issuer and the cover pool. Source: . Morgan International ABS & CB Research 11 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Below, we set out to define the core characteristics of the covered bond product, despite recognising that by making some generic statements, we ignore some of the multiple nuances that issuance from a number of issuers and jurisdictions necessarily implies. We update this segment to reflect changes to legislative frameworks and the rating methodologies of the main agencies. For more detail on individual jurisdictions, please see the respective country sections towards the back of this publication. What exactly is a covered bond? In a sentence… Covered bonds are secured, senior, bullet instruments of an issuer (typically a bank), that provide investors with recourse to both the issuing institution and the underlying, revolving collateral pool. Structural form Covered bonds are typically thought of as bonds issued from the balance sheet of an originating bank, with the revolving collateral pool remaining with the originator, albeit ring-fenced for covered bond investors in case of institutional insolvency. This model is deployed in a number of significant issuing jurisdictions (for example, Austria, Finland, Germany, Greece, Portugal, Spain and Sweden); however, there are also two other forms of covered bond structures common in a number of jurisdictions. Figure 1: Forms of covered bonds Source: . Morgan International ABS & CB Research Secured debt with dual recourse to both the issuer and the collateral pool… 12 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ The most simplistic alternate structure can be accurately described by its name: ‘Specialist Banking Principle’, whereby a ‘full service’ financial institution establishes a limited function subsidiary, which in turn issues the covered bonds, backed by assets transferred from the originator. This form is typical in Ireland, and France (for Obligations Foncière), Hungary, Luxembourg and Norway. The third variation on issuance form tends to have been adopted by the Anglo-Saxon jurisdictions (Australia, Canada, New Zealand and the UK) along with Italy, the Netherlands and Switzerland. This structure was typically adopted initially by countries that did not benefit from specific covered bond legislation, but rather adopted securitisation techniques to create a covered bond investment (Figure 2). A growing number of these jurisdictions (the UK, Canada, New Zealand, Australia), however, have been cementing such structures into a legislative framework. Figure 2: Example structured covered bond diagram Source: . Morgan International ABS & CB Research Under this approach, covered bonds are actually unsecured obligations of the issuer. Funds raised from the issuance of covered bonds are then on-lent to a guarantor entity (typically a limited liability SPV), which uses the loan to acquire collateral from the originator. This entity then acts as guarantor to the unsecured bonds, agreeing to repay bondholders on insolvency of the issuer. Market participants often refer to ‘legislative’ and ‘structured’ covered bond markets, distinguishing between the first two forms described above and the latter (although these terms can be something of a misnomer since ‘structured’ markets now also have legislation). Recourse & seniority Covered bond investors benefit from dual recourse, whereby they have recourse to both the collateral pool backing the specific programme as well as a shortfall claim to the estate of the originator on its default. Securitisation investors on the other hand have recourse only to the collateral pool. Covered bonds remain the obligation of the issuing institution prior to its default, similar to any unsecured obligation and irrespective of the collateral performance in the cover pool (non-payment of a covered bond typically constitutes a default of the institution). Only after an institution’s default does the primary source of programme payments switch to the cover pool itself. Subsequently, should the pool prove Bank ABC Seller ABC CB LLP LLP Bank ABC Issuer CB Investors Swaps Provider(s) Consideration Loans & related security ProceedsCB Interco loanRepayment of Interco loan Trustee Bank ABC Seller ABC CB LLP LLP Bank ABC Issuer CB Investors Swaps Provider(s) Consideration Loans & related security ProceedsCB Interco loanRepayment of Interco loan Trustee Three broad structural forms used in covered bond issuance Only after issuer default does the primary source of investor cashflows become the cover pool 13 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ insufficient to repay all outstanding obligations under the programme, covered bond investors will have further recourse to the bankruptcy estate of the issuer. These residual claims would rank pari passu with those of other senior (unsecured) bondholders. Collateral Covered bond legislation typically defines the list of collateral eligible to be included in a cover pool. The main types of assets used as primary collateral (substitute assets are also eligible in cover pools up to a pre-defined threshold, typically 10-15%) are mortgages (both residential and commercial), and public-sector exposures. Finally, shipping and aircraft loans can also be used as collateral – but remain minor parts of the market. As the product expands its geographic reach beyond its traditional home in Europe, the list of eligible (primary) assets may also expand. Figure 3: Covered bond collateral by outstanding volumes, %, as at 31st December 2018 Source: ECBC In the EU, the primary source of guidance is provided in Article 129 of the Capital Requirements Regulation1 (CRR), which sets out the following:  Exposures to or guaranteed by public sector entities (central governments, central banks, PSEs, regional governments and local authorities) in the EU.  Exposures to or guaranteed by third country public sector entities (central governments, central banks, MDBs, international organisations, PSEs, regional governments and local authorities qualifying as Credit Quality Step 1). Exposures falling into Credit Quality Step 2 cannot exceed 20%.  Exposures to institutions qualifying as Credit Quality Step 1, not to exceed 15%, or Credit Quality Step 2 with a maturity <100 days.  Residential (80% LTV limit) and commercial mortgage loans (60% LTV limit, or 70% if an issuer provides a minimum of 10% over-collateralisation).  Senior MBS (both residential and commercial) issued by securitisation entities, where at least 90% of the underlying mortgages comply with the above rules for unsecured mortgage exposures. The MBS must be rated Credit Quality Step 1, and can form only 10% of the collateral pool. For the 10% limit to be waived, the MBS must be self-originated and the originator must retain the first loss piece.  Loans secured by ships (60% LTV limit). 1 Mortgage % Public Sector % Mixed Assets % Ships % Others % Most common form of collateral used remains mortgages, followed by public sector assets 14 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Derivatives are also permitted in certain jurisdictions to hedge specific risks, including interest and foreign exchange exposures. Cover pools backing covered bonds are dynamic in nature, with investors essentially assuming the credit risk of the cover pool only upon issuer default. Insolvency Covered bonds do not necessarily accelerate on insolvency of the issuing institution. Only the failure of the programme to make payments as and when due results in the acceleration of the obligations. Regulatory update Covered Bonds Package (including the Directive and the Regulation) In March 2018, the European Commission published a legislative proposal for a Covered Bond Directive, with the aim of establishing a minimum harmonisation framework for EU covered bonds (recognising the disparate nature of national covered bond frameworks), as well as a related amendment to the Capital Requirements Regulation (CRR); together, these are known as the ‘Covered Bonds Package’. Following the initial publication of a draft report on the Commission’s proposal by lead MEP, or Rapporteur, Bernd Lucke in August 2018 and subsequent compromise amendments in October, the European Parliament’s Economic and Monetary Affairs (ECON) Committee adopted the draft report on the Covered Bonds Package in November 2018. Most recently, after relatively brief trilogue negotiations between the European Commission, the European Council, and the European Parliament which began in late January 2019, the European Parliament’s ECON Committee adopted the final agreement on the Covered Bonds Package in April 2019 (see here for the adopted text on the Directive and the Regulation). At present, it is anticipated that the agreement will be published in the Official Journal of the EU in late 2019, with adoption by Member States intended 18 months after publication (in H1 2021) and full application 12 months later (in H1 2022). Though there are many aspects of the Covered Bond Directive that are intended to define an EU-wide, harmonised covered bond framework, we summarise some of the most basic aspects of the agreement below. We note that while the Directive provides guidance and minimum standards for EU covered bond issuance, the framework leaves considerable scope for interpretation, specification, and refinement by individual Member States. Key highlights of the Covered Bond Directive include:  Defining the required characteristics of a covered bond as “a debt obligation issued by a credit institution in accordance with the provisions of national law transposing the mandatory requirements of this Directive and secured by cover assets to which covered bond investors have direct recourse as preferred creditors;”  Establishing that both covered bond investors and derivative counterparties are entitled to dual recourse, including (in case of issuer insolvency) a claim on the cover assets and, if that is insufficient, a claim on the insolvency estate of the issuer that is pari passu with unsecured creditors;  Covered bonds must be bankruptcy remote, and not automatically accelerate upon insolvency of the issuer; The Covered Bond Directive, which will likely apply from H1 2022, establishes an EU-wide, harmonised covered bond framework 15 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @  Defining eligible assets within a cover pool, which in part recalls Article 129(1) of the CRR (outlined in its current form above, and select amendments below). Physical collateral assets that fall outside the scope of Article 129 are subject to an LTV limit of 70%, while covered bonds backed by public sector assets are subject to minimum overcollateralisation (OC) of 10%;  At the discretion of individual Member States, collateral assets located outside of the EU can be included in the cover pool, subject to security and enforcement requirements (similar or equivalent to the standard in the EU);  Creates two categories of covered bonds, including ‘Premium’ and ‘Ordinary’ European Covered Bonds, where ‘Premium’ covered bonds comply with the requirements of Article 129 of the CRR.  Permitted use of derivatives in the cover pool, solely for hedging risk;  Establishes minimum standards for required segregation of cover pool assets;  Transparency for investors via reporting requirements (to be provided at least quarterly);  Cover pools must contain a liquidity buffer of sufficient liquid assets (including HQLA Level 1, 2A, or 2B assets, or short-term exposures or deposits to sufficiently highly-rated credit institutions) to cover “the maximum cumulative net liquidity outflow for 180 calendar days;”  Extendable maturity structures are permitted, with ”objective” extension triggers defined by national law rather than at the issuer’s discretion, and where maturity extensions do not affect the ranking of covered bond investors in the event of issuer insolvency;  No immediate 3rd country equivalence, but with a provision to be reviewed in a report and potential legislative proposal by the European Commission and the EBA, falling 2 years from the application of the Directive;  Further reports on extendible maturity structures and the potential development of a new product, European Secured Notes (backed by riskier assets such as SME exposures), to also be published 2 years from the application of the Directive. Moreover, key points of the related amendments to the CRR include:  In terms of acceptable cover pool collateral for covered bonds to receive preferential capital treatment (as outlined in Article 129), included will be short- term exposures (maturity of less than or equal to 100 days) and derivative contracts to credit institutions that qualify for CQS 3. The short-term exposures and derivative contracts to CQS 3 institutions are capped at 8% of an issuer’s total exposure of the nominal amount of covered bonds outstanding (total of exposures to CQS 2 and CQS 3 institutions capped at 10%);  The 80% LTV limit for residential mortgages under Article 129 will be applied on a loan-by-loan basis. Additionally, the 60% or 70% LTV limit (depending on sufficient overcollateralisation) for commercial property and 60% for ship loans will also be applied on a loan-by-loan basis. To this end, ship loans will be also subject to the same requirements as immovable property, as outlined in Article 208 of the CRR.  Sets a minimum 5% overcollateralisation (OC) requirement, though individual Member States have discretion to lower this threshold (but not below 2%). However, outstanding covered bonds that were issued before the date of 16 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ application of the amended Regulation are not subject to this overcollaterisation requirement, and can continue to receive preferential capital treatment through maturity. Covered bonds vs. RMBS Mortgage-backed covered bonds and RMBS have more than a passing similarity to each other. However, there are also some notable structural differences between the two products. We set out to highlight the most prominent below. Definitions The ECBC2 sets out a definition of a covered bond as having the following essential features that are achieved under either a special-law or general-law based framework.:  The bond is issued by, or bondholders have full recourse to, a credit institution which is subject to public supervision and regulation;  Bondholders have a claim against a cover pool of financial assets in priority to the unsecured creditors of the credit institution;  The credit institution has the ongoing obligation to maintain sufficient assets in the cover pool to satisfy the claims of covered bondholders at all times; and  The obligations of the credit institution in respect of the cover pool are supervised by public or other independent bodies. More fully, the BIS sets out a definition of securitisation in its ‘International Convergence of Capital Markets and Capital Standards’3 document: ‘A traditional securitisation is a structure where the cash flow from an underlying pool of exposures is used to service at least two different stratified risk positions or tranches reflecting different degrees of credit risk. Payments to the investors depend upon the performance of the specified underlying exposures, as opposed to being derived from an obligation of the entity originating those exposures.’ As we can see from the above BIS definition, covered bonds fail to meet this test on a number of fronts. First, as we have already noted, cashflows from the underlying pool are not necessarily used to service the covered bonds, but rather the general resources of the issuing institution are utilised. Second, as such there are no stratified risk positions or tranches reflecting different credit risk profiles in covered bonds. Finally, payments to investors do not depend on the performance of the underlying exposures while the issuing entity remains solvent. The credit risk of the cover pool is not transferred until issuer insolvency. 2 3 Covered bonds do not meet the international definition of securitisation 17 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Amortisation European securitisation bonds typically amortise over time through the repayment of the underlying exposures (a notable exception to this are UK credit card and UK and Dutch mortgage master trusts, which offer investors soft-bullet bonds). Distributed covered bonds typically utilise a hard or soft-bullet redemption profile (there are some pass-through covered bonds, but these have typically been retained by originators for use as central bank repo collateral). Increasingly however, ‘hybrid’ instruments known as Conditional Pass-Through (CPT) bonds are being used, which combine a scheduled soft-bullet maturity, with a pass-through 'tail' following institutional default. Credit enhancement & Investor protections Covered bonds are less structurally engineered than even the simplest type of pass- through securitisation vehicles (even setting aside the complexities of ABS master trusts). To this end, covered bonds do away with much of the credit enhancement offered to securitisation investors (subordinated tranches, reserve funds, excess spread, etc). Rather, covered bond investors’ main form of credit enhancement stems from programme over-collateralisation (which is naturally dynamic based on issuer actions, including collateral additions and the programme’s issuance/redemption profile). Unlike in securitisations, where credit enhancement tends to increase over time as the structure delevers (barring collateral credit issues and the specific case of master trusts), over-collateralisation in covered bond programmes can increase or decrease as the programme is utilised by the issuer. Further investor protection is provided to CB investors by tests adopted in local legislation or programme terms. For example, ‘structured’ covered bond programmes (. Canada, the Netherlands, the UK, etc) typically require that the assets of the guarantor entity are subject to an Asset Coverage Test (ACT) on a regular basis. The test is designed to ensure a minimum level of over-collateralisation in the cover pool to protect investors from market and liquidity risks. The guarantor must therefore ensure that on each calculation date, the ‘Adjusted Aggregate Loan Amount’ (. the aggregate loan amount haircut by predefined criteria) is at least equal to the outstanding amount of the programme’s CB. The ACT is conducted by the Cash Manager, with annual third-party asset monitor reviews. Failure to remedy a breached ACT by the next calculation date usually results in an Issuer Event of Default. Similarly, programmes from these jurisdictions also typically include an Amortisation Test (AT), which is designed to ensure that the cover pool exceeds the outstanding notional of CB at all times. The adoption of an AT serves to minimise time subordination within the structure for outstanding noteholders. Following service of a Notice to Pay on the guarantor, it must ensure that on each calculation date following an Issuer Event of Default, the Amortisation Test Aggregate Loan Amount will at least equal the aggregate outstanding amount of the CB. Other tests offering protection to bondholders include ‘Pre-maturity Tests’ (which are designed to ensure the borrower can provide sufficient liquidity in case of downgrade (. pre-defined period prior to scheduled bond redemption, if a borrower’s short-term rating is below a prescribed threshold, the borrower must fund a cash collateral account to ensure redemption)); and ‘Interest Coverage Tests’ to ensure interest from the cover pool after hedges always exceed interest payments due on the covered bonds over a given period. Repayment profiles differ between the two secured products Over-collateralisation and programme tests are the main types of credit enhancement for CB investors 18 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Market statistics ECBC data as at the end of 2018 shows that the aggregate volume of covered bonds outstanding totals nearly €, of which the majority (%, see Figure 3) is backed exclusively by mortgage assets. This represents a YoY growth rate of nearly 5%, or net issuance of € during 2018 (we estimate net issuance of benchmark bonds was €66bn). The five largest markets by outstanding volume, which are led by Denmark at €406bn and Germany at €370bn, account for € of bonds, or 60% of all outstanding covereds (while the top 10 countries, at €, account for 84% of all bonds). Table 2: Covered bond outstandings, €mm, as at 31st December 2018 Position Jurisdiction Public Sector Mortgage Ships Others Mixed Assets Total as at end of 2018 1 Denmark 4,375 396,246 5,370 - - 405,991 2 Germany 134,717 233,372 1,154 505 - 369,747 3 France 64,482 194,227 - - 62,602 321,311 4 Spain 18,362 213,253 - - - 231,615 5 Sweden - 217,979 - - - 217,979 6 Italy 5,625 163,311 - - - 168,936 7 Norway 1,784 119,398 - - - 121,182 8 Switzerland - 119,422 - - - 119,422 9 Canada - 107,496 - - - 107,496 10 United Kingdom 4,662 93,530 - - - 98,192 11 The Netherlands - 94,797 - - - 94,797 12 Australia - 65,855 - - - 65,855 13 Austria 16,926 42,001 - - - 58,928 14 Finland - 37,257 - - - 37,257 15 Portugal 600 35,795 - - - 36,395 16 Ireland 2,531 20,788 - - - 23,319 17 Belgium 2,461 20,092 - - - 22,553 18 Greece - 13,840 - - - 13,840 19 Czech Republic - 13,757 - - - 13,757 20 New Zealand - 9,803 - - - 9,803 21 Singapore - 8,466 - - - 8,466 22 Luxembourg 6,103 - - - - 6,103 23 Poland 79 4,925 - - - 5,004 24 Slovakia - 4,858 - - - 4,858 25 Hungary - 3,762 - - - 3,762 26 Iceland - 3,123 - - - 3,123 27 South Korea - 2,771 - - - 2,771 28 Turkey - 2,334 - - - 2,334 29 Japan - 1,000 - - - 1,000 30 Cyprus - 650 - - - 650 31 Brazil - 454 - - - 454 32 Panama - 10 - - - 10 Total 262,706 2,244,572 6,524 505 62,602 2,576,909 Source: ECBC By transaction size (Figure 4) and currency (Figure 5), benchmark (>€500mm), EUR-denominated deals remain the market’s mainstay. Covered bond net issuance totalled c.€116bn in 2018, the first year of positive net supply since 2012 19 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Figure 4: Covered bonds outstanding by size, %, as at 31st December 2018 Source: ECBC Figure 5: Covered bonds outstanding by currency, %, as at 31st December 2018 Source: ECBC Splitting the two most significant collateral types, we see from Figure 6 that Denmark is the largest mortgage covered bond jurisdiction, with €396bn of bonds outstanding as at the end of 2018, although much of the Danish product is issued in both the domestic currency and non-benchmark format – predominantly finding a home with the local investor base. Second is Germany, with €233bn of mortgage covered bonds outstanding, while Sweden, Spain, and France take up the next three spots at €218bn, €213bn, and €194bn of outstanding mortgage-backed covered bonds, respectively. Figure 6: Outstanding mortgage-backed covered bonds by issuance jurisdiction, %, as at 31st December 2018 Source: ECBC Turning to public sector-backed covered bonds, Figure 7 shows that Germany dominates the product at €135bn, or 51% of outstanding volume. While still meaningful in terms of outstanding volumes, this represents a smaller balance than year-end 2017 (€148bn), with net issuance of -€13bn in 2018. >€1bn % €500mm-€1bn % <€500mm % Private % Euro % Domestic currency % Other % Denmark 18% Germany 10% Sweden 10% Spain 10% France 9% Italy 7% Switzerland 5% Norway 5% Canada 5% The Netherlands 4% Others 17% Denmark and Germany rank first and second in terms of outstanding mortgage-backed bonds Germany still dominates public- sector outstandings, but the absolute balance continues to shrink 20 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Figure 7: Outstanding public sector-backed covered bonds by issuance jurisdiction, %, as at 31st December 2018 Source: ECBC Finally, considering new issuance volume, the ECBC calculates that €500bn of bonds were issued in 2018, up 12% vs. the €446bn issued in 2017, of which 94% were backed by mortgages (Table 3). Denmark, with its unique mortgage funding model, led the way at €119bn of bonds, but as previously noted, this balance is overwhelmingly DKK-denominated. Sweden, Germany, and Italy take the next 3 spots, though the majority of Swedish bonds are also denominated in the local currency, while most Italian supply was privately placed. For benchmark investors, Germany, France, and Canada were the largest providers of new supply in FY 2018. Table 3: 2018 Covered bond issuance, €mm Position Jurisdiction Public Sector Mortgage Ships Others Mixed Assets Total as at end of 2018 1 Denmark 4,382 113,441 1,183 - - 119,006 2 Sweden - 54,199 - - - 54,199 3 Germany 7,230 43,142 10 - - 50,382 4 Italy - 45,200 - - - 45,200 5 France 5,483 27,108 - - 5,218 37,809 6 The Netherlands - 28,714 - - - 28,714 7 Norway 332 24,331 - - - 24,663 8 Canada - 24,384 - - - 24,384 9 Spain 800 19,935 - - - 20,735 10 United Kingdom - 14,916 - - - 14,916 11 Switzerland - 13,725 - - - 13,725 12 Austria 2,040 11,007 - - - 13,047 13 Australia - 11,075 - - - 11,075 14 Greece - 6,650 - - - 6,650 15 Belgium 161 5,842 - - - 6,003 16 Finland - 5,650 - - - 5,650 17 Ireland - 5,575 - - - 5,575 18 Singapore - 3,762 - - - 3,762 19 Czech Republic - 2,573 - - - 2,573 20 Portugal - 2,350 - - - 2,350 21 Hungary - 2,004 - - - 2,004 22 Poland 79 1,244 - - - 1,323 23 New Zealand - 1,250 - - - 1,250 24 Japan - 1,000 - - - 1,000 25 Slovakia - 800 - - - 800 26 Turkey - 766 - - - 766 27 Iceland - 755 - - - 755 28 Luxembourg 726 - - - - 726 29 South Korea - 587 - - - 587 30 Brazil - 454 - - - 454 31 Panama - 10 - - - 10 Total 21,232 472,448 1,193 - 5,218 500,092 Source: ECBC Germany 51% France 25% Spain 7% Austria 6% Luxembourg 2% Italy 2% United Kingdom 2% Denmark 2% Ireland 1% Others 2% Denmark was the largest issuance jurisdiction in 2018, whileSweden, Germany, and Italy take the next three spots 21 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Rating agency approaches We set out below an overview of the ratings approaches adopted by the four agencies with respect to covered bonds. All four agencies link the rating of covered bonds to the rating of the issuing bank, providing further scope for uplift from the issuer rating based on both collateral and cover pool cashflow characteristics. DBRS The following is our synopsis of the methodology used by DBRS to rate covered bonds. For a complete overview of the Agency’s approach, please see Rating and Monitoring Covered Bonds, published in June 2019. DBRS sees covered bonds as being akin to senior secured bank debt, therefore deploys a ‘linked approach’ to its ratings methodology. The ratings process is built around four building blocks:  Covered Bond Attachment Point (CBAP). Since the issuer is the primary source of timely payment and ultimate repayment of a programme’s outstanding covered bonds prior to institutional default, the basis for the CBAP is either the senior unsecured rating of the issuer or the Critical Obligations Rating.  Legal and Structuring Framework (LSF) and LSF-implied Likelihood (LSF- L). This assessment is the most significant of the four building blocks, and involves the evaluation of the level of delinkage between the issuer itself and the covered bond programme. The five LSF assessments range between Modest and Very Strong, and primarily involve the review of the national legislative backdrop, and the contractual framework and terms of the programme. By combining the LSF (to determine the applicable ratings matrix), and using the CBAP and CP Credit Assessment (next step), the LSF-L can be identified. The CBAP serves as the floor for the LSF-L. We show the ‘Average’ LSF matrix in Table 4.  CP Credit Assessment. Credit analysis of the cover pool, the expected cashflows from hedging and other transaction counterparties, and various stresses (. interest rate and currency stress) form part of a multi-scenario cash flow anaylsis, with the objective to test the receipt of timely interest and full principal at the maturity date of the covered bond.  High Recovery Prospects provided by the CP. Grants up to an extra two notches from the LDF-L if the CP analysis shows it would provide substantial support following the default of its covered bonds. All agencies generally use the unsecured rating of the issuer as a rating’s floor for its covered bonds 22 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Table 4: Average LSF CP credit Assessment CBAP AAA AAH AA AAL AH A AL BBBH BBB BBBL BBH BB AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAH AAA AAA AAA AAA AAA AAA AAH AAH AAH AAH AAH AAH AA AAA AAA AAA AAA AAH AAH AAH AA AA AA AA AA AAL AAH AAH AAH AAH AAH AA AA AA AAL AAL AAL AAL AH AA AA AA AA AAL AAL AAL AAL AAL AH AH AH A AA AAL AAL AAL AAL AAL AAL AH AH AH A A AL AH AH AH AH AH AH A A A A AL AL BBBH A A A AL AL AL AL AL AL AL BBBH BBBH BBB AL AL AL AL AL AL AL AL AL AL BBBH BBBH BBBL AL AL AL AL AL AL BBBH BBBH BBBH BBBH BBB BBB BBH BBB BBBL BBBL BBBL BBBL BBBL BBBL BBBL BBBL BBBL BBBL BBBL BB BBBL BBBL BBBL BBBL BBBL BBBL BBBL BBBL BBBL BBBL BBH BBH BBL BBBL BBBL BBBL BBBL BBBL BBH BBH BBH BBH BBH BBH BBH BH BBH BBH BBH BBH BBH BBH BBH BBH BBH BBH BB BB B BB BB BB BB BB BB BB BB BB BB BBL BBL BL BBL BBL BBL BBL BBL BBL BBL BBL BBL BBL BH BH CCCH BH BH BH BH BH BH BH BH BH BH B B CCC BH BH BH BH BH B B B B B B B CCCL BL BL BL BL BL BL BL BL BL BL BL BL Source: DBRS Fitch Ratings The following is our synopsis of the methodology used by Fitch Ratings to rate covered bonds, which was updated in July 2019. For a complete overview of the Agency’s approach, please see Fitch Ratings’ Covered Bond Rating Criteria, published on 24th July 2019. First, the issuing institution’s Issuer Default Rating (‘IDR’) forms the starting point of the covered bond rating. In situations where an issuing subsidiary is likely to be supported by the parent in the face of financial difficulties, or if the assets of the issuing entity are comprised only of advances granted to the parent and secured against the cover assets, Fitch will utilise the Long-Term IDR of the parent, known as the “reference IDR”. Furthermore, in instances where the covered bonds are guaranteed by a rated third party, Fitch will use the higher or the guarantor’s Long- Term ID or the issuer's IDR. Finally, for cases where the IDR or reference IDR is below ‘B-‘, Fitch will set the floor for the covered bond rating at the higher of: ‘B-‘, the IDR plus IDR uplift, or one-notch above the rating of the Derivative Couterparty, provided it expects that recourse will not switch to the cover pool in the event of a default on senior unsecured debt. However, in instances where recourse to the cover pool is expected in the event of an issuer default (when IDR is below ‘B-’), the rating agency will not set a rating floor. To recognise the introduction of the BRRD regime in many jurisdictions, whereby an institution may default on its senior unsecured obligations while maintaining payments to its covered liabilities, it is possible to use an IDR with an uplift given covered bonds’ favourable position compared to unsecured senior investors. In this situation, the uplifted IDR becomes the floor for the covered bonds’ rating. An IDR uplift of up to two notches can be used in covered bond jurisdictions with advanced bank resolution regimes in place, that includes bail-in for senior unsecured liabilities, (but not for covered bonds), and where enforcement will not be made against the cover pool. Furthermore, an IDR uplift may only be applied to programmes seen as having a sufficiently low risk of undercollateralisation at the point of resolution. Fitch covered bond rating steps Issuer Default Rating (‘IDR’) plus any IDR uplift plus Payment Continuity Uplift plus Recovery Uplift = Maximum Achievable Rating 23 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ A maximum IDR uplift of two notches can be assigned to programmes from issuers with a Viability Rating (VR)-driven IDR, those from institutions whose IDR is based on participation in a mutual support scheme, those from institutions receiving temporary liquidity support which have an IDR above the Viability Rating, and Support Rating of '5' and a Support Rating Floor of 'No Support', and those from issuers with a support-driven IDR that are integrated with a parent bank whose IDR is not support-driven; programmes from certain other institutions with a support- driven IDR may be eligible for a one notch uplift, while programmes from small, independent issuers and standalone specialised lenders will not benefit from any uplift. The second step involves determining the maximum achievable covered bond rating by determining the applicable Payment Continuity Uplift (PCU), which reflects the extent to which covered bonds are protected from payment interruption upon the enforcement of recourse to the cover pool. This Payment Continuity Uplift serves as a replacement for the old discontinuity cap (D-Cap) analysis that formerly comprised this step of the rating process. The PCU is expressed as an uplift above an issuer’s adjusted IDR, and ranges between 0 and 8 notches. The main driver of the PCU is liquidity, and Fitch assesses the degree of liquidity protection provided through legal requirement or contractual provisions. Pass through programmes, where the maturity date extends beyond the longest maturing asset in the cover pool, benefit from the maximum PCU of 8 notches, while mortgage and public sector programmes predominantly exposed to developed banking markets can receive a PCU between 3 and 6 notches, depending on the duration of effective liquidity protection for principal payments (6, 9, or 12 months). No uplift is given to programmes exposed to maturity mismatches. At this stage, the Agency also carries out a recovery given default analysis, which can result in further uplift to the Maximum Achievable Rating. The maximum recovery uplift can be 2 notches for programmes with an investment grade tested rating on a PD basis (which is determined via a cash flow stress test, described below) and 3 notches for a non-IG tested rating. Table 5: Maximum uplift to covered bonds’ tested rating on a PD basis due to recovery considerations Recovery prospects Investment grade Non-IG Outstanding +2 +3 Superior +1 +2 Good +1 +1 Average 0 0 Source: Fitch Ratings The last step involves assessing the highest level of stress that the over- collateralisation in the cover pool can withstand while still maintaining timely interest and principal payments in a stress scenario. The pool is assessed under economic downturn conditions, and compares the stressed cashflows from the cover pool to the payments required to be made on the covered bonds themselves. Over- collateralisation is key to the rating since it is the main form of credit-enhancement available to covered bond investors. Fitch applies stress scenarios covering credit losses and prepayment of the assets, servicing and management fees, refinancing spreads and negative carry-cost assumptions, and movements in interest and foreign exchange rates. In essence, there are two main sources of risk which are evaluated to assess the timely payment of covered bonds in these scenarios. The first is the credit loss, which reflects the 24 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ credit risk of the cover assets, and the second is the ALM loss, which relates to the asset-liability mismatch between the cover assets and covered bonds. The results of the stress tests give the breakeven OC (or Asset Percentage), which is the minimum OC or AP required to support timely payment in a stressed scenario for a given covered bond rating. Fitch gives credit for over-collateralisation in the following order: legal and contractual commitments, if legally binding and enforceable; non-contractual public statements and/or covenants; and the lowest level of over-collateralisation during the last twelve months (for institutions rated at least ‘F2’ and the programme is not in wind-down or dormant). For issuers rated F3 or below or programmes in wind-down or dormant, Fitch gives credit for the minimum level of over-collateralisation required by legislation. Fitch also notes that it will assign limited or no ratings uplift above an issuer’s IDR for programmes that have limitations in available cover pool assets, cash flows, or market information. Moody’s The following is our synopsis of the methodology used by Moody’s to rate covered bonds. For a complete overview of the agency’s approach, please see Moody’s Approach to Rating Covered Bonds, published in February 2019. Moody’s covered bond rating methodology follows a two stage process:  First, the Agency applies a quantitative model, called the Expected Loss Covered Bond Model (‘EL model’) which produces a maximum potential rating for an institution's covered bonds based on a combination of the probability that the issuer will cease making payments under the covered bonds (‘a CB anchor event’) and the estimated losses that would accrue to the cover pool after the CB anchor event.  Second, they adjust the maximum potential rating from the EL model to account for certain risks such as refinancing risk following the CB anchor event, via the Agency's Timely Payment Indicator (‘TPI’). The TPI in effect limits the uplift above the CB anchor, potentially constraining the maximum rating under the EL model. The EL model looks to capture the value of the cover pool following a CB anchor event, which in turn will be driven by the collateral pool’s credit quality, refinancing risk and any interest-rate or currency mismatches between the assets and liabilities of the covered bond structure (the latter two combining to be termed ‘market risk’). The model looks at a covered bond on a monthly basis, estimates the probability of a CB anchor event occurring in each period and the loss to the covered bond following such an anchor event. The probability of a CB anchor event in each period is multiplied with the relevant loss for that month, and these values are then discounted back and aggregated to arrive at the expected loss amount for the programme. The probability of a CB anchor event happening is based on the probability of the issuer failing to meet its obligations, or the Counterparty Risk (CR) Assessment of the issuer. The CB anchor, may in fact be either the CR, or the CR+1 rating notch in situations where the local bank resolution regime is expected to prioritise the continuity of covered bond payments. 25 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Table 6: TPI table when CB anchor is CR TPI CR Assessment Very improbable Improbable Probable Probable-High High Very High A1 (cr) Aaa Aaa Aaa Aaa Aaa Aaa A2 (cr) Aa1 Aa1 Aaa Aaa Aaa Aaa A3 (cr) Aa2 Aa2 Aaa Aaa Aaa Aaa Baa1 (cr) Aa3 Aa3 Aa1 Aa1 Aaa Aaa Baa2 (cr) A1 A1 Aa2 Aa2 Aa1 Aaa Baa3 (cr) A3 A2 A1 Aa3 Aa2 Aa1 Ba1 (cr) Baa1-Baa3 A3-Baa2 A2-Baa1 A1-A3 Aa3-A2 Aa2-A1 Ba2 (cr) Baa2-Ba1 Baa1-Baa2 A3-Baa2 A2-Baa1 A1-A3 Aa3-A2 Ba3 (cr) Baa3-Ba2 Baa2-Baa3 Baa1-Baa3 A3-Baa2 A2-Baa1 A1-A3 B1 (cr) Ba1-Ba3 Ba1-Ba2 Baa3-Ba2 Baa1-Baa3 A3-Baa2 A2-Baa1 B2 (cr) Ba2-B1 Ba1-Ba3 Ba1-Ba3 Baa2-Ba1 Baa1-Baa3 A3-Baa2 B3 (cr) Ba3-B2 Ba2-B1 Ba1-Ba3 Baa3-Ba2 Baa2-Ba1 Baa1-Baa3 Source: Moody’s Table 7: TPI table when CB anchor is CR+1 notch TPI CR Assessment Very improbable Improbable Probable Probable-High High Very High A2 (cr) Aaa Aaa Aaa Aaa Aaa Aaa A3 (cr) Aa1 Aa1 Aaa Aaa Aaa Aaa Baa1 (cr) Aa2 Aa2 Aaa Aaa Aaa Aaa Baa2 (cr) Aa3 Aa3 Aa1 Aa1 Aaa Aaa Baa3 (cr) A1 A1 Aa2 Aa2 Aa1 Aaa Ba1 (cr) A3 A2 A1 Aa3 Aa2 Aa1 Ba2 (cr) Baa1-Baa3 A3-Baa2 A2-Baa1 A1-A3 Aa3-A2 Aa2-A1 Ba3 (cr) Baa2-Ba1 Baa1-Baa2 A3-Baa2 A2-Baa1 A1-A3 Aa3-A2 B1 (cr) Baa3-Ba2 Baa2-Baa3 Baa1-Baa3 A3-Baa2 A2-Baa1 A1-A3 B2 (cr) Ba1-Ba3 Ba1-Ba2 Baa3-Ba2 Baa1-Baa3 A3-Baa2 A2-Baa1 B3 (cr) Ba2-B1 Ba1-Ba3 Ba1-Ba3 Baa2-Ba1 Baa1-Baa3 A3-Baa2 Source: Moody’s The Value of the Cover Pool is determined by three inputs:  Credit quality of the cover pool – Measured by a ‘collateral score’, with the higher the quality of the cover pool, the lower the ‘collateral score’. To reflect a highly rated issuer’s ongoing support for the cover pool, a collateral score may be haircut to give the ‘collateral risk’ metric.  Refinancing of the cover pool – Assuming that natural portfolio amortisation will be insufficient to meet covered obligations when due, the EL model assumes the issuer must part-fund the cover pool following an anchor event, most likely at a discount in a stressed environment. The assumed refinancing margin, proportion of the cover pool exposed to refinancing risk, and the average life of refinancing risk determines the programme’s ‘refinancing risk’.  Interest-rate and currency mismatches – Determining the amount of both risks following a CB anchor event. The TPI indicator reflects the probability of covered bond payments being made in a timely fashion following a CB anchor event. Their calculation is derived from two separate stages of analysis; first, a jurisdictional analysis considering the level of systemic support and legal framework, followed by a programme-specific analysis which looks at the contractual features of the shelf, including hedging arrangements. 26 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Standard & Poor’s The following is our synopsis of the methodology used by Standard & Poor’s to rate covered bonds. For a complete overview of the Agency’s approach, please see Covered Bond Ratings Framework: Methodology and Assumptions, published 30th June 2015. In short, the rating’s framework involves four distinct phases:  Analysis of issuer specific factors to determine whether the covered bond rating can be higher than that of the issuer itself;  Assessing the ratings starting point, based on various resolution regimes;  Determining the maximum covered bond rating from jurisdictional and covered bond specific factors; and  Combining the above three steps, and adjusting for any additional factors such as counterparty risk, country risk and sovereign default risk. Figure 8: S&P covered bond ratings approach Source: Standard and Poor’s Under the Agency’s rating framework, there are four key stages to the ratings process. Firstly, the Agency assesses whether the rating of the covered bonds may exceed that of the issuer by considering legal & regulatory risks, alongside operational & administrative risks. The assessment of legal & regulatory risks considers the degree to which a covered bond programme isolates the cover pool from the bankruptcy estate of the issuer. If asset isolation is found to exist then a covered rating higher than the issuer’s own can be assigned; if, however, the analysis concludes that there is a chance of a loss or 27 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ temporary disruption to programme cashflows following issuer insolvency, then a higher rating than the issuer’s can only be assigned if additional structural mitigants address the identified credit or liquidity risks. Operational & Administrative risks focus on the key transaction parties, and whether they are capable to manage a covered programme. This involves considering both the ability of the issuer itself prior to any default event, and also the potential for a successor manager. Should the determination under Stage 1 be that the rating of the covered bond programme should be higher than the issuer's credit rating, then Stage 2 determines which reference rating should be used. In general, the Reference Rating Level (‘RRL’) should be at least equal to the issuer's ICR, or supplemented by a number of notches for programmes issued from regimes that are subject to bank resolution regimes. In jurisdictions where the systemic importance of covered bonds is deemed to be either ‘weak’ or ‘moderate’, one notch is added, in countries where it is viewed as being ‘strong’ or ‘very strong’ the RRL may differ from the ICR by up to 3 notches. Stage 3 of the Agency's approach conducts analysis on the level of Jurisdictional Support, and considers the likelihood that a covered bond programme would benefit from a government-sponsored initiative to maintain cashflows, rather than relying on cover pool liquidation. This analysis takes into account the strength of the legal framework, the systemic importance of covered bonds within a jurisdiction, and the credit capacity of the sovereign. This Stage determines the maximum number of notches above the RRL that a programme can be given. Pool-specific factors also play a role in this stage of the ratings process, with an analysis of the cover pool’s assets and the payment structure and cash flow mechanics of the programme. Finally, Stage 4 looks to capture considerations which are not directly related to the covered bond issuer or the programme itself, but that would also affect the maximum achievable rating. Most pertinently, these can be categorised as relating to counterparty risks and country risks. Table 8: Uplift from RRL for jurisdictional support Assessment # Notches Very Strong Up to 3 Strong Up to 2 Moderate Up to 1 Weak No uplift Source: Standard & Poor’s 28 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ This page is intentionally left blank 29 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ A u s tr a li a n C o v e re d B o n d s 30 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Australian Covered Bonds In pictures… Figure 9: Distributed benchmark CB issuance as of July 2019, €mm Source: Dealogic, . Morgan International ABS & CB Research Figure 10: Distributed benchmark CB redemption profile, €mm Source: Dealogic, . Morgan International ABS & CB Research Figure 11: Distributed benchmark CB issuance by currency as of July 2019, % Source: Dealogic, . Morgan International ABS & CB Research Figure 12: Distributed benchmark CB outstanding by currency as of July 2019, % Source: Dealogic, . Morgan International ABS & CB Research Figure 13: Distributed benchmark CB outstanding by issuer as of July 2019, % Source: Dealogic, . Morgan International ABS & CB Research Figure 14: Distributed benchmark CB outstanding by coupon type as of July 2019, % Source: Dealogic, . Morgan International ABS & CB Research 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 Q 4 20 11 Q 1 20 12 Q 2 20 12 Q 3 20 12 Q 4 20 12 Q 1 20 13 Q 2 20 13 Q 3 20 13 Q 4 20 13 Q 1 20 14 Q 2 20 14 Q 3 20 14 Q 4 20 14 Q 1 20 15 Q 2 20 15 Q 3 20 15 Q 4 20 15 Q 1 20 16 Q 2 20 16 Q 3 20 16 Q 4 20 16 Q 1 20 17 Q 2 20 17 Q 3 20 17 Q 4 20 17 Q 1 20 18 Q 2 20 18 Q 3 20 18 Q 4 20 18 Q 1 20 19 Q 2 20 19 Q 3 20 19 0 2,000 4,000 6,000 8,000 10,000 12,000 Q 3 20 19 Q 4 20 19 Q 1 20 20 Q 2 20 20 Q 3 20 20 Q 4 20 20 Q 1 20 21 Q 2 20 21 Q 3 20 21 Q 4 20 21 Q 1 20 22 Q 2 20 22 Q 3 20 22 Q 4 20 22 Q 1 20 23 Q 2 20 23 Q 3 20 23 Q 4 20 23 Q 1 20 24 Q 2 20 24 Q 3 20 24 Q 4 20 24 > 20 24 0% 20% 40% 60% 80% 100% Q 4 20 11 Q 1 20 12 Q 2 20 12 Q 3 20 12 Q 4 20 12 Q 1 20 13 Q 2 20 13 Q 3 20 13 Q 4 20 13 Q 1 20 14 Q 2 20 14 Q 3 20 14 Q 4 20 14 Q 1 20 15 Q 2 20 15 Q 3 20 15 Q 4 20 15 Q 1 20 16 Q 2 20 16 Q 3 20 16 Q 4 20 16 Q 1 20 17 Q 2 20 17 Q 3 20 17 Q 4 20 17 Q 1 20 18 Q 2 20 18 Q 3 20 18 Q 4 20 18 Q 1 20 19 Q 2 20 19 Q 3 20 19 EUR AUD USD GBP USD 24% EUR 63% AUD 6% GBP 7% Westpac 34% CBA 23% Macquarie 1% ANZ 16% NAB 24% BoQ 2% Suncorp 0% Fixed 92% Floating 8% 31 Europe Credit Research 06 September 2019 Meghan C Kelleher (44-20) 7134-2591 @ Suraj Dey, CFA (44-20) 7134-1722 @ Legislative snapshot We set out in Table 9 a snapshot of key covered bond attributes in Australia. Table 9: Australian covered bond legislative overview Attribute Commentary Overview and key facts Size The Australian covered bond market has around €52bn of distributed benchmark paper (>€500mm equivalent) outstanding as of July 2019. Australian banks issued € of benchmark paper in FY 2017, followed by benchmark supply of € in FY 2018. Meanwhile, in 2019 YTD, € of benchmark bonds has been issued, of which €4bn is denominated in EUR. Type of CB Mortgage covered bonds only. Issuers The “big four”, joined by Suncorp Metway (although it has no benchmark covered bonds outstanding at present), Macquarie, and more recently in 2017, Bank of Queensland. Currencies USD-, EUR- and GBP-denominated bonds are the most common, although banks have issued AUD, NZD and CHF bonds, mostly in non-benchmark size. Framework Legislative Framework The legal framework was introduced in October 2011 by Act 125, which amends the Banking Act of 1959 to allow the issuance of covered bonds by Australian Authorised Deposit-taking Institutions (ADIs). Types of covered bonds One, Mortgage-backed. Only Australian residential and commercial mortgages are allowed in the cover pool, in addition to highly liquid substitute collateral and derivatives used for hedging purposes. Structure of Issuer Direct issuance? Yes and no. The current construct is similar to that used in the Netherlands and in the UK, whereby a securitisation technique is used to recreate a traditional covered bond structure using common and contract law. The assets are purchased by a bankruptcy-remote vehicle (providing segregation for the cover pool assets), the Guarantor, via an intercompany loan granted by the issuer and the Guarantor then provides a guarantee on the issuer's covered bonds. Comments (if any) The framework includes a "demand loan" feature, whereby the issuer can claim back any extra collateral above the ACT. Issuance limits of maximum 8% encumbered assets in the cover pool as a proportion of the ADI's total Australian assets. Bankruptcy remoteness The assets are sold via a legal true sale to the Guarantor and are therefore segregated from the issuer. Legal title to the assets remains with the issuer until the breach of a trigger. Dual claim Yes Bond format Typically fixed. Bonds can be extended by up to 12 months if the issuer fails to repay in full on original maturity. Supervision APRA Cover pool Eligible assets Mortgage Residential and commercial mortgages. LTV caps For the calculation of the LTV-adjusted balance, only the first 80%/60% of residential/commercial loans is taken into account. Public Sector No public sector CB for the moment. Non-performing collateral 0% weight in calculation of LTV-adjusted balance. Substitution Assets Not allowed to exceed 15%. Hedging Derivatives are allowed to hedge interest and exchange rate risk. Valuation Individual asset market value. When conducting the Asset Coverage Test (ACT) LTV amounts in excess of 80% for residential loans and 60% for commercial loans are not considered. Other comments (if any) n/a Requirements ALM matching Asset coverage The issuer is required to stress the cover pool when carrying out an ACT in order to ensure the cover pool is enough to cover all covered

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