OREANDA-NEWS. The ratings of non-UK covered bonds whose cover pools include UK assets are not affected by the downgrade of the UK's Issuer Default Rating (IDR) to 'AA' from 'AA+' (see 'Fitch Downgrades the United Kingdom to 'AA'; Outlook Negative', dated 27 June 2016, on www. fitchratings. com). Limited rating vulnerability is expected from the decision by the UK to leave the EU, given the low exposure of most programmes to UK assets.

Fitch rates 10 such covered bond programmes with exposures to the UK: six public sector and four mortgage programmes, issued by French, German and Luxembourg banks, with ratings between 'AA' and 'AAA'. The downgrade of the UK's IDR does not have a direct rating impact on these covered bonds, with credit loss components remaining generally unchanged.

For the public sector programmes, the exposure to the UK is low to moderate, ranging from 0.3% to 11.8% of their respective cover pools. While stressed expected losses from UK assets increased slightly based on the increased default risk and lower recovery rate assumptions for such assets following the downgrade of the UK, the maximum increase is below 1pp in 'AA' to 'AAA' scenarios.

All four of the mortgage programmes are German Pfandbriefe. Their exposure to the UK consists of loans backed by commercial real estate and ranges from 2.6% to 12.7% of cover assets. The stressed expected loss for these loans is derived based on loan and property characteristics, as well as market expectations such as vacancy rates, property yields and rental value declines. So far, these programmes have been unaffected by the UK downgrade.

Potential economic, political and regulatory consequences of the Brexit vote could affect the ratings of programmes with high exposure to the UK. A weaker economic environment may increase loss expectations for public sector assets linked to the sovereign rating. Credit losses modelled in rating scenarios corresponding to the current covered bonds rating could increase if the UK IDR is downgraded further.

Loans backed by commercial real estate (CRE) assets may be subject to higher expected defaults and lower recovery expectations if economic uncertainty and reduced demand lead to downward pressure on UK CRE markets. However, given the strict German mortgage lending valuation guidelines applicable to Pfandbriefe and consequently low loan-to-market value ratios of the UK exposures, market values would have to fall significantly to lead to substantial increases in Fitch's stressed loss expectation for these programmes.

Depreciation of GBP against the euro would lead to declining cover pool values if not hedged or fully offset by GBP covered bonds issuance. Most of the programmes exhibit only small open GBP positions, which are subject to foreign currency stresses outlined in Fitch's Covered Bond Criteria, dated 11 March 2016. Therefore, Fitch does not expect a significant increase in the breakeven OC for the assigned ratings.

Fitch does not currently expect any downgrades to non-UK covered bond programmes, given an average buffer between the breakeven OCs for the ratings and the OC Fitch relies upon of more than 8%.