OREANDA-NEWS.  Fitch Ratings has upgraded Kookmin Bank's (KB; A/Stable) inaugural series of mortgage covered bonds to 'AAA(EXP)' from 'AA+(EXP)'. The Outlook is Stable.

The rating upgrade was based on the inclusion of transfer and convertibility (T&C) risk mitigation in the covered bond programme through a covered bond swap, which will provide covered bondholders protection should a T&C event occur. This, along with overcollateralisation (OC) that supports mitigation of currency risk, allows Fitch to provide an uplift of one notch above the Korean Country Ceiling of 'AA+'.

KEY RATING DRIVERS

The 'AAA(EXP)' rating is based on KB's Long-Term Issuer Default Rating (IDR) of 'A', an unchanged Discontinuity Cap (D-Cap) of 4 notches; and the asset percentage (AP) to be disclosed in the issuer's investor report, which is expected to be equal to or lower than Fitch's breakeven AP for a 'AAA' rating of 83.5%. This provides more protection than Fitch's previous 'AA+' breakeven AP of 85.5%. The Outlook on the covered bonds reflects the Stable Outlook on KB's IDR.

The upgrade to 'AAA(EXP)' follows the introduction of T&C protection through the covered bonds swap, under which a counterparty rated at least 'A/F1' will continue to make payment in foreign currency denominated bonds to bondholders, matching Korean won payments affected by a T&C event. This provision is expected to be in place for each foreign currency-denominated series to be issued. Fitch notes that the swap would terminate upon a covered bonds default, leaving bondholders exposed on cash flows received by way of recoveries from the cover pool. However, Fitch deems this risk to be compatible with the scope of one-notch credit for recoveries. Fitch also believes that any T&C event in South Korea would be temporary.

The revised breakeven AP considers whether timely payments are met in a 'AA+' scenario and tests for recoveries given default of at least 51% in a 'AAA' scenario. When Fitch considers a stressed valuation of the cover pool following a covered bond default and swap termination, the breakeven OC is sufficient to cover a Korean won devaluation that leads to foreign currency bonds becoming more than three times more expensive over the next four years. Fitch has also assumed multiple bond issuances outstanding to reflect dynamic future issuance profiles in this recovery analysis. The 'AAA' breakeven AP of 83.5% corresponds to a breakeven OC of 19.8%. It is driven by the cash flow valuation component of 10.5% due to Fitch's stressed weighted average life of the assets (5.7 years) versus the liabilities (1.5 years). This is followed by the asset disposal loss of 6.0%, reflecting the maturity mismatches between weighted average life of assets (15.5 years) and the life of bonds up to five years and the refinancing assumptions applied to Korean mortgages, and finally the cover pool's credit loss of 4.2% in a 'AAA' scenario.

The programme D-Cap of 4 notches reflects Fitch's "moderate" discontinuity risk assessment related to the liquidity gap and systemic risk and the cover pool-specific alternative management components. In a scenario where the recourse of the covered bonds switches from the issuer to the cover pool, Fitch believes that a successful sale of the cover assets would be possible within the extendible maturity of 12 months of the expected issuance, which is envisaged in the documentation to make timely payments on the covered bonds. Furthermore, the cover-pool specific alternative management assessment addresses both the quality and quantity of the data provided by the issuer.

At end-June 2015, the cover pool consisted of 15,301 loans secured by first-ranking mortgages of Korean residential properties with a total outstanding balance of KRW2.17trn. The portfolio has a weighted average (WA) current loan-to-value ratio (CLTV) of 43.1% and is 20 months seasoned. By current balance, 49.0% of the pool comprises loans with an interest-only period that convert to full amortisation, 86.7% hybrid loans of floating and fixed rate, and 98.4% loans are secured by apartments. The cover pool is geographically diversified across Korea with the largest exposures in Kyounggi (42.6%) and Seoul (29.8%). Fitch's calculated 'AAA' expected loss on the residential mortgage assets is 4.0%. The assets have a WA life of approximately 15.5 years.

RATING SENSITIVITIES

The 'AAA(EXP)' rating would be vulnerable to downgrade if any of the following occurred: (i) KB's Issuer Default Rating was downgraded by one notch to 'A-'; (ii) the Discontinuity Cap fell by one notch to 3 (Moderate High); (iii) the asset percentage (AP) that Fitch takes into account in its analysis increased above Fitch's 'AAA' breakeven AP of 83.5%; (iv) or if the Country Ceiling of Korea was revised to 'AA' or below; or (v) transfer and convertibility risk mitigation was no longer available.

Fitch's 'AAA' breakeven AP for the covered bond rating will be affected, among others, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore the 'AAA' breakeven AP to maintain the covered bond rating cannot be assumed to remain stable over time.