OREANDA-NEWS. Fitch Ratings has updated its Covered Bonds Rating Criteria by publishing its approach to analysing residual foreign exchange (FX) exposures in covered bonds, which is included in an appendix to the criteria. All other aspects of the criteria remain unchanged.

As introduced in the exposure draft, Fitch has defined two 10% limits in determining whether FX mismatches are a residual risk for the covered bond programme rating. The agency believes the risk associated with large unhedged FX exposures is not consistent with high, stable ratings on covered bond programmes given the uncertain magnitude of changes in FX rates. The published stresses will only be applied when FX exposure is considered a residual risk.

Relative to the exposure draft, Fitch has modified the calculation methods for the two 10% limits. The open FX position between the assets and the bonds is calculated relative to the total assets so that the same nominal amounts of assets and liabilities in a given foreign currency with similar weighted average lives (WAL) would not lead to an open FX position under Fitch criteria. Also, Fitch has specified that assets and liabilities in the same foreign currency would be netted, for the purpose of setting the first 10% limit, if their difference in WAL does not exceed one year, or does not exceed three years if both WAL are above five years.

For the second limit, Fitch will additionally consider the currency of the property's/borrower's income versus the currency of the loan. If the property's/borrower's income is in a different currency from the currency of the loan, then the exposure will be measured as a proportion of the respective loans to the total cover pool. If the property's/borrower's income is in the same currency as the currency of the loan, then the exposure will be measured as the 'B' default rate multiplied by the 'B' recovery rate ('B' recoveries upon default) for the respective loans, calculated before applying any FX stresses.

The agency expects to receive reliable evidence on the property's/borrower's income currency from the issuer and will not measure the exposure by the 'B' recoveries upon default if it expects that the property's/borrower's income currency is likely to change. Fitch will monitor these elements over time.

Fitch currently rates 13 covered bond programmes exposed to FX cover assets and covered bonds, which are not fully swapped or where the security is based in a country with a different currency than the loan. These are nine public sector programmes and programmes secured by commercial real estate loans from German issuers, two mortgage programmes from Polish issuers, one public sector programme from a Luxembourg issuer and one mortgage programme from a French issuer. None of these programmes has open FX position above the 10% limits. Breakeven overcollateralisation (OC) levels for the ratings are likely to increase for seven programmes but no rating impact is expected if issuers plan to maintain OC in their programmes at levels higher than any updated breakeven OCs for the ratings. For each of these programmes, the level of OC that Fitch currently gives credit to, which is often the lowest level of OC of the last year, would provide sufficient protection after application of the currency stresses.