New Developments In The Covered Bond Market

Cover of Covered Bonds magazineCovered bonds are a way to increase credit flow to the commercial real estate industry.  A covered bond is a way for a bank to issue a bond backed by a pool of real estate assets that are backed not only by the assets contained therein, but also by the bank’s promise to repay.

NAR has been advocating for a commercial bond market because of the benefits it would bring to the industry in terms of credit availability.  An April podcast by NAR Treasurer Bill Armstrong discusses the market and regulations on the table.

What’s new this month is that ratings agency Fitch seems to be working ahead of the coming growth in covered bonds by adjusting their rating criteria for covered bonds.  Those of you recalling Fitch’s (and Moody’s and S&P’s) enormous roles in enabling the 2008 subprime mortgage meltdown might be surprised to learn that ratings agencies actually have criteria they use to make their ratings, but indeed, they do, and here’s Fitch’s new rules for covered bonds:

Fitch has made several changes to its criteria, all of them being limited in terms of rating impact.

The three main changes are the introduction of a benefit for tenant granularity, the consideration of additional securities related to the cover assets, and an adjustment of the default modelling for loans secured by multifamily properties (MFH).

With the updated methodology, Fitch recognizes the benefit of tenant granularity in its recovery analysis for loans that are assumed to default immediately based on their current property income. Whereas previously the assumed property income was adjusted downwards under the assumption that all tenants would default in a stress scenario, now Fitch uses a rating dependent default rate to adjust the property income until lease expiry. Additional securities will now be considered in the recovery analysis if they are solely available for the benefit of the bondholders, held in cash or highly rated sovereign bonds, and assumed to have a material impact on the portfolio’s expected loss.

Additional information is available on

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