Expected Loss Covered Bond Model

APPENDIX D4: SIMPLIFIED EXAMPLE TO SHOW HOW TO TRANSLATE A
STRESSED REFINANCING MARGIN INTO A LOSS ON THE COVER POOL
This Appendix presents an example to show what effect the stressed refinancing margin in Appendix D1 may have
on the value of the Cover Pool. It should be noted that the example below is a simplification of the corresponding
calculation in Moody’s EL Model.
The example is based on the following assumptions, amongst others.
• A single Covered Bond is outstanding under a “programme” of Covered Bonds.
• Issuer Default takes place one month prior to legal final maturity of the Covered Bond.
• The remaining average life of the Cover Pool at the time of its refinancing is two years.
• The refinancing takes place five years after the Covered bond was issued.
• The Cover Pool consists of prime residential mortgages (and matches the sample pool used to create the
refinance margins in Appendix D1).
The impact of the refinancing margin stress on the value of the Cover Pool may be calculated as follows:
Refinancing margin * liquidity stress *average life of the Cover Pool = reduction in the value of the Cover Pool
95 * 2 * 2 = 380 bps reduction in the value of the Cover Pool
Amongst others, this example highlights the importance of the average life of the Cover Pool. If the example were
repeated with an average life of the Cover Pool at time of refinance of four years, the reduction in the value of the
Cover Pool would be doubled. Conversely, if the example were repeated with an average life of the Cover Pool at
time of refinance of one, the reduction in the value of the Cover Pool would be halved.
European Covered Bond Rating Methodology Moody’s Investors Service • 19