Expected Loss Covered Bond Model

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APPENDIX E1: MARKET RISKS – KEY RISKS For purposes of the appendices which describe market risks, the expression “market risks” will be reference to the mismatches between Covered Bonds and the Cover Pool that arise from the different payment promises and durations made on the Cover Pool and the Covered Bonds. Specific examples of some of the material market risks to which Covered Bonds are exposed are discussed below. Under the Moody’s EL Model analysis of market risks following Issuer Default will be undertaken in respect of two time periods as follows. • Market risks that arise after Issuer Default and prior to any refinancing of part or whole of the Cover Pool. • Market risks that arise on refinancing of part or whole of the Cover Pool. Market risks that arise after Issuer Default and prior to any refinancing of the Cover Pool During this period prior to any refinancing of part or the whole of the Cover Pool, Moody’s EL Model will assess whether market risks materialising may lead to an acceleration of the Covered Bonds. This may arise as follows. • Cash flow deficiencies may result from market risk materialising. For example, interest or currency rate movements might lead to collections being below that required to pay interest (in the case of interest and currency rate differences) and principal (in the case of currency rate differences) on the Covered Bonds. A missed payment could in turn lead to acceleration of all payment obligations under the Covered Bonds, whether or not then due. • Market risk materialising may affect matching test compliance under the Covered Bonds, failure of which may lead to acceleration of payment obligations under the Covered Bonds. The applicable approach to calculating any matching tests will be set out in the relevant legislation or contractual arrangements for the Covered Bonds. Methods of calculation may include: • Notional value matching, which will not be affected by any changes in interest rates (but may be affected by changes in currency rates). • Net present value matching, which may be affected by both interest and currency rate changes. Where net present value matching is applicable, the Moody’s EL Model will recalculate the net present value of the Cover Pool and Covered Bonds on monthly or quarterly basis to check for failure of the matching test. Market risks arising on refinancing of the Cover Pool Under the Moody’s EL Model, if part or whole of the Cover Pool is subject to refinancing either to meet the principal payment due on a Covered Bond or following acceleration payment of all Covered Bonds outstanding, then various market risks may be crystallised. The Moody’s EL Model will measure the extent of the risk to the Covered Bonds in different ways depending on the nature of the market risk. Interest rate risks The exposure to interest rate movements at time of refinance will depend on the mismatch that exists between the Covered Bonds and the Cover Pool. Material levels of exposure to interest rate movements will arise in the following circumstances amongst others: • Interest rates applicable to (i) the collateral in the Cover Pool are based on a fixed rate with a long maturity (assuming no reset), and (ii) the Covered Bonds are based either on a short maturity or floating rate. • Interest rates applicable to (i) the collateral in the Cover Pool are based either on a short maturity or are floating rate, and (ii) the Covered Bonds are based on a fixed rate with a long maturity (assuming no reset). In the first bullet above, a loss on the Cover Pool may arise in respect of a rising interest rate environment. By contrast, in the second bullet above, the loss to the Cover Pool may arise in respect of a falling interest rate environment. Moody’s EL Model considers scenarios of both rising and falling interest rate environments and assumes application of the scenario with the more stressed result. Appendices E3 and E4 describe further the levels of stress considered in Moody’s EL Model as well as setting out the relevant workings of Moody’s EL Model for exposure to interest rate risks. Appendix E5 provides an example of the impact of interest rate risk on the Cover Pool. Currency rate risks Currency rate risks are less commonplace in respect of Covered Bonds than interest rate risk. However, increasingly, collateral in Cover Pools is originated, and Covered Bonds are issued, respectively in currencies other than the currency of the Issuer. Appendices E3 and E4 describe further the levels of stress considered in Moody’s EL Model for exposure to currency rate risks as well as setting out the relevant workings of the Moody’s EL Model. 20 • Moody’s Investors Service European Covered Bond Rating Methodology
APPENDIX E2: MARKET RISKS – MOODY’S EL MODEL’S ANALYSIS OF HEDGING ARRANGEMENTS Moody’s EL Model will analyse the market risks that may arise between the Covered Bonds and the Cover Pool following Issuer Default. Consideration will be given under Moody’s EL Model to which of the following market riskrelated scenarios may arise after Issuer Default: • Structured finance-compliant arrangements are in place to cover all relevant market risks. The meaning of the expression “structured finance-compliant arrangements” will include the following requirements, amongst others: • Hedging arrangements are designed to survive Issuer Default (reasons for this requirement are described in the next following paragraph). • Moody’s swap-related criteria will be fulfilled in all respects for all hedging arrangements. 13 • Arrangements are in place to cover market risks, though these do not comply with all requirements of structured finance-compliant arrangements in one or more respects. These hedging arrangements do, however, survive Issuer Default. • No suitable arrangements in place, or if there are arrangements in place, these will terminate on Issuer Default. Under Moody’s EL Model, any market risk not covered by arrangements that are designed to survive Issuer Default may negatively affect the Covered Bonds. Reasons for this approach include the following considerations, amongst others: • An administrator will be assumed to be appointed to manage the Cover Pool following Issuer Default. • However, it is Moody’s view that an administrator may experience difficulty in trying to cover market risks following Issuer Default. 14 Under Moody’s EL Model, account may be taken of any legislation- or contractual-specific features that mitigate any of the above considerations as well as any other market risks taken into account. The remainder of the appendices which describe market risks focus attention on stresses that are applied by Moody’s EL Model in the event that hedging arrangements do not constitute structured finance-compliant arrangements. 13 See Swaps in European Term Securitisations, May 2002 and Impact of Swap Counterparty Risks on Global Structured Finance Transactions Moody’s Revised Methodology - Call for Comments, March 2005. 14 In support of its view, Moody’s expects that, in considering entering into hedging arrangements with an administrator, a hedge counterparty may require collateralisation of the arrangements. This may include frequent posting of collateral, dependent on the evolution of the exposure. An administrator may not always be permitted following Issuer Default to enter into additional or replacement hedging arrangements. Furthermore, if entering into hedging arrangements is permitted, an administrator may either additionally not be permitted to provide collateralisation to hedge counterparties, or have sufficient funds available for this purpose. European Covered Bond Rating Methodology Moody’s Investors Service • 21
Page 1 and 2: STRUCTURED FINANCE/BANKING RATING M
Page 3 and 4: Within the Moody’s EL Model, the
Page 5 and 6: APPENDIX A1: THE JOINT DEFAULT APPR
Page 7 and 8: APPENDIX A2: THE RELATIVE CONTRIBUT
Page 9 and 10: APPENDIX C1: DEFINING AND CALCULATI
Page 11 and 12: APPENDIX C3: CALCULATION OF THE HAI
Page 13 and 14: APPENDIX C4: USING THE COLLATERAL S
Page 15 and 16: APPENDIX D1: REFINANCING RISK - THE
Page 17 and 18: APPENDIX D2: REFINANCING RISK - THE
Page 19: APPENDIX D4: SIMPLIFIED EXAMPLE TO
Page 23 and 24: APPENDIX E4: MARKET RISKS - CALCULA
Page 25 and 26: APPENDIX E5: SIMPLIFIED EXAMPLE TO
Page 27 and 28: APPENDIX F2: RATING A PROGRAMME: TH
Page 29 and 30: APPENDIX F4: PROBABILITY OF DEFAULT

Expected Loss Covered Bond Model

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