Expected Loss Covered Bond Model

APPENDIX E5: SIMPLIFIED EXAMPLE TO SHOW HOW TO TRANSLATE A
STRESSED INTEREST RATE MOVEMENT INTO A LOSS ON THE COVER POOL
This Appendix presents an example to show what effect the stressed interest rate movement calculated in
Appendix E3 may have on the value of the Cover Pool. It should be noted that this is a simplification of the
corresponding calculation in Moody’s EL Model and assumes no hedging arrangements are in place to protect
against interest rate exposure.
The example is based on the following assumptions, amongst others;
• There has been an Issuer Default.
• A single Covered Bond is outstanding under a “programme” of Covered Bonds.
• The remaining average life of the Cover Pool at the time of its sale is two years.
• The Cover Pool comprises collateral which is all based on fixed rates of interest until respective maturity
(which means for this example the average life of Cover Pool is also the period of interest rate exposure).
• No principal payments will be made in respect of the collateral in the Cover Pool.
• The Interest Exposure Period (see Appendix E3) is one year.
• The increase in interest rates during the Interest Exposure Period is 165 basis points (as described in
Appendix E3).
The impact of market risk stress on the value of the Cover Pool may be calculated as follows:
Interest rate increase * average life of the interest rate exposure = reduction in the value of the Cover Pool
165bps * 2 = 330bps reduction in the value of the Cover Pool
European Covered Bond Rating Methodology Moody’s Investors Service • 25