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Fitch revises methodology on covered bonds secured by commercial mortgages

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Fitch Ratings has published its revised methodology relating to the analysis of European covered bonds secured on commercial mortgage loans.

The revised approach measures more precisely the credit risks of granular commercial mortgage loan portfolios securing covered bonds. The main methodological change is driven by the type of borrower. Particular analytical emphasis will now be placed on property income information for special property companies whose only tangible asset is the actual property itself, whereas operating companies’ probability of default relates more closely to the risks stemming from their general business activities.

Commercial real estate is an asset class that is vulnerable to the economic cycle, and the sector has experienced substantial difficulties during the current period of global economic stress.
Despite declines in asset values, many European banks have yet to report substantial losses on their commercial mortgage loan portfolios. In Fitch’s opinion this is partly due to continued debt service capability, but it also obscures pressures that continue to build on bank balance sheets.
Cash-flows are a key component of performance, which explains why losses to date have, for most banks, been relatively small despite considerable falls in asset prices. However, continued downward pressure on rents could result in an erosion of debt service coverage and higher foreclosure rates. In updating its approach, the agency has also updated its data templates for commercial real estate loans securing covered bonds to better capture the risk drivers inherent in this type of asset.


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