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Fitch Affirms KB's Mortgage Covered Bonds at 'AAA'; Outlook Stable
December 16, 2016 / 9:33 AM / a year ago

Fitch Affirms KB's Mortgage Covered Bonds at 'AAA'; Outlook Stable

(The following statement was released by the rating agency) SEOUL/SYDNEY, December 16 (Fitch) Fitch Ratings has affirmed the rating of South-Korea based Kookmin Bank's (KB, A/Stable/F1) mortgage covered bond programme at 'AAA'. The Outlook is Stable. The programme has KRW1.17trn mortgage covered bonds outstanding. The affirmation follows the implementation of the updated Covered Bonds Rating Criteria published on 26 October 2016. KEY RATING DRIVERS The programme's rating is based on KB's Long-Term Issuer Default Rating (IDR) of 'A', a newly assigned IDR uplift of zero notches, a newly assigned payment continuity uplift (PCU) of six notches and a recovery uplift of one notch. In its analysis Fitch relies on the highest nominal asset percentage (AP) for last 12 months (50%), which provides more protection than Fitch's 'AAA' breakeven AP of 81.5%. The breakeven AP corresponds to a 'AA+' tested rating on a probability-of-default basis and a one-notch recovery uplift. The Stable Outlook on the covered bond rating reflects the two-notch buffer against the downgrade of the issuer's IDR. Fitch has assumed a further bond of USD500m will be issued out of KB's programme. This is based on Fitch's understanding that an increase of the cover pool in February 2016 was for the purpose of bond issuance. The 'AAA' breakeven AP of 81.5% is equivalent to a breakeven overcollateralisation (OC) of 22.7%. This is driven by the asset disposal loss of 12.1%. This is higher than previously as the mortgage refinance spread assumptions for Korea have increased under the new criteria. The asset disposal loss also reflects the programme's significant asset and liability mismatch, with the weighted-average (WA) life of the cover assets at 14.8 years and the liabilities at 4.5 years. The cash flow valuation component contributes 7.0% to the breakeven OC and takes into account the effect of the interest-rate mismatch between the mostly fixed-rate cover assets and floating-rate swap liabilities during the covered bond extension period. This component is lower than our previous analysis, as we expect the proportion of hybrid loans that revert to floating-rate will be higher at the time of an enforcement of the recourse against the cover pool than at time of a cover pool top up. The credit loss component is 3.6% to the breakeven OC and reflects the 'AA+' stress scenario being tested. The IDR uplift assigned to the programme is zero notches. Under Korea's banking regulations, the option to resolve an authorised bank is possible as part of the Financial Services Commission's supervisory powers, but the current framework does not contemplate the power to bail-in creditors. Covered bonds are not explicitly exempt from bail-in. This means that if the bank were resolved, it would give rise to the risk of enforcement of the cover pool. Therefore, no IDR uplift is applicable to Korean programmes. The assigned PCU of six notches reflects the principal protection in the form of an extendible maturity of 12 months for principal payment on covered bonds. The programme also provides for a three-month reserve for interest payments and senior expenses funded on a rolling basis. Fitch also considers transfer and convertibility risk protection, which is provided by each swap on the outstanding bonds. The recovery uplift on the mortgage covered bonds is limited to one notch due to the programme's exposure to recoveries denominated in a different currency than the covered bonds. The cover assets are denominated in Korean won, while the outstanding covered bonds are denominated in US dollars. Currency risk is hedged for the term of the liabilities inclusive of the extension period, but we expect these hedges to terminate in the event of a covered bond default. Fitch also tested the effect of currency risk on the US dollar denominated outstanding liabilities versus the stressed remaining cover-asset-recovery value in Korean won in its recovery analysis. This is because the rating uplift exceeds the Korean country ceiling of 'AA+'. The agency has applied a stressed Korean won/US dollar exchange rate as per Fitch's Foreign-Currency Stress Assumptions for Residual Foreign-Exchange Exposures in Covered Bonds and Structured Finance. The agency derived a foreign-exchange loss value of 4.8%, which represents the additional assets to support at least 51% of recoveries on covered bonds assumed to be in default. Stressed recoveries of 51% are compatible with a recovery uplift of one-notch. VARIATION FROM CRITERIA Fitch has applied a variation from its Criteria for Country Risk in Global Structured Finance and Covered Bonds, which states that the rating of a foreign-currency issue cannot exceed the Country Ceiling of the country of the issuer or the cover assets, unless the transfer and convertibility (T&C) risk is mitigated. KB's covered bonds are protected via the swaps against T&C risk; however, this T&C risk will become unhedged after a default of the covered bonds as the swaps would be terminated. Fitch believes the covered bonds could be rated one notch above the Country Ceiling despite the lack of T&C protection in a recovery given default scenario because timely payment is not expected in such a scenario and T&C risk is not viewed as permanent. Without this variation to criteria, the rating on the covered bonds would be one-notch lower. As the recovery uplift is above the Country Ceiling, the agency has applied a variation to its Covered Bond Rating Criteria by incorporating an analysis of currency stress impact for the recovery uplift of one notch. This quantifies the loss on the recovery value of the cover assets based on a depreciation of the Korean won against the outstanding US dollar liabilities and the amount of assets to support a minimum of 51% of recoveries in a stress above the Country Ceiling. The 'AAA' breakeven AP takes into account the effect of the applied currency stresses. There was no ratings impact to the covered bonds as a result of this variation to criteria. Fitch has given credit in its cash flow analysis to asset cash flow seasoning of one year. This is because KB intends to maintain a certain level of fixed-rate loans without frequent asset replenishments of the cover pool. However, in a scenario where recourse switches to the cover pool, Fitch expects a lesser share of fixed-rate loans than when KB tops up the cover pool. The seasoning of the cash flows has resulted in an increased proportion of floating-rate assets to support the floating payments due under the swap during the extension period. This has resulted in an improved cash flow valuation of 7.7%, from 14.1% previously. There was no ratings impact to the covered bonds as a result of this variation to criteria. RATING SENSITIVITIES Kookmin Bank's covered bonds are vulnerable to downgrade if the relied upon asset percentage (AP), which is the highest AP of the last 12 months (50%), rises above the 'AAA' breakeven AP of 81.5%, or if the bank's Long-Term Issuer Default Rating (IDR) falls below 'BBB+', or if the Country Ceiling on Korea is lowered by one-notch to 'AA'. If the AP in the programme rises to the maximum 95.0% contractual AP stipulated in the programme documents, the rating on the covered bonds would fall to 'A+', one notch above the bank's Long-Term IDR. Fitch's 'AAA' breakeven AP for the covered bond rating will be affected, among other things, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore, it cannot be assumed that the 'AAA' breakeven AP, which maintains the covered bond rating, will remain stable over time. Contact: Primary Analyst Keum Hee Oh Director +82 2 3278 8373 Fitch Australia Pty Ltd, Korea Branch 9F, 97 Uisadang dae-ro Youngdeungpo-Gu Seoul, 150-737, Republic of South Korea Secondary Analyst Claire Heaton Senior Director +61 2 8256 0361 Committee Chairperson Helene Heberlein Managing Director +33 1 44 29 9140 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email:; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on The source of information used to assess these ratings was KB. The issuer has informed Fitch that not all relevant underlying information used in the analysis of the rated bonds is public. Applicable Criteria APAC Residential Mortgage Criteria (pub. 30 Aug 2016) here Counterparty Criteria for Structured Finance and Covered Bonds (pub. 01 Sep 2016) here Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum (pub. 18 Jul 2016) here Covered Bonds Rating Criteria (pub. 26 Oct 2016) here Criteria for Country Risk in Global Structured Finance and Covered Bonds (pub. 26 Sep 2016) here Criteria for Interest Rate Stresses in Structured Finance Transactions and Covered Bonds (pub. 26 Oct 2016) here Fitch's Cover Asset Refinancing Spread Level (RSL) Assumptions - Excel File (pub. 26 Oct 2016) here Fitch's Interest Rate Stress Assumptions for Structured Finance and Covered Bonds - Excel File (pub. 17 May 2016) here Global Bank Rating Criteria (pub. 25 Nov 2016) here Related Research South Korea Covered Bond Programmes - Rating Action Report here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1016628 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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