Brexit: Now Comes the Hard Part

According to James McCormack Global Head of Sovereigns at Fitch Ratings, nearly nine months after the UK voted in a referendum to leave the EU, the British government will soon provide notice to the European Council of its intention to withdraw under Article 50 of the EU Treaty, marking the beginning of exit negotiations. As contentious as the last year has been, first in debates on the merits of Brexit leading up to the referendum, and more recently amid criticisms of the government’s negotiating priorities and strategy, the period ahead promises to be even more combative.

Being the first country to leave the EU, the UK has no pre-established path to follow, and will forge ahead knowing only that Article 50 stipulates a two-year period to negotiate and ratify an agreement on the terms of exit, unless Member States unanimously agree an extension. There are five primary challenges facing the UK that are identifiable from the outset.

Timing is Tight, and the Exit Bill Looms

Most fundamentally, the UK will not be in full control of the negotiating agenda, and specifically the order in which issues will be addressed. Prime Minister May has said that a comprehensive free trade agreement with the EU is one of the government’s objectives, and that a smooth and orderly Brexit means having it in place by the end of the negotiating period. Most observers agree that two years is a short time to negotiate a free trade deal, but the actual time available to do so could prove even shorter, as some European leaders have suggested that the UK’s post-exit trade arrangements can only be negotiated once the most important terms of its exit have been agreed, which could take several months.

This may simply be an early negotiating tactic, but if less time is available, it becomes more likely a transition agreement would be needed to avoid what the prime minister has called “a disruptive cliff edge”. However, such an agreement would also take time to negotiate, and, once in place, it could reduce the urgency of reaching a final agreement, possibly drawing out negotiations well beyond two years.

The second major challenge faced by the UK will be settling the financial terms of its EU departure, or its “exit bill”, which EU leaders have indicated will be among the issues they seek to resolve up front. The main elements to be discussed will be future EU spending commitments agreed when the UK was a member state and EU officials’ pensions, and a figure of EUR60 billion has been bandied among European leaders. The amount will certainly be disputed by the UK, but it will have a strong incentive to agree to terms quickly and move on to more contentious and important issues, even though the concept of post-membership payments to the EU will be portrayed by some in the UK as an early and unnecessary concession.

Scotland and Other Internal Divisions

The three remaining challenges are domestic, and centre on Scotland, the lack of a unified national position on Brexit and the need to manage expectations.

The Scottish Parliament’s Culture, Tourism, Europe and External Relations Committee has published a report calling for “a bespoke solution that reflects Scotland’s majority vote to remain in the single market”. It would greatly complicate both the negotiations with the EU as well as border and logistics issues if such a bespoke arrangement were in place post Brexit. The lingering risk of a second independence referendum raises the stakes in how the UK government deals with any Scottish requests, and will require policymakers’ careful attention when government resources will already be stretched.

Beyond Scotland, it has been made clear in a variety of forums that the UK is not entering Brexit negotiations with unified views of the most desirable outcomes. In considering future UK trade arrangements, for example, Parliament’s International Trade Committee recently recommended joining the European Free Trade Area, and there are sure to be a raft of other proposals put forward on this issue alone from public and private sector groups. In the midst of negotiations, open debates within the UK can expose domestic political pressure points that could be strategically exploited by the European side. It may be of some comfort that the EU will be subject to similar internal disagreements, but the upshot of this is likely to be delays in formulating negotiating positions — an unfavourable outcome for the UK.

The final UK challenge as negotiations begin is managing expectations and uncertainties. Prime Minister May promised “no running commentary”, but there will be leaks, as with any negotiation. Progress will not be linear, in the sense that the UK and EU will appear alternatively to be closer to achieving their objectives, and financial markets may react accordingly. Domestic opponents of the UK government are likely to be quick to attribute any economic underperformance or market turbulence to shortcomings in the government’s approach to negotiations. The biggest associated risk is that the balance of public opinion shifts to a decidedly more negative view of Brexit, lending support to ideas already circulating on either a greater role for Parliament in approving the final negotiated agreement or another opportunity for the electorate to formally express its view.

EU Defends Use of Banks’ Internal Capital Models

The European Central Bank (ECB) review of internal models TRIM, is a project to assess whether the internal models currently used by banks comply with regulatory requirements, and whether they are reliable and comparable. Banks sometimes use internal models to determine their Pillar 1 own funds requirements, i.e. the minimum amount of capital they must hold by law. TRIM was launched in late 2015 and is expected to be finalised in 2019. This underscores the ECB’s desire to safeguard internal model use for retail and SME portfolios from the potential imposition of a capital floor.

ECB Banking Supervision is making a large investment in TRIM in terms of its own staff as well as the cost of external resources. With regards to staff, close to 100 ECB and national supervisors will be involved.

The targeted review of internal models, or TRIM, is a project to assess whether the internal models currently used by banks comply with regulatory requirements, and whether they are reliable and comparable. Banks sometimes use internal models to determine their Pillar 1 own funds requirements, i.e. the minimum amount of capital they must hold by law.

One major objective of TRIM is to reduce inconsistencies and unwarranted variability when banks use internal models to calculate their risk-weighted assets (RWAs). This may occur because the current regulatory framework gives banks a certain freedom when modelling their risks.

TRIM also seeks to harmonise practices in relation to specific topics. As a result, the review should help to ensure that internal models are being used appropriately.

Thus, the objectives for TRIM coincide with two major goals of ECB Banking Supervision: to foster a sound and resilient banking system through proactive and tough supervision and to create a level playing field by harmonising supervisory practices across the euro area.

This signals the EU’s determination to restore market confidence in banks’ use of internal models to calculate capital requirements, Fitch Ratings says. It may indicate a desire by the ECB to safeguard internal model use for retail and SME portfolios from the potential imposition of a capital floor.

For the eurozone, whose lawmakers and regulators mostly support the use of internal models and the risk-weighting framework for banks, TRIM is important to their argument that internal models make sense for certain portfolios. The ECB hopes to iron out unwarranted variability between models and restore credibility to the use of internal models, at least for “high-default” portfolios where there is sufficient default data for good-quality modelling.

The ECB’s large investment in TRIM suggests that internal models will continue to play an important role in how eurozone banks compute their regulatory capital requirements. TRIM’s focus on retail and SME credit risk may reveal where the ECB’s focus is for discussions on international bank regulation. The EU may be prepared to lose the use of internal models for “low-default” portfolios, such as financial institutions and large corporates, where it is more of a challenge to model statistically robust estimates for unexpected losses.

TRIM seeks to reduce inconsistencies and unwarranted variability when banks use internal models to calculate their risk-weighted assets (RWAs), by harmonising bank and national supervisory practices relating to models. The ECB has issued a 150-page guide allowing banks to assess themselves against common standards and prepare for the scrutiny to come. TRIM is the biggest single investment made by the ECB in supervision since it started in November 2014. The ECB will lead more than 100 reviews in 2017, involving more than 600 people, at 68 eurozone banks, covering approved internal models for credit, market and counterparty credit risks.

TRIM will take place in 2017 and 2018 with a possible extension into the following year. The ECB will ask banks to put right any shortcomings based on the final version of the guide. We expect the ECB to take a harsher stance with tighter timelines for shortcomings due to the banks’ own practices, while allowing more time to adjust for changes from national standards applied by supervisors in the past. Banks are likely to start work this year on aligning their models with the ECB’s standards. This may lead to movements in RWAs from model changes in 2017-2018, before TRIM is completed in 2019.

Disclosure of RWA movements due to model changes would provide helpful insight to analysts, creditors and investors. These market participants will need to be convinced of the TRIM process if the ECB is to remove their scepticism of RWA calculations based on internal models, in our view.

UK Faces Debt Challenge Despite Short-Term Growth Boost

Reducing public debt remains a long-term challenge for the UK despite the upbeat news on the near-term outlook for growth and borrowing in yesterday’s Budget, Fitch Ratings says. This challenge is reflected in the Negative Outlook on the UK’s ‘AA’ sovereign rating.

The Office for Budget Responsibility (OBR) has raised its growth forecast for this year to 2% from 1.4% in the Autumn Statement. But downward revisions for the following two years leave the level of both real and nominal GDP by 2019 broadly unchanged from November. The OBR expects real GDP growth to be around 2% beyond 2019.

We have also revised our near-term UK growth forecasts higher in our most recent Global Economic Outlook to reflect the resilience of the economy in 2H16 following the Brexit vote. But we still forecast lower growth than the OBR this year (1.5%) and next (1.3%), with the difference mainly due to our forecast for weaker investment, due to the uncertainties about UK trade relations after Brexit.

Discretionary fiscal measures in the budget were very small, reflecting the government’s intention to move its main fiscal policy event to the autumn. Higher spending on social care and schools over the next three years is offset by changes in dividend taxation and social contributions for the self-employed. The overall impact is deficit-increasing in FY17/18 and FY18/19, and deficit-reducing thereafter – but the changes are minimal (around 0.1% of GDP in FY17/18, for example).

Currently we assume that the government debt to GDP ratio will peak in 2018, but that would still leave the UK with one of the highest public debt ratios among highly rated (‘AAA’ and ‘AA’) sovereigns. The OBR’s latest projections underscore this view. The OBR estimates that in the current financial year government borrowing will be GBP16.4bn (0.8% of GDP) lower than previously expected, due to higher-than-expected tax receipts and some underspending by government departments. But it expects the positive impact of such one-off factors and timing effects to unwind over the next three financial years.

The government’s plans imply a consolidation of around 1.6% of GDP until the end of the current parliament. Official projections point to the public deficit in structural terms falling to 0.9% of GDP by FY20/21 – below the government’s target of under 2%. But they also indicate that additional tightening is likely to be needed to meet the government’s overall objective of balancing the budget as early as possible in the next parliament.

Furthermore, the OBR expects that general government gross debt as a share of GDP will remain broadly at its current level over the next two financial years, and only start declining in FY19/20. This underlines the scale of the challenge of putting the debt ratio on a downward path.

Leverage Ratio Hurdle Not a Cure-All for Bank Failures

A 10% leverage ratio hurdle for US banks to obtain significant regulatory relief, as proposed under the original Financial Choice Act (FCA), would not completely prevent bank failures, says Fitch Ratings.

Based on an analysis of bank failures from 2007 through 2011, 35% of those banks that failed would have qualified for regulatory relief at year-end 2006 under the FCA, according to FDIC data.

Fitch believes that the FCA, proposed by House Financial Service Committee Chairman Representative Jeb Hensarling, R-TX, in 2016, may serve as a blueprint for some of the regulatory changes ahead, although it remains unclear which policies will be the focus of Congress and the administration and eventually passed. The FCA is broad in scope and includes proposals that would potentially reduce financial regulators’ authority and limit regulatory burdens for certain financial institutions.

Specifically, banks that meet an average 10% simple leverage ratio over four quarters and certain other requirements may elect to become a qualifying banking organization. These banks would see requirements for stress testing (for those under $50 billion in assets), other liquidity and capital rules, concentration limits and restrictions on capital distributions and M&A activity lifted. Other requirements in the original FCA proposal include a lack of trading assets and liabilities, derivatives activity limited to foreign exchange and interest rates, notional derivatives contracts below $8 billion and a CAMELS rating (a supervisory rating system assessing capital adequacy, assets, management capability, earnings, liquidity and sensitivity to market risk) of 1 or 2 from the bank’s regulators, which is not public information.

Based on 418 FDIC bank failures during and after the financial crisis (2007-2011), 144 (35%), of failed banks met a 10% simple leverage ratio and other requirements at year-end 2006 that would have qualified them for regulatory relief under the FCA proposal. While none of these banks were systemically important, costs to the FDIC from these 144 failures exceeded $12 billion. This equates to a 3.6% failure rate for banks meeting the 10% simple leverage hurdle, compared to a 4.8% overall bank failure rate during the selected time frame.

While the data suggest some reduced risk of failure, Fitch believes that the use of such a simple leverage hurdle does not in and of itself completely prevent bank failures. Fitch assesses a wide range of quantitative and qualitative factors in developing its rating opinions, including company profile, asset quality, management, earnings, liquidity and risk appetite.

Regardless of the leverage ratio, most failed banks during that period exhibited high asset class concentrations restrictions on which would be lifted under the original FCA proposal. For example, of the 144 failed banks that would have qualified for regulatory relief at year-end 2006, the average commercial real estate (CRE) concentration was over 60% of loans, with an average concentration in construction lending at over 30% of loans at year-end 2006. This is particularly notable given recent regulatory guidance regarding CRE and construction concentrations, which would no longer be enforceable if the original FCA proposal is enacted for banks that qualify.

As of Sept. 30, 2016, nearly 58% of US banks meet a 10% simple leverage ratio and other requirements for trading and derivatives activity and could potentially qualify for significant regulatory relief, according to bank-level FDIC data. Without specific, finalized policy proposals, determining the aggregate ratings or credit impact of a major deregulatory initiative would be premature.

Rate Cuts Help Lower Australian Mortgage Arrears in 3Q16

Australia’s mortgage arrears decreased by 8bp to 1.06% in 3Q16, as borrowers benefitted from the May and August 2016 Reserve Bank of Australia rate cuts and continued low mortgage rates, says Fitch Ratings in the latest Dinkum RMBS Index report.

The lower arrears were primarily in the 30-59 days bucket, but when compared to 3Q15, arrears were actually up by 16bp, despite Australia’s strong economic environment of appreciating house prices and low interest rates. Fitch believes underemployment and the mining sector slowdown, which have led to lower house prices in the regional areas of Queensland, Western Australia and the Northern Territory, may have also affected borrowers.

Losses experienced by Australian RMBS transactions remained extremely low, with lenders’ mortgage insurance payments and/or excess spread sufficient to cover principal shortfalls during the quarter.

Fitch’s Dinkum RMBS Index tracks arrears and performance of mortgages underlying Australian residential mortgage-backed securities

Deregulation on Horizon for US Financial Institutions

Deregulation is likely to be a significant theme for US financial institutions (FIs), with the Trump administration and Republican leaders in Congress indicating broad support to limit and simplify the regulatory regime, says Fitch Ratings. Fitch does not believe that the Dodd-Frank Act will be repealed in full; however, select provisions are potentially subject to substantial revision.

Determining the aggregate ratings or credit impact of a major deregulation initiative without specific policy proposals would be premature. It remains unclear which, if any, deregulation policies will be the focus of the administration and ultimately be passed.

However, Fitch believes that the Financial Choice Act (FCA), proposed by House Financial Service Committee Chairman Representative Jeb Hensarling, R-TX, in 2016, may serve as a blueprint for some of the changes ahead. The FCA is broad in scope and includes proposals to change FI activities, modify and potentially reduce financial regulators’ authority, limit regulatory burdens for certain FIs, add greater congressional oversight of regulators and propose reform to market infrastructure.

In determining the potential impact of such regulatory changes, both the direct impact of the change and the responses from individual banks will be key in determining the ultimate issuer credit effect. The extent to which the reforms could lead to a reduction or changes to the quality of capital and/or liquidity, or weaken governance, will be particularly important for ratings over time.

Several parts of the FCA target regulatory relief for strongly capitalized and well-managed banks, such as a proposal to exempt banks from many regulations should they exceed a 10% or higher financial leverage ratio. Smaller banks meeting the requirements would most likely benefit. For large global systemically important banks, Fitch estimates that the $400 billion in incremental Tier I capital necessary to achieve the minimum leverage ratio – the calculation would likely be similar to the Basel III supplementary leverage ratio – would outweigh any potential cost benefits of regulatory relief.

Limiting regulatory authority is another key plank of the FCA. The most significant change for the markets would be the proposed restructuring of the Federal Reserve, including how it sets interest rates, as well as its authority as a central bank. The proposed rule also calls for restructuring the Consumer Financial Protection Bureau (CFPB), adding congressional review of financial agency rulemaking and subjecting agencies’ rulemaking to judicial review, among others.

Overall, Fitch believes that such reviews could hamper agencies’ effectiveness and significantly impede their ability to issue new rules, which could have an overall negative effect on the system. Fitch believes that restructuring the CFPB with a Consumer Financial Opportunity Commission, as stipulated in the FCA, would lower compliance costs and reduce potential fines for consumer finance, but lead to weakening control frameworks.

US Protectionism Tops TPP Demise as Threat to APAC Growth

The rising possibility that the US will shift towards trade protectionism – beyond the likely collapse of the Trans-Pacific Partnership (TPP) – has become a credible downside risk to the economic outlook for the Asia-Pacific (APAC) region, says Fitch Ratings.

There is a growing risk that APAC economies will be negatively affected by a US shift toward trade protectionism. President Donald Trump has threatened to label China a currency manipulator and to place large tariffs on Chinese imports, and has criticised the US-Korea FTA. Some Republicans are also pushing for tax reforms that would impose a levy on US imports from all countries. Fitch would expect China to respond with counter-measures including, but not necessarily limited to, tariffs on US imports. A ‘trade war’ would have adverse spillovers for APAC economies, particularly those that are closely connected to regional supply chains and that are most dependent on exports.

We believe this could potentially be more relevant to the APAC economic outlook than US withdrawal from TPP. The TPP, had it been implemented, would have set important foundations for economic integration in APAC, and delivered a significant long-term boost to some economies. That said, US Congressional approval of the TPP was unlikely even before President Trump’s formal withdrawal this week; TPP was not directly factored into Fitch’s baseline growth forecasts or ratings. We also did not view the agreement as a potential game-changer for members’ short-term economic prospects.

The TPP would have lowered tariffs among its 12 member countries. It also aimed to address other wide-ranging barriers to trade by setting rules governing intellectual property rights, business competition policies – including those related to state-owned enterprises and public procurement policies – and labour standards. The TPP therefore had the potential to help drive structural reforms that could have raised productivity and lifted foreign investment in a number of economies, particularly those with weaker business environments.

Various studies suggested that Vietnam would have been among the biggest beneficiaries of TPP. One study by the US-based Peterson Institute estimates that it would have delivered an 8% boost to Vietnam’s GDP by 2030 – relative to the baseline. Malaysia and Singapore were also expected to be significant beneficiaries – because of their export exposure to TPP members – while Japan was expected to benefit from the agreement serving as a catalyst for domestic structural reform, particularly in the agricultural sector, under the third arrow of Abenomics.

Member countries will miss out on potential benefits, but non-participants will be spared the potentially damaging effects that could have ensued from trade and investment being diverted to TPP participants. China, Indonesia, the Philippines and Thailand were notable non-participants in APAC, although some may have come under pressure to join later on (Indonesia had recently signalled an eagerness to join at TPP’s outset).

China is pushing its own Regional Comprehensive Economic Partnership (RCEP) as an alternative to the TPP. However, of the other participants – ASEAN, Japan, India and Korea – ASEAN and Korea already have free trade agreements (FTA) with China. Moreover, with its narrow focus on tariffs, the RCEP is unlikely to be the catalyst for structural reform that TPP could have been. Furthermore, it is unclear to what extent RCEP, without the participation of the US and its strong import demand, can replicate the same boost to regional economic growth prospects that was expected under TPP.

Chinese banks to issue more bad loan-backed securities in 2017: Fitch

From South China Morning Post

China may permit more commercial banks to sell bad loan-backed securities in 2017 to help lenders cope with surging sour loans and deepening economic slowdown, according to global ratings agency Fitch Ratings.

Under the government’s regulatory support, China’s nascent structured finance market has seen a strong growth in 2016, with the total issuance of asset-backed securities up 42 per cent year-on-year to 865 billion yuan (HK$975.9 billion), according to recent statistics from Fitch.

Asset-backed securities are bonds or notes backed by financial assets, including loans, leases, company receivables etc. China’s asset-backed securities market was restarted in 2012 after three years of suspension. After a flattish start in 2012 and 2013, it gained strong momentum in 2014 and has expanded at a rapid pace since then.

In 2016, six Chinese commercial banks become pilot banks for issue of asset-backed securities products backed by non-performing loans, with a total quota of 50 billion yuan. These banks include the Industrial and Commercial Bank of China, China Construction Bank, Bank of China, Agricultural Bank of China, Bank of Communications, and China Merchants Bank.

The six pilot banks issued a combined 15.6 billion yuan of non-performing loans’ asset-backed securities products in 2016, according to recent data from China Government Securities Depository Trust & Clearing Company.

“We expect further issuances in 2017,” said Hilary Tan, director of Non-Japan Asia Structured Finance for Fitch Ratings.

Tan said the government is likely to expand approval to more commercial banks to help them deal with rising bad loans.

The bad debt ratio of Chinese banks has risen to 1.81 per cent by the end of 2016, the highest since the second quarter of 2009, according to recent data from the China Banking Regulatory Commission, the China’s banking regulator.

Statistics from Fitch also showed that 53 per cent of the asset-backed securities issuance in 2016 was under the asset-backed specific plan, regulated by the China Securities Regulatory Commission. These asset-backed specific plan products reached 459 billion yuan, representing a 134 per cent year-on-year increase.

About 45 per cent of the total issuance was under the credit asset securitization scheme, governed by the People’s Bank of China and China’s banking regulator. These issued credit asset securitization scheme products reached 391 billion yuan in 2016, slightly down 5 per cent year-on-year.

Fitch said the asset-backed specific plan attracted more corporate issuers due to the diversified underlying asset-classes it issued in the bond exchange market.

Fitch puts Australian banks on negative watch

From Business Insider.

Fitch Ratings has revised its outlook on Australia’s banking for 2017 to negative from stable.

In its 2017 outlook report, the agency says the change reflects an increase in macroeconomic risks and pressure on profit growth.

The change follows Moody’s which in August last year changed the outlook for the banking system in Australia to negative from stable.

Profits at Australia’s banks are under pressure. The combined cash profits of the big four banks didn’t make last year’s record $30 billion.

Fitch now says Australia’s household debt is high and rising relative to disposable incomes, making borrowers sensitive to changes in the labour market and interest rates.

“Profit growth is likely to continue to slow in 2017, reflecting low interest rates, slow asset growth, competition for assets and deposits, higher funding costs, and a rise in loan-impairment charges,” Fitch says.

Fitch expects improvements in cost management to be offset by increased investment in technology.

The agency says the ongoing rise in household debt and house-price growth heightens the banking system’s sensitivities to a sharp correction if labour market conditions and interest rates changed.

“In addition, a worse-than-expected slowdown in China’s growth would negatively impact Australia’s economy given the countries’ strong economic ties,” the agency says.

“These scenarios — although not our base case — could jeopardise the banks’ strong asset quality and profitability, and weaken capitalisation.

“A prolonged global funding market disruption could place significant pressure on the banks’ balance sheets despite the improvements in liquidity.”

Standard and Poor’s in July last last year placed Australia’s sovereign rating on credit watch negative from its previously stable outlook.

EU Covered Bond Liquidity Buffer Could Be Rating Positive

Fitch Ratings says the introduction of liquidity buffers as recommended by the European Banking Authority (EBA) could in some cases increase the difference between the Issuer Default Rating (IDR) and covered bond rating determined by Fitch.

The potential for rating upgrades would apply to legislative covered bonds secured by standard assets such as mortgages and public sector exposures issued in jurisdictions with no mandatory liquidity protection such as Austria, Slovakia and Spain.

The proposed liquidity buffer forms part of step one of the EBA’s three-step recommendations on harmonisation of covered bonds frameworks in the European Union, published in December. Step one aims to provide a definition of covered bonds for regulatory recognition.

While many covered bonds include liquidity protection, requiring it as a basic feature would mark a departure from the historical concept of this type of secured bank debt. Without liquidity buffers, investor protection primarily rests on the prospect of higher recoveries from the segregated cover pool if an issuer defaults. Adding liquidity protection may also lower the probability of default on a covered bond relative to that of the issuing institution. This would depend on the length of the protection, and whether alternative refinancing can be found during this time at a cost which can be met through over-collateralisation.

The EBA proposes a buffer of liquid assets covering net outflows between cover assets and covered bonds at least over the next 180 days following an issuer default. It does not distinguish between interest and principal payments. The same timeframe would apply irrespective of the cover asset type. The proposed minimum protection of 180 days is less than the market standard for mortgage programmes, which is a 12-month extension. Fitch does not expect legislation or programmes with longer liquidity protection mechanisms to revert to the proposed minimum, and as a result we do not expect negative rating impact.

Unlike the EBA recommendation, Fitch differentiates between interest and principal payment interruption risk. For interest payments, Fitch expects at least three-month coverage on a rolling basis plus a buffer for senior expenses to assign rating uplifts for payment continuity of four or more notches. Fitch generally expects this protection to be provided on a gross basis, ie disregarding scheduled incoming cash flows. This is to mitigate disruption stemming from operational hurdles such as redirecting cash flows or setting up alternative management after an issuer default.

Regarding principal payments, the recommended six-month protection would be eligible for a maximum five notch payment continuity uplift if the cover pool consists of public sector exposure in developed banking markets, and a lower uplift of three or four notches if the cover pool consists of residential or commercial real estate mortgage loans in developed banking markets. A six-month protection is unlikely to lead to any payment continuity uplift for programmes secured by ship mortgages or aircraft financing, as Fitch views these asset classes as too illiquid, and a limited number of programmes offer an alternative refinancing option.

The EBA’s recommended definition of liquid assets is slightly wider than Fitch’s, in particular regarding LCR Level2A assets. In our programme analysis, we take the respective definition of liquid assets into account and may reduce payment continuity uplift if the discrepancy to our criteria is material. However, we expect this to be the case for a limited number of programmes, as we generally see liquid assets defined as cash in combination with an account bank replacement provision.