Rating agency DBRS has released its Covered Bond (CB) rating methodology, which it says sets new standards in transparency and predictability.

The CB market has seen a dramatic increase in issuance in recent years, and by the end of 2007 it is estimated that there will be over 2 trillion euros of outstanding CBs in Europe, with approximately 80 issuers and over 200 investors, it notes. Perceived as being a highly secure asset class, CBs have becoming increasingly popular in the current market environment, DBRS adds.

The DBRS methodology adopts an integrated approach that encompasses both qualitative and quantitative elements in order to determine CBs default probability. It differs from existing propositions by integrating three building blocks: the credit strength of the issuer; the credit quality of the cover pool; and, for the first time, the strength of the legal frameworks (ranked in four categories from Very Strong to Modest) in which CBs are issued.

Catherine Gerst, head of Covered Bonds and managing director SF EMEA, DBRS said, “By integrating three key building blocks we believe we have created an evolutionary methodology that will become a template for the CB market. The ongoing turbulence in the credit markets ensures continued demand for greater insight into the ratings process.”

Legal frameworks are ranked according to their ability to minimize the degree of linkage between an issuer’s credit risk and its CBs. For instance, the better ranked the legal framework, the smaller the link between the CB rating and the issuer’s credit quality. DBRS says it will closely monitor changes in legal frameworks and their impact on bonds. It plans to publish a full report detailing the ranking assessments for each legal framework in the first quarter of 2008.

The DBRS CB methodology also aims to provide greater transparency and predictability by publishing rating tables, demonstrating CB ratings on a case-by-case basis according to the issuer, its cover pool credit quality and its legal framework. DBRS says it believes that this approach enables both issuers and investors to better understand how risks are assessed and anticipate potential rating changes.

“The development of this methodology is a significant milestone in the CB ratings process. We believe that demand for an accurate and reliable assessment of risk will continue to rise and this new methodology will play a key role in contributing to greater levels of knowledge across the CB market,” adds Apea Koranteng, head of SF EMEA.

DBRS has already rated its first CB deal using the methodology, in a transaction for Royal Bank of Canada. A DBRS rating of AAA was assigned to this first RBC issue.