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Fitch Affirms Bank of Scotland's Covered Bonds at 'AAA'; Outlook Stable
February 3, 2017 / 3:38 PM / 9 months ago

Fitch Affirms Bank of Scotland's Covered Bonds at 'AAA'; Outlook Stable

(The following statement was released by the rating agency) LONDON, February 03 (Fitch) Fitch Ratings has affirmed Bank of Scotland's (BOS, A+/Stable/F1) GBP7.2 billion equivalent mortgage covered bonds at 'AAA' with a Stable Outlook. KEY RATING DRIVERS The covered bonds' rating is based on BOS's Long-Term Issuer Default Rating (IDR) of 'A+', an unchanged IDR uplift of two notches, an unchanged Payment Continuity Uplift (PCU) of six notches and the 87.0% asset percentage (AP) that Fitch gives credit to, which is in line with the 87.0% 'AAA' breakeven AP. The latter supports a 'AA+' tested rating on a probability of default basis and a one-notch recovery uplift (RU) to 'AAA'. The Stable Outlook on the covered bonds' rating reflects that on the issuer and a five-notch buffer against a downgrade due to the different uplift factors above the bank's IDR. The updated IDR uplift, PCU and RU were firstly assigned to the programme on 30 November 2016 following the implementation of the agency's revised Covered Bonds Rating Criteria published on 26 October 2016. The programme's two-notch IDR uplift reflects that collateralised covered bonds in the UK are exempt from bail-in, the risk of under-collateralisation is deemed sufficiently low, and a resolution of BOS, should it happen, is not likely to result in the direct enforcement of the recourse against the cover pool. It also reflects that BOS's IDR of 'A+' is above the institution's Viability Rating of 'a' due to the junior debt buffer within the group that could be made available to protect senior obligations from default in case of failure. The PCU of six notches reflects the 12-month liquidity protection in place allowed by (i) the 12-month maturity extension applicable to the four soft bullet bonds and (ii) the 12-month pre-maturity test in place for the three remaining hard bullet bonds. A reserve fund has also been established to cover three months' interest payments and some senior expenses. Amounts due under the interest rate swap on cover assets rank senior to the payments under the covered bond swap but are not sized in the reserve fund. However, it would become subordinated in case the issuer, acting as swap counterparty, defaults. The RU for this programme is capped at one notch due to the presence of significant pre-swap FX mismatches between cover assets and liabilities. While the FX covered bonds are fully hedged till maturity (including the extension period), upon a covered bonds' event of default, recoveries from GBP-denominated assets, which have a longer weighted average life than the covered bonds, could expose holders of non GBP-denominated bonds to FX risk. The 'AAA' breakeven AP is unchanged at 87.0%, corresponding to a breakeven over-collateralisation (OC) of 14.9%. The asset disposal loss component of 20.4% in 'AA+' tested rating scenario remains the main driver of the breakeven OC due to the maturity mismatches between the cover pool and the covered bonds (12 years versus 3.1 years), which create the need for stressed asset sale to meet timely payments on the bonds should the recourse against the cover pool be enforced. The credit loss component is 4.8%, based on the 'AA+' tested rating on the PD basis. The cash flow valuation component is -10.3%, reflecting the excess spread and longer weighted average life of assets than that of liabilities. Based on the loan-by-loan data as of end-November 2016, the 'AAA' weighted average foreclosure frequency (FF) is 14.1% and the 'AAA' weighted average recovery rate (RR) is 61.3%. Both metrics have improved compared with the last analysis as the pool is more seasoned and is benefitting from increasing house prices in the UK. Fitch relies on the AP used in the asset coverage test, which is published in monthly investor reports, since this is a wind-down programme. The last issuance took place in 2010. RATING SENSITIVITIES The 'AAA' rating of BOS's mortgage covered bonds is vulnerable to a downgrade if any of the following occurs: (i) the bank's Long-Term IDR is downgraded by six notches to 'BB+' or below; or (ii) the number of notches represented by the IDR uplift, the PCU and the RU is reduced to three or lower; or (iii) the relied-upon AP rises above Fitch's 'AAA' breakeven AP of 87.0%. The Fitch breakeven AP for the covered bond rating will be affected, among others, 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 the breakeven AP to maintain the covered bond rating cannot be assumed to remain stable over time. Contact: Anne-France Chane Analyst +44 20 3530 1491 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Justina Niu Analyst +44 20 3530 1589 Committee Chairperson Cosme de Montpellier Senior Director +44 20 3530 1407 Media Relations: Athos Larkou, London, Tel: +44 203 530 1549, Email: athos.larkou@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria 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 Addendum: UK Residential Mortgage Assumptions (pub. 22 Jul 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 Criteria for Rating Currency Swap Obligations of an SPV in Structured Finance Transactions and Covered Bonds (pub. 11 Aug 2016) here EMEA RMBS Rating Criteria (pub. 29 Nov 2016) here Fitch's Cover Assets Refinancing Spread Level (RSL) Assumptions - Excel file (pub. 20 Jan 2017) here Fitch's Interest Rate Stress Assumptions for Structured Finance and Covered Bonds - Excel File (pub. 17 May 2016) here Fitch's Foreign-Currency Stress Assumptions for Residual Foreign-Exchange Exposures in Covered Bonds and Structured Finance - Excel File (pub. 26 Oct 2016) here Global Bank Rating Criteria (pub. 25 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1018557 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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