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Fitch Affirms Bank of Scotland's Covered Bonds at 'AAA'; Outlook Stable
April 4, 2014 / 3:11 PM / 3 years ago

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

(The following statement was released by the rating agency) LONDON, April 04 (Fitch) Fitch Ratings has affirmed Bank of Scotland plc's (BoS; A/Negative/F1) GBP10.9bn mortgage covered bonds at 'AAA' with a Stable Outlook following a review of the programme. KEY RATING DRIVERS The covered bonds' rating is based on BoS's Long-Term Issuer Default Rating (IDR) of 'A', IDR uplift of 1 and a Discontinuity Cap (D-Cap) of 4 (moderate risk), which allow for a maximum achievable rating for the covered bonds of 'AAA' on both a probability of default and instrument rating. The rating is also based on the asset percentage (AP) of 77% used in the asset coverage test, as communicated in the investor report, which provides a cushion compared with Fitch's breakeven AP of 81% for the 'AAA' rating. The Outlook on the covered bonds' rating is Stable, since the rating could sustain a one-notch downgrade of BoS's IDR to its Viability Rating. The IDR uplift of 1 is driven by the large size of BoS's ultimate parent, Lloyds Banking Group (A/Negative/F1) in the UK market (see 'Fitch Affirms UK Covered Bonds on Criteria Amendments' dated 03 April 2014 at for further details). The D-Cap of 4 is driven by the moderate risk assessment of four of the five components: liquidity gap and systemic risk, systemic alternative management, cover pool-specific alternative management and privileged derivatives, which are the joint weakest of the D-Cap components. The asset segregation has been assessed as very low risk. The asset segregation is driven by the strong asset segregation of the cover pool in a bankruptcy-remote special purpose entity. The liquidity gap and systemic risk component reflects the agency's view of mitigants against liquidity gaps in place in the form of a pre-maturity test and a three-month dynamic interest reserve. The systemic alternative management's assessment reflects Fitch's positive view of the active oversight taken by the FCA under the UK regulated covered bond framework. The cover pool-specific alternative management moderate assessment reflects Fitch's view on BoS's processes and its internally developed IT systems. The moderate risk assessment for the privileged derivatives is due to the internal asset swap in place on the cover pool, which is considered material to the programme. Fitch continues to classify the programme as dormant as there has been no public issuance from the programme for more than two years and no issuance is expected in the short to medium term. As a result, Fitch only gives credit to the AP of 77% publicly stated in the investor report. Fitch believes the issuer is unlikely to provide less support for this programme so no deduction has been applied to the cover pool specific alternative management component. The 'AAA' breakeven AP has increased to 81% from 78% last year. The increase was driven by (i) the improved calculated losses on the pool due to a smaller quick sale adjustment applied as BoS provided repossession data for this review compared with last year when a conservative assumption was applied; and (ii) the lower refinancing stress assumptions, reflecting a sustained decrease in UK RMBS spreads over the past 12 months. This results in a lower discounting of the cover assets when modelling a stressed sale of the assets in Fitch's cash-flows model. There are currently 12 hard bullet bonds outstanding. The bonds are issued in euro, sterling, US dollar and Danish krone with a total sterling equivalent volume of approximately GBP10.9bn compared with GBP16.1bn in August 2013. The weighted average (WA) term to maturity has increased to 4.1 years from 3.5 years as a result of BoS buying back some bonds. The cover assets yield both floating and fixed rates and an interest rate swap is in place with BoS to transform the interest collections from the cover assets into one-month GBP LIBOR plus a spread. At end-February 2014, the cover pool consisted of GBP19.8bn of residential mortgages. The pool consisted of 219,749 loans secured on residential properties in the UK with 45.6% on interest-only repayments and 59.4% standard variable rate loans. The mortgage portfolio had a WA current indexed loan-to-value ratio of 63% and seasoning of 90.9 months. The cover pool assets are reasonably diversified across the UK, with the highest concentrations mainly in London (16.2%), the south east (15.5%), Scotland (11.7%) and Yorkshire and Humberside (9.4%). There are no buy-to-let loans or offset mortgage loan products in the cover pool. In a 'AAA' scenario, Fitch has calculated the pool's cumulative WA frequency of foreclosure at 27.8% and a WA recovery rate of 58.9%. RATING SENSITIVITIES The rating would be vulnerable to downgrade if any of the following occurred: (i) BoS's IDR was downgraded by three notches to 'BBB' or lower; or (ii) the D-Cap fell by at least three categories to 1 (very high risk); or (iii) the AP that Fitch takes into account in its analysis increased above the 'AAA' breakeven AP of 81%. Given the dynamic nature of the programme, the composition and credit quality of the cover pool may change over time. 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 issuances. Therefore it cannot be assumed to remain stable over time. Contacts: Primary Analyst Stephen Kemmy Associate Director +44 20 3530 1474 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Iva Detelinova Analyst +44 20 3530 1663 Committee Chairperson Cosme de Montpellier Senior Director +44 20 3530 1407 Media Relations: Christian Giesen, Frankfurt am Main, Tel: +49 69 768076 232, Email: Additional information is available at Applicable criteria, Covered Bonds Rating Criteria, dated 10 March 2014; Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum and Counterparty Criteria for Structured Finance and Covered Bonds, both dated 13 May 2014; Criteria for Interest Rate Stresses in Structured Finance Transactions and Covered Bonds, dated 23 January 2014; EMEA RMBS Master Rating Criteria, dated 6 June 2013; EMEA Criteria Addendum - United Kingdom, dated 09 August 2012; Covered Bonds Rating Criteria - Mortgage Liquidity and Refinancing Stress Addendum, dated 4 February 2014, all available at Applicable Criteria and Related Research: Covered Bonds Rating Criteria here Counterparty Criteria for Structured Finance and Covered Bonds here Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum here Criteria for Interest Rate Stresses in Structured Finance Transactions here EMEA Criteria Addendum - United Kingdom - Mortgage and Cashflow Assumptions here Covered Bonds Rating Criteria - Mortgage Liquidity and Refinance Stress Addendum here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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