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July 11 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings, London, 11 July 2014: Fitch Ratings has affirmed Coventry Building Society’s (CBS, A/Stable/F1) GBP3.2bn mortgages covered bonds at ‘AAA’ with a Stable Outlook and increased the Issuer Default Rating (IDR) uplift for the programme to 1 from zero.
The covered bond rating is based on CBS’s Long-term IDR of ‘A’, an IDR uplift of 1, an unchanged Discontinuity Cap (D-Cap) of 4 (moderate risk) and the 87% asset percentage (AP) that Fitch takes into account in its analysis, which is equivalent to the ‘AAA’ breakeven AP at 87%. The Stable Outlook reflects that on CBS’s IDR.
The IDR uplift of 1 reflects an increase in CBS’s senior unsecured debt to total adjusted assets to over 5%, which is the threshold defined under Fitch’s criteria. This provides a buffer for covered bondholders should equity and junior instruments prove insufficient to absorb losses. Fitch views that the senior unsecured debt-to-total adjusted assets ratio will remain at over 5% in the medium term given CBS’s accessibility to wholesale funding and CBS’s recognition of the diversification benefit of wholesale funding. However, Fitch is also of the view that it may be easier to liquidate CBS over resolution by other methods due to its small size and that the UK is not deemed by Fitch as a covered bond-intensive jurisdiction. Therefore the IDR uplift is limited to only one notch.
The ‘AAA’ breakeven AP is largely driven by refinancing and reinvestment costs as a result of a material mismatch of the weighted average life between the cover pool and covered bonds, and by, to a lesser extent, ‘AAA’ expected credit loss.
The unchanged D-Cap of 4 is driven by liquidity gap & systemic risk and systemic alternative management, which Fitch assesses as moderate. The programme has a reserve fund, which covers up to three months of interest and senior fees, and all the five outstanding covered bonds have a 12-month extendable maturity. Fitch takes into account the contractual AP in the asset coverage test which supports a ‘AA’ rating on the covered bonds on a probability of default basis.
The contractual AP is also sufficient to achieve recoveries in excess of 91% should the covered bonds default, supporting a two-notch uplift to ‘AAA’.
The ‘AAA’ rating would be vulnerable to downgrade if any of the following occurs: (i) the IDR of CBS is downgraded by three or more notches to ‘BBB’ or below; or (ii) the combined notches represented by the IDR uplift and the D-Cap is reduced to three or less; or (iii) the AP that Fitch considers in its analysis increases above Fitch’s ‘AAA’ breakeven level of 87%.
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.
More details on the portfolio and Fitch’s analysis will be available in a full rating report, which will shortly be available at www.fitchratings.com.