OREANDA-NEWS. Fitch Ratings has affirmed The Royal Bank of Scotland PLC's (RBS, BBB+/Stable/F2) GBP4.2bn equivalent mortgage covered bonds at 'AAA'. The Outlook is Stable.

KEY RATING DRIVERS

The rating is based on RBS's Long-Term Issuer Default Rating (IDR) of 'BBB+', an unchanged IDR uplift of 1 notch and Discontinuity Cap of 4 notches and the 87.5% asset percentage (AP) that Fitch takes into account in its analysis, which provides more protection than the 90% 'AAA' breakeven AP. The latter supports a 'AA' tested rating on a probability of default basis and enables a recovery of 91% to support a two-notch recovery uplift to a 'AAA' rating. The Stable Outlook on the covered bonds' rating reflects that on RBS.

The 90.0% 'AAA' breakeven AP has increased from 87.5% since September 2015. The change is driven by a smaller 'AAA' credit loss following the application of the updated assumptions in the UK mortgage loss criteria addendum, as well as a higher negative carry factor (NCF) sized in the form of mortgages, which adds another layer of over-collateralisation. The higher NCF is a result of a higher weighted average (WA) covered bonds' swap margin following the maturity of lower-margin covered bonds in the past 12 months, and the longer WA life of the outstanding covered bonds when payment switches to the cover pool in Fitch's cashflow model.

The asset disposal loss component of 16.2% remains the main driver of the 'AAA' breakeven OC. This is followed by the 'AAA' credit loss of 4.1% (2015: 5.3%), which is better than the UK peer average due to the continued seasoning of the pool and a lower-than-average sustainable loan-to-value of the cover pool. Stressed cash flow valuation reduces the 'AAA' breakeven OC by 8.0%.

The IDR uplift is unchanged at 1 notch, reflecting RBS's systemic importance in the domestic market, so that resolution by other means than liquidation is deemed likely.

The D-Cap is unchanged at 4 notches and is driven by what Fitch assesses as moderate risk in four of five components: liquidity gap and systemic risk component, systemic and cover pool specific alternative management components and privileged derivatives component. The asset segregation component remains very low risk.

Fitch currently determines its refinancing assumptions for UK mortgages based on observed RMBS spreads. These are stressed to higher rating scenarios using multipliers that are dependent on the country's rating. Typically, lower-rated countries have higher observed spreads but lower multipliers to avoid excessively high stresses in high rating scenarios.

Since the UK was downgraded in June 2016, lower multipliers apply under the criteria. However, because RMBS spreads have not moved significantly the application of the criteria would have led to lower 'AAA' refinancing spread assumptions. Fitch views the current stresses as appropriate and decided to keep the multiplier applicable to 'AA+' rated countries. This constitutes a variation from the criteria 'Covered Bonds Rating Criteria - Mortgage Liquidity and Refinancing Stress Addendum'. It should be noted that Fitch is proposing a new methodology for its refinancing spread assumption that will result in slightly higher refinancing stress assumptions for the UK than the current ones. Should the criteria variation not be applied, the covered bonds rating is not expected to be affected.

RATING SENSITIVITIES

The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) RBS's IDR is downgraded by one or more notches to 'BBB' or below; or (ii) the number of notches represented by the IDR uplift and the D-Cap is reduced to 4 or lower; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'AAA' breakeven level of 90.0%.

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.