Correct: Fitch Upgrades Bank of Cyprus's Covered Bond Programme to 'B'; Outlook Stable
Fitch Ratings has upgraded Bank of Cyprus Public Company Ltd's (BoC, CCC/C, Viability Rating: ccc) mortgage covered bonds to 'B' from 'B-'. The rating action follows the restructuring to a conditional pass-through (CPT) from a soft bullet liability structure on 29 September 2015. The Outlook is Stable.
KEY RATING DRIVERS
The 'B' rating is based on BoC's Long-term Issuer Default Rating (IDR) of 'CCC', an unchanged IDR uplift of 1, a revised Discontinuity Cap (D-Cap) of 8 notches (Minimal Discontinuity) from 0 (Full Discontinuity) and the 47% committed overcollateralisation (OC). The Outlook on the covered bond rating remains Stable and reflects the slower pace of underlying asset quality deterioration, compared with 2013 trends, despite continued economic pressure.
The 47% OC that the issuer will publicly commit to in its investor report allows for at least 71% stressed recoveries on the covered bonds assumed to be in default in a 'B' rating scenario. However, it does not sustain timely payments above the 'CCC+' tested rating on a probability of default basis, which is also the floor for the covered bonds rating.
Fitch has revised the D-Cap to 8 from 0 notches to reflect Fitch's minimal discontinuity (from full discontinuity) risk assessment related to the liquidity gap and systemic risk component following the restructuring. Fitch recognises that the CPT structure removes refinancing needs via a forced sale of assets, should the recourse switch from the issuer to the cover pool. It also factors in the mandatory principal coverage and six-month interest provisions; in Fitch's view this further contributes to reducing liquidity risk in the aftermath of a cover pool enforcement event.
Fitch has also revised its assessment of the cover-pool specific alternative management to moderate from moderate high; in Fitch's view the pass-through nature of the structure combined with the pool composition are expected to contribute to a smoother transition to an alternative manager. In its D-Cap assessment Fitch also considered the strong oversight and commitment by the Central Bank of Cyprus in the supervision of covered bonds' issuers and its involvement in protecting covered bonds holders once the cover pool is enforced as a source of payments, as reflected in the low assessment of the systemic alternative management component.
The other D-Cap components, namely asset segregation (very low), and privileged derivatives (very low), remain unchanged.
In its cash flow analysis, Fitch has calculated a 'B' breakeven OC of 31%. The greatest contributor to the breakeven OC is the asset disposal loss of 58.9%. This component, driven by the refinancing spreads that Fitch applies to Cypriot residential assets (1500bps at 'B'), represents a stressed evaluation of the entire cover pool should the covered bonds default in a 'B' rating scenario.
The cover pool credit loss of 22.2% reflects Fitch's 'B' weighted average (WA) foreclosure frequency of 57.2% and the 'B' WA recovery rate of 68.3%. The cash flow valuation component of 3.0% is driven by limited open interest rate positions (87.6% floating-rate assets vs 100% floating-rate covered bonds) between assets and liabilities.
All else being equal, the 'B' covered bonds rating would be vulnerable to downgrade if any of the following occurs: (i) the Issuer Default Rating (IDR) of Bank of Cyprus Public Company Ltd is downgraded by one notch or more to 'CC' or below; or (ii) the number of notches of IDR uplift and Discontinuity Cap is reduced to zero; or (iii) the overcollateralisation (OC) that Fitch considers in its analysis decreases below the Fitch's 'B' breakeven level of 31%.
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.