Fitch Affirms Bank of Scotland's Covered Bonds at 'AAA'; Outlook Stable
KEY RATING DRIVERS
The covered bonds' rating is based on Bank of Scotland's Long-Term Issuer Default Rating (IDR) of 'A+', an unchanged IDR uplift of one notch, an unchanged Discontinuity Cap (D-Cap) of four notches (moderate risk) and the 86.0% asset percentage (AP) that Fitch takes into account in its analysis. This AP provides more protection than the 88% 'AAA' breakeven AP, which supports a 'AA' tested rating on a probability of default (PD) basis and a 'AAA' rating after factoring in a two-notch recovery uplift. The Outlook on the covered bonds is Stable.
The 88% 'AAA' breakeven AP corresponds to a breakeven overcollateralisation (OC) of 13.6%, which is higher than the 86% 'AAA' breakeven AP published in August 2015. The asset disposal loss component of 19.3% remains the main driver due to the maturity mismatches between the cover pool and the covered bonds (11.3 years versus 3.2 years), which creates the need for a stressed asset sale to meet timely payments of the bonds should the recourse against the cover pool be enforced. This is followed by the 'AAA' credit loss component of 6.3% which has improved from its August 2015 level of 8.4%, due to the reduced 'AAA' weighted average foreclosure frequency at 14.8% versus 19.0% as of August 2015. The decrease is due to the more favourable foreclosure frequency assumptions published in Fitch's most recent Criteria Addendum for UK mortgages. The cash flow valuation component (-9.9%) has a positive impact on the 'AAA' breakeven OC due to excess spread.
The D-Cap is unchanged at four notches. The weakest link remains the liquidity gap and systemic risk, systemic alternative management, and privileged derivatives components. The programme is winding down as the issuer does not plan to issue any covered bonds in the future and no covered bonds have been issued for more than two years. However, the agency has not adjusted downwards the alternative management component of the D-Cap as it believes the issuer will not manage the programme in a way that would adversely impact the covered bondholders.
Fitch maintains an IDR uplift of one to the programme because the covered bonds in the UK are exempt from bail-in and the issuer is a global systemically important financial institution for which resolution by other means than liquidation is likely.
Fitch relies on the AP used in the asset coverage test, which is published in the investor reports.
The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) Bank of Scotland's IDR is downgraded by four 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 one or lower; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'AAA' breakeven level of 88%.
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 cover pool and Fitch's analysis will be available in a credit report, which will shortly be available at www.fitchratings.com.