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Fitch Affirms Four UK Covered Bonds Programmes at 'AAA'
October 6, 2017 / 5:05 PM / 2 months ago

Fitch Affirms Four UK Covered Bonds Programmes at 'AAA'

(The following statement was released by the rating agency) LONDON, October 06 (Fitch) Fitch Ratings has affirmed the rating of four UK mortgage covered bond programmes issued by Bank of Scotland plc's (BoS, A+/Stable/F1), Barclays Bank plc's (A/Stable/F1), Lloyds Bank plc's (A+/Stable/F1), and Santander UK plc's (A/Stable/F1) at 'AAA' with a Stable Outlook. KEY RATING DRIVERS Breakeven Asset Percentage for the Ratings The 'AAA' breakeven Asset Percentage (AP) has been revised to 87.5% for BoS's mortgage covered bonds, 84.0% for Barclays and 89.5% for Santander UK. The 'AAA' breakeven AP for Lloyds' mortgage covered bonds is unchanged at 92.5%. For all programmes, there is a cushion between the 'AAA' breakeven AP and the level of AP that Fitch relies upon. For Barclays, Lloyds and Santander UK, Fitch gives credit to the highest adjusted nominal AP of the past 12 months. For BoS, Fitch gives credit to the AP used in the asset coverage test (ACT), since this is a wind-down programme. The last issuance took place in 2010. Issuer Default Rating Uplift of Two Notches Unchanged The two-notch Issuer Default Rating (IDR) uplift remains unchanged for all programmes given that collateralised covered bonds in the UK are exempt from bail-in, the risk of under-collateralisation is deemed sufficiently low, and that a resolution, should it happen, is not likely to result in the direct enforcement of the recourse against the cover pool. The two-notch IDR uplift also reflects that the banks' Long-Term IDRs are either driven by their Viability Rating (VR) or are above their VR due to sufficient junior debt buffers. Payment Continuity Uplift of Six Notches Unchanged The programmes' Payment Continuity Uplift (PCU) remain unchanged at six notches and reflect the 12-month liquidity protection for principal payments in forms of maturity extension for the soft-bullet bonds or pre-maturity test for the hard-bullet bonds, as well as the protection for interest payments in the form of reserve funds that cover three months' interest payments and certain senior expenses. Recovery Uplift of One Notch Unchanged The Recovery Uplift (RU) for each of the four programmes is capped at one notch due to the presence of significant pre-swap foreign-exchange mismatches between cover assets and liabilities, which expose the programmes to foreign-exchange risk from recoveries given default of the covered bonds. In each programme, the cover assets are all sterling-denominated while a significant portion of the bonds outstanding is denominated in other currencies, mainly the euro. Although swaps are in place on the bonds until maturity (including the extension period for the soft-bullet bonds), Fitch expects them to terminate upon a covered bonds' event of default. BoS's Mortgage Covered Bonds The 'AAA' rating of the covered bonds is based on BoS's Long-Term IDR of 'A+', an unchanged IDR uplift of two notches, an unchanged PCU of six notches and the 87.0% AP that Fitch gives credit to, which gives more protection than the 87.5% 'AAA' breakeven AP. The latter supports a 'AA+' tested rating on a probability of default (PD) basis and a one-notch RU to 'AAA'. The Stable Outlook on the covered bonds' rating reflects the five-notch buffer against an issuer downgrade. The 'AAA' breakeven AP at 87.5%, corresponding to a breakeven overcollateralisation (OC) of 14.3%, has increased from 87.0% previously. This is primarily driven by the asset disposal loss component of 18.6%, which has decreased by 1.8 percentage points. This is due to the redemption of two bonds in February and June 2017, which lowered the impact of the sale constraint in place in the programme. The credit loss component is unchanged at 4.8%, based on the 'AA+' tested rating on the PD basis. The cash flow valuation component is higher (+0.9%) at -9.4%, reflecting the lower excess spread, consequence of the change in maturity mismatches between assets and liabilities. Barclays' Mortgage Covered Bonds The 'AAA' rating of the covered bonds is based on Barclays' Long-Term IDR of 'A', an unchanged IDR uplift of two notches, an unchanged PCU of six notches and the 58.4% AP that Fitch relies upon, which provides more protection than the 'AAA' breakeven AP of 84%. The latter supports a 'AA+' tested rating on a PD basis and a one-notch RU to 'AAA'. The Stable Outlook on the covered bonds' rating reflects the four-notch buffer against an issuer downgrade. On 28 September, Fitch assigned an expected rating to the new ring-fenced entity called Barclays Bank UK plc of 'A+ (EXP)'/'F1(EXP)', with Stable Outlook. The covered bonds will be transferred to this new entity in 2018, at which point the reference IDR will be the new entity's IDR. The 84.0% 'AAA' breakeven AP, corresponding to a breakeven OC of 19.0%, has increased from 82.5% previously. This is primarily driven by the asset disposal loss of 16.0% which has decreased by 1.9 percentage points. This reflects the redemption of three bonds in February, May and September 2017, which lowered the impact of the sale constraint in place in the programme. The 'AA+' credit losses are unchanged at 3.5%. The cash flow valuation component (-0.3%) has a minimal impact on the 'AAA' breakeven AP. The 'AAA' breakeven AP is lower than the average for the UK regulated covered bond programmes. It is primarily driven by the low swap margin on the cover pool, which leads to a less beneficial cash flow valuation component than its peers. It is also driven by the programme constraint that limits the amount of mortgages selected for sale to the pro-rata proportion of each bond, weighted by a negative carry factor component that increases with the margin and weighted average life of the bonds. In addition, the negative carry component is not sized for in the ACT as long as the total return swap remains in place and the issuer's rating does not breach another rating agency's rating trigger, as is currently the case. Lloyds' Mortgage Covered Bonds The 'AAA' rating of the covered bonds is based on Lloyds' Long-Term IDR of 'A+', an unchanged IDR uplift of two notches, an unchanged PCU of six notches and the 84.1% AP that Fitch relies upon, which provides more protection than the 92.5% 'AAA' breakeven AP. The latter supports a 'AA+' tested rating on a PD basis and a one-notch RU to 'AAA'. The Stable Outlook on the covered bonds' rating reflects the five-notch buffer against an issuer downgrade. The 'AAA' breakeven AP is unchanged at 92.5%, corresponding to a breakeven OC of 8.1%. The asset disposal loss component of 5.9% remains the main driver of the breakeven OC due to the maturity mismatches between the cover pool and the covered bonds (9.7 years versus 5.2 years). This creates the need for a stressed asset sale to meet timely payments on the bonds should the recourse against the cover pool be enforced. The credit loss component is 4.1% based on the 'AA+' tested rating on the PD basis. The cash flow valuation component is -1.6%, reflecting the excess spread and longer weighted average life of assets than that of liabilities. Santander UK's Mortgage Covered Bonds The 'AAA' rating of the covered bonds is based on Santander UK's Long-Term IDR of 'A', an unchanged IDR uplift of two notches, an unchanged PCU of six notches and the 79.6% AP that Fitch relies upon, which provides more protection than the 89.5% 'AAA' breakeven AP. The latter supports a 'AA+' tested rating on a PD basis and a one-notch RU to 'AAA'. The Stable Outlook on the covered bonds' rating reflects the four-notch buffer against an issuer downgrade. The 89.5% 'AAA' breakeven AP, corresponding to a breakeven OC of 11.7%, has increased from 89.0% previously. The asset disposal loss of 12.9% in a 'AA+' tested rating scenario has decreased by 0.7% due to the redemption of two bonds this year. However, it remains the main driver of the breakeven OC and is primarily driven by the programme constraint that limits the amount of mortgages selected for sale. The amount is limited to the pro-rata proportion of each bond, weighted by a negative carry factor component. The sale constraint is somewhat mitigated by a supplemental liquidity reserve in the form of mortgages. The negative carry component is not sized for in the ACT as long as the cover pool swap hedges the cash and substitution assets, which is currently the case. The credit loss component is 4.3% is based on the 'AA+' tested rating on the PD basis. The cash flow valuation component, which reduces the breakeven OC by 5.6%, reflects the excess spread and longer weighted average life of assets than liabilities (7.0 years versus 4.0 years). RATING SENSITIVITIES BoS's Mortgage Covered Bonds The 'AAA' rating of BoS's mortgage covered bonds is vulnerable to a downgrade if any of the following occurs: (i) the bank's Long-Term IDR is downgraded by six notches to 'BB+' or below; or (ii) the number of notches represented by the IDR uplift, the PCU and the RU is reduced to three or lower; or (iii) the relied-upon AP rises above Fitch's 'AAA' breakeven AP of 87.5%. Barclays' Mortgage Covered Bonds The 'AAA' rating of Barclays's mortgage covered bonds is vulnerable to a downgrade if any of the following occurs: (i) the bank's Long-Term IDR is downgraded by five notches to 'BB+' or below; or (ii) the number of notches represented by the IDR uplift, the PCU and the RU is reduced to four or lower; or (iii) the relied upon AP rises above Fitch's 'AAA' breakeven AP of 84%. If the relied-upon AP rises to the 82.5% AP used in the ACT, the 'AAA' rating will be unchanged. Lloyds' Mortgage Covered Bonds The 'AAA' rating of Lloyds' mortgage covered bonds is vulnerable to a downgrade if any of the following occurs: (i) the bank's Long-Term IDR is downgraded by six notches to 'BB+' or below; or (ii) the number of notches represented by the IDR uplift, the PCU and the RU is reduced to three or lower; or (iii) the relied-upon AP rises above Fitch's 'AAA' breakeven AP of 92.5%. If the relied-upon AP rises to the 92.0% AP used in the ACT, the 'AAA' rating will be unchanged. Santander UK's Mortgage Covered Bonds The 'AAA' rating of Santander UK's mortgage covered bonds is vulnerable to a downgrade if any of the following occurs: (i) the bank's Long-Term IDR is downgraded by five notches to 'BB+' or below; or (ii) the number of notches represented by the IDR uplift, the PCU and the RU is reduced to four or lower; or (iii) the relied upon AP rises above Fitch's 'AAA' breakeven AP of 89.5%. If the relied-upon AP rises to the 89.0% AP used in the ACT, the 'AAA' rating will be unchanged. Contact: Primary Analysts Anne-France Chane (BoS, Barclays) Analyst +44 20 3530 1491 Fitch Ratings Limited 30 North Colonnade London E14 5GN Justina Niu (Lloyds) Associate Director +44 20 3530 1589 Fitch Ratings Limited 30 North Colonnade London E14 5GN Barbara M. Burdzy (Santander UK) Director +44 20 3530 1820 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analysts Justina Niu (Barclays, BoS, Santander UK) Associate Director +44 20 3530 1589 Barbara M. Burdzy (Lloyds) Director +44 20 3530 1820 Committee Chairperson Cosme de Montpellier Senior Director +44 20 3530 1407 Media Relations: Athos Larkou, London, Tel: +44 203 530 1549, Email: athos.larkou@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Covered Bonds Rating Criteria (pub. 26 Oct 2016) here Criteria for Rating Currency Swap Obligations of an SPV in Structured Finance Transactions and Covered Bonds (pub. 11 Aug 2016) here EMEA RMBS Rating Criteria (pub. 15 Sep 2017) here Fitch's Cover Assets Refinancing Spread Level (RSL) Assumptions - Excel file (pub. 20 Jan 2017) here Fitch's Interest Rate Stress Assumptions for Structured Finance and Covered Bonds - Excel File (pub. 17 Feb 2017) here Global Bank Rating Criteria (pub. 25 Nov 2016) here Structured Finance and Covered Bonds Counterparty Rating Criteria (pub. 23 May 2017) here Structured Finance and Covered Bonds Counterparty Rating Criteria: Derivative Addendum (pub. 23 May 2017) here Structured Finance and Covered Bonds Country Risk Rating Criteria (pub. 18 Sep 2017) here Structured Finance and Covered Bonds Interest Rate Stresses Rating Criteria (pub. 17 Feb 2017) here UK Residential Mortgage Rating Criteria Addendum - Residential Mortgage Assumptions (pub. 02 Jun 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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