OREANDA-NEWS. Fitch Ratings has affirmed Bank of Scotland Plc's (BoS, A+/Stable/F1/a) Intelligent Finance GBP 3.9bn covered bonds at 'AAA' with a Stable Outlook.

KEY RATING DRIVERS

The rating is based on BoS's Long-Term Issuer Default Rating (IDR) of 'A+', an unchanged Discontinuity Cap (D-Cap) of 2 (high risk) and the 86.7% asset percentage (AP) that Fitch takes into account in its analysis. This AP provides more protection than the 91.0% 'AAA' breakeven AP, which supports a 'AA' tested rating on a probability of default (PD) basis and a 'AAA' rating after giving credit for a two-notch recovery. The Stable Outlook on the covered bonds reflects that on the issuer.

The 91.0% 'AAA' breakeven AP, which corresponds to a breakeven overcollateralisation (OC) of 9.9%, is higher than the 87% 'AAA' breakeven AP published in July 2015, and is mainly driven by the credit loss.

The 'AAA' credit loss calculated for the cover pool has improved since the last annual review to 9.8% from 16.1%. The decrease is a result of more favourable foreclosure frequency assumptions in Fitch's most recent Criteria Addendum for UK mortgages, published in December 2015. However, it remains higher than its peers, due to higher sustainable loan-to-value ratios for the loans (76.5%) and the large proportion of interest-only loans in the pool (74.9%), as well as the conservative assumptions Fitch applied in the analysis where data was not provided.

In its analysis, Fitch relies on an AP of 86.7%, which is used in the asset coverage test disclosed in the programme's investor reports.

The D-Cap is unchanged at two notches. The weakest link remains the liquidity gap and systemic risk component, which reflects the high risk of payment interruption shortly after the recourse switches to the cover pool, as both the reserve fund and account bank replacement provisions in the programme are not fully in line with Fitch's criteria. Fitch considers these deviations increase the risk of payment interruption should the issuer default. This is reflected in the D-Cap of two notches, significantly lower than the maximum eight notches that applies to other pass-through programmes, whereby principal payments are only due by the legal final maturity of the bonds.

An IDR uplift is not applicable for this programme due to its non-regulated status. It is not compliant with the Undertakings for Collective Investments in Transferrable Securities (UCITS) Directive and hence not explicitly exempt from bail-in.

RATING SENSITIVITIES

The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) BoS's IDR is downgraded by one or more notches to 'A' or below; or (ii) the number of notches represented by 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 91.0%.

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.