OREANDA-NEWS. Fitch Ratings has affirmed Nationwide Building Society's (Nationwide, A/Positive/F1) GBP14.3bn equivalent mortgage covered bonds at 'AAA' with a Stable Outlook.

KEY RATING DRIVERS

The rating is based on Nationwide's Long-Term Issuer Default Rating (IDR) of 'A'/Positive, an unchanged IDR uplift of one notch, an unchanged Discontinuity Cap (D-Cap) of 4 notches (moderate risk) and the 90% asset percentage (AP) that Fitch takes into account in its analysis. This AP provides more protection than the 92.5% 'AAA' breakeven AP, which support a 'AA' tested rating on a probability of default (PD) basis and a 'AAA' rating after factoring in a two-notch recovery uplift. The Stable Outlook on the covered bonds' rating reflects a 2-notch rating cushion against a downgrade of the issuer.

The unchanged 92.5% 'AAA' breakeven AP, which corresponds to a breakeven overcollateralisation (OC) of 8%, is equivalent to the minimum regulatory OC for UK regulated programmes. It is driven by an asset disposal loss component of 5.2%, followed by a 'AAA' credit loss of 4.2% and a cash flow valuation component of 0.2% in a high prepayment scenario.

The programme's asset disposal loss component is smaller than its peers because the programme has a supplemental reserve in the form of mortgages (5%). The reserve mitigates the programme constraint that limits the amount of mortgages selected for sale for bond repayment following a switch of the recourse to the cover pool.

Based on the loan-by-loan data as of 31 July 2016, the 'AAA' weighed average (WA) foreclosure frequency (FF) is 10.1% and the 'AAA' WA recovery rate (RR) is 60.5%. Nationwide's cover pool is of sound quality while improvements of the 'AAA' WAFF and WARR are constrained by the 4% minimum 'AAA' expected loss in Fitch's criteria, to take into account idiosyncratic risks.

The IDR uplift is unchanged at 1 notch because Nationwide is recognised as other systemically important financial institution (OSII) in the UK by the European Banking Authority.

The D-Cap is unchanged at 4 notches. The weakest link remains the liquidity gap and systemic risk, systemic alternative management, and privileged derivatives components.

In its analysis, Fitch relies on an AP of 90.0%, which is the issuer's committed AP that is used in the asset coverage test.

RATING SENSITIVITIES

The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) Nationwide's IDR is downgraded by three 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 2 or lower; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'AAA' breakeven level of 92.5%.

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.

Fitch has made two variations from its criteria on the refinancing stress assumptions used and the account bank's analysis, none of which has had a rating impact.

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 stresses applied so far 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.

In addition, the rating analysis related to the collateralised GIC account constitutes variations from the Counterparty Criteria for Structured Finance and Covered Bonds due to the complex nature of the structure, which has not been fully described under the criteria. Under the structure, the collateralised GIC account can only hold non-time critical fund as long as the issuer maintains an investment-grade rating. Time-critical funds, including reserve funds for liquidity purposes, will at all times be held in an account bank with rating trigger and remedial action in line with Fitch's criteria. However, swap cash collateral may be held in the collateralised GIC when the issuer is rated below 'A'/'F1' provided these amounts are collateralised by eligible securities. It should be noted that Nationwide is currently an eligible GIC account provider and the collateralised GIC account will only become functional when Nationwide is downgraded below 'A'/'F1'. Should the criteria variation not be applied, the covered bonds' rating is not expected to be affected.