OREANDA-NEWS. Fitch Ratings has affirmed Bank of Scotland plc's (BoS; A/Negative/F1) GBP 8.4bn mortgage 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 IDR uplift of 1, an unchanged Discontinuity Cap (D-Cap) of 4 (moderate risk) and an asset percentage (AP) of 78.0% that Fitch takes into account in its analysis, which provides more protection than the 86.0% 'AAA' breakeven AP. The Stable Outlook on the covered bond rating reflects the fact that it could sustain a potential one-notch downgrade of BoS's IDR to its Viability Rating (a-).

Fitch has increased the 'AAA' breakeven AP to 86.0% from 81.0%. This is driven by (i) the lower refinancing stress assumptions of 230bps (from 270bps previously) in a 'AAA' scenario, reflecting a sustained decrease in UK RMBS spreads in the recent past; and (ii) the updated UK residential mortgage loss assumptions, which result in a smaller credit loss.

The updated 'AAA' breakeven AP, corresponding to a breakeven over-collateralisation (OC) of 16.3% is materially influenced by the reduced asset disposal loss component of 12.2% (from 20.9% previously). This results from the higher stressed net present value of cover assets modelled to be refinanced in order to bridge maturity mismatches in an amortising scenario. Maturity mismatches between the cover assets (11.5 years weighted average remaining term) and the covered bonds (3.8 years) remain large. The credit loss component has also reduced to 10.9% (from 12.9% previously) due to Fitch's revised debt-to-income calculation incorporating a lower Libor stress. Finally, the cash flow valuation component leads to a lower 'AAA' breakeven OC by 9.9%. The effect is stronger than previously (6.2%) due to the increase in excess spread following the removal of tracker loans from the cover pool (previously 10%), which have a lower post-swap margin than fixed rate and standard variable rate mortgage loans.

Fitch compares the 'AAA' breakeven AP of 86.0% with the AP of 78.0% that is used in the asset coverage test in the programme's investor reports. The breakeven AP considers timely payments in a 'AA' scenario and recoveries given default of at least 91% in a 'AAA' scenario.

The account bank remedy period is currently 30 business days in the programme documentation and is not in line with Fitch's counterparty criteria, which states 30 calendar days. BoS has confirmed that this will be addressed, such as through an amendment of 30 business days to 30 calendar days before year end and therefore this does not result in any adjustment to the D-Cap of 4 (see 'Fitch: Covered Bond Counterparty Risk Flagged in D-Cap Review', dated 27 March 2015 at www.fitchratings.com). The overall D-Cap remains moderate risk. All the components have an unchanged risk assessment, of moderate for the liquidity gap and systemic risk, alternative management and privileged derivative component, and of very low for the asset segregation component.

The IDR uplift of 1 notch stems from the fact that UK regulated covered bonds are exempt from bail-in and that Fitch deems the issuer banking group is more likely to be resolved than liquidated.

RATING SENSITIVITIES
The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) the IDR is downgraded by three or more notches to 'BBB' or below; or (ii) the number of notches represented by the D-Cap and the IDR uplift is reduced to 1 or lower; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'AAA' breakeven level of 86%.

The Fitch breakeven AP for the covered bond rating will be affected, amongst 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 update report, which will shortly be available at www.fitchratings.com.