OREANDA-NEWS. Fitch Ratings has upgraded Bank of Cyprus Public Company Ltd's (BoC, CCC/C, Viability Rating: ccc) EUR1bn outstanding residential mortgage covered bonds to 'B-' from 'CCC'. The Outlook is Stable.

The rating action follows the upgrade of BoC's Long-term (LT) Issuer Default Rating (IDR) to 'CCC' from 'CC' (see "Fitch Upgrades Bank of Cyprus to 'CCC' and Hellenic Bank to 'B-'/Stable" dated 28 April 2015 on www.fitchratings.com).

KEY RATING DRIVERS
The covered bonds' rating is based on BoC's 'CCC' LT IDR, an unchanged IDR uplift of 1, a Discontinuity Cap (D-Cap) of 0 (full discontinuity) and the programme asset percentage (AP) of 95.24%, which provides at least 51% recoveries on the bonds assumed to be in default in a 'B-' rating scenario and allows a one-notch uplift above the 'CCC+' tested rating on a probability of default basis.

Fitch has assigned a Stable Outlook to the 'B-' rating of the covered bonds to take into account the slowdown in the underlying loan quality deterioration even if pressures continue in 2015 as the economy contracts further; also, the recently passed debt insolvency framework and foreclosure laws should help arrears recovery via, for example, restructuring and/or asset repossessions within a shorter timeframe.

The agency's view on the use of resolution methods other than liquidation contributes to the IDR uplift of 1 for BoC's covered bond programme. This is based on BoC's large size in its domestic market and its interconnectedness with the Cypriot economy.

The 95.24% AP (equivalent to 5% over-collateralisation) which Fitch relies upon in its analysis is the maximum level allowed by the Cypriot covered bond law and equals to Fitch's calculated breakeven AP for the 'B-' rating.

Fitch's unchanged D-Cap of 0 (full discontinuity) is driven by the liquidity gaps and systemic risk component. In Fitch's view the programme extendible maturity of 12 months would not be sufficient to successfully refinance the cover assets when the source of payments for the covered bonds switches from the issuer to the cover pool.

RATING SENSITIVITIES
All else being equal, the covered bonds' 'B-' rating would be sensitive to movements of BoC's LT IDR. The covered bonds' rating would also be vulnerable to a sharper deterioration of the performance of the residential mortgage portfolio than currently foreseen.

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.