OREANDA-NEWS. Fitch Ratings has affirmed Bank of Scotland Plc's (BoS, A+/Stable/F1/a) Intelligent Finance GBP4.3bn 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+', a revised Discontinuity Cap (D-Cap) of 2 (high risk) and the 86.7% asset percentage (AP) that Fitch takes into account in its analysis, which provides more protection than the 87.0% 'AAA' breakeven AP, supporting 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 rating reflects that on the issuer.

Following a review of the D-Cap assessment, Fitch has revised the liquidity gap and systemic risk assessment for the programme to high from minimal, resulting in a tightening in the programme's D-Cap to 2 from 8. The lower D-Cap reflects the 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 sufficiently material to lower the D-Cap, despite the programme being pass-through, whereby principal payments are only due by the legal final maturity of the bonds.

The account bank (BoS) is internal and the remedial period is 30 business days, versus the 30 calendar days outlined in the agency's counterparty criteria. This longer replacement period could increase the risk of default in the event of the cover pool becoming the sole source of payment (see "Fitch: Covered Bond Counterparty Risk Flagged in D-Cap Review" dated 27 March 2015 at www.fitchratings.com).

In addition, the one-month interest reserve to be sized upon the loss of the issuer's Short-term rating of 'F1' is not in line with Fitch's criteria. Short-term liquidity shocks may arise from interest payments due shortly after the recourse to the cover pool has been enforced. For programmes where the tested rating on a PD basis is above the IDR, Fitch expects protection to cover at least three months interest payments on a rolling basis plus a buffer to cover senior expenses and potential interest rate movements.

The 87.0% 'AAA' breakeven AP, corresponding to a breakeven overcollateralisation (OC) of 14.9% is mainly driven by the credit loss component. Fitch also carried out cash flow analysis to test whether the OC that it relies upon can withstand the counterparty exposure at risk. The potential commingled amount has been incorporated into the breakeven OC for the rating.

The 'AAA' credit loss calculated for the cover pool has improved since the last annual review to 16.1% from 20.6%. However, it remains high compared with its peers, due to the high LTV and large proportion of interest-only loans in the pool and 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.

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) the 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 87.0%.

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.