OREANDA-NEWS. November 10, 2015. Fitch Ratings has affirmed Leeds Building Society's (Leeds, A-/Stable/F1) GBP819.3m mortgage covered bonds at 'AAA' with a Stable Outlook.

KEY RATING DRIVERS
The covered bond's rating is based on Leeds's Long-Term Issuer Default Rating (IDR) of 'A-', an unchanged IDR uplift of 0, an unchanged Discontinuity Cap (D-Cap) of 4 notches (moderate risk) and the 83.0% asset percentage (AP) that Fitch takes into account in its analysis, which provides more protection than the 87.0% 'AAA' breakeven AP. The latter supports a 'AA' tested rating on probability of default basis and a two-notch recovery uplift to a 'AAA' rating. The Stable Outlook for the covered bonds rating reflects that of the issuer.

Fitch has revised the 'AAA' breakeven AP to 87.0% (from 86.0%), corresponding to a breakeven overcollateralisation (OC) of 14.9%, to reflect an improvement in the credit loss component. The 'AAA' credit loss has been reduced to 8.7% from 10.0% due to a lower proportion of interest only (including partial repayment) mortgages in the pool to 23.3% as of end August 2015 from 34.0% as of end September 2014, as well as a decrease of buy-to-let mortgages in the pool to 9.8% from 12.4%. The increase in the UK house prices also contributes to a better recovery rate.

The asset disposal loss component of 18.2% remains the main driver of the 'AAA' breakeven OC due to the maturity mismatches between the cover pool and the covered bonds (12.1 years versus 3.6 years), which creates large refinancing needs in the event of an issuer default. Those are assumed to be bridged by a stressed sale of assets in Fitch's cash flow model. The cash flow valuation component leads to a lower 'AAA' breakeven OC by 9.0% which reflects the excess spread in the programme.

The IDR uplift is unchanged at zero. Although the level of outstanding senior unsecured debt to total adjusted assets (excluding insurance assets and derivatives) is above 5% as of 1H15, this ratio may not be found to be sustainable going forward based on an analysis of the past trends and future funding and lending plans of the issuer. A one-notch IDR uplift can be granted if that ratio is higher than 5% on sustainable basis, disregarding the senior unsecured debt maturing over the next 12 months.

The D-Cap is unchanged at four notches. The weakest link remains the liquidity gap and systemic risk and systemic alternative management. Fitch notes that Leeds's covered bond programme has an account bank remedial period of 30 business days versus the 30 calendar days outlined in the agency's counterparty criteria. However, Fitch has not adjusted the D-Cap assessment because the issuer is now in the process of the annual programme update and is amending its documentation to mitigate counterparty risk to be in line with Fitch's criteria.

In its analysis, Fitch relies on an AP of 83.0%, which is used in the asset coverage test and disclosed in the programme's investor reports.

RATING SENSITIVITIES
The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) Leeds's IDR is downgraded by one 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 three or lower; or (iii) the AP that Fitch takes into account in its analysis increased above Fitch's 'AAA' breakeven AP of 87.0%.

On 22 September 2015, Fitch published an exposure draft for UK residential mortgage assumptions. The proposed criteria, if adopted, will lead to smaller loss expectations for all types of mortgage portfolios. As a result, Fitch expects all outstanding UK RMBS and CVB ratings to either be affirmed or upgraded. If the current criteria are updated after considering market feedback, Fitch will review the existing ratings accordingly (see "Exposure Draft Criteria Addendum: UK" at www.fitchratings.com)

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.

More details on the cover pool and Fitch's analysis will be available in a report, which will shortly be available at www.fitchratings.com.