OREANDA-NEWS. Fitch Ratings has upgraded Bank of Cyprus Public Company Ltd's (BoC, CCC/C, Viability Rating: ccc) EUR650m covered bonds to 'B+' from 'B' and removed them from Rating Watch Positive. The Outlook is Stable.

The rating action follows a downward revision in Fitch's rating spread level (RSL) assumptions for Cypriot cover pools of residential mortgage loans to 650bps from 1,500bps at 'B' (see "Fitch's Mortgage Covered Bond Refinancing Stresses - Excel File" dated 23 November 2015) after the recent sovereign upgrade (see "Fitch Upgrades Cyprus to 'B+'; Outlook Positive" dated 23 October 2015).

KEY RATING DRIVERS
The one-notch upgrade reflects the improved stressed valuation of the cover pool under Fitch updated RSL assumptions of 659bps in a 'B+' scenario. Assuming recourse would switch from the issuer to the cover pool, this would provide recoveries given default in excess of 91% in a 'B+' stress scenario, commensurate with a three-notch uplift above the covered bonds rating floor represented by the bank's IDR of 'CCC', plus one notch corresponding to the IDR uplift assigned to this programme. The previous cover pool valuation supported recoveries given default commensurate with a two-notch uplift above the same floor.

The rating of the covered bonds is constrained by the level of over-collateralisation (OC) that the issuer commits to, which stands at 47%. This level of protection does not support a timely payment on the covered bonds in rating scenarios above the rating floor. This is due to the high level of credit risk in the cover pool. Fitch assumes a stressed credit loss of 37% in a 'B+' rating scenario and 61% in a 'BB-' rating scenario.

Fitch has recalculated the breakeven OC at the relevant rating scenarios with the revised RSLs. The 'B+' breakeven OC is 37%, which compares with the previous 31% 'B' breakeven OC. The covered bonds issued by BoC have a conditional pass-through amortisation profile and, in its cash flow analysis, Fitch does not factor RSL assumptions to test OC for timely payments because there is no forced sale of the assets. However, when measuring recovery given default prospect, Fitch incorporates half of the RSL in the stressed interest rate used to derive the net present value of the cover pool in a given stress scenario.

The 'B+' rating is based on BoC's IDR of 'CCC', an unchanged IDR uplift of 1 reflecting covered bonds exemption from bail-in and the domestic importance of BoC, an unchanged Discontinuity Cap (D-Cap) of 8 notches (Minimal Discontinuity) reflecting the conditional pass-through profile of the covered bonds, and the 47% committed OC, which provides more protection than the 37% 'B+' breakeven OC.

RATING SENSITIVITIES
Factors that may lead to an upgrade of the covered bonds issued by Bank of Cyprus Public Company Ltd (BoC) include (i) an upgrade of BoC's Issuer Default Rating (IDR); (ii) a significant improvement in the credit quality of the cover pool or in the observed performance of the residential mortgage market in Cyprus, such as measured by the level of non-performing loans; and (iii) an increase in the level of protection for the covered bonds.
Conversely, negative rating actions would be triggered by (i) a downgrade of the IDR of BoC; (ii) a reduction in the total number of notches for the IDR uplift and the D-Cap to zero; and (iii) a decrease in the programme over-collateralisation (OC) below Fitch's 37% breakeven OC.

The Fitch breakeven OC 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 OC to maintain the covered bond rating cannot be assumed to remain stable over time.