OREANDA-NEWS. Fitch Ratings is maintaining Clydesdale Bank plc's (Clydesdale, A/RWN/bbb+) GBP700m mortgage covered bond, rated at 'AAA', on Rating Watch Negative (RWN).

KEY RATING DRIVERS
The covered bond's rating is based on Clydesdale's Long-term Issuer Default Rating (IDR) of 'A', which is also on RWN, 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 RWN on the covered bond will be resolved upon the resolution of the RWN on the bank's IDR. Clydesdale's covered bond programme has a one-notch rating cushion against a potential downgrade of the bank's IDR. However, should Clydesdale's IDR be downgraded to the level of its Viability Rating (bbb+) the one-notch cushion will not be sufficient to maintain the covered bond' rating at 'AAA'.

Fitch has revised the 'AAA' breakeven AP to 87.0% from 83.0%, corresponding to a breakeven overcollateralisation (OC) of 14.9%. This is partially due to a change in the liability maturity profile following the redemption of GBP400m covered bond in 2015. Currently, only one bond remains outstanding with a maturity in 2026. The sizeable negative carry risk in a high prepayment scenario is mitigated by additional OC being provided via the negative carry component sized in the asset coverage test as disclosed in the programme's investor report. Fitch has taken this amount into account in its analysis. The breakeven OC would be revised downwards should the negative carry no longer be sized in the asset coverage test.

The main driver of the 'AAA' breakeven OC is an asset disposal loss component of 22.2%, which is based on a worst-case scenario that assumes an issuer event of default occurs just before the bond matures, which reflects the need of a stressed asset sale to meet the bond payment. This is followed by the cover pool's credit loss of 7.9% in a 'AAA' scenario. The cash flow valuation component leads to a lower 'AAA' breakeven OC by 12.6%, which reflects the excess spread in the programme.

The D-Cap of 4 notches reflects Fitch's unchanged moderate risk assessment for four out of five D-Cap components, including the liquidity gap and systemic risk component. The remaining component - asset segregation - has a very low risk assessment.

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) Clydesdale's IDR is downgraded by two 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 two or lower; or (iii) the AP that Fitch takes into account in its analysis increases 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.