OREANDA-NEWS. Deposit set-off risk in UK covered bond programmes is adequately addressed by structural features even after the reduction in the UK's deposit protection limit, Fitch Ratings says.

Eligible deposits were previously protected by the Financial Services Compensation Scheme (FSCS) up to GBP85,000. The maximum compensation was reduced to GBP75,000 at the start of this year to reflect changes in the euro-sterling exchange rate. The FSCS limit is recalculated every five years to keep it equivalent to EUR100,000, the level at which European deposit guarantee schemes are harmonised under the relevant EU Directive.

Theoretically, lowering the deposit guarantee limit increases deposit set-off risk in covered bond programmes by increasing the amount that obligors who hold deposits with an originating bank or building society might seek to set-off against mortgage payments if the originator failed.

However, Fitch-rated UK covered bond programmes have structural features that mean deposit set-off risk is not affected. Some programmes feature asset coverage tests (ACT) that define potential deposit set-off risk as the full deposit, without taking into account the FSCS's deposit protection limit. Therefore set-off risk would not increase in these programmes even if no deposits were guaranteed.

Bank of Scotland PLC's Intelligent Finance programme, with a cover pool of 100% offset mortgages, achieves a similar effect by deducting the value of deposits from the mortgage loan balance in its ACT.
A second group of programmes incorporate an ACT that defines a fixed percentage of the current mortgage loan balance as subject to set-off risk. This percentage varies from 2.6% to 7%, which we believe covers potential set-off risk at the lower FSCS limit (deposit amounts exceeding the limit have historically amounted to a smaller proportion of mortgage cover pools).

In the case of Royal Bank of Scotland PLC's covered bond programme, the same effect is achieved by periodically updating the deposit set-off amounts that exceed the FSCS's protection limit in the ACT. The issuer is currently in the process of updating the set-off amounts based on the lower deposit limit.