(The following statement was released by the rating agency)
Oct 11 - Fitch Ratings has affirmed Royal Bank of Scotland plc's (RBS, 'A'/Stable/'F1') GBP10.0bn equivalent mortgage covered bonds at 'AAA' with a Stable Outlook following a review of the programme.
The rating is based on RBS's Long-term Issuer Default Rating (IDR) of 'A', the Discontinuity Cap (D-Cap) of 4 (moderate risk) and the asset percentage (AP) of 65.2% that Fitch takes into account in its analysis.
The 'AAA' rating would be vulnerable to downgrade if any of the following occurred: (i) RBS's IDR was downgraded by two or more notches to 'BBB+' or lower; or (ii) the D-Cap fell by two or more categories to 2 (high risk) or lower; or (iii) the programme's AP went above 83.6%, which is the breakeven level in line with the 'AAA' rating. The Stable Outlook on RBS's IDR drives the Stable Outlook on the covered bonds.
The agency takes into account the highest AP of the last year in its analysis, reflecting the issuer's 'F1' Short-term IDR. The level of AP Fitch relies upon supports a 'AA+' rating on a probability of default (PD) basis and supports a 'AAA' rating considering recoveries given default.
The D-Cap of 4 is driven by the moderate risk assessment of four out of the five components: liquidity gap and systemic risk, cover pool-specific and the systemic alternative management and privileged derivatives, which are the joint weakest of the D-Cap components. The asset segregation has been assessed as low risk and systemic alternative management as moderate risk in line with other UK issuers (see "Fitch Puts YBS Covered Bonds on RWN; Assigns UK Programmes Outlooks & D-Caps" dated 13 September 2012 at ).
The 12-month extendible maturity on the covered bonds drives the liquidity gap and systemic risk assessment. Regarding cover pool-specific alternative management, Fitch views positively RBS's processes, data delivery and the internally developed IT systems, but notes that internally developed IT systems will likely lead to a more difficult transition to an alternative manager than market-based systems. Finally the risk assessment for privileged derivatives is due to RBS acting as counterparty for all swaps, which cover the cover pool and all eight outstanding bonds.
The Fitch breakeven 'AAA' AP level of 83.6% for the covered bond rating is higher than Fitch's previous supporting AP of 75.2%, which related to a covered bond rating of 'AAA' on a PD basis. Following the publication of its revised covered bonds rating criteria, the agency now communicates the breakeven AP to maintain the covered bonds rating rather than to maintain the current rating on a PD basis plus recovery uplift if needed. The breakeven AP also improved due to the application of Fitch's updated refinancing spread assumptions, which are lower than those applied previously, and applying lower default stresses following RBS providing cohort-based performance data.
The main contributors to the 'AAA' breakeven AP are the credit risk of the cover pool ('AAA' weighted-average frequency of foreclosure of 19.5% and weighted-average recovery rate of 58.6%) and the impact of the refinancing stresses considering the large asset and liability mismatches. The weighted-average maturity of the assets is 20 years and of the liabilities 4.7 years.
At end-August 2012, the cover pool consisted of GBP17.1bn of mortgage loans secured on residential properties in the UK (92.8% owner-occupied with the remainder rental properties). The seasoning is low at 23 months but coincides with a period of tighter underwriting by the issuer.
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 issuances. Therefore it cannot be assumed to remain stable over time.
(Caryn Trokie, New York Ratings Unit)