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Fitch Affirms Coventry Building Society's Covered Bonds at 'AAA'; Outlook Stable.

London: Fitch Ratings has affirmed Coventry Building Society's (Coventry; A/Stable/F1) GBP3,622 million equivalent mortgage covered bonds at 'AAA'; the Outlook is Stable.

KEY RATING DRIVERS

The covered bonds' rating is based on Coventry's Long-Term Issuer Default Rating (IDR) of 'A', an unchanged IDR uplift of two notches, an unchanged payment continuity uplift (PCU) of six notches and the 79.3% asset percentage (AP) that Fitch gives credit to, which provides more protection than the 87.5% 'AAA' breakeven AP. The latter supports a 'AA+' tested rating on a probability of default (PD) basis and a one-notch recovery uplift (RU) to 'AAA'. The Stable Outlook on the covered bonds' rating reflects a four-notch buffer against a downgrade due to the different uplift factors above Coventry's IDR.

The 'AAA' breakeven AP is unchanged at 87.5%, corresponding to a breakeven overcollateralisation (OC) of 14.3%. The asset disposal loss component of 14.5% in a 'AA+' tested rating scenario on a PD basis remains the main driver of the breakeven OC due to the maturity mismatches between the cover pool and the covered bonds (10.2 years versus 3.7 years). This creates the need for a stressed asset sale to meet timely payments on the bonds if recourse against the cover pool is enforced.

The credit loss component is 3.5% based on the 'AA+' tested rating on the PD basis. The cash flow valuation component is -3.8%, reflecting the excess spread and longer weighted average (WA) life of assets than that of liabilities.

Based on the loan-by-loan data at end-August 2017, the 'AAA' WA foreclosure frequency (FF) is 9.3% and the 'AAA' WA recovery rate (RR) is 57.1%. Coventry's cover pool is of strong quality. The 'AAA' expected loss is constrained by the 4% minimum level assumed in Fitch's criteria to account for idiosyncratic risks. The 'AAA' WARR is adjusted such that the adjusted 'AAA' expected loss is equal to the floor level. A corresponding adjustment is also applied to the WARR in lower rating levels in order to have a proportional effect on the loss rate.

The unchanged IDR uplift of two notches reflects that collateralised covered bonds in the UK are exempt from bail-in, the risk of under-collateralisation is deemed sufficiently low, and a resolution of Coventry, should it happen, is not likely to result in the direct enforcement of the recourse against the cover pool, and that Coventry's IDR of 'A' is driven by its Viability Rating of 'a'.

The PCU of six notches reflects the 12 months' liquidity protection in place allowed by the 12-month maturity extension applicable to the soft-bullet bonds. A reserve fund has also been established to cover three months' interest payments and some senior expenses. Amounts due under the interest-rate swap on cover assets rank senior to the payments under the covered bond swap, but are not sized in the reserve fund. However, it would become subordinated in case the issuer, acting as swap counterparty, defaulted.

The RU for the programme is capped at one notch due to the presence of significant pre-swap foreign-exchange (FX) mismatches between cover assets and liabilities. The FX covered bonds are fully hedged until maturity (including the extension period if applicable). However, upon a covered bonds' event of default, recoveries from assets denominated in British pounds, which have a longer WA life than the covered bonds, could expose holders of non-pound-denominated bonds to FX risk.

RATING SENSITIVITIES

The 'AAA' rating of Coventry's mortgage covered bonds is vulnerable to a downgrade if any of the following occurs: the bank's Long-Term IDR is downgraded by five notches to 'BB+' or below; the number of notches represented by the IDR uplift, the PCU and the recovery uplift is reduced to four or lower; or the relied-upon AP rises above Fitch's 'AAA' breakeven AP of 87.5%.

In this programme, Fitch gives credit to the highest level of AP of 79.3% calculated during the preceding 12 months, which is based on the nominal value while adjusted in accordance with the programme's asset coverage test, as the issuer's Short-Term IDR is not lower than 'F2' and the programme is not in wind-down or dormant. If the nominal AP in the programme rises to the 87.0% AP used in the asset coverage test disclosed in the programme's investor reports, the 'AAA' rating will be unchanged.

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. The breakeven AP to maintain the covered bond rating cannot therefore be assumed to remain stable over time.
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Publication:Daily the Pak Banker (Lahore, Pakistan)
Geographic Code:4EUUK
Date:Jan 26, 2018
Words:786
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