Yorkshire Building Society covered bonds were put on Rating Watch Negative as Fitch yesterday (Thursday) detailed the impact of its updated criteria on the UK sector, while three pass-through programmes were assigned the highest D-Caps, reflecting minimal discontinuity risk.

The two UK issuers are rated BBB+ and newly assigned Fitch Discontinuity Caps (D-Caps) of 4, or “moderate risk”, mean that the maximum covered bond rating achievable is AA+ – which also incorporates a two notch recovery uplift – rather than the prevailing AAA ratings of YBS and Co-op covered bonds. Co-op covered bonds were already on RWN because the issuer has been under negative review.

The rating agency said that it expects to receive feedback from YBS and Co-op within one month regarding any plans to change their programmes.

“If no changes are proposed, Fitch expects to downgrade the ratings,” it said. “If changes likely to impact the ratings are proposed, Fitch will review any implementation plans to determine how the RWN should be resolved.

“If changes are implemented that address the drivers of a potential downgrade, the agency will affirm the ratings.”

Bradford & Bingley and Northern Rock Asset Management covered bonds have been assigned negative outlooks because their ratings rely heavily upon the UK’s AAA rating, which is on negative outlook. They have not been assigned D-Caps because Fitch does not apply its standard methodology to their issuance.

Other UK covered bonds have been assigned stable outlooks because most of the issuers are on stable outlook or because a one notch downgrade of the issuer would not result in a downgrade of the covered bonds and nor would a one notch sovereign downgrade. Fitch added that that it expects their asset performance and AP maintenance to remain stable.

Three UK covered bond programmes were assigned the highest D-Cap of 8, reflecting “minimal discontinuity”.

“The BoS Intelligent Finance, Barclays Public Sector and Clydesdale No 1 programmes are pass-through and have a three month interest reserve and therefore, the highest risk of the components does not drive the D-Caps of 8,” said Fitch. “The agency believes that none of the components compromise the overall minimal discontinuity assessment for the programme.

“For the Barclays Public Sector and the Clydesdale No 1 programme, the PD rating has changed to AAA from AA, driven by a D-Cap of 8 and because the AP level Fitch considers in its analysis is also in line with this rating on a PD basis.”

Bank of Scotland and Barclays Bank Residential Mortgage programmes were assigned D-Caps of 3, “moderate high risk”, driven by an assessment at this level of the programmes’ liquidity gap and systemic risk component of the overall D-Cap assessment.

“This is driven by the pre-maturity test, the breach of which leads to an issuer event of default and a sale of cover assets by the LLP at least six months prior to a scheduled covered bond maturity for cover pool asset sales, while Fitch has assessed the stressed time to sell residential mortgage cover assets in the UK as nine months,” it said. “The rating for the programmes on a PD basis has changed to AA from AA+ driven by a D-Cap of 3 and because the AP level Fitch considers in its analysis is in line with this rating on a PD basis.”

The rating agency noted that BoS had successfully appealed Fitch’s initial D-Cap component assessment, resulting in a different outcome to that originally arrived at by its rating committee.

The remaining UK programmes were assigned D-Caps of 4.

The calculation of D-Caps incorporates assessments of five factors, and, in Fitch’s words, these are the rating agency’s summaries of these for the UK:

Fitch has assigned a very low risk or low risk assessment to the asset segregation component for most UK covered bonds, because the agency considers it very unlikely that any claims would reduce the cover pool available to investors post issuer default.

The liquidity gap and systemic risk component of the D-Cap is moderate for most non-pass-through UK programmes, due to the 12 month extension periods and pre-maturity tests in place, which are considered adequate protections for UK residential mortgages. As the UK sovereign IDR is ‘AAA’/Negative, the rating does not act as a constraining factor in this assessment.

The systemic alternative management risk assessment is moderate for all non-pass-through UK programmes. Fitch views the significant roles being performed post issuer default by the administrator of the limited liability partnership that would need to contract other parties to perform important functions as a potential negative for the programmes, but the positive effect of the active oversight taken by the FSA under the UK regulated covered bonds framework is also taken into account.

The cover pool-specific alternative management risk assessment is moderate risk for the majority of the UK programmes, driven by Fitch’s view of the issuer’s processes, data delivery and IT systems in place. Issuers with market-based systems for cover pool management, excellent data provision to Fitch and strong experience in covered bonds and securitisation have a low risk assessment. Programmes that are considered to be in wind down/dormant are assessed up to two categories worse, as Fitch believes this may lead to a higher risk of pool deterioration.

The risk assessment for privileged derivatives ranges from very low to moderate, depending on the materiality of the exposure and whether the derivatives are provided by external or intra-group counterparties. This component is not the sole driver of the D-Cap for any of the listed programmes.