Investor consent is being sought for changes to a Bank of Scotland Eu60bn covered bond programme in response to rating agency criteria changes, with the proposed amendments aimed at averting a downgrade by S&P under new counterparty criteria and improving the D-Cap assigned by Fitch.

The UK issuer will hold a covered bond investor meeting on 6 December and proposes an extraordinary resolution setting out proposed amendments to its programme, which it noted was the first covered bond programme to be established in the UK, in 2003. The covered bonds are registered under the UK’s Regulated Covered Bond regime.

Ten main changes are being proposed under the extraordinary resolution. If the proposed changes are not approved, said Bank of Scotland, the covered bonds could be downgraded to below triple-A by Standard & Poor’s or have their ratings “otherwise adversely affected”, with other adverse effects for covered bondholders also potentially arising, such as in relation to the price at which the bonds trade.

S&P published revised counterparty criteria for covered bonds and structured finance transactions at the end of May, and Bank of Scotland said that the new criteria do not permit the grandfathering of existing covered bonds or programmes.

“[T]herefore the Programme and/or S&P’s AAA rating of the covered bonds issued under it are expected to be directly impacted if the amendments required in order to implement the New S&P Counterparty Criteria are not so implemented,” it said. “To avoid any such impact the amendments required in relation to the New S&P Counterparty Criteria must be implemented by 11 January 2013.”

Natixis analysts cited a possible four notch downgrade to A+ if the changes are not implemented.

The issuer is at the same time also seeking to improve the assessment of its covered bonds by Fitch, noting that the rating agency under updated covered bond criteria assigns a Discontinuity Cap (D-Cap) of 3, for moderate risk, to its programme, with a commensurate restriction on the uplift from its issuer rating to the covered bonds’ rating.

“The proposed amendments are intended to improve the Fitch D-Cap score,” said Bank of Scotland.

The issuer is also taking the opportunity to make changes to its programme to align it with other UK covered bond programmes and its “current business practices”.

The proposed amendments relate to features such as interest rate and covered bond swap agreements, stand-by bank account and guaranteed investment contract arrangements, set-off risk calculation, and swap collateral.

Bernd Volk, head of covered bond research at Deutsche Bank, said that the proposed changes appear to improve investor protection, but that the issuer is also asking for general consent to potential future changes.

Citing a passage in the consent solicitation memorandum, Volk said:

“According to this, the Bond Trustee and the Security Trustee could in the future agree (without the need for further consent of the holders of any Series of Covered Bonds) to future amendments of the covered bond prospectus relating to rating agency requirements,” he said. “While such amendments typically increase investor protection, we argue that prospect amendments should always need investor consent.”

One of the changes that would be allowed in this context would be the introduction of soft bullet covered bonds.

The proposed change in question is worded thus in the extraordinary resolution:

“to amend the Trust Deed to allow the Bond Trustee and the Security Trustee to agree (without the need for further consent of the Covered Bondholders) future amendments to the Transaction Documents required as a result of, or in consequence of ongoing updates and changes to the methodologies and criteria adopted by rating agencies, to the RCB Regulations, to permit for greater efficiency in any future novation of counterparty roles, and to introduce soft bullet covered bonds into the covered bond programme”.

The consent solicitation memorandum states that potential future amendments under these terms, i.e. without the need for further investor consent, could only be made if the LLP or cash manager in the programme certifies that the changes will not have an adverse effect on the covered bond ratings. In the event the modifications are being made to conform to updated rating agency methodologies or criteria, added Bank of Scotland, the LLP or cash manager would additionally need to certify to the bond trustee and the security trustee that this is the case.

The notice of the covered bondholder meeting can be found here.