Covered bonds issued by The Co-operative Bank were downgraded from A- to BBB+ yesterday (Tuesday) after Fitch lowered the UK issuer’s rating from BB- to B last Thursday. The rating agency is also closely monitoring remedial action being undertaken by the issuer.

Cutting Co-op’s issuer rating from BB- to B, Fitch said its downgrade reflects the impact a revised strategy announced on 4 November is likely to have on the bank’s internal capital generation ability.

The covered bonds were downgraded one notch less than the issuer because under Fitch’s methodology the maximum uplift over covered bonds’ probability of default (PD) ratings rises from two to three notches when their PD rating is sub-investment grade, and Co-op achieved this extra uplift.

The BBB+ rating takes into account the B issuer rating, a Discontinuity Cap (D-Cap) of 4 (“moderate risk”) and asset percentage (AP) of 77.5%. The AP allows the covered bonds to be rated BB+ on a PD basis and BBB+ considering recoveries given default, said Fitch, as it is lower than the breakeven AP of 90%.

The rating agency noted that for issuers with a short term issuer default rating below F2, it takes into account any public or contractual issuer commitment to maintaining a certain level of overcollateralisation, and in Co-op’s case this is a 77.5% level used in its asset coverage test (ACT).

The covered bonds’ Rating Watch Negative matches that of the issuer rating. Fitch said, all else being equal, that any rating action on Co-op’s issuer default rating would likely translate into an action of the same magnitude on the covered bonds.

Fitch also noted that under the programme documentation, Co-op should within 60 days of being downgraded to below BBB- (which happened on 20 June) use reasonable endeavours to enter into a back-up servicing agreement with a third party as appropriate and appoint a suitable back-up cash manager on a best-effort basis. The rating agency said that 60 days have passed and that it is closely monitoring remedial action being put in place by the issuer.