U.K. building societies are in talks with the Bank of England (BoE) about their use of the Special Liquidity Scheme (SLS), according to Dresdner Kleinwort analysts.

The U.K. SLS has allowed U.K. mortgage lenders to secure liquidity on a long-term basis and has been actively used through the delivery of covered bonds.

Dresdner analysts said that various banks have set up a covered bond programs specifically to take part in the SLS.

According to BoE requirements, bonds taking part in the program must offer a minimum of two triple-A ratings. However, Moody’s Investors Service downgrades of numerous U.K. building societies last week jeopardizes their covered bond ratings.

"The 'Aaa' ratings of all issuers affected were placed under negative review as they are no longer fully consistent with the new bank ratings and respective Timely Payment Indicators (TPI) under Moody’s methodology,"analysts said.

The covered bonds of Chelsea Building Society have already been lowered to 'Aa3.' Dresdner analysts said that only Yorkshire Building Society holds two alternative 'AAA' ratings from Standard & Poor's and Fitch Ratings. The rest are at risk of no longer complying with the admission criteria of the SLS in the future and in the case of Chelsea Building Society this has already materialized.

"The issuers may thus have to resort to the central bank’s discount window facility whose term has also been expanded to one year," Dresdner analysts said. "While here too the BoE insists on two triple-A ratings at the time of issuance, the credit rating is allowed to fall to 'A3'/'A-' thereafter."

Analysts believe that the expected rating adjustments by S&P and Fitch may trigger additional pressure fairly soon given that the triple-A's for U.K. covered bonds are also fragile with these agencies under their adjusted liquidity assessments.

Dresdner said that the U.K. government and the Financial Services Authority have plans to review the current regulatory regime, which was introduced one year ago, in order to enhance investor confidence. Results are to be announced by the 2009 Pre-Budget Report this fall.

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