Fitch Ratings will no longer consider certain eligible U.K. bank loans in its analysis for affected transactions and programs in light of a protection for deposits scheduled for implementation later this year, the rating agency announced today.

The planned protection considers eligible bank loans on a gross basis, rather than the current net basis. Fitch said that the change will diminish deposit-set off exposure in U.K. structured finance (SF) transactions and covered bond (CVB) programs.

The U.K.'s Financial Services Compensation Scheme (FSCS) compensates depositors in cases where deposit-taking institutions enter into insolvency and deposit balances are lost.

“Due to the lack of directly applicable statute or case law, transaction and programme legal opinions have been unable to provide an unequivocal view with respect to whether obligors are able to validly apply set-off,” explained the Fitch report.

While the credit rating agency is confident that legal set-off risks are properly addressed with respect to deposits made by obligors after borrowers receive the receipt of notification, it previously assumed that set-off risks stand in relation to deposits made prior to the receipt of notification and remain outstanding when an originator becomes insolvent.

In July 2009 the FSCS announced that it would protect the gross amount of eligible deposits, effective December 31, 2010. Essentially, depositors will not need to set off balances that they owe to the deposit-taking institution prior to receiving payment for lost deposits. The schemes current rules only compensate depositors for net debts owed.

Under the net pay-off rule, Fitch did not consider the scheme to mitigate set-off risk for SF transactions and CVB programs.

Deposits GBP50,000 per depositor are eligible for protection under the program. To minimize the liquidity impact on investors, compensation payments must be made within 20 days of a bank’s insolvency. Set-off risks for deposits in excess of GBP50,000, deposits under certain off-set mortgages, and claims arising under mortgages with additional drawdown features and potential other claims against the originator will not be mitigated.

Fitch will continue to analyze set-off exposure in new transactions and programs on a case-by-case basis until December 31.

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