Fitch Ratings says that it expects the Bank of England’s Special Liquidity Scheme (SLS) to result in a sharp increase in both residential mortgage-backed security and covered bond issuance out of the United Kingdom in the coming six months.

The rating agency stressed that the scheme is far from a taxpayer “bail-out” of banks, as claimed by some, with significant protection for the BOE built into the scheme and only the highest-rated securities eligible for swapping.

Under the terms of the SLS, UK banks and building societies have a six-month window in which to swap their currently illiquid RMBS, covered bonds and credit card ABS for liquid UK Treasury bills – this window started yesterday. The terms of the SLS stipulate the bonds must not only be rated ‘AAA’ at the outset but that if they lose their ‘AAA’ rating the bank must replace them with other appropriately rated bonds.

“Losses can only occur to the BOE, and therefore the taxpayer, in the event that the bank becomes insolvent and is unable to replace collateral following a downgrade and if the significant protection accorded in terms of in-built transaction credit enhancement, mark-to-market discount and generous haircuts prove insufficient to absorb losses on the securities. Fitch regards these circumstances as remote in the extreme,” said, Philip Walsh, managing director in the agency’s structured finance department with overall responsibility for its RMBS and ABS ratings.