Fitch has downgraded the ratings of obrigações hipotecárias issued by Portugal’s Caixa Económica Montepio Geral from BBB to BBB-, and removed them from Rating Watch Negative, due to the application of its covered bonds counterparty criteria and revised refinancing cost assumptions for Portuguese residential mortgage loans.

A review of these refinancing cost assumptions, due to the continued rise of Portuguese RMBS and government bond yields, has increased the overcollateralisation deemed by Fitch to support a given rating.

The obrigações hipotecárias could be rated as high as BB+ on a probability of default (PD) basis based on Montepio’s BB long term issuer default rating (IDR) and a 70% Discontinuity Factor (D-Factor), said Fitch.

However, the issuer publicly commits to a 35% minimum overcollateralisation that in Fitch’s view “only allows for the equalisation of the rating of the covered bonds on a probability of default (PD) basis with Montepio’s IDR”.

The rating agency said the mortgage covered bonds can be rated two notches higher than the issuer after taking into account recoveries from the cover pool in the event of a covered bond’s default.

Portuguese covered bond programmes are exposed to the risk of time subordination post-issuer default, said Fitch. It therefore deviated from its standard recoveries analysis and stressed the covered bonds for 100% recoveries in all but the last maturing covered bond series, which was found to provide sufficient (more than 71%) for a two notch uplift to BBB-.

The rating agency said Montepio’s covered bonds benefit from asset and liability swaps with the Royal Bank of Scotland to hedge the interest rate mismatches between the cover pool and the covered bonds.

Fitch said that it assessed the programme’s hedging arrangements, including the swaps’ market valuations, based on the rating agency’s counterparty criteria, and found that materiality of the swaps for the programme is overall low.

“Given that the swap counterparty’s rating stands higher than the covered bond rating itself and Fitch’s view that the risk of an A/F1 entity proceeding straight into default is rather remote, the swap counterparty exposure and existing collateralisation arrangements are considered commensurate with the current covered bond rating,” said Fitch.

Montepio intends to maintain a minimum overcollateralisation of 35%, which is in line with the level of overcollateralisation supporting its covered bonds’ BBB- rating, said Fitch.

It added that overcollateralisation supporting a given rating will be affected, among other factors, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance, and that it can also change depending on the direction of Portuguese bond yields, which could affect Fitch’s refinancing cost assumptions.

“Therefore it cannot be assumed that the current level of OC supporting the assigned rating will remain stable,” it said.