Any perceived loss of market access by Italy could lead to increased refinancing cost assumptions and therefore higher overcollateralisation supporting a given rating for Italian mortgage covered bonds and European public sector covered bonds exposed to Italian public sector debt, Fitch said on Friday.

It identified this and the reduction of rating uplift provided by maturity extensions as two consequences for covered bond ratings should it judge the Italian sovereign to be losing market access and cut its rating.

Loss of market access is not Fitch’s base case, but a risk that it highlighted in a special report published on Thursday, ‘Italy – The Challenge Ahead’.

The rating agency noted that if it considers that the Italian sovereign is losing market access it will increase the stresses incorporated in its covered bond rating criteria.

Any increase of stresses incorporated in its covered bond rating criteria would affect covered bonds with exposure to Italian assets, such as mortgage obbligazioni bancarie garantite (OBG) and other European covered bonds secured by Italian public sector debt, such as those issued by Germany’s Aareal Bank, Deutsche Pfandbriefbank (pbb), and Eurohypo.

Fitch downgraded Italy to A+, negative outlook, on 7 October, and said that since then the country’s near and medium term economic growth prospects have deteriorated, with refinancing spreads for assets in Italian cover pools increasing.

The rating agency said that if Italy loses market access and the sovereign were downgraded to a low investment grade category, covered bond ratings would be affected in two ways.

Firstly, a scarcity of available liquidity for cover assets would reduce the possible rating uplift between an Italian issuer and its mortgage covered bond rating.

“It is likely that the current liquidity gap protection in the form of twelve to fifteen months maturity extension for the mortgage OBG would only enable an uplift of one notch in terms of probability of default above the issuer default rating (IDR) of the issuing bank,” it said, “to which a maximum two notches (or up to three notches if the rating of the covered bond on a probability of default basis is not investment grade) could be assigned to reflect recoveries in the case of default.”

Secondly, if Fitch were to cut Italy some covered bond issuers would also be downgraded, it said, adding that the linkage between the covered bond rating and the issuer could also prompt the covered bond ratings to be lowered.

“An increase in stressed refinancing cost assumptions will lead to an increase in the percentage of overcollateralisation supporting a given rating both for mortgage OBG and European public sector covered bonds exposed to Italian public sector debt,” said Fitch, noting that it expects such a rise in overcollateralisation to occur even though the mortgage covered bonds’ rating would be lower than today.

Fitch placed on Rating Watch Negative (RWN) seven OBG programmes and three German public sector Pfandbriefe (see below) after downgrading the sovereign in early October. It said that existing RWNs will be resolved based mainly on the recalculation of the level of overcollateralisation supporting the rating of each programme as well as any liquidity mitigants put in place by the issuers.

Italian issuers whose OBG programmes are rated AAA, on RWN: Banca Carige, Credito Emiliano, Banca Monte dei Paschi di Siena, Banca Popolare di Milano, Banco Popolare, Unione Banche Italiane, and UniCredit.

German issuers whose public sector Pfandbriefe are rated AAA/RWN: Aareal Bank, Deutsche Pfandbriefbank and Eurohypo.

Fitch said that the ratings of German Pfandbriefe that are backed by a significant proportion of lower rated Italian public sector exposure are unlikely to be affected by liquidity concerns, but that the bonds are exposed to Italian credit risk and increased refinancing costs.