Fitch downgraded three Cypriot covered bond programmes yesterday (Wednesday) following a downgrade of the sovereign and a subsequent downgrade of the related banks.

Cyprus was downgraded on 27 January from BBB to BBB- to better reflect the Cypriot banks’ large capital need in light of the Greek debt restructuring expected this quarter, according to Fitch.

Covered bonds issued off Marfin Popular Bank’s programmes I and II, and covered bonds issued by Bank of Cyprus (BoC) have been downgraded in this rating action by Fitch from BBB to BBB-.

Marfin’s programme I covered bonds and BoC’s covered bonds have both been assigned a Discontinuity Factor (D-Factor) of 100%; this D-Factor only allows for equalisation of each of the covered bonds’ rating on a PD basis, with the corresponding issuer’s rating being BB+ in both.

All else being equal, given the equalisation of the probability of default (PD) rating of the covered bonds with the BB+ rating of the respective issuer on all three programmes, any further downgrade of the two banks’ ratings would result in a corresponding downgrade of the rating of the associated covered bonds.

Up to three notches of uplift for recoveries could be granted on the two programmes, depending on the level of overcollateralisation between the cover pool and covered bonds. Fitch has said that overcollateralisation of 16.3% and 14.9% for Marfin’s programme I and BoC, respectively, would allow for recoveries in excess of 51% from the covered bonds assumed to be in default in a BBB- rating scenario. The overcollateralisation levels publicly committed under Marfin programme I (16.3%) and BoC (17.6%) are sufficient to grant one notch uplifts above the covered bond PD ratings to BBB-.

Covered bonds issued under Marfin’s programme II have a D-Factor of 70% that, in combination with Marfin’s rating, allows the covered bonds to be rated as high as BBB- on a PD basis, and up to BBB+ after taking into account recoveries given default.

However, Fitch noted the 8.15% minimum overcollateralisation level that the issuer has committed to in its investor report only allows for equalisation of the rating of the covered bonds on a PD basis with Marfin’s rating.Based on this level of overcollateralisation, the covered bonds can only be rated one notch higher after giving credit to recoveries from the cover pool when a default of the covered bonds is assumed.

Marfin’s programme I and BoC’s covered bonds remain on Rating Watch Negative (RWN), reflecting adverse economic conditions and heightened uncertainty surrounding ongoing developments in Greece, where the cover assets are domiciled.