Standard & Poor’s has downgraded from BB+ to BB- public sector covered bonds issued by Portugal’s Banco BPI because it considers that credit enhancement available in the programme is not able to protect against asset default risk, and therefore does not justify an uplift above the issuer rating.

The rating agency at the same time affirmed at A- mortgage backed covered bonds issued by the bank. Each rating was removed from negative review and assigned a negative outlook. The rating actions were carried out on Friday, and follow a downgrade of the issuer, from BB+ to BB- on 14 February.

Under S&P EMU criteria the rating agency considers that public sector covered bonds have “high” sensitivity to sovereign risk, and a programme that has what it considers to have such high risk would typically only achieve a one notch uplift above the rating on the country in which the cover pool assets are located.

“Based on these criteria, our maximum potential rating on Banco BPI’s public sector covered bond program is currently capped at BB+ – two notches above our long term rating on Banco BPI,” said S&P.

However, the rating agency said that the programme’s available credit enhancement is not able to cover the asset default risk, and that it is therefore not able to achieve the first notch of uplift under its asset liability mismatch criteria for rating covered bonds.

It said that a high asset default rate combined with low recovery assumptions means that the available credit enhancement (66.14%) is lower than that (71.64%) which it considers to be commensurate with a first notch of uplift above the issuer credit rating (BB-).

Following a downgrade of the Portuguese sovereign rating in January S&P assumes a 30%-50% recovery on Portuguese sovereign assets in the case of a default.

“Given the current speculative grade ratings or credit estimates assigned to the cover pool assets and the high concentration within the cover pool, our modelling would assume that the issuer and the sovereign would default,” said S&P. “The programme would therefore need to be able to support a scenario default rate of 100% with an assumed recovery for principal and interest of 40%.”

The negative outlooks assigned to the mortgage and public sector backed covered bonds reflect a negative outlook for issuer credit rating and the Portuguese sovereign rating.