Standard & Poor’s will apply larger target asset spreads to cover pools of residential mortgage loans originated in Ireland and Italy, and has introduced two new “buckets” to capture assets exposed to sovereigns rated triple-B and lower.

The rating agency yesterday (Tuesday) said that it updated some of its target asset spreads and that it is also clarifying the methodology for periodically adjusting these assumptions, with the update based on recent widening of spreads observed in certain European RMBS and sovereign spreads.

S&P applies target asset spreads as part of its asset-liability mismatch (ALMM) analysis, with target asset spreads representing stressed spreads used to model revised market value haircuts for different types of assets. Application of its updated target asset spreads and bucket definitions is not expected to lead to changes to outstanding covered bond ratings, said the rating agency.

As regards residential and commercial mortgage target asset spreads, S&P moved residential mortgage loans originated in Italy from bucket 1 to bucket 2, meaning that a 275bp larger spread, of 700bp, will be applied.

The target asset spread for bucket 1 is 425bp, for bucket 2 700bp, and for bucket 3 1,000bp.

The definition of bucket 3 was expanded to include prime residential mortgage loans, to which residential mortgage loans originated in Ireland have been allocated, having previously been part of bucket 2.

S&P said that its update also clarifies that residential mortgage loans originated in Belgium and Portugal are classified in bucket 1 and bucket 3, respectively, and that residential mortgage loans originated in Australia are included in bucket 1.

Residential mortgage loans originated in Greece are no longer allocated to any bucket, according to S&P.

The rating agency typically reviews secondary market spread data for residential and commercial mortgage loans on a quarterly basis, generally on the basis of its analysis of country-specific RMBS, commercial mortgage backed securities (CMBS), or covered bond secondary market spread data or similar data.

“In applying the criteria, we generally reclassify a country in a higher bucket based on observed historical spread movements and our forward looking view,” said S&P. “An example would be if the four week rolling average spread exceeds the current bucket assumption, plus one-third of the difference between the current bucket to which the country is assigned and the next highest bucket.”

Reviews of secondary market spread data for sovereign assets are typically carried out in a similar manner, with S&P in general applying a higher target asset spread if the four week rolling average for one of the countries in given bucket exceeded the target asset spread for that bucket.

The changes made by S&P to target asset spread for sovereign assets involved increasing the bucket 2 target asset spread to 350bp, redefining bucket 3 as containing sovereigns in the single-A category and increasing the target asset spread to 550bp.

The rating agency also introduced a fourth bucket for sovereigns rated in the triple-A category, to which it applies a 900bp spread assumption, and a fifth bucket for sovereigns rated in the non-investment grade category.

“The split of A and BBB category sovereigns into two buckets reflects the different spread behaviours that we have observed,” said S&P.