Fitch cut mortgage covered bonds issued by Banco Popular Portugal to the brink of sub-investment grade yesterday (Wednesday) and kept them on negative review because of the addition of commercial assets to the cover pool in December, while also cutting Banco Santander Totta obrigações hipotecarias, by one notch.

Totta’s covered bonds were cut from BBB+ to BBB and placed on Rating Watch Negative (RWN).

The downgrades are the result of cuts to the issuers’ ratings, from BBB- to BB+ in the case of Banco Popular Portugal and from BBB to BBB- for Totta. These rating actions occurred last Thursday and Friday, respectively.

The Discontinuity Factor (D-Factor) for both programmes is 100%, meaning that the covered bonds’ rating is on a Probability of Default (PD) basis equalised with the issuer rating, with up to two or three notches possible for recoveries depending on whether the rating on a PD basis is in the investment or sub-investment grade category.

All else being equal, a downgrade of the issuer will lead to an equivalent downgrade of its obrigações hipotecarias (OH), said Fitch.

Banco Popular Portugal’s OH benefit from a one notch uplift for recoveries based on committed overcollateralisation level of 47%. The RWN reflects the addition of commercial assets to the cover pool in December 2011 and the subsequent possible deterioration of the credit quality of the cover pool.

Fitch said that it is awaiting receipt of information from the issuer, which will help form a more complete opinion on the credit quality of the cover pool, and that Banco Popular Portugal’s covered bonds will likely be downgraded in line with the issuer rating if a complete information package is not delivered by the end of June.

In the case of Totta, Fitch only gives credit to the minimum level of OC required by the Portuguese covered bond legislation, 5.26%, because the bank’s short term IDR is below F2 and it does not make any contractual or public commitment.

“When assuming the aforementioned minimum legal OC, stressed recoveries from the cover pool in a BBB scenario are not sufficient to ensure 100% recoveries for all covered bonds,” said Fitch. “Nonetheless, they may sustain recoveries in excess of 51% on the longer dated covered bonds, leading to a one notch uplift above the covered bonds rating on a PD basis.”

The RWN reflects the recalculation of the OC levels pending the redetermination of refinancing costs and expected loss levels.

Fitch is consulting on changes to its covered bond rating criteria, but said that if implemented as proposed these would not affect the rating of Banco Popular Portugal’s or Totta’s covered bonds.