Intesa Sanpaolo is inviting investors to swap Eu3.5bn of public sector covered bonds for new mortgage OBGs with the same terms but a likely two notch higher rating from Moody’s, after the rating agency on Wednesday cut the public sector OBGs to A1 on insufficient overcollateralisation.

The exchange offer is understood to be targeting the only remaining publicly placed issuance under Intesa’s public sector programme, a Eu2bn 3.25% 28 April 2017 issue and a Eu1.5bn 5% 27 January 2021 issue. Bondholders are being invited to exchange these for new bonds that will feature the same coupon and maturity date, differing only in that they will be issued under the bank’s mortgage covered bond programme.

The exchange offer was launched on Friday and expires on 4 July, and is being managed by Banca IMI, Barclays, Crédit Agricole, Deutsche Bank and Morgan Stanley. The issue price of the new covered bonds has been set at 100% to achieve a par for par exchange of the nominal principal amount of the existing covered bonds.

A banker at one of the dealer managers said that the exercise is to be seen in the context of Moody’s last week downgrading Intesa’s public sector OBGs and the requirements to sustain their rating.

Moody’s on Wednesday cut the covered bonds from Aa3 to A1 because they were insufficiently overcollateralised – the level of OC is 22.6%, in contrast with the 39.5% that the rating agency said it considers necessary for the bonds to maintain a Aa3 rating.

“Based on feedback from the issuer on the amount of overcollateralisation it intends to maintain in the programme, Moody’s expects that the maximum ratings the covered bonds can achieve will be A1,” it said.

Moody’s rates Intesa’s mortgage backed covered bonds Aa2. The Timely Payment Indicator (TPI) is “improbable”.

Intesa referred to Moody’s downgrade in a press release announcing the exchange offer, which it cast as an exercise aimed at “renewing its strong commitment towards investors”, noting that the new mortgage bonds on offer are expected to be rated two notches higher.

The issuer is also proposing to make certain related amendments to its public sector covered bond programme, subject to approval at an extraordinary general meeting, although details of these could not be obtained from the dealer managers as they were said to be for bondholders only.

The exchange offer is the latest in a series of liability management exercises in covered bonds this year, although the majority of which have been cash-for-bonds buybacks. Intesa’s exercise is thought to be the first covered bond exchange offer not targeted at a liability extension and the first to swap mortgage for public sector backed issuance.

Dexia Kommunalbank and Berlin-Hannoversche Hypothekenbank recently completed buybacks of public sector Pfandbriefe that were driven by a mix of reasons, including a retreat from public sector financing business, rating pressure and rating agency requirements, and a desire to smooth liability profiles.

Richard Kemmish, head of covered bond origination at Credit Suisse, said that Intesa’s exchange offer makes sense for all involved.

“I don’t see any downside for investors and it is a sensible management of collateral given that the world is a very different place from when the issuer started its programmes,” he said. “I’m sure it won’t be the last.”

He said that Intesa’s exchange offer will have been motivated in part by the better treatment of mortgages than public sector collateral in Italy by rating agencies and the repo eligibility of public sector loans on a standalone basis.

“The obvious analogy would be BHH, which bought back public sector bond and issued new mortgage Pfandbriefe a few weeks later,” said Kemmish, “although there are distinct differences in that in Germany public sector loans are better than mortgages and eligible as substitute collateral for mortgage cover pools.”

Intesa’s exchange offer comes after significant, credit quality-enhancing changes to the volume and structure of Intesa’s mortgage covered bond pool, according to Bernd Volk, head of covered bond research at Deutsche Bank, including the removal of RMBS.

These are apparent from a comparison of cover pool reports as at the end of November 2011 and as at the end of March, with Volk noting that while committed overcollateralisation was 3.1% on both report dates OC required by Moody’s to keep the prevailing rating – Aa2 – was 1% at the end of November but 7.5% at the end of March 2012, with actual OC increasing from 44.9% to 63.6% by March 2012, and that the increase in required OC is likely due to the removal of senior RMBS notes (Adriano Finance SRL) from the cover pool.

He said that according to the end-March cover pool report, residential mortgage loans accounted for 81.3% compared with 59.3% as of the end of November, and that while there was a 31% share of RMBS at the end of November, there were no RMBS in the Intesa cover pool as of March 2012.

The volume of outstanding covered bonds under the mortgage programme declined from Eu10.26bn to Eu6.4bn based on the two cover pool reports, according to Volk, who said that he assumed Intesa cancelled retained covered bonds and used the collateral for other funding.

“We assume, of the total outstanding volume of Intesa covered bonds as of March 2012, all but Eu2.3bn of covered bonds were publicly issued,” he said. “We like issuers separating collateral in pools backing publicly outstanding covered bonds and use other collateral for other funding (or even other covered bond programmes for central bank funding, if legally possible).”