Moody’s has cut eight Italian covered bonds to A2, the level the rating agency lowered Italy’s country debt ceiling to after downgrading the sovereign to Baa2 on Friday, with all OBG programmes rated by Moody’s also placed on review for downgrade. OBG spreads were this (Monday) morning said to be stable, albeit at wide levels, in the face of the rating actions.

The rating agency said that the cuts of the obbligazioni bancarie garantite (OBGs) and the reviews for downgrade reflect the potential negative impact of the lower sovereign rating on Moody’s expected loss and timely payment analysis of Italian covered bonds, with a weakening of the sovereign’s creditworthiness and a continued weakness of the Italian economy, for example, affecting refinancing margins and the credit risk of the underlying assets.

Intesa Sanpaolo’s and UniCredit’s mortgage OBG programmes and Cassa Depositi e Prestiti’s covered bond programme, having been the highest rated, were the worst affected, being downgraded from Aa2 to A2. A full list of the covered bond programmes and how they were affected by the rating actions can be found here.

RBS analysts this morning said that Italian covered bond spreads are holding up at their prevailing wide levels despite the cuts, but that they see a risk of further downgrades of the sovereign, which could lead to the country’s debt ceiling being lowered to A3 or even Baa1.

“We fear that many rates investors would reduce their OBG holdings in such a scenario, as many are not allowed to hold triple-B rated debt,” they said. “We also expect that a few investors will try to offload their remaining Italian exposure in anticipation of further downgrades.

“We remain underweight Italian and Spanish covered bonds.”

A syndicate banker said that covered bonds were being sought in the secondary market this morning, including cédulas and OBGs from top tier issuers, but that Italian covered bond spreads were largely stable.

The Baa2 rating of the Italian sovereign is on negative outlook.

Moody’s has lowered Italy’s country debt ceiling to A2 to reflect the weakening of the Italian government’s creditworthiness, captured in the cut in the sovereign’s rating from A3 to Baa2 on Friday, as a result of which no Italian covered bond can be rated above this level.

The rating agency’s review will take into account the impact on the expected loss borne by the covered bonds as a result of, inter alia, the increased funding costs for the sovereign and a potential acceleration of the credit deterioration of the underlying cover pools, especially for public sector assets.

However, it noted that issuers may be able to offset any deterioration in the expected loss analysis if sufficient collateral is held in the cover pool.

Italian covered bonds have been assigned a Timely Payment Indicator (TPI) of “improbable” by Moody’s, one level above the worst TPI assessment of “very improbable”, and the rating agency said that it will reassess the rating caps under its TPI framework following the downgrade of the sovereign.

Bernd Volk, head of covered bond research at Deutsche Bank, said that with Spain rated Baa3 and the TPIs assigned to cédulas at “improbable”, a deterioration of the TPIs for Italian covered bonds seems unlikely at this stage.

“However, given that further bank rating downgrades are likely and sub-investment grade bank ratings would necessarily lead to a triple-B covered bond rating (based on a TPI of ‘improbable’), Banca Popolare di Milano, Banco Popolare SC and Banca Monte Dei Paschi are most vulnerable, facing triple-B haircuts at the ECB for their covered bonds.”

Italian covered bonds seem well collateralised, he added, given a focus on primary, residential owner-occupied, amortising, income-verified, and full recourse mortgages, but because issuers bear refinancing risk increasing central bank dependency is the best case scenario as long as they do not have market access.

Moody’s has disclosed the TPI leeway for 11 of the 13 OBG programmes on review for downgrade, with three having zero leeway, four a one notch leeway, and another four a three notch leeway.

However, Moody’s noted that covered bonds can be rated higher than the level indicated by its TPI framework, and this is particularly the case for sub-investment grade rated issuers.

Mortgage OBGs issued by Banca delle Marche, which is rated Ba1, for example, are rated two notches above the Baa2 level indicated under Moody’s TPI framework, with the higher rating due to factors such as: the issuer’s rating being at the high end of the range indicated by the TPI table for a Baa2 covered bond rating; a high level of committed overcollateralisation (27%); and a four-year extension period for the payment of principal under the covered bonds.