Standard & Poor’s dropped Spanish covered bond programmes from Category 1 to Category 2 within its rating framework yesterday (Thursday), limiting the number of notches of uplift cédulas can achieve over their issuers in a move that contributed to downgrades of four Spanish covered bond programmes.

In accordance with S&P’s asset-liability mismatch criteria, under Category 1 Spanish covered bonds programme could achieve a maximum of seven notches of uplift over their issuers – although ratings are capped at BBB for cédulas territoriales and AA- for mortgage backed cédulas as a result of a country ceiling put in place on 16 October after a downgrade of Spain to BBB-.

Under Category 2, Spanish covered bond programmes can now benefit from a maximum of six notches of uplift over their issuers.

The recategorisation contributed to cédulas issued by four Spanish banks being downgraded by one notch: Banco Popular Español’s, from A to A-; Catalunya Banc’s, from BBB+ to BBB, Ibercaja Banco’s, from AA- to A+; and Bankinter’s, from A to A-. The downgrades also reflect rating actions taken by S&P last Friday (23 November), with Bankinter having been cut from BB+ to BB and Ibercaja Banco from BBB- to BB+.

The four programmes were removed from CreditWatch negative and assigned negative outlooks – as were those of CaixaBank, Kutxabank and NCG Banco – with the outlooks being in line with the rating agency’s negative outlooks on the issuers’ creditworthiness.

The rating agency said that a reduced ability of Spanish banks to provide liquidity to the covered bonds of a potentially insolvent issuer, weaker demand for Spanish assets among a broad range of investors, and an increasingly uncertain likelihood of government support were the reasons for the recategorisation.

S&P noted that Spanish banks would be less able to provide liquidity to support a defaulting issuer because of increasingly challenging economic conditions in Spain, and constraints to access to wholesale funding, on which Spanish issuers rely.

The rating agency said that interest in cédulas has decreased, as “international real money investors have a limited appetite for Spanish assets or funding products”. Domestic demand is also constrained by a wave of consolidations and restructuring, according to the rating agency.

Government support is seen as increasingly unlikely, as the Spanish government would be willing, but may no longer be able to provide extraordinary support to a defaulting issuer, said S&P.

However, S&P noted that cédulas continue to have “high” systemic importance, and their issuance volumes have been increasing in 2012, mainly as a result of repurchase agreements with the European Central Bank. The relative size of the covered bond market is 22% of domestic bank capital markets funding, above the 20% threshold S&P sets to assign a high rating for systemic importance, while mortgage covered bond volumes represent 34.4% of GDP and more than one-third of housing finance, well above S&P’s 20% threshold

“We continue to believe that covered bond financing is an integral feature of the domestic funding market and, to date, we have not observed any covered bond defaults,” said the rating agency, “cédulas continue to provide most Spanish banks with one of the few reliable sources of funding.”

The downgrade of Spanish cédulas to Category 2 was not unexpected, said covered bonds analysts. Most market participants were surprised that Spanish cédulas were previously in the same category as covered bonds issued in Germany and Sweden, which have longer histories of support for banks and several regulatory and support practices, said Bernd Volk, head of covered bond research at Deutsche Bank.

“After Spain has shown plenty of support for banks in the recent past and never provided the slightest resemblance of an indication regarding burden-sharing or losses for cédulas, cédulas receive a lower category and therefore a lower maximum uplift,” he added. “S&P may have simply recognised that cédulas’ ratings are currently high compared to the sovereign rating and may simply need a technical excuse for a general shift.”

Florian Eichert, senior covered bond analyst at Crédit Agricole, noted that S&P is the latest agency to start limiting the uplift that cédulas can achieve over the issuer.

“Moody’s as well as Fitch have done so a long time ago,” he said. “And with ratings still in the double-A camp for Kutxa and CaixaBank, single A ratings for Ibercaja, Popular as well as triple-B ratings for Catalunya and NCG Banco, S&P is the most optimistic agency on cédulas out there.”

According to Eichert, the downgrade is unlikely to affect investor sentiment or spreads.