An increase in issuance of unrated covered bonds by Italian banks could hinder timely repayments of OBGs in the event of an issuer default, said Fitch yesterday (Tuesday), especially if maturities are not spread out or the bonds do not revert to pass-through.

Five banks with obbligazioni bancarie garantite (OBG) programmes rated by Fitch issued unrated covered bonds totalling Eu27.5bn in the first three quarters of 2012, said the rating agency, more than twice the amount of rated issuance.

“If this trend continues it could make it harder to redeem the bonds in time if an issuer defaults because of the volume of assets that need refinancing,” it said, “particularly if bond maturities are not spread or do not revert to pass-through.”

At the end of the third quarter unrated OBGs represented on average over 30% of the total outstanding covered bond volume for issuers with a Fitch-rated programme, according to Fitch, although it noted there is significant variation by issuer and that it will continue to seek information from issuers about the profile of their covered bonds.

Investors holding rated OBGs could be exposed to greater maturity concentration risk as a result of the rise in unrated issuance, said the rating agency, in particular in light of the larger size of individual issues.

“If cover assets securing unrated and rated covered bonds from the same issuer hit the market at the same time, it could push their price down, reducing proceeds and consuming more overcollateralisation,” it said. “It could also delay sale and hamper timely payment.”

If the rating agency considered this to be likely it would lower the price cap in its assessment of asset sales, and/or adjust the Discontinuity Cap assigned to the covered bonds in question, it said.

Fitch has assigned D-Caps of 2 to all Italian mortgage covered bonds, driven by a high risk assessment for the liquidity gap and systemic risk component. This, according to Fitch, “reflects a less predictable wholesale market access that may reduce the likelihood that an Italian financial institution could buy a portion of Italian mortgage loans in the event of a default of one of its competitors”. The assessment is also driven by Fitch’s rating of the Italian sovereign (A-).

The rating agency yesterday said that a probable driver for the issuance of unrated OBGs was the need for collateral to access central bank liquidity. It noted that unrated covered bonds are still eligible as collateral for ECB repo transactions, using an institution’s issuer default rating as the basis for valuation haircut calculations.

“Depending on the issuer rating and the bonds’ residual maturity,” said Fitch, “this may enable an issuer to obtain cheaper funding than by taking rated mortgage-backed or asset-backed securities as collateral.

“It may also enable a bank to be less selective in its choice of cover assets while still complying with legislative eligibility criteria.”