Mortgage covered bonds issued by Banco Comercial Português (BCP) and subsidiary Banco de Investimento Imobiliario (BII) were cut to sub-investment grade by Moody’s yesterday (Wednesday) as a result of a downgrade of BCP.

BCP’s covered bonds were cut from Baa3 to Ba1 after a downgrade of the issuer from B1 to B2, and BII covered bonds were also cut from Baa3 to Ba1 as BII is fully owned by BCP, said Moody’s.

According to analysts, BCP covered bonds remain eligible for European Central Bank (ECB) repo, as they are rated BBB- by Fitch and A (low) by DBRS.

“The ECB looks at the best rating, which is the DBRS one at A (low), when determining ECB repo eligibility and haircuts,” said Florian Eichert, senior covered bond analyst at Crédit Agricole. “Repo eligibility and haircuts are thus not affected here.”

However, he noted that BCP covered bonds will drop out of iBoxx and Barclays covered bond indices, as these require the average covered bond rating to be at least investment grade. DBRS is not included in the list of relevant rating agencies, and the average of Fitch’s BBB- and Moody’s Ba1 is below the investment grade threshold.

He noted that should the issuer seek and attain an investment grade Standard & Poor’s rating its covered bonds would be index eligible.

Bernd Volk, head of covered bond research at Deutsche Bank, said that the downgrade of BCP’s covered bonds is mainly driven by Moody’s rating methodology, and results from the downgrade of the issuer and a Timely Payment Indicator of “very improbable” that constrains the rating.

Moody’s estimates cover pool losses in case of BCP’s default at 45.9%, split between market risk of 39.1% and collateral risk of 6.7%. The overcollateralisation of the cover pool is 27%, of which the issuer provides 5.3% on a committed basis. The minimum OC level that is consistent with the Ba1 rating target is 14.5%.

“These numbers show that Moody’s is relying on uncommitted OC in its expected loss analysis and also show that high OC is mainly driven by refinancing risk, and not collateral risk,” said Volk. “At least from a practical perspective, with central banks remaining in ‘non-standard-measure-mode’ for the foreseeable future, this seems overdone.”

Volk also noted that the secondary market spreads of BCP covered bonds “did not react at all and continue to trade tighter than sovereign bonds”.

Moody’s mentioned progressively declining conditions for the Portuguese economy as one of the main reasons for the downgrade of BCP and fellow Portuguese issuer Banco Internacional do Funchal (Banif) on Wednesday. However, the rating agency has not taken any rating action against other Portuguese covered bond programmes, except for putting on review with direction uncertain the Baa3 rating of mortgage covered bonds issued by Banif, as the bank’s outlook was also put on direction uncertain until a merger with Banif SGPS is finalised.