Moody’s said yesterday (Tuesday) that amendments to the documentation of 10 OBG programmes have weakened investors’ credit protection and could trigger rating downgrades – although analysts noted that a high amount of the Italian covered bonds are retained.

The rating agency said that some Italian issuers have reacted to a decline in issuer or covered bond ratings by making “multiple documentation changes deeply modifying the structural credit protection offered by rating triggers”, or have failed to take actions prescribed in the documentation once trigger thresholds had been crossed.

The amendments mainly concern asset and liability swaps mitigating interest rate risks.

In three programmes – namely those of Banca Popolare dell’Emilia Romagna, Intesa Sanpaolo (mortgage), and UniCredit – regulations on posting of swap collateral have been amended so that the posting will occur when a rating trigger threshold in the Baa range is crossed, down from a previous threshold of A2/Prime-1.

In four programmes – those of Banca Popolare dell’Emilia Romagna, Intesa Sanpaolo (mortgage and public sector), and UniCredit – a change or guarantee of the swap counterparty will occur once the rating of the swap counterparty falls in the “lower band of the Baa range”, said Moody’s, down from a previous A3/Prime-2 threshold.

Moody’s also noted modification to set-off and commingling collateral posting provision, which delay an increase in overcollateralisation as specified in covered bond documentation, with Intesa Sanpaolo’s residential and public sector programmes having had the threshold for collateral posting lowered.

“Lowering the threshold reduces the liquidity available until the ratings of the servicer/issuer reach the new lower threshold level and reflects the issuers’ decreased willingness to post collateral in the context of expensive liquidity,” said Moody’s.

Issuers such as Banca Carige, Banca delle Marche, Banca Popolare di Milano and UBI modified guidance on collateral posting provision so that commingling mitigants, such as reserve or servicer’s guarantees, could serve as an alternative to notification the issuer needs to give to mortgagors for their instalments to be directed to another bank account after the crossing of rating threshold.

Beyond amending documentation, Moody’s also noted that issuers have not yet put in place remedies contemplated in swap documentation after trigger thresholds were crossed. This happened for the programmes of Monte dei Paschi di Siena, Banca Popolare di Milano, Credito Emiliano, and UBI.

Moody’s said that as a result of these modifications or failure to implement remedies, the rating agency adjusted the expected loss assumptions of its analysis to reflect the programmes’ increased exposure to interest rate risk, but that no rating, expect for one, has been affected so far.

This is because following downgrades of Italian covered bonds because of systemic risks, the application of an A2 country ceiling and issuers’ credit deterioration, amendments made by the issuers are such that the credit assessments remain consistent with the current rating levels.

The only rating affected was that of Intesa Sanpaolo’s public sector covered bonds. Moody’s downgraded Intesa’s public sector covered bonds from Aa3 to A1 on 13 June, saying that, at 22.6%, overcollateralisation was no longer consistent with a 39.5% target consistent with the previous rating.

However, the rating agency said that ratings could be affected if issuers continue to amend their documentation so as to lower investors’ credit protection to a level that “might exert pressure on the structural integrity of the affected programmes”.

“Further relaxation of credit protection could negatively impact our assessment of timely payments to covered bondholders following issuer default – the Timely Payment Indicator – and ultimately constrain the covered bond ratings to lower levels,” said Moody’s.

The rating agency noted that implementation of the amendments was easier for issuers that hold significant amounts of retained covered bonds.

Bernd Volk, head of covered bond research at Deutsche Bank, highlighted that the amount of covered bonds retained by Italian issuers exceeds the amount outstanding on the covered bond market.

“With around Eu61.4bn of Italian covered bonds being retained compared to around Eu48.8bn sold to investors, the Italian covered bond market probably faces bigger challenges than changes in set-off risk or commingling risk rating triggers,” he said.

ING analysts noted that covered bonds have been used by Italian issuers for central bank funding purposes, and that “their importance for this purpose was illustrated by the most recent programme changes made to Banca delle Marche’s covered bond programme”.

They said that Banca delle Marche OBGs have been retained by the issuer for central bank refinancing, but after Moody’s downgraded them from A3 to Ba2 following an issuer downgrade, they lost their eligibility. Banca delle Marche then lengthened the maturity extension period of its issuance by 30 years, and this prompted Moody’s to upgrade the covered bonds’ rating to Baa3 on Friday.

Despite warning of the potential consequences in term of ratings deriving from the amendments it described, Moody’s also noted that some changes made by Italian issuers were credit positive, such as the appointment of a back-up servicing trigger or facilitator for the programmes of Banca Carige, Banca Monte dei Paschi di Siena, Banca Popolare di Milano, Intesa Sanpaolo (mortgage).