Italy’s financial institutions have made haste to take advantage of renewed investor interest in the country and cast the outcome of their deals as a vote of confidence. Now they are seeking to extend this success via SME-backed covered bonds Neil Day and Susanna Rust report.

There was a time when the resignation of an Italian prime minister would have been enough to spark a bout of volatility in financial markets. But when Enrico Letta resigned as prime minister on 14 February, not only did the markets barely bat an eyelid, but Moody’s went on to raise the outlook on the country’s rating from negative to stable later that day.

Citing the “resilience” of Italy’s government financial strength in its action, the rating agency said: “Today’s resignation of prime minister Enrico Letta and the expectation that Matteo Renzi will head a newly formed government does not alter Moody’s expectations in this respect.”

The transition to the prime ministership of Renzi (pictured) was similarly smoothly accepted by the markets. And while not getting carried away, analysts have been positive on developments.

“Sentiment toward Italy is improving on the back of the formation of a new government with a constructive reform agenda and also by Moody’s decision last Friday to raise the outlook on Italy’s sovereign credit rating to stable from negative and affirm the rating at Baa2,” said Barclays’ analysts on 20 February. “Since the end of last week, 10 year Italian government bonds have outperformed German Bunds by about 10bp.

“Although there are still some implementation risks for the reform agenda and at this stage it is unclear to what extent a government under the leadership of Democratic Party Secretary Matteo Renzi could overcome the veto power of small parties belonging to the grand coalition government, our overall assessment of recent developments is positive.”

If confirmation were needed in the covered bond space that it was business as usual for Italy, Credito Emiliano provided that emphatically when it came to market on 18 February: its Eu750m five year OBG was more than three times oversubscribed.

The deal was first marketed at the 95bp over mid-swaps area and then priced at 88bp over on the back of a Eu2.5bn order book involving 120 investors. Barclays, BNP Paribas, Credit Suisse, HSBC, and Société Générale were bookrunners. A syndicate official at one of the leads said that the issue was priced some 25bp through Italian government bonds, flat to 5bp through the issuer’s curve, and roughly flat to where a new five year for its peer UBI Banca would come. He said Credem’s OBG was the best performing covered bond issue out of five deals totalling Eu4bn that were priced that week.

Gabriele Minotti, head of ALM and funding at the issuer, told The Covered Bond Report that Credito Emiliano took Moody’s revision of Italy’s outlook as a signal to proceed with the new issue after it had been eyeing the market for a week or so.

“We were in the right place at the right time,” he said. “This was a stellar performance.”

Minotti said the issuer was pleased with the level of foreign investment in the transaction, with domestic accounts taking only 36% of the bonds.

“The level of foreign investment shows that confidence has improved in both the bank and the country,” he said. “We are one of the few Italian banks to print at a double-digit spread and this is a good sign going forward.”

Minotti said that the bank intends to issue more frequently.

“We are planning to issue again in the second half of the year, following the maturity of an OBG in June,” he said. “Being on the market frequently is important as it improves customer confidence in the issuer and reduces the need to roadshow without losing the assurance of customer reception.”

The issuer is also aiming to further scale bank financing from the European Central Bank, which is at Eu3bn after Eu2bn was repaid last year, according to Minotti.

‘No concerns whatsoever’

Credito Emiliano’s deal came after peers Intesa Sanpaolo and UBI Banca had attracted strong demand two weeks earlier despite competing with two other euro covered bond benchmarks the same day. A Eu1bn 10 year OBG issue for UBI Banca was the pick of the quartet on 29 January, drawing some Eu4.4bn of demand in an hour of bookbuilding, while national champion Intesa Sanpaolo could also pull Eu2.2bn of orders for a Eu1.25bn 12 year issue.

This was despite the two peripheral issuers coming to a market that was only just reopening after a volatile period for the wider financial markets brought on by concerns about emerging markets.

The Italian transactions were “a clear sign that the periphery is better bid”, according to a syndicate official.

“It’s not a surprise in terms of spread and overall yield,” he said, “but more importantly it’s a clear sign that investors have no concern about these markets or credits whatsoever, and credit lines are available.”

UBI leads Barclays, Crédit Agricole, Goldman Sachs, Natixis, Société Générale and UniCredit set initial price thoughts at the 130bp over area and then guidance at the 120bp over area before fixing the spread at 118bp over. A lead syndicate official said the re-offer spread of 118bp over was “pretty impressive”, incorporating a relatively minimal new issue premium of some 3bp.

In the case of UBI, investors were getting some 45bp on the swap curve and 10bp on the credit curve, he said, citing outstanding UBI seven year OBGs at around 105bp over mid.

Intesa Sanpaolo’s 12 year OBG was priced at 108bp over mid-swaps, following guidance of the 115bp over area. The deal was the longest dated euro benchmark covered bond so far this year.

UniCredit had earlier reopened the Italian covered bond market for 2014 with a Eu1.5bn dual tranche OBG issue on 16 January that included a ground-breaking public euro FRN benchmark. The Eu1.5bn dual tranche transaction was split between a Eu500m three year floating rate note (FRN) and a Eu1bn 10 year fixed rate issue and was lapped up by investors.

Leads Crédit Agricole, Credit Suisse, Danske, ING, Natixis and UniCredit built a combined order book of around Eu3.6bn, post-reconciliation, with nearly 250 accounts involved, according to one of the leads. Each tranche was well oversubscribed, although demand was strongest for the 10 year fixed rate tranche, amounting to around Eu2.2bn, while some Eu1.4bn of interest was registered for the FRN.

The 10 year OBG was priced at 98bp over mid-swaps and the FRN at 57bp over three month Euribor, the tight end of guidance that followed two spread revisions. Syndicate bankers away from the leads were positive about the transaction, saying it was “a great deal”.

Waleed El Amir, head of strategic funding and portfolio at UniCredit, said that the transaction surpassed the issuer’s expectations, and vindicated what was a difficult call to proceed with the deal given a shaky market backdrop.

“It wasn’t an easy call for us but we felt that the weakness was in the peripheral senior unsecured and core covered bond market, and that the peripheral covered market was pretty healthy,” said El Amir. “I was surprised by how well the deal went.”

At 98bp over, the 10 year fixed rate tranche came 5bp inside where a one year shorter UniCredit OBG was trading at the time of pricing, according to El Amir, beating the issuer’s expectation.

“The double-digit spread is phenomenal,” he said. “In 2012 we priced a seven year at 295bp over, so the rally and growth in confidence in Italian credit has been incredible.”

‘Elegant’ FRN, fixed combo

While the issuer was convinced that the FRN tranche would be well received, the pricing of that was also better than expected, said El Amir.

The dual tranche structure is unusual in euro benchmark covered bonds, and the FRN was said to be unprecedented, with floating rate covered bonds hitherto limited to private, sub-benchmark size deals. Syndicate bankers involved in UniCredit’s deal as well as others considered the FRN a new product with the potential to become more widespread given structural and market shifts.

UniCredit’s El Amir said that the FRN was launched to take advantage of a bank treasury bid in covered bonds for Liquidity Coverage Ratio (LCR) and general investment purposes, and that the issuer felt FRN demand observed in senior unsecured would translate to the covered bond market.

The FRN also targeted accounts positioning themselves for eventual interest rate rises, he added.

The motivation and benefits for the issuer of the dual tranche deal were manifold, according to El Amir.

“It was a very elegant way of doing a large deal, diversifying our investor base, and doing something new,” he said. “It was also a clever way of averaging down the maturity, effectively to seven years.

“It cheapens the cost of funding while from an ALM perspective you stay roughly were you are on maturity, it attracts new investors and you move away from the concentration risk of having the entire deal mature in a single year.”

The issuer discussed doing an FRN on a standalone basis, but felt a dual tranche structure was the best way of testing the new product without exposing itself to too much execution risk, said El Amir.

“We typically issue Eu1bn deals, which may have been a stretch for an FRN and we also didn’t know if we really wanted to do that much for a three year FRN,” he added.

The leads and the issuer discussed sizing the FRN and fixed rate tranches at Eu750m each, according to El Amir, but decided to upsize the 10 year fixed rate tranche and downsize the FRN to stick to the issuer’s tradition of doing Eu1bn fixed rate deals.

Asset managers and banks drove the three FRN, taking 50% and 41%, respectively, followed by 6% for insurance companies and 3% for other accounts, according to one of the leads. Germany and Austria were allocated 30%, Italy 30%, France 11%, the UK and Ireland 9%, Iberia 9%, the Benelux 5%, Nordics 2%, Switzerland 1%, and others 3%.

CDP activates programme

In parallel to an easing of wholesale funding conditions for peripheral debt, the Italian government-owned fund Cassa depositi e prestiti (CDP) in the new year made inroads into an OBG purchase programme it had announced in November.

Having made its first purchases under the scheme in December, by early February, after the aforementioned Intesa, UBI and UniCredit deals but before Credito Emiliano’s, CDP had bought a total nominal amount of Eu550m, with three issues in its portfolio. By 10 March, with Credito Emiliano’s deal the only new OBG benchmark to have been priced in the interim, total buys under the purchase programme stood at Eu735m, across five OBGs, according to an update from a CDP spokesperson.

The purchase programme is part of a “Plafond Casa” initiative to stimulate residential mortgage lending, with CDP allocating up to Eu3bn to purchases of OBG issuance and securities of a similar nature.

The aim of the purchase programme is “to help improve the liquidity of this instrument, especially when the issuer is a small to medium-sized Italian bank, with the presence of a qualified institutional investor”, a spokesperson at CDP told The Covered Bond Report.

The intention is for this to help banks raise cheap funding by using their residential mortgage assets, with CDP’s involvement linked to issuers committing to use the funding to originate new residential mortgages, according to the spokesperson.

With two of the five OBGs in the CDP’s purchase programme portfolio UBI issues and another the aforementioned Intesa 12 year, an investor noted that it was “interesting to see that CDP assumes Intesa to be a small to medium-sized bank” and that Intesa and UBI are rated investment grade on a senior unsecured level.

The CDP spokesperson said that CDP asks representatives at the issuing banks to sign, before a deal is closed, a letter in which the institution commits to “irrevocably undertake to allocate the net proceeds of the Notes underwritten by CDP to the granting of new residential mortgage loans to Italian residents” and, upon request, “undertake to provide CDP with evidence of that allocation”.

According to the spokesperson CDP only buys OBGs under the purchase programme on the primary market, subject to eligibility criteria being met with respect to ratings, asset quality, and the maturity of the bond, with the size of CDP tickets capped at 25% of the total nominal bond amount issued.

TPI uplifts follow

As well as consolidating the improvement in sentiment towards Italy, Moody’s revision of the sovereign’s outlook from negative to stable had a more direct impact on several Italian banks and covered bonds it rates. Most immediately, Moody’s changed the outlooks of seven Italian financial institutions from negative to stable after the move on the sovereign, including those of UniCredit and Intesa Sanpaolo.

The rating agency then gave OBGs a boost when it on 21 February upgraded four Italian covered bonds after raising the Timely Payment Indicator (TPI) for all public sector-backed and almost all mortgage-backed OBG programmes from “improbable” to “probable”.

The rating agency said that the revised TPIs reflect a stabilisation of Italy’s economy as well as improved funding conditions for banks, a high level of overcollateralisation maintained by Italian issuers, and the stable credit quality of cover pools. The decision by the rating agency to raise Italian TPIs and its rationale mirrored recent TPI upgrades by Moody’s of covered bond programmes in Ireland and Spain, noted covered bond analysts.

As a result of the TPI lift, the rating agency upgraded covered bonds issued by Banca Popolare dell’Emilia Romagna and OBGs issued under the residential mortgage covered bond programme of Banco Popolare from Baa2 to Baa1. It also upgraded commercial mortgage-backed covered bonds issued by Banco Popolare, from Baa3 to Baa2, and public sector-backed covered bonds issued by Intesa Sanpaolo from A3 to A2.

However, Moody’s maintained at “probable-high” the TPI assigned to a Banca Carige commercial mortgage-backed OBG programme (programme 2), noting that this already reflects the limited level of refinancing risk in the programme.

Moody’s had in December also flagged as credit positive changes to Law 130/99 that affect certain aspects of securitisations and covered bonds because they will reduce certain risks associated with servicer and debtor defaults. It said that the amendments to Law 130/99 improve the segregation of transaction funds and, in case of debtors’ default, limit potential clawbacks of prepayments.

Introducing SME covered

But the potentially more significant part of the legislative package that included the changes referred to by Moody’s — Law Decree 145, dubbed “Destinazione Italia” by the Italian government — was the creation of a new type of covered bond backed by assets such as SME loans. The legislation was ultimately passed by the Italian government on 19 February.

According to Fitch, the new bonds are outlined in Article 12 of the law decree, which adds provisions to Law 130. They are intended to provide banks with an additional funding tool and to encourage the banks to increase lending to companies. The provisions for the collateralised bank bonds are understood to draw on Article 7bis of Law 130.

The rating agency said that the “collateralised bank bonds” would be dual recourse bonds similar to OBGs, but secured by assets currently not eligible by law for OBG cover pools.

“These include corporate bonds, loans to small and medium enterprises (SME), shipping loans, and lease and factoring receivables, as well as tranches of securitisations backed by these assets,” said Fitch.

An official familiar with the law proposal said that Italian banks are generally in favour of SME-backed covered bonds, but that it is important for a clear distinction to be drawn between OBGs and the new debt instrument.

While some Italian market participants have been cautious in their expectations for the new instrument, Paolo Altichieri, head of finance at Banca Popolare di Vicenza, said that SME covered bonds could be enthusiastically welcomed by Italian financial institutions if certain key conditions are met.

Speaking at the 8th LBBW European Covered Bond Forum in early February, he said that there is currently a lot of uncertainty around covered bonds backed by loans to SMEs, but that he would take them up immediately if certain conditions were present, not least legislation.

Altichieri said that the Bank of Italy would then need to put in place specific rules governing the new instruments, saying that he would like to see it issue stringent criteria and transparent regulations.

“If these conditions come to pass, these covered bonds could prove very popular with Italian financial institutions,” he said.

Altichieri stressed the importance of the criteria that would be necessary on the types of loans that would be eligible, and the percentage of secured versus unsecured loans, for example. He noted that the Ministry of Economic Development — “putting lots of presents under the Christmas tree” — had also put together a framework for the issuance of securities by SMEs, and that this could provide a basis for standards for SME covered bonds.

According to Altichieri, Banca Popolare di Vicenza is the only Italian bank to have issued an SME ABS since 2005, having sold one in July last year, and he noted that one aspect of this that had been well received was that the average size of the loan was Eu153k — not much larger than the average residential mortgage and hence offering comparable granularity, which could help attract investors.

He said that SME covered bonds would be “one ingredient” in helping the flow of finance to SMEs, likely being better than ABS in terms of funding. A fall of 25% in lending to the real economy from 2008 to 2013 by Italian banks had occurred, which did not reflect a fall in demand for SME financing, and were SME covered bonds to take off, they would definitely be beneficial, Altichieri concluded.

A weaker credit proposition

Outlining how a new collateralised bank bond might be rated, Fitch said that liquidity gaps and the creditworthiness of the underlying pools, as assessed by the rating agency, could limit the uplift above the issuer rating for the new category of covered bonds. It said that any maturity mismatches between the cover assets and bonds post-issuer default would be difficult to bridge and that the new asset types are less tradable than those eligible for OBGs.

“Therefore the typical soft bullet redemption profiles of OBG rated by Fitch, which have a maturity date extension of up to 15 months, would not result in the same notching differential if applied to the collateralised bank bonds,” it said.

Fitch expects the credit quality of the assets eligible for this debt instrument to be worse or more volatile than those eligible for OBGs.

“Depending on the availability of performance data, this could either lead to higher breakeven overcollateralisation levels for a given rating level or limit the potential rating uplift of the new-style bond above the bank’s Issuer Default Rating (IDR),” it added.

Moody’s and DBRS have meanwhile highlighted that the new type of Italian covered bond lacks the systemic support provided for OBGs because under the new legal framework the Italian Ministry of Economy & Finance will differentiate the two bond types and the Bank of Italy will not provide any regulation.

“By comparison, OBGs are subject to specific supervision from the central bank in addition to that for the issuers, and must have an asset monitor,” said Moody’s.

Alongside permitting banks to use new asset classes in cover pools, the collateralised bond is not subject to the minimum capital ratio requirement for issuers, which is in place under OBG legislation. As a result, the rating agencies noted that smaller local banks, which cannot issue OBGs, will be able issue collateralised bonds.

“This raises the risk that collateralised bond pools from the smaller issuers would lack regional diversification,” said Moody’s. “They would be exposed to a higher default correlation between the collateral and the issuer and have less granularity versus OBG pools.”

DBRS noted that issuers are more likely to contractually include more flexible asset-liability matching terms such as a conditional pass-through structure in the contracts of the new bank bonds.

Pass-through bonds reduce the risk of asset fire sales following an issuer default, noted Moody’s. As a result of the long maturity extensions associated with pass-through bonds issuers are able to collect sufficient cashflow from the assets before repaying the bonds.

Issuers may also include residential and commercial mortgages which exceed the loan-to-value limit set by OBG regulations in the asset pools of the new bonds, according to the rating agency.

“The possibility of having a mixed cover pool for the new bonds would partly mitigate the concentration risk found in the new collateral type,” said Moody’s.

According to Moody’s, cumulative defaults on pools backing Italian SME and leasing transactions have consistently risen since 2010 and are higher than cumulative defaults on Italian prime residential mortgage-backed securities (RMBS).

Italy’s financial institutions have made haste to take advantage of renewed investor interest in the country and cast the outcome of their deals as a vote of confidence. Now they are seeking to extend this success via SME-backed covered bonds Neil Day and Susanna Rust report.

There was a time when the resignation of an Italian prime minister would have been enough to spark a bout of volatility in financial markets. But when Enrico Letta resigned as prime minister on 14 February, not only did the markets barely bat an eyelid, but Moody’s went on to raise the outlook on the country’s rating from negative to stable later that day.

Citing the “resilience” of Italy’s government financial strength in its action, the rating agency said: “Today’s resignation of prime minister Enrico Letta and the expectation that Matteo Renzi will head a newly formed government does not alter Moody’s expectations in this respect.”

The transition to the prime ministership of Renzi (pictured) was similarly smoothly accepted by the markets. And while not getting carried away, analysts have been positive on developments.

“Sentiment toward Italy is improving on the back of the formation of a new government with a constructive reform agenda and also by Moody’s decision last Friday to raise the outlook on Italy’s sovereign credit rating to stable from negative and affirm the rating at Baa2,” said Barclays’ analysts on 20 February. “Since the end of last week, 10 year Italian government bonds have outperformed German Bunds by about 10bp.

“Although there are still some implementation risks for the reform agenda and at this stage it is unclear to what extent a government under the leadership of Democratic Party Secretary Matteo Renzi could overcome the veto power of small parties belonging to the grand coalition government, our overall assessment of recent developments is positive.”

If confirmation were needed in the covered bond space that it was business as usual for Italy, Credito Emiliano provided that emphatically when it came to market on 18 February: its Eu750m five year OBG was more than three times oversubscribed.

The deal was first marketed at the 95bp over mid-swaps area and then priced at 88bp over on the back of a Eu2.5bn order book involving 120 investors. Barclays, BNP Paribas, Credit Suisse, HSBC, and Société Générale were bookrunners. A syndicate official at one of the leads said that the issue was priced some 25bp through Italian government bonds, flat to 5bp through the issuer’s curve, and roughly flat to where a new five year for its peer UBI Banca would come. He said Credem’s OBG was the best performing covered bond issue out of five deals totalling Eu4bn that were priced that week.

Gabriele Minotti, head of ALM and funding at the issuer, told The Covered Bond Report that Credito Emiliano took Moody’s revision of Italy’s outlook as a signal to proceed with the new issue after it had been eyeing the market for a week or so.

“We were in the right place at the right time,” he said. “This was a stellar performance.”

Minotti said the issuer was pleased with the level of foreign investment in the transaction, with domestic accounts taking only 36% of the bonds.

“The level of foreign investment shows that confidence has improved in both the bank and the country,” he said. “We are one of the few Italian banks to print at a double-digit spread and this is a good sign going forward.”

Minotti said that the bank intends to issue more frequently.

“We are planning to issue again in the second half of the year, following the maturity of an OBG in June,” he said. “Being on the market frequently is important as it improves customer confidence in the issuer and reduces the need to roadshow without losing the assurance of customer reception.”

The issuer is also aiming to further scale bank financing from the European Central Bank, which is at Eu3bn after Eu2bn was repaid last year, according to Minotti.

‘No concerns whatsoever’

Credito Emiliano’s deal came after peers Intesa Sanpaolo and UBI Banca had attracted strong demand two weeks earlier despite competing with two other euro covered bond benchmarks the same day. A Eu1bn 10 year OBG issue for UBI Banca was the pick of the quartet on 29 January, drawing some Eu4.4bn of demand in an hour of bookbuilding, while national champion Intesa Sanpaolo could also pull Eu2.2bn of orders for a Eu1.25bn 12 year issue.

This was despite the two peripheral issuers coming to a market that was only just reopening after a volatile period for the wider financial markets brought on by concerns about emerging markets.

The Italian transactions were “a clear sign that the periphery is better bid”, according to a syndicate official.

“It’s not a surprise in terms of spread and overall yield,” he said, “but more importantly it’s a clear sign that investors have no concern about these markets or credits whatsoever, and credit lines are available.”

UBI leads Barclays, Crédit Agricole, Goldman Sachs, Natixis, Société Générale and UniCredit set initial price thoughts at the 130bp over area and then guidance at the 120bp over area before fixing the spread at 118bp over. A lead syndicate official said the re-offer spread of 118bp over was “pretty impressive”, incorporating a relatively minimal new issue premium of some 3bp.

In the case of UBI, investors were getting some 45bp on the swap curve and 10bp on the credit curve, he said, citing outstanding UBI seven year OBGs at around 105bp over mid.

Intesa Sanpaolo’s 12 year OBG was priced at 108bp over mid-swaps, following guidance of the 115bp over area. The deal was the longest dated euro benchmark covered bond so far this year.

UniCredit had earlier reopened the Italian covered bond market for 2014 with a Eu1.5bn dual tranche OBG issue on 16 January that included a ground-breaking public euro FRN benchmark. The Eu1.5bn dual tranche transaction was split between a Eu500m three year floating rate note (FRN) and a Eu1bn 10 year fixed rate issue and was lapped up by investors.

Leads Crédit Agricole, Credit Suisse, Danske, ING, Natixis and UniCredit built a combined order book of around Eu3.6bn, post-reconciliation, with nearly 250 accounts involved, according to one of the leads. Each tranche was well oversubscribed, although demand was strongest for the 10 year fixed rate tranche, amounting to around Eu2.2bn, while some Eu1.4bn of interest was registered for the FRN.

The 10 year OBG was priced at 98bp over mid-swaps and the FRN at 57bp over three month Euribor, the tight end of guidance that followed two spread revisions. Syndicate bankers away from the leads were positive about the transaction, saying it was “a great deal”.

Waleed El Amir, head of strategic funding and portfolio at UniCredit, said that the transaction surpassed the issuer’s expectations, and vindicated what was a difficult call to proceed with the deal given a shaky market backdrop.

“It wasn’t an easy call for us but we felt that the weakness was in the peripheral senior unsecured and core covered bond market, and that the peripheral covered market was pretty healthy,” said El Amir. “I was surprised by how well the deal went.”

At 98bp over, the 10 year fixed rate tranche came 5bp inside where a one year shorter UniCredit OBG was trading at the time of pricing, according to El Amir, beating the issuer’s expectation.

“The double-digit spread is phenomenal,” he said. “In 2012 we priced a seven year at 295bp over, so the rally and growth in confidence in Italian credit has been incredible.”

‘Elegant’ FRN, fixed combo

While the issuer was convinced that the FRN tranche would be well received, the pricing of that was also better than expected, said El Amir.

The dual tranche structure is unusual in euro benchmark covered bonds, and the FRN was said to be unprecedented, with floating rate covered bonds hitherto limited to private, sub-benchmark size deals. Syndicate bankers involved in UniCredit’s deal as well as others considered the FRN a new product with the potential to become more widespread given structural and market shifts.

UniCredit’s El Amir said that the FRN was launched to take advantage of a bank treasury bid in covered bonds for Liquidity Coverage Ratio (LCR) and general investment purposes, and that the issuer felt FRN demand observed in senior unsecured would translate to the covered bond market.

The FRN also targeted accounts positioning themselves for eventual interest rate rises, he added.

The motivation and benefits for the issuer of the dual tranche deal were manifold, according to El Amir.

“It was a very elegant way of doing a large deal, diversifying our investor base, and doing something new,” he said. “It was also a clever way of averaging down the maturity, effectively to seven years.

“It cheapens the cost of funding while from an ALM perspective you stay roughly were you are on maturity, it attracts new investors and you move away from the concentration risk of having the entire deal mature in a single year.”

The issuer discussed doing an FRN on a standalone basis, but felt a dual tranche structure was the best way of testing the new product without exposing itself to too much execution risk, said El Amir.

“We typically issue Eu1bn deals, which may have been a stretch for an FRN and we also didn’t know if we really wanted to do that much for a three year FRN,” he added.

The leads and the issuer discussed sizing the FRN and fixed rate tranches at Eu750m each, according to El Amir, but decided to upsize the 10 year fixed rate tranche and downsize the FRN to stick to the issuer’s tradition of doing Eu1bn fixed rate deals.

Asset managers and banks drove the three FRN, taking 50% and 41%, respectively, followed by 6% for insurance companies and 3% for other accounts, according to one of the leads. Germany and Austria were allocated 30%, Italy 30%, France 11%, the UK and Ireland 9%, Iberia 9%, the Benelux 5%, Nordics 2%, Switzerland 1%, and others 3%.

CDP activates programme

In parallel to an easing of wholesale funding conditions for peripheral debt, the Italian government-owned fund Cassa depositi e prestiti (CDP) in the new year made inroads into an OBG purchase programme it had announced in November.

Having made its first purchases under the scheme in December, by early February, after the aforementioned Intesa, UBI and UniCredit deals but before Credito Emiliano’s, CDP had bought a total nominal amount of Eu550m, with three issues in its portfolio. By 10 March, with Credito Emiliano’s deal the only new OBG benchmark to have been priced in the interim, total buys under the purchase programme stood at Eu735m, across five OBGs, according to an update from a CDP spokesperson.

The purchase programme is part of a “Plafond Casa” initiative to stimulate residential mortgage lending, with CDP allocating up to Eu3bn to purchases of OBG issuance and securities of a similar nature.

The aim of the purchase programme is “to help improve the liquidity of this instrument, especially when the issuer is a small to medium-sized Italian bank, with the presence of a qualified institutional investor”, a spokesperson at CDP told The Covered Bond Report.

The intention is for this to help banks raise cheap funding by using their residential mortgage assets, with CDP’s involvement linked to issuers committing to use the funding to originate new residential mortgages, according to the spokesperson.

With two of the five OBGs in the CDP’s purchase programme portfolio UBI issues and another the aforementioned Intesa 12 year, an investor noted that it was “interesting to see that CDP assumes Intesa to be a small to medium-sized bank” and that Intesa and UBI are rated investment grade on a senior unsecured level.

The CDP spokesperson said that CDP asks representatives at the issuing banks to sign, before a deal is closed, a letter in which the institution commits to “irrevocably undertake to allocate the net proceeds of the Notes underwritten by CDP to the granting of new residential mortgage loans to Italian residents” and, upon request, “undertake to provide CDP with evidence of that allocation”.

According to the spokesperson CDP only buys OBGs under the purchase programme on the primary market, subject to eligibility criteria being met with respect to ratings, asset quality, and the maturity of the bond, with the size of CDP tickets capped at 25% of the total nominal bond amount issued.

TPI uplifts follow

As well as consolidating the improvement in sentiment towards Italy, Moody’s revision of the sovereign’s outlook from negative to stable had a more direct impact on several Italian banks and covered bonds it rates. Most immediately, Moody’s changed the outlooks of seven Italian financial institutions from negative to stable after the move on the sovereign, including those of UniCredit and Intesa Sanpaolo.

The rating agency then gave OBGs a boost when it on 21 February upgraded four Italian covered bonds after raising the Timely Payment Indicator (TPI) for all public sector-backed and almost all mortgage-backed OBG programmes from “improbable” to “probable”.

The rating agency said that the revised TPIs reflect a stabilisation of Italy’s economy as well as improved funding conditions for banks, a high level of overcollateralisation maintained by Italian issuers, and the stable credit quality of cover pools. The decision by the rating agency to raise Italian TPIs and its rationale mirrored recent TPI upgrades by Moody’s of covered bond programmes in Ireland and Spain, noted covered bond analysts.

As a result of the TPI lift, the rating agency upgraded covered bonds issued by Banca Popolare dell’Emilia Romagna and OBGs issued under the residential mortgage covered bond programme of Banco Popolare from Baa2 to Baa1. It also upgraded commercial mortgage-backed covered bonds issued by Banco Popolare, from Baa3 to Baa2, and public sector-backed covered bonds issued by Intesa Sanpaolo from A3 to A2.

However, Moody’s maintained at “probable-high” the TPI assigned to a Banca Carige commercial mortgage-backed OBG programme (programme 2), noting that this already reflects the limited level of refinancing risk in the programme.

Moody’s had in December also flagged as credit positive changes to Law 130/99 that affect certain aspects of securitisations and covered bonds because they will reduce certain risks associated with servicer and debtor defaults. It said that the amendments to Law 130/99 improve the segregation of transaction funds and, in case of debtors’ default, limit potential clawbacks of prepayments.

Introducing SME covered

But the potentially more significant part of the legislative package that included the changes referred to by Moody’s — Law Decree 145, dubbed “Destinazione Italia” by the Italian government — was the creation of a new type of covered bond backed by assets such as SME loans. The legislation was ultimately passed by the Italian government on 19 February.

According to Fitch, the new bonds are outlined in Article 12 of the law decree, which adds provisions to Law 130. They are intended to provide banks with an additional funding tool and to encourage the banks to increase lending to companies. The provisions for the collateralised bank bonds are understood to draw on Article 7bis of Law 130.

The rating agency said that the “collateralised bank bonds” would be dual recourse bonds similar to OBGs, but secured by assets currently not eligible by law for OBG cover pools.

“These include corporate bonds, loans to small and medium enterprises (SME), shipping loans, and lease and factoring receivables, as well as tranches of securitisations backed by these assets,” said Fitch.

An official familiar with the law proposal said that Italian banks are generally in favour of SME-backed covered bonds, but that it is important for a clear distinction to be drawn between OBGs and the new debt instrument.

While some Italian market participants have been cautious in their expectations for the new instrument, Paolo Altichieri, head of finance at Banca Popolare di Vicenza, said that SME covered bonds could be enthusiastically welcomed by Italian financial institutions if certain key conditions are met.

Speaking at the 8th LBBW European Covered Bond Forum in early February, he said that there is currently a lot of uncertainty around covered bonds backed by loans to SMEs, but that he would take them up immediately if certain conditions were present, not least legislation.

Altichieri said that the Bank of Italy would then need to put in place specific rules governing the new instruments, saying that he would like to see it issue stringent criteria and transparent regulations.

“If these conditions come to pass, these covered bonds could prove very popular with Italian financial institutions,” he said.

Altichieri stressed the importance of the criteria that would be necessary on the types of loans that would be eligible, and the percentage of secured versus unsecured loans, for example. He noted that the Ministry of Economic Development — “putting lots of presents under the Christmas tree” — had also put together a framework for the issuance of securities by SMEs, and that this could provide a basis for standards for SME covered bonds.

According to Altichieri, Banca Popolare di Vicenza is the only Italian bank to have issued an SME ABS since 2005, having sold one in July last year, and he noted that one aspect of this that had been well received was that the average size of the loan was Eu153k — not much larger than the average residential mortgage and hence offering comparable granularity, which could help attract investors.

He said that SME covered bonds would be “one ingredient” in helping the flow of finance to SMEs, likely being better than ABS in terms of funding. A fall of 25% in lending to the real economy from 2008 to 2013 by Italian banks had occurred, which did not reflect a fall in demand for SME financing, and were SME covered bonds to take off, they would definitely be beneficial, Altichieri concluded.

A weaker credit proposition

Outlining how a new collateralised bank bond might be rated, Fitch said that liquidity gaps and the creditworthiness of the underlying pools, as assessed by the rating agency, could limit the uplift above the issuer rating for the new category of covered bonds. It said that any maturity mismatches between the cover assets and bonds post-issuer default would be difficult to bridge and that the new asset types are less tradable than those eligible for OBGs.

“Therefore the typical soft bullet redemption profiles of OBG rated by Fitch, which have a maturity date extension of up to 15 months, would not result in the same notching differential if applied to the collateralised bank bonds,” it said.

Fitch expects the credit quality of the assets eligible for this debt instrument to be worse or more volatile than those eligible for OBGs.

“Depending on the availability of performance data, this could either lead to higher breakeven overcollateralisation levels for a given rating level or limit the potential rating uplift of the new-style bond above the bank’s Issuer Default Rating (IDR),” it added.

Moody’s and DBRS have meanwhile highlighted that the new type of Italian covered bond lacks the systemic support provided for OBGs because under the new legal framework the Italian Ministry of Economy & Finance will differentiate the two bond types and the Bank of Italy will not provide any regulation.

“By comparison, OBGs are subject to specific supervision from the central bank in addition to that for the issuers, and must have an asset monitor,” said Moody’s.

Alongside permitting banks to use new asset classes in cover pools, the collateralised bond is not subject to the minimum capital ratio requirement for issuers, which is in place under OBG legislation. As a result, the rating agencies noted that smaller local banks, which cannot issue OBGs, will be able issue collateralised bonds.

“This raises the risk that collateralised bond pools from the smaller issuers would lack regional diversification,” said Moody’s. “They would be exposed to a higher default correlation between the collateral and the issuer and have less granularity versus OBG pools.”

DBRS noted that issuers are more likely to contractually include more flexible asset-liability matching terms such as a conditional pass-through structure in the contracts of the new bank bonds.

Pass-through bonds reduce the risk of asset fire sales following an issuer default, noted Moody’s. As a result of the long maturity extensions associated with pass-through bonds issuers are able to collect sufficient cashflow from the assets before repaying the bonds.

Issuers may also include residential and commercial mortgages which exceed the loan-to-value limit set by OBG regulations in the asset pools of the new bonds, according to the rating agency.

“The possibility of having a mixed cover pool for the new bonds would partly mitigate the concentration risk found in the new collateral type,” said Moody’s.

According to Moody’s, cumulative defaults on pools backing Italian SME and leasing transactions have consistently risen since 2010 and are higher than cumulative defaults on Italian prime residential mortgage-backed securities (RMBS).

Italy’s financial institutions have made haste to take advantage of renewed investor interest in the country and cast the outcome of their deals as a vote of confidence. Now they are seeking to extend this success via SME-backed covered bonds Neil Day and Susanna Rust report.

There was a time when the resignation of an Italian prime minister would have been enough to spark a bout of volatility in financial markets. But when Enrico Letta resigned as prime minister on 14 February, not only did the markets barely bat an eyelid, but Moody’s went on to raise the outlook on the country’s rating from negative to stable later that day.

Citing the “resilience” of Italy’s government financial strength in its action, the rating agency said: “Today’s resignation of prime minister Enrico Letta and the expectation that Matteo Renzi will head a newly formed government does not alter Moody’s expectations in this respect.”

The transition to the prime ministership of Renzi (pictured) was similarly smoothly accepted by the markets. And while not getting carried away, analysts have been positive on developments.

“Sentiment toward Italy is improving on the back of the formation of a new government with a constructive reform agenda and also by Moody’s decision last Friday to raise the outlook on Italy’s sovereign credit rating to stable from negative and affirm the rating at Baa2,” said Barclays’ analysts on 20 February. “Since the end of last week, 10 year Italian government bonds have outperformed German Bunds by about 10bp.

“Although there are still some implementation risks for the reform agenda and at this stage it is unclear to what extent a government under the leadership of Democratic Party Secretary Matteo Renzi could overcome the veto power of small parties belonging to the grand coalition government, our overall assessment of recent developments is positive.”

If confirmation were needed in the covered bond space that it was business as usual for Italy, Credito Emiliano provided that emphatically when it came to market on 18 February: its Eu750m five year OBG was more than three times oversubscribed.

The deal was first marketed at the 95bp over mid-swaps area and then priced at 88bp over on the back of a Eu2.5bn order book involving 120 investors. Barclays, BNP Paribas, Credit Suisse, HSBC, and Société Générale were bookrunners. A syndicate official at one of the leads said that the issue was priced some 25bp through Italian government bonds, flat to 5bp through the issuer’s curve, and roughly flat to where a new five year for its peer UBI Banca would come. He said Credem’s OBG was the best performing covered bond issue out of five deals totalling Eu4bn that were priced that week.

Gabriele Minotti, head of ALM and funding at the issuer, told The Covered Bond Report that Credito Emiliano took Moody’s revision of Italy’s outlook as a signal to proceed with the new issue after it had been eyeing the market for a week or so.

“We were in the right place at the right time,” he said. “This was a stellar performance.”

Minotti said the issuer was pleased with the level of foreign investment in the transaction, with domestic accounts taking only 36% of the bonds.

“The level of foreign investment shows that confidence has improved in both the bank and the country,” he said. “We are one of the few Italian banks to print at a double-digit spread and this is a good sign going forward.”

Minotti said that the bank intends to issue more frequently.

“We are planning to issue again in the second half of the year, following the maturity of an OBG in June,” he said. “Being on the market frequently is important as it improves customer confidence in the issuer and reduces the need to roadshow without losing the assurance of customer reception.”

The issuer is also aiming to further scale bank financing from the European Central Bank, which is at Eu3bn after Eu2bn was repaid last year, according to Minotti.

‘No concerns whatsoever’

Credito Emiliano’s deal came after peers Intesa Sanpaolo and UBI Banca had attracted strong demand two weeks earlier despite competing with two other euro covered bond benchmarks the same day. A Eu1bn 10 year OBG issue for UBI Banca was the pick of the quartet on 29 January, drawing some Eu4.4bn of demand in an hour of bookbuilding, while national champion Intesa Sanpaolo could also pull Eu2.2bn of orders for a Eu1.25bn 12 year issue.

This was despite the two peripheral issuers coming to a market that was only just reopening after a volatile period for the wider financial markets brought on by concerns about emerging markets.

The Italian transactions were “a clear sign that the periphery is better bid”, according to a syndicate official.

“It’s not a surprise in terms of spread and overall yield,” he said, “but more importantly it’s a clear sign that investors have no concern about these markets or credits whatsoever, and credit lines are available.”

UBI leads Barclays, Crédit Agricole, Goldman Sachs, Natixis, Société Générale and UniCredit set initial price thoughts at the 130bp over area and then guidance at the 120bp over area before fixing the spread at 118bp over. A lead syndicate official said the re-offer spread of 118bp over was “pretty impressive”, incorporating a relatively minimal new issue premium of some 3bp.

In the case of UBI, investors were getting some 45bp on the swap curve and 10bp on the credit curve, he said, citing outstanding UBI seven year OBGs at around 105bp over mid.

Intesa Sanpaolo’s 12 year OBG was priced at 108bp over mid-swaps, following guidance of the 115bp over area. The deal was the longest dated euro benchmark covered bond so far this year.

UniCredit had earlier reopened the Italian covered bond market for 2014 with a Eu1.5bn dual tranche OBG issue on 16 January that included a ground-breaking public euro FRN benchmark. The Eu1.5bn dual tranche transaction was split between a Eu500m three year floating rate note (FRN) and a Eu1bn 10 year fixed rate issue and was lapped up by investors.

Leads Crédit Agricole, Credit Suisse, Danske, ING, Natixis and UniCredit built a combined order book of around Eu3.6bn, post-reconciliation, with nearly 250 accounts involved, according to one of the leads. Each tranche was well oversubscribed, although demand was strongest for the 10 year fixed rate tranche, amounting to around Eu2.2bn, while some Eu1.4bn of interest was registered for the FRN.

The 10 year OBG was priced at 98bp over mid-swaps and the FRN at 57bp over three month Euribor, the tight end of guidance that followed two spread revisions. Syndicate bankers away from the leads were positive about the transaction, saying it was “a great deal”.

Waleed El Amir, head of strategic funding and portfolio at UniCredit, said that the transaction surpassed the issuer’s expectations, and vindicated what was a difficult call to proceed with the deal given a shaky market backdrop.

“It wasn’t an easy call for us but we felt that the weakness was in the peripheral senior unsecured and core covered bond market, and that the peripheral covered market was pretty healthy,” said El Amir. “I was surprised by how well the deal went.”

At 98bp over, the 10 year fixed rate tranche came 5bp inside where a one year shorter UniCredit OBG was trading at the time of pricing, according to El Amir, beating the issuer’s expectation.

“The double-digit spread is phenomenal,” he said. “In 2012 we priced a seven year at 295bp over, so the rally and growth in confidence in Italian credit has been incredible.”

‘Elegant’ FRN, fixed combo

While the issuer was convinced that the FRN tranche would be well received, the pricing of that was also better than expected, said El Amir.

The dual tranche structure is unusual in euro benchmark covered bonds, and the FRN was said to be unprecedented, with floating rate covered bonds hitherto limited to private, sub-benchmark size deals. Syndicate bankers involved in UniCredit’s deal as well as others considered the FRN a new product with the potential to become more widespread given structural and market shifts.

UniCredit’s El Amir said that the FRN was launched to take advantage of a bank treasury bid in covered bonds for Liquidity Coverage Ratio (LCR) and general investment purposes, and that the issuer felt FRN demand observed in senior unsecured would translate to the covered bond market.

The FRN also targeted accounts positioning themselves for eventual interest rate rises, he added.

The motivation and benefits for the issuer of the dual tranche deal were manifold, according to El Amir.

“It was a very elegant way of doing a large deal, diversifying our investor base, and doing something new,” he said. “It was also a clever way of averaging down the maturity, effectively to seven years.

“It cheapens the cost of funding while from an ALM perspective you stay roughly were you are on maturity, it attracts new investors and you move away from the concentration risk of having the entire deal mature in a single year.”

The issuer discussed doing an FRN on a standalone basis, but felt a dual tranche structure was the best way of testing the new product without exposing itself to too much execution risk, said El Amir.

“We typically issue Eu1bn deals, which may have been a stretch for an FRN and we also didn’t know if we really wanted to do that much for a three year FRN,” he added.

The leads and the issuer discussed sizing the FRN and fixed rate tranches at Eu750m each, according to El Amir, but decided to upsize the 10 year fixed rate tranche and downsize the FRN to stick to the issuer’s tradition of doing Eu1bn fixed rate deals.

Asset managers and banks drove the three FRN, taking 50% and 41%, respectively, followed by 6% for insurance companies and 3% for other accounts, according to one of the leads. Germany and Austria were allocated 30%, Italy 30%, France 11%, the UK and Ireland 9%, Iberia 9%, the Benelux 5%, Nordics 2%, Switzerland 1%, and others 3%.

CDP activates programme

In parallel to an easing of wholesale funding conditions for peripheral debt, the Italian government-owned fund Cassa depositi e prestiti (CDP) in the new year made inroads into an OBG purchase programme it had announced in November.

Having made its first purchases under the scheme in December, by early February, after the aforementioned Intesa, UBI and UniCredit deals but before Credito Emiliano’s, CDP had bought a total nominal amount of Eu550m, with three issues in its portfolio. By 10 March, with Credito Emiliano’s deal the only new OBG benchmark to have been priced in the interim, total buys under the purchase programme stood at Eu735m, across five OBGs, according to an update from a CDP spokesperson.

The purchase programme is part of a “Plafond Casa” initiative to stimulate residential mortgage lending, with CDP allocating up to Eu3bn to purchases of OBG issuance and securities of a similar nature.

The aim of the purchase programme is “to help improve the liquidity of this instrument, especially when the issuer is a small to medium-sized Italian bank, with the presence of a qualified institutional investor”, a spokesperson at CDP told The Covered Bond Report.

The intention is for this to help banks raise cheap funding by using their residential mortgage assets, with CDP’s involvement linked to issuers committing to use the funding to originate new residential mortgages, according to the spokesperson.

With two of the five OBGs in the CDP’s purchase programme portfolio UBI issues and another the aforementioned Intesa 12 year, an investor noted that it was “interesting to see that CDP assumes Intesa to be a small to medium-sized bank” and that Intesa and UBI are rated investment grade on a senior unsecured level.

The CDP spokesperson said that CDP asks representatives at the issuing banks to sign, before a deal is closed, a letter in which the institution commits to “irrevocably undertake to allocate the net proceeds of the Notes underwritten by CDP to the granting of new residential mortgage loans to Italian residents” and, upon request, “undertake to provide CDP with evidence of that allocation”.

According to the spokesperson CDP only buys OBGs under the purchase programme on the primary market, subject to eligibility criteria being met with respect to ratings, asset quality, and the maturity of the bond, with the size of CDP tickets capped at 25% of the total nominal bond amount issued.

TPI uplifts follow

As well as consolidating the improvement in sentiment towards Italy, Moody’s revision of the sovereign’s outlook from negative to stable had a more direct impact on several Italian banks and covered bonds it rates. Most immediately, Moody’s changed the outlooks of seven Italian financial institutions from negative to stable after the move on the sovereign, including those of UniCredit and Intesa Sanpaolo.

The rating agency then gave OBGs a boost when it on 21 February upgraded four Italian covered bonds after raising the Timely Payment Indicator (TPI) for all public sector-backed and almost all mortgage-backed OBG programmes from “improbable” to “probable”.

The rating agency said that the revised TPIs reflect a stabilisation of Italy’s economy as well as improved funding conditions for banks, a high level of overcollateralisation maintained by Italian issuers, and the stable credit quality of cover pools. The decision by the rating agency to raise Italian TPIs and its rationale mirrored recent TPI upgrades by Moody’s of covered bond programmes in Ireland and Spain, noted covered bond analysts.

As a result of the TPI lift, the rating agency upgraded covered bonds issued by Banca Popolare dell’Emilia Romagna and OBGs issued under the residential mortgage covered bond programme of Banco Popolare from Baa2 to Baa1. It also upgraded commercial mortgage-backed covered bonds issued by Banco Popolare, from Baa3 to Baa2, and public sector-backed covered bonds issued by Intesa Sanpaolo from A3 to A2.

However, Moody’s maintained at “probable-high” the TPI assigned to a Banca Carige commercial mortgage-backed OBG programme (programme 2), noting that this already reflects the limited level of refinancing risk in the programme.

Moody’s had in December also flagged as credit positive changes to Law 130/99 that affect certain aspects of securitisations and covered bonds because they will reduce certain risks associated with servicer and debtor defaults. It said that the amendments to Law 130/99 improve the segregation of transaction funds and, in case of debtors’ default, limit potential clawbacks of prepayments.

Introducing SME covered

But the potentially more significant part of the legislative package that included the changes referred to by Moody’s — Law Decree 145, dubbed “Destinazione Italia” by the Italian government — was the creation of a new type of covered bond backed by assets such as SME loans. The legislation was ultimately passed by the Italian government on 19 February.

According to Fitch, the new bonds are outlined in Article 12 of the law decree, which adds provisions to Law 130. They are intended to provide banks with an additional funding tool and to encourage the banks to increase lending to companies. The provisions for the collateralised bank bonds are understood to draw on Article 7bis of Law 130.

The rating agency said that the “collateralised bank bonds” would be dual recourse bonds similar to OBGs, but secured by assets currently not eligible by law for OBG cover pools.

“These include corporate bonds, loans to small and medium enterprises (SME), shipping loans, and lease and factoring receivables, as well as tranches of securitisations backed by these assets,” said Fitch.

An official familiar with the law proposal said that Italian banks are generally in favour of SME-backed covered bonds, but that it is important for a clear distinction to be drawn between OBGs and the new debt instrument.

While some Italian market participants have been cautious in their expectations for the new instrument, Paolo Altichieri, head of finance at Banca Popolare di Vicenza, said that SME covered bonds could be enthusiastically welcomed by Italian financial institutions if certain key conditions are met.

Speaking at the 8th LBBW European Covered Bond Forum in early February, he said that there is currently a lot of uncertainty around covered bonds backed by loans to SMEs, but that he would take them up immediately if certain conditions were present, not least legislation.

Altichieri said that the Bank of Italy would then need to put in place specific rules governing the new instruments, saying that he would like to see it issue stringent criteria and transparent regulations.

“If these conditions come to pass, these covered bonds could prove very popular with Italian financial institutions,” he said.

Altichieri stressed the importance of the criteria that would be necessary on the types of loans that would be eligible, and the percentage of secured versus unsecured loans, for example. He noted that the Ministry of Economic Development — “putting lots of presents under the Christmas tree” — had also put together a framework for the issuance of securities by SMEs, and that this could provide a basis for standards for SME covered bonds.

According to Altichieri, Banca Popolare di Vicenza is the only Italian bank to have issued an SME ABS since 2005, having sold one in July last year, and he noted that one aspect of this that had been well received was that the average size of the loan was Eu153k — not much larger than the average residential mortgage and hence offering comparable granularity, which could help attract investors.

He said that SME covered bonds would be “one ingredient” in helping the flow of finance to SMEs, likely being better than ABS in terms of funding. A fall of 25% in lending to the real economy from 2008 to 2013 by Italian banks had occurred, which did not reflect a fall in demand for SME financing, and were SME covered bonds to take off, they would definitely be beneficial, Altichieri concluded.

A weaker credit proposition

Outlining how a new collateralised bank bond might be rated, Fitch said that liquidity gaps and the creditworthiness of the underlying pools, as assessed by the rating agency, could limit the uplift above the issuer rating for the new category of covered bonds. It said that any maturity mismatches between the cover assets and bonds post-issuer default would be difficult to bridge and that the new asset types are less tradable than those eligible for OBGs.

“Therefore the typical soft bullet redemption profiles of OBG rated by Fitch, which have a maturity date extension of up to 15 months, would not result in the same notching differential if applied to the collateralised bank bonds,” it said.

Fitch expects the credit quality of the assets eligible for this debt instrument to be worse or more volatile than those eligible for OBGs.

“Depending on the availability of performance data, this could either lead to higher breakeven overcollateralisation levels for a given rating level or limit the potential rating uplift of the new-style bond above the bank’s Issuer Default Rating (IDR),” it added.

Moody’s and DBRS have meanwhile highlighted that the new type of Italian covered bond lacks the systemic support provided for OBGs because under the new legal framework the Italian Ministry of Economy & Finance will differentiate the two bond types and the Bank of Italy will not provide any regulation.

“By comparison, OBGs are subject to specific supervision from the central bank in addition to that for the issuers, and must have an asset monitor,” said Moody’s.

Alongside permitting banks to use new asset classes in cover pools, the collateralised bond is not subject to the minimum capital ratio requirement for issuers, which is in place under OBG legislation. As a result, the rating agencies noted that smaller local banks, which cannot issue OBGs, will be able issue collateralised bonds.

“This raises the risk that collateralised bond pools from the smaller issuers would lack regional diversification,” said Moody’s. “They would be exposed to a higher default correlation between the collateral and the issuer and have less granularity versus OBG pools.”

DBRS noted that issuers are more likely to contractually include more flexible asset-liability matching terms such as a conditional pass-through structure in the contracts of the new bank bonds.

Pass-through bonds reduce the risk of asset fire sales following an issuer default, noted Moody’s. As a result of the long maturity extensions associated with pass-through bonds issuers are able to collect sufficient cashflow from the assets before repaying the bonds.

Issuers may also include residential and commercial mortgages which exceed the loan-to-value limit set by OBG regulations in the asset pools of the new bonds, according to the rating agency.

“The possibility of having a mixed cover pool for the new bonds would partly mitigate the concentration risk found in the new collateral type,” said Moody’s.

According to Moody’s, cumulative defaults on pools backing Italian SME and leasing transactions have consistently risen since 2010 and are higher than cumulative defaults on Italian prime residential mortgage-backed securities (RMBS).