A new type of Italian covered bond that can be backed by SME loans and other assets ineligible under the obbligazioni bancarie garantite framework lacks the systemic support provided for OBGs because it is not regulated by the Bank of Italy, Moody’s said yesterday (Monday).

Banca d'Italia, Rome

The Italian government passed legislation introducing the new covered bond, described as a collateralised bond, on 19 February.

A clear distinction is made between OBGs and collateralised bonds under the law, according to Moody’s, with Italian lawmakers introducing the new bond in a separate article rather than incorporating it into the existing OBG article.

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 the rating agency.

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, Moody’s 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 the rating agency. “They would be exposed to a higher default correlation between the collateral and the issuer and have less granularity versus OBG pools.”

Alongside SME loans, issuers can also incorporate corporate bonds, commercial paper, shipping loans, lease and factoring receivables, and asset backed securities (ABS) backed by the aforementioned assets into their cover pools.

“These new asset classes pose higher credit risk than traditional mortgage OBG pools,” said the rating agency.

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).

Speaking at the a recent LBBW event (7 February), Paolo Altichieri, head of finance at Banca Popolare, said that there was a lot of uncertainty surrounding SME-backed covered bonds, but that they could be enthusiastically welcomed by Italian financial institutions if certain conditions are met. (See article here.)