Italian issuance has underperformed a tightening covered bond market in recent weeks and the country’s economy has re-entered recession, but market participants have downplayed the weakness and cited multiple arguments in support of OBGs.

Bernd Volk, head of covered bond research at Deutsche Bank, yesterday (Tuesday) noted that there has been some weakness in Italian covered bonds recently, for example compared with cédulas, and that the iBoxx Italy Covered index was the only iBoxx covered bond index not to have tightened over the past four weeks, having widened slightly in that timeframe.

While the economies of fellow bailed-out countries Ireland, Portugal and Spain have started to grow after the broad recession induced by the financial and European sovereign crises, in Italy the economy shrank by 0.2% in the second quarter, following a 0.1% contraction in the first quarter. The recession is Italy’s third since 2008, according to Moody’s, which on Thursday said it is credit negative for Italy’s banks.

Deutsche’s Volk said he expects the recent economic contraction and uncertainty regarding credit quality of second tier Italian banks to dominate sentiment toward OBGs in the weeks to come, but that “the cover pool reports of Italian covered bonds continue to look rock solid”.

“While spreads of covered bonds of weaker Italian banks seem vulnerable in such an environment, besides the still high spread pick-up compared with covered bonds of international Italian banks, the usual arguments in favour of Italian covered bonds fully apply,” he added, citing covered bonds’ bail-in exemption under BRRD, relatively low asset encumbrance via covered bonds in Italy, low supply, high overcollateralisation, and the performing amortising low LTV owner-occupied residential mortgage loans backing obbligazioni bancarie garantite (OBGs) issuance.

A syndicate official today agreed that although Italian covered bond spreads have underperformed, but said the development is “negligible”, with cédulas for example some 3bp-4bp tighter over recent weeks and OBGs 1bp-2bp.

“Yes, there has been underperformance, but it’s not material,” he said, adding that there is still room for performance in second tier Italian covered bond issuance, in part because there has not been that much supply.

Besides a sole-led Eu500m five year issue for newcomer Banca Popolare di Sondrio on 29 July, a Eu1bn 10 year OBG for Banca Monte dei Paschi di Siena on 8 July was the last Italian covered bond benchmark to have hit the market after only two Italian benchmarks in the second quarter. MPS’s benchmark was priced at 148bp over mid-swaps, but was today said to be bid at 170bp over. Mediobanca priced a Eu750m five year issue at 51bp over on 10 June, and that was said to be at 50bp over bid after having been tighter.

Moody’s today said that Italian banks’ reliance on central bank funds is the largest compared with that of the Irish, Portuguese and Spanish banking systems, but that concerns about liquidity and the expiry of the ECB longer term refinancing operation (LTRO) in all four systems are greatly reduced by the ECB’s targeted LTRO (TLTRO), a switch to shorter term repos and improving market confidence.

“Market access is opening, even for weaker banks, and the pricing differential for funding continues to converge with core Europe,” said the rating agency. “These gains remain fragile, however, as market confidence could reverse quickly.”

In general, the covered bond market has rallied over the summer, with a syndicate official yesterday describing the tightening has “striking”. Another today said that Australian covered bonds have outperformed, due to speculation about favourable Liquidity Coverage Ratio (LCR) treatment, while another said he was taking secondary levels with a pinch of salt given light flows.

“Everything is tighter, but on small turnover,” he said.