Fitch downgraded Banca Carige and Banca MPS OBGs to BBB- on Friday, but the programmes avoided a cut to sub-investment grade, in contrast to earlier expectations, because of an improvement the rating agency made to Italian Discontinuity Caps (D-Caps).

Banca Monte dei Paschi di Siena (MPS) obbligazioni bancarie garantite (OBGs) were downgraded from A to BBB- , while Banca Carige covered bonds were downgraded from BBB+ to BBB-. The programmes are on stable outlook.

The OBG downgrades followed rating actions on the IDRs of a range of banks, which included revisions to support assessments in conjunction with a Fitch review of sovereign support for banks. Among the rating actions were a downgrade of Banca MPS’s IDR by seven notches from BBB to B- and Banca Carige’s by three notches from BB to B.

After the IDR downgrades several analysts said that while the rating actions would not have a major impact on the covered bond market the OBGs of the two Italian issuers could be lowered to sub-investment grade status, adding that Banca Carige’s could have lost their CBPP3-eligibility.

However, on Wednesday Fitch announced a reassessment of the D-Cap for the affected programmes, revising from “very high” to “high” the liquidity gap and systemic risk assessment of a typical covered bond programme secured by Italian residential mortgage loans and with maturity extension of 12 to 15 months.

“This amendment is driven by the enhanced liquidity and funding profile of the Italian banking system, with a functioning interbank market, mainly in the form of secured transactions, and a reduced recourse, albeit still high, to funding via the European Central Bank (now mainly in the form of Targeted Long-Term Refinancing Operations),” said Fitch. “The updated assessment is also supported by the size of the Italian covered bonds market, with an increased number of active issuers, which could use their programmes to fund a potential portfolio acquisition, and a lower share of retained issuance than in the peak years of 2011 to 2014.”

For programmes where the liquidity gap and systemic risk is the weak link compared with other D-Cap components, Fitch said its assessment had moved from “very high” to “high”, leading to a D-Cap of 2 rather than 1. This increases the maximum uplift of the covered bonds’ ratings above the IDR from one to two notches.

“Under Fitch covered bonds criteria, a sovereign rated in the BBB category such as Italy would unlikely lead to a D-Cap higher than 1 (very high),” said Fitch, “however, departures from this may apply where access to liquidity is robust, which is the case for the Italian market.”

After this announcement, analysts had revised their expectations.

“With a D-Cap of 2, Banca MPS covered bonds could have more leeway to remain IG,” analysts at Société Générale, for example, said ahead of Fitch’s ultimate moves. “If the D-Cap was maintained at 1, given the current IDR of B-, we would have expected Banca MPS covered bond ratings to be downgraded by five notches to junk status.

“However, with a D-Cap of 2, we believe there is a possibility MPS covered bonds could be rated BBB-, all else being equal.”

Florian Eichert, head of covered bond and SSA research at Crédit Agricole, said that Fitch’s move looked “very much like a Monte and Carige-inspired methodology change”, given that the one extra notch afforded by the D-Cap change was exactly what was needed for their OBGs to remain investment grade.

“While it is obviously good for their programmes,” he said, “it is a little annoying to us as the predictability of rating agencies is substantially reduced if methodologies can be changed that way.”

Banca MPS covered bonds had widened more than 20bp on the back of Fitch’s downgrade of the issuer, but analysts at ING noted this (Tuesday) morning that the OBGs had tightened back in, citing, for example, July 2024 paper bid only 6bp wider than at the beginning of last week, at a Z-spread of 102bp.

Meanwhile, the OBG ratings of Banca Popolare di Sondrio and UniCredit were upgraded, from A to A+, on negative outlook, and from AA- to AA, on stable outlook, respectively.