The yield on 10 year BTPs exceeded 6% for the first time in the euro era this (Tuesday) morning, pushing Italy rapidly towards levels that have been judged unsustainable. However, analysts were measured in their verdicts on what the development could mean for covered bonds.

Italian bank shares were down again – alongside those of European banks with exposure to Italy – but BTP yields fell later in the morning. Italian finance minister Giulio Tremonti is leading efforts to get Eu40bn of austerity measures approved, with a vote on the package by Thursday being targeted.

Giulio Tremonti

In the case of other countries that have ultimately had to be bailed out, covered bond ratings have been dragged down by sovereign downgrades.

“It’s all sovereign driven,” said Florian Eichert, senior covered bond analyst at Crédit Agricole. “All the covered bonds are at the moment following what’s happening on the sovereign front.

“Greece, Ireland, and Portugal followed the sovereigns as well, widening very fast and very far.”

But although markets are pricing in the risk that Italy could go down the road of Greece and Portugal and rating pressure on the sovereign is already weighing on obbligazioni bancarie garantite, covered bond analysts said that they do not expect Italian covered bond ratings to drop as low as those of Portugal or Greece.

Covered bond programmes of five Italian institutions were placed on review for possible downgrade by Moody’s on 27 June, after the rating agency put 16 Italian financial institutions on negative review a day earlier. Moody’s had placed Italy’s Aa2 rating on review for possible downgrade on 17 June.

The rating agency said that if the issuers behind the mortgage backed programmes under review were to be downgraded below A3 then their Timely Payment Indicators (TPIs) could lead to downgrades of the respective covered bonds, to below Aaa.

Jan King, senior credit analyst at LBBW, said that Italy could follow the same path as Ireland or Portugal.

“I wouldn’t expect to see it be to the same extent as with Ireland or Portugal,” he said, “but the development will be the same.

“It’s not the fault of the Italian banks,” he added. “It’s bad luck for them and rather the fault of the Italian government.”

King added that Italian covered bonds had a good risk profile, but said that was not enough to save them from a sovereign-related downgrade.

“I think that the sovereign development,” he said, “the contagion from the increase in sovereign risk will probably outweigh the positive factors, which are the strong legal framework and collateral.

“The problem is that liquidity can dry up quickly,” he added, “and then whatever spread development you see, you cannot get out.”

UniCredit not only has OBGs outstanding, but its German subsidiary, UniCredit Bank, also issues Pfandbriefe. But the analysts were more relaxed about any impact on these.

“I doubt there will be a major contagion effect on Pfandbrief spreads, because they are two separate entities with two fairly separate investor bases,” said Eichert at Crédit Agricole. “We have seen a bit of nervousness in the Pfandbrief as well, but that has so far been rather limited. Most of the volatility with Italian covered bonds has been driven by sovereign volatility and we haven’t had that in Germany.

King at LBBW said he thinks a spread increase in Italian covered bonds could negatively affect the German subsidiary of UniCredit, but not to a large extent.

“I do not expect it to be material,” he said. “From the Italian bank perspective, UniCredit is among the strongest, or the strongest, banks in Italy, with systemic importance in three countries, Italy, Germany, and Austria.”

The cover pool of UniCredit Bank’s public sector Pfandbriefe comprises 96% German assets and Bernd Volk, head of covered bond research at Deutsche Bank, included them among a group of public sector Pfandbriefe backed by cover pools with an “overwhelming” majority of German assets. His research came on the back of data from the Bank for International Settlements showing that German banks have Eu162bn of exposure to Italy (with Eu181bn to Spain and total exposure to Greece, Ireland and Portugal of Eu189bn).

The issuers with public sector cover pools comprising the highest total peripheral exposure (including Belgium) are, according to Volk: WestLB with 6.5%, Eurohypo 7%, Münchener Hypothekenbank 7%, HSH Nordbank 7.5%, WL Bank 9.5%, Deutsche Postbank 15%, Deutsche Hypothekenbank 15.5%, Dexia Kommunalbank Deutschland 18.5%, Düsseldorfer Hypothekenbank 19.5%, Deutsche Pfandbriefbank (pbb) 20.5%, and DG Hypothekenbank 24.5%.

“OC is typically close to or even higher than the total peripheral exposure,” said Volk. “Of course, details regarding country distribution are crucial.

“We highlight that the German Bank Restructuring Act is clear regarding the exclusion of Pfandbriefe from direct burden sharing measures in case of bank restructuring,” he added. “Moreover, also the insolvency remoteness of voluntary OC seems clear, at least regarding anything available at time of bank insolvency and not being obviously excessive.”