Standard & Poor’s yesterday (Wednesday) lowered mortgage covered bonds issued by Portugal’s Banco Santander Totta from A- to BBB because of a downgrade of the issuer and higher foreclosure frequency and refinancing assumptions linked to a cut of the sovereign in January.

The rating agency in January downgraded the sovereign from BBB- to BB, and on 14 February cut Totta’s issuer rating from BBB- to BB. The covered bonds are on negative outlook, reflecting the outlook on the issuer rating.

Totta’s mortgage covered bonds are a Category 2 programme under S&P’s covered methodology, with the rating agency identifying asset liability mismatch (ALMM) risk in the programme as “high”. This means that the bonds can be rated up to four notches above the issuer.

S&P’s downgrade of Portugal led it to increase its assumptions for the weighted average foreclosure frequency (WAFF) in Totta’s cover pool, from 14.5% to 18.85%, and for the programme’s refinancing spread. It said it has increased its target asset spread from 700bp to 1,000bp due to heightened observed spreads in Portuguese mortgage backed assets.

The rating agency said while its premise is that covered bonds would continue to perform in a stress scenario where the government has defaulted on its obligations, it considered that risks affecting programmes backed by Portuguese assets have increased materially due to heightened country risk, which is in part reflected in the negative BB rating of Portugal.

“As a result, the likelihood that these transactions could experience an unusually large adverse change in credit quality has also increased, in our view,” said S&P.

It believes that the covered bonds should be able to withstand losses that would be at least 1.3 times the initial loss expectations for S&P’s rating scenario.

The target credit enhancement needed to support the maximum uplift for Totta’s covered bond ratings has increased in line with the increased WAFF and refinancing spread assumptions, based on an unchanged asset and liability structure.

S&P said that it downgraded Totta’s mortgage covered bonds because the available credit enhancement in the programme is lower than the target credit enhancement and only commensurate with three notches of uplift above the ICR.