The sovereign upgrade to A3, on stable outlook, reflects the sustained positive credit effects over the medium term of a series of economic and fiscal reforms, private sector deleveraging and ongoing strengthening of the banking sector, according to Moody’s.

The rating action on the government was accompanied by a lifting of Portugal’s country ceilings from Aa2 to Aaa, reflecting a six-notch gap for which Eurozone jurisdictions are typically eligible under the rating agency’s methodology.

On the back of the sovereign upgrade, Moody’s upgraded seven Portuguese banks, among them covered bond issuers Banco BPI (upped from A3 to A2), Banco Comercial Português (BCP/Millennium bcp) (Baa2 to A3), Banco Santander Totta (A3 to A2), Caixa Geral de Depósitos (CGD) (Baa1 to A3), Caixa Economica Montepio Geral (Banco Montepio) (Ba2 to Baa3), and Novo Banco (Ba3 to Ba1). Their counterparty risk (CR) assessments also improved.

“The increase in the starting points for the covered bond ratings (CB Anchor) enabled all Portuguese issuers to raise their mortgage covered bonds to the level of Aaa by maintaining the necessary overcollateralisation,” noted DZ analysts.

“The public sector covered bonds of Banco BPI were also upgraded, but only by one notch from Aa3 to Aa2. In our opinion, Moody’s rating methodology would have allowed a higher upgrade. We suspect that the issuer was not prepared to commit to the necessary overcollateralisation.

In upgrading the Portuguese mortgage programmes, the rating agency also noted that it had also lowered its refinancing margins for all Portuguese covered bonds, citing, in addition to macro improvements, a significant reduction in their spreads over the last years, and successful implementation of the EU covered bond directive, reinforcing their systemic importance.

The obrigações hipotecárias (OHs) of Caixa Económica Montepio Geral (Banco Montepio) had been downgraded from AA- to A in July, following a cut in its issuer default rating from B+ to B-.

Yesterday’s upgrade back from A to AA- is the result an improvement in the payment continuity uplift (PCU) under Fitch’s methodology from six to eight notches, which in turn reflects amendments to the covered bonds’ liquidity reserve and their CPT amortisation profile.

Previously, the alternative manager, who would be responsible for managing payments upon maturity extension, would only call upon the account bank holding the liquidity reserve for payment after a five day grace period and the triggering of a pass-through event – which occurs upon an issuer insolvency or non-payment of interest or principal. The timeline for receiving the funds was also not determined.

Following the programme amendments, drawings from the liquidity reserve are requested immediately after an issuer event or missed payment, and available one business day after a pass-through event is determined upon the end of the grace period.

The reserve is held by Elavon Financial Services DAC, rated AA-/F1+, on negative outlook.

The improvement in Banco Montepio’s PCU from six to eight notches brings it into line with the PCU typically assigned by Fitch to other CPT programmes.

The new rating is also based on a committed overcollateralisation (OC) level of 18%, which provides more protection than the breakeven OC level of 8% for the new, higher AA- rating (the breakeven OC for the previous A rating was 5%).

The prospectus containing the programme amendments was published on 4 December.

The covered bond rating is on negative outlook, alongside the issuer’s rating.

Article ammended to clarify comparables.

The new issue is Caixa Económica Montepio Geral’s first euro benchmark covered bond since 2009. The issuer converted an existing programme from soft bullet to conditional pass-through (CPT) format in mid-2016 and has no publicly issued benchmarks outstanding.

Following a European roadshow that concluded last week, leads JP Morgan, NatWest Markets and UniCredit launched the five year obrigações hipotecárias with initial price thoughts of the mid-swaps plus 75bp area this morning. Guidance was later revised to the 70bp area on the back of Eu1.4bn of orders.

The spread was ultimately fixed at 65bp and the size at Eu750m with books at Eu2.7bn, pre-reconciliation.

“Eu2.7bn demand is quite remarkable, and it shows that peripheral trades can go really, really well, with a pick-up,” said a syndicate banker.

Some peripheral markets widened over the last week on the back of concerns over developments in Catalonia, particularly the Spanish AT1 and Tier 2 markets. However, within covered bonds only Spanish cédulas have widened, and bankers said demand for new covered bonds from other peripheral countries had held up well after limited issuance – with Montepio’s deal only the fourth Portuguese benchmark of 2017.

Bankers said it was difficult to calculate fair value for the new issue given a lack of outstanding paper from Montepio and Portuguese comparables. However, they noted it offered an attractive pick-up versus two issues sold by Banco Santander Totta this year. A Eu1bn April 2024 issue for Totta was priced at 62bp in April and seen trading in the mid to low 20s, mid, today, while a Eu1bn September 2027 issue was priced at 48bp on 19 September was trading at around 35bp.

Montepio’s CPT covered bonds are rated A3/A/A (Moody’s/Fitch/DBRS) while Totta’s are rated A1/A/A by the same rating agencies. Totta’s covered bonds tend to trade well inside those of other Portuguese issuers.

The last euro benchmark five year from Portugal, a Eu1bn May 2022 issue for Banco Commercial Português, was priced at 65bp and seen trading at around 38bp, mid. BCP’s covered bonds are rated BBB+/A (Fitch, DBRS).

“You’d expect any other Portuguese issuer to price well back of Santander, so it is difficult to tell how much of the premium relates to this being Montepio’s first trade in a long time and how much relates to the CPT features,” said a syndicate banker.

Montepio’s CPT programme includes a number of features that are not found in those of established Dutch and Italian CPT issuers. These differences include that the maturity of individual bonds issued by Montepio can be automatically extended in the event of non-payment of any principal or interest due, and that the maturity extension can be for 50 years, whereas in the Netherlands this is limited to 32 years.

Montepio also offers a repurchase agreement allowing investors to sell bonds back to the issuer in the event of a maturity extension, within 10 to 60 days of the original redemption date. If Montepio does not fulfill this commitment, this will not constitute a covered bond default but will constitute a default in respect of the issuer’s senior unsecured obligations.

In the event of issuer insolvency, the maturity of all Montepio’s bonds will be automatically extended, as is conventional in other CPT programmes.

Analysts noted that the discretionary nature of the condition allowing the maturity extension of individual series means the programme may need to be adjusted should the European Commission’s eventual harmonised covered bond framework follow recommendations from the EBA.

Bankers said the strong demand for the new issue showed that these unfamiliar features did not dissuade many investors from participating in the deal.

“Investors who have significant issues with extendible structures to begin with are probably also less likely to get involved in deals from higher beta issuers like this one,” said one. “It’s a single-A rated note, so it’s not like we’re looking at a sub-investment grade NBG transaction, but the people already looking at this are probably less likely to be put off by the structural features.”

National Bank of Greece will conclude a European roadshow today ahead of an expected three year euro benchmark covered bond, which could be launched as soon as tomorrow (Tuesday), according to bankers at the leads. Like Montepio, its covered bonds are also conditional pass-through with the programme allowing for the extension of individual bonds and offering a put option.

Montepio on 1 July gained bondholders’ consent to convert two outstanding covered bonds from soft bullets to CPTs, in a move the issuer expected to result in upgrades of its covered bond ratings from Moody’s, Fitch and DBRS.

Fitch had on 17 May placed its BBB- rating of Montepio’s OHs on Rating Watch Evolving. Fitch said the rating action followed a downgrade of the bank from B+ to B on 12 May, but that the review would also take into account the issuer’s plans regarding the CPT restructuring.

The rating agency this morning upgraded the BBB- rating to A-, on stable outlook.

Fitch said the A- rating is now based on a Discontinuity Cap (D-Cap) revised from zero notches (full discontinuity) to six notches (very low), as well as Montepio’s Issuer Default Rating (IDR) of B, an unchanged IDR uplift of 1, and 18% contractual overcollateralisation (OC), which provides more protection than the 17.5% breakeven OC required for the A- rating.

Fitch said the D-Cap of six notches reflects its very low risk assessment related to the liquidity gap and systemic risk component, which is now driving the D-Cap for the programme.

“The agency revised this component from full discontinuity as it recognises the restructuring removes the need to refinance assets in order to meet timely payments on covered bonds, should the recourse switch to the cover pool,” it said.

Fitch added that the programme also benefits from a rolling three month liquidity reserve to cover interest payments on the covered bonds, held by Elavon Financial Services Limited, which Fitch rates AA.

“According to the programme documents, it is made available upon an issuer event or if triggered by a missed payment of interest, only after the five business day grace period has elapsed,” said the rating agency. “Fitch has taken this into account in its discontinuity assessment, as reflected by the ‘very low’ liquidity gap and systemic risk, instead of minimal discontinuity, which is typically assigned to CPT programmes with liquidity coverage.”

Montepio on 1 June announced a consent solicitation to convert to CPT structures two outstanding obrigações hipotecárias (OHs) – an Eu1bn December 2016 issue (PTCMKTOE0007) and a Eu500m May 2017 (PTCMGXOE0015), which are FRNs.

The meetings were held on Friday (1 July), with the quorum being 50% of the outstanding principal amount. The Portuguese issuer announced on Friday afternoon that the conversion had been approved, and said the changes were in force “regarding the already issued series under the programme and currently outstanding”.

Similar consent solicitations have typically offered fees for bondholders that vote in favour of proposed changes, but no fees were offered to participating Montepio bondholders, which some market participants said was unusual.

However, the two bonds targeted in the exercise were not initially placed publicly, and it is understood that they were retained before being sold on the secondary market. Montepio also has a third covered bond outstanding, a Eu500m December 2020 FRN, which is privately placed.

“The number of bondholders can therefore be assumed to be very manageable,” said analysts at DZ Bank. “The issuer itself, which also apparently holds the OHs affected, is also entitled to vote.

“Based on this information it is not surprising that the now usual ‘compensation’ of five basis points for this type of vote is not envisaged. It could well be that the bank has already reached agreement with the bondholders ahead of the actual voting rounds.”

Following the launch of the consent solicitation, Moody’s on 8 June placed its Baa1 ratings of Montepio’s mortgage covered bonds on review with direction uncertain. It said the review reflected the potential upward pressure on the ratings should the proposed changes be approved, but also the downward pressure on the covered bonds’ ratings following a downgrade of Montepio’s CR assessment from Ba3 to B1 on 7 June, which, the rating agency said, would have limited the covered bonds’ ratings at Baa2 should the restructuring have not been approved.

Fitch on 17 May placed its BBB- rating of Montepio’s OHs on Rating Watch Evolving, with no direction indicated. Fitch said the rating action follows a downgrade of the bank from B+ to B on 12 May, but that the review will take into account the issuer’s announcement that it intends to convert its covered bonds to CPT structures.

DBRS rates the OHs A.

Caixa Económica Montepio Geral noted its intention to convert its covered bonds to a CPT structure when announcing its results on 18 March.

On Wednesday it announced bondholder meetings for the holders of the two outstanding obrigações hipotecárias (OH), which are FRNs, to seek approval for their conversion from soft bullets to a CPT structure. As of the end of April, Montepio had one other OH outstanding, which is listed as a private placement by the issuer.

The Portuguese issuer added it has discussed the proposed changes with Fitch, Moody’s and DBRS.

“It is the issuer’s expectation, based on the issuer’s understanding of the relevant criteria published by the rating agencies, that the proposed changes will be ratings positive,” it said.

The bonds targeted in the consent solicitation are an Eu1bn December 2016 issue (PTCMKTOE0007) and a Eu500m May 2017 (PTCMGXOE0015).

The meetings will be held on 1 July, with a quorum of 50% of the outstanding principal amount. If the first meetings are not quorate, adjourned meetings will be held on 18 July. The quorum for the second meetings will be one or more persons representing any amount.

Similar consent solicitations have typically offered fees for bondholders that vote in favour of proposed changes, but no fees are offered to participating Montepio bondholders.

“That is unusual,” said a market participant. “This is the first exercise like this without a fee that I have seen.”

He noted that the two bonds targeted in the exercise were not initially placed publicly, and suggested that they were retained before being sold on the secondary market.

“If there were 80 or so investors holding these bond then they probably have to offer some kind of fee,” he said. “But if they sold off only a smaller amount to a few investors, maybe they figure they can just have discussions directly with them.

“But either way, from a ratings perspective the conversion would be positive for investors, so there is something in it for them, and if Montepio are looking to market these bonds at a later date then they will have a better chance with a single A-rating.”

He added that when Banca Monte dei Paschi di Siena (Banca MPS) converted its OBGs to CPTs last year, the switch had a positive impact on the market value of the bonds.

“The only caveat is under what circumstances it can extend,” he added, “and how much of an option there is for Montepio to extend – or whether they include some kind of structural feature that gives investors comfort that they won’t have that option.”

Fitch on 17 May placed its BBB- rating of Montepio’s OHs on Rating Watch Evolving, with no direction indicated. Fitch said the rating action follows a downgrade of the bank from B+ to B on 12 May, but that the review will take into account the issuer’s announcement that it intends to convert its covered bonds to CPT structures.

“At execution of the restructuring, Fitch would review its Discontinuity Cap (D-Cap) assessment,” the rating agency said. “If the liquidity gap and systemic risk is appropriately mitigated and Fitch does not identify issues on the other structural features proposed by the issuer, the agency would likely upgrade the OH to a rating up to the A+ Country Ceiling.”

Fitch had in January upgraded Montepio’s OH from BB+ to BBB-, after the Bank of Portugal identified the issuer as being systemically important at a domestic level. The designation meant that Fitch raised the IDR uplift for the programme from 0 to 1.

Moody’s in June 2015 also upgraded Montepio’s OHs to investment grade, lifting them three notches from Ba1 to Baa1, after assigning the issuer a Counterparty Risk assessment.

DBRS rates the OHs A.

If the proposed changes are implemented, Montepio will become the second Portuguese issuer with a CPT covered bond programme, following Novo Banco, which has not yet used its programme for public issuance.

RBS is the arranger.

On 29 December the central bank identified six Portuguese banks as other systemically important institutions (O-SIIs), among them Santander Totta and Montepio.

Fitch consequently raised the IDR uplift for the obrigações hipotecárias (OH) programmes of the two banks from 0 to 1 to reflect the domestically systemic importance of the issuers. Fitch said it believes that authorities, if necessary, are more likely to apply resolution methods other than liquidation to preserve important banking operations, including covered bonds.

“None of the issuers have a level of senior debt in excess of 5% total adjusted assets and Portugal is not considered a covered bond-intensive jurisdiction by Fitch,” it added.

Totta’s OH rating was upgraded from BBB+ to A-. Fitch said the new rating is based on the revised IDR uplift, Totta’s IDR of BBB, an unchanged discontinuity cap (D-Cap) of 0, and 15% overcollateralisation (OC) that Fitch takes into account in its analysis, which, it noted, provides more protection than the 8.5% breakeven OC required for the A- rating.

Fitch said 15% committed OC allows the OH to achieve at least 51% recoveries given default, which is commensurate with a one notch uplift from the revised BBB+ tested rating on probability of default.

Montepio’s OH rating was upgraded from BB+ to BBB-. Fitch cited the revised IDR uplift, Montepio’s IDR of B+, an unchanged D-Cap of 0 and 35% OC that Fitch takes into account in its analysis, which provides more protection than the 16.5% breakeven OC required for the BBB- rating.

Fitch said the 16.5% breakeven OC considers a three notch uplift for at least 91% recoveries given default from the revised BB- tested rating on probability of default.

Totta’s OH rating is on positive outlook while Montepio’s is on stable outlook, both reflecting the respective outlooks on the issuers’ IDRs, Fitch said.

The Bank of Portugal also identified Banco Comercial Português and Caixa Geral de Depósitos as O-SIIs, but Fitch said this had no impact on the ratings of the issuers’ OH ratings, as the programmes already benefitted from an IDR uplift of 1.

“Fitch believes resolution measures would apply to BCP and CGD, if needed, due to their large size and economic inter-connectedness,” it added.

Also designated O-SIIs were Banco BPI and Novo Banco.

The covered bond anchor for Moody’s Portuguese covered bond ratings is the CR assessment plus one notch.

Banco Santander Totta mortgage covered bonds were upgraded from A3 to A1 following the assignment of a Baa3 CR, those of BANIF from Baa3 to Baa2 with a B3 CR, and those of Caixa Económica Montepio Geral from Ba1 to Baa1 with a Ba3 CR.

Public sector covered bonds of Banco BPI were upgraded from Baa3 to Baa1 and its mortgage covered bonds from Baa2 to A3 after the assignment of a Ba2 CR. Banco Comercial Português’s mortgage covered bonds were upgraded from Ba1 to Baa1, and those of its Banco de Investimento Imobiliário subsidiary from Baa1 to A2 upon the assignment of Ba3 CRs.

Caixa Geral de Depósitos obrigações hipotecárias were upgraded from Baa2 to A3 after a CR of Ba2 was assigned. The covered bond upgrade came after Caixa Geral’s senior unsecured debt was downgraded from Ba3 to B1, on negative outlook, on Thursday as Moody’s concluded a review of six Portuguese banks’ ratings, which also saw the senior unsecured rating of Caixa Económica Montepio Geral upped from B2 to B1, on stable outlook, and others corresponding ratings affirmed on stable outlook.

Wolf Schumacher, Aareal CEO

Aareal cited a preliminary purchase price of Eu342m for the acquisition of Corealcredit, which it expects to be completed in the first half of the year. Corealcredit is the former troubled Allgemeine HypothekenBank Rheinboden, which US fund Lone Star took over in 2005 and turned into a specialist German commercial mortgage lender.

“By acquiring the newly realigned Corealcredit Bank, we are exploiting an attractive opportunity for inorganic growth at a favourable time,” said Aareal CEO Wolf Schumacher. “With this step, we are further expanding our position as one of the leading providers of commercial property financing, and at the same time making an active contribution to sustainably safeguarding the stability of an economically important segment of the German banking sector.”

Fitch affirmed Aareal Bank at A- on 27 December, and placed Corealcredit’s rating (BBB-) on Rating Watch Positive.

Mortgage covered bonds issued by Caixa Económica Montepio Geral were downgraded by Moody’s from Baa3 to Ba1 on 19 December and their rating left on review for downgrade. The cut followed a downgrade of Montepio’s issuer rating from Ba3 to B2. Moody’s said the review will take into account proposed bail-in-related changes to its methodology.

NCG Banco mortgage covered bonds (Ba1) are on review for downgrade, after Moody’s put the issuer’s B3 rating on review for downgrade on Monday. The issuer action followed the conditional sale of NCG Banco to Banco Etcheverria, part of Banesco Group of Venezuela.

Moody’s on 20 December put on review for downgrade mortgage covered bonds issued by AIB Mortgage Bank (Baa2), Bank of Ireland Mortgage Bank (Baa2), and EBS Mortgage Finance (Baa3), after downgrading the three issuing Irish banks’ senior unsecured ratings. It said the reviews will take into account the proposed changes to its methodology.

Unione di Banchi Italiane (UBI) was downgraded by Moody’s from Baa2 to Baa3, on negative outlook, on 18 December, but the rating agency affirmed the A2 rating of the bank’s OBGs the next day. The rating had previously been constrained by Italy’s A2 country ceiling and after the downgrade is constrained by the programme’s Timely Payment Indicator (TPI) of “improbable”.

The rating agency upgraded the ratings of BPI’s obrigações hipotecarias (OHs) from BBB to BBB+ and those of Caixa Económica Montepio Geral from BBB- to BBB. It also affirmed the ratings of OHs issued by Banco Comercial Português (BCP) and Caixa Geral de Depósitos, at BBB- and BBB, respectively. Fitch separately affirmed the rating of Banco Santander Totta OHs, at BBB.

The covered bond ratings are all on negative outlook to reflect the status of the issuer ratings and a negative outlook on the Portuguese residential mortgage market.

“The rating actions follow a full review of the programmes, and notably the revision of the breakeven level of overcollateralisation (OC) for a given rating, applying the agency’s updated covered bond master criteria and assumptions for assessing credit risk of Portuguese residential mortgage loans pools,” said Fitch. “In particular, Fitch has modelled recovery prospects for covered bonds subject to time subordination and to full discontinuity risk upon an issuer’s event of default.”

Fitch lowered the stressed refinancing spread assumptions used to calculate the net present value of future cashflows from Portuguese residential mortgages.

“The revised assumptions reflect the declining trend observed on spreads from secondary market Portuguese residential mortgage-backed securities and government bonds over the past three to five years,” it said, “but also takes into account the political instability and macroeconomic uncertainties surrounding the Portuguese economy.”

The upgrade of BPI’s OHs takes into account a reduction in the breakeven OC level in a BBB+ stress scenario from 35% to 32.5%, while in the case of Montepio the relevant breakeven OC decreased from 35% to 26% for a BBB scenario.