OREANDA-NEWS. Fitch Ratings has placed two Italian mortgage covered bonds (Obbligazioni Bancarie Garantite, OBG) programmes on Rating Watch Positive (RWP), as follows:

OBG issued by Credito Emiliano S. p.A. (Credem, BBB+/Stable/F2) and guaranteed by Credem CB S. r.l., rated 'A+'

OBG issued by Mediobanca Spa (Mediobanca, BBB+/Stable/F2), rated 'A+'

The rating actions follow the publication of Fitch's "Counterparty Criteria for Structured Finance and Covered Bonds" and "Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum" on 18 July 2016. The rating action on Mediobanca's OBG also takes into account the annual review of the programme. Fitch will implement the criteria changes and resolve the RWP on both programmes within six months from the criteria publication date.

KEY RATING DRIVERS

The RWP on Credem's and Mediobanca's OBG programmes reflects the potential rating impact from Fitch's updated counterparty criteria. This clarifies that where the documented counterparty provisions are not fully in line with the criteria, the covered bonds can still be assigned a rating uplift above the maximum ratings envisaged by the criteria, provided that adequate protection is available to absorb counterparty-related losses at the OBG rating.

The 'A+' ratings of both programmes are currently constrained by, among others, the documented account bank replacement provisions. At present the maximum achievable rating for the OBG issued by Credem is 'AA-' and for Mediobanca is 'AA'. In accordance with its counterparty and covered bonds rating criteria, Fitch may reflect unmitigated counterparty risk in its discontinuity assessment and test the programmes' asset percentage (AP) at the respective rating levels.

Credem and Mediobanca act as internal swap counterparty on the liability swaps (93% and 100% of the outstanding OBG, respectively). According to the swap documentation, the hedging providers are considered eligible to support OBG rated in the 'AA' category with posting of collateral.

The Discontinuity Cap (D-Cap) of two notches assigned to both programmes is driven by the high discontinuity risk assessment of the liquidity gap and systemic risk, which also considers the sovereign IDR of 'BBB+'. Both programmes envisage a soft bullet liability structure and benefit from a three-month rolling reserve, which covers interests due on the OBG as well as senior expenses. Fitch believes the 12-month principal maturity extension is sufficient to successfully refinance the cover pool at a rating scenario up to two notches above the banks' IDR, as adjusted by the IDR uplift.

Credem

The 'A+' rating of the OBG is based on Credem's Long-Term Issuer Default Rating (IDR) of 'BBB+', an unchanged IDR uplift of zero notches, an unchanged D-Cap of two notches (high discontinuity risk) and the 76.6% AP that Fitch takes into account in its analysis, which provides more protection than the unchanged 78.5% 'A+' breakeven AP (corresponding to a 27.4% overcollateralisation (OC)).

The 76.6% highest AP observed in the last 12 months (as of October 2015 and without considering the cash balance on the account) allows the OBG to achieve a two-notch recovery uplift from the 'A-' tested rating on a probability of default (PD) basis.

The unchanged IDR uplift of zero notches reflects the bail-in exemption for fully collateralised covered bonds and that none of the factors Fitch considers in assigning an IDR uplift higher than zero are satisfied for this programme.

Mediobanca

The 'A+' rating of the OBG is based on Mediobanca's Long-Term IDR of 'BBB+', an unchanged IDR uplift of one notch, an unchanged D-Cap of two notches (high discontinuity risk) and the 71.6% AP that Fitch takes into account in its analysis, which provides more protection than the revised 86.5% (from 84%) breakeven AP (equivalent to 15.6% OC).

The IDR uplift of one notch reflects bail-in exemption for fully collateralised covered bonds and the cushion provided by senior unsecured in excess of 5% total adjusted assets.

The greatest contributor to the breakeven OC remains the asset disposal loss component of 17.7% (from 18.6%), which reflects a stressed evaluation of the entire cover pool based on half of the 'A+' 399bp rating spread levels that Fitch assumes for Italian mortgage loans. The cash flow valuation is 1.6% (from 2.0%), which reflects the excess spread available in the structure and the maturity mismatches between assets and liabilities (the weighted average life of the assets is 17.7 years (taking into account the extended amortisation profile and stressed prepayments) versus 6.7 years of the covered bonds).

In an increasing interest rate scenario, which drives the results for this programme, inflation-linked loans (69% from 76%) expose covered bonds investors to potential losses on principal and interest. This is factored into the agency's cash flow analysis and reflected in the asset disposal loss and cash flow valuation components. The revised credit loss is 7.6% and reflects the stressed weighted average default rate (21.7% at A+) and recovery rate (67.4% at A+) of the cover pool.

Fitch relies upon the 71.6% highest AP of the last 12 months (December 2015 and without considering the cash balance on the account) that allows the OBG to achieve a two-notch recovery uplift from the 'A-' tested rating on a PD basis, which is also the floor for this programme.

CRITERIA VARIATION

Mediobanca

The agency varied from its Covered Bonds Rating Criteria in order to analyse the 69% inflation-linked loans that are part of the cover pool (as of December 2015). The instalment amount, which comprises interest and principal, resets every 12 months and is capped at the inflation rate at that point in time. Increases or decreases in interest rates may determine a slower or faster principal repayment. In addition, a lengthening of the maturity date by a maximum of 10 years is envisaged by this product. Any principal left unpaid at that time is taken as a loss by the originator.

In an increasing interest rate scenario, which drives the breakeven AP for the programme, the amortisation profile of inflation-linked loans is stressed considering an inflation rate equal to half of the corresponding interest rate. In this scenario, the agency has modelled the programme's cash flows assuming that the principal loss that materialises after considering the loans maximum lengthened maturity is left unpaid.

In an increasing interest rates scenario, the interest component of the instalment that exceeds the instalment amount is not paid, as the instalment amount is capped at the inflation rate. Fitch has deducted from the interest revenues the amounts which are assumed to be lost in a scenario whereby the instalment amount is higher than the inflation rate. The rating impact of applying this criteria variation is undetermined.

In addition, Fitch varied from its Criteria Addendum: Italy - Residential Mortgage Assumptions and has not increased the frequency of foreclosure of the inflation-linked loans, instead of applying an adjustment of 1.2. In the agency's view, they do not expose the borrowers to a balloon payment risk. There is no rating impact from this criteria variation.

RATING SENSITIVITIES

Credem and Mediobanca

The 'A+' ratings of the OBG issued by Credem and Mediobanca will be upgraded provided sufficient OC is available in the programmes to protect against counterparty-related losses that may occur at rating scenarios above the 'A' rating category; otherwise the ratings will be affirmed.

Credem

All else being equal, the rating of Credem's OBG would be vulnerable to downgrade if any of the following occurs: (i) the IDR is downgraded by two or more notches to 'BBB-' or below; or (ii) the number of notches represented by the IDR uplift and the D-Cap is reduced to zero; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'A+' breakeven level of 78.5%.

If the programme nominal AP that Fitch considers in its analysis reaches the maximum contractual of 93%, the covered bond rating would likely be downgraded to 'A-', because this level of OC would limit the covered bond rating to one-notch above the IDR as adjusted by the IDR uplift.

Mediobanca

All else being equal, the rating of Mediobanca's OBG would be vulnerable to downgrade if any of the following occurs: (i) Mediobanca's IDR is downgraded by three or more notches to 'BB+' or below; (ii) the number of notches represented by the IDR uplift and Discontinuity Cap is reduced to zero; or (iii) the AP that Fitch takes into account in its analysis goes above the 86.5% breakeven AP for the 'A+' rating.

If the programme nominal AP that Fitch considers in its analysis reaches the maximum contractual of 82%, this would still provide enough protection in line with the 'A+' stresses.

The Fitch breakeven AP for the covered bond rating will be affected, among others, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore the breakeven AP to maintain the covered bond rating cannot be assumed to remain stable over time.