Correct: Fitch Takes Rating Actions on 4 Italian Medium-Sized Banks' OBG Programmes
Fitch Ratings has affirmed the Italian mortgage covered bond (Obbligazioni Bancarie Garantite, OBG) programmes issued by Banca Carige S. p.A. - Cassa di Risparmio di Genova e Imperia (Carige, B-/Stable/B) and guaranteed by Carige Covered Bonds S. r.l.; Credito Emiliano S. p.A. (Credem, BBB+/Stable/F2) and guaranteed by Credem CB S. r.l.; and Banca Popolare di Sondrio - Societa Cooperativa per Azioni (BPS, BBB/Stable/F3). The Outlooks are Stable.
At the same time the agency is maintaining the 'BBB+' rating of the OBG issued by Banca Popolare di Milano (BPM, BB+/RWN/B) and guaranteed by BPM Covered Bond S. r.l., on Rating Watch Negative (RWN).
The rating actions follow the programmes' periodic review.
The Stable Outlooks and the RWN mirror that of the respective banks' Issuer Default Ratings (IDR). Fitch will resolve the RWN on BPM's covered bonds following the resolution of the RWN on the bank's IDR (see "Fitch Places BPM Covered Bonds Rating on Negative Watch" dated 27 April 2016 available at www. fitchratings. com).
A full list of rating actions, breakeven (BE) asset percentage (AP) and overcollateralisation (OC) components is available at the end of this rating action commentary.
KEY RATING DRIVERS
All the above-mentioned programmes have a soft-bullet amortisation profile with a principal maturity extension of 12 months (BPM, BPS and Credem OBG) and 15 months (Carige OBG) and benefit from a three-month rolling reserve, which covers interests due on the OBG as well as senior expenses.
This has led Fitch to assess the discontinuity risk as 'high', resulting in a Discontinuity Cap (D-Cap) of two notches for each programme, driven by the liquidity gap and systemic risk component. Fitch views a contractual principal maturity extension up to 15 months adequate to successfully refinance the cover pool at a rating scenario up to two notches above the banks' IDR, as adjusted by the IDR uplift.
Although the programmes are eligible for an IDR uplift, reflecting the bail-in exemption for fully collateralised covered bonds, the IDR uplift for these programmes continues to be of 0 notches as none of the factors that Fitch considers in assigning a IDR uplift higher than 0 are satisfied for these programmes.
The greatest contributor to the breakeven OC of the OBG issued by Carige, BPS and Credem is asset disposal loss, which accounts for 10.9%, 13.9% and 15.2% of OC respectively, and represents the cost of bridging maturity mismatches between assets and liabilities. The magnitude of this component is driven by large maturity mismatches (3, 4 and 4.1 years respectively) and the rating spread levels assumed for Italian residential mortgage loans and for mortgage loans granted to small and medium enterprises (SMEs) that Fitch uses to determine the stressed asset sale price (in a 'B' scenario 325bp and 425bp respectively).
The cash flow valuation component is the major contributor to the breakeven OC for the OBG issued by BPM, which absorbs 10.5% of OC. This is followed by the asset disposal loss at 9.3%, reflecting the stressed valuation of the entire cover pool after an assumed covered bonds default in a 'BBB+' scenario. Credem's OBG also show a fairly high cash flow valuation component at 10.7%. For both Credem and BPM, the cash flow valuation component is driven by interest rate mismatches between assets and liabilities and the interest type composition of the cover pools: optional loans represent 24.8% of the cover pool for BPM and 44.1% for Credem and floating-rate loans with a cap are 35.4% of BPM's cover pool and 2.2% of Credem's. In its cash flow analysis, Fitch has considered these loan types as fixed-rate loans in a rising interest rate scenario, which is the scenario that drives the rating of these programmes.
The negative cash flow valuation of Carige's (-2.7%) and BPS's (-5.0%) OBG reflects the presence of hedging structures as well as limited open interest rate positions (5.6% for Carige and 8.9% for BPS) and excess spread available over the life of the programme (2.9% and 9.2% respectively).
Credit Suisse International (A-/Stable/F1) acts as swap counterparty on the asset (71% of the cover pool) and on liability side (69% of the outstanding OBG) in Carige's programme. BNP Paribas (A+/Stable/F1) hedges 65% of the OBG issued by BPS whereas UBS Limited (A/Positive/F1) and Societe Generale (SG) (A/Stable/F1) provide hedging on BPM's fixed-rate covered bonds (25.8% of the liabilities). Credem is internal swap counterparty for 92.9% of Credem's OBG. The swap providers are eligible counterparties as per Fitch's criteria and in its analysis the agency considered post-swaps cash flows for the hedged assets or liabilities.
The cover pools of BPM, BPS and Credem comprise residential mortgage loans, while Carige's includes a limited portion of SMEs (6.3% as of February 2016). The 'B' portfolio loss rate reflects the cover pools' composition: 1% for Credem, 1.3% for BPS, 1.6% for BPM and 3% for Carige. These portfolio loss assumptions result in a 'BBB+' credit loss of 3.7% for BPM OBG, 'A+' credit loss of 6.4% for BPS OBG, 'A+' credit loss of 4.9% for Credem OBG and 'BB+' credit loss of 5.2% for Carige OBG.
In its analysis Fitch relied upon the AP publicly disclosed in the programmes' investor report for Carige's, BPM's and BPS's OBG. The highest nominal AP recorded in the last 12 months is considered for Credem's OBG, as the issuer has a Short-Term IDR of 'F2' and the programme is actively managed by the issuer.
Carige
The rating is based on Carige's Long-Term IDR of 'B-', an unchanged IDR uplift of 0 notches, an unchanged D-Cap of two notches and the 81.97% publicly disclosed AP (from the April 2016 investor report) that Fitch takes into account in its analysis, which provides more protection than the unchanged 89.5% 'BB+' breakeven AP (11.7% OC).
The breakeven AP considers whether timely payments are made in a 'B+' scenario (tested rating on a probability of default (PD) basis) and tests for recoveries given default of at least 91% in a 'BB+' scenario.
BPM
The rating is based on BPM's Long-Term IDR of 'BB+', an unchanged IDR uplift of 0 notches, an unchanged D-Cap of two notches and the 89% publicly disclosed AP (from the April 2016 investor report) that Fitch takes into account in its analysis, which is in line with the 89% 'BBB+' breakeven AP (12.4% OC).
The 89% publicly disclosed AP allows the OBG to achieve a three-notch recovery uplift from the 'BB+' tested rating on a PD basis, which is also the rating floor for the covered bonds. This level of AP provides for recoveries given default of at least 91% in a 'BBB+' scenario but it is not adequate to sustain timely payments in a 'BBB' scenario, given by the IDR adjusted by the IDR uplift and by the D-Cap.
Fitch has revised its assessment of the cover-pool specific alternative management to 'moderate' from 'moderate high' to factor in the improved quality and regularity of data delivery, which is now in line with peers; in Fitch's view this would translate into a smoother transition to an alternative manager once the bondholders' source of payment switches from the issuer to the cover pool.
BPS
The rating is based on BPS's Long-Term IDR of 'BBB', an unchanged IDR uplift of 0 notches, an unchanged D-Cap of two notches and the 78.74% publicly disclosed AP (from the April 2016 investor report) that Fitch takes into account in its analysis, which provides more protection than the revised 88.5% 'A+' breakeven AP (13.0% OC).
The change in the breakeven AP to 88.5% (from 83%) factors in the impact of the two new asset transfers occurred in December 2015 and January 2016, which reduced the open interest rate positions (to 8.9% from the previous 14% in a rising interest rate scenario), and of the new EUR500m series of OBG issued in April 2016, which reduced maturity mismatches between assets and liabilities (to 4 from 5.9 years). The breakeven AP considers whether timely payments are met in a 'A-' scenario (tested rating on a PD basis) and tests for recoveries given default of at least 91% in a 'A+' scenario.
Fitch's analysis of BPS's cover pool varied from the "Criteria Addendum: Italy - Residential Mortgage Assumptions". The agency applied a PD adjustment of 1.3 instead of 1.5 to the 39% portion of loans granted to SAE 614/615 borrowers (artisans and family run businesses as coded by the Bank of Italy) based on the observed levels of default rates which, in Fitch's view, warrant an adjustment smaller in magnitude than the one envisaged by the criteria.
The application of the above variation has no impact on the OBG programme's rating.
Credem
The rating is based on Credem's Long-Term IDR of 'BBB+', an unchanged IDR uplift of 0 notches, an unchanged D-Cap of 2 notches and the 75.4% nominal AP that Fitch takes into account in its analysis, which provides more protection than the revised 78.5% 'A+' breakeven AP (27.4% OC).
The revision of the breakeven AP to 78.5% (from 80.5% at the last programme review) is mainly driven by an increase in open interest rate positions (to 54% from around 50% in a rising interest rate scenario) following a EUR700m asset transfer in April 2016.
The 75.4% AP (highest nominal AP of the last 12 months, as of October 2015) would theoretically allow the OBG to reach the maximum achievable rating of 'AA-'. However, replacement provisions relating to the account bank limit the OBG rating at the 'A' category as per Fitch's current counterparty criteria. The programme AP provides for at least 91% recoveries on the covered bonds assumed to be in default in a 'A+' scenario and allows a two-notch recovery uplift from the 'A-' tested rating on a PD basis.
RATING SENSITIVITIES
Banca Popolare di Milano (BPM)
The 'BBB+' rating of the covered bonds issued by BPM and guaranteed by BPM Covered Bond S. r.l. would be vulnerable to downgrade if any of the following occurs: (i) BPM's IDR is downgraded by one or more notches to 'BB' or below; or (ii) the AP that Fitch considers in its analysis increases above Fitch's 'BBB+' breakeven level of 89%.
Banca Carige S. p.A. - Cassa di Risparmio di Genova e Imperia (Carige)
The 'BB+' rating of the covered bonds issued by Carige and guaranteed by Carige Covered Bonds S. r.l. would be vulnerable to downgrade if any of the following occurs: (i) Carige's Issuer Default Rating (IDR) is downgraded by one or more notches to 'CCC' or below; or (ii) the number of notches represented by the IDR uplift and the Discontinuity Cap (D-Cap) is reduced to one or lower; or (iii) the asset percentage (AP) that Fitch considers in its analysis increases above Fitch's 'BB+' breakeven level of 89.5%.
Banca Popolare di Sondrio - Societa Cooperativa per Azioni (BPS)
The 'A+' rating of the covered bonds issued by BPS would be vulnerable to downgrade if any of the following occurs: (i) BPS's IDR is downgraded by one 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 one or lower; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'A+' breakeven level of 88.5%.
Credito Emiliano S. p.A. (Credem)
The 'A+' rating of the covered bonds issued by Credem and guaranteed by CREDEM CB S. rl. would be vulnerable to downgrade if any of the following occurs: (i) Credem's 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 AP that Fitch considers in its analysis drops to the contractual limit of 93%, it would not be sufficient to allow for timely payment of the covered bonds following an issuer default. As a result, the rating of the OBG issued by Credem would likely be downgraded to 'A-', because this level of OC would limit the covered bond rating to one-notch recovery uplift above the IDR as adjusted by the IDR uplift.
The Fitch breakeven AP for the covered bond ratings 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.
The rating actions are as follows:
Carige OBG affirmed at 'BB+'; Outlook Stable with a breakeven AP of 89.5%
BE OC components: -2.7% cash flow valuation, 5.2% credit loss, 10.9% asset disposal loss
BPM OBG 'BBB+' rating maintained on RWN; breakeven AP of 89.0%
BE OC components: 10.5% cash flow valuation, 3.7% credit loss, 9.3% asset disposal loss
BPS OBG affirmed at 'A+'; Outlook Stable with a breakeven AP of 88.5%
BE OC components: -5.0% cash flow valuation, 6.4% credit loss, 13.9% asset disposal loss
Credem OBG affirmed at 'A+'; Outlook Stable with a breakeven AP of 78.5%
BE OC components: 10.7% cash flow valuation, 4.9% credit loss, 15.2% asset disposal loss
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