OREANDA-NEWS. Fitch Ratings has assigned Mediobanca Spa's (Mediobanca, BBB+/Stable/F2) mortgage covered bonds (Obbligazioni Bancarie Garantite, OBG) an 'A+' rating with a Stable Outlook.

KEY RATING DRIVERS
The 'A+' rating is based on Mediobanca's Long-term Issuer Default Rating (IDR) of 'BBB+', an IDR uplift of 1, a Discontinuity Cap (D-Cap) of 2 notches (high risk) and the 58% asset percentage (AP) that Fitch takes into account in its analysis, which provides more protection than the 84% 'A+' breakeven AP. The Stable Outlook on the covered bonds' rating reflects the Stable Outlook on Mediobanca's IDR.

The IDR uplift of 1 takes into account the covered bonds exemption from bail-in and the protection provided by senior unsecured debt in excess of 5% of total adjusted assets.

The 58% AP that Fitch gives credit to provides for a two-notch recovery uplift from the 'A-' tested rating on a probability of default, which is also the floor for the covered bond rating given by the IDR, as adjusted by the IDR uplift. This level of AP allows at least 91% stressed recovery on the covered bonds assumed to be in default in an 'A+' rating scenario.

In its analysis, Fitch considers the highest AP of the last 12 months (September 2014: 58%), because the issuer has a Short-term rating of 'F2'. This level of AP would be adequate to reach the 'AA' maximum achievable rating on the covered bonds. However, the replacement provisions in the programme documentation limit the rating of the covered bonds to 'A+'.

The breakeven AP for the 'A+' rating is 84% (equivalent to 19% breakeven over-collateralisation (OC)). The main contributor is the asset disposal loss component, which counts for 18.6%. This represents a stressed evaluation on the entire cover pool once a default on the covered bonds is assumed. High refinancing spreads and large maturity mismatches between assets and liabilities lead to large asset disposal loss figures. Fitch's 'A+' refinancing spread assumption for Italian residential mortgages is 399bps. The weighted average (WA) life of the assets is 10.2 years versus 6.3 years for the covered bonds.

The cover pool's credit loss component increases the breakeven OC by 10.3%. This reflects the 'A+' WA foreclosure frequency of 20.8% and a WA recovery rate of 67.1% for the cover pool. The credit loss component exceeds the 6.8% expected loss as it factors in the net present value (NPV) of the principal loss that may arise from the 76% inflation-linked constant instalment and variable maturity loans in the pool.

The instalment of these loans resets every 12 months and the instalment amount, which comprises interest and principal, is capped at the inflation rate at that point in time. In an increasing interest rate scenario, the principal component reduces and the loan amortises at a slower pace; the maturity date can be extended by a maximum of 10 years and any unpaid principal beyond that date translates into a loss for the issuer and, potentially, for the covered bond holders. Fitch has factored this risk into its cash flow analysis via the NPV principal loss.

The cash flow valuation component of 2.0% reflects the open interest rate position (8.5%) between assets and liabilities and considers the loss of interest revenues that may occur in an increasing interest rate scenario, determined by the inflation rate cap to the instalment amount. Fitch has modelled current interest rate mismatches pre-asset swap; 91.5% of the cover pool comprises floating rate loans while the covered bonds are fixed rate, hedged via a liability swap provided by Mediobanca.

In its cash flow analysis, Fitch has modelled pre-asset swap cash flows. This is because in the agency's view, the total return asset swap provides strong support to the structure and replacing it under similar terms might be challenging, should Mediobanca's IDR fall below the 'BBB-' replacement trigger envisaged in the programme documentation.

The D-Cap of 2 notches is driven by the liquidity gap and systemic risk assessment. In a scenario where the recourse of the covered bonds switches from the issuer to the cover pool, Fitch believes that the extendible maturity of 12 months, as envisaged in the programme documentation, provides a sufficient mitigant to the risk of refinancing the cover assets to make timely payments on the covered bonds in rating scenarios up to two notches above the bank's IDR, as adjusted by the IDR uplift.

RATING SENSITIVITIES
All else being equal, the 'A+' rating of the covered bonds would be vulnerable to downgrade if any of the following occurs: (i) Mediobanca Spa's Issuer Default Rating (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 asset percentage (AP) that Fitch takes into account in its analysis goes above the 84% 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 'A+' rating of the covered bonds could also be affected by the net present value (NPV) of the principal loss on inflation-linked loans. The NPV may vary based on interest rates and would be closer to its face value moving towards the remaining life of the cover pool.

The Fitch breakeven AP for the covered bond rating will be affected, amongst 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.

More details on the cover pool and Fitch's analysis will shortly be available in a new issue report at, www.fitchratings.com.