OREANDA-NEWS. Fitch Ratings has affirmed Banco Popolare's (BP, BBB/Negative/F3, Viability Rating (VR): bb+) EUR8.45bn mortgage covered bonds (Obbligazioni Bancarie Garantite, OBG), guaranteed by BP Covered Bond S.r.l. at 'BBB+' with a Negative Outlook. The affirmation follows a full review of the programme.

KEY RATING DRIVERS
The 'BBB+' rating is based on BP's Long-term Issuer Default Rating (IDR) of 'BBB', an unchanged (and still not applied) IDR uplift of 1, an unchanged Discontinuity Cap (D-Cap) of 1 (very high risk) and the 80.7% asset percentage (AP) that Fitch takes into account in its analysis, which provides more protection than the 'BBB+' breakeven AP that remains unchanged at 93%. The Negative Outlook on the OBG mirrors that on the issuer.

The level of AP the issuer commits to in its latest quarterly performance report (80.7% as of November 2014) continues to not be adequate to achieve a tested rating on a probability of default (PD) basis higher than BP's 'BBB' IDR, which is the floor for the OBG rating, because Fitch is not applying the IDR uplift of 1. The IDR uplift is currently not applied, because BP's IDR has a Negative Outlook for support reasons and a potential downgrade of BP's IDR to its VR is not expected to be fully compensated by the one-notch IDR uplift.

Furthermore, in a jump-to-default scenario, Fitch deems the exposure towards the account bank (Banco Popolare, London Branch) excessive, amounting to EUR1.3bn (12.9% of the cover pool) as of end-November 2014. As a result, Fitch continues to cap the tested rating on a PD basis to the issuer's 'BBB' IDR.

The covered bonds' rating is also constrained by the replacement provisions for the account bank, which limits the covered bond rating to 'BBB+'. The 80.7% AP would potentially allow the OBG to benefit from a two-notch uplift from the 'BBB' IDR, because recovery prospects in a 'A-' rating scenario would be expected to be at least 91%. However, due to the constraint on the 'BBB+' rating, Fitch applies a recovery uplift of one notch.

The major contributor to the 93% 'BBB+' breakeven AP, equivalent to 7.5% overcollateralisation (OC) and aligned with the level allowed by the programme documents, is the asset disposal loss component of 11.7%, followed by around 10.0% cash flow valuation and 7.2% credit loss components.

The asset disposal component, which is in line with the previous 12.7%, represents a stressed valuation of the full cover pool at half of the 'BBB+' refinancing spread for Italian mortgage loans (187.5bp). In a recovery scenario there is less pressure for an alternative manager to liquidate the portfolio.

The cash flow valuation of about 10.0% reflects open interest rate positions in an increasing interest rate scenario, which drives breakeven OC. Around 70% of the cover pool bears floating rate interest compared with 98% of the liabilities. Fitch calculates open interest rate positions after the swaps that hedge 45% of the cover pool and 62.7% of the OBG. The programme benefits from liability swaps provided by external counterparties. The swap documentation is in line with Fitch's criteria.

The unhedged portion of the portfolio comprises floating (46.0%), fixed rate loans (24.3%) and optional and modular loans (29.7%), with a weighted average (WA) margin and coupon of 4.9% and 1.5%, respectively. In a rising interest rate scenario, Fitch assumes that the loans with switching options would change to fixed rate, increasing the interest rate mismatches in the programme.

The credit loss component has increased to 7.2% from 5.0% reflecting a 'BBB+' WA frequency of foreclosure of 21.0% and a WA recovery rate of 68.2%. Fitch has worsened its loss expectations because the historical performance of the bank's residential mortgage book has continued to deteriorate and the vintages of default do not show signs of flattening.

RATING SENSITIVITIES
The 'BBB+' rating would be vulnerable to downgrade if BP's IDR is downgraded by four or more notches, disregarding counterparty-related issues. The rating of the covered bonds is not sensitive to changes to the D-Cap or to the breakeven AP. The rating is limited by OC constraints and counterparties rating caps and does not benefit from the full uplift which results from the D-Cap of 1 plus the two-notch recovery uplift.

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.