OREANDA-NEWS. Fitch Ratings has affirmed Banca Popolare di Milano (BPM; BB+/Stable/B) EUR3.7bn mortgage covered bonds (Obbligazioni Bancarie Garantite; OBG) at 'BBB+'. The Outlook is Stable.

The affirmation follows the annual review of the programme.

KEY RATING DRIVERS
The 'BBB+' rating is based on BPM's Long-term Issuer Default Rating (IDR) of 'BB+', an unchanged IDR uplift of 0, an unchanged Discontinuity Cap (D-Cap) of 2 (high risk) and the 88% asset percentage (AP) that Fitch takes into account in its analysis, which provides more protection than the unchanged 89% 'BBB+' breakeven AP. The Stable Outlook on the OBG reflects that on BPM's IDR.

The 88% AP that the issuer publicly discloses in its latest investor report (as of September 2015) allows the covered bonds to achieve a three-notch recovery uplift from the 'BB+' tested rating on a probability of default basis, which is also the rating floor. This level of AP provides for at least 91% recoveries on the covered bonds assumed to be in default in a 'BBB+' scenario but prevents timely payments above the 'BB+' rating floor.

The greatest contributors to the 'BBB+' breakeven AP (equivalent to an overcollateralisation (OC) of 12.4%) are asset disposal and cash flow valuation, accounting for 10.4% and 9.6% OC, respectively. The asset disposal represents a stressed valuation of the cover pool and is driven by the refinancing spreads assumed for Italian residential mortgage loans (375bp at BBB+) and maturity mismatches between assets and liabilities. The weighted average (WA) life of the assets is 9.9 years versus that on the bonds of 1.8 years.

The cash flow valuation is also driven by open interest rate positions, which account for 35% in an increasing interest rate scenario. Fitch assumes optional loans (24.9% of the pool) to switch to a fixed rate and floating rate loans with cap (35.3% of the pool) to reach their WA cap. On the liabilities side, the EUR0.88bn fixed-rate covered bonds are hedged via fixed to floating swaps and the cash flows are modelled after the swap.

The cover pool composition is broadly in line with the last review and the credit loss component is 3.3%. This reflects a 'BBB+' WA frequency of foreclosure of 14.1% and a 'BBB+' WA recovery rate of 77.2%.

The D-Cap remains of 2 notches driven by the high risk assessment of the liquidity gap and systemic risk component. The IDR uplift of 0 reflects the exemption of the covered bonds from bail-in, Fitch's view that Italy is not a covered bonds intensive jurisdiction, the fact that the issuer is not a systemically important bank and the level of protection offered by senior unsecured below 5% of the total adjusted assets.

RATING SENSITIVITIES
The 'BBB+' rating of the covered bonds would be vulnerable to downgrade if any of the following occurs: (i) Banca Popolare di Milano's Issuer Default Rating is downgraded by one or more notches to 'BB' or below, or (ii) the asset percentage (AP) that Fitch gives credit to increases above the 89% 'BBB+' breakeven AP.

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 absence of new issuance. Therefore the breakeven AP to maintain the covered bond rating cannot be assumed to remain stable over time.