OREANDA-NEWS. Fitch Ratings has affirmed UniCredit S.p.A.'s (UC, BBB+/Stable/F2) mortgage covered bond programmes (Obbligazioni Bancarie Garantite, OBG). A list of rating actions, breakeven (BE) asset percentage (AP) and the over-collateralisation (OC) components is at the end of this rating action commentary.

The affirmation follows the annual review of the programmes. The Stable Outlook on the soft bullet (SB) and conditional pass-through (CPT) programme reflects that on the bank's Long-term Issuer Default Rating (IDR). For the CPT programme it also reflects the cushion provided by the discontinuity assessment (D-Cap) of 8 notches.

KEY RATING DRIVERS
The main contributor to the BE OC for the SB is the 17.7% asset disposal loss (down from 19.6%) driven by the high refinancing spreads applied for Italian residential mortgage loans (415bps at 'AA'). Most of the OC is absorbed to bridge liquidity needs between amortising assets and soft bullet OBG.

The CPT programme has an asset disposal loss of 0% reflecting the absence of a forced sale of assets embedded in the CPT structure. The 17.2% credit loss component drives the BE OC and reflects the 'AA+' rating default rate of 40.1% and the rating recovery rate of 63.5%.

The asset assumptions for the CPT cover pool take into account that 19.6% comprises secured loans to Italian small and medium enterprises (SME), which Fitch considers riskier than residential mortgage loans. The cover pool also includes about 10% UC employee loans; Fitch has tested the sensitivity of the programme rating to the employee portion of the portfolio and believes that the treatment of employee loans is still not a rating driver based on the current portfolio composition.

The SB cover pool's credit loss of 13% (down from 14.2%) is the result of a 'AA' weighted average (WA) foreclosure frequency of 31.8% (down from 33.7%) mainly reflecting lower portfolio exposure to foreigners (12.6% compared to 13.1%) and a broadly unchanged WA recovery rate of 64%. The credit loss reflects also a cover pool comprising 32.4% broker-originated loans, which show higher arrears than the loans originated by the branch network. Fitch has reflected this in its default assumptions.

The SB cash flow valuation component of -3% (from -4.2%) reflects hedged interest rate positions and a longer WA life of the cover pool than the covered bonds, which leads to a higher net present value of the assets than that on the liabilities. The programme benefits from an asset and liability swap, on the fixed rate OBG, to mitigate interest rate risk.

The CPT cash flow valuation is 7.7% (down from 10%), which mainly reflects open interest rate positions (19.7%) under a decreasing interest rates scenario, which is the most stressful scenario under Fitch's assumptions, 16.9% of the portfolio is fixed rate versus 36.6% fixed rate-OBG. The cash flow valuation decrease is also due to a better WA life asset-liability mismatch of 5.5 years down from 6.6.

For both programmes, the 'A-' OBG rating floor results from the 'BBB+' bank's IDR, as adjusted by the unchanged IDR uplift of 1, which reflects Fitch's view on the use of resolution method other than liquidation based on the complexity and the systemic importance of the issuer. Italy is not a covered bonds intensive jurisdiction, and there is no protection provided by senior unsecured debt, which is below the level of 5% of total adjusted assets.

KEY RATING DRIVERS - UC SB
The 'AA' rating is based on UC's IDR of 'BBB+', an unchanged IDR uplift of 1, an unchanged D-Cap of 2 notches (high risk) and the 72.1% AP that Fitch takes into account in its analysis, which provides more protection than the 80.5% 'AA' BE AP (equivalent to 24.2% BE OC). The 72.1% AP allows a two-notch uplift for recoveries given default above the 'A+' tested rating on a probability of default (PD) basis, which is commensurate with recoveries given default of at least 91%.

Fitch has revised the BE AP for the 'AA' rating to 80.5% from 79% (26.6% OC) mainly driven by the reduction in the credit loss.

The unchanged D-Cap of 2 notches is due to the weak link assessment of liquidity gap and systemic risk component. In a scenario where the recourse of the covered bonds switches from the issuer to the cover pool, Fitch expects the 12-month maturity extension that is envisaged in the documentation to be sufficient to successfully refinance the cover pool in a stress scenario two notches above the IDR, as adjusted by the IDR uplift.

The AP of 72.1% that Fitch took into account in its analysis is the highest nominal AP of the last 12 months (as of June 2015); the agency relies on the highest nominal AP of the last 12 months because the issuer's Short-Term IDR is 'F2' and the programme is not dormant.

KEY RATING DRIVERS - UC CPT
The 'AA+ 'rating is based on UC's IDR of 'BBB+', an unchanged IDR uplift of 1, a D-Cap of 8 notches (minimal discontinuity risk) and the 80% AP that Fitch takes into account in its analysis, which provides more protection than the unchanged 81.5% 'AA+' breakeven AP (equivalent to 22.7% breakeven OC).

The 80% AP that the issuer publicly discloses in its investor report (latest available July 2015) supports timely payments at 'AA-', which is the tested rating on PD, and allows a two-notch uplift for recoveries given default which is commensurate with recoveries given default of at least 91%.

The unchanged D-Cap of 8 notches reflects Fitch's minimal discontinuity risk assessment related to CPT amortisation profile of the covered bonds and the extendible maturity of 38 years, which in Fitch's view eliminate the risk of refinancing, should the recourse switch to the cover pool.

RATING SENSITIVITIES
UC Soft Bullet
The 'AA' rating of the Obbligazioni Bancarie Garantite (OBG) issued by UniCredit S.p.A. (UC) and guaranteed by UniCredit BpC Mortgage S.r.l. would be vulnerable to downgrade if (i) the Long-Term Issuer Default Rating (IDR) is downgraded by one or more notches to 'BBB'; or (ii) the number of notches represented by the IDR uplift and Discontinuity Cap (D-Cap) is reduced to 2; or (iii) the asset percentage (AP) that Fitch relies upon goes above the 80.5% 'AA' breakeven AP.

In addition, if the AP that Fitch considers in its analysis goes to the contractual limit of 93% the OBG would likely be downgraded to 'A'.

UC Conditional Pass-Through
The 'AA+' rating of the OBG issued by UC and guaranteed by UniCredit OBG S.r.l. would be vulnerable to downgrade if any of the following occurs: (i) the IDR is downgraded to 'B+' or below; or (ii) the number of notches represented by the IDR uplift and the D-Cap is reduced to 3 or below; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'AA+' breakeven level of 81.5%.

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.

The rating actions are as follows:

UC SB - UC OBG guaranteed by UniCredit BpC Mortgage S.r.l. affirmed at 'AA'; Outlook Stable with a BE AP of 80.5%
BE OC components: -3% cash flow valuation, 13% credit loss, 17.7% asset disposal loss

UC CPT - UC OBG guaranteed by UniCredit OBG S.r.l. affirmed at 'AA+'; Outlook Stable with a BE AP of 81.5%
BE OC components: 7.7% cash flow valuation, 17.2% credit loss, 0% asset disposal loss.