The market’s reaction so far to Spain’s downgrade by Standard & Poor’s on Oct. 10 has been “inadequate,” according to a report by analysts at Bank of America Merrill Lynch.

The rating agency cut the sovereign’s long-term rating to the investment-grade cusp of ‘BBB-’ from ‘BBB+.’  

"[The downgrade] will unleash a wave a of downgrades by S&P of banks and covered bonds, and subsequently ABS/MBS,” the analysts said.

The BofA Merrill report noted that, in the secondary market, Spanish covered bonds last week shrugged off the S&P downgrade. “We continued to see buyers with a specific focus on the largest banks (Santander, BBVA, CaixaBank) and multi-cedulas,” the analysts said. Multi-cedulas refer to deals backed by assets pooled from more than one lender.

The analysts estimated that there is about €240 billion ($311 million) in Spanish covered bonds outstanding. The figure for ABS from the country is €180 billion, according to Moody’s Investors Service.

An argument in the report was that banks whose covered bonds will feel the cascading effect of the sovereign downgrade are unlikely to have the option of putting up more collateral, since assets are in short supply.

At any rate, the pool backing a Spanish issuer’s mortgage covered bonds already include all of the mortgages on its books.

The report also said that ABS/RMBS will get hit, either directly through the sovereign or through the eventual downgrades of derivative counterparties in the special purpose vehicles of these transactions. 

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