RPT-Fitch: BaFin Role Looks Positive for Pfandbriefe, Needs Detail

Wed May 21, 2014 4:24am EDT

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May 21 (Reuters) - (The following statement was released by the rating agency)

The proposal to give BaFin powers to set individual minimum overcollateralisation (OC) levels for German Pfandbriefe may prove credit positive, as it could increase legal minimum OC requirements, Fitch Ratings says. But additional details are needed for a full assessment of the proposal's likely impact, including any positive or negative ratings implications.

The proposal, one of several suggested amendments to Germany's Pfandbrief Law, would enable BaFin to impose minimum OC requirements programme by programme. BaFin would review all German Pfandbrief programmes, and recommend increasing minimum OC where it thinks the current legal minimum - 0% on a nominal or 2% on a stressed net-present-value basis, as set out in the Pfandbrief law - is too low. BaFin's decision would be an administrative act, and therefore binding on the issuer, effectively superseding the current legal minimum requirement.

Increasing compulsory protection would be positive for bondholders, although the size of the increase would vary by programme. The mandatory nature of BaFin's decisions would eliminate the risk that if an issuer were facing insolvency it could remove assets from the cover pool to the new, higher minimum OC level. But important details, including BaFin's approach to assessing credit and market risk in covered bond programmes, remain unknown. The current NPV calculation used to determine legal minimum levels uses interest rate and currency stresses, but does not address the cover pool's credit risk or maturity mismatches between cover assets and outstanding covered bonds. It also remains unclear how frequently BaFin will review OC levels or incorporate changes in market conditions.

The potential impact on asset segregation will also be important. Specifically, more clarity is needed on treatment of voluntary OC held above BaFin's required minimum. The excess may imply that a corresponding proportion of cover assets would be deemed "obviously not needed" to repay Pfandbriefe, in line with existing provisions in the Pfandbrief Law.

This could increase the risk that, following enforcement of the recourse against the cover pool, the administrator could successfully demand the transfer of cover assets to the issuer's general insolvency estate, arguing that BaFin has set the level of OC necessary to pay back investors. This risk is not new, but the low current legal minimum OC would in our view make it very difficult to prove that any additional collateral is "obviously not needed" to repay covered bonds.

We expect BaFin to set some individual minimum OC levels above the current generic minimum requirements, but doubt they would be as high as the 'AAA' breakeven ratio calculated for rated Pfandbriefe, which currently range between 8% and 25%.

The ratings implications of the proposal are therefore unclear. Existing legal minimum OCs are insufficient to withstand our stresses for a timely payment of Pfandbriefe in rating scenarios above the issuer's rating, and raising legal minimum OCs could result in upgrades. But if the proposal reduced the cover assets available to secure investor claims, the new legally required minimum OC might be incompatible with existing high ratings.

The proposed amendments to the Pfandbrief Law are part of the German government's draft law for implementation of the European Bank Recovery and Resolution Directive.

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