The Dutch central bank has sanctioned conditional pass-through (CPT) covered bond programmes because, all else being equal, they have favourable implications for asset encumbrance, a spokesperson told The CBR, and it is deciding upon its treatment of them.

De Nederlandsche Bank, Amsterdam

In a landmark transaction for the covered bond market Dutch bank NIBC on 1 October sold the first ever legislative benchmark covered bond with a partial pass-through structure, a Eu500m five year mortgage backed deal. (This followed an earlier Eu1m test trade).

The new benchmark issue was launched off a Eu5bn conditional pass-through covered bond programme that is registered with the Dutch central bank under the country’s covered bond regulatory framework and is therefore UCITS-compliant. NIBC’s CPT covered bonds also comply with the Capital Requirements Directive (CRD).

In response to questions from The Covered Bond Report, a spokesperson for De Nederlandsche Bank (DNB) said that CPT covered bonds are effective in mitigating asset-liability mismatches “and thus, ceteris paribus, require lower OC, which, as you say, has favourable implications in terms of asset encumbrance”.

“This is the reason DNB has officially allowed pass-through covered bonds by registering them (if issued in a separate programme), since a too high level of asset encumbrance may reduce the stability of the bank’s funding profile,” he said.

NIBC’s CPT programme was registered with DNB on 9 September, according to the central bank’s website. The issuer’s preparations for setting up such a programme date back to at least late last year, and it is around this time that the central bank published a definition of a conditional pass-through covered bond and related information in a Question & Answer section of its website.

Published on 20 December, the definition describes a CPT covered bond as “a covered bond which has an extension period that is longer than 24 months” and states that the extension period is the maximum term by which the covered bond company can postpone its contractual payment obligations, meaning that the covered bonds must be redeemed no later than the end of this period.

The central bank said that it distinguishes between standard and CPT covered bonds because there are differences with respect to the risks for investors and that although both types of bond can be issued under the supervision of DNB, they must be sold under separate covered bond programmes.

“Because of these differences in risk profiles, DNB considers it important that investors can immediately understand what is offered,” the spokesperson told The CBR. “Therefore DNB requires banks to issue traditional covered bonds and conditional pass-through covered bonds in different programmes as part of the requirements for registration of such a bond by DNB.”

Asked how this may reflect the central bank’s treatment of CPT covered bonds under its framework, for example with respect to repo, the spokesperson noted that the first Dutch CPT covered bond was issued last month, and said that “DNB is currently in the process of forming an opinion on the eligibility of conditional pass-through covered bonds”.

NIBC referred to “favourable liquidity treatment” of its CPT covered bonds in materials relating to its programme.

As part of its supervision of Dutch regulated covered bonds, DNB requires certain conditions to be met before it registers a programme and permits fresh issuance off it, and in the context of discussions around incentives for issuers to turn to CPT covered bonds market participants have pointed out that one of the DNB requirements is that covered bonds be rated at least AA-/Aa3.

Asked to confirm the minimum rating requirement and explain the rationale for it, the DNB spokesperson said that it is part of the regulatory requirements determined by the Ministry of Finance.

“The rationale is to safeguard a certain minimum quality for registered covered bonds,” he added.

NIBC soft bullet covered bonds are rated A+ by Fitch after having been downgraded to that level from AA- in July because the rating agency considers the programme to be “dormant”.

Hans Starrenburg, head of treasury at NIBC, told The CBR that a lack of rating stability in the issuer’s soft bullet programme was an important driver – together with a desire to exclude derivatives and associated burdens – of its move to explore an alternative and then set up the conditional pass-through covered bond programme. He pointed out that NIBC’s soft bullet covered bonds were still rated AA- by Fitch several months after the issuer began working on the pass-through structure, and that NIBC will no longer issue off the older programme.

The Dutch covered bond legal framework is principles-based, emphasising, according to DNB, the underlying objective of investor protection, rather than detailed formal requirements for the instrument, for example in relation to the type and composition of underlying assets.

However, changes to the Dutch covered bond legal framework are under discussion and include the possible introduction of some new rules. As previously reported by The CBR, changes being eyed include the introduction of a statutory minimum overcollateralisation (OC) level. A market participant suggested that this could replace the minimum rating requirement as an alternative credit quality threshold.

See here for more on possible changes to the Dutch framework.