A proposal to grant BaFin powers to set individual minimum OC levels for German Pfandbriefe may prove credit positive, but rating implications, including potential cuts of highly rated issuance, depend on important details that are as yet unknown, said Fitch.

The proposal is one of several suggested amendments to Germany’s Pfandbrief Act that are in turn part of the German government’s draft law for implementation of the Bank Recovery & Resolution Directive (BRRD).

According to Fitch the proposal would enable BaFin, the German financial supervisory authority, to impose minimum overcollateralisation (OC) requirements programme by programme, which it could recommend be higher than the prevailing legal minimums (0% on a nominal or 2% on a stressed net present value basis).

As an administrative act BaFin’s decision would be binding on the issuer, effectively superseding the prevailing legal minimum requirement, said the rating agency.

It said that the proposal may prove credit positive by increasing compulsory protection.

“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,” said Fitch.

However, it emphasised that important details remain unknown, such as how BaFin would assess credit and market risk in covered bond programmes and how frequently it would review OC levels or reflect changes in market conditions.

The rating implications of the proposal are unclear, said the rating agency, citing the possibility of upgrades and downgrades.

“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,” it said. “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 latter relates to questions about the proposal’s potential impact on asset segregation, specifically about the treatment of voluntary OC held above BaFin’s required minimum, according to Fitch.

It said that the excess OC 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 Act.

“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,” said Fitch.

Although the risk is not new, “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,” it added.

Fitch expects BaFin to set some individual minimum OC levels above the prevailing generic minimum requirements, but doubts they would be as high as the AAA breakeven ratio calculated for rated Pfandbriefe, which is presently between 8% and 25%.