New powers to increase minimum OC that are expected to be granted to the German regulator as part of an update of Germany’s covered bond legislation are credit positive, Moody’s said yesterday (Monday). The vdp sees it as a valuable addition, but wants to avoid its use leading to misunderstandings.

Moody’s comment comes after the German government on Wednesday published its draft for an update to the Pfandbrief Act. The rating agency sees as the most prominent new feature a new power granted to BaFin, the German financial services authority, to unilaterally increase the minimum level of overcollateralisation (OC) for a covered bond programme above a minimum 2% required by the Pfandbrief legislation.

“This amendment strengthens the high level of specific supervision for the Pfandbrief product and improves its overall credit quality by allowing regulators to adjust collateral requirements based on the specific risk characteristics of individual covered bond programmes,” said Moody’s.

It noted that the risk profiles of Pfandbrief programmes differ “remarkably” because of rather wide eligibility criteria under the Pfandbrief Act, which imposes only limited restrictions on the geographic location of cover assets and the share of commercial loans in mortgage cover pools.

“A minimum OC over and above the one-size-fits-all 2% current requirement will allow covered bondholders to benefit from more tailor-made overcollateralisation levels in accordance with the risk profile of a particular programme,” said Moody’s.

It is unclear how BaFin will use its new power, added the rating agency – it could react quickly to specific market events or take a long term view depending on the expected asset mix of a given programme.

The Association of German Pfandbrief Banks (vdp) sees BaFin’s power to prescribe a collateral “add-on” as a sensible addition to the statutory 2% minimum OC requirement, according to Otmar Stöcker, managing director at the vdp.

Writing in the vdp’s third quarter 2014 newsletter, which was published at the beginning of the month, he said that BaFin will examine every Pfandbrief cover pool to check if the 2% minimum OC is sufficient; if not, it can via an administrative act require a top-up. Pfandbrief issuers get a chance to comment in advance of such a move, he said, which allows issuers to prepare for any higher OC requirement.

The vdp is keen that any use by BaFin of its new power neither leads to misunderstandings nor stigmatises affected Pfandbrief issuers, according to Stöcker.

He said that there have already been suggestions that BaFin requiring a given issuer to increase OC could be seen as meaning that the bank in question has difficulties and is possibly close to being wound up.

The vdp is therefore working to ensure that the preamble to the updated Pfandbrief Act stresses that BaFin’s OC examinations and potential stipulations of additional collateral are a standard element of the regulator’s specific supervision relating to Pfandbriefe and cover pools.

In a similar vein, the association is also keen that when BaFin first applies its new power it examines multiple Pfandbrief issuers’ cover pools in parallel and issues any administrative acts in one go.

Another feature of the envisaged updated Pfandbrief Act, according to the vdp, is the introduction of an additional Pfandbrief “reporting system”. This would cover the financial position of cover pools and is intended to ensure that BaFin has the authority and the skills it needs in the event that a Pfandbrief bank is subject to supervision by the European Central Bank. The details of this new reporting system are to be set out in a separate regulation, according to the association.

The update to the Pfandbrief legislation also envisages that “transparency obligations would be arranged in such a way as to eliminate any potential doubts about compliance with the Capital Requirements Regulations (CRR)”.

The vdp said that the new amendment to the Pfandbrief Act is anticipated to be enacted in German law by the end of the year, as part of a package which includes the implementation of the Bank Recovery & Resolution Directive (BRRD).