Kommunalkredit Austria (KA) has the option of terminating an overcollateralisation (OC) commitment on its public sector covered bond programme as part of a planned demerger, Moody’s has warned, adding that a split of the cover pool would require higher OC for ratings to be maintained.

KA announced the demerger plans last Friday and Moody’s said today (Thursday) that the Austrian issuer has the option to terminate a contract committing it to a minimum overcollateralisation level of 28% in its public sector covered bond programme, which is rated Aa3.

“Because Gesetz betreffend fundierte Bankschuldverschreibungen, Austria’s covered bond act, does not require minimum OC, the option to terminate the contract and reduce or remove overcollateralisation is credit negative for covered bonds in that programme,” said the rating agency, although it noted that it continues to give benefit to the OC commitment.

Moody’s said that banks in wind-down situations often voluntarily maintain high OC levels to protect their covered bond programmes, citing Heta Asset Resolution and NRAM plc (formerly Northern Rock Asset Management).

“However, should KA decide to terminate the OC commitment contract, we expect that it would reduce the OC below the current level,” it added.

KA’s plan to split covered bonds and its cover pool between KA New and KA Finanz and Moody’s said the move is likely to result in two riskier cover pools.

“We do not believe that the risks can be evenly balanced easily between two programmes,” it said. “In addition to the risk of falling OC, the two pools will be less granular than the currently combined pool.

“The OC necessary to maintain the current Aa3 ratings on the two separate covered bonds would then be higher than currently for the combined programme, even if we assume that the two entities’ credit strength remains unchanged after the demerger.”

Moody’s said it expects the credit strengths of the covered bonds going to KA New and KA Finanz to diverge for reasons including the difference in the credit quality of the sponsors who will own the new legal issuance entities. KA New’s owners will be a private equity group, while KA Finanz is owned by a Republic of Austria holding company.

The rating agency further noted that KA’s programme is primarily backed by exposure to Austrian regions/federal states.

“Around 13.4% of these assets and 24.2% of the covered bond liabilities are denominated in Swiss francs,” it said, “which have recently appreciated considerably and put additional pressure on debtors financed in this currency.”