An amendment to the German Pfandbrief law proposed by the vdp to allow maturity extensions would be positive for Pfandbriefe, according to a preliminary assessment from Fitch, because the changes could lead to lower breakeven overcollateralisation (OC) for its ratings.

As previously reported, the Association of German Pfandbrief Banks (vdp) has outlined amendments to German Pfandbrief legislation that would introduce a maturity extension of up to 12 months for newly issued and outstanding Pfandbriefe in the event of an issuer insolvency if it is not possible to generate sufficient liquidity to repay principal, subject to other conditions.

Fitch said that, if adopted, the proposed amendment is not expected to change its current assessment of discontinuity risk for German Pfandbriefe.

Fitch said that a combination of a liquidity buffer for upcoming interest and principal payments, and an additional principal extension period would be stronger than standard provisions used in the covered bond market, and said this would further protect covered bond holders from discontinuity risk.

However, the rating agency noted that all programmes it rates have already received the lowest liquidity gaps and systemic risk assessment that it assigns to non-pass-through covered bond programmes – of “moderate” for mortgage backed programmes and “low” for public sector programmes.

It said that this reflects the variety of options an alternative cover pool administrator (Sachwalter) has to manage liquidity gaps, including potential access to central bank liquidity.

Fitch said that the proposal could, however, lead to lower breakeven overcollateralisation (OC) levels for Pfandbrief ratings, as the rating agency would factor into its cashflow analysis the Sachwalter’s ability to postpone an individual Pfandbrief’s maturity by up to 12 months.

“This would reduce modelled liquidity gaps and the need to sell assets at a stressed price,” Fitch said. “This would be most beneficial for programmes exhibiting larger maturity mismatches.”

The rating agency said it does not expect any risk of time subordination from maturity extension as the Sachwalter is obliged to test if the coverage is sufficient for full and timely payment of all outstanding Pfandbriefe.

“For a final assessment,” it added, “we will need to review the requirement stated for this coverage test.”

Fitch noted that the proposed principal extension would not be trigger-based, unlike many other soft bullets, but could be activated by the Sachwalter in times of extreme market stress after the recourse against the cover pool has been enforced, while currently such liquidity gaps would lead to the liquidation of the cover pool.

The rating agency also noted that the existing mandatory 180-day liquidity protection will stay in place and will be based on the expected rather than extended redemption date.

Fitch added that the proposal mirrors a market-wide move towards maturity extensions, noting that of the 132 covered bond programmes it rates, 72 include covered bonds with maturity extensions. Among these, 53 programmes only issue soft bullet bonds, generally with a 12 month extension period, the rating agency said.