Proposed amendments to Slovakia’s covered bond legislation could address weaknesses in the current law that prevent Fitch from assigning Payment Continuity Uplift to the ratings of Slovak covered bonds, the rating agency said on Tuesday, while stressing that more information is required in some areas.

The Slovak Ministry of Finance published proposed updates to the country’s covered bond law for consultation last month. The ministry, along with the National Bank of Slovakia, have been working on changes to the law to align it with European best practices.

The consultation period closed on 24 July, and the law is expected to be considered by Slovakia’s parliament in September and, if passed, come into force on 1 January 2018.

In a comment published on Tuesday, Fitch said that in its understanding, the proposals would allow for a potential covered bond maturity extension of up to 23 months when the bank issuing the bonds is placed into receivership or resolution, or is declared bankrupt.

“This would be a significant change from the current legislation, under which insolvency proceedings against the issuer trigger an automatic acceleration of the covered bonds, preventing us from assigning any Payment Continuity Uplift (PCU),” said the rating agency.

However, Fitch said the process for triggering the maturity extension is not clearly defined.

“We believe there is not yet enough detail to ensure that it could sufficiently protect covered bond investors,” it said.

According to Fitch, the draft rules would require the bank receiver or bankruptcy administrator to assess if a transfer of the covered bond programme, or parts thereof, to another bank would be more beneficial for the covered bonds’ holders than the further management of the programme.

This decision would be taken jointly by the bankruptcy administrator and the cover pool monitor and a notification of intent to transfer the programme would then be sent to the central bank.

All payments falling due in the first month after the notification would have to be met, but an 11 month maturity extension period would then be triggered. If no transfer occurs within a year, the central bank could allow a further extension of up to 12 months.

“It is unclear on what basis the bankruptcy administrator and the cover pool monitor would make the decision, or whether there will be a specific test that will be applied in making it,” said Fitch. “It is also not clear that the decision would be taken quickly enough to avoid payment interruption.”

The rating agency also noted that a 180 day liquidity buffer included in the proposals is weaker than that required in other countries, and that the definition of liquid assets is more broad than that used by Fitch, which, it said, could also affect the rating agency’s view of the ability to maintain payment continuity once recourse against the cover pool has been enforced.

However, Fitch said there would be nothing to stop an issuer opting to maintain a larger buffer than the rules required. The rating agency said that in its understanding, the buffer would cover total net negative cashflows for the first 30 days, while for days 31 to 180 it would cover net negative cashflows, but only taking into account 40% of the principal payment amount due under the bonds.

“When determining the PCU for covered bonds, we also consider the degree of development in the banking market and factors that might affect portfolio transfers,” Fitch added. “At this stage, the role of the bankruptcy administrator is crucial, in particular its ability to execute a refinancing or sale of cover assets if the natural cash flows from the cover pool and the liquid buffer assets are insufficient to make the interest payments.”

Photo: National Bank of Slovakia; Credit: Roman Paholik/Wikimedia Commons