Fitch and DBRS have questioned the wisdom of a 5% minimum overcollateralisation (OC) standard recommended to the European Commission by the European Banking Authority, while the latter rating agency also questioned the EBA’s maturity structure advice, warning of its effect on the Danes.

In a study published on Tuesday, Fitch found that such an OC level would not cover expected losses in cover pools in a ‘B’ rating scenario for 10 of the 98 programmes analysed, with the ‘B’ rating scenario representing a mild stress (and not that which is the expected case scenario for the rating agency). A ‘B’ portfolio loss rate (PLR) of more than 4.76% would reduce a programme’s collateralisation from 105% to 100%, whereas the ‘B’ PLR for the 10 programmes range from 6.8% to 14.3%.

“The high PLRs for programmes in Cyprus, Greece and Spain reflect both the impact of the sovereign debt and financial crises on those peripheral Eurozone economies and the cover pool composition,” said Fitch. “Notably, Spanish cédulas hipotecarias are secured against an issuer’s entire mortgage book, including riskier SME loans and loans to real-estate developers.”

2017 Average ‘B’ PLR – by Country and Programme Type

MO: Mortgage, PS: Public Sector; Source: Fitch

DBRS yesterday (Monday) echoed this, saying that in many cases a 5% nominal OC is unlikely to generate a sizeable uplift from the rating of an issuer.

“It could create a false sense of comparability across jurisdictions and programmes, as the same nominal OC level does not translate into the same protection for investors,” it added. “National regulators should maintain strict control over the general quality of the cover pool and covered bonds and, if necessary, set higher OC minimum level on a case-by-case basis.”

The rating agency noted that a minimum OC recommendation also features in an ICF study for the Commission, while a 2% minimum OC is included in EMIR eligibility criteria.

DBRS also, on Thursday, queried the EBA’s advice relating to maturity extensions, again arguing against a one-size-fits-all approach, saying the recommendations could cause more problems than they are intended to solve.

In its December report, the EBA proposed that in order for soft bullet and conditional pass-through (CPT) covered bonds to qualify as covered bonds eligible for preferential regulatory treatment any decision to extend the maturity of a soft bullet or conditional pass-through (CPT) structure should not be at the absolute discretion of the issuer. It recommended that a maturity extension can only be effected upon two triggers that must occur cumulatively: (i) that the covered bond issuer has defaulted; and (ii) that the covered bond breaches pre-defined criteria/a test indicating a likely failure of the covered bond to be repaid at the scheduled maturity date.

The question of the extent to which the EBA’s draft proposals adequately dealt with different types and models of issuers was already raised at a public hearing before the recommendations were delivered to the Commission.

According to DBRS, the final version remains at odds with some existing business models, notably Denmark, where in 2014 regulation was passed to allow for the extension of covered bonds when they cannot be refinanced at a reasonable rate or in the case of a refinancing auction failure. The rating agency said that the EBA may have left room for a carve-out of such a procedure, but if not, enactment of the regulator’s recommendations could push Denmark down a “perilous path”.

European authorities have hitherto proven willing to make allowances for Denmark’s unique model, most recently regarding an MBS waiver.

DBRS also noted that not all current covered bond maturity extensions have the default of the issuer as a necessary trigger.

It said that overall, the EBA’s recommendations: discount the value of oversight provided by national regulators, assume a level of harmonisation of national bank liquidation processes yet to be implemented; and appear to be more focused on the risk of extension borne by investors than on mitigation of credit risk caused by cover pool/covered bond maturity mismatches.