Fitch: Maturity Extension Would Be Positive for Pfandbriefe
The Association of German Pfandbrief Banks said recently that it submitted a proposal late last year to the German finance ministry for the introduction of a maturity extension of up to 12 months for newly issued and outstanding Pfandbriefe.
Our assessment is preliminary. If the proposal resulted in an amendment to the Pfandbrief law, our assessment would incorporate legal opinion in particular regarding the applicability of the change to outstanding bonds.
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 bonds market. It would further protect covered bond holders from the risk of payment interruption when the source of payments switches from the issuer to the cover pool (discontinuity risk).
However, we do not expect to change our discontinuity risk assessment for German Pfandbriefe, as all programmes have already received the lowest liquidity gaps and systemic risk assessment that we assign to non-pass-through covered bond programmes ('moderate' for mortgage covered bonds and 'low' for public-sector covered bonds). This reflects the variety of options an alternative cover pool administrator (Sachwalter) has to manage liquidity gaps, including potential access to central bank liquidity.
The proposal could lead to lower breakeven OC levels for Pfandbriefe ratings, as we would factor in the Sachwalter's ability to postpone individual Pfandbrief's maturity by up to 12 months in our cash flow analysis. This would reduce modelled liquidity gaps and the need to sell assets at a stressed price. This would be most beneficial for programmes exhibiting larger maturity mismatches.
Fitch 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, we will need to review the requirement stated for this coverage test.
This proposed principal extension would not be trigger-based, unlike other common soft-bullet but could be activated by the Sachwalter in times of extreme market stress after the recourse against the cover pool has been enforced. Currently, such liquidity gaps would lead to the liquidation of the cover pool. The existing mandatory 180-day liquidity protection will stay in place and will be based on the expected rather than extended redemption date.
The proposal mirrors a market-wide move towards maturity extensions. Out of the 132 covered bond programmes Fitch rates, 72 include covered bonds with maturity extensions. Among these, 53 programmes only issue soft-bullet bonds, generally with a 12-month extension period.
Extending a covered bond's maturity to avoid a payment interruption would leave some investors having to wait longer than anticipated for principal repayment. However, the overall risk of missed payments for all investors would fall because cover assets would not have to be sold rapidly in an unfavourable market to meet principal payments.
The proposal applies to both new issues and existing covered bonds. Accordingly, the terms and conditions of existing covered bonds would change. We would not view this modification as a default or distressed debt exchange, as the provisions are not aimed at preventing an imminent issuer default.