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German covered bonds under scrutiny

October 7, 2009

Fitch Ratings seems to be getting nervous about the amount of commercial real estate loans included in German banks’ covered bond pools.

The agency today affirmed 17 covered bond programs as part of a review, but kept nine German banks programs `under analysis.’ The rating firm now wants more information from the banks on the kind of real estate debt they use as collateral for their covered bonds.

Covered bonds are a kind of secured debt issued by banks in which bondholders have recourse against both the issuer and a segregated pool of assets, such as mortgage or public sector loans.  German banks include large amounts of commercial real estate debt in the covered bond pools, alongside more granular and lower risk residential and public sector loans. Investors were happy to keep funding the banks and rating agencies gave the debt AAA ratings because the loans included in cover pools were required by law to be backed by a minimum amount of collateral, giving the loan a cushion in case the borrower defaulted.

The rules state that loans can only be included in covered bond pools if the principal is no more than 60 percent of the value of the property. However, given the sharp fall in commercial property values in recent years, Fitch is no longer comfortable relying on just this rule.

Fitch said today in a report:

“Whereas so far, Fitch considered that the mortgage lending value threshold set at 60% by the German Pfandbrief Act provided adequate protection against expected losses evening higher stress scenarios, the agency recognises commercial real estate risks in German cover pools need to be assessed more precisely’’

The rating firm has given banks three months to gather all the necessary data it needs to analyse the loans. There’s no mention of downgrades in Fitch’s report., though if the firm does decide the bonds aren’t adequately covered by the current cover pool, it could mean banks will have to stump up more collateral to support the deals’ ratings.

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