Legislation on Covered Bonds in Europe The German Experience: from Mortgage Bank Act to Pfandbrief Act

„Covered Bonds“ – DDF Seminar Copenhagen, 15 November 2006 Dr. Otmar Stöcker Association of German Pfandbrief Banks

Table of Contents

A.

Legislation on Covered Bonds in Europe

B.

The German Experience: from Mortgage Bank Act to Pfandbrief Act

2

A. Legislation on Covered Bonds in Europe I.

Geographical Overview

II.

Structure of the Issuer

II.

How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated? 3

A) I. Geographical Overview Covered Bond Legislation in Europe

as of September 2006 Legislation in countries of the EU/EEA/CH

20

2000 2006 2003 2004 1998 2002

2003

Legislation in future EU member and further countries in transition

24

2005 1998

4

 1997 2006

1995 1996 2005

1999 2005 2006

2003

1997 2006

Concrete legislation in preparation

4 2000

28

4

A) II. Structure of the Issuer

Basic questions: 1. Who is the issuer? 2. Does the issuer hold the cover assets on his balance sheet or are they transferred to a SPV guaranteeing the covered bonds? 3. Specialized bank principle? 4. What is the legal relation of the covered bonds and the cover assets - is there a direct legal link between each other? 5. Static or dynamic cover pool?

5

A) II. Structure of the Issuer Pfandbrief and Covered Bonds Models of Covered Bonds

Covered Bond issuer as completely specialised funding institute Finland, France, Ireland, Norway, partially Sweden

borrowers Origination and servicing of eligible assets and management of covered bond issuing institute mostly by parent bank

parent bank

Funding institute has no other function than holding eligible assets transfer of eligible assets

Issuer has bank status

acquisition of eligible assets

Covered Bond issuer

payment of principal and interest purchase of Covered Bonds

Issuance governed by special legal framework Issuer has no or nearly no staff

investor

6

A) II. Structure of the Issuer Pfandbrief and Covered Bonds Models of Covered Bonds

Covered Bond issuer is a specialized bank by law Denmark, Hungary, Luxemburg, Poland, partially Sweden Covered Bond issuer

borrowers

payment of principal and interest

non-eligible assets

payment of principal and interest

investors

eligible assets grants loans

purchase of Covered Bonds

 Issuer originates, services and funds eligible and non-eligible business  Loan origination restricted by law to property and public-sector loans  Issuer has bank status  Issuance governed by special legal framework 7

A) II. Structure of the Issuer Pfandbrief and Covered Bonds Models of Covered Bonds

Covered Bond issuer is a universal bank with qualified Covered Bond license Germany, Latvia, Russia, Slovenia (draft law), Turkey (draft law) Covered Bond issuer payment of principal and interest

payment of principal and interest

eligible assets

borrowers grants loans

purchase of Covered Bonds

investors

 Issuer originates, services and funds eligible and non-eligible business  license granted only to banks complying with legal license requirements  Strict eligibility criteria apply to eligible cover assets  Issuance governed by special legal framework 8

A) II. Structure of the Issuer Pfandbrief and Covered Bonds Models of Covered Bonds

Covered Bond issuer as universal bank without qualified license Bulgaria, Czech Republic, Lithuania, Romania, Spain, Ukraine Covered Bond issuer payment of principal and interest

borrowers

eligible assets

payment of principal and interest

grants loans

investors purchase of Covered Bonds

 Issuer originates, services and funds eligible and non-eligible business  Strict eligibility criteria apply to eligible cover assets  Issuance governed by special legal framework  No issuing license required or license granted without any requirements 9

A) II. Structure of the Issuer Pfandbrief and Covered Bonds Models of Covered Bonds

Structured covered bonds Contractual: Regulated by specific law:

mortgage loans

United Kingdom, Netherlands Italy originator = issuer of covered bonds

transfer • fully legal • equitable SPV • partial • loan claim + collateral • only claim – collateral stays in hand of originator

covered bonds

guarantee

10

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

Questionnaire in order to check the level of segregation and bankruptcy remoteness of cover assets and of covered bonds:

1.

How to identify the cover?

2.

How to segregate the cover assets from the insolvency’s estate?

3.

Are covered bonds touched by the insolvency procedure?

4.

How to ensure liquidity in case of insolvency of the issuer? 11

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

Fundamental question: what does „covered“ mean? purpose = transformation of cover assets into covered bonds (securitisation) cover assets  • quality of assets • management of - interest rate risks - liquidity risks - operational risks

≥

covered bonds  designation of cover assets to holders of covered bonds  • segregation of cover assets from originator’s other assets in case of insolvency of originator • bankruptcy remoteness of cover assets and covered bonds  timeliness of payment realistic? 

The less covered bond issuers are legally specialised, the more and detailed regulations their covered bonds need in order to achieve clear segregation and bankruptcy remoteness and to convince capital markets of it.

12

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

1. How to identify the cover? Business const raint s of t he i ssuers

no business constraints

specialised inst it ut ions, non cover-eligible business allowed

t wo-t iered st ruct ures

but

flexibilit y t o creat e cover pools

limit ed

closely rest rict ed

E

N old

no separat e cover pool

1 cover pool

special purpose vehicle

LT

CZ

E AYT

S old

CH

H

- only mort gages

1 cover pool

F

LV

- mort gages + publ ic sect or asset s

PL

2 cover pools - mort gages - public sect or asset s

free grouping of cover pools

A ÖPG

SK

D

RUS

UA

ROU 2006

S 2004

A HBG

LUX

IRL FIN

DK

ITA

N 2005

MBS

Big differences in legislation and supervisors‘ rules regarding structure and administration of cover pools!

True sale initiative in Germany

as of 6.11.2006

13

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

2. How to segregate the cover assets from the insolvency’s estate? (1) Questions:

• Any legal or administrative action necessary or automatically by law? • Who administrates the cover assets from then on? A special cover pool administrator or the normal insolvency administrator, who also is in charge of the issuer’s assets? (CHART) • Do the cover assets form a separate legal estate, a pool administered in favour of the covered bond holders or are they held in (legal) trust? (CHART)

special cover pool administrator or general bankruptcy administrator?

14

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

2. How to segregate the cover assets from the insolvency’s estate? (2) •

Who administrates the cover assets from then on? A special cover pool administrator or the general insolvency administrator, who also is in charge of the issuer’s assets?

 special cover pool administrator

 general bankruptcy administrator

as of 14.9.2006

15

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

2. How to segregate the cover assets from the insolvency’s estate? (3) • Do the cover assets form a separate legal estate? Is there only an insolvency privilege? When issuer is insolvent, cover assets are:

 legally separated (trust)

 part of insolvency estate, but holders of covered bonds have insolvency privilege as of 17.3.2006

16

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

3. Are covered bonds touched by the insolvency procedure? Do covered bonds accelerate automatically, when the issuer goes insolvent?

NO

1

YES

2

as of 12.4.2006

17

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

3. Are covered bonds touched by the insolvency procedure? • What is the legal consequence of the insolvency of the issuer for the derivatives (and respective collateral), which are part of the cover? • Do covered bond holders get a preferential treatment in the insolvency of the issuer? Are they restricted to this preferential treatment? • Could a judicial stay (moratorium) on the insolvency’s estate delay the cash flows from the cover assets and, therefore, endanger the timely payment of interest and the principle on covered bonds?

18

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

4. How to ensure liquidity in case of insolvency of the issuer? •

Who is entitled to the cover assets?

•

Who has the first access to the cash flows on cover assets?

•

Is there a mandatory OC?

•

Are there specific regulations that voluntary OC is insolvency remote?

•

Are liquid (substitute) cover assets allowed for the cover of mortgage covered bonds?

•

Can the (special) administrator of the cover pool take a loan to get liquid assets? Would this loan rank pari passu with the covered bonds?

•

Are there any specific regulations for the sale and transfer of mortgages respectively to other issuers? How easy is the sale of mortgage cover assets?

19

A) III. How are segregation of cover assets and bankruptcy remoteness of covered bonds regulated?

Final Overview Business const raint s of t he issuers no business constraint s

specialised instit utions, non cover-eligible business allowed

segregat ion of cover pools

but

limited

SK

insolvency privilege + cover pool

insolvency remot eness of cover pool

N old

detailed reg. det ailed regulations regulat ions reg. ' segregat ion procedure procedure' of segregation cover poolpool of cover

legal separat ion

S old

E AYT

E

F CZ

RUS

H ROU

D

PL IRL

UA S 2004 A ÖPG SV

CH

LT

ROU

LV

t wo-t iered st ruct ures

closely restricted rest ricted closely

no insolvency privilege

insolvency privilege, but no specific cover pool

special purpose vehicle

UA

LUX DK

N 2006

FIN

A HBG

ITA F

MBS

Pooling Models

in respect t o originat or

as of 2.11.2006

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B. The German Experience: from Mortgage Bank Act to Pfandbrief Act

21

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

GermanPfandbrief Pfandbriefregulation regulationuntil untilJuly July18, 18,2005: 2005: German MortgageBank BankAct Act Mortgage

PublicPfandbrief PfandbriefAct Act Public

ShipBank BankAct Act Ship

20specialized specialized 20 mortgagebanks banks mortgage

10Landesbanks Landesbanks/ / 10 18savings savingsbanks; banks;55other otherbanks banks 18

specialized 22specialized shipmortgage mortgagebanks banks ship

fromJuly July19, 19,2005: 2005: from PfandbriefAct Act(PBA) (PBA) Pfandbrief

allGerman Germanbanks banksfulfilling fulfillinglicence licencecriteria criteriamay mayissue issuePfandbriefe Pfandbriefe all

22

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

33public publicsector sector 33 Pfandbriefissuers issuers Pfandbrief Legal basis: Legal basis: PublicPfandbrief PfandbriefAct Act(ÖPG) (ÖPG) Public

20private privatemortgage mortgagebanks banks 20 Legalbasis: basis: Legal MortgageBank BankAct Act(HBG) (HBG) Mortgage

Abolitionofof Abolition stateguarantees guarantees state

Perforationofof Perforation specialistbank bankprinciple principle specialist

PublicPfandbrief PfandbriefAct Act Public losesjustification justification loses

MortgageBank BankAct Act Mortgage needsmodification modification needs

Abolitionofof Abolition PublicPfandbrief PfandbriefAct Act Public

Abolitionofofspecialist specialist Abolition bankprinciple principle bank

Creationofofaauniform uniform Creation PfandbriefAct Act Pfandbrief 23

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

Implications of the Pfandbrief Act for the issuer landscape  issuer landscape has not grown  commercial banks have not yet started to issue themselves  continued restructuring among former mortgage banks: - some former mortgage banks use possibility to become fully chartered global player in mortgage and public sector lending - merger onto commercial bank (mother bank): AarealHyp => Aaarealbank SEBHyp => SEB Bank HSHNordHyp => HSHNordbank - merger onto former mortgage bank: Hypo Real Estate International Dublin => Württemberger Hypothekenbank (after transaction renamed HRE International) Wüstenrotbank => Wüstenrot Hyp, renamed Wüstenrotbank Pfandbriefbank - acquisition of mortgage bank by commercial bank: Commerzbank / Eurohypo

24

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

Structure of a Pfandbrief Bank non-eligible loans

other bank business

general supervision

other funding instruments

on basis of KWG (Banking Act)

special banking supervision of Pfandbrief Bank on basis of Pfandbrief Act (PBA) mortgage loans - commercial - residential

PBA

public-sector loans

60 % of mortgage lending value 100 % of loans

ship financings

60 % ltv

  

Mortgage Pfandbrief Public Pfandbrief

PBA

Ship Pfandbrief

cover pool monitor administrates cover register and checks cover pools

25

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

Safety shield for Pfandbrief based on PBA 1) quality of cover pool assets 6) emergency plan in crisis of issuer

2) transparency

5) segregation of cover pools in case of insolvency

3) supervison

4) safety buffer overcollateralization (oc) 26

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

1. Quality of cover pool assets 

prime public-sector, property and ship loans as cover assets



conservative valuation for property



•

loan appraisal according to Mortgage Lending Value principle

•

only senior tranches with up to 60% ltv eligible for cover

professional risk management systems for identification, qualification, management and surveillance of • credit risks • interest rate risks • currency risks  + stress test by statutory order • market risks on net present value calculation • operational risks • liquidity risks • large exposure risks in the cover pools

27

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

Mortgage and Public Sector Lending

.

Cover Business: EU, European Economic Area, Switzerland USA, Canada, Japan as of: 19.7.2005

28

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

2. Transparency requirements quarterly disclosure of

nominal value, npv and npv at risk of Pfandbriefe and their respective cover pools maturity structure of Pfandbriefe and their respective cover pools in four maturity bands < 1 yr.; 1 yr. – 5 yrs.; 5 – 10 yrs.; > 10 yrs. share of derivatives in cover pools Cover pool Mortgage Pfandbriefe

Cover pool Public Pfandbriefe

Cover pool Ship Pfandbrief

 loans grouped according to their amount (nominal amounts): < 0.3 mn; < 5 mn; 5 mn € incl. geographical distribution

 loans grouped according to geographical distribution (nominal values) and according to debtors

 loans grouped according to nominal amount outstanding: < 0,5 mn; 0,5 – 5 mn; > 5 mn €

 type of building

 payments in arrears for at least 90 days incl. geographical distribution

 payments in arrears for at least 90 days incl. geographical distribution

 geographical distribution of ship registration  payments in arrears for at least 90 days incl. geographical distribution 29

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

3. Regulatory demands / supervision by BaFin  mandatory Pfandbrief bank licence  granting of Pfandbrief bank licence conditional upon strict requirements  ongoing specific supervision of Pfandbrief business by separate department of regulator  biannual cover pool audits by separate department of regulator  upon revocation of a Pfandbrief licence or insolvency of a Pfandbrief bank tight supervision of management of cover pools

30

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

4. Insolvency remoteness of cover assets

voluntary OC

mandatory OC = 2% of the stressed net present values of each cover pool separately invested in assets eligible as substitute cover de facto overcollateralisation (OC) through observation of stress scenarios according to net present value calculation of cover assets

ordinary cover

Every type of cover is insolvency remote

31

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

5. Segregation of cover pools in case of insolvency issuer´s insolvency Insolvency administrator Pfandbrief bank

other assets

other assets (=insolvency estate) Cover pool administrator

cover pools cover pools

32

B) The German Experience: from Mortgage Bank Act to Pfandbrief Act

6. Emergency plan in crisis of issuer  Appointment of special cover pool administrator by supervisory authority (BaFin) even before a bank’s insolvency if necessary  Specific supervision of BaFin remains effective  All cash-flows from cover loans are allocated directly to the cover pool administrator  3 options with regard to cover assets •

administration of the cover pools until all claims under Pfandbriefe are fully satisfied

•

sale of specific cover assets  cash remains in cover pools

•

transfer of cover assets and Pfandbriefe to other Pfandbrief bank  Pfandbrief holder has two debtors

33

Summary

CBs are revitalized all over Europe CBs are very important financial instruments to fund mortgage loans via international capital market Pfandbrief Act sets new standards on covered bond legislation  specialist bank principle replaced by safety shield  key issues: insolvency segregation of cover assets and bankruptcy remoteness of covered bonds 34

Further Information

Internet Homepage

http://www.pfandbrief.org

Bloomberg

HYP GO

Association of Fon: +49 – 30 - 2 09 15 - 100 German Pfandbrief Banks Fax: +49 – 30 - 2 09 15 - 419 (Headquarters) email: [email protected] Tokyo Liaison Office: International Financial Consulting K.K. (IFC)

Fon: +81 3 5532-8921 Fax: +81 3 5532-8367 email: [email protected]

New York Liaison Office: Fon: +1 212 508 - 9600 Makovsky & Company Inc. Fax: +1 212 751 - 9710 email: [email protected]

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Member Institutions of the Association of German Pfandbrief Banks

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