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26 January 2015 Supervision Supervision label Q&A

Question:

How does DNB check compliance with the minimum OC requirement of 105%?

Answer:

A bank issuing registered covered bonds must submit proof to DNB each quarter showing that the aggregate value of cover assets equals at least 105% of the nominal value of the outstanding bonds.

To allow us to check whether the issuing bank meets the minimum OC of 105% required under Section 40f(1) of the Decree on Prudential Rules for Financial Undertakings (Besluit prudentiële regels Wft - Bpr), the bank must submit data statements on a loan-by-loan basis. An external auditor must verify the data quality of the underlying loan documentation on a sample test basis each year.

The issuing bank must deduct from the nominal amount of the primary cover assets the following amounts when calculating their aggregate value:

  • Cover assets for which defaults have occurred within the meaning of Article 178 of the Capital Requirements Regulation.
  • These are cover assets for which the debtor is in arrear more than 90 days, or is unlikely to pay.
  • The pro rata value of the cover assets to which a third party has rights;
  • This concerns a situation in which a third party on the grounds of the law or a legal act has such rights to the specific cover asset that it must be considered, at least in part, as its beneficial owner. These are rights which (a) relate to a specific cover asset (i.e. this does not include a general right of recourse to the assets of the legal entity that is the ultimate beneficial owner of the cover assets), and (b) rank equally with or higher than claims from the bond holders. In practice, such a situation occurs when the beneficial owner of the cover assets enters into an agreement with a bank or insurer providing that the latter will be mandatorily entitled to a part of the proceeds from an individual mortgage loan. In exchange, the bank or insurer typically undertakes to the beneficial owner of the cover assets that it will pay the accrued or periodic payments that consumers to whom a mortgage loan has been provided make under a bank savings account or savings insurance policy, which those consumers use to accrue an amount for future repayment of their mortgage loans. Should the mortgage loan in question be repaid, whether or not through recourse, the beneficial owner of the cover assets is typically obliged to pay the bank or insurer on a priority basis an amount equal to the latter's claim. The statutory provision referred to above prescribes that the amount of the cover assets to which the bank or insurer is entitled must be deducted.
  • Exposures relating to the issuing bank.
  • This may concern a cash deposit that the covered bond company holds with the issuing bank or an entity in the latter's group, or bonds of such entity.

If the bank also holds other cover assets in addition to its primary cover assets, such as sovereign bonds, to cover the covered bonds, these assets must be valued at market value.

The table below illustrates a covered bond programme with residential mortgage loan claims as its primary cover assets.

Nominal aggregate outstanding principal of the mortgage loan claims (primary cover assets): EUR 1,500 (A);

  • The aggregate amount of EUR 1,500 consists of 15 individual mortgage loan claims with outstanding principal amounts of EUR 100 each, each covered by collateral worth EUR 100.

Cash deposit held with the issuing bank (non-primary cover assets): EUR 50 (B);

Mortgage loan claims for which the debtor is in arrear more than 90 days: EUR 100 (C);

Savings components of mortgage loan claims of which third parties are the beneficial owners: EUR 80 (D);

Total covered bonds outstanding: EUR 1,000 (E);

The aggregate value of the mortgage loan claims equals the sum of the value of all individual mortgage loan claims. They may not be assigned negative values resulting from deduction from a nominal principal amount due to the debtor being in arrear more than 90 days or in the event that a third party is entitled to part of a cover asset.

Aggregate value of the cover assets under Section 40f(1) of the Decree on Prudential Rules for Financial Undertakings (Besluit prudentiële regels -Bpr): EUR 1,340

OC = aggregate value of the cover assets under Section 40f(1) of the Bpr / total covered bonds outstanding = EUR 1,340 /EUR 1,000 = 134%.

This means that the issuing bank satisfies the minimum OC requirement of 105%.

The value of derivatives may not be considered in calculating the minimum OC. A covered bond company may only enter into derivatives contracts for the purpose of risk management and only into contracts of which DNB believes that the continuity of the derivatives is sufficiently secure in the event that the issuing bank becomes insolvent or its credit rating is downgraded.

Relevant to:

  • Banks