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A Dutch contribution to human progress

09 January 2015
Richard Kemmish


One of Holland’s greatest contributions to history is of course the invention of gin. But it took the British to think of adding tonic to it. With the publication of the new draft covered bond law in Holland the collaboration is working in the other direction with another of my favourite things – the asset cover test.

Whilst continental Europe was messing around with debates about whether over-collateralisation should be calculated on a nominal or NPV basis, the British (specifically HBOS) invented a very different way of calculating over-collateralisation. The amount of collateral in the pool would be the higher of whatever number was needed to keep the rating agencies happy and whatever number was needed to keep the regulators happy.

The regulators in this case were basing their thinking on the thoughts of a German idea of credit-worthiness 200 years ago – that every loan should be a maximum of three fifths of the value of the thing on which it is secured (or, 60% LTV to use the modern, rather than the original description).
This is of course an excellent way of looking at the value of an individual loan (and still in use to determine capital for the bank) but not particularly clever for looking at the riskiness of a portfolio. Never mind, it is enshrined in European law all the way up to the Capital Requirements Directive. 

The EBA’s recommendation that there should be a minimum over-collateralisation in covered bond laws brings the concept up to date slightly but it also recognises the impossibility of actually saying a number that would apply across Europe (a view that I’ve agreed with here before).

Which is where the new Dutch law comes in. The Dutch have said (I understand, but don’t quote me on this. My appreciation for all things Dutch falls short of actually learning their language) the amount of overcollateralization in the pool should be the greater of what is needed to keep the EBA happy and what is needed to keep the 200 year old German happy.

The EBA is kept happy by 105 of assets – irrespective of whether they are over or under a 60% LTV – backing 100 of bonds. The 200 year old German is kept happy by 100 of assets with an LTV under 60% matching 100 of bonds.

Issuers will of course add a third element to this, the over collateralisation needed to keep the rating agencies happy.

So everyone is happy.

(Incidentally, in all of this I have referred to a 60% LTV to keep it simple. It of course does vary by country and programme. The same principles apply. Whether the asset cover test refers to 60% or 80% is totally irrelevant – the other leg of the asset cover test (the ‘how much do the rating agencies need’ leg) is the important one for credit. It’s a bit like whether you want your gin and tonic with Bombay Sapphire or Gordons – they both taste good).

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