Following on from my last post, if you accept that the rating agencies and/or the regulators have modelled the pool, the swaps and any possible stress scenarios, systemic or idiosyncratic, to within an inch of their lives, what else that can not be captured on a spreadsheet can possibly go wrong? Thinking out loud, here are a few that occurred to me.
1/ Other creditors
Yes of course voluntary overcollateralization is protected by both national law and the bank resolution directive. But what if that over-collateralisation is clearly too much? You cant leave all of the over-collateralisation in the pool until the last bond has been paid out the unwinding of a major financial institution cant be delayed until that last 30 year private placement matures. So someone, somewhere needs to decide how much is enough and take the excess away from the cover pool for the sake of the resolution of other creditor claims.
German law for example - allows over-collateralisation that will clearly not be needed to return back to the insolvency estate. Does that mean with 99% certainty? Not enough for Aaa then. What if the insolvency court is swayed by political considerations (depositors losing out for example) to reduce that 99%?
Everyone is very relaxed about set off the idea that the mortgage in the cover pool might be netted against the deposit in the failed bank. Deposits are guaranteed, set off is explicitly forbidden, so what is there to worry about? Two things: failing deposit guarantee schemes they havent been mutualised across the EU yet (and looking at the Greek-German ructions currently, wont be any time soon) and consumer protection laws, in particular unfair contract terms. So, Ive lost my life savings but have to carry on paying my mortgage because of a clause buried in a complex legal document that no-one explained to me when I took out the mortgage?!
3/ Property activism
A right to decent housing is quite rightly enshrined in EU legislation. But the implications of this right, could (lets be realistic....will) contradict the right to the ownership of property. One day that will apply to cover pools. If you underestimate this risk, take a look at the ruling of the European Court of Human rights in the case of the Salt housing complex near Girona.
4/ A change in government sentiment
So much in covered bond land hasnt ever been tested because of government sentiment towards covered bonds in particular and the survival of banks in general. Will contracts be enforceable? Will back-up servicers be found? Will trustees make potentially controversial decisions?
Clearly there has been a sea-change in sentiment, recovery and resolution directive, popular sentiment and more aggressive state aid rules all suggest we might not be able to rely on the old certainties next time.
Four very real risks, none will be revealed when you hit F9, and Ive only just got started. More on the next post.
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