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Soft-bullet pfandbriefe (2)

15 June 2016
Richard Kemmish

As discussed in my last post, the pfandbrief community is currently debating the introduction of a concept that shares some of the DNA of contractual extendible maturity structures (aka soft bullets) but are reticent to reveal too many of the details of the structure before it is finalised.

When they describe the proposal though it does sound remarkably similar to a traditional soft bullet. After the insolvency of the issuer the person managing the pool on behalf of the creditors is allowed to extend the planned repayment date of the bonds, presumably for a short and defined maximum time period, presumably at a floating and punitive interest rate, presumably only if the alternative is a default.

So far, fairly similar to an extendible maturity. The only difference being one of sequencing and the level of automation – in the traditional extendible structure the issuer needs to fail to meet the original payment date on the bond, in which case the extension is automatic and (usually) triggers a cross default of the issuer, but not the bond (most programmes differentiate an issuer and a bond/pool event of default. The former is what triggers protection such as the trustee to step in). Seemingly in the German proposal the extension is at the discretion of the post-insolvency pool administrator (in German the ‘sachwalter’) and can therefore only be after he is involved, that is after what would be called an issuer EoD in common law programmes.

But the interesting structural points that may or may not differentiate this from a traditional soft bullet slightly more subtle. So, some questions:

Firstly, if you extend for one bond, do you extend for all? And/or does an extension of bond A cause bond B – that hasn’t reached its maturity date yet - to accelerate? I hope and presume ‘no’ to both questions. The principle of ‘non-acceleration unless it is really necessary to avoid time sub-ordination of long dated to short dated bonds’ should be sacrosanct. Which leads to my second question..

How will time subordination be protected under the new proposal? I presume the existing inter-creditor principles will continue to apply. But is the pari passu principle upheld if two bonds get paid out in full, but one on an extended deadline, one on the original?

Finally, what is the rated event, payment on the original or extended deadline? If the bond technically defaults if an extension occurs then the calibration of the rating models should be the same as before and ex ante over-collateralisation levels should be unchanged by the proposal. If the bond is only judged to have defaulted if the extended maturity is not honoured then ex ante over-collateralisation will be less for any given rating. Personally I see no problem with that. Not everyone will agree with me.  

Overall the extension proposal should be a very positive development to the pfandbrief law in the best interests of bond holders. But we need more detail please, and more debate about that detail.

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