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Pfandbriefe - Tinkering with the specialist principle

Germany’s mortgage banks are in discussion with the regulators over further revisions to their business charter. Widening the mortgage banks’ lending activities to include the US, Canada and Japan, and including derivatives as cover for Pfandbriefe (bonds collateralized by mortgage assets and public sector loans) are among the more far-reaching proposals. Euan Hagger reports


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The German Mortgage Bank Association - or the Verband Deutscher Hypothekenbanken (VDH) to give the organization its proper title - is expecting amendments to the German Mortgage Bank Act to come into force next year. Some proposed changes, particularly the idea of adding derivatives to Pfandbrief collateral pools, have caused sharp intakes of breath, because of the counterparty risk that would be introduced to the book. Suddenly, the hidebound VDH is recast as a revolutionary body.

"I can't see this happening," says a director of capital markets at a large German Landesbank. "In effect we are talking about changes to the legislation that would permit mortgage banks to issue a Pfandbrief and do a swap against it and arbitrage the credit risk between the issuer and the swap market. In situations where you see most of the Pfandbriefe trading at sub-Libor, that would provide an immediate arbitrage profit of at least 2bp to 3bp, but using derivatives as cover for Pfandbriefe could have a serious impact on the quality of the collateral pool.

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