Best of breed
The German jumbo Pfandbrief sector has remained resilient in the face of a widening in spreads and difficult market conditions, with volumes holding up as those of covered bonds in less established jurisdictions plummeted. Hardeep Dhillon reports.
Pfanbrief issuance in the first five months of 2008 totalled €19bn, versus €18.6bn for the same period in 2007. First quarter volumes of all covered bonds may have fallen 41% compared to 2007 levels, but stable issuance in April and May have put the market on a much more healthier path than three months ago, said Ted Packmohr, Dresdner Kleinwort’s head of covered bond research. “Before April the primary market was stop and start, now after stabilising somewhat, demand has been picking up as more investors are prepared to buy at current spreads,” he said.
A re-pricing of the market in mid-April saw public sector (Öffentliche) and mortgage (Hypotheken) Pfandbrief spreads widen out up to 5bp by the end of May. In addition, a growing number of primary market transactions are being priced at significant premiums over outstanding bonds. On average Pfandbrief new issue premiums have widened to 5bp over mid-swaps, from about 3bp-4bp during the second half of 2007, and compared to 10bp for other covered bond markets, states one head of covered bond strategy.
“Issuers accept they have to pay a significant premium to get deals done,” said Frank Will, senior strategist for frequent borrowers at Royal Bank of Scotland. Issuance has focussed on shorter-dated tenors with 60% of this year’s volumes in two- to three-year maturities, 29% between four and five years and only 11% at longer maturities. “Investor demand for shorter maturities is driven by yield, as they are able to get the same or better yield for a two-year maturity than a three-year or longer tenor,” added Will.
Though the weighted average duration for jumbo covered bonds issued in 2008 has fallen to four years from 7.5 in 2007 and 8.2 in 2006, longer maturities were beginning to appear by May, said Franz Rudolf, head of financials credit research, UniCredit Markets and Investment Banking. Dexia Kommunalbank and Eurohypo launched 10-year jumbo Pfandbriefe, while Deutsche Postbank issued a seven-year transaction.
“Eurohypo and Dexia Kommunalbank showed that there is still demand at the longer-end of the curve for Pfandbrief issuers,” said Will. “These transactions illustrate a return of the investor base for longer-dated paper which prompts more borrowers to look at other maturity segments,” added DK’s Packmohr.
Two five-year deals particularly represent the impact that collateral can have on spread levels even within the German Pfandbrief market: Dexia’s public sector Pfandbrief priced at 9bp over mid-swaps and Eurohypo’s mortgage Pfandbrief priced at 13bp over. The Pfandbrief market has remained relatively stable compared to many peer covered bond markets due to a very supportive and loyal domestic investor base, which is hungry for paper: between 30% and 50% of new issues (not just Pfandbrief bonds) are being allocated to German portfolios.
The supply demand imbalance caused by a shrinking Pfandbrief market is resulting in ever more pronounced spread levels between public sector and mortgage bonds. A 1bp differential in the middle of 2007 had widened to 5bp by May, and this gap could widen even further.
March figures from the Bundesbank show public sector issuance fell by 17.4% in that time. One German bank strategist predicted volumes will continue to fall as many banks have seen their public sector business decrease over 2007. The mortgage Pfandbrief market has been shrinking by 10% year-on-year, though growth levels in the last year have remained flat. “We are going to see more supply of mortgage Pfandbrief, which have become a more attractive instrument in the past twelve months,” said the strategist. “A lot more borrowers are focussing their origination business towards assets that are eligible for Pfandbrief cover or enhancing existing loan documentation.”
A number of debut borrowers have tapped the jumbo market, including Deustche Postbank, which launched its inaugural €1.5 billion five-year jumbo mortgage Pfandbrief in January and HSH Nordbank that issued the first ever jumbo Pfandbrief backed by ship mortgages. Another German newcomer, apoBank, is currently in preparations for its debut Pfandbrief issue.
DK’s Packmohr believes the launch of the ship jumbo market will help the acknowledgment of the Pfandbrief product as is offers diversification but believes the ship sector to remain a niche sector in comparison to the mortgage and public sector jumbo Pfandbrief segments.
Proposals to amend the Pfandbrief Act could add aircraft loans as a new asset class to the Pfandbrief stable. Several German mortgage banks possess substantial aircraft financing portfolios, with NordLB owning the world’s fifth largest portfolio of €6.8 billion at the end of 2007. “Aircraft Pfandbrief are comparable to ship mortgage transactions and could be quite an interesting growth area for the Pfandbrief. It is another form of secured funding and another category of covered bonds,” said the strategist.