Little supply, big demand
As the eurozone crisis grinds on, German Pfandbriefe have become the haven trade pricing ever tighter. But issuance cannot keep up with demand.
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Since the end of May a string of German issuers has come to the market with Pfandbriefe that have flown off the shelves and priced tighter and tighter. The pinnacle – so far – was reached with Landesbank Baden-Wuerttemberg’s 1.375% €500m five-year which went at 7bp over mid-swaps, the tightest print of the year. Since then it has tightened even more in the secondary market by 3bp–4bp. No wonder then that bankers have called the current pricing levels insane.
With no let-up in the eurozone crisis, Spanish 10-year debt hitting 7% in mid-June and Italian three-year bonds up to 5.3%, German debt, especially Pfandbriefe have become the ultimate in safe haven trades. The pricing on German covered bonds might be offering small yield, but at least it is still there.
“You have to see the pricing of German Pfandbriefe in the context of the Bund issuance. They are still offering a pick-up over Bunds,” said Armin Peter, head of covered bonds at UBS in London. It is worth remembering that two-year Schatz yields at the end of May hit zero while 10-year Bunds have been below 1.5%.
Massive order books
No surprise then that order books have been massive. Bookbuilds are fast and books that are double the final print are commonplace. Sven Schukat, head of treasury, at the Berlin-Hannoversche Hypothekenbank, reopened the Pfandbrief market on May 23.
“We started to bookbuild on Monday [May 21] afternoon. We had €1.2bn orders in an hour and a half. Within 45 minutes on Tuesday [May 22] we had reached €2.2bn orders and closed the book,” he said. The €1bn five-year issue priced at mid-swaps plus 9bp and has since tightened in secondary. “This is our one and only offering in 2012. Investors knew that if they wanted to buy BHH debt then this was their only opportunity,” said Bodo Winkler, head of investor relations at BHH.
Rarity value and high demand is what is allowing such tight prints. Every deal seen recently has priced at the tight end of guidance. Indeed many of the deals could have printed even more tightly than their final level.
Rafael Scholz, head of treasury for Muenchener Hypothekenbank, is of the opinion that his €1bn 10-year which guided at 10bp–12bp over and went out at 10bp over mid-swaps, could have priced at 9bp over. But as Torsten Elling, co-head of rates syndicate at Barclays in London, pointed out, although German issuers could push for tighter pricing, they don’t. “German issuers don’t want a 100% German book,” he says.
Changing the mix
But tight pricing means that the traditional mix of investors has changed. “Banks and asset managers are currently driving public Pfandbrief issuance,” said Ralf Grossmann, head of covered bonds at Societe Generale. Given the lack of yield, this is perhaps not surprising. For Deutsche Hypothekenbank’s €500m five-year, banks and asset managers took 49% and 37% respectively, while insurance companies took 1%.
It was a similar story for HSH Nordbank’s €500m four-year. Banks took 46%, fund managers 27% while insurance companies and pension funds only took 2%. Deutsche Hypothekenbank priced at mid-swaps plus 9bp and HSH Nordbank priced at mid-swaps plus 18bp with coupons of 1.25% and 1.125% respectively.
In an ideal world, insurance companies want a yield of 3%–4%, though even they are having to lower the bar. Aarreal Bank’s €500m 1.375% five-year which sold at a comparatively generous mid-swaps plus 20bp saw a 16% take-up from insurance companies.
Nonetheless, the flurry of Pfandbrief issuance since late May cannot hide the fact of how little supply there has been this year. There has been only €5bn issuance so far, according to Barclays. On the back of €38bn of redemptions, total supply out of Germany is expected to reach only €28bn. And it is unlikely to change going forward.
The lack of supply has been down to the winding down of public sector Pfandbrief issuance. And even though there is a comparative boom in the German housing market, residential mortgage covered bond issuance is never going to compensate. To see how much the landscape has changed, you need only go back to 2009, when supply was €43bn.
Even though supply is down, it would be wrong to think that investors are just buying anything. “There remains a discrepancy in deals even within Germany,” says Barclays’ Elling, explaining that investors are taking time to look closely at the composition of the cover pools and that the pricing of deals reflects that.
In early March ING DiBa, the direct and retail banking arm of ING Groep in Austria and Germany, sold a €500m seven-year mortgage-backed Pfandbrief that priced at mid-swaps plus 17bp. Compare that with Aarreal Bank’s €500m five-year mentioned above which priced at mid-swaps plus 20bp. ING’s cover pool was 100% residential and 100% German. That from the Wiesbaden-based real estate bank was only 10% residential and 17.1% German.
But if the public markets have been quiet, the private Pfandbrief market in Germany has been turning over deals quietly and solidly with no break. Of course there is the familiar advantage for the buyer that they can choose the maturity they need for their debt profile, but perhaps more importantly under German law they don’t need to mark-to-market. No surprise then, as BHH’s Schukat explained: “We are seeing stable demand in the private market and it is being driven primarily by the insurance companies.”
Nonetheless, even that market has been impacted by the dynamics of the eurozone and relentless demand for German paper. Private placements have tightened in the past two or three months, by up to 20bp in mid-maturities.
What that has meant is that the European Central Bank, which had been the dominant voice in the room, has been able to take a step back in Germany and holds more of a watching brief. Unlike some of their eurozone colleagues, German banks have not had to be quite as enthusiastic about the €1trn liquidity and cheap, unlimited three-year funds that the ECB injected into the market.
As Christian Klocke, covered bond syndicate at Commerzbank in Frankfurt, explained, the central bank’s role has become more subtle. “The ECB has been active in all recent deals, but it has been flexible with expectations in terms of allocation,” he said. What the ECB has done has been to step up as a cornerstone investor when needed, but has also been happy not to take the full allocation.
The outlook for the rest of the year remains quiet. The majority of German banks are now pretty much funded for 2012 and while some pre-funding for next year is likely later in the year, issuance is going to be a trickle rather than a tidal wave. For investors there is little choice other than to turn to corporate debt or sovereign debt.