Pfandbriefe Roundtable 2009: Part I
IFR: What impact has the ECB's covered bond purchase programme had on the Pfandbrief market?
Thomas Sommer, WL Bank: In the midst of the crisis we had a problem of trust. The banks did not trust each other and the effect was a massive meltdown of market liquidity and a significant widening of spreads. But, that was not a phenomenon specific to the Pfandbrief market, but to nearly all markets.
At the beginning of this year we saw quite good appetite from risk oriented investors for higher-yielding bonds, for example government guaranteed bank bonds (GGBs) or corporate bonds. As the Pfandbrief market began to reopen in February and March with issuers such as LBBW Postbank and Eurohypo, we started to see a tightening of spreads as the support for the market improved.
An example of the better market conditions was the normalization of government CDS spreads: the CDS spreads for bunds with a maturity of three years came down from 81bp in February to 23bp in May.
Then we had quite a good market environment as the performance of Pfandbriefe began to improve. Then the effect of the ECB announcement of its covered bond purchase programme was to inject good impetus into the movement of the market. This caused a massive tightening of Pfandbrief spreads.
Gerald Rosenberger, Eurohypo: I think that the timing of the ECB's purchase programme was ideal, as it coincided with an already stabilising market. We had already begun to see more positive economic indicators, a stronger stock market and falling interest rates. We saw a tremendous volume coming into the Pfandbrief market as spreads started to tighten, which they continued to do without any counter movement. I think the ECB managed the programme perfectly and they continued to bring more information about it, which helped to keep the spread tightening trend on course.
Andreas Schenk, Deutsche Pfandbriefbank: I think an important aspect of the ECB programme is that it is not only a short-dated programme with a one time effect. Therefore, it will not only help the Pfandbrief. If the Pfandbrief market and other covered bond markets in Europe can pick up, this will also help other markets such as the senior, unsecured market.
IFR: Do you feel that €60bn is an adequate amount for the programme?
Tammo Diemer, Aareal Bank: As far as I understand, the ECB had three goals: a tightening of spreads in the Pfandbrief and covered bond market, ensuring a resumption of issuing activity in the primary market, providing a revival of activity in the secondary market.
The ECB did very well by every week buying a certain amount in the primary and secondary market to provide the spread tightening. That assured and motivated issuers. Even weaker banks were able to issue Pfandbriefe after this announcement.
However, the secondary market is still lacking in the sense that now, due to this constant buying, we have a lack of bonds to provide a liquid secondary market.
Ted Packmohr, Commerzbank: This is a discussion which started as soon as the programme was announced in May. It's very funny to look back at some of the newspaper articles quoting that €60bn would be far too little to be of any real value, considering the size of the overall covered bond market. I think it very quickly became apparent that statement was wrong. Look at what the ECB has achieved: it is quite clear that €60bn is a sum which is not to be sneezed at.
Torsten Elling, Barclays Capital: After buying €10bn already, just imagine what another €50bn can do.
IFR: So has the problem now changed? Is the liquidity bottleneck on the offer side and not on the bid side?
Rosenberger: We are moving away from a seller only market. The ECB certainly solved the problem of the primary market, which is performing well now. But, the secondary market is something we still have to address as a community.
Packmohr: I think times have already changed again on whether this is a seller’s or a buyer’s market. We have seen a more balanced approach during the summer break. That the ECB and the other central banks were able to buy that high a volume during August, despite the primary market being basically closed and 95% of the volumes they purchased actually being contracted in the secondary market at the time. That implies that at the currently tight spread levels there was indeed a significant revival of selling and switching interest.
Look at Pfandbriefe, for example, compared to some peripheral government bond markets. On relative value terms it has become a relatively tight and relatively rich product. This, of course, is a reason for some accounts to hold back and look at relative value opportunities.
It would actually be helpful for the ECB to now scale back their buying activity a little in the secondary market. That would let some of these volumes, which are looking for new hands, come to the market, creating a bit more balance between bid and offers. This will help to revive the trade and turnover density which in turn would also help to narrow bid/offer spreads again.
Elling: It will be quite important to see the statistics at the end of September to see how much the ECB buying has changed from the secondary to the primary market. Clearly in August the primary market was pretty thin, there hasn't been a lot of activity. But still the European central banks continued to buy on a very mathematic and arithmetic basis. Hopefully this has changed during the month of September and they are picking up more primary paper than the secondary market paper.
Packmohr: It is also worth mentioning that the activity of the central banks in the primary market is by no means unusually high by historic standards. If you look back to July, when the market on the primary side was still very much alive and kicking, central banks achieved placement shares of around 10% to 15%. If you look at what the ECB published in their statistics, the amount of covered bonds they bought in comparison to the eligible amount of supply which came to the market at that time would equate to a placement share of around 10%. That's pretty much in line with the standard historic placement that we used to see from the central bank sector before the crisis.
So it's not that the placement of new issues is really reliant on the ECB: they are supportive, but the Pfandbrief market has its own customer base.
Rosenberger: I think it is important to say that no transaction so far in the primary market was based only on ECB demand or orders from the central banks.
IFR: Do we expect the ECB to move more of its buying into the primary market as it reopens after the summer break?
Elling: They already buy in the primary market as they have done so in the past. Clearly August was not the biggest month for primary activity so it will be interesting to look at the monthly report at the end of September to see whether the ratio between primary and secondary purchases has changed.
IFR: Has the ECB given any clarification from the in terms of what proportion of covered bonds they are buying from which jurisdiction?
IFR: Should there be?
Packmohr: As soon as you have certain quotas being published, then a political discussion starts about the fairness of such quotas.
IFR: So has the ECB been quite clever in the way they have communicated what they are buying?
Packmohr: I think so, yes. First of all everybody was complaining about the fact that they were only relaying information piece by piece. In the end I think that it was actually quite clever of them to do that because they kept the market on the hook for some time. Upon announcing their programme in May, the ECB had already reaped the benefit long before they started their actual buying. And that was just by revealing selected pieces of information, keeping it in people's minds every month. In the end they didn’t need to reveal too much detail or answer too many of the questions everybody was throwing at them. So in the end, I think that was quite cleverly handled.
IFR: Have we seen more flow going through the electronic platforms since the ECB announcement?
Laurent Viteau, EuroMTS: We have both inter dealer and B2C platforms. Pre-crisis inter-dealer activity used to be nine or ten times what the B2C was. Now it is completely the reverse.
We have seen an increase in customer activity pretty much every month this year and even more so since the ECB announcement. In fact, we are probably back to the same level in B2C where we were pre-crisis.
IFR: Has the secondary market seen an increase in two-way flows?
Elling: There is a simple example. In the last couple of months we've sent out offer lists where investors could see the offers which we have. It's currently coming back more as bid lists, where we are trying to cover short positions and we see two way flows. But I think there is still a bias towards the offers that you put out because investors are keen to invest their cash currently in the product.
IFR: Has there been much activity on the Eurex auction system since it was launched?
Elling: There was a small pick up in activity, but I do not think that the volumes are what we expected. We can argue about the reasons, but overall volume is still quite low.
Packmohr: I think that was to some degree due to timing. We cannot blame it all on the idea or on the technicalities. It would be very difficult for any electronic trading system to generate liquidity in a single sided market. If traders want to hold on to existing positions, you cannot force them to relinquish volume into the market. They will provide liquidity by whatever means. That was what caused these bond auctions to not kick off as one might have hoped.
Elling: I still believe that the idea of having a kind of fixing or auction is somewhat similar to the fixing in the German government bonds. I think that's a great idea: it gives you transparency, which all the investors want. At least once a day you have a price, which is then more or less driven by demand and supply. That at least gives you liquidity once a day when the auction is taking place to put in orders. The idea is still something which I very much agree with.
IFR: Was the ECB intervention really necessary for the Pfandbrief?
Jens Tolckmitt, vdp: I think it was important. The ECB announcement helped to speed up the spread tightening that was already occurring in the market. It was not necessary to kick start the market or even to help the market liveliness, but it certainly contributed to the positive development that we have now seen.
Schenk: And it also served to broaden the investor base again. This is a very important outcome because while it was possible to place Pfandbriefe for many issuers, it was not possible for every issuer.
For example, look at the orderbook for Deutsche Pfandbriefbank's €1.5bn 3.125% September 2014 Pfandbrief we priced this week, the first benchmark Pfandbrief we have issued for more than a year. Deutsche Pfandbriefbank is part of the Hypo Real Estate Group, which has many past issues. Yet we still had very broad orderbook with more than 160 names involved. It really shows that many investors are coming back on a broad basis to this market.
Sommer: We basically had the same experience as Deutsche Pfandbriefbank with our benchmark deal. We issued it in May, just after the ECB announcement at the tail end of the crisis. We saw around 95% of domestic bids in the book, and when we later tapped it in August by a further €250m, 40% of the demand came from overseas accounts and even central banks.
The environment has changed and the ECB decision gave the market good impetus.
IFR: Has this broadening of the investor base brought the market back to where it was before the crisis, or is there still some way to go?
Schenk: I think in some respects that it is even broader than before. If I compare the orderbooks we have seen this week with those of a year or 18 months ago, we now have a many names taking part, which were not present before.
Also, as we do not have the choice of so many functioning markets as we did in 2006 or the beginning of 2007, I think the investor base is getting even broader.
It was surprising that many real money investors have become involved in the recent deals which we haven't previously seen in Pfandbriefe. The Pfandbrief levels were simply too tight for them back at 2006 and 2007. Therefore I do think that the investor base for Pfandbriefe is even broader than it was in the past.
IFR: Is this internationally or within Germany?
Schenk: The investor base is definitely broader in Germany; we are seeing some names we have not seen before. But it is also the case on an international basis at least that is what I can say for us as Deutsche Pfandbriefbank. It is really surprising the names we have seen from international investors.
Rosenberger: And when you look at spread performance, in the widening spread environment we had after the Lehman crisis, the Pfandbrief clearly outperformed other covered bonds. It was pretty clear to me that the Pfandbriefe would be the first in the covered bond world to recover because it is the strongest product, and this is exactly what we saw even before the ECB announcement.
However, the levels of other covered bonds indicate that the problems there were much bigger. Clearly help was needed for markets outside of the Pfandbrief realm. But it was not acceptable to exclude Pfandbriefe from the purchase programme, so I think it also helped the Pfandbrief recovery to be quicker than it would have been otherwise.
Elling: I can also echo what has been said. There is much broader investor interest in the product that there was previous to the ECB buyback. We have even seen some Asian accounts coming back into the market who have been absent for quite some months, if not years. This is obviously a very positive signal.
Of course, one thing that makes a big difference here is the ECB buyback. The announcement obviously took care of the liquidity issue which was mentioned by many investors before the crisis. But, also, there is now a real spread performance opportunity for investors in buying Pfandbriefe and that was something that all investors took on board when they put in an order.
If you look at the deals that have been issued so far this year, they have all generated a very positive spread performance. Some have done better than others, but nevertheless there was a strong performance overall. Investors utilised this chance of potential performance.
Also, if we look at the syndicate process, I think it is fair to say that bringing a deal is a much quicker nowadays. The books are oversubscribed again, sometimes even twice as much if not more, and this cover ratio is something which was needed again. This is a very positive signal.
Packmohr: I do not think we should credit all the recovery to the ECB and nor should it just be credited to the safety of the Pfandbrief. If you look at the markets it is simply the case that risk appetite is back again and so is the hunt for yield. We have moved into an overall very positive market from which covered bonds are benefiting, in the same way as some unsecured credits are benefiting from the overall conditions.
Elling: But, to this point, there was a clear lag between when we saw the performance of senior debt take off two months earlier and when we saw the performance of covered bonds pick up just after the ECB announcement in May.
I tend to agree with what you are saying, but clearly covered bonds as a product lagged the performance of other asset classes, instigated by the positive quarterly reports of banks and by the additional collateral that ECB took on board. Then, after the ECB announcement this performance was also seen in covered bonds.
Click here for Part two of the Roundtable.