Pfandbriefe Roundtable 2009: Part II
IFR: The Bank of Ireland issued a covered bond at 190bp over mid-swaps this week. Can the Pfandbrief market compete with covered bonds at these levels?
Elling: When we are talking about levels around the 200bp area where the Bank of Ireland opened books - later printing at 190bp and quoted at 178bp bid without any offer- it is obviously a great achievement for the Bank of Ireland. But we have to keep in mind that Irish government debt is trading around 85bp over swaps as well. So, putting this into perspective with Pfandbrief trading versus the German government, it is a slightly different picture.
Clearly here the investors are looking at the different quality of the products. Pfandbriefe have a 200-year history and are regarded by investors as of the highest quality. This is also being seen by the spreads that can be achieved by the issuers.
IFR: Has the tightening of spreads also been driven by the strong domestic investor bid and not just an improving market environment and ECB buying?
Diemer: I would say that generally every successful Pfandbrief issue from an international primary book perspective had a strong domestic bid. It is the strong domestic bid which also brings the international investor on board. That's the history of the Pfandbrief. Other covered bonds have different primary book compositions, but Pfandbriefe always benefit from combination of both.
Rosenberger: Germany is the biggest economy in Europe so the demand for investment is highest in Germany. That makes investors from Germany very attractive for issuers, not only Pfandbrief issuers but covered bond issuers all over Europe. Investors need diversification so they are looking not only at domestic paper, they want to diversify into different names. In the end, I think other covered bond issuers are certainly looking for the German investor bid, but they will first of all base their funding on their own domestic bid.
Schenk: But what's also important in this respect is we should not only look at benchmark jumbo issuance but also private placements.
Private placements are important for every Pfandbrief issuer. While private placements were traditionally driven by German investors, now you are seeing international investors buying private placements. If you look at the different jumbo deals, the orderbooks are also more international now.
Sommer: May I post a theory that in the midst of the crisis we saw a trend of deglobalisation in nearly all markets. Is that right?
Tolckmitt: Yes, I would agree with that. The most important aspect in the Pfandbrief holding up reasonably well during the crisis was due to the core German investor base. Now that the market is opening up again, a strong international base is coming back. Where you saw the importance of a strong domestic investor base was deep into the crisis where Pfandbriefe traded at very different spread levels to the rest of the covered bond market, and were always able to find placement with investors.
Packmohr: I think that is also due to some of the specialities of the German market, in particular to the status of registered Pfandbriefe without the need to mark to market them. This of course was a great help during the crisis.
Let's not forget, when we talk about the Pfandbrief market, people typically focus on the jumbo market straight away. But the registered Pfandbrief market is actually a larger market percentage wise, in terms of outstanding volume. This is one of the cornerstones which held up particularly well during the crisis, due to the features which were not open to other covered bond jurisdictions.
Tolckmitt: They were quite substantial amounts that were raised through registered Pfandbriefe in an environment where you would, with most capital market products, have thought there was no possibility of actually getting liquidity through the capital markets.
Rosenberger: Eurohypo was, during the whole crisis, able to raise long dated funding via the registered market and for me, this is proof of the long standing relationship between the institutional investors in Germany and Austria and Eurohypo.
IFR: Can an issuer with a high funding requirement rely on private placements and the registered Pfandbrief market if the jumbo market is closed?
Schenk: The real question is would the jumbo market really close? It would definitely have some impact on the private placement and registered markets – but overall I would say they are reliable for funding. Perhaps for us it was a little bit different, but what I've seen with other issuers that were more stable during the crisis is that there was always a bid and therefore a funding possibility. But if the jumbo market closes for one reason or another, I think this would have some impact on the private placement market.
IFR: And you can fund long term with registered Pfandbriefe?
Schenk: Longer dated than in the jumbo market.
Diemer: Usually the registered market is longer dated, from a term perspective, than the wholesale or syndicated market. I think it is necessary to have access to both in order to manage the liability side. Then you can achieve capital market funding and simultaneously cover your private placement investors in order to ensure refinancing sources.
Tolckmitt: Looking at the question slightly differently, the important thing about registered Pfandbriefe, or smaller bearer Pfandbriefe, was the fact that they showed that they are a means of getting liquidity in a difficult market environment. That does not mean that you can only rely on registered and smaller bearer Pfandbriefe to actually fund yourself in the normal market environment, but that is not necessary. It is important to have a channel to obtain money even if markets are very difficult.
Rosenberger: Looking at it from an ALM perspective, we all have a very granular asset side, so it is very important to not only fund through jumbo Pfandbriefe, but also to better match assets and liabilities by doing smaller private placements and registered Pfandbriefe.
Schenk: And small placements for us mean starting at €5m, for example. It really is a daily business; we are not only active every few months or when we issue benchmarks. I think that is something not many people are aware of, that we are involved on a daily basis and every day closing a couple of deals, even if they are small. From the asset and liability profile that is really very important.
Sommer: The overall market issued Pfandbriefe in 2008 was roughly €150bn. 24% of this figure comprised registered bonds, so called Namenspfandbriefe, and if you compare this ratio with 2009 it has grown. From January to June this year we had around €65-€67bn issued Pfandbriefe, 33.8% of which was registered Namenspfandbriefe. So in the midst of the crisis, even the part of the registered bonds grew. That is a typical phenomenon in this market.
Rosenberger: What this shows is that the registered Pfandbrief is a success story; foreign issuers have even started to set up registered Pfandbrief programmes and they would not do that if it wasn’t an interesting or attractive market.
IFR: Has there been a change in issuing volumes of public sector Pfandbriefe versus mortgage Pfandbriefe?
Sommer: At the beginning of September we had roughly €80bn Pfandbrief issues, of which around €42bn or €43bn was comprised of mortgage Pfandbriefe, €38bn public sector and around €1bn ship Pfandbriefe. So there is a clear trend in the direction of mortgage Pfandbriefe.
Rosenberger: You have to look back at the years 2006 and 2007, where in reality risk was not correctly priced. There was no appropriate spread differentiation between public sector assets, which meant a serious threat to the public finance business model during this period. This is clearly not the case anymore. We now have risk priced fairly and banks now look at how to adjust their business models accordingly. I think we will see Oeffentliche Pfandbriefe coming back to the market as the business model now works.
Issuers have not been that active in the public Pfandbrief market, Eurohypo especially has not been active in the public Pfandbrief market because the business model of the public-sector Pfandbrief is pretty spread sensitive.
On the one hand, we have the possibility to fund the assets via the repo market and one good thing that was clear during the crisis was that the repo market continued to function. It provided us with cheap funding for assets, so we were in the good situation that we were not forced to come to the Pfandbrief market as long as the spreads were really wide.
On the other hand, the repo market allows us to generate cover assets quickly, so if we see a good opportunity in a market window for public Pfandbriefe we can react pretty quickly to these opportunities.
Tolckmitt: I agree that there may be opportunities, but the overall volume of Pfandbriefe is also contracting this year. We had a total outstanding volume of around €800bn at the end of last year and we at the association expect this volume to decline to between €730bn and €750bn by the end of this year.
The bulk of this reduction is obviously due to the contraction of public-sector Pfandbriefe, which is not only a trend that has been going on this year but for some years now. Prior to this it was public-sector Pfandbriefe that was driving the increase in overall volumes. To that end, we are moving back to where we were before public-sector Pfandbriefe increased in volumes originally.
With respect to mortgage Pfandbriefe, we have already seen an increase compared to last year. Half year figures in 2008 show mortgage Pfandbrief issuance of roughly €32bn, we had a half year figure in 2009 of €35bn and this trend is continuing. I think one of the underlying reasons for this trend is that other means of funding the asset side obviously dried up and haven't reappeared again. So as is with the public sector Pfandbriefe, this is an ongoing trend. But mortgage Pfandbriefe will become more important in terms of volume.
Diemer: I think funding strategies will move from ABS funding and senior funding towards mortgage Pfandbrief funding. I also think that all banks will check the potential of issuing mortgage Pfandbriefe by looking at their own existing balance sheet and asking themselves the question: which of these existing loans can be refinanced using mortgage Pfandbriefe?
Packmohr: This is a question which has already been answered by some of the banks. Deutsche Bank recently entered the Pfandbrief market and Postbank has become more active.
So we have on the one hand new banks entering the mortgage Pfandbrief business; but on the other hand strong issuer consolidation, particularly with regards to the public sector names.
I think it's important when talking about the Pfandbrief and how important this has become for the overall German banking market to realise that if you look at, for example, the top 20 list of German banks, there is barely anyone left not making use of Pfandbriefe as a means of funding, either directly or via a subsidiary. So the only banks not involved in the Pfandbrief market are institutions such as KfW, which simply does not need the Pfandfbrief market because of its status, and NRW Bank, which is no longer making use of it because they are a public sector development bank. I'm pretty sure if you look at the top 15 or even top 20 institutions in Germany, they are all in some degree involved in the Pfandbrief market.
IFR: You mention that the top institutions are all involved in this asset class in one degree or another, but Germany's banking sector is actually very fragmented. Do these smaller institutions have access to Pfandbrief funding?
Packmohr: The smaller banks are also increasingly accessing the market. Just this summer, for example, Degussa Bank received a Pfandbrief licence with a mortgage book of some €2bn. They are by no means a large bulge-bracket name in the German market. The savings banks are becoming increasingly active in this segment too. So the Pfandbrief is very widespread across all sectors and sizes.
Tolckmitt: Given the spread differentiation between the various products in Europe - Pfandbriefe being the best performer - there are a number of banks loosely looking to issue Pfandbriefe. This was ruled out only a couple of years ago when banks said it was too burdensome to actually do it, given the fact that for a long time spreads between the different jurisdictions and products were very narrow. Now the differential has widened substantially banks are therefore looking for information on the prerequisites to issue Pfandbriefe and how to do it.
IFR: Has the creation of the government-guaranteed bond (GGB) market had any impact on Pfandbriefe?
Sommer: I think at the beginning there were fierce concerns that the effect on Pfandbriefe would be extremely negative. But, in actuality, the effect was not as big as initially feared, due to the limited period of issue for GGBs and the restricted secondary market. To cite the recent analysis of Barclays Capital in the AAA Investor research titled: GGB - The (Almost) Forgotten Asset Class. "Affected by the continuing improvement in funding conditions in the global money and capital markets, and the ECB’s announcement that the European System of Central Banks would purchase €60bn of euro-denominated covered bonds issued in the euro area until June 2010, the issuance of GGBs ground to an abrupt halt in May 2009."
This had to do with a loss of the relative funding advantages of the GGBs. Even the head of the Dutch Treasury says there's no longer a need for state guarantees.
If a bank needs GGBs to issue, that can be a signal today that the bank is not able to issue in, or has only a limited access to the capital markets. So there is a kind of stigma. In Germany, I believe only six banks up to now have issued GGB's: Commerzbank, HSH, AarealBank, DusseldorfHyp, BayernLB and IKB.
Rosenberger: In the first months of 2009 the GGB was an important instrument for many banks in which to raise senior funding and to raise volume at spreads which they would not otherwise have been able to achieve. Even as Eurohypo was not looking for a guarantee itself, it clearly benefited from Commerzbank being able to issue a GGB. It secured a good portion of the senior funding need for the whole group for 2009.
Packmohr: I think Commerzbank is an excellent example of the change in sentiment regarding GGBs. It was the first one to really open this market segment with a large €5bn deal, and recently announced it will not be making use of the remaining capacity to issue such bonds. Instead, it will return this to the sovereign. That tells you a lot about the status of the GGB market.
Diemer: It was clear from the beginning that GGBs had a short life-span. They have also a limited investment horizon concerning issuers, concerning duration and currencies. The Pfandbrief offers all sorts of varieties; it's a quality product with a clear future. .
Viteau: There is a parallel on the secondary market for GGBs. When they were first introduced we had a lot of demand to include them on the system so people could trade and make prices. Indeed, there were prices at the beginning for these bonds. But soon there was no more interest in GGBs. We began to see returning interest in Pfandbriefe and covered bonds, but not in the GGB market.
Elling: This is if you have funding alternatives where you can achieve a tighter funding than in a GGB market, where your all in level is pretty well defined by the medium of the CDS plus the 50bp fee. In the current environment, where one market is really performing, it makes it really difficult for GGBs to continue to be a liquid asset class – when one cannot foresee a lot of issuance going forward, if any at all. Therefore, it is obviously difficult for a trader to keep the liquidity these days and specifically to go short on such transactions.
Click here for Part three of the Roundtable.