Pfandbriefe Roundtable 2009: Part IV
IFR: So what are we anticipating from the Pfandbrief market going forward in terms of issuance volumes?
Packmohr: I think the market has already returned towards healthier issuance volumes and that is going to continue. Keep in mind, however, that some of the issuers out there have been pretty active in pre funding their yearly targets. The inactivity of the last month does not necessarily mean that all issuers are going the same speed throughout the year end.
Schenk: But looking forward we will hopefully come to see a more stable market. We are already close to the year end but I think issuance will emerge on a more stable basis than what we saw during the last year, where we had peaks with a lot of issuance and then times where we saw nothing. Hopefully it will come back to a more balanced level.
IFR: Are issuance volumes down compared to previous years?
Tolckmitt: At the beginning of the year we estimated that the funding need for our members was around €100bn. Until now we have seen almost €85bn in issuance. So you can see that not only during last month but during the last months, the issuance was almost back to normal. Mortgage Pfandbriefe saw even more issuance than during the same period last year. There was less public Pfandbrief issuance, but that was expected and would even have been expected without the crisis.
IFR: What's the situation in the jumbo market? Are we seeing more or less jumbo issuance compared to previous years?
Packmohr: We are also seeing some sort of revival, but if you compare year on year, 2008 has not been all bad. You can clearly make a distinction in pre Lehman and post Lehman, so 2008 did see some stronger months. Also this year, Pfandbrief issuers at relatively early stages of the year have been able to access the market, so it has had a more stable profile than in some other countries and was disturbed by the crisis.
But what is clearly beneficial now is that we see that issuers from across the whole scale can again access the market. We also have new issuers that have joined the market just this year which helps in turn adding to the impetus.
IFR: Where are we in terms of spreads versus senior bonds and how does this affect the market? Does issuing jumbo Pfandbriefe become more difficult if there is a wide differentiation between the two spreads?
Rosenberger: No, I think that Pfandbriefe are fairly priced at the moment. The next asset class where investors will find value is the unsecured bank market, where we will begin to see more issuance and better performance.
IFR: Is there much room for performance in the Pfandbrief market now?
Packmohr: I personally think that we have reached some resistance in the Pfandbrief market, judging from the fact that so much volume has also been given to the ECB. There was so much selling and switching interest implying there are some relative value considerations now kicking in.
In the meantime, we also saw several issues in the five year segment being placed at low double digits. But it is very difficult then to go into the single digit area. There is a natural bottoming out that was to be expected and indeed is healthy for the market, in order to stabilise. As I said before, it is not about spread performance, it is also about regaining stability in order to help liquidity again. So you need a bit more of a balanced bid and offer profile to get the market up and running in this segment.
IFR: Is there any crossover between the investor base of unsecured securities and Pfandbriefe?
Elling: I think there is a very limited crossing between those two investor bases, although if you look at overall relative value investors obviously there are some opportunities on senior debt versus covered bonds. Specifically in some markets like Canada and Sweden you could even find that the covered bonds of certain issuers were trading at wider levels than the senior debt. Again, this is not a market which is properly working again, so there is some disorder and the misallocations of relative value. But if you look around you come across some opportunities and there you will find investors looking at both asset classes, looking to set up a trade.
IFR: Is there a threat to Pfandbriefe from the rating agencies and the proposed changes in methodologies?
Tolckmitt: Obviously Standard & Poor's not yet published approach to Pfandbriefe poses a certain threat. The thing that we are addressing at the association with all rating agencies is that when they look at Pfandbriefe they use complex measures from the securitisation world to assess the credit quality of the product. We have a problem with this. We think some of what we call soft factors contributing to the stability of the Pfandbrief that is reflected by the market performance, such as the strong legal framework, the commitment of both the industry and the explicit commitment in the government, are not properly built into the rating approaches of the rating agencies.
For instance, I do think you cannot get a stronger commitment than the government saying "We will make sure that no Pfandbrief will ever default."
In addition, whether approaches are reality tested is a real concern. Can what the rating agencies imply in stress testing actually happen in the case of Pfandbriefe? If this is not the case, then it begs the question: is it the right way to measure the credit quality of the product?
IFR: Do we agree with this point?
Sommer: One important aspect is the stand alone rating has more weight than in previous years. In this respect, we don't think that it is necessary to make a strict link between the stand alone rating and the Pfandbrief rating. If a Pfandbrief bank has an investment grade rating, it should, theoretically, be able to reach a AAA rating if the bank fulfils all the criteria.
Diemer: And it deserves a AAA from our point of view in that case.
Schenk: As long as this remains in the discussion phase it will not help the investor or the issuer. I think some clarity in this respect is necessary; we need to find a solution with the agencies soon.
Tolckmitt: At the moment you really cannot discuss the approach of S&P because we only have a consultation paper that was issued in February. This is quite a long time to wait for the results to be published.
If I may take one example, one of the main concerns for all the rating agencies is the liquidity situation of the cover pools. An implicit answer to this concern in their first paper was for a contractual third party liquidity provision, which is clearly an element of the securitisation world. You have difficulties in incorporating this into the Pfandbrief environment because Pfandbriefe are a legally based instrument.
The second thing is, why should a contractually based third party liquidity provision be seen as more secure in the case of crisis than what the Pfandbrief law has initiated with the legal provisions? Some of the third party liquidity provisions in the past have not proved to be very valuable.
Simply having a liquidity provider is no guarantee. It is not appropriate to measure ratings of covered bonds, if they are legally based, with elements that are clearly taken from the securitisation world.
Rosenberger: I think the market prices the risk of Pfandbriefe against the risk of covered bonds every day. When you look at the spread curves of the individual jurisdictions you see that the risk of Pfandbriefe is clearly priced lower than the risk of other covered bonds. This is due to the strong law, and this is what S&P has not fully incorporated into their first draft. What I appreciated was that they were actually willing to consult with us, that they had an open dialogue on all the points and that they really have to take their time with a long consultation phase before making a decision.
On the other hand, they cannot argue against the market. It is clear that the market has priced these risks over a long period of time to the favour of the Pfandbrief.
Schenk: Which is really surprising. Normally uncertainty undermines confidence in a financial market, but even in this climate of uncertainty we had pricing development in Pfandbriefe. That's the really the surprising part of it.
Rosenberger: It is important the rating agencies, investors and issuers keep an ongoing dialogue so we can continue to improve the product, ensuring it remains one of the most secure investments in any investors portfolio.
Tolckmitt: And that's what I meant when I said "reality testing". If you look at the market and how differentiated it is, particularly since Lehman, then I would have set that against the potential results of my own rating process when looking at different products.
One thing, however, that in my view is positive from the crisis is that it has encouraged investors to do their own analysis. They have to decide whether they can live with a product and not rely entirely on the rating agencies.
IFR: Do investors have access to cover pool information?
Tolckmitt: In Germany we have a legal transparency requirement to disclose cover pool data according to different criteria on a quarterly basis.
When the Pfandbrief act was enacted in 2005, the scope of disclosure requirements was widened to quote on a quarterly basis. We are discussing with investors on an ongoing basis additional interesting information in order to continuously better meet their needs.
IFR: Are investors becoming less reliant on ratings?
Packmohr: I think the sensitivity towards rating changes has, to some degree, diminished, simply because there's so many of them. I remember when a rating change on a covered bond issuer was an exceptional event. For some months now we have generally had a downward trend in terms of ratings from all the agencies, so it is becoming less of a big deal.
Investors are also realising that there is potentially an increasing link between covered bond quality and issuer quality, you can see that in the receptiveness of new issues. It is not all about the cover pool anymore. If you want to really evaluate a covered bond, any investor will look at issuer quality, at legal and segregation quality and cover pool quality. To some degree that is irrespective of short term rating trends, even though credit worthiness and general trends are very much in people's minds, as you can see in several countries such as Spain and Ireland. So you cannot really separate these factors.
Elling: I agree with what Ted just said. I think a AAA rating is currently a box which investors need to tick off to put the order into the book or invest into the product. Then many investors are just doing their own analysis, whether it is on the credit, on the collateral pool or on the legislation. They are much more sophisticated in doing that than they were pre crisis.
IFR: Even with the pressure from the rating agencies it is still quite rare to see an issuer without a AAA rating in this market; Deutsche Pfandbriefbank being the exception. How did that impact your deal, if at all?
Schenk: Investors are definitely looking at the ratings but, as I said earlier, they are also looking at collateral pools, they are looking at the issuer as an institution, and therefore I think it is more work if you do not have the AAA ratings, but it is definitely possible to place Pfandbriefe and other covered bonds into the market if they are not rated AAA by all the agencies.
IFR: So investors are now doing more of their own due diligence?
Schenk: They are doing their own due diligence, but I think what's also important is that investors also began to see the distinction between covered bonds and Pfandbriefe again.
IFR: So one year on since the collapse of Lehman Brothers, have issuers or bankers had to change the way they approach the market with a benchmark deal?
Schenk: It has become more important to explain the cover pool to investors: the quality and composition are certainly more scrutinised than in the past. It's very important that you are able to explain this to investors and those investors can see on a regular basis what the composition of the cover pool is.
IFR: As issuers, how important now is your pre launch marketing campaign? Is it more important now to meet investors face to face?
Schenk: From our perspective, as it was really the first transaction after having been absent from the jumbo market for a year, I don’t think the transaction would have been possible without approaching all the investors and talking to end investors.
We did a very intensive roadshow for our core investors in Germany and in Europe.
Rosenberger: We are the biggest Pfandbrief issuer and we certainly need to be face to face with our investors on a regular basis, which we have been for many years now. I think our investors understand the credit, which clearly is shown in our latest transaction, the €1bn September 2014 public-sector Pfandbrief, which with a preparation of just one day and very quick book building achieved excellent pricing.
IFR: Are issuers and bankers sounding the market more quietly than they typically would have done before the crisis? Are we still in the situation that the announcement of a new deal can impact spreads?
Elling: I think sounding in covered bonds developed over the last 18 months. Two years ago, it was not required because we all knew where the market was trading and you could rely on these levels. During the crisis it became more difficult because there was a higher execution risk when a transaction was not able to price because you could not generate enough demand.
But the instrument of sounding a transaction is nothing new; it is standard in the emerging market and the corporate market. As uncertainty grows you want to minimise the execution risk and this was a tool which gives you the right ingredients to do so.
Packmohr: I think the importance of sounding has also changed over time. There was a phase when issuers were a little more reluctant to sound because they knew that they could damage their own spreads in doing so.
IFR: Has that fear lessened now?
Rosenberger: Actually, with our latest transaction, we did not do any sounding at all. We did not mention any spread before we started the book building, we just came out with a range and then priced the trade one and a half or two hours later. That clearly showed the syndicate was fully informed where the spreads should be. It's a sign that the market is much healthier, that people know where prices should be and where risks should be priced.
IFR: So how do you identify the spread range when the market is lacking liquidity?
Diemer: Every issuer sitting here is in the private placement market every day and is aware of what levels they can achieve for their Pfandbriefe. You then enter into discussions with the syndicate desks until you find the right level for larger transactions. The process hasn’t really changed.
Packmohr: Also, when you mention a market missing liquidity, this doesn't necessarily mean that there is no turnover. This is often misunderstood. Of course we have turnover, but it is perhaps happening at wider bid offer spreads and might not be to the same degree as we used to see in pre crisis times. But of course a trader or a syndicate member will have a feeling for where a bond should be priced.
IFR: Have we seen a change in the placement statistics of who is buying benchmark Pfandbriefe? Are any groups of investors still absent?
Sommer: I think it's the same investors as we had before the crisis, 50% or 60% of which tend to be banks and most of the rest are pension funds. Insurance companies and central bank participation is at around 5% to 10%, the same quota as in the past.
Elling: There are certain investors that have still not returned for certain reasons. We are in ongoing discussions with these investors and expect them to regain their confidence, not only in the product but also because of the performance we have seen in the market. That is a very strong indication that this market is recovering and will recover even further. I think the potential performance in this product is very positive for investors.
IFR: So in that respect Pfandbriefe have not been too affected by the crises?
Sommer: It was more a reaction of spread widening. But, if you compare for example Irish ACS, they widened to over 300bp. The highest level in the German Pfandbrief market was 80bp to 100bp. It was the best performance in the midst of the crisis.
Diemer: And the engagement of banks is also clearly supported by the ECB, I don't mean the covered bond programme but by their providing liquidity to the inter bank market in offering 12 month tenors.
Sommer: A conclusion we can draw from the crisis is: if you are a specialised Pfandbrief bank with limited business areas it is easier to gain to constant and sufficient liquidity if you are a part of a bigger group like the cooperative sector than to work on a stand alone basis.
IFR: Then is that reflected in the levels at which you can fund?