Pfandbriefe/Covered Bonds 2008
It has been an interesting year for covered bonds. While few asset classes outside commodities have flourished in the current market conditions, covered bonds on aggregate have enjoyed relatively good performance. This has ranged from being among the least bad performers in the credit universe in some of the newer covered bonds markets – such as Spain and the UK – to delivering very good returns in absolute terms in some of the more established markets – like Germany and France.
This has attracted considerable new attention to the sector from players on both sides of the net: issuers with no history in covered bonds have been bringing deals to market, with a number of inaugural issues – often from new markets like Italy – coming in 2008. Meanwhile, investors have been turning their attention in increasing numbers to an asset class that promises to outperform in difficult times. There has been much debate as to where these investors are coming from – or, more accurately, whether the rise of covered bonds will be offset elsewhere as investors turn their backs on other asset classes.
RMBS is one of the most obvious comparisons to make. Many people argue RMBS has been discredited, and that the asset class is set for terminal decline, in which case an argument can be made that covered bonds make a natural replacement.
This is, however, an oversimplification. As our article comparing covered bonds with structured products (page 20) outlines, the similarities between the two products do not extend much further than the mortgages underlying them. There are, in fact, significant differences between them and their risk profiles, a product of their structures (covered bonds tend to be structured as bullets while RMBS transactions amortise) and the recourse to the issuer provided by covered bonds. This accounts for the differences in the types of investor the different markets have traditionally attracted – and are likely to continue to attract.
Yet undeniably covered bonds have looked increasingly attractive relative to a number of other sectors and it is obvious that the product's success as an asset class has, to some extent, been at the expense of a number of other credit products.
It has not been all plain sailing. The industry faces a range of challenges, particularly pertaining to the wide disparity between markets – not only between those that already exist, but, even more challengingly, between those just emerging now or planning to emerge in the foreseeable future. Many of these differences are based in cultural and legislative traditions and will be difficult to change, while others may be ironed out to create something a little more standardised from the patchwork quilt of markets which acts as a barrier to entry for some investors.
The other headline-grabbing challenge for covered bonds has been market making, which broke down as market volatility increased. The system is yet to be adequately fixed, although much attention has been given to this problem by regulators, investment banks and trading technology providers.
Considering these obstacles, the big question is whether covered bonds can live up to their hype.