Shadow of its former self
Lack of supply means Pfandbrief issuance is likely to be down by a third this year, but demand is such that pricing in single digits over mid-swaps is now the norm.
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It has been a thin year so far for the covered bond market, one of the hardest in the past decade. The first quarter of the year saw only €36bn covered bond issuance globally, according to Barclays. Thanks to continued attempts by eurozone banks to deleverage their balance sheets the supply simply isn’t there. So much so that at the beginning of April Barclays revised its global supply forecast for 2013 from €175bn to €110bn.
The lack of supply has been even more marked in Germany. Predicted issuance this year has been cut by 33%, from €15bn to €10bn, thanks to the long-standing decline of the public sector Pfandbrief market and the gradual deleveraging of the Pfandbrief banks.
What has also hit volumes is that covered bonds are being put aside in favour of senior unsecured issuance.
“Last year covered bonds were the funding tool of choice, but the shine has come off them slightly in favour of senior unsecured debt,” said Armin Peter, head of covered bonds at UBS in London. Mauricio Noe, head of covered bond origination at Deutsche Bank, agreed. “There is little covered bond supply. Many European banks are well-funded, and where possible they are using senior unsecured.”
What the lack of supply means is that demand for any European issues that emerge is overwhelming and pricing is tight. Bear in mind that across the border in France, at the beginning of April, HSBC France sold a €1.25bn 10-year with no new issue premium at mid-swaps plus 22bp, BNP Paribas priced a no-grow €1bn seven-year SFH covered bond at mid-swaps plus 22bp and then Credit Mutuel-CIC Home Loan sold a €1.25bn seven-year at mid-swaps plus 23bp. German issues generally price inside that.
There are fears too that demand will only increase before it declines. Pressure is expected from Japanese investors in what has been called the Kuroda effect. In early April Bank of Japan’s governor Haruhiko Kuroda announced a shift in monetary policy which is likely to see Japanese investors putting their money more broadly into Europe.
“We have not seen a lot of Japanese real money yet, but some banks are positioning themselves already in order to attract potential JGB investors,” said Torsten Elling, co-head of rates syndicate at Barclays in London.
Another banker mentioned a general change in attitude towards the euro and that the Asian component of books is rising. UniCredit Bank HVB’s €500m seven-year Pfandbrief in late April saw Asian investors take 13% of the paper.
With even French issues pricing tightly, no surprise then that in Germany they are pretty much on swap levels. At the beginning of April, market stalwarts Muenchener Hypothekenbank and Bayerische Landesbank priced a €750m eight-year and a €500m 10-year respectively at mid-swaps plus 3bp and mid-swaps plus 11bp.
Both of the deals had comfortably large order books and, above all, both deals avoided charges of gouging investors and offered some kind of a pick-up. MunHyp priced at a 4bp premium to its own June 2022 deal, even though this deal matures 14 months earlier. BayernLB looked even more generous with a 5bp premium over the bank’s July 2022s.
The pricing on these deals may look incredibly tight, but not only do they offer a pick-up on previous issuance, they also offer something over German government debt. That is the real point here.
“Look at recent deals. As a spread over Bunds, the pricing is still attractive. The last seven-year MunHyp deal for example, does give investors a more than 50bp pick-up over Bunds,” said Ralf Grossmann, head of covered bonds at Societe Generale.
This is a tight line to tread and there is a danger of pricing too tightly. For issuers who try to see how far investors can be pushed, there is the cautionary tale of Berlin Hyp.
For those with longer memories, last summer, it priced one of the tighter covered bonds of the year. A €2.2bn book allowed it to price an €1bn five-year at mid-swaps plus 9bp. In secondary the paper even traded in a couple of basis points.
With that in mind, in February this year, Berlin Hyp went to market with another €1bn five-year. This time it priced at mid-swaps –1bp. The rumour mill went into overdrive suggesting that investors simply did not bite and more than half of the bonds had to be covered by syndicate banks – Barclays, Credit Agricole, JP Morgan, LB Berlin and UniCredit.
Boosted by CRD IV
What could give the market a boost and is certainly being watched carefully is the EU bank regulation, CRD IV. At the beginning of April, the latest version of the paper accepted claims from Denmark that its covered bonds should be regarded as Level 1 assets – in other words, equivalent to sovereign paper. Until now it had been seen as Level 2, meaning that only 40% of a bank’s liquidity buffer could be held in covered bonds and there would be a 15% haircut. Now banks will be able to hold as much Level 1 paper as they want and with no haircut applied.
“Of course Germany wants that for its Pfandbriefe,” said one banker and it is certainly being watched closely. Although the legislation is targeted at a specific problem (Denmark has a large number of covered bonds and little sovereign issuance), there is an expectation that lobbying from other European countries could see a change later in the year.
“The EU appears reluctant to open the door to allowing German covered bonds as Level 1 assets, at the moment,” said another. “But who knows what will happen later in the year.”
So while the German covered bond market appears at first glance to be happy and successful, some are starting to ask questions about the purity of the asset class. For a start, it is worth noting that books are always anchored by German accounts. In the MunHyp, BayernLB and UniCredit Bank HVB deals above, German accounts took 51.1%, 65% and 66% of the deals, respectively.
As one banker put it: “Germans want to keep money in Germany in products they understand.”
It is worth asking whether investors really do still understand the product. Questions have been raised about cover pools. In mid-March Deutsche Pfandbriefbank sold a €500m no-grow seven-year which priced at mid-swaps plus 25bp. More than two-thirds of the cover pool, 69%, is made up of commercial property while only 54% is in Germany. While there is no question of default – there is an overcollateralisation of 42% – that kind of cover pool is not what investors immediately think of when they consider the German Pfandbrief.
Testing the limits
The Deutsche Pfandbriefbank issue came on the back of Commerzbank’s SME structured covered bond at the end of February, which still has bankers huffing and puffing.
Commerzbank sold a €500m five-year covered bond via Barclays, Commerzbank, Credit Agricole CIB and UniCredit at mid-swaps plus 47bp. As a means of supporting lending to small and medium-sized enterprises, the deal cannot be faulted. But with covered bond investors naturally cautious and conservative, any evolution must be done carefully. Has this caused any problems? No, not yet, but covered bond bankers are starting to ponder, increasingly vocally, how far the structure can be pushed.
It looks as though issuance patterns are unlikely to change for the rest of the year. The best that can be hoped for is that issuance will pick up in the third quarter.
“In Q3 we are likely to see the usual pattern. At the back end of the year issuers begin to try again for the following year, so from September onwards the market will become more active,” said Societe Generale’s Grossmann.
The best that most bankers can expect is that issuance for 2013 will be a third down on last year. It could be even lower.