Thursday, 21 March 2019

Waiting for some action

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Pfandbrief issuance inevitably slowed as pricing squeezed ever tighter making it increasingly difficult to seduce investors. With yields and spreads seemingly past their lows, deal activity looks to be on the rise with new deals on the road.

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With traditional covered bond supply thin, Germany’s covered bond market is looking at new collateral types.

The lack of supply in the covered bond markets this year has been particularly marked in Germany. According to Deutsche Bank, the total outstanding volume of Pfandbriefe hit €490bn at the end of March this year. This compares to just over €1trn of outstanding volume at the end of 1999.

“There has been a net negative supply of covered bonds for some time,” said Mauricio Noe, head of covered bond origination at Deutsche Bank.

With a lack of supply, spreads have been getting ever tighter. The average swap spread of the bonds included in the Barclays Germany Covered Bond Index came in from mid-swaps plus 15bp in mid-2012 to minus 1bp in May 2013. It has been a similar story with average spreads between mortgage and public sector Pfandbriefe. These have tightened from plus 4bp in mid-2012 to minus 1bp in May 2013.

“We have reached a low on spreads. At the moment we have low yields and low spreads,” said Ralf Grossmann, head of covered bonds at Societe Generale. “In theory they could go below swap rates.”

Grossmann mentioned the Muenchener Hypothekenbank €500m five-year deal in September last year, which is still spoken of with awe. The issue priced at mid-swaps minus 14bp via BayernLB, Credit Suisse, DZ Bank, Goldman Sachs and HSBC. As significantly, investors were not put off by the pricing.

“Investors are primarily seeking safety and quality in today’s environment in the capital markets, which is why they value MuenchenerHyp’s conservative and low-risk business strategy”

“Investors are primarily seeking safety and quality in today’s environment in the capital markets, which is why they value MuenchenerHyp’s conservative and low-risk business strategy,” said Louis Hagen, the spokesman for the bank’s board of management, at the time.

And spreads have shown little sign of widening since then, especially as German Bund yields remain low. At the time of writing, the 10-year is trading at 1.54% while the five-year is at 0.56%. In February, real estate financing bank Berlin Hyp sold a €1bn 1.125% five-year covered bond. Led by Barclays, Credit Agricole, JP Morgan, Landesbank Berlin and UniCredit, the deal priced at mid-swaps minus 1bp. With a reoffer of 99.8650 it yielded 1.153%.

Berlin Hyp has form in tight pricing. February’s deal followed another blockbuster last year. A €2.2bn book allowed Berlin Hyp to price a €1bn five-year at mid-swaps plus 9bp in May 2012. In secondary the paper even traded in a couple of basis points.

This year’s trade was not another blowout, leading to complaints from bankers away from the deal about aggressively tight pricing and the inevitable mutterings about the size of the order book. But the deal does reflect the new pricing reality of covered bond issuance out of Germany. There is no sign that the current environment of tightening spreads and low yields is likely to change any time soon.

Bodo Winkler, head of investor relations at Berlin Hyp, said it was not always helpful just to focus narrowly on the pricing, the more so as covered bonds from German issuers tend to price with regards to agencies or to where Laender, German states, have priced.

“The discussion of whether a covered bond has priced Libor plus or minus is psychological,” he said.

It is a point picked up by Torsten Elling, co-head of rates syndicate at Barclays in London, which led the deal. He said that the focus on Libor meant that “people are ignoring the absolute yields”. He compares the Berlin Hyp deal with the Deutsche Hypothekenbank covered bond that printed a couple of weeks previously in mid-January.

Led by Commerzbank, Deka, Deutsche Bank, Natixis and Nord/LB, Deutsche Hypo’s five-year no-grow 0.25% €500m deal was initially marketed at flat to 2bp over mid-swaps. In the end it priced in the middle of that range at mid swaps plus 1bp with a reoffer price of 99.9000 to yield 0.317181%.

“On an absolute yield basis the Berlin Hyp covered bond offers 25bp more than Deutsche Hypothekenbank’s,” said Elling. And of course there is also the decent pick-up over German government debt.

With one jumbo under its belt, Berlin Hyp has covered the majority of its funding needs for the year. “The €1bn covered bond in February will be our only jumbo this year, though we may do a smaller €500m later in the year,” said Winkler. “Pfandbrief will remain the most important funding tool for us.”

“Pfandbrief will remain the most important funding tool for [Berlin Hyp]”

Innovate for issuance

But despite the market’s inevitable conservatism, the German covered bond market has been home to innovation and one has pricked interest from across Europe.

At the end of February Commerzbank sold a structured covered bond secured by a portfolio of SME loans. “Within the current low interest rate environment, the product represents a genuine alternative for investors seeking attractive returns and a safe investment. This is particularly evident from the high demand from classic Pfandbrief investors for the issue. We are opening up a market for these instruments with this transaction,” said Roman Schmidt, director of corporate finance at Commerzbank.

The 1.5% €500m five-year covered bond went via Barclays, Commerzbank, Credit Agricole CIB and UniCredit at mid-swaps plus 47bp. The still controversial deal hit a book of €1bn before printing halfway between comparable covered bonds and senior unsecured.

As a means of supporting lending to small-sized and medium-sized enterprises – the backbone of the German economy – the deal cannot be faulted, but covered bond bankers remain cautious. “The structure has its own merits. But will it solve the SME funding problem in Europe? I am not sure about that,” said SG’s Grossmann.

This was reflected most of all in the fact that initially the European Central Bank demanded a haircut on the bond in line with senior unsecured issuance, before deciding that it did qualify as a covered bond. Both Italy and France are currently looking at the structure with interest as a way of easing funding needs and it is not out of the question that another issue will be seen out of Germany this year.

Signs of life

Although the covered bond market in Germany has been subdued this year, it should not be written off altogether. Gross covered bond supply across Europe is 43% down at the end of May compared to the same period in 2012, according to Barclays. But there are signs of life with both April and May registering an uptick in issuance over a year earlier.

Going into June the pick-up has continued. Across Europe, seven euro covered bond benchmarks hit the market in the first week – more than was seen in the whole of either February or March.

The climate in Germany has improved too. In late May, Deutsche Pfandbriefbank priced the longest Pfandbrief transaction seen since 2003 – a €500m no-grow 2.375% 15-year secured offering that was fixed at mid-swaps plus 40bp and leapt on by insurance companies.

At the time of writing, at least three significant deals have been roadshowed: Commerzbank roadshowed its public sector Pfandbrief shelf, visiting investors in London, Paris, Munich and Frankfurt; Deutsche Hypo plans to sell a €500m no-grow seven-year via BayernLB, Credit Agricole, Commerzbank, DZ Bank and Nord/LB; and WIBank, the Wirtschafts und Infrastrukturbank Hessen, has mandated Deutsche Bank and Helaba for a potential trade.

It is true of course that given how quiet the market has been so far this year, it does not require a great deal of issuance for the market to look busier, but with even German Bund yields rising, the rest of the year could be much more positive than it seemed at the end of the first quarter.

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