IFR Pfandbriefe Roundtable 2016: Part 3

IFR: To Thomas’s point, will you both be looking to get the bulk of your funding out of the way in the first half, pending a potentially uncertain second half?

Götz Michl, Deutsche Pfandbriefbank: Every year, a funding manager tries to do as much as possible in the first half but of course we need to use market windows and for the next couple of months we will use them as we described. We always look at the market and are prepared to issue. If there is a window and we think: “OK, we can issue a Pfandbrief” we will probably do it.

[pbb announced its first Pfandbrief of 2016 on January 12, a €750m due 2023 and followed up with a €500m due 2022 after the IFR Roundtable took place on February 21.]

If you get too much funding in by, say, March/April, then we will want to slow it down. With our first issue done at the beginning of the year, there’s an argument not to issue until May or June simply because we do not really need the cash position.

That said; if the opportunity is there and there is a good market window, we would probably issue. That is driven not so much from the fear that the second half will be worse but simply knowing if there is a good opportunity to issue, you had better use it and not wait for a good window in September that might not be there.

Jörg Huber, LBBW: Over the last few years it has become so important to use windows when they come. It is not the case any more like it was in the past to say: “OK at the beginning of the year, real money accounts are cash-rich so it’s a good time to issue. And then again after the summer break and there might be some times in-between”.

Nowadays if there are windows and the markets are strong, that’s something we should really focus on. And if they are all in the first half of the year and if it’s do-able, you should concentrate on that rather than saying you’d like to spread your funding over the whole year.

Thomas Cohrs, NordLB: My own institution is not quite as flexible in this respect and I would guess there are issuers that work similarly. I would love from a syndicate point of view to do exactly that; if the market is there let’s issue what we can issue.

But the problem is you may look a bit desperate if you are issuing too much in too-short a timeframe so it is always a question of market perception in this respect. And our treasury likes the idea of funding plans; they are just not up to saying: “we’re going to fund €10bn this year so do whatever you like with whatever product you like whenever the market is there”.

I would love that. Instead, they tell me: “You want to do a deal? OK you have permission to do exactly this type of deal within these types of parameters and after that we’ll talk about the next possibility over the next three months or so”.

So in this respect we have taken a bit more of a Statist approach, if I can call it that. I would be surprised if everybody who needs to do even significant amounts of funding will do that whenever there is a window, as early as possible. There will be a lot of people, who for various institutional constraints, will have to stagger this over the year.

IFR: How receptive are non-eurozone markets to Pfandbrief issuers? How successful have you been and how much appetite is there? And what are the conditions like for you to access these markets? Do you have targets that you want to hit in terms of levels or is it purely diversification and opportunity?

Götz Michl, Deutsche Pfandbriefbank: For us it is quite easy. We look for the currencies where we have assets. That’s very important from the perspective of rating agencies but it is also important for the cover pool to have the same currency. Any currency mismatch is negative so we would currently not issue an Australian dollar Pfandbrief because we don’t have assets nominated in Australian dollars in the cover pool.

We have Swedish kronor assets so we look for Swedish kronor liabilities, which works in smaller tranches. That increases the investor base and saves the cost for cross-currency swaps. The same applies for sterling. Two years ago we were very active in GBP and SEK; last year it was less. For US dollars it is similar but the need is more on the public-sector side. Jörg you have more experience with USD Pfandbriefe – it is probably more benchmark-driven.

Jörg Huber, LBBW: On our side, it is mainly US dollars and perhaps some sterling. There is a large investor base in Europe but also in Germany looking for some yield pick-up. They are prepared to go into US dollars to have a positive yield for two to three-year paper where they see less volatility or less danger that the currency will deteriorate against the euro.

And then of course we have our investor base in Asia. We are regularly in Asia visiting investors who buy Pfandbriefe, not just in dollars but also in euros. They follow our name quite closely and so quite often it is not even necessary to do a marketing roadshow before you do a dollar transaction.

What is much more important for us is to see the kind of level where you could issue. We don’t issue dollars for opportunistic reasons but if you compare it against cross-currency levels, it has to be at the same kind of level where we would issue euros. If that matches and the demand is there, that is another route which we easily go down.

Thomas Cohrs, NordLB: We have issued dollar Pfandbriefe in both Reg S and in 144a format but not for opportunistic reasons but with a strategic objective. A similar idea to when we issued Flugzeugpfandbriefe; and we would love to issue ship Pfandbriefe if the market was there. The problem is that the constraints in terms of documentation and accessing the US investor base, especially coming from Germany at the moment and being a Landesbank, are somewhat obtrusive.

The cost of setting up these instruments at the moment doesn’t make much economic sense for us. We are still interested in maintaining a curve but that is also becoming a bit difficult becuase the expectations in the US market are very high in terms of the frequency and the volumes that you have to print. People are not generally satisfied with US$500m issues; they want to see at least a billion and ideally several times a year.

We have fallen somewhat short of those expectations for various reasons. Also because at the moment the dollar market is not where it should be for us. Like Jörg, we also tend to look more favourably at the Asian market and the European investor base for dollars.

Having said that, if market conditions improve, we have a significant part of our balance sheet in dollar assets so we have a natural need for dollars and would go about it with the same approach as Götz mentioned: refinancing assets in the currencies in which they’re denominated.

Ideally this would mean we would have to issue Flugzeug and ship Pfandbriefe in dollars, which is a market that doesn’t exist yet. So anybody who would like to join it would be more than welcome!

IFR: I wanted to move on and talk briefly about the prospects for Green and Socially-Responsible Pfandbriefe. We have seen some beginnings in this regard in 2015 and I was wondering to what extent this is a theme within the Pfandbrief market or whether is being seen more as a gimmick.

I’m also interested in the way in which Green Pfandbriefe might emerge from a technical perspective in light of stipulations contained in the Pfandbrief Act and the Green Bond Principles, including the rules around sub-accounts, reporting and monitoring. Frank: what are your thoughts?

Frank Will, ECBC: It is quite interesting to look at green products, whether we talk about covered bonds, other bonds or even shares. The green investor base is currently dominated by equity investors and we see a lot of companies trying hard to be green to tap into this growing investor base.

On the fixed-income side, the main issuers will continue to be the agencies and supranationals. In Germany, two issuers have done green or sustainable bonds. I think it is quite an interesting instrument and going forward it will increase in importance, given that more and more investors have dedicated portfolios that can only invest in green assets.

The last time I was in Brussels, several investors asked me about green covered bonds. These were typical green investors but what they planned to do was to show in their year-end breakdown of assets that a certain amount of funds were invested into green projects. Even if the portfolio is not dedicated to green assets, at least they would like to show in their statistics the proportion of money invested into those products. That could become some kind of general trend in terms of demand.

If you take a look at the structure, the big problem we have with these instruments is that investors don’t have preferential claims on those assets. So if you have a pool that includes green assets, as a green bond investor you still rank pari passu to other covered bond investors. That is something people need to bear in mind. The whole idea is that the money received from green bond issuance is used for green or sustainable projects or social housing.

From an industry perspective, we need to get more harmonisation around what is really a green asset or a green mortgage. At the European level, we have Energy Performance Certificates but we have to go beyond that and get more clarity and some kind of common definition to make sure that there is a really growing market.

Jörg Huber, LBBW: It also depends on what are you aiming for. Some investors are just looking for green status i.e. for wind energy and things like that. Others also take social responsibility into account and their thinking is: “we can do something here that forces the banks to take that money and invest it in these kinds of projects”.

The first thing to note around green covered bonds is that most of the proceeds from the issues done so far were not used for new green projects; it was for existing projects that the banks already had on their balance sheets which they had to flag as a screen so issued against it.

At the beginning, it was certainly a big marketing gimmick but now it is established and more and more companies are saying they want to earmark green funds. A lot of issuing companies already have a rating, not for the product but for the company itself. For some investors, that is sufficient; others need the green bond.

As for issuers, we looked into it and it is definitely an expensive exercise and you don’t get any kind of funding benefit from it. Investors say they want it to be green but won’t pay up for it.

In the secondary market, green bonds tend to trade tighter but I haven’t seen any issuer being able to issue new green bonds at these tighter levels. So the incentive to go quickly down this route and set everything up internally is quite limited, specifically as regulatory changes are such a big burden on banks’ internal systems.

Flagging all the green assets on top of what you already have to do is such an additional burden to the extent you need to be quite desperate to get new investors in. That is where we are for the time being. I guess more will come over time but for me, at the moment, it is still quite a big marketing gimmick.

Jens Tolckmitt, VDP: We are not euphoric about the prospects for green issuance, either because we are aware of the difficulties around defining standards and creating a ring-fence around what is green or what is socially responsible or both. What does this mean for the issue itself? What does it mean for the issuer, i.e. the whole bank? How much importance does the whole issuer have in the definition of a green bond?

That said, if you look at the discussions that we have on our board from time to time about how the importance of sustainability issues, social responsibility issues, green issues are growing for the whole bank. I would say in the mid term – not in the short term – why not green covered bonds?

I still think there is a natural fit between the idea of a covered bond and the idea of sustainability in a different sense. So I am not euphoric but I am not pessimistic either, and given the developments we have seen over the last two to three years I would say with regard to sustainability issues in general in banks and from the investor side too, let’s wait and see.

IFR: The Pfandbrief Act only allows for one cover pool and this can’t be sub-segmented. The Green Bond Principles, however, have moved to formal sub-segmentation, formal ring-fencing, creation of sub-accounts, separate treatment of proceeds, formal reporting and all sorts of additional items. Is there is a technical incompatibility between the Green Bond Principles and the Pfandbrief Act?

Jens Tolckmitt, VDP: We haven’t tried so far to put them over each other but I don’t think there is an incompatibility. I do think the approach that the two or three banks that have issued green covered bonds have taken is the right one: looking at individual assets, defining them as green and then looking at whether the overall issue fits into the Green Bond Principles.

For the time being, I think that is perfect. We have looked at other forms of green Pfandbriefe with totally different asset classes and it turned out to be impossible in the short run. The most realistic way to go about it is the way the banks that have taken this route are going about it: defining those assets in existing cover pools that fulfil the criteria and issuing against them.

Frankly, yes, you can call it a marketing gimmick and you can to a certain extent criticise that this is funding for projects that are already on the balance sheet of the bank. But from an investor perspective you could also make the point that having these green projects on the balance sheet and issuing against them is more convincing than collecting money and promising that you are going to spend it within the next three years for green or sustainable projects.

Götz Michl, Deutsche Pfandbriefbank: There are green investors who could enlarge our investor base. That is positive. We travel to meet these new investors. There is definitely a new group of “green” investors and it is therefore worth looking into the topic.

On the other hand, there are internal costs for selecting eligible loans. As Jörg already said, we have many projects to handle the new regulations, so we need to be mindful with additional workload. It’s complex. If a property in Sweden is green, it has to be built to a better standard than a property in Spain because it is colder in Sweden than it is in Spain, and while it’s fine to have single-pane windows in Spain, in Sweden you need triple-glazing.

I think it is worth looking into the topic but the question of how green a property is has room for interpretation. You might have a new building with theoretically low energy consumption in comparison to an old building but it might look different in reality. It also depends on the tenants. You can argue on one hand that it is a new building so by definition “green” because it has been built to a good standard. But you might have a tenant who has very high energy consumption.

I can give an example how difficult it is to define green buildings. When we started selecting assets we had a very nice new building with very high energy standards.

When we spoke with the valuer, we found out that the ground on which it was built was polluted. We are a specialised real estate finance and public investment finance bank and we finance office, retail, residential and logistics properties. We don’t finance companies that pollute the environment, so we have a pool of mortgage loans to select from.

Green bonds might be a great idea for corporates to invest proceeds in a factory for hybrid cars, for example. For us as a specialised lender, there is not such a significant distinction between the assets.

Of course one property has a better CO2 footprint than another but the properties we finance, which are mostly in Germany, have certain standards and there is nothing exceptionally poor in the pool. The distinction between the assets is not that big. All of that said, if investors demand it, we will consider placing a green bond in the future.

IFR: Let’s move to our conclusion. Can you each summarise your thoughts for 2016? What is on your mind? What are your concerns? What are you excited about? What keeps you awake at night?

Frank Will, ECBC: We expect the market will be quite volatile through 2016. The key focus will remain on the ECB and its behaviour on the covered bond purchasing side. People will try to read the weekly statistics to capture any trend towards the ECB slowing down its purchasing activities. Given the size of what they continue to own in the market, we do expect them to slow down their purchases; in fact there have already been some statements from the Bundesbank and ECB members pointing to that. The market will be clearly focusing on it.

In terms of issuance, we expect something like €130bn to €150bn of euro benchmark issuance so it will be a lot but if you take into account redemptions of more than €140bn, we will end up flat.

Overall it will be quite volatile but from an investor perspective, that could open up some interesting opportunities. We expect investors will continue to focus on the primary market to get their hands on the new-issue premiums. We also see some opportunities opening up at times of market weakness or if there has been a significant new-issue wave or cluster of issuance for investors to buy into covered product.

Götz Michl, Deutsche Pfandbriefbank: I think it will be probably one of the most interesting years to-date, bearing in mind all the political impacts in the world and the market volatility. What happens when the ECB starts withdrawing from the Covered Bond Purchase Programme will be a big question, but we will see.

Thomas Cohrs, NordLB: Not that it will exactly keep me up at night because I am actually quite looking forward to it, but I think it is going to be a very interesting year as the last five have been. As far as I am concerned, we aim to shoot on all fronts in terms of all available asset classes; senior unsecured, euros, dollars, Pfandbriefe in both of these currencies and if possible aircraft Pfandbriefe; and I should mention lettres de gages as well.

I am pretty positive and optimistic about the primary markets in covereds in general and Pfandbriefe in particular. There are new issuers coming to the market, there are old issuers reviving their activities and Pfandbriefe will keep on going strong.

Sabrina Miehs, Helaba: I have a very optimistic view too although I guess there is still a higher probability for risk than last year because of political risk. I agree with Frank: we will have more volatility in spreads than last year though I expect a stable trend around the levels we are now.

I think the outlook is a little dependent on which country you are talking about. It will be interesting to see if investors prefer to go into French senior, the new senior unsecured, rather than into German senior unsecured. Will this give a bit of a push for Pfandbriefe in comparison to French covered bonds?

So some interesting things this year. In terms of structural trends we will see more soft bullets. We have seen quite a lot in the first two weeks of this year, certainly more than hard bullets, so that’s another interesting trend to follow as well.

In terms of creditworthiness I don’t see main changes this year. We had the main changes last year as a consequence of bank ratings being updated as a follow-up to BRRD. So we already had an improvement on covered bond ratings last year.

I have most of the covered bonds in my coverage area on stable outlook with a few on negative outlook. We will have to look what France is doing next year; they have elections coming up the year after so a little sovereign risk there. We have some caps, which could influence some ratings. I see Spain as an absolutely positive trend this year; and Germany stable on average.

Jens Tolckmitt, VDP: Regulation will again play a pivotal role this year in the markets. I do think, though, that it is more overall bank regulation that will be challenging, rather than covered bond regulation.

There are so many issues around banking regulation and supervision in general and on the assets side of the business that is relevant for covered bonds that I think can have a much more detrimental impact because they are not yet as settled as maybe some of the covered bond regulations; we should be aware of that as well. That concerns me more than anything around covered bonds.

The same is true for the market environment, which I think will remain challenging for banks, especially the interest-rate environment on a broader scale. I think it is putting banks’ business models under scrutiny.

For covered bonds, I’d end in a similar way to how I ended last year. At this roundtable last year, I said: “we don’t want a product that has survived for 250 years through different times to be threatened by regulation”.

Today I would say, given the discussions we have had and given what we have seen from the Commission so far with regard to harmonisation, that I am quite optimistic that we will not see the traditional Pfandbrief threatened by harmonisation as the Commission is pursuing it.

IFR: Thank you all very much for your comments and insights.