The Ultimate Validation

IFR Covered Bonds 2009
4 min read

Until now, Germany's biggest bank has raised most of its debt financing via unsecured bank bonds. As a national champion, its decision to issue Pfandbriefe - Germany's largest and highly coveted bond market - was a welcome boost for the asset class. But why has it taken Germany’s biggest bank so long to reach this point? Rachelle Horn reports.

With a history dating back over 200 years and a total worth of over €800bn - practically one fifth of the entire German bond market - one may well ask why it took Germany's leading bank so long to catch on to the Pfandbriefe craze.

Before borrowing costs commenced their upward spiral Deutsche Bank, a strong Double A rated issuer, could typically rely on a relatively low cost of funding. It did not make economic sense to enter the covered bond market due to the "not inconsiderable cost of setting up the programme without any significant funding advantage," said Jonathan Blake, global head of debt issuance at Deutsche.

The massive jump in the spreads of senior, unsecured debt finally gave Deutsche an incentive to establish itself in its home covered bond market. Its decision to turn to the asset class for the first time was seen as the ultimate validation for the product which, along with other covered bonds, has seen significant deterioration both in terms of issue volumes and spread since the crisis took hold.

The bank announced board approval for the establishment of its Pfandbrief programme late last year, and was granted a licence from Germany's banking regulator BaFin in April. It's roadshow with select European investors was quickly followed by a jumbo deal in June, hailed a big success by covered bond professionals.

Deutsche Bank's €1bn 3.75% seven-year debut mortgage Pfandbrief, backed predominantly by commercial mortgages, achieved a very punchy spread of 55bp over mid-swaps. With orders close to €5.5bn through nearly 180 single orders - the largest order book seen in covered bonds this year - clearly investors were perfectly comfortable with this level. All loans included in the €1.57bn cover pool are at 60% of mortgage lending value. According to Blake, the rationale was that existing residential mortgage loans were not originated with a view to putting them in the cover pool, but that new residential mortgages may well end up in the mix at some point in the future. The commercial cover pool also gave rise to an interesting price discovery process, though Blake said that investors ultimately favoured the name and strong credit ratings of Deutsche Bank.

The weighted average remaining term in the cover pool is just under five years, 95% of which matures prior to the maturity of the Pfandbrief - giving a well matched funding structure. The programme is rated Triple A by Moody's and Standard & Poor's.

In the same week BNP Paribas made its debut in Obligations Foncieres with a transaction offering a shorter five-year maturity and backed by higher quality public sector assets. It priced at a spread of 77bp over mid-swaps, underlining Deutsche’s achievement.

The 55bp level gave Deutsche Bank an even more eye-watering saving of some 100bp relative to what it would have paid to issue a comparable senior, unsecured deal. Before the crisis this cost advantage would barely have offered a fifth of this figure. For a bank that has vowed not to turn to Berlin for help with its funding, this shift in pricing offered a financing opportunity that was simply too hard to ignore. Deutsche Bank has indicated is long-term commitment to the market but envisages annual issuance of €2bn to €3bn. If this proves accurate, it will enjoy the status of a relatively rare issuer, increasing investor interest.

A typical funding year for Deutsche Bank is probably in the €20bn to €25bn region. This year the bank targets €16bn in the capital markets, of which it has already raised €8bn, leaving it ahead of schedule. Deutsche predicted Pfandbriefe will account for up to €2bn of this figure.

"Given that we have so little capital market issuance to do over the course of 2009, the Pfandbrief may be the only opportunity to buy Deutsche Bank in liquid format during the course of the year," said Blake. He would not rule out some activity in the senior, unsecured space later in the year, but stressed that this "looked unlikely from a current perspective."