By autumn, three innovations emerged that – beyond helping German banks maintain strong balance sheets – should enhance the country’s attractiveness as a financial centre.
The first of the innovations was Germany’s first “true sale” securitisation, a deal considered crucial to the future development of the country’s asset-backed securities (ABS) market. The second was the advent of a non-performing loan (NPL) industry in Germany. And the third was the launch of an exchange allowing German banks to buy and sell single loans so that credit risk can be spread more evenly.
In the case of the true sale deal, last November, Volkswagen’s financial arm sold €1bn-worth of consumer car loans to a special purpose vehicle (SPV) it had created. The SPV then successfully issued investment grade bonds based on those car loans. Though the transaction was minor, the implications for Germany’s ABS market were enormous.
Consider that before the securitisation, ABS deals in Germany had been strictly synthetic ones – where loan risk, instead of the loans themselves, are transferred from the bank to investors. This was due to German tax rules that made true sale securitisations prohibitively expensive. Growth of Germany’s ABS market had been further stunted by the fact that the KfW, a state-owned development bank, dominated synthetic transactions. The reason was simple: since a top-notch credit rating can be crucial to the success of a synthetic deal, triple ‘A’-rated KfW had a natural advantage over other German banks.
Hence, while the total market for loan securitisations in Germany is estimated at €300bn, ABS transaction volume languished below €20bn. This pales in comparison to volumes in the US or the UK, ensuring that Germany has simply not been competitive in this asset class.
But German finance experts say the success of VW’s true sale securitisation has opened the door to further deals of this type, adding that such deals will drive future growth of Germany’s ABS market. “After several years, ABS has finally established itself as an asset class in Germany,” says Jens Schlendzielorz, a specialist at Citigroup in Frankfurt who advises clients on structured bonds.
While not predicting a boom in Germany’s ABS market, both Citigroup and the rating agency Moody’s believe that volume for this asset class will increase steadily in coming years from €14.5bn in 2004.
Crucial initiative
VW’s securitisation was done with the help of the True Sale Initiative (TSI), a company founded in March 2003 by 13 major banks in Germany and KfW. Back then, there was an urgent need among the banks to reduce over-exposure to loans while increasing their capital base.
TSI performs crucial tasks such as bringing the parties for the deal together, setting standards for any transaction and clearing any legal or regulatory hurdles standing in the way. Indeed, the VW deal would not have gone ahead without TSI: the German government had to amend the tax laws so that the carmaker’s consumer loans could be securitised in true sale fashion.
Having just put the VW deal behind him, Harmut Bechtold, co-managing director of TSI, is even more bullish on the prospects for Germany’s ABS market than either Citigroup or Moody’s.
“I expect the market to take off now, as German banks will make frequent use of our platform both to reduce the risk of loan over-exposure and to refinance themselves cheaply,” he says.
He adds that between €5bn and €10bn-worth of true sale securitisations will be done via TSI in 2005, adding that the company is already negotiating with interested parties.
However, not all players in Germany’s ABS market share his optimism. One such player is Bernd Knobloch, chief executive of Eurohypo, Germany’s largest real estate bank and a TSI shareholder. Although he acknowledges that the creation of TSI was necessary to invigorate the market, he says that, so far, it has not lived up to the industry’s expectations.
Bernd Knobloch: ‘TSI missed an important window of opportunity in the ABS market’
The main problem, he says, is that it took the TSI no less than 18 months to facilitate Germany’s first true sale securitisation. In the meantime, the urgent need among German banks to reduce loan over-exposure has passed, he says. As an example he cited Deutsche Bank, which has cut its corporate loan exposure by half in the interim period. “By taking so long to get started, TSI missed an important window of opportunity in the ABS market,” says Mr Knobloch.
That said, because of the stricter capital ratio requirements required by Basel II, “those windows will be opened again but for now they’re closed”, he adds.
Mr Bechtold, however, is adamant that, given the inherent difficulty in getting something like the TSI going in Germany, its 18-month start-up phase was remarkably short. “I disagree that it took too long for the TSI to do its first true sale transaction. We spent months clearing all the legal and tax barriers to this type of a transaction and it was only last summer when this process was completed,” he says.
NPL market
Around the time of the VW deal, Germany’s new non-performing loans (NPLs) market was born. This was due both to record sales of NPLs from German banks to institutional investors and Eurohypo’s decision to try and capitalise on this growing business.
In September, Hypo Real Estate, an arch rival of Eurohypo in Germany, made headlines by selling €3.6bn in German real estate NPLs to Lone Star, a US investment company that specialises in securitising NPLs.
The transaction was a strong indication that foreign investors, such as Lone Star and its US peer Cerberus, have a huge appetite for German NPLs. The presence of such investors is a further blessing for many German banks, as they are spared the considerable trouble and cost of setting up institutional restructuring units to deal with NPLs.
The contours of Germany’s new NPL market became clearer in November when Eurohypo formed a joint venture with Citigroup to deal with non-performing mortgage loans. The venture, Opus, has done its first transaction, taking custody of €2.4bn in mortgage NPLs from Eurohypo.
To illustrate the huge effect such a sale has on a German bank’s balance sheet, the share of NPLs as a proportion of Eurohypo’s total credit portfolio has been cut to 4.9% from 11% previously. Eurohypo also plans to cut its NPL exposure further by selling another €1.4bn worth of the loans.
Mr Knobloch says that beyond using Opus to handle its own mortgage NPLs, the platform will be open to mortgage banks in and outside of Germany that have the same need. He notes that Eurohypo already has plenty of experience in the field owing to Opera, a London-based subsidiary that handles large-volume true sale transactions for the European market.
Germany’s NPL market should take another big step forward this year when, according to Moody’s, the first securitisations of NPLs in Germany take place.
Spreading risk
The third and final innovation of 2004 was also meant to help German banks clean up their balance sheets: Deutsche Kredit Börse (DKB), a loan exchange in Munich that seeks to provide German banks a means to spread their corporate risk better.
DKB works like this: if a bank is overexposed to a certain corporate sector, it can offer those loans on DKB’s exchange to another bank which has a much lower exposure to that sector. DKB does not set prices for such transactions, but instead these are agreed by buyer and seller on a bilateral basis.
Since The Banker first reported on the DKB (November 2004), the exchange says that 140 banks active in Germany have expressed an interest in trading on the DKB. Of these, 37 have committed to doing so when the exchange goes live by the end of the first quarter this year. Although trading will initially be done by telephone or face-to-face, DKB plans to launch an electronic platform by the second half of 2005. However, DKB founders Gerrit Schulken and Michael Klein stress that, unlike the securitisation business, the market for single loans is far smaller. They estimate that, at most, €60bn in single loans will be traded on their exchange. “We regard our exchange as a complement to the loan securitisation industry that has emerged in Germany,” says Mr Schulken. “Our exchange is particularly suited to banks that have small loan volumes. Securitisation is not an option for them due to the cost and trouble.”
It seems that between Germany’s fast-growing securitisation industry and the DKB, its banks will have no excuse for weighing their balance sheets down with bad debt. Whether these same banks can thrive in such a fragmented market as Germany remains the crucial question.
