Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Western EuropeApril 2 2006

Refining the pfandbrief

Germany’s new pfandbrief law was designed to end anomalies arising from the ending of state guarantees for Landesbanken. Many hope that it will also reinvigorate the pfandbrief market in the face of growing international competition. Michael Marray reports.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

Traditionally, pfandbrief issuance in Germany has been governed by three separate laws: the Mortgage Bank Act, the Public Pfandbrief Act and the Ship Banking Law. Issuers had to be specialist mortgage lenders and were not permitted to engage in other activities, so private universal commercial banks were unable to issue pfandbrief under the Mortgage Bank Act (some set up subsidiaries to issue out of Luxembourg). Meanwhile, the Landesbanken, which were universal banks, issued them under the Public Pfandbrief Act.

Since last summer, all issuance has been governed by a single Pfandbrief Act and the specialist bank principle has been abolished. Now, any bank that is granted a licence by the Federal Financial Supervisory Authority (BaFin) can issue pfandbrief.

Changes to product

From an investor’s point of view – setting aside the domestic reasons for German laws being tidied up – there have also been some significant changes to the actual product.

While drafting the new law, the opportunity was taken to make the collateral more international. The early drafts did not allow eligible assets from the US, Canada and Japan, but these were eventually included. Ship loans are still eligible, as before, but despite various requests, aircraft loans were not made eligible. And mortgage pfandbrief with bullet maturities longer than 10 years are now permitted, whereas before only public pfandbriefe could have longer tenors.

“The new pfandbrief law was designed to level the playing field for all banks after the state guarantees for Landesbanken disappeared,” explains Helene Heberlein, head of the covered bond team at Fitch Ratings.

In addition, during the drafting, some changes were made to the eligible countries for the cover pools. Mortgage cover pools used to have tight limits on non-German collateral but now assets can come from anywhere within the EU, plus Switzerland, the US, Canada and Japan.

“Mortgage assets from the EU can be included in cover pools without any limit but assets from other countries where the privilege of pfandbrief investors is not established are subject to a global 10% limitation,” Ms Heberlein says.

Investors will thus see a different mix of collateral, though strict loan-to-value ratios and cover pool overcollateralisation rules will remain in place, making Pfandbriefe a safe investment.

“For investors who see increasing risks for German mortgage pfandbriefe because of the enlarged geographical scope of the cover pool, we note that generally the enlargement of the geographical scope leads to a greater diversification which, at least in theory, reduces the volatility of cover pools,” says Florian Hillenbrand, analyst at HVB Corporates & Markets in Munich.

“In addition, empirical data has demonstrated that the real estate markets in the US, Canada and Japan are not riskier than European real estate markets,” Mr Hillenbrand adds.

Tight pricing

The basic structure remains the same, however, and liability is still not limited to the assets in the cover pool. As with all covered bonds, pfandbrief investors have recourse to the issuer, with access to the assets in the cover pool in case of default. Pfandbrief instruments still lead the way with the tightest pricing in the European covered bond market, though structured covered bonds from various jurisdictions have gained good investor acceptance and price only a couple of basis points wider.

BaFin wants issuers to be tapping the market regularly and is discouraging very small banks from doing one-off pfandbrief deals by letting it be known that lack of regular issuance may result in a pfandbrief licence being revoked.

Rules on compliance and on making data available to investors will also be tightened up, so the costs associated with a Pfandbrief programme will increase under the new law.

One institution that will benefit from the changes to collateral rules is Aareal Bank, which has followed an international strategy over the past 15 years and is a major commercial property and public sector lender across the EU, while also growing its operations in North America. In late January, Aareal Bank Group launched its first jumbo mortgage pfandbrief, a €1bn offering of five-year floating rate notes that priced at Euribor flat. The deal was led by Barclays Capital, Deutsche Bank and Dresdner Kleinwort Wasserstein.

Arrangers like to stress that a solid marketing effort is important and that issuers need to work on telling their story. Aareal Bank used three teams on a two-week European road show that included meetings with 100 investors in 10 countries. In particular, they aimed to introduce new investors to the Aareal business model, and explain how jumbo pfandbrief issuance will fit into its refinancing strategy. The marketing effort paid off – two hours after the book was opened on January 23, it was three times oversubscribed.

International outlook

“In the past, Aareal Bank refinanced itself mainly with bond offerings bought by German-speaking investors, but this jumbo transaction was designed to internationalise our capital markets activities and enlarge our circle of investors,” says Tammo Diemer, head of capital markets at Aareal Bank. “With our first deal, we already fulfilled certain targets originally set for transactions two or three, in particular to have an allocation of more than 50% outside of Germany.

Pfandbriefe are going to be an important source of funding,” Dr Diemer explains. “Until now, only 15% of our outstanding long-dated funding comprises pfandbriefe, whereas the rest are senior unsecured debt offerings. In the medium term, pfandbrief issuance will increase step by step until it makes up 40% to 60% of our refinancing mix. Our new issues, worth between €4bn and €5bn per year, will be split between pfandbriefe and senior unsecured funding.

“The new pfandbrief law makes it easier for us to refinance our international loan book,” he adds. “Most European covered bonds have mainly domestic collateral but we are able to offer investors pfandbriefe backed by a well diversified, mainly European, asset pool that includes 14 countries, with Germany making up only 35%.”

Previously, Aareal had issued via its specialist subsidiary Aareal Hyp. But it is in the process of merging Aareal Hyp with the parent to issue under its own name, Aareal Bank AG. Some other German banks are also merging their pfandbrief issuing entities with the parent, though others are choosing to keep existing subsidiaries in place.

“Most investors now view the European covered bond market as one universe, and most feel comfortable with the various types of structured covered bonds and those issued under covered bond laws,” says Achim Linsenmaier, vice-president with responsibility for the covered bond syndicate at Deutsche Bank in Frankfurt. “So if spreads are comparably more attractive, they often switch from one jurisdiction to another.

“But the difference between spreads on covered bonds from different jurisdictions has been narrowing,” he says. “Pricing often reflects the amount of supply coming out of one country or the difference in the risk weightings. Spain has overtaken Germany as the jurisdiction with the biggest new supply of jumbo covered bonds, therefore investors demand a small premium, of a couple of basis points only on the whole curve, because of the comparably larger amount of supply. For German or French issuers, spreads are tighter, also because there is less supply coming out of those jurisdictions.”

Indeed, most recent offerings of both pfandbriefe and other covered bonds have been comfortably oversubscribed, both fixed rate and floating rate tranches, with huge demand across Europe and strong interest from Asia. Demand is very strong for bonds with three, five or seven years, with a smaller number of accounts looking for 10-year paper.

The number of institutional accounts buying covered bonds is rising, and they are also placing bigger orders. Central banks play an increasingly important role and, although they have generally preferred public sector covered bonds, they are now also buying mortgage covered bonds. They tend to hold shorter dated assets, so up to seven years their participation can be huge but beyond that it shrinks.

Diversification trend

“There is a continued diversification by institutional investors from government bonds into covered bonds,” says Ted Lord, managing director and global head of covered bonds at Barclays Capital. “Governments may or may not live within their budget guidelines, but a covered bond issuer is on a very tight leash and is heavily regulated in what it can and cannot do. In addition, the investor gets a higher yield with good liquidity and high ratings through covered bonds.

cp/16/pLord, Ted.jpg
Ted Lord: central banks have been moving strongly into the covered bond market

 

“Central banks around the world have been moving strongly into the covered bond product,” he adds. “We now calculate that 78 central banks can invest their reserves in these instruments. This is partly helped by supranational and multilateral organisations that encourage diversification of currency reserves into currencies other than the US dollar. In addition, many central banks have reserve positions that are far greater than what they would need in an emergency. Therefore, they begin to invest more like global fund managers.”

Was this article helpful?

Thank you for your feedback!