Following a quiet 2005, there are indications that some much needed diversification is starting to feed its way into Luxembourg's market for Lettres de Gage, both in terms of product structure and issuer type.
Innovation returned to the Lettres de Gage market in January when Erste Europäische Pfandbrief- und Kommunalkreditbank (EEPK) issued a Eu100m FRN via Commerzbank (its majority owner), DZ Bank and WGZ Bank. The deal broke new ground, being the first mortgage backed Lettres de Gage, although collateral takes the form not of direct mortgage loans but of mortgage backed covered bonds.
"The EEPK deal is a repackaging of existing mortgage backed issues from Germany, France, Hungary and Spain, so it is an interesting alternative for investors who are unable to diversify their portfolios," says Claudia Vortmüller, head of covered bond research at Commerzbank Corporates & Markets in Frankfurt. "But I don't see this as a product with potential for jumbo issuance, and EEPK has already indicated that it is only planning to issue Eu300m of these Lettres de Gage Hypothecaires over the next three years, so it will remain a relatively small programme."
Potentially a much larger source of new issuance from Luxembourg, says Vortmüller and other analysts, is the market for German Landesbanks using Luxembourg's legislation on Lettres de Gage to issue covered bonds backed by unguaranteed Landesbank paper.
Since the loss of the Landesbanks' state guarantees last year, bonds that are not grandfathered are no longer eligible as cover for German Pfandbriefe. But less restrictive legislation in Luxembourg would allow for Lettres de Gage issuance using unguaranteed collateral — which, as Vortmüller says, could be attractive for investors looking for a yield pick-up over Pfandbriefe. NordLB and LBBW are two Landesbanks that are weighing up the potential of issuance in the Lettres de Gage market, which would clearly add liquidity and diversification to the Luxembourg market.