Want proof that a well articulated borrowing strategy can pay dividends? Then look no further than DePfa. One of the pioneers of the internationalisation of the Pfandbrief market, DePfa is now trying to distinguish itself from the crowd - and position its credit closer to the European agency peer group.
Neil Day reports on how DePfa has turned a Eu20bn-plus annual funding challenge to its advantage.
Predicting the shape of bond markets is no easy task, but one borrower that has consistently placed itself at the forefront of the market is DePfa Bank. Any issuer hoping to stay ahead of the curve could do a lot worse than take a close look at the German mortgage bank's strategy.
Few other European borrowers have the combined size, flexibility and quality to match the array of options open to DePfa. With a gross funding requirement of Eu20bn to Eu25bn in 1999, the bank has the flexibility to issue deals which, in volume terms, match what other borrowers raise in an entire year.
DePfa's triple-A Pfandbrief ratings from the three major rating agencies offer it access to almost every account investing in bonds. But the bank has not rested on its laurels. DePfa's extensive marketing efforts have made sure that nearly everyone is aware of the institution's strengths.
The German mortgage banking community, where DePfa's origins lie, began an aggressive international marketing campaign for its Pfandbrief product several years ago, but while its peers were laying the foundations of international distribution, DePfa was already building its investor base.
"DePfa has been the leading house in bringing Pfandbrief - previously a purely domestic product - to an international investor base," says Ralph Berlowitz, head of syndicate at Deutsche Bank. "It was clearly in the driving seat, launching its globals and introducing new features to the product. This got a lot of attention from international investors and helped the whole sector."
So successful has been DePfa's strategy, and so extensive its preparations for new issues, that any barriers to new investors have quickly been swept aside. "The first borrower to enter a new market normally has to pay an entrance fee," says Ludger Poos, syndicate director at Westdeutsche Landesbank, "but DePfa does a lot of preparations so that everybody knows in advance what it will be doing. By doing that they are usually able to avoid paying a significant entrance fee."
This was highlighted by DePfa's euro debut in January. The largest ever non-sovereign euro or tributary currency issue, the Eu3bn 10 year global was priced up to 5bp inside other triple-A jumbo Pfandbriefe. And although bankers disagreed on the exact pricing of the deal, nearly all concurred that as a result of its size and reputation, DePfa was pulling away from its peers.
DePfa's strategy of distancing itself from other mortgage banks was accompanied by its departure from the Association of German Mortgage Banks last year. Although differences over a future European Pfandbrief market were the reasons for the split, the move underlined its aspirations to be viewed on its own merits.
Christoph Schörnig, DePfa's co-head of treasury, says that having established its name in the international arena, the challenge is now to persuade investors to take a new approach to its products. Rather than being seen as the leading mortgage bank, DePfa is positioning itself as close as possible to the emerging European agency market.
"While we still belong to the Pfandbrief market," says Schörnig, "we have more and more investors who view our bonds as closer to government and agency paper. But it's not as if yesterday we were a jumbo issuer and today we are an agency. It's a dynamic process."
Much of the bank's progress towards its goal has come from incremental changes to the bank's marketing and issuance. But in October 1997, with the euro rapidly approaching, the bank took its funding strategy to a higher plane when it launched its global Pfandbrief programme.
"If, in the euro, you have many triple-A borrowers," says Schörnig, "the question to ask is what will distinguish them from one another. Our advantage is that we can issue large liquid deals that others can't."
DePfa kicked off its global Pfandbrief programme in January 1999 with a DM4bn deal, the largest single Pfandbrief issue to date. Only the mortgage bank itself had a larger outstanding jumbo, a DM5bn issue that was initially launched for DM1bn and then increased four times.
The global transaction featured liquidity enhancing features that have become a hallmark of DePfa's benchmark programme.
Four features were highlighted by the mortgage bank when marketing the programme:
* A committed market maker group of eight to 10 domestic and international banks appointed to provide liquidity in the cash and repo markets. The group, subject to revision, initially included 10 banks, with Deutsche and Goldman Sachs as bookrunners.
*An initial size of DM3bn to DM5bn for all globals, with a target size of up to DM10bn. DePfa also committed itself to reopen individual jumbo issues to support liquidity in the market.
*The establishment of a functioning repo market for Pfandbriefe. Each market maker committed to provide visible repo prices for the global issues among each other and the dealing community at large with 20bp bid/offer spreads for sizes of up to DM25m.
*Regular issuance to build a DePfa yield curve.
The announcement of the programme coincided with a new trend in the international markets: that of superliquidity. The financial crises of 1997 had highlighted the problem of liquidity and 1998 was the year that borrowers offered some solutions.
Alongside DePfa's programme, Fannie Mae announced its Benchmark Notes programme and other agency borrowers such as Freddie Mac of the US and Kreditanstalt für Wiederaufbau of Germany were introducing liquidity enhancing features on their issues to position themselves as close to government bonds as possible.
"When we decided on the global Pfandbrief programme we were not aware of other borrower's plans," says Schörnig. "But their similar approach, particularly that of Fannie Mae, made us even more confident to go out with our concept."
These borrowers' goal was to introduce a win/win formula to their funding strategy: to offer investors a product that was so attractive they would be willing to pay more, while the issuers benefited from tighter funding levels. DePfa was one of the first to achieve the dual targets, according to an official at Deutsche.
"The fact that we were able to launch the deal at a tighter spread than comparable Eurobonds," he said, "demonstrates the fact that investors appreciate liquidity, even at the expense of yield."
Launched at 16bp over the 7.375% January 2003 Bund, the February 2003 issue attracted widespread international demand. Deutsche and Goldman Sachs sold around half their paper internationally, with 10% sold to US accounts via rule 144A.
Some bankers questioned the usefulness of the global tag, but applauded DePfa's forward-looking strategy. "In the long term, DePfa's plans will probably pay off," said one syndicate manager at the time. "When the euro is introduced this, with its liquidity and quality, will be the kind of instrument that US investors look for as euro assets."
The next step for DePfa was to ease placement in the US. As a key investor base for the future, it was important for the bank to be able to approach the US market with the same flexibility as European markets.
With the aid of Goldman Sachs, DePfa established a global Pfandbrief facility with the SEC. Under SEC rules 144A and 12g3-2(b), the bank is now able to sell Pfandbriefe in the primary market to qualified US investors.
As well as increasing the bank's flexibility and reducing its issuing costs, the US facility highlighted DePfa's quasi-agency status as the issuing method is the same - that used to sell European government bonds to US investors.
"The key to this move is that banks will be distributing our paper in the US in the same way that they sell European government bonds there," said Schörnig at the time the facility was established. "That can only underline how close in quality Öffentlicher Pfandbrief are to government debt."
The deal also reaffirmed DePfa's pioneering approach to the international markets: since the development of the facility, Hypothekenbank in Essen and Rheinische Hypothekenbank have established similar US shelves.
DePfa's first deal under the facility further pushed back the limits of the market. At DM5bn, the July 2008 issue was the largest ever non-sovereign Deutschmark issue.
Launched at 26bp over the July 2008 Bund in a month of heavy 10 year supply, the deal was nevertheless priced at the tight end of price talk and sized at the high end of the early plans of a DM3bn to DM5bn issue.
Led by Commerzbank and Goldman Sachs, over 70% of the paper was placed outside Germany, with Goldman placing 25% of its ticket in the US.
The next step for the bank was to launch its first euro denominated issue. But while many borrowers rushed to the market in the first few days of the new currency, DePfa stayed away until the end of January.
"Difficult arbitrage affected our plans and it made no sense to come in the first weeks of the year," says Schörnig. "Investors were not ready to buy and although there was heavy issuance because everybody wanted to be the first, paper was not being absorbed."
When it finally hit the market, DePfa's first euro deal proved to be its most ambitious to date. Not only was the Eu3bn size the largest ever non-sovereign issue in euros or in a tributary currency, but the pricing of 35bp over the 3.75% January 2009 Bund was 4bp to 5bp inside other jumbos, including a recently issued Eu2.5bn 10 year global for triple-A rated Hypothekenbank in Essen.
Launched by Commerzbank and Morgan Stanley Dean Witter, the syndicate included nine other banks and the deal carried all the liquidity enhancing elements of the previous two globals, with two new features.
DePfa offered investors a repo back-stop facility for up to 5% of the total issue size at a rate of Euribor minus 70bp. Along with guaranteed liquidity in the repo market, the aim of the facility was to achieve tighter bid/offer spreads on the part of the market makers.
The leads also committed to offer investors tradable prices for OTC bond options. Such options had been written on DePfa's previous issues as more market participants developed option based trading strategies and the bank saw the feature as a further move closer to government debt.
But despite its new features and the groundbreaking volume, the pricing of the deal aroused strong feelings in the Pfandbrief market. While most market participants acknowledged that DePfa can command a premium for its globals, bankers were divided over how much of a premium was appropriate.
"DePfa is trying, successfully, to divorce its product from the jumbo Pfandbrief market," said one banker. "But the question is how much that equates to in terms of basis points."
Schörnig says that the bank took several factors into consideration when pricing the transaction: the level outstanding jumbos were trading at; where agency product was trading; and the differences between its product and standard jumbos.
"In our view, this was just the right price market price for this product," he says. "We didn't just compare the spread to other jumbos, we also compared it to agency and government paper. And at the beginning of the year all very high quality paper was trading very expensively, but Pfandbriefe were trading cheap."
Commerzbank and Morgan Stanley then launched and marketed the deal in the 35bp area over the January 2009 Bund. When the deal was priced the next day, a 35bp over spread was fixed. The rationale behind the pricing inside other jumbos was that the international investors who were buying the deal would not buy the competing jumbos.
"The global could not have been done at these levels without the name recognition DePfa has built up over the years," says Wally Höfer-Neder, director of syndicate and origination for frequent borrowers at Commerzbank. "The issue was clearly supported and made possible by investors outside Germany.
"Co-leads have since told us that they were surprised they could sell their commitments as they initially thought the deal was 2bp too tight. But when we were premarketing the issue in the 35bp area, we even had orders at 33bp over from investors who were not comparing the deal to Pfandbriefe, but to other top quality instruments."
Other bankers argue that DePfa was a victim of its approach to the market. "DePfa was under pressure to print something at the beginning of the year," says one head of syndicate, "but the arbitrage was difficult. The pricing of the global was a reflection of their trying to find a compromise between investor driven pricing and their funding targets."
"There is always a trade-off in launching a big premarketed transaction," says another banker. "Although the market always welcomes that kind of approach and instrument, the borrower isn't going to compromise completely on its targets. On such a big deal a 1bp difference in pricing is real money."
Schörnig argues that the performance of the deal demonstrates that the pricing was correct. "The deal achieved all the hopes of investors," he says. "It tightened from 35bp over Bunds to 26bp over, tightened against other government bonds, and even against Euribor it traded more and more expensive."
He adds that the subsequent tightening of other 10 year jumbos, against the DePfa global and Bunds, shows that the bank was right to think other Pfandbriefe were trading too cheap.
But aside from whether or not bankers are in agreement over the pricing, one of the main questions was whether international investors were approaching DePfa's global as an alternative to government and agency product, or whether it remained bracketed with other mortgage banks.
An official at Morgan Stanley said that international accounts were clearly buying the deal as an alternative to government and agency product. "The international distribution for the issue, driven by buyers looking for a spread alternative to Bunds, enabled DePfa to price this deal through other jumbos," he said.
Others feel that although DePfa has begun the move away from the jumbo market, it still has some way to go. "What they have not yet been really successful at is achieving the pricing differential against other Pfandbriefe that they would like," says one banker.
"When investors think 'what do I sell to buy this DePfa paper?' some say that they won't sell a higher yielding Pfandbrief to buy another Pfandbrief. DePfa's issues are still priced as Pfandbrief minus and what they need to be seen as is Belgium plus. The way to do this is to sell to an international investor base that isn't normally active in the Pfandbrief market."
Schörnig sees this as the key to DePfa's future.
"Even if we were very successful in the capital markets in the past, we were always held back by other smaller Pfandbriefe," he says. "We decided we really needed to focus on the pricing of our deals over government bonds - not only over Bunds, but over OATs, BTPs, etc - and find the right price for our product.
"This is the only way for us to prove that our credit can trade freely in the market."
Attracting international investors has been made easier by the introduction of the euro. "We can no longer say that Germany is our home market," says Schörnig, "as Europe is becoming more and more our home market, even more than it was for our two globals in 1998.
"In 1998, we had to do a lot more work to attract European investors, but now, even without lots of premarketing, we see a lot of international participation."
The next step for DePfa is to increase its distribution outside Europe, says Schörnig. Although this has been difficult for any borrower this year, with US investors shunning the new currency, Schörnig is keen to lay the foundations for future international placement.
"We will have to work hard over the next two years to get more global distribution," he says. "In Asia we will probably be successful much sooner, but the percentage we sell in the US should be higher and we still have a lot of work to do."
DePfa already enjoys excellent name recognition internationally and bankers are quick to pay tribute to the work the borrower has done over the years to enhance its profile. "When international investors think of Pfandbriefe, they think of DePfa," says one.
Rob Jolliffe, managing director of new issues syndicate at Goldman Sachs, says that as far as some international accounts are concerned, DePfa is in a league of its own. "Last year when the market fell out of bed we couldn't get some clients to sell DePfa's DM5bn global when they could switch into smaller triple-A Pfandbrief with a 5bp pick up," says Jolliffe. "Investors have met DePfa, they know who they are and where they are coming from."
While DePfa's globals have been the focus of market participants, the bank has not restricted its internationalisation to debt issuance. In the past year the group has expanded its public sector financing activities to diversify into new regions and to increase the range of products it provides. Next week DePfa will officially open a branch in Tokyo and already the bank has set up operations in New York.
A subsidiary, DePfa-Investments Ltd of Cyprus, has been set up to focus on arranging and syndicating project finance and infrastructure measures - primarily in central and eastern Europe, building up a consultancy business for the public sector, further developing a fund management business, and to carry out limited own account trading in emerging market securities.
The increase in the group's international activities is highlighted by the fact that 42.6% of its public sector lending activities in 1998 were to borrowers outside Germany. The international proportion of its new lending in 1998 was even higher, at 59%. By the end of the third quarter of 1998, the latest figures available, DePfa's balance sheet total was up 11.9% from 1997 to DM226.836bn and lending volume up 10.1% to DM206.396bn.
If growth continues at the pace DePfa hopes, the size of the bank's jumbos could grow larger still. Schörnig believes that although some market participants may find it hard to envisage DePfa's issues growing much larger than Eu3bn, they should remember how its earlier deals were received.
"When we announced our plan to issue deals of DM3bn to DM5bn, tapping them up to DM10bn, some people said that we could never achieve this," he says. "But if you look now, there are plenty of Eu2bn deals."
When DePfa began trading, under a different guise, on July 22, 1922, few people could have foreseen that after such a tumultuous century in Germany the bank would be the force it is today.
That was the date on which the Prussian minister of finance, the minister for public welfare and the justice minister signed a memorandum of association setting up a non-profit making mortgage credit institution with the right to issue Pfandbriefe under the name of Preußische Landespfandbriefanstalt.
During its early years - operating in a period marked by internal political confusion, a lack of economic control and rapidly rising inflation - the bank experienced several historical anomalies: Pfandbrief issues were gold backed and at the end of the first financial year the bank had a balance sheet total of some 1,200,000 trillion marks.
Since that time the bank's role and status has undergone several changes. In 1950 the bank's name was changed to "Deutsche Pfandbriefanstalt" and in 1979 the bank took a majority holding in Deutsche Bau- und Bodenbank AG.
On December 31, 1989 the foundations of the present European financial services group were laid.
On that day the bank, previously a public corporation, was converted into a joint stock company and renamed "Deutsche Pfandbrief- und Hypothekenbank AG."
The most recent changes to the group's structure came into effect on the same day that the euro was born, January 1, 1999. Under the new name DePfa-Deutsche Pfandbrief Bank AG, the bank's main business areas became public sector financing, issuing, and group management. All the property activities of the group are now pooled under the renamed DePfa Bank AG-BauBoden arm.
But it was well before the launch of the euro that DePfa, alongside its mortgage banking peers, began to gear up for the promised globalisation of capital markets.
"At the time, our investor base was sufficient for our needs," says Schörnig, "but we could see that the way things were going, and with the euro getting ever closer, we had to reach out to more investors."
A comment from one German banker on the birth of the jumbo market in 1995 highlights how early the mortgage banking community woke up to the key to international placement: "What had been missing in the Pfandbrief market until 1995 was a guarantee of liquidity. That is what we are aiming to supply."
Since that realisation, the history of the jumbo market can be read in DePfa's issuance.
In August 1995, DePfa was the first bank to launch a syndicated jumbo Pfandbrief, a DM2bn five year issue. "This is a vision in some ways," said an official at Commerzbank when the deal was launched.
"It is definitely a blueprint for the future and we have had interest from all over the place. With this instrument we have committed ourselves to making a market at tight spreads, providing real competition for the Euromarkets."
Blueprints for the future became the defining feature of DePfa's issuance: the first global jumbo in January 1996; the first Euro-Asian jumbo in October 1996; and the longest dated jumbos to date - the first a 12 year in January 1998, followed by the first 15 year jumbo one week later.
Another step taken by DePfa to increase international distribution was the launch of a DM1bn issue through the Unico partnership of cooperative banks. The banking group includes members in several countries and offered DePfa the chance to tap into the client bases of banks previously inactive in the Pfandbrief market.
"This idea offered DePfa a totally new distribution channel as we were the only syndicate member already active in Pfandbrief market making," says Roland Zemelka, head of DG Bank's frequent borrower desk. "It was the right platform for the bank as they already had their name in the market but they could access new investors."
DG approached DePfa with the idea for the transaction - the first to be launched through the Unico group since the 1980s. Crédit Agricole Indosuez and Rabobank acted as joint bookrunners alongside DG, while market making commitments were shared by the three and RZB as out of order co-lead. Following the success of the issue the Unico group increased its activities and has launched several deals for other borrowers.
Although the Deutschmark was the currency through which DePfa sold its jumbos across Europe in the years before Emu - the currency being seen by many investors as a euro proxy - the bank was actively marketing its credit through other means.
"When DePfa started to internationalise its debt six years ago," says Schörnig, "building up an international capital markets presence, at the beginning we focused on Europe. We did a lot of marketing and investor relations in France, the Netherlands and elsewhere for Pfandbriefe and for DePfa.
"At the same time, we issued unsecured debt in French francs and Dutch guilders as we did not feel the time was right for Pfandbrief in those currencies."
DePfa was keen for its jumbos to be benchmarks and felt that currencies other than Deutschmarks offered neither the liquidity nor the international reach to attain benchmark status.
"For the euro itself, we didn't market our name through foreign currency Pfandbrief as we wanted to present ourselves as a benchmark issuer," says Schörnig. "We could only achieve that through Deutschmarks last year and euros this year."
Now that the euro has arrived and DePfa has launched its first deal in the new currency, building on the global Pfandbrief programme, Schörnig is optimistic about the bank's future.
"We are in between the mortgage banks and agencies," he says, "and the competition we will face from other mortgage banks depends on what strategy they follow. Some will follow us and others will remain in the Pfandbrief bracket."
Schörnig is happy for other mortgage banks to follow the path to global success and even for competition from other European mortgage banks that are launching Pfandbrief style transactions. This can only help DePfa, says Schörnig, as it can only highlight the differences in the Pfandbrief market that is emerging as investors are forced to focus more and more on credit.
"In the past all Pfandbriefe in Germany were trading
at very similar levels," he says, "but in the future we will
see more different levels. Our first global at 5bp inside
other jumbos was the first step in this