When it comes to what to do with Depfa plc, Germany may feel more compelled to follow the terms of the bail-out agreed with the European Commission, and sell the bank, rather than carry out an orderly wind down.
But investors do not seem to think the same. Depfa plc’s two year covered bonds were trading just 30bp wider than the Allied Irish Banks’ bonds on Tuesday afternoon, a spread that implies Germany will not sell the bank.
But last Friday HRE Holding, Depfa's owners, said in a press release that a sale was on track for a possible signing in the first half of this year.
The trouble is that a sale for the reported €350m is way below the bank’s €900m book value, meaning a humiliating loss for the German taxpayer. But with the European Commission pushing Germany to get rid of Depfa plc under state aid rules, covered bond investors need to wake up to the possibility that their state sponsored obligor could soon be owned by private equity.
Two factors make Depfa different to the ordinary bailed-out German bank.
First, its covered bonds are not Pfandbriefe but Asset Covered Securities, and the issuer is not German but Irish. While German banks are likely to be viewed by the German Finance Ministry as being of systemic importance, Irish banks are almost irrelevant to the financial system in Germany.
Pfandbriefe are a systemically important financial product that is in the gene pool of every German mortgage bank. The German regulator, BaFin, would be fully responsible for their orderly wind down. But BaFin doesn’t care about Irish banks, nor their Asset Covered Securities.
Second is Depfa's business model. Rather than being a lender to the German real economy or a bank with a public mission, Depfa plc was run like a hedge fund. Its spectacular profits before failing were a function of its risky business model. Only 27% of the covered bond assets were German and the rest were mainly from the US and UK.
Its business model was therefore entirely different to Austria’s Kommunalkredit and France’s DexMA, which have both survived as issuing covered bond entities, thanks to state support for their lending objectives.
Under the European Commission's bail-out terms, the German finance ministry may therefore overrule the Treasury and the Green party, which are aghast at the likely cost to taxpayers.
A prospective sale to a non-bank investor such as a hedge fund or private equity firm is therefore more than likely not, which will result in multiple rating downgrades, and a major spread widening. The German government is not bluffing, and covered bond investors need to price that in.