The German Pfandbrief still stands on a pedestal above the rest of the covered bond market. Its legislation is exalted as the standard that other jurisdictions should aspire to, and the almost iconic conservatism of the product, which has never suffered a default, has won many supporters in key regulatory bodies.
But that does not mean there is no room for improvement. New covered bond laws, in Canada for instance, have moved the market forward by enacting a higher level of transparency and disclosure among issuers, raising the bar for everyone. Germany has stayed in step with this transparency zeitgeist, regularly amending the law since 2004 to ensure issuers abide by a legislated reporting framework.
But the transparency issue has taken on a greater level of urgency across Europe since the Capital Requirements Regulation became effective on January 1 2014, obliging bank investors to make additional due diligence for covered bonds.
“The new transparency requirements were introduced for the benefit of investors, but also to stay in line with CRD IV regulations, as the risk weight of covered bonds is also dependent on fulfilling certain minimum transparency standards,” says Ted Packmohr, head of covered bond research at Commerzbank.
In other words, if investors hold a covered bond that does not meet the disclosure requirements, then they would not be allowed to apply lower risk weights for that investment.
German authorities have moved quickly to ensure Pfandbriefe fully comply with CRR, though Jens Tolckmitt, chief executive of the Association of German Pfandbriefbanks (vdp), says the latest set of amendments were driven by investor consultation before the CRR was finalised.
“As usual, we consulted with investors to see what would be appropriate additions to the transparency framework, and the result is the enacted law you can read now,” he says.
“Given we have one of the few legal frameworks for transparency, we knew we would be broadly in line with CRR,” he says, adding that the vdp was already beginning work on new amendments on transparency and the powers of the post-insolvency cover pool administrator.
Not yieldy enough
The strength of the German legislation has always helped Pfandbrief issuers when marketing and selling deals. But execution in the primary market is not as straightforward as it used to be because very tight spreads have given international and even domestic investors pause for thought.
“Investors have to some degree sobered up and there is less demand for tightly priced Pfandbriefe,” says Packmohr. “They have traded stably, but they now look rich compared with German agencies or Lande.
“Since the second half of last year even German investors have become more cautious over tight levels for Pfandbriefe. We can see this in the order books in recent deals. German issuers need to take care not to price new deals too opportunistically or tightly.”
Many of the order books for the eight benchmark Pfandbriefe sold to date in 2014 were just covered and struggled for traction outside Germany. All of those deals, apart from Helaba’s €1bn five year, were €500m.
German savings and Landesbanks played a vital role in anchoring deals and getting them over the line. With deals regularly pricing flat or inside mid-swaps, attracting real money investors from outside Europe is a tall order.
“There is a clear division between official and private investors outside Europe,” says Tolckmitt. “The low yield environment makes it hard to appeal to private investors, though they still want updates on the market, but official investors such as central banks take a different view and look at things like the safety of the product.”
The tight spreads are driven in part by the continued shrinking of outstanding Pfandbriefe volumes. By the end of 2013, VDP member banks (which include the vast majority of Pfandbriefe issuers, apart from Deutsche Bank) reported outstanding covered bonds of €437.9bn. This was a big fall from the €505.6bn reported at the end of 2013.
This downward trend is only likely to slow when European banks have finished deleveraging and fulfilled tougher regulatory capital requirements. “Once this consolidation phase is over, perhaps one or two years from now, there is potential for a moderate increase in issuance, especially in the mortgage Pfandbriefe sector,” says Tolckmitt.