How much of an impact the after-effects of the recent crisis are having on the spreads of Landesbanks public bonds is open to question, for a number of reasons. First, having stored up substantial reserves of grandfathered debt before the loss of their state guarantees in 2005, few are facing much in the way of refinancing pressures, which has meant that there has been very scant supply of new public and internationally targeted unsecured debt from the sector.
Instead, most Landesbanks have favoured domestic options such as the Schuldschein market or the Namenspfandbrief, or registered Pfandbrief market, where funding levels have been much more competitive. Analysts say that in the market for 10 year Schuldscheine, BayernLB paper trades in the region of mid-swaps plus 58bp, for example, while LBBW Schuldscheine with the same maturity pay around 50bp. Helaba, which only issues up to four years, pays closer to 40bp.
This understandable focus on the domestic market contrasts with the expectations that were generated some years ago by players such as Helaba, which chalked up a landmark for the Landesbank community at the end of 2004, when it launched the first transaction from the sector to be rated on a non-guaranteed basis. That was a Eu200m FRN maturing in 2019, well after the 2015 cut-off date for grandfathering of Landesbanks debt.
This initiative from Helaba was accompanied by a marketing push by the bank outlining what it called a "refinancing and liquidity strategy for the future". Pivotal to that strategy was a commitment to more internationally targeted issuance. "Helaba has made diversifying its sources of refinancing a major priority," the bank reported in 2004. "The bank intends to place its funds procurement activities on a broader and more diverse international footing with a campaign to attract suitable new investors and penetrate new markets. Previously we have met 60% of our refinancing needs in Germany and only 40% elsewhere; our new policy aims to reverse this ratio over the next few years."
Representatives of the Landesbanks say that they are not prepared to pay up to issue benchmark-style transactions targeted at international investors. Indeed, the most recent large size unsecured transactions to emerge from the sector were the subordinated deals launched at the start of 2007.
BayernLB led the way January with the first syndicated lower tier two deal since the loss of the guarantees, which was a Eu750m 12 year non-call seven deal via Citi and Merrill Lynch alongside BayernLB itself. Early the following month, HSH Nordbank upped the stakes with a dual tranche lower tier two issue divided into a Eu750m fixed rate bond and a Eu1bn FRN via Deutsche, HSH and UBS.
Resolute political commitment
A second reason why Landesbank spreads have been resilient in the face of the global meltdown is the political importance of the Landesbank sector and in turn the resolute commitment of regional governments to continue to support their Landesbanks come what may.
"At the start of the crisis, and when the news about IKB broke, we saw a huge widening in the prices of Landesbanks CDS," says Alexander Plenk, a banking analyst at UniCredit in Munich. "But that was partially reversed when it became clear that there was still a huge amount of implicit state support for these banks which will prevent them from defaulting."
Landesbanks issuance in the jumbo Pfandbrief market has also been muted in recent months, reflecting the diminishing size of their public sector cover pools, and the upheavals in the broader European covered bond market.
With Landesbanks able to command very tight levels in the market for registered Pfandbriefe, Öffentliche (public sector) issues have almost attained something that would have been unthinkable a few years ago rarity value. Nevertheless, following the shutdown of the market last summer it was a Landesbank LBBW that re-opened the jumbo Pfandbrief sector in September 2007 with a Eu2bn five year public sector transaction led by LBBW alongside Citigroup, which was its largest ever jumbo Pfandbrief.
LBBW paid 1bp through swaps for the September transaction, which some bankers interpreted as a high price to pay for re-opening the market, but it was rewarded with an order book of Eu5.6bn.
The re-opening of the jumbo Pfandbrief market in late summer and the solid secondary market performance of the LBBW deal helped pave the way for other Landesbanks to test the market at more ambitious pricing levels.
Troubled WestLB, for example, demonstrated the robustness of the Pfandbrief structure when its Eu1bn three year transaction in November was priced at 5bp through mid-swaps. Barclays Capital, Dresdner Kleinwort and Société Générale led the WestLB deal which generated an order book of Eu2bn, with some 21% of the bonds placed in Asia.
Landesbank Berlins three year Eu1bn issue in February was also a runaway success. Led by Deutsche, Dresdner Kleinwort and UniCredit, the LBB transaction generated well diversified demand of some Eu3.5bn within an hour, allowing for pricing to be set at 1bp through mid-swaps, the tight end of guidance.
LBBs transaction was followed a week later by another well received benchmark from LBBW, a Eu1.5bn 5-1/2 year deal led by Morgan Stanley and Natixis alongside LBBW.
Demand in excess of Eu5bn allowed for pricing to be revised from a guidance level of 1bp over swaps to flat. "Our February deal was a huge success, but it was aimed more at helping to re-open the market than as a funding exercise," says Jorg Huber, head of debt capital markets at LBBW in Stuttgart. "Since then, however, spreads have deteriorated once again, largely because we have seen other issuers paying up so heavily in the new issue market. In the cédulas market we have seen two year issues coming in the range of 60bp-75bp over, which makes it very difficult for the top quality issuers in the German public sector Pfandbrief market to compete."
The good ship HSH Nordbank
Perhaps the most innovative recent development among Landesbanks in the Pfandbrief market, however, has been the long awaited launch by HSH Nordbank of the first covered bond backed by shipping loans. This was a Eu1bn two year transaction led by Deutsche Bank, HSBC and HSH which was priced flat to mid-swaps and garnered a healthy demand of more than Eu3bn, with 67% placed in Germany and the balance distributed principally in Europe, although Asia accounted for 6% of placement.
Jochen Friedrich, the management board member responsible for financial markets at HSH Nordbank, says that he was delighted with the outcome of the inaugural ship Pfandbrief. "Our bank is able to issue Pfandbriefe in all three forms shipping-backed, mortgage-backed and public sector-backed," he says. "That is a huge advantage in the current funding environment, when Pfandbrief spreads have been relatively stable compared with spreads in the covered bond and unsecured markets.
"When we started marketing the ship Pfandbrief we were a little nervous that we would need to pay a premium for the new product. As it turned out, demand was such that we could have issued at minus one or minus two, but we priced at flat to swaps because we wanted to leave something on the table for investors. That strategy has paid off because since that transaction we have issued another Eu2bn of our three types of Pfandbriefe at an average spread of minus five."
To Friedrich, the strength of investor demand for the ship Pfandbrief was a reflection of its novelty value and the intrinsic credit quality embedded in the market for shipping loans. "In the last 18 years our portfolio of shipping loans has incurred losses per annum of just 3bp, which obviously compares very favourably with mortgage and public sector loans," he says.
Little wonder, against that backdrop, that HSH Nordbank is aiming to shift much of its long term funding away from the senior unsecured market and towards Pfandbriefe. "Last year we issued about Eu15bn, of which Eu10bn was in senior unsecured debt and Eu5bn in covered bonds," says Friedrich. "This year we want to issue about 30% less long term funding. We are well on our way although not as far ahead of schedule as we were this time last year."
Although the economics of covered bond issuance look compelling in comparison with the senior unsecured sector, for Landesbanks in the Pfandbrief market, pricing dynamics are still very different from the levels they were enjoying some years ago.
"The time when Landesbanks could issue cheap paper and go shopping on the asset side is definitely over," says one banker. "Of course that is a much bigger problem for those Landesbanks that have still to establish a sustainable business model."
Funding alternatives for Landesbanks
Bernd Volk, head of European covered bond research at Deutsche Bank, says that for Landesbanks that are finding the going increasingly tough in the jumbo Pfandbrief market, two options have been mooted as alternative funding mechanisms.
The first is the so-called pooling model which combines mortgage loans from a number of banks into a single cover pool to generate sufficient firepower as collateral for jumbo Pfandbriefe. As research published by Deutsche Bank points out, this could be an especially appealing option for savings banks, which have some Eu300bn of mortgage loans on their balance sheets, of which "at least half" are eligible as collateral for Pfandbriefe.
Although the German Banking Law has been amended to allow for the transference of mortgage loans (as distinct from public sector facilities), Volk suspects that political objections are likely to hinder the development of the pooled model in the Pfandbrief market.
"Three or four years ago LBBW said it was ready to issue Pfandbriefe based on the pooling model, but nothing happened in terms of issuance volume," says Volk. "In practice the pooling mechanism is very difficult to achieve because, besides the fact that the model in its current form is technically very complex, savings banks are reluctant to allow the size of their balance sheets to be reduced or to give away their client data. So from a practical perspective pooling is unlikely."
Volk says that for an issuer like LBBW another alternative would be to look at the potential for issuing in the Luxembourg covered bond (lettres de gage) market.
"Conceptually that would be straightforward and efficient because savings banks bonds are still eligible as collateral in the lettres de gage market," says Volk. "But politically it is difficult for German Landesbanks to use the Luxembourg market because if they did so they would basically be circumventing the amendments of the German Pfandbrief legislation of July 2005, in which the eligibility of savings banks bonds was abolished."