Philip Moore looks at the Pfandbrief market trying to fight back.
In a miserable year for the German Pfandbrief market, the research note distributed by Dresdner Kleinwort Wasserstein on HypoVereinsbank subsidiary, Württembergische Hypothekenbank, at the start of October was something of a novelty. It was a novelty because the e-mail was accompanied by the headline message, "Positive News for WürttHyp".
That news, rare enough for issuers in the Pfandbrief market these days, emerged when Moody's announced that it would be maintaining its stable rating on WürttHyp at a time when other subsidiaries of HVB (HVB Real Estate and Westfälische Hypothekànbank) were assigned with negative outlooks in reflection of the ratings prognosis for their parents. DrKW was quick to note in its bulletin that it did not expect WürttHyp's bonds to outperform significantly in response to the ratings outlook, but it did advise that the news would "definitely be supportive for the mortgage bank".
The good news for WürttHyp was a rare piece of positive intelligence in a market where the news over recent months has been characterised by almost unremitting gloom. Aside from the continuing spiral of downgrades, there has been the embarrassment of being overshadowed by the French and Spanish covered bond markets.
As SG notes in its October edition of EuroCredit, "in the second half of September, the collapse of the stock markets, in which financial stocks were particularly hard hit, triggered a further widening of covered bond spreads. However, this was far less marked for cédulas hipotecarias, and especially for obligation fonciers, than for Pfandbriefe, which are being adversely affected by the continuing troubles of German banks."
In September, those troubles were most obviously manifested in the outlook for Deutsche Bank, Commerzbank and HVB being switched by Moody's from stable to negative, with Fitch doing the same for HVB. With little prospect of any better news emerging from the German banking sector in the near term, SG echoes a number of other analysts by recommending that investors "operate selectively inside the sector" and favour French obligation fonciers and Spanish cédulas hipotecarias over Pfandbriefe, "whose spreads seem likely to widen further or to be fairly volatile".
If there is an exception to the rule within the Pfandbrief market, say SG and other analysts, it is Depfa, whose bonds are trading "at a level close to Dexma's and showing remarkable resistance to the current upheavals".
A trend that continues to gather momentum in the Pfandbrief market is the diversity of credit quality among issuers - something that was conspicuous by its absence in the early days of the Jumbo market, when all borrowers were perceived to be close to identical in terms of credit quality.
These days, it seems that some issuers in the market are more equal than others. "We haven't seen continued spread widening across the covered bond market as a whole this year," says Iain Barbour, global head of structured finance research at Commerzbank Securities in London, "and there has been continued differentiation between spreads in the Pfandbrief world. That differentiation has been triggered largely by the different ratings approaches of Moody's and Standard & Poor's. For example, the fact that Allgemeine Hypothekenbank Rheinbodlen (AHBR) is trading in the 20-something range over mid-swaps when Depfa can issue in single digits is a function of the Moody's ratings which have meant that AHBR has been the first Pfandbrief programme with a single-A rating."
At DrKW in Frankfurt, former head of debt syndicate Matthias Wittenburg also points out that something akin to a super league is now forming within the Pfandbrief market, and this is a reflection not just of the credit quality of issuers but also of their approach to syndication and pricing. "Borrowers such as Depfa, HVB and, in the near future, Eurohypo are clearly establishing a prime segment in the Pfandbrief market," he says. "Depfa in particular has adopted an agency style approach to the market. It encouraged the arrival of the pot system in the covered bond sector and brought discipline back to the market. That gave investors more reassurance that new issues were being priced to sell, and in turn brought some confidence back to the market."
Perhaps. But some bankers argue that a disturbing indication of international investors' uneasiness about the credit quality of the Pfandbriefe was the reception given to Depfa's inaugural global dollar bond led at the end of September by Citigroup/SSSB, HSBC and Merrill Lynch. Originally planned as a $3bn benchmark, and intensively marketed in the US and Asia, this 144A five year offering was cut to $2bn and priced at the wider end of guidance, or 65bp over US Treasuries, the equivalent of spreads plus 1bp.
"I wouldn't describe the Depfa deal as a disaster," says one Frankfurt-based banker. "But a lot of investors told us that they have problems with the Pfandbriefe as an asset class. Some people now see them as an expensive alternative to ABS paper. But I think the other problem with the Depfa transaction was that by selling only dollars rather than euros there was no backstop bid."
Others argue that there is nothing fundamentally wrong with the Depfa credit story, its funding strategy or the way in which its dollar global was marketed. "Depfa has clearly come a long way in differentiating itself from other issuers in the Pfandbrief market," says another banker. "I think it was much more badly impacted by what was going on in the Freddie Mac and Fannie Mae rumour mill than by what was happening in the Pfandbrief market. The Depfa issue was launched in a terrible market with bond spreads widening and equity markets collapsing, so I would take the view that to have raised $2bn in that environment was an impressive achievement."
That view is echoed by a number of other bankers who argue that behind the negative headlines there were some very positive elements of the Depfa dollar deal. One banker close to the transaction says that the deal was immensely popular with investors in Asia, where Depfa has developed a very strong and loyal following that was appreciative of the opportunity for non-euro exposure. But he adds that Depfa and its advisers probably underestimated the relatively parochial attitude that continues to prevail among US institutional investors.
"We met with some huge accounts who listened very carefully to the Depfa story and said they liked it, but they wanted to wait for the borrower to establish a track record in the dollar market or to see a fully registered bond," the banker says. "Some of these investors told us that they had not even started to buy KfW yet, and we are talking about institutions with more than $100bn under management. We all had to learn the lesson that American investors can still be very domestic-minded."
Another recent indication of investor caution on the Pfandbrief sector was the cancellation in September of a planned public sector bond from Essen Hyp, and although a handful of issuers have been able to launch new offerings as planned in recent weeks, bankers say that they have been compelled to pay up for the privilege. Take the Eu1.25bn three year transaction led in September by Deutsche, DrKW and HVB for AHBR, which was priced at the wide end of its guidance range of between 16bp and 19bp over swaps. That, say bankers, is the sort of pricing level that the AHBR of 1999 or 2000 would never have countenanced.
But it was also taken as a very encouraging signal that AHBR is committed to re-cultivating lasting relations with its investor base following the trauma of its downgrade, in May, to A1 from Aa2. AHBR consciously erred on the side of generosity in pricing the issue at 19bp over swaps, although the strength of the order book allowed it to increase the size of the transaction from an originally planned Eu1bn.
Another positive development within the Pfandbrief market in 2002 has been the passage of the Fourth Financial Promotion Act and the reform of the German Mortgage Banking Act that came into effect on July 1. Over the longer term, this has laid the foundations for issuers within the market to enjoy much more flexibility in their asset-liability management.
The principal features of the new regulatory guidelines are that mortgage banks are now allowed to include derivatives in their cover pool and to expand their lending franchises into new markets. Specifically, public sector exposure in Japan, Canada, the US and a number of central and eastern European economies can now act as collateral for öffentlichepfandbrief issuance, giving mortgage banks the sort of expanded freedom for which they have been lobbying for years.
"Over the longer term the new regulations should be positive for the market because they broaden the mortgage banks' business scope," says Barbour at Commerzbank Securities.
As with the Landesbanks, the key for issuers, now doubly important because the new legal framework allows them to expand into new territory, will be to establish clear business plans and to convey their messages articulately to the capital market. That imperative, some bankers think, will lead to an increase, in relative terms, in issuance of mortgage-backed Pfandbriefe (Hypothekenpfandbriefe) and a decline in the importance of the öffentlichepfandbriefe that have accounted for the lion's share of issuance in the Jumbo market since its inception in 1996.
At Citigroup/SSSB in Frankfurt, Günter Gleumes says that with the exception of a handful of issuers very few of the more active issuers in the Jumbo market can demonstrate a sustainable business model in the public sector arena. That explains why a prolific issuer such as Essen Hyp, a mainstay of the öffentlichepfandbrief market in its heyday at the end of the 1990s, is increasingly making noises about moving more and more into the mortgage lending business.
Another development that Gleumes foresees in the Pfandbrief market is the emergence of new issuers, perhaps in the form of the savings banks (Sparkassen), a market that Citigroup/SSSB opened for the first time in February when Stadtsparkasse Köln became the first savings bank to raise funding through the Pfandbrief market with a three year issue rated Aaa by Moody's.
That particular transaction was less noteworthy for its size (Eu100m) than for the potential precedent it set. Gleumes says that he knows of a number of Sparkasse that are studying the potential of the Pfandbrief market, although these banks are also looking closely at the way in which smaller savings banks in Spain have successfully tapped the cédulas market through pooled collateral. Given the fragmented nature of the German Sparkassen, very few of these would be able to amass sufficient collateral to issue Jumbo Pfandbriefe as independent borrowers, meaning that they may replicate the AyT structure that has worked so effectively in Spain. *