Innovations underline possibilities
Although German ABS/MBS volumes may have fallen in 2000, bankers involved in the asset backed market
are optimistic. The development of new structures unique to the German arena, healthy demand from investors for ABS/MBS product and the strong performance that has been delivered by the asset class means there is no doubting the market's potential for continuing robust growth. Lower new issue volumes this year are largely a result of a fall off in bank CLO offerings, but residential mortgage backed securities in particular are seen as a source of strong supply, with credit linked notes providing a possible template.
To many investors in the German capital markets, one of the brighter spots this year has been the asset backed market. "The ABS sector has been an interesting market this year and one of the best performing credit products," says Birgit Specht, head of ABS research at Dresdner Kleinwort Benson (DKB) in Frankfurt.
"ABS investors have not been as disappointed this year as investors in the corporate bond market, where spreads have widened in response to ratings downgrades. The ABS market has demonstrated that it can withstand a severe downturn in the general credit market."
This is a phenomenon that has not been confined to Germany. Merrill Lynch noted in its most recent ABS/MBS quarterly that across Europe the "relentless pace of ABS and especially MBS issuance could lead to pressure on spreads, especially for repeat issuers to which investors have built up considerable exposure.
"To date, however, we have seen spreads tighten rather than widen, mainly due to the almost bulimic appetite for MBS and ABS. The levels of oversubscription on tranches speak for themselves, and this is true for tranches at all ratings levels."
If bankers express disappointment about the evolution of the German asset backed market, it is because after bursting to life in 1998 and 1999, primary market activity has failed to live up to the more bullish expectations in 2000. By the end of the third quarter of this year, according to Merrill Lynch data, total German ABS/MBS volumes amounted to only $4.5bn, out of total European issuance of almost $59bn and compared with $11.6bn of German issuance in the same period in 1999.
The lower volumes are largely a reflection of the sharp decline in bank CLO issuance this year, which DKB's Specht says has so far contributed Eu1bn, compared to Eu8bn in 1998. Instead, the focus among asset backed issuers in Germany has increasingly been on the residential mortgage backed securities (RMBS) market.
As reported by Standard & Poor's (S&P) in a recent release, "the German RMBS market has significantly deepened in 2000, backed by lenders increasingly striving for efficient balance sheet management". As well as repeat issuance by Deutsche Bank, S&P points out that "a large number of first time issuers have additionally entered the market and we expect them to tap it again now that a framework is in place".
One notable debut issuer in this market in 2000 was Landesbank Schleswig-Holstein (LB Kiel), which in April launched the first public term securitisation by a Landesbank - a Eu1.01bn synthetic residential mortgage deal named Förde 2000-1, led by WestLB.
The use of the synthetic structure rather than the true sale route by LB Kiel and others in the German market is seen by a number of bankers as another sign of the heightened sophistication of issuers as well as investors in the market. So too is the increased use by German issuers of securitisation without SPVs. "One trend that has been very much confined to Germany has been the use of credit derivatives within an ABS structure," says Specht. "The strategy among many bank issuers has shifted from placing notes through an SPV towards credit linked note structures."
In its latest analysis of developments in the ABS/MBS market in Europe, Merrill Lynch sees this as a key challenge to traditional structuring mechanics in the securitisation market. "First introduced in 1999, the structure dispenses with an SPV with all notes issued on balance sheet," Merrill observed.
"Senior notes achieve their triple-A rating through collateralisation by Öffentliche (Public Sector) Pfandbriefe. All junior notes remain unsecured obligations of the issuer, but differ in credit rating to reflect their order in the priority of payments. Over the past quarter, use of structured products has broadened from the CLOs through which it was originally introduced to residential mortgages."
To date, Merrill points out, the structure has not been used outside Germany. "Nor at this point in time," it adds, "is there any mention of transactions in the international pipeline using a similar model.
"The importance of this discussion, however, is not whether the German model will become an international standard. Instead, it is significant the way German issuers have been able to modify the traditional framework to meet their particular circumstances. Since its inception, the concept of the SPVs - or its like - has appeared fundamental to securitisation. The German model demonstrates that alternatives can be developed."
DKB's Specht believes there is plenty more room for increased issuance of RMBS out of Germany. "We will probably see more diversification in the RMBS market," she says, "largely because more and more mortgage banks are turning to the sector. If you look at the total amount of mortgages that are funded via the Pfandbrief market it is still less than 20%, with more than 80% of mortgage lending funded through deposits or unsecured bonds.
"Plenty of mortgages could be securitised, either because they do not qualify as collateral for Pfandbriefe, or because they are mortgages granted by banks that are not legally privileged to issue Pfandbriefe." *