Landesbank Berlin AG (LBB) plans to issue structured mortgage covered bonds under its Daheim Nr 1 covered bond programme. This is the first time that a German financial institution has issued covered bonds under general German law, and outside the ambit of the Pfandbrief act.
Although the bank says that it originated the structure on its own, a fortuitous consequence is that it could be used by numerous other institutions in Germany: namely, smaller savings banks.
"Applying for LBB’s own Pfandbrief privilege, we realized the costs and effort involved in order to meet all requirements under the Pfandbrief act," says Christian Scheibe, director in LBB’s treasury department. "These costs are too high for smaller banks. So we came up with the idea of utilizing these mortgages for a structured covered bond, which is basically a secured bearer bond."
The Pfandbrief is the leading product in the covered bond universe but the rigid legal framework often makes it too complicated and costly for smaller institutions to implement. LBB’s structured covered bond will enable these banks access to the kind of cheap funding available to covered bond issuers.
"The first issue under the new programme will be a test transaction, backed by LBB’s assets, to show the product to small savings banks and investors," Scheibe told Euromoney. "Obviously, the Pfandbrief will always be in the market, and for big banks with a critical mass of mortgages on the balance sheet it remains the best source of funding. But for smaller banks, the work involved and the costs incurred make issuing Pfandbriefe very difficult."
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Funding alternative |
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Borrowing alternative |
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Source: Moody’s |
The test transaction will be a three-year, sub-€500 million issue. If it’s successful, savings banks (Sparkassen) could soon issue covered bonds through the bank’s Daheim Nr 1 programme. Each issue will constitute a separate covered bond, backed by a separate cover pool made up of one or both of two types of securities. The first are residential mortgage loans originated by the Sparkasse. This will be known as the borrowing alternative. The second are secured loans granted to the Sparkasse, which are in turn backed by residential mortgage loans. This will be referred to as the funding alternative.
This structure is similar to those already used elsewhere in Europe. "The LBB issue is analogous to what’s been going on in Spain," says Richard Kemmish, head of European covered bonds at Credit Suisse. "These club deals make a lot of sense commercially for the banks involved." The three main issuers of this kind of platform in Spain are AyT Cédulas Cajas, Cédulas TDA and IM Cédulas Banco Popular.
LBB’s plans have ruffled some feathers among traditional Pfandbrief issuers in Germany, as well as the association of German mortgage banks (VDP). The VDP has responded to news of LBB’s venture by saying that the new instrument will be to the detriment of the Pfandbrief’s growth, and make it more difficult for international investors to accurately analyse products in the market. They argue that the introduction of the funding register last year allows smaller banks to issue Pfandbriefe cheaply and without complications, rendering LBB’s structured covered bond unnecessary as it adds complexity to the otherwise homogeneous German covered bond market.
Those outside the Pfandbrief world might argue that this is the latest sign that covered bond markets are developing beyond regulatory frameworks. Structured covered bonds used to be issued exclusively in unregulated markets. But the success of these markets, particularly in the UK, has encouraged issuers in regulated markets to consider issuing outside specific legal frameworks. The LBB issue is a first in Germany but is by no means a first for the covered bond market. In November, BNP Paribas issued a covered bond outside the French obligations foncières framework. The issue was oversubscribed, despite uncertainty over its 20% risk weighting as opposed to the 10% enjoyed by obligations foncières. Unregulated markets, such as the Netherlands and the US are also vibrant.
"Homogeneity and structure are very important in new covered bond markets," says Mauricio Noé, co-head of covered bonds at ABN Amro. "But in existing markets, with a well-defined curve, there may be scope to push the envelope a bit."
Ironically, the UK market, which is the largest unregulated covered bond market, is bucking the trend. The UK authorities are working on a legal framework, and the publication of a draft law is expected just after Easter. Following a three-month statutory waiting period beginning in May, the laws will be put to the politicians, and the final regulatory structure should be in place by Christmas. This will instantly transform all structured covered bonds originated in the UK into legally compliant covered bonds, halving the risk weightings and allowing advantageous treatment under Basle II, but also increasing the level of public supervision and decreasing cover pool flexibility.
Moody’s, in its pre-sale report of the Daheim Nr 1 programme, has given the issue a provisional rating of Aaa. Moody’s rating for LBB is A1, while Fitch rates the bank BBB+. LBB structured the deal with the aid of law firm DLA Piper, and will be engaging investment banks to work on future issues.