Covered bonds enter negative territory

Bodo WinklerBy Bodo Winkler, Head of Investor Relations & Credit Treasury at Berlin Hyp

On Tuesday, 8 March 2016 something happened that some analysts and market participants have already described as the beginning of a new era. The first publicly-placed, Euro-denominated bond, that was not issued by a public entity or an SSA but a private financial institution, was successfully placed on the market. Berlin Hyp’s 3y Mortgage Pfandbrief was priced by syndicate banks Credit Agricole, Deka, J.P. Morgan, LBBW and UniCredit at a reoffer price of 100.488 per cent. As the bond has a 0 per cent coupon, the result is a yield of -0.162 per cent at issuance.

Although the issuer effectively pays back less at maturity than he received at issuance the book, which was opened with an initial spread guidance of MS + 4bp, was almost three times over-subscribed. It amounted to almost EUR 1.4bn when leads closed it only one hour and twenty minutes after opening and fixed the reoffer spread at MS + 1bp.

With approximately 65 per cent of the bond, bank treasuries took the lion’s share, followed by central banks and official institutions with 20 per cent (the minor share of which went to the Eurosystem) and asset managers with 15 per cent. What about regional distribution? 71 per cent went to Germany, 9 per cent to the UK and CEE took the third-biggest chunk with 6 per cent.

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Avoiding Asset-Liability-Mismatches

Pfandbrief Banks have so far avoided issuing bonds at a negative yield as they feared investors would shun these instruments even though about ¾ of all German covered bonds are trading at negative yields in the secondary market. As one maturity after another went into negative yield territory, possible maturities became more and more limited. We at Berlin Hyp had exactly that experience in April 2015 when we prepared for the issuance of our inaugural Green Pfandbrief. We had to rethink this innovation when it became obvious that the favoured 5y maturity would lead to a negative yield. The result was that the first green covered bond finally came with a 7y maturity. But investors have adapted to the new normal.

Covered bonds should allow issuers a funding with matching maturities as this is one of the many features that make the instruments so secure. It is a means of managing liquidity and interest rate risk within the cover pool. Thus, it is important for issuers to be able to choose the maturities, from a wide range, that best match their profile on the asset side.

Positive impetus for the market

From our point of view it was striking that real money investors took a substantial part of the deal. While we expected a high participation of bank treasuries who have to manage a LCR portfolio and central banks from outside the Eurozone, we were pleasantly surprised by the large chunk that went to asset managers. Irrespective of the negative yield, the deal offered a decent pick-up of close to 40bp against German Bunds. This might have been important for those who want or need to be invested in highly secure German debt. In addition to that, the yield offered was still higher than the ECB’s deposit rate (at issuance 0.3 per cent). Thus the bond offers bank treasuries a positive return compared to the alternative of parking liquidity in their central bank account.

“The bond offers bank treasuries a positive return compared to the alternative of parking liquidity in their central bank account.”

We hope that our Pfandbrief opens the door for other covered bond issuers to reanimate the more short-term end of the curve. They have seen encouraging signs from the deal. Basically, it is possible to issue a covered bond with negative yield and still have a highly over-subscribed order book, achieve a comparatively high regional investor diversification, and enjoy the participation of investors that are not LCR-driven or central banks.

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