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DEBT REPORT: JUMBO PFANDBRIEFE 54 Jumbo How the took flight It is ten years since the birth of Jumbo Pfandbriefe propelled the antiquated covered-bond market from the relative calm of the backwaters of German finance onto the world stage. In that time the Jumbo covered bond market has grown from a gleam in a banker’s eye to more than €400bn today. Meanwhile new issuance of covered bonds for 2005 alone is forecast to top €130bn. The number of issuing countries has grown from one (Germany) to seven and at the same time the share of non- German investors in the Jumbo Pfandbriefe market has risen from as little as 5% to almost 30%. Where can the market go next? By Paul Whitfield THE SUCCESS OF today’s covered bond business seems a long way from the withering market into which a handful of German banking pioneers sought to pump life with the launch of the first Jumbo Pfandbriefe back in 1995. Then, a combination of small issuance size (typically less than DM60m; the equivalent of €30.6m) and an insignificant secondary market had squeezed liquidity out of the Pfandbriefe market driving spreads to insupportable levels. “Investors had to pay about 100bp over Libor,” says Claudia Vortmueller a covered-bond analyst at Commerzbank Corporates & Markets. The extent of the market’s liquidity problem became painfully evident in the two years prior to the birth of the Jumbo market. In 1993, a Pfandbriefe bull market had attracted large amounts of both investors and issuers into covered bonds. However, when the market turned in 1994 investors found themselves trapped by the paucity of willing buyers. The experience spooked investors. Foreign investment banks in particular were rattled and all but abandoned the market. By 1995 it was estimated that non-Germans held a meagre 5% share of the of Pfandbriefe market. Even in its homeland Pfandbriefe began to lose its appeal. From accounting for about half of the German bond market in 1990, Pfandbriefe had shrunk to nearly a third by 1995. There is disagreement over what constituted the first Jumbo Pfandbriefe. Most agree that the first major step toward the new market, if not the birth of the Jumbo itself, came in May 1995, with the DM500 million Frankfurter Hypothekenbank deal, a 5.875% June 1999 public sector Pfandbriefe. The deal was the first truly large Pfandbriefe but it lacked many of the essential features that have been enshrined in today’s Jumbo market. Crucially the market maker was also the issuer – Frankfurter Hypothekenbank (now Eurohypo AG) – an arrangement which while necessary, given the lack of other options, meant the market lacked the transparency of today’s Jumbos. The first Jumbo to incorporate most of the key features that sit at the core of today’s vehicles was an August 2005 issue by Depfa. The bond was far larger than the Frankfurter issue, at DM2bn, and, crucially, it had three lead managers who also pledge to create a secondary market and maintain tight spreads. Since 1995 the Jumbo market has grown quickly. By mid 1996 the amount of outstanding paper topped €50bn. Within another two years it had tripled in size to €150m and by 2000 was approaching the €350m mark. Today’s outstanding volume of about €400 million makes the Jumbo Pfandbriefe market Europe’s fourth-largest bond market, behind the government bonds of Italy, Germany and France. Yet, however spectacular the growth of Jumbo Pfandbriefe has been in Germany, the most interesting aspect of its success has been the spread of Jumbo’s beyond German borders.“It is wrong to think of this as a German product anymore, covered-bonds are now a European market and we will see the percentage share of the German market continue to decrease over time as European issuance grows,”says Vortmueller. In 2000 about 90% of all new Jumbo issues originated in Germany, that percentage had fallen to 50% by 2003 and by the end of 2004 it had fallen to almost 30%. Investing in JULY/AUGUST 2005 • <strong>FTSE</strong> GLOBAL MARKETS
Jumbos is also no longer an exclusively German practice – a 10-year €1bn Jumbo covered bond issued in February by Austria’s Kommunalkredit was bought by investors in France, Spain, the Benelux countries, Scandinavia, China and South Korea, as well as Austria and Germany. The attraction of Jumbo covered-bonds to foreign banks is easy to understand. On the supply side the bonds are popular with banks because they allow issuers with AA or A credit ratings to create instruments that typically enjoy ratings of AAA – making raising funds cheaper. On the buy side, the bonds have both the liquidity and size that are necessary to attract large investors. They also have the key advantage for banks of requiring only half the capital coverage of a bond issued directly by banks that issue mortgages. The reason for this, say regulators, is because the bonds are secured against stable long-term loans, making them particularly safe – though critics suggest that the narrow asset base means the bonds are not as safe as many think. The financial advantages of Pfandbriefe, coupled with the new found success of the Jumbo format, led, in 1999, to the first non-German issuance of covered-bonds when Spain launched its cédulas hipotecarias and France issued obligations foncières. More recently they have been joined by Austria, the UK (which in 2003 became the first country The Pfandbrief In 2005 the Jumbo Pfandbrief marks its 10th anniversary. For a decade, the Jumbo Pfandbrief has been setting the standard in the international fixed income market. From a standing start, the Jumbo Pfandbrief has grown to a market of 400 billion euros and an average issue size in excess of 1.7 billion euros. The groundbreaking Jumbo segment has spurred the development of the pan-European Jumbo covered bond market worth nearly 600 billion euros. The Jumbo Pfandbrief: quality, liquidity and a yield pick-up. Find out what investors should know about the Pfandbrief � � � www.pfandbrief.org <strong>FTSE</strong> GLOBAL MARKETS • JULY/AUGUST 2005 to issue a covered-bond without specific legislative backing), Ireland, and in March 2005, Italy’s first Jumbo covered-bond – albeit one sponsored by the state rather than a private bank. The ranks of Jumbo covered-bonds are expected to be further swelled by issues from Sweden, Norway and perhaps Portugal, all which could make their debut later this year, and, at a later date, Finland, Poland and Hungary.“The coveredbond markets have expanded into almost all the European countries, but although legislation has been implemented, covered-bonds have not actually been issued in all areas,” says Christof Juetten, executive director, responsible for covered-bond Origination at Goldman Sachs International. For the time being the big three markets of Germany, Spain and France, collectively account for about 90% of all Jumbo covered-bond issuance. That high-rollers club may have to expand in the coming years, says Juetten.“We expect to see most growth from Italy. It is the last, large European economy which has yet to introduce covered-bonds on a significant scale.” Doomsayers had predicted that European-wide issuance of Jumbos would lead to thinner demand. In fact the opposite has occurred. Investors in new issuing countries have more than met their own domestic demand and begun to search in other markets. MEMBER INSTITUTIONS OF THE ASSOCIATION OF GERMAN MORTGAGE BANKS AHBR Berlin Hyp Deutsche Hypo Deutsche Schiffsbank Dexia Hypothekenbank DG HYP Düsseldorfer Hypothekenbank Essen Hyp Eurohypo HSH Nordbank Hypo Hypo Real Estate Bank Hypo Real Estate Holding HypoVereinsbank Karstadt Hypothekenbank MünchenerHyp SEB Hyp Warburg Hyp WL-BANK Württemberger Hypo Wüstenrot Hypothekenbank 55
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