Section 2 - FTSE

Covered bonds have underlined their importance and stabilising role in mortgage financing in
Europe to such an extent that the authorities in the United States are seeking to introduce a set of
guidelines designed to replicate the high quality of this quintessentially European instrument. In
part because of the safe-haven reputation of covered bonds it appeared for most of 2007 and early
2008 to have successfully withstood the credit crisis. However, partly because the availability of
executable prices for bonds on screens highlighted their vulnerability, and partly because the fixed
bid/ask spreads in covered bonds started to become far smaller than the bid/ask spreads in any
comparable markets (most significantly perhaps in the swaps and agency markets) the contagion
that affected other credit markets began to impinge on Europe’s covered bonds. Questions are still
extant as to the true nature of covered bonds: either as a ratings or a credit product. Whatever the
ultimate outcome of that debate, we asked some of the leading market makers in the covered
bond market to give us their views on the sustainability and future of this deep and diversified
market through 2009 and beyond.
After what looked to be a protracted period of
stability, the European covered bond market hit a high
wall in the late summer/early autumn, as it began to
feel the impact of the contagion that has created
extreme volatility in the global capital markets. What
do you think were the main reasons for the relative
lateness of this dip and the intensity of the dip when
it did arrive?
DR. LOUIS HAGEN, ASSOCIATION OF GERMAN
PFANDBRIEF BANKS: Until mid-September at least the
Pfandbrief market proved exceptionally resilient to
dislocations in the capital markets in general and their
impact on the covered bond market in particular. This is
due to the solid legal foundations provided by the
Pfandbrief Act and the flawless track record of the
Pfandbrief market and its committed domestic investor
base. The different formats of Pfandbrief, i.e. bearer
instruments in traditional or Jumbo size and registered
Pfandbrief offer a wide spectrum to investors. Especially
tailor made issues and private placements were sought for
and the German investor community proved to be solid as
a rock. The suddenness of the disruption in demand clearly
had some irrational motives when Pfandbrief was taken
hostage by negative headlines that originated in the US
and in Ireland. Pfandbrief markets were shocked by two
events. First the Lehman insolvency and subsequently the
Hypo Real Estate rescue action. The bail-out of
HypoRealEstate closed the market where you may have
expected it to underpin the commitment of the entire
German financial community to protect the Pfandbrief
from harm. In the aftermath of the European rescue
packages and the creation of a new asset class – state
guaranteed senior unsecured bank bonds – the market
now is going through a period of re-pricing in order to find
levels commensurate with the new credit environment and
new competitors. But I would like to make clear that
Pfandbrief issuance is still working. Issuance levels,
however, have halved during the last two months.
TED LORD, BARCLAYS CAPITAL: Throughout the credit
crisis and liquidity problems facing many sectors of the
F T S E G L O B A L M A R K E T S • J A N U A R Y / F E B R U A R Y 2 0 0 9
capital markets, investors have maintained their faith in the
covered bond asset class. Investors still purchase covered
bonds in private placement format and in the secondary
market. Due to the liquidity problems in the secondary
market, however, some investors are seeing covered bonds
more as a credit product and not as much as a
rates/government bond surrogate product.”
CARLOS STILIANOPOULOS, CAJA MADRID: Since the
beginning of the crisis back in August 2007 investors´
appetite has been draining away gradually from the
different products in accordance with their risk perception
on the products. This is probably why investors have been
buying Covered Bonds all the way up to summer 2008,
whilst at the same time they had stopped buying other
products which they considered riskier, starting on
securitized transactions, tier II and tier I deals, and finally
senior unsecured. However, further turmoil in the markets
during the months of September and October has even
affected safer products such as Covered Bonds.
Do you think there were infrastructural weaknesses
or vulnerabilities in the make up of the trading
market, which were exacerbated by the global crisis,
such as: the availability of continuous executable
prices on bond screens?/ or the extreme narrowing of
bid/ask covered bond spreads?
TIM SKEET, MERRILL LYNCH: The recent re-pricing of the
SSA curve, though itself not helpful in the overall picture of
the capital markets evolution has at least served to bring a
measure of consistency to the performance of all the asset
classes. Covered bonds have suffered but without
exception so has every part of the market
Despite the current turmoil, there is a belief that
the European covered bond model is far superior to
that in the United States. Is this wishful thinking,
or is there real substance behind the claim.
Moreover, if it is true, in a post crisis market is it
feasible for Europeans to export their expertise to
the US and Asia?
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