Historically cheap Pfandbrief funding on the back of ECB policies has led to a significant widening of the spread between German mortgage cover pool assets and liabilities in recent years, according to Fitch – although an analyst underlined how retail savings have been squeezed out of the equation.

Fitch said today (Friday) that the ECB’s monetary easing and covered bond purchases have seen funding costs through mortgage Pfandbriefe reach historic lows, while the yield on the mortgage portfolios has fallen less. It said that mortgage programmes that have experienced a sustained increase in their net interest position are less reliant on overcollateralisation to achieve a given rating.

The rating agency said it assessed the impact on effective collateralisation levels in Pfandbrief programmes based on the present value of the spread between assets and liabilities accruing over the life of the programme.

“The benefit of this spread can be measured by discounting cover assets’ and covered bonds’ future cashflows, and comparing the discounted and nominal values, assuming no overcollateralisation,” it said. “This is expressed as the ratio of assets, net of overcollateralisation, to total covered bonds.

“As Pfandbriefe funding costs dropped faster than interest earned on mortgage cover assets, the present value of this spread increased.”

Across Fitch-rated mortgage programmes, the average benefit to collateralisation reached the equivalent of 2.8% of liabilities at the end of 2015, up from a low of around zero in 2012.

Average spread between present value of assets and liabilities in German Pfandbrief programmes

Source: Association of German Pfandbrief Banks, Fitch

However, the spread between assets and liabilities tightened in the first half of 2016, and Fitch believes the current high level is not sustainable.

“With the redemption of high-yielding assets and further margin pressure for new loans origination, the average net present value effect will reduce, but is likely to remain positive if funding costs stay low,” the rating agency said. “This may reverse some of the benefit to breakeven overcollateralisation in the medium to long term.”

Fitch noted that public sector Pfandbrief programmes have not benefitted from the development of funding costs and lending margins in the same way as mortgage programmes, since average funding costs from their older outstanding Pfandbriefe remain relatively high compared with the average income of cover assets. Indeed, the average overcollateralisation benefit it found has turned negative (see chart).

More-active Pfandbrief issuers have benefitted the most from the medium term development, with favourable funding conditions resulting in a lower cashflow valuation component in breakeven overcollateralisation for three out of the six Fitch-rated German mortgage programmes in its most recent reviews. This has not occurred in the remaining three programmes it rates due to low recent funding activity, high-yielding legacy covered bonds or lower-yielding assets.

While Pfandbriefe have thence gained from the ECB’s policies, they may have lost the support of a class of investors as a result of the plunge in yields, an analyst reiterated today.

Bernd Volk, head of covered bond and SSA research at Deutsche Bank, said the fall in Pfandbrief yields without direct substantial participation from retail investors is a sign of the ECB having a distorting impact on the covered bond market.

“From 1954 to 1961, Deutsche Investitionsbank – back then, the bank of the government of the German Democratic Republic – issued mortgage Pfandbriefe,” said Volk. “The mortgage Pfandbriefe were issued to natural persons to invest retail savings with the proceeds being used for the development of housing.

“While the environment is of course currently not at all comparable to Pfandbriefe, Pfandbriefe were also until recently an investment tool for retail savers.”

However, Volk said that with Pfandbriefe now trading at or close to historically tight spreads, and by far most of them at negative yields, directly purchasing Pfandbriefe makes little sense anymore for retail investors who have access 0% or even low positive yielding cash accounts and term savings.

“In our view, covered bonds have traditionally been used as an instrument to allocate retail savings directly to housing finance,” he added. “Due to the current ECB policy, this mechanism seems partly impaired.”