Deutsche Pfandbriefbank (pbb) is analysing the possibility of issuing structured covered bonds alongside Pfandbriefe, and a market participant said that it is just one of a few major German players that could also operate outside the country’s historic legal framework.

Pbb, which is the main covered bond issuing entity of the HRE group, has been one of the largest issuers of Germany Pfandbriefe. A market participant familiar with the discussions said that he could imagine that consideration of structured covered bonds could also make sense for the likes of Eurohypo and Landesbank Baden-Württemberg.

Pbb mentioned the plans at an event last Friday (9 September) and said that it is “analysing possibilities of structured covered bonds” in an associated presentation. The possibility was mentioned in a section on alternative funding sources, and pbb prefaced the idea by saying that “high OC requirements highlight need for alternative approaches, e.g. using non-encumbered assets”.

Highlight Towers, Munich - one of the financings pbb has participated in

According to analysts at UniCredit, Stefan Krauss, partner at Hengeler Mueller, presented a concept for an “unregulated” covered bond at pbb’s event.

“The basic idea behind ‘unregulated’ covered bonds is to set up a structure comparable to what we know from UK covered bonds, i.e. a segregation of assets in a special purpose entity in combination with a senior unsecured bond issued by a bank,” said UniCredit’s analysts. “The special purpose entity would then guarantee the timely payment of interest and principal in addition to the unsecured claim versus the bank.”

They said that although many details remained unclear, Krauss explained how this would fit with German laws and regulations to create what he said would be “quite a strong legal body”. UniCredit’s analysts said that the assets considered as having the most interesting potential for such a covered bond are: mortgage loans not included as Pfandbrief cover, corporate loans (SMEs and others), and consumer loans.

UniCredit analysts said that while the project made sense given the trend towards secured financing, questions remained over how such a product would be received, particularly by the authorities.

“The question will be whether: (i) guaranteeing an entity with a certain probability of default (which is associated with the weighted average default probability of all asset types) by assets with a lower than the weighted average probability of default leads to a funding advantage,” they said, “and (ii) whether German lawmakers and regulators who have only just voted for quite a strong bail-in clause will be happy with an increase in asset encumbrance.”

Bernd Volk, head of covered bond research at Deutsche Bank, raised similar concerns, while acknowledging the attractions of the project to pbb.

“We argue that a legislative decision for a specific covered bond (e.g. the German Pfandbrief) generally suggests that further contractually based covered bond structures are vulnerable from a legal point of view,” he said. “On the other hand, a pure wholesale funded bank like pbb does not have to deal with subordination of depositors and actually may find ways to optimise its funding structure via introducing a further covered bond format.”

Any such issuance from pbb would not, however, be without precedent, with Landesbank Berlin having launched structured covered bonds alongside Pfandbriefe.

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