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10 | ifr special report | December 2008 PFANDBRIEFE ROUNDTABLE

Engelhard : It's already reflected in the numbers. Compare the vdp data on the cover assets of mortgage and public sector Pfandbriefe: we have experienced a drop in mortgage sector cover assets in Pfandbriefe programmes, from €682bn to €640bn – a drop of more than €40bn. Yet on the mortgage side we have seen a increase from €214bn to €218bn – a slight increase of €4bn.

So mortgage Pfandbriefe has already gained in importance. It could gain more importance when the Pfandbriefe law is amended, when it gets easier to put mortgage assets into the cover pool of a Pfandbriefe from an operational point of view.

Pimper : But the shrinking market in the public cover pool was more foreseeable with the loss of state guarantees. What we are facing now in the market is a trade off: public sector cover pools are faster to liquidate for investors than the mortgage cover pools. But on the other hand the business model of the public sector banks have been hit harder by the credit crisis. German Pfandbrief banks face problems arising from their pure public sector funding vehicles. So it looks like the pure business model, with its reliance on the wholesale market, does not work when there is no wholesale market between the banks.

Hagen : It's also a question of how the asset prices develop. We are already faced with higher credit costs for some public entities, public municipalities and the German Laender. It will be more expensive for them to fund themselves, but the real question will be whether the Pfandbrief banks can fund themselves more cheaply? At the moment, this seems far away. But

we have to consider the development on the assets side. In the mortgage business we are already seeing it: loan prices are increasing in the commercial mortgage market, though less so for the private sector or residential mortgage markets, where there is still a lot of competition. In the end I predict we will also see a change to that.

On the public sector side it's much more difficult to predict.

Huber : I don't think that it's so much more difficult. Of course the public sector will continue to shrink: with all of the redemptions of the state guaranteed paper

which is still in the cover pools, you will see a natural shrinking.

But we also see demand from the asset side, all the Laenders and municipalities may need to borrow more because of the recession. The tax income will be lower and there will be much more need for raising money.

Public sector cover pools are faster to liquidate

for investors than the mortgage cover pools. But on the other hand the business model of the public sector banks have been hit harder by the credit crisis.

There are fewer competitors these days. Depfa was one of the biggest players, as was Dexia. They will certainly change their business models to a certain extent. There's certainly room for improvement here, as well as on the public covered bond side. An additional point is headline risk, which will be of increasing interest to investors in the future. They will look at headline risk: which institutions use the Pfandbrief, be it mortgage Pfandbriefe or public Pfandbriefe; and what is the composition of the different collateral pools. On the mortgage side you have fantastic spread opportunities because of scarce liquidity and the fact there is not much lending going on.

On the residential side, you hardly get these kinds of margins because of the competition, specifically from the savings bank side. These institutions are certainly cash rich: a lot of investors are putting their money into savings banks at the moment, so the competition is here very big. Investors may believe residential mortgages are much better quality than commercial mortgages, but is the spread d- ifferentiation of 50bp justifiable? Such questions will continue to generate a lot of debate and a lot of research. Investors will dig much deeper into the

product they are thinking of investing in. We will see specifically, on the mortgage side, a much higher differentiation. But both products will survive. They might equal out in size, so that one day mortgage Pfandbriefe and public Pfandbriefe are more or less the same outstanding value. But going beyond that to a phase where public covered bonds are extinct is much harder to envisage.

Volk : At the moment public Pfandbriefe is a German product: the share of foreign assets might be very high for some issuers and in some pools, but overall it's 80% German exposure. If you want to avoid certain countries, for example Iceland, following all the headlines we saw coming out of there recently, that is unlikely to be a problem. Icelandic exposure in the cover pools of public Pfandbriefe is negligible. Even eastern European exposure in Pfandbrief cover pools is single digit. The issuers themselves are also very het- erogeneous. We have a few issuers that are almost purely domestic, and others that are more engaged in foreign public sector lending. So investors can focus on the type of exposure that suits them.

Engelhard : Just to be clear, I'm not talking about the possible extinction of the public sector Pfandbrief market. But I think it will be subject to this overall deleveraging process, which means we are facing an overall downsizing of the market.

IFR: Perhaps we can talk over the primary market? Who will reopen the German jumbo Pfandbriefe market next year? What issuer would it take?

Bertram : Everyone should be prepared to be first. A lot of banks will have the state as an owner, or part owner. Most of the banks issuing these kinds of products will be state owned, these days. It will be a question of who is ready first. If the market is there, everyone will be ready within five minutes. We have already seen a complete change in issuance behaviour this year. Preparing an issue over four weeks was hardly possible. Everyone had to be prepared. If some clever investment banker said there is a market for this, you simply had to go and get your €1bn or your €1.5bn. If the preparatory work was not done before then the issue would have failed anyway.

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