As an asset-backed debt instrument with an investment-grade rating, German covered bonds seem like a great deal for investors, yet issuance has plummeted. The FT's Jonathan Eley explains why their yields are likely to remain low.
Produced by Filip Fortuna. Filmed by Rod Fitzgerald.
If you're a yield-hungry, risk-averse investor, how does this grab you? An asset-backed debt instrument with an investment-grade rating. It gives you a yield premium over sovereign bonds. You can lodge it as collateral at the European Central Bank, and there hasn't been a default, ever.
I'm describing Pfandbriefe, or German covered bonds. You might think investors would be crying out for them, yes issuances plummeted, as this chart shows. This is partly because of regulatory changes which have drastically cut the number of Pfandbriefe backed by public sector loans.
But it's also because of-- guess what-- QE. The European Central Bank's refinancing operations have provided some banks with a cheap alternative to Pfandbrierer. And the bank itself is a big buyer of the instruments.
At one stage, it's accounted for almost half of purchases. That crowded out other buyers who instead bought similar bonds from non-european issuers. The ECB is not buying as many Pfandbriefe as it was.
And the yield premium over bonds of a similar maturity has widened since 2015, as chart shows. But it is unlikely to recover much more until ECP QE winds down, or until interest rates rise.
German savers are fed up of low rates. So increasingly, they are only putting their money on short-term deposit. Rising rates will quickly feed through to these, creating a mismatch with the fixed rates on the longer-term mortgages that these deposits are funding.
Now, Moody's thinks that using Pfandbriefe might help banks reduce these discrepancies in their maturity profiles. The trouble is, rates are unlikely to rise much until 2019, and there's no sign of QE winding down yet. So yields from Pfandbriefe are likely to remain frustratingly low.