Rolling the Dice

ECB’s Bond-Buying Spree Might Backfire

Covered Bonds
German government bonds, called bunds, used to be the go-to investment for many international and domestic investors. But no longer.
  • Why it matters

    Why it matters

    • Buying covered bonds is a central plank of the ECB’s plan to increase lending and prevent the euro zone economy from falling back into recession.
  • Facts


    • The ECB plans to buy as much as €600 billion in covered bonds in an attempt to increase bank lending.
    • Demand for covered bonds already outstrips supply, investors say.
    • The ECB’s covered bond buying is part of a wider plan to expand its balance sheet by as much as €1 trillion.
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In Germany’s finance industry, the covered bond, or “Pfandbrief,” has an almost sacred aura. No wonder, because the principle of covered bonds goes back about 245 years.

Internationally, there are over €2.6 trillion ($3.3 trillion) covered bonds outstanding – €1.5 trillion of those from banks in the euro zone, especially from Germany, France and Spain.

“Covered” bonds involve creating pools of bank loans – mortgages or company loans – that can be sold on to investors but still remain on the balance sheet of the issuing bank. The fact that banks still have a stake in the loans makes them more secure.

These securities came under pressure during the 2008 financial crisis, but the market is now back in full swing. A covered bond has never failed, demand is great and interest payments are low. Banks can now refinance themselves via secured bonds more favorably than ever before. For bonds secured by mortgages, German banks pay interest averaging only 0.5 percent and for Spanish bonds just 1.3 percent.

All the more reason for the financial world to wonder why the European Central Bank is about to launch a program to buy these covered bonds – a program set to last for at least two years.

“The demand for covered bonds already exceeds supply. When the ECB joins the party, they will all be stepping on each other’s toes.”

Ralf Burmeister, Fund manager, Deutsche Asset and Wealth Managent

The plan is a bid by the monetary authorities – who indisputably have done a great deal to keep the euro zone afloat in the past few years – to increase the still low availability of credit in the economy, especially for small and mid-sized companies on the continent.

Covered bonds are the third plank of a massive ECB plan that also includes buying up asset-backed securities – uncovered bonds – as well as lending cheap money directly to banks. Whether it’ll work is another matter.

“We do not see how the ECB can boost demand for loans with its purchasing program,” said Frank Will, an analyst at HSBC. Florian Eichert of Crédit Agricole said: “Even more cheap liquidity is still a long way away from more credit being made available.”

The European Covered Bond Council, the ECBC, the lobby for covered bonds, was more optimistic. “Property markets are a decisive factor in supporting the real economy,” said General Secretary Luca Bertalot. For that reason, the measure could aid the euro zone’s economic recovery if it increases the supply of mortgages.


Bonds Running Low-01


But even Mr. Bertalot saw a danger. He feared the European monetary authorities could drive private purchasers of covered bonds out of the market. Two-thirds of the more than 100 European investors and banks surveyed by Crédit Agricole also feared this crowding-out effect.

“The demand for covered bonds already exceeds supply,” said Ralf Burmeister, fund manager at the Deutsche Bank subsidiary Deutsche Asset and Wealth Management. “When the ECB joins the purchasing party in a big way, they will all be stepping on each other’s toes.”

The reason for the great demand is not just the security that covered bonds offer, but also because banks have to put only a small amount of capital aside to backstop covered bonds when they purchase them.

While demand remains high, the supply of covered bonds is decreasing — especially because banks, under pressure from regulators, have to reduce their balance sheets. That’s why financial institutions worldwide issued fewer covered bonds last year than the number that matured.

The scope of the ECB’s plan remains unclear. The central bank’s vice president, Vítor Constâncio, has mentioned a maximum figure of €600 billion for covered bond purchases. Mr. Eichert estimated the ECB would make purchases worth about €80 billion in the next 24 months.

That could further reduce yields on the bond market, and investors don’t like that at all. Low interest rates have been a concern for investors for some time, said Daniel Rauch of Union Investment.

The ECB is aware of the problems. “We want to maintain a functioning covered bond market with an intact investor base,” ECB General Director Ulrich Bindseil told industry magazine The Cover. The ECB has to give the market time and is hoping that more covered bonds will be issued in the end.

Investors such as Mr. Burmeister remain unconvinced.

”On the one hand, the ECB wants to increase the size of its balance sheet considerably, and on the other it wants to keep the structure of the covered bond market intact,” Mr. Burmeister said. “That does not go together.”


The author is a correspondent with Handelsblatt in Frankfurt. To contact the author:

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