The Upside Down World of Covered Bonds

Berlin Hyp office building Budepester strasse
Berlin Hyp issued the first negative yield covered bonds.
  • Why it matters

    Why it matters

    Issuing new covered bonds is easier thanks to demand created by ECB bond buying. But banks worry private investors will be driven away.

  • Facts


    • On average, 64 percent of all Pfandbriefe, or covered bonds, being traded have negative yields.
    • The European Central Bank is a pillar of demand for covered bonds. On average it purchases €10 billion of covered bonds per month.
    • Last year German banks issued €58 billion worth of covered bonds, an increase of 27.5 percent from the year earlier.
  • Audio


  • Pdf

There was a time when private investors regarded covered bonds as an attractive alternative to government bonds, but that was long ago.

In the current environment of rock-bottom interest rates, many covered bonds, known as Pfandbriefe in Germany, are in negative-yield territory, making them of little use as a direct investment.

That hasn’t stopped them from being in tremendous demand. Many private investors remain indirect holders of the bonds because asset managers and insurance companies continue to invest in them. And then there’s the European Central Bank, which has been buying up as much as €10 billion per month since last year as part of its massive quantitative easing program.

“As long as covered bonds offer a little more yield than German government bonds, they remain attractive for institutional investors,” explained Jens Tolckmitt, managing director of the VDP Association of German Pfandbrief Banks.

Investors who hold on to negative-yield bonds until they mature take a loss. But that’s not killing demand for them.

Pfandbriefe are issued by banks, but they’re safer than ordinary bonds because they’re covered by mortgages or public-sector loans. They were introduced in 1769 under Prussian King Frederick the Great to provide cash-strapped landowners with credit after the Seven Years’ War. In their 250-year history, not one has defaulted.

Because they’re so low-risk, this type of covered bond is emulated by many countries and traditionally offers lower yields than conventional bank bonds. These days, many offer no yield at all.

In fact, 64 percent of all covered bonds being traded have negative yields, according to NordLB analyst Matthias Melms, based on volumes in iboxx cash bond indices compiled by financial information services company Markit.

Covered bonds with maturities of five to seven years on average yield 0.05 percent. For seven- to 10-year bonds, it’s 0.28 percent on average. By comparison, German government bonds up to nine years are yielding below zero.

Investors who hold on to negative-yield bonds until they mature take a loss. But that’s not killing demand for them.

Indeed, the German mortgage bank Berlin Hyp AG last month managed to place the first benchmark negative-yielding covered bond. The maturity was three years and, despite yielding minus 0.163 percent, the bond was three times oversubscribed.

Mr. Melms said he was certain that more banks will issue covered bonds with negative yields.

The European Central Bank is an important driver of demand. It’s buying €80 billion, or $91.3 billion, of bonds every month as part of its quantitative easing program. The aim is to boost lending, stoke euro zone growth and get inflation back up to near 2 percent.

The bank’s monthly purchases include €10 billion worth of Pfandbriefe and other covered bonds on average.

“The ECB is promoting covered bond sales as an additional big investor,” said Mr. Tolckmitt of the VDP association.

That’s reflected in issue volumes. For the first time since the financial crisis, the volume of newly-placed covered bonds rose again in 2015. Last year German banks issued €58 billion worth of these types of bonds, an increase of 27.5 percent from the year earlier.

But Pfandbrief banks aren’t all happy about the ECB’s bond buying.

“The covered bond market worked without the ECB and doesn’t need support through purchases by the central bank,” said Jan Bettink, chief executive of Berlin Hyp and president of the VDP group.

Issuers are in a quandary, he said. Placing new covered bonds is easier thanks to demand from the ECB, but the banks want to keep other investors in the hunt as well.

The danger is that smaller institutional investors might withdraw from that market. Mr. Bettink said he believed investors were losing faith in the effectiveness of the ECB’s measures.

Even Larry Fink, chief executive of Blackrock, the world’s largest asset management company, shares Germany’s mounting angst over negative interest rates. He said efforts by central banks in Europe and Japan to boost economic growth with low interest rates could prove counterproductive.

“Their actions are severely punishing the world’s savers and creating incentives to reach for yield, pushing investors into less liquid asset classes and increased levels of risk, with potentially dangerous financial and economic consequences,” Mr. Fink wrote in a letter to shareholders published Monday.

“Not nearly enough attention has been paid to the toll these low rates — and now negative rates — are taking on the ability of investors to save and plan for the future,” he wrote. “People need to invest more today to achieve their desired annual retirement income in the future.”

Mr. Fink provided the example of a 35­-year­-old trying to generate $48,000 per year in retirement income beginning at age 65. He would need to invest $178,000 today at 5 percent interest. In a 2 percent interest rate environment, he would need to invest over three times as much to get the same pension.

That factor could thwart the central banks’ attempts to stimulate growth, Mr. Fink argued.

“Consumers saving for retirement need to reduce spending if they are going to reach their retirement income goals, and retirees with lower incomes will need to cut consumption as well. A monetary policy intended to spark growth, then, in fact, risks reducing consumer spending,” he wrote.

Mr. Fink has been warning of a pensions crisis for years and has urged investors to set aside more savings. Of course, that would be good for Blackrock, which manages $4.6 trillion worldwide.

Lloyd Blankfein, the head of Goldman Sachs, is more optimistic.

“We don’t see how a world of zero or negative interest rates could possibly be the ‘new normal,’” he wrote to shareholders last week. He added that “we find ourselves generally optimistic about the longer term.”

And Mr. Tolckmitt, managing director of the VDP association, is also less concerned.

“The ECB is impacting the market, but covered bonds remain popular among other investors as a safe investment,” he said. “(Investors) who might not be so active today will come back when interest rate levels return to normal.”


Andrea Cünnen is a finance reporter based in Frankfurt. To contact the author:




We hope you enjoyed this article

Make sure to sign up for our free newsletters too!