The 3-5Y PBB covered bonds currently trade at +ASW82-85bp (after peaking at c.95bp on 15 February) and the 5Y AARB issued in early January is just above 70bp, c.20bp wider than the issuance spread at asw+52bp, levels not seen in German Pfanbriefbank since the global financial crisis. As a result of the increased volatility in both PBB and AARB, the issuer rating of the latter entities was downgraded by S&P and Fitch to BBB- (negative outlook) and BBB (stable outlook), respectively, although the covered bond programmes are both rated by Moody’s.
- Both AARB and PBB covered bond programmes are rated by Moody’s at Aaa and Aa1, respectively, but they are not rated on an issuer level, which makes visibility difficult concerning the timing of any potential rating action on the covered bonds. The German covered bond framework is categorised as “High” in the TPI matrix and uses the baseline credit assessment (BCA) for the CR rating plus an uplift to the debt instruments of these issuers where there is a resolution regime in place. The uplift over the BCA also depends on the volume of junior bail-in cascade liabilities of the specific issuer.
- In our view, we would need to see a Moody’s counterparty risk (CR) assessment of Ba2 (and hence a BCA of Ba3 assuming a one-notch resolution uplift) to see PBB and Areal’s covered bonds downgraded below the Aa3 level. Hence and assuming the same BCA from Moody’s that the actual ratings from S&P and Fitch, AARB would have a four-notch leeway and PBB two notches to keep their covered bond ratings in the Aa range.
According to Savills, European average office vacancy rates rose by 60bp YoY to 8.4% in 4Q23, although the ratio is beginning to stabilise on a quarterly basis. With core European office vacancy rates between 2-5%, prime rents rose by an average of 4.3% in 2023; the vacancy rate in the main German hubs such as Cologne, Hamburg, Dusseldorf, Munich and Berlin is below the European average, in the 4%-6% range area. According to JLL, the vacancy rate in the top-seven hubs in Germany was 5.8% as of 4Q23, 0.3% higher than three months prior. On the positive side, and given peak weekly occupancy rates across Europe are only 10% below the pre-pandemic weekly peak, occupiers are unable to downsize to any significant extent, all things being equal. The main CRE consulting firms expect that the current vacancy rates in Germany will remain steady in the next few years, as long as Germany does not slide into a deep and sustained recession.
Over a wider perspective, the pace of supply has moderated in February after the busiest January (EUR41bn) since at least 2012. Only EUR8bn was issued to Monday February 19 due to the fact that many issuers are in their blackout periods ahead of the publication of their full-year results and, therefore, we are running around the same level as last year (but still EUR20bn ahead of the level in 2022 during the same period). The lower level of issuance in February is driven by the combination of a) earnings blackouts; b) the high issuance activity in 2024; c) displaced issuance towards the SP/SNP format due to the very strong market footing; and d) access to other currencies (GBP, CAD, CHF,…). We expect 2024 issuance to be lower than in 2023 in the same period, as loan origination continues to decline while deposits remain firm.
Issuance activity in February continues to focus on 7Y and longer covered bonds. Peripheral covered bonds remain in (very) high demand, as seen with the last two Portuguese issuances, the 6Y BPI (5.7 x oversubscribed) and the 3Y Novo banco, with the latter c.EUR5bn book being the joint largest in Euros so far YtD, with a bid-to-cover ratio of 9.8x. The average bid-to-cover YtD is c.2.5x, the highest in the last five years.
Spreads-wise, and excluding the relative value in long-tenor core covered bonds vs supras in the EU, covered bond spreads are still a compelling proposal not just for rates but also for credit investors. If the current risk-on mood continues, we see covered bond spreads tightening in line with the market, as we see the repricing that has taken place in the last 18 months as largely complete, particularly in the belly of the curve, while if at any point we have a negative change in backdrop, covered bond spreads should outperform the rest of the credit market.