Highly commended: EEPK's Luxembourg covered bond

Luxembourg-based Erste Europaische Pfandbrief- und Kommunalkreditbank (EEPK), the first bank to launch a Luxembourg public sector covered bond, has issued the country's first ever mortgage-backed transaction. "It has been five and a half years since the first public sector deal and we wanted to introduce a more international product for the mortgage-backed market, in a form that was easy to construct and manage," says Hans-Dieter Kemler, managing director of EEPK.

Termed lettres de gage hypothecaire, the EUR100 million three-year floating-rate note was priced at mid-swaps flat and is linked not to mortgage loans as in other traditional transactions, but to other European mortgage covered bonds. Exposure is to bonds issued by HypoVereinsbank (40%), Caja Madrid (20%), HypoTirol (20%) and OTP Mortgage Bank (20%), bought by EEPK between 2000 and 2002 to serve as substitute collateral for the firm's lettres de gage publique (public sector).

"We bought them in double-digit spreads in the high teens, when there was a massive spread widening in the mortgage covered bond market, and simply reallocated them in the new cover pool for the hypothecaire, which is a perfect match for those assets," says Kemler.

Every bond in the cover pool has an external rating - the triple-A ratio of the cover pool is 80% - and EEPK has additional bonds on its books that are eligible for hypothecaire products. The size of the transaction may not be all that noteworthy, but Kemler states that the deal was a cautious first step which also helps explain the lack of rating. "It would have destroyed the economics of the trade if we had applied for a public rating," he says.

Distribution was predominantly to financial institutions bought as substitute collateral for European Central Bank portfolios at a slight pick-up. However the transaction's unrated nature excluded it from many institutional portfolios and this proved problematic in placement.

Kemler says that further hypothecaire transactions will follow although he admits that this part of the business is not expected to grow as large as the bank's public sector financing.

Market volumes are expected to grow sooner rather than later, according to media sources. Dekabank and NordLB are tipped as potential issuers; the latter is aiming to build a EUR9.5bn lending business in the country by 2010. In addition, HVB's Hypo Real Estate Group is said to be looking to refinance its loans through its regional subsidiary Hypo Pfandbrief Bank International.

Issuer: Erste Europaische Pfandbrief- und Kommunalkreditbank
Date of issue: January 26, 2006
Underwriters: Commerzbank, DZ Bank, WGZ-Bank
Total size of deal: EUR100 million floating-rate notes
Cover pool: German Hypotheken Pfandbrief (40%), Spanish cedulas hypothecarias (20%), Austrian fundierte Anleihen (20%), Hungarian mortgage covered bonds (20%)
Ratings: unrated

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ANALYSTS' VERDICT

Ted Packmohr, DrKW

Analyst reaction to the transaction was mixed. Ted Packmohr, covered bond analyst at Dresdner Kleinwort Wasserstein in Frankfurt, is dubious about whether the deal provides much added value to investors. "It is an interesting structure but if I want that kind of diversified bond portfolio, it is easier to do it myself and then at least I have the liberty to change the asset allocation if required," he says.

For Frank Will, frequent borrower analyst at Royal Bank of Scotland, the problem with this particular covered bond is the risk analysis. "Eligible assets could include Pfandbriefe from strong issuers like Eurohypo or WL-Bank. However, it could theoretically also include Pfandbriefe from the troubled [German bank] AHBR making the risk analysis more complicated. Moreover, the Hungarian bonds will probably carry higher risk analysis than the other bonds in the pool," he says.

Nonetheless, Will does point to the deal's strong rating mix: "The rating quality of EEPK's pool seems good." And despite some failings within the transaction, analysts do concur on the attractions of the lettres de gage. Will expects the lettres de gage market to gain in importance this year and praises the more flexible structure of the Luxembourg legislation compared with peer covered bonds. "Legislation allows issuers for instance to include other covered bonds in the cover pool," he says.

DrKW's Packmohr concurs: "There are less quantitative limits to the collateral: assets can come from all OECD countries, giving the cover pool greater internationalisation and diversification," he says.

CREDIT SAYS... Despite issues about the deal's size, rating and placement, the opening up of a new segment in the European covered bond market is an important step. The deal even made it onto to the agenda at the European Covered Bond Council third plenary meeting in Zurich, just a few days after launch. And already, a number of other mortgage banks are lining up to follow EEPK's lead and use the lettres de gage market for refinancing.