German mortgage bank Deutsche Genossenschafts-Hypothekenbank is looking to invest €200-300 million by the end of the year in U.K. and Italian commercial mortgage-backed securities and the buy-to-let and non-conforming segments of the U.K. residential mortgage-backed market. Elke Hadenfeldt, head of DG Hyp's €2 billion in European mortgage-backed securities in Kiel, said there is better value in the secondary market and for the most part the portfolio is not looking to invest in new deals. The mortgage lender planned to invest about €500 million in the European mortgage market at the start of the year and has invested about half that amount so far.
In particular, Hadenfeldt is looking at CMBS deals launched two to three years ago. "There is better spread pick-up on more seasoned deals and in addition there is more information available on the portfolio," said Hadenfeldt. She noted the pick-up between the triple-A tranches of a primary and secondary CMBS deal is five to eight basis points, while on a single-A tranche this rose to 10bps. Currently 40% of the portfolio is in CMBS, with the remaining 60% in RMBS and a handful of non-performing loans.
The regions Hadenfeldt favors for additional investment this year and next are the U.K. and Italy. "We expect the U.K. economy to pick up and therefore think it makes sense to invest there, particularly in the retail sector, which is quite stable," she said. Hadenfeldt is looking to Italian CMBS for diversification.
Hadenfeldt favors synthetic MBS, because fewer investors are able to invest in this sector of the market and spreads are wider. By way of example, she said spreads on a recent CMBS transaction originated by a German bank on pan-European collateral offers a spread of 100-110bps on the single-As, versus 90bps offered on the comparable tranche of Morgan Stanley's ELOC deal.
The areas she finds attractive in RMBS are the buy-to-let and non-conforming mortgage sectors in the U.K. "The Kensington Mortgages, Pacific Mortgages and GM-RFC RMAC deals have all performed very well," she noted. "We have seen a bit of softness lately, but spreads are not yet wide enough," she said, specifying that the spreads on triple-As would have to widen from today's 15-16bps to 22-23bps and on single-As from 45bps to 55-60bps before she would consider buying them.
The fund is 60% invested in triple-A credits but is moving down the credit curve. "Two years ago we had good opportunities to buy triple-As, but now we are focusing on double-As and single-As," said Hadenfeldt. While DG Hyp cannot invest below single-A yet, changes to the German mortgage act due in mid-2005 should remove that restriction and she expects the fund to invest further down the credit curve.
The portfolio is not benchmarked against an index but instead has to achieve a certain return on equity for the firm. "Our alternative is to underwrite loans ourselves," noted Hadenfeldt.
