In the public flow market over the past five years, German securitization has mostly meant auto ABS. Along with Dutch and UK mortgages, it was, for a time, one of the only asset classes European securitization buyers could get hold of in the primary market.
This was mostly because of issuer need. Unlike some other European markets, German consumers carried on borrowing money to buy cars through the crisis, and so the big car manufacturers piled up loans and leases in their financing subsidiaries to help them do so.
These loan pools were ideal securitization assets for the depths of the crisis. Short-dated, self-liquidating and German, there were investors with appetite for this risk even during the worst peripheral jitters. Because a typical auto ABS amortises down in one or two years, paying principal back every month, investors are not so reliant on secondary market liquidity — if they can’t get a bid they like, sitting and waiting still gets them cash.
This market structure is a major bugbear for issuers since the European Banking Authority decided not to class auto ABS as “highly liquid assets” for European banks. The EBA based its assessment on several liquidity metrics, including daily turnover, which auto ABS players say hurts their market. Auto ABS can be sold in size in poor market conditions, arguably making it suitable for bank liquidity buffers, even if bonds are rarely offered in ordinary conditions.
The market never had more than 30-40 buyers, but these were diverse. Opportunistic bond funds, delighted to get 100bp or more for one year triple-A risk, rubbed shoulders with bank treasuries and public sector institutions, including KfW and NRW.bank as well as the Central Bank of Latvia.
But spreads have been compressing ever since the crisis. Volkswagen, once seen as the market gold standard, now trades barely inside non-captive originators or even French deals, as it has issued large volumes, as others have held back.
“Performance of the various German auto deals is all more or less the same,” said Christopher Schumann, head of ABS trading at DZ Bank in Frankfurt. “The distinctions only come because of servicer risk, and these have been eroded. Lots of German accounts are now full on frequent issuers, so the niche issuers are finding more appetite.”
Bond funds that can look across structured finance or other credit assets have turned to peripheral securitizations or non-conforming RMBS to find some juice, though plenty of more conservative asset managers remain.
With spread compression, issuers are becoming bolder in selling down the capital structure. Longer-dated class ‘B’ tranches (which start amortising after the class ‘A’ has paid), are the most sought-after supply in German autos, with subscriptions of three times or more common. Several issuers have placed previously retained class ‘Bs’ in the secondary market, and it looks set to become market standard that they will be sold in primary.
From cars to apartments
As auto ABS has tightened, another German asset class, drastically more profitable for the arrangers, has hit the market — multifamily CMBS.
Partly thanks to legacy housing policy, and partly because of culture, vast apartment complexes, particularly in the former East Germany, house millions of Germans.
These were snapped up by private equity firms and real estate investors in the early 2000s as local authorities sold them off, based on the hope that the long-term rental culture of Germany would be replaced by a more Anglo-Saxon leverage-based owner-occupier society. The sponsor could sit back and collect the rents, but also expect capital appreciation if Germans caught house-buying fever.
Naturally the new private equity owners put as much leverage against the portfolios as possible, often in CMBS form, raising refinancing fears during the crisis. But as banks have started to lend again, the sponsors have returned to the securitization market to refinance.
First out of the door was Vitus, with Florentia CMBS — a €754m agency trade managed by Deutsche Bank, and refinancing the pre-crisis CMBS Centaurus (Eclipse 2005-3). But with the whole top of the capital stack placed to JP Morgan, the bonds are rarely seen in the market, and even at the time, the economics looked doubtful — the blended funding cost was 300bp.
The first true public trade in multifamily was Taurus 2013 (GMF 1), a deal which refinanced the WOBA portfolio in Dresden.
This book is owned by Gagfah, which in turn is owned by Fortress Investments, and was previously securitized in Lehman’s Windermere IX and Deutsche Bank’s Deco 14. Rather than being an agency deal, as Florentia was, it was wholly underwritten by arranger Bank of America Merrill Lynch, and reputedly netted the US bank €50m, with a blended CMBS margin of around 140bp and loan margin 100bps wider. HSBC was joint lead and provided the liquidity line for the deal.
Martin Migliara, head of EMEA mortgages at the US bank, described it as a landmark transaction, and said: “Initially German multi-family is probably best suited to securitization, but I think we’ll also see single property or single loan CMBS in the near future.”
The senior notes, which were priced at 105bp, are now trading at around 82bp.
Other deals followed, buoyed by abundant market appetite, and cash from the (mostly non-securitized) refinancing of the largest European CMBS ever structured, Deutsche Annington’s €5.4bn GRAND.
Investors argued that these German deals offered an excellent alternative to the poor supply on offer in other European securitization markets. German residential risk (in CMBS format) helped substitute for thin supply in UK and Dutch RMBS through 2013.
Toxic legacy
Legacy deals in Germany, however, continue to struggle. Enormous volumes of German commercial property, often in less desirable regional locations, had been bundled into pre-crisis conduit deals. Germany was the largest European CMBS market other than the UK before the crisis, and collateral tended to be assets which weren’t suitable for inclusion in Pfandbriefe — large loans or high LTVs, many of which have not been paid on time. Furthermore, if a loan is not paid, it can be hard for lenders to collect their security.
“The German enforcement regime, while not as time-consuming and cumbersome as that of some of its European neighbours, is nevertheless not an instant a solution as its English law equivalent,” wrote the law firm Mayer Brown in 2011.
From 2012, the law was changed to improve creditor rights. Stefan Sax of Clifford Chance in Frankfurt says: “The changes are an important development in promoting Germany as a place where complex restructurings can be achieved.”
However, this legal change has not yet flowed through to loan performance — figures from Fitch show nearly 70% of German CMBS loans in the deals it rates have missed their bullet repayments, while around 40% are in standstill (less than 10% fully paid at maturity).
Worse still than German CMBS performance has been the performance of mezzanine CLOs. These were securitizations of mezzanine loans to mid-cap corporates. The loans from an economic point of view were close to being equity — some are even called “profit participations”, but benefitted from tax treatment as though they were debt. Unsurprisingly given the high embedded leverage, lots of these deals are now looking ugly.
From Capital Efficiency Group’s Preps shelf, the largest programme in the market, one deal is short €78m, another €55m (with €12.8m late), and a third €61m, according to Fitch. Preps 2007-1 reached scheduled maturity in March this year, at which point Fitch lowered its recovery estimate on the most senior ‘A1’ notes from 70% to zero.
Where next?
In autos and in apartments, the German securitization market could not get much healthier. The market is open, and all it needs is more issuers. The German RMBS market, never large, is almost certain not to return, with Pfandbriefe funding costs easily outpacing anything securitization could offer.
Across other asset classes, SME securitizations are attracting most attention, buoyed by encouragement from the ECB. A trickle of deals has been issued since the crisis.
UniCredit maintained its Geldilux programme, selling notes to KfW and the European Investment Fund, while Commerzbank has placed several SME capital relief securitizations under the CoSMO shelf.
But excess liquidity in the banking system — and abundant cheap covered bond funding — will likely keep a lid on volumes.
“Everyone would like to have exposure to the German Mittelstand, but there’s not much appetite from the issuer side material for securitizations,” said Schumann. “There would definitely be interest in new German SME deals, and the authorities would like to see it.”
Domestic buyers
A final challenge for the future of German securitization will be building up the domestic buyer base. German banks have had well documented problems with securitization investments in the past, and the European securitization market remains dominated by the big UK and Dutch asset managers.
German buyers are well represented in most German auto deals, but in the recent CMBS placements they are nowhere to be seen. Taurus went 62% to UK investors, the Dutch took 11%, Nordics took 10%, and non-Europeans 9%. The rest of the book split between Swiss, German, French and Italian buyers. Forward thinking managers, including MEAG and Allianz, are putting money to work in securitization, as are plenty of asset managers, but the industry still has a long way to go in rebuilding trust among the country’s largest investors.
“The client group in Germany is more like funds or real money,” said Schumann. “Many bank treasury managers are still a bit afraid of the product, though they seem to be getting more comfortable, helped by European politicians making supportive noises.”
German securitization has had a chequered past, but official support, new asset classes and a buyer base that is slowly regaining its trust in the product means there is everything to play for.