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Covered & Pfandbrief spreads over the hill

Emanuel Teuber

Emanuel Teuber

Bayrische Landesbank

Since mid-March 2024, sentiment on the covered bond markets has turned and compared to the start of the year, the iBoxx Euro Covered is now trading at 31 bp, 2 bp below the start of the year and 7 bp below the highs in March. The German sub-index is still around 5 bp higher than at the beginning of the year. This is due to the fact that the cover pools of German Pfandbriefe also include commercial property loans and the correction in this segment has not yet been completed.

The good performance of covered bonds since March is primarily due to two factors. Firstly, the increased absolute yields of covered bonds have also prompted non-benchmark-driven investors such as insurance companies to get involved again and thus fill the gap left by the ECB. Covered bond yields measured by the iBoxx EUR Covered are now averaging 3.28% with a duration of 4.4 and thus in a range that helps even German life insurance companies to service their liabilities with guaranteed interest (on average, the current interest rate for existing contracts is around 2.7%). However, asset managers have also increased their investments and not only reinvested maturities, but also put fresh money into this asset class. The return of these investors has ensured well-filled order books, including for issues from outside the eurozone, whose pick-up was particularly attractive for investors not investing for LCR reasons. The second reason is the declining issue volumes, as this year, with the exception of January and March, there was less supply on the market than in the previous year.
German Pfandbriefe continue to offer an attractive pick-up over Bunds. Although Pfandbrief yields have fallen by around 14 bp compared to Bunds since the beginning of the year, driven by the falling Bund swap spreads, this has not been to the same extent as the Bund swap spreads. The main reason for this is the comparatively weaker spread performance of German Pfandbriefe due to the commercial real estate assets in the cover pools. The pick-up is therefore still comfortably higher than the long-term average. If the uncertainty surrounding commercial property decreases, which we expect in the medium term, the pick-up could actually decline further.