Hypo Real Estate — the nationalised German bank and the only one to have failed this summer’s stress tests — passed a(nother) milestone earlier this month.
It transferred assets worth a nominal €173bn to FMS Wertmanagement (FMSW) — the big bad bank set up by the German state earlier this year specifically to take on non-strategic assets and ‘risk positions’ from Hypo. The plan is for the government-guaranteed FMSW to eventually be wound down over the course of 10 years.
The support package requires European Commission approval. But even if Germany does get the go-ahead for its Hypo plans, the bank may still face an uphill battle. It’s famously reliant on capital markets for funding — especially the covered bond market via its two subsidiaries, Deutsche Pfandbriefbank and Depfa. It also has plenty of exposure to peripheral Europe — those troubled spots in Greece, Portugal and so on.
No surprise then, that the bank is looking to improve the quality of collateral in its cover pools using the bad bank scheme. Here’s Bank of America Merrill Lynch’s Sabine Winkler and Alexander Batchvarov explaining how it works:
Pfandbriefbank, DEPFA ACS Bank or Hypo Pfandbrief Bank International to the FMSW. It has, however, transferred €28bn of collateral backing public covered bonds of these banks – i.e., €5bn of the collateral of Deutsche Pfandbriefbank’s public covered bonds, €22bn of the collateral of DEPFA ACS Bank public covered bonds, and €1bn of the collateral of Hypo Pfandbriefbank International’s public covered bonds.
The cover pools backing these bonds will be reorganised and the restructuring will be conducted in three stages. First, the collateral was transferred to the FMSW. Second, in order to meet asset liability matching requirements, the transferred collateral was temporarily replaced with claims against the FMSW. Third, these claims will in subsequent weeks be replaced with assets eligible as covered bond collateral that are currently being used as collateral for central bank credit operations; the retained covered bonds will be bought back.
So it’s out with those risk positions, and in with those FMSW claims.
And the stuff being picked out of these covereds is rather interesting. For Deutsche Pfandbriefbank public covered bonds, exposure to Greek, Icelandic and erm, Canadian public sector debt– will be reduced to absolute zero.
For Depfa’s public covered bonds, exposure to Iceland and Greece is also being eliminated — along with Portugal. Exposure to UK and US will also drop some.
You can see the Pfandbriefbank collateral switch in the below Hypo chart:
So Germany’s bad bank is now the not-so-proud owner of Greek and Portuguese collateral. It is, as financial consultant Achim Dübel points out, rather ironic given that the eurozone is busy bailing out those countries with another mega-billion SPV.
Full BofAML note in the usual place.