Dow Jones

NEW YORK - The market in German mortgage-backed securities could surge this year as investors search for higher yields and banks seek ways to lift return on equity.

The young market has seen few deals so far, but that is about to change, say investors, ratings agencies, and analysts. One key development involves recent changes in tax treatment of private pension contributions. Those are expected to attract fresh capital, which is likely to flow into mortgage-backed securities.

In addition, European and Japanese investors are eyeing structured products, such as mortgage-backeds, as a way to pick up extra yield. And banks see them as an attractive way to sell their assets and increase return on equity.

To be sure, the fledgling German market faces challenges.

For example, although government bond issuance is stagnating, more companies are looking to raise funds in the capital markets, noted Jeorg Warncke, portfolio manager at DWS Investment GMBH in Frankfurt.

A swelling supply of corporate bonds would compete for the attention of investors, he said.

The spread product doesn't look particularly attractive at current levels, Mr. Warncke said, noting that the 10-year swap spread over comparable German government treasury bonds is only 36 basis points, down from a six-month average of 45 basis points. Nonetheless, he thinks that the extra yields that mortgage-backeds offer make the securities worth considering.

"A lot of banks are thinking about mortgage deals throughout 2000," said Jurgen Haferkorn, associate director of Duff & Phelps Credit Rating Co. in London. "It is recognized as a very effective tool to increase return on equity." His firm is rating several German mortgage-backed securities transactions, the first of which could hit the market by Jan. 31, he said.

German banking authorities provided impetus for the mortgage-backed market in 1997, when they issued regulations allowing banks to securitize their own assets. There since have been only a handful of such deals, as both investors and banks become familiar and comfortable with the new structures.

Only about a quarter of German mortgages qualify to be sold as Pfandbriefs, high quality German mortgage bonds which account for more than half of all Deutsche Mark-denominated bonds. Pfandbriefs can be issued only by approved lending institutions and are limited to first-lien mortgages with loan-to-value ratios of 60% or less.

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