UPDATE 1-Dexia postpones covered bond on market turmoil

(Adds details, comment, background)

By Jane Baird

LONDON, Sept 2 (Reuters) - Dexia Kommunalbank Deutschland AG has postponed the sale of a 1 billion euro ($1.45 billion) covered bond after the return of market-making in the German market pushed spreads wider, bankers said.

"Due to the unfavourable market conditions, Dexia has decided to postpone," an official at one of the banks managing the sale said on Tuesday. "It was not the right time ... we did not get enough investors in the book to print a 1 billion (euro) deal."

On Monday, at the same time that the Dexia deal came to market, the Association of German Pfandbrief Banks, known as the vdp, re-introduced market-making for jumbo Pfandbriefe, which was frozen at the height of the credit crisis in March.

The effect was to push spreads wider, not tighter, because a number of dealers had been caught long in March and took advantage of the vdp move to reduce their positions, said a covered bond analyst in Frankfurt who declined to be identified.

Pfandbriefe spreads were wider by between 1 basis point on the stronger names to 6 or 7 basis points on weaker names on Tuesday, analysts and traders said, in a normally stable market with spreads in the single digits and low teens.

Another London banker, a covered bond specialist on a syndicate desk, cited spreads on a Hypo Real Estate Bank Pfandbrief maturing March 2012, which rose to around 18 basis points from around 10 basis points on July 29 when the vdp first sent a letter to the market on its plans, with about half of the jump in the past two days.

A second analyst in Frankfurt said his bank did not see that the introduction of market-making had put selling pressure on the market overall, however.

He said the Dexia Kommunalbank deal was hurt by the fact that the arm of Belgian-French financial service group Dexia DEXI.PA(DEXI.BR) had already issued close to 4 billion euros in several Pfandbriefe this year, adding that it typically does no more than one per year.

NEED FOR LIQUIDITY

The association said market participants had welcomed its market-making initiative.

"Liquidity is an essential feature of the jumbo Pfandbrief. That is why this first step toward the normalisation of interbank market-making is in the interest of investors and our member institutions," said Henning Rasche, vdp president in a statement on Monday.

Covered bonds are backed by a pool of assets that remain on the borrower's balance sheet, giving an investor a claim both on the bank and on the assets. This added security enhances their creditworthiness, usually resulting in triple-A ratings.

The Pfandbriefe market is unusual in that most trading takes place directly between market-makers, rather than through inter-dealer brokers, which tends to accentuate spread moves, said the London covered bond specialist.

Guidance on the deal had been at around 8 basis points over mid-swaps, two bankers said. That is a fair level for Dexia, but the bank had already come to market in April and May, and lines were tight for its name, said a banker on a syndicate desk in Frankfurt.

"There are no doubts about the creditworthiness of the deal, but the high volume and high frequency were not really appreciated," the second Frankfurt analyst added.

Bankers cited the sale of two covered bonds outside Germany on Tuesday at much wider spreads -- a debut 2 billion euro, two-year issue by Canadian Imperial Bank of Commerce (CM.TO) at mid-swaps plus 52 basis points and a five-year deal by Norwegian borrower SpareBank 1 Boligkreditt, with guidance at around 48bp.

Dexia could well have had an influence, the London covered bond specialist said, pointing to a five-year covered bond sale by Norwegian borrower Danske Bank in early June at a spread of mid-swaps plus 20 basis points.

"To see a public-sector Pfandbrief deal fail doesn't add confidence to the market," he added.

Dexia Kommunalbank is rated Aa2 by Moody's Investors Service and AA by Fitch Ratings. Barclays, Commerzbank, Deutsche Bank and UniCredit (HVB) were managing the sale of the five-year public-sector bond before postponement. (Additional reporting by Maya Thatcher; Editing by Quentin Bryar)