Pfandbrief banks well equipped to handle COVID 19 crisis after a successful 2019

Following a successful 2019 financial year, German Pfandbrief banks are currently focusing on working hand-in-hand with their customers to get to grips with the impact of the COVID 19 crisis.

“Pfandbrief banks are keen to seek pragmatic solutions in individual cases and to ensure a stable supply of credit for the economy. At the same time, efforts are focusing on safeguarding banks’ own liquidity and ability to act”,

explained Dr Louis Hagen, President of the Association of German Pfandbrief Banks (vdp), at the vdp’s annual press conference. Pfandbrief banks are still willing to provide financing in general and are also making a key contribution to ensuring that the government support measures take effect quickly. Yet again, the Pfandbrief is proving to be an anchor of stability in turbulent times and a reliable source of funding for its issuers.

The COVID 19 pandemic is expected to have a considerable impact on all areas of the economy, according to Hagen. It is not yet possible to arrive at any serious estimate regarding the scale of the impact on those sectors that are particularly relevant for Pfandbrief banks, and in particular the real estate markets. Hagen is confident about what the future holds for the Pfandbrief, which celebrated its 250th anniversary in 2019:

“The Pfandbrief has always proved to be stable and crisis-proof in the past and will stand the test in this crisis, too.”

Impact of the COVID 19 crisis

Pfandbrief market is in good working order

With their specific business, real estate financing banks are showing themselves to be robust even in the face of the COVID 19 crisis. “Despite the increase in debt service deferrals, the current liquidity situation at institutions will remain adequate in the short and medium term. What is more, the Pfandbrief can also be used to obtain long-term liquidity at any time”, said Hagen. “The Pfandbrief market is, and will remain, in good working order for its issuers.”

Impact on real estate market and financing remains unclear

There is palpable uncertainty regarding the direct and indirect implications of the COVID 19 crisis on the real estate markets. The vdp believes that the income and wealth effects that the crisis will have on households and investors alike could well put a damper on demand for real estate. In addition, the economic viability of real estate projects is likely to be examined more closely in future. While signs of a drop in prices are yet to emerge, they cannot be ruled out going forward.

Rental losses and debt service deferrals are having a negative impact on banks that finance real estate. In the commercial real estate financing segment, new business is currently being generated primarily via business that had already been initiated before the crisis broke out, although genuine new business is still being generated on a selective basis. New business in private real estate financing is currently being concluded at a somewhat lower level.

Need for further regulatory relief for the banking sector

While Pfandbrief banks generally see the crisis management measures launched by policymakers and regulators to date in a positive light, there are concerns surrounding the effect that individual measures will have on institutions’ existing business. The COVID 19 crisis is an exceptional situation which, as the Pfandbrief banks see it, now calls for further regulatory relief to allow banks to fulfil their economic function. For example, the vdp welcomes the three-month deferral of consumer loans, but strongly advocates that loans should not be interest-free during the deferral period. In addition, the Association is firmly opposed to prolonging the deferral period and extending the possibility of deferral to companies.

The European Central Bank (ECB) also has an important role to play as a source of liquidity for the institutions, which, like national central banks in the euro area, should now further reduce collateral requirements in order to give European credit institutions easier access to ECB liquidity.

Development in Pfandbrief business in 2019

Mortgage Pfandbrief’s share of total outstanding volume increases again

Pfandbriefe with a volume of EUR 55.0 billion were issued in 2019, up by 9.1% year-on-year (2018: EUR 50.4 billion). At EUR 42.0 billion (2018: EUR 43.2 billion), Mortgage Pfandbriefe remain the most important Pfandbrief category by far, followed by Public Pfandbriefe at EUR 11.2 billion (2018: EUR 7.2 billion) and Ship Pfandbriefe at EUR 1.8 billion (2018: EUR 0.0). With a total of 46 benchmark issues, the high level witnessed in the previous year was maintained (2018: 46). This means that the German Pfandbrief market remains the European leader.

The increasing importance of the Mortgage Pfandbrief is reflected in the development in the volume of Pfandbriefe outstanding: At EUR 239.6 billion (2018: EUR 233.7 billion), the volume of Mortgage Pfandbriefe outstanding rose again last year, bringing their share of total Pfandbriefe outstanding up to 65.8% (2018: 63.3%). Due to a further drop in the volume of Public Pfandbriefe, the volume of Pfandbriefe outstanding in 2019 dipped slightly to EUR 364.1 billion in total (2018: EUR 369.1 billion).

Development in real estate financing business in 2019

Real estate financing business benefits from positive overall conditions

The positive economic development continued in 2019. This was a trend that benefited the real estate industry, which was also favoured by the ongoing low interest rate environment. These overall conditions also had a positive impact on real estate financing business: vdp member banks granted real estate loans worth

EUR 167.1 billion last year, almost exactly on a par with the previous year’s result (2018: EUR 167.4 billion). The two asset classes showed distinctly uneven development: whereas new commercial real estate financing business declined by 5.8% to EUR 69.3 billion (2018: EUR 73.6 billion), Pfandbrief banks upped their commitments for residential real estate financing by 4.3% to EUR 97.8 billion (2018 EUR 93.8 billion).

The lower level of new business in commercial real estate loans is largely attributable to slower development in the retail real estate segment. This segment’s financing volume was down by 25.4% in a year-on-year comparison to EUR 15.0 billion (2018: EUR 20.0 billion). By contrast, Pfandbrief banks, which make up the most important provider group for the financing of commercial real estate in Germany with a market share of 55.2%, increased their exposure to two real estate categories in particular: by 5.9% to EUR 38.7 billion for office real estate (2018: EUR 36.6 billion) and by 19.9% to EUR 2.2 billion for industrial buildings (2018: EUR 1.9 billion). The increase in loan commitments for office properties also increased these properties’ share of the total commercial loan volume significantly again to 56% in 2019 (2018: 50%).

Real estate loan portfolio 4.9% larger

The increase in residential real estate financing was driven by positive development in all property categories. New financing business for single-family and two-family houses, for example, increased by 2.1% to EUR 48.1 billion (2018: EUR 47.2 billion), with an increase of 6.2% to EUR 20.2 billion for condominiums (2018: EUR 19.0 billion), 6.0% to EUR 26.5 billion for multi-family houses (2018: EUR 25.0 billion) and 13.6% to EUR 3.0 billion for other residential buildings (2018: EUR 2.6 billion).

The real estate loan portfolio of vdp member banks increased to EUR 877.8 billion in 2019 (2018: EUR 836.5 billion). Both residential and commercial real estate financing contributed to the increase of 4.9% or EUR 41.3 billion, with growth rates of 5.1% and 4.7% respectively.

Current regulatory issues

Basel III: vdp welcomes postponement and continues to call for adjustments to the output floor

Regulatory priorities are currently shifting in response to the COVID 19 pandemic, both in terms of timing and with regard to content. During and after the crisis, the top priority first of all has to be financing the real economy – all other projects have to be systematically reviewed in light of, and brought into line with, this objective. As a result, the vdp welcomes both the recent announcement regarding the postponement of Basel III implementation by one year, and indications that the European Commission plans to take another look at individual, particularly adverse elements of Basel III, such as the output floor, in light of the COVID 19 pandemic.

“If the European Commission quite rightly takes the view that supplying credit to real economy has to remain the top priority even after the COVID 19 pandemic has subsided, then any sort of regulatory intervention that achieves precisely the opposite is out of the question”, explained vdp Chief Executive Jens Tolckmitt.

Official EBA calculations show that the implementation of Basel III would lead to a drastic increase in capital requirements for European, and especially German, banks.

This would put a disproportionately hefty burden on institutions, particularly for the low-risk business of providers of real estate financing. Tolckmitt stressed that the resulting higher cost of credit and shortage of credit supply cannot be what regulators are aiming for, and nor can a shift in traditional banking business to less regulated areas of the financial industry.

“As it stands at the moment, Basel III is the very opposite of the sort of risk-sensitive regulation with a sense of proportion that we are calling for.”

Irrespective of any COVID 19-related adjustments, Pfandbrief banks will continue to push for appropriate implementation, especially with regard to the particularly challenging output floor, in order to take account of the special features and stability of the German real estate market. The EBA’s recommended over-fulfilment of the Basel III requirements (“gold plating”) would represent an unjustified tightening of capital requirements in all scenarios, which would inevitably weaken the European banking market, explained Tolckmitt.

He added that the output floor would push the price of credit up considerably, creating false incentives, such as a willingness to enter into higher risks, the removal of financing arrangements from the balance sheet (“off-balance”) and even the abandonment of the proven, bank-based financing model in Europe.

“We do not want to see an Americanisation of European financing culture”,

warned Tolckmitt. As a result, when it comes to implementing the output floor, the vdp advocates the approach referred to by the EBA as the “parallel stacks approach”, which is compatible with the Basel requirements while keeping the burden on real estate financing providers at a tolerable level. The vdp enjoys the support of the entire German banking industry and European banking associations in its efforts. At government level, the French National Assembly and the French Ministry of Finance, the Danish Ministry of Finance, the Danish Ministry of Industry, Business and Financial Affairs, and the Danish parliament have already signalled their support for the “parallel stacks approach”. A legal opinion published by Banque de France also confirms the compatibility of the approach with the Basel Capital Accord.

Amendment of the German Pfandbrief Act: vdp providing close support

The vdp explicitly welcomes moves to harmonise covered bonds at European level which were adopted at the end of 2019 and came into force at the beginning of 2020. The package of legislation adopted by the European Parliament and the European Council responds to the vdp’s call to ensure the regulatory privilege that covered bonds enjoy and to provide sufficient scope for preserving and enhancing tried-and-tested, successful national products such as the Pfandbrief. The fact that the European covered bond regulations are modelled strongly on the German Pfandbrief Act (Pfandbriefgesetz) is another welcome development. National legislators now have until July 2021 to transpose the European regulations into national law. In Germany, this will entail an amendment of the Pfandbrief Act. The vdp is committed to ensuring that this process involves appropriate application of the European regulations, i.e. that the German regulations do not extend beyond these requirements.

Sustainable finance: “We cannot allow excessive regulation to prevent banks from financing the real economy at this time”

Another regulatory project that is currently having a considerable impact on the work of Pfandbrief banks comes in the form of the planned “sustainable finance” measures. The political agreement reached at European level by the European

Commission, the Council and the European Parliament on the Taxonomy Regulation, and the proposals put forward by the Technical Expert Group on Sustainable Finance set up by the European Commission will increase transparency and provide the definition, called for by many market participants, of what can be referred to as “green” in terms of climate protection and moves to adapt to climate change. At the same time, however, the proposals for technical criteria, in particular, are extremely complex, meaning that their viability in practice has not yet been demonstrated. Pfandbrief banks, by contrast, have already been making a contribution to climate protection and limiting global warming for years now with the Green Pfandbrief.

“Pfandbrief banks are ready to continue to drive the process of transformation to a climate-friendly, resource-efficient and sustainable economy”,

explained Tolckmitt. As with other regulatory projects, the aim with sustainable finance, too, is to ensure that existing market momentum is not slowed down by excessive regulation. The vdp is also making urgent calls for consolidation of the various sustainability initiatives in order to ensure their market success. Tolckmitt concluded by emphasising:

“But for the time being, the immediate crisis response has to be at the very top of the agenda: we cannot allow excessive regulation to prevent banks from financing the real economy.”

vdp membership development

vdp welcomes first international member institution

The vdp currently has 49 member institutions representing a total market share of just under 97% of total outstanding Pfandbriefe. The most recent new members are Bausparkasse Mainz, Alte Leipziger Bauspar AG and HYPO TIROL BANK AG, the first member bank to be headquartered outside of Germany.