A successful year for Pfandbrief banks in a challenging market environment

Berlin/Frankfurt, 25 April 2022

  • A further significant rise in Pfandbrief sales and volume in circulation
  • New business in real estate financing up by almost 10%
  • Banking regulation limits institutions’ future lending capacity
  • Specific consequences of the war in Ukraine are currently impossible to predict

The institutions belonging to the Association of German Pfandbrief Banks (vdp) can look back on a successful financial year in 2021. Despite continually facing the COVID-19 pandemic, the institutions recorded significant growth in both Pfandbrief and real estate financing business.

“In a challenging market environment, the Pfandbrief banks performed well in 2021. They continued to meet high demand for real estate financing and at the same time acted in a risk-oriented manner. Via the Pfandbrief, they were able to refinance at attractive conditions at all times,” said vdp President Dr. Louis Hagen at the Association’s annual press conference today. “So far, the Pfandbrief banks have coped well with the effects of the COVID-19 pandemic. However, Russia’s war of aggression against Ukraine now poses an even greater challenge for the global political and economic situation, on a scale which cannot yet be foreseen.”

Direct consequences of the war in Ukraine for Pfandbrief banks and the German real estate market are not yet discernible. “Pfandbrief spreads have been stable since the beginning of the war,” said Hagen. “Russia and Ukraine are not target countries for Pfandbrief banks in real estate and public-sector financing business.” He explained that this is due, among other things, to the fact that financing secured by real estate in Russia or Ukraine is not Pfandbrief-eligible.

Any second and third-round effects from the war cannot currently be predicted, Hagen stressed. Given the massive increase in uncertainty on all markets and the already significantly downgraded growth forecasts, 2022 will be a challenging year for the entire economy – and thus also for the financial sector. However, there are no signs of market turbulence at the present time.

•    Development of Pfandbrief business in 2021

“The Pfandbrief is seen as a safe haven”

Having widened slightly for a brief period at the start of the COVID-19 pandemic in March 2020, Pfandbrief spreads quickly returned to their pre-crisis level and tightened still further during the course of 2021.

“During times of uncertainty in particular, the Pfandbrief demonstrates its quality as a competitive source of funding and is seen as a safe haven,” said Hagen. Whether it is the financial crisis, the euro crisis, the COVID-19 crisis or now the war in Ukraine: “The Pfandbrief has shown itself to be resilient through all crises and has consistently met with high investor demand.”

Pfandbriefe with a volume of EUR 64.7 billion were issued in 2021, up by 8.2% year-on-year (2020: EUR 59.8 billion). With a share of 71.7% or a volume of EUR 46.4 billion, Mortgage Pfandbriefe continued to account for the majority of issuing activities. Their volume increased by 14.0% year-on-year (2020: EUR 40.7 billion). On the other hand, Public Pfandbriefe, with an issuance volume of EUR 18.3 billion, did not quite reach the previous year’s level (2020: EUR 19.1 billion), but achieved the second-highest volume since 2011.

Mortgage Pfandbriefe in circulation reach record level

The volume of Pfandbriefe in circulation increased by 5.2% year-on-year to reach EUR 391.4 billion at the end of 2021 (2020: EUR 371.9 billion), thereby consolidating the upward trend that was already apparent in the previous year. With a volume in circulation of EUR 266.1 billion, at the end of 2021 Mortgage Pfandbriefe reached the highest volume outstanding ever recorded (2020: EUR 248.5 billion). For the second time in a row, the volume of Public Pfandbriefe outstanding also increased, reaching EUR 125.3 billion (2020: EUR 123.4 billion).

The Green Pfandbrief also delivered a very encouraging performance, with new issues amounting to EUR 2.8 billion in 2021 – almost three times the previous year’s figure (2020: EUR 1.0 billion). As a result, the volume in circulation also increased, reaching EUR 8.0 billion (2020: EUR 5.2 billion). The number of Green Pfandbrief issuers doubled to six in 2021.

“As the importance of ESG continues to grow, we expect further issuers and further significant growth in Green Pfandbriefe in the coming years,” Hagen said.

•    Development of real estate financing business in 2021

Significant expansion of loan commitments and loan portfolio

Pfandbrief banks once again reaffirmed their position as the main providers of real estate finance in Germany in 2021, committing EUR 175.0 billion in loans, up 9.5% on the previous year (2020: EUR 159.8 billion). Residential property financing accounted for a volume of EUR 118.5 billion, an increase of 11.2% on the previous year (2020: EUR 106.6 billion). Commercial property financing rose by 6.1% to EUR 56.5 billion (2020: EUR 53.2 billion). Office properties were once again by far the most dominant property class: they alone accounted for commitments of EUR 31.7 billion (2020: EUR 29.5 billion), followed at a considerable distance by retail buildings at EUR 13.1 billion (2020: EUR 13.0 billion).

The Pfandbrief banks’ real estate loan portfolios also expanded in 2021. After growth of 5.9%, the aggregate volume of their portfolios came to EUR 947.5 billion (2020: EUR 894.4 billion). The increases in new business and in the loan portfolio were the result of consistently high demand for property, which in turn had an impact on property prices.

Property prices continued to rise in 2021

The rise in property prices that has been ongoing for years continued last year, with the vdp property price index reaching a new high of 187.4 points at the end of 2021. As a result, property prices in Germany were up by 8.4% year-on-year in the final quarter of 2021, with residential property prices again increasing significantly (10.7%). Commercial property prices showed a slight increase of 0.3% after four quarters for the first time since the end of 2020.

From today’s perspective, the vdp expects property prices to continue rising in the coming years, albeit at a slower pace. An ongoing tight situation on many rental housing markets as well as continuing surplus demand on the investment market will ensure further price increases. Higher building costs are also making property more expensive, Hagen explained. On the other hand, the gradual rise in interest rates and the consequent reduction in affordability of residential property are having an inhibiting effect on demand for real estate. How prices develop in the future also depends on how long the war in Ukraine lasts, whether it will intensify or expand regionally, and how the sanctions imposed will be handled once hostilities have ceased, Hagen said. Stagflation or even recession would certainly put pressure on the commercial property market. In contrast, a noticeable impact on the residential property market would only be expected in the event of a massive rise in unemployment.

•    Current regulatory issues

Basel III:

“It is absurd that Basel III will mainly put pressure on low-risk business”

The Pfandbrief banks have mixed views on the European Commission’s legislative proposal for implementation of the Basel III reform published in autumn 2021. First, they are glad that the European Commission now recognises that residential real estate finance needs to be treated differently and that the implementation date should be deferred until 2025. Second, they welcome the fact that the European Commission’s draft proposal evidently seeks to provide effective reliefs in certain areas compared with the EBA’s economically harmful proposals for maximum implementation.

From the vdp’s point of view, however, it is not at all clear why the different treatment of residential property should apply only temporarily and why the envisaged relief completely ignores commercial property. “Residential property financing, especially for properties with low LTVs, is a low-risk business – not just for a limited period, but over the long term. The same is true of commercial property loans with low LTVs, which are just as low-risk as residential property financing,” explained vdp Chief Executive Jens Tolckmitt, adding that: “In the further legislative process, we will work to ensure that the burdens on real estate financing providers are noticeably reduced. It is absurd that Basel III will mainly put pressure on low-risk business such as real estate finance.”

The legislative proposal needs further improvement

During the current negotiations in the European Council and the European Parliament and the trilogue negotiations that will begin thereafter, the vdp will push for improvements to the legislative proposal and warn against over-fulfilment of the Basel requirements.

“The increase in capital requirements for credit institutions will be significantly higher than was recently forecast by the European Commission,” Tolckmitt fears. Most of this increase, he said, is due to the so-called output floor, which prevents a risk-sensitive capital adequacy framework. “Basel III is yet another example of how credit institutions are driven by regulation towards higher risks, and incentives are created to shift business into less strictly regulated areas,” said Tolckmitt.

Macro-prudential instruments:

“Capital buffers limit lending by credit institutions”

The vdp considers the capital buffers recently activated by the Federal Financial Supervisory Authority (BaFin), namely the countercyclical capital buffer of 0.75% and the sectoral systemic risk buffer for loans secured by residential property of 2.0%, to be counter-productive in the current phase. According to Bundesbank calculations, both buffers will increase the need for Common Equity Tier 1 capital by a total of EUR 22 billion.

“The capital buffers place a dual burden on residential property loans and limit future lending by credit institutions,” Tolckmitt noted.  

Nor does he understand the timing of the activation of the capital buffers.

“Currently there is no sign of any development in the German residential property market that would justify such severe measures by BaFin,”

Tolckmitt emphasised, referring to the results of a study presented at the end of 2021, which the vdp has been conducting on a regular basis for the last 30 years. According to the study, the banks’ lending standards continued to be risk-oriented. The share of borrowed funds in financing has decreased recently to an average of 80%. The percentage of loan-servicing costs relative to the acquiring household’s disposable income – the debt service ratio – has fallen over the past two years from 26% to 25%. Furthermore, high average initial repayments of 3%, which considerably shorten the loan term, and fixed-interest periods, which have now reached 14 to 15 years, have had a risk-mitigating effect.

vdp argues for a reassessment of capital buffers

The vdp also criticises the fact that the capital buffers only affect the banking industry. Other market participants are not affected by the measures. Against this background, in the highly competitive finance market the buffers are unlikely to dampen the residential property market.

“Like the Basel III reform, the capital buffers will also shift financing business to areas of the finance sector that are subject to different or less regulation. This is not conducive to financial stability,” Tolckmitt emphasised.

“Regulatory measures such as the implementation of Basel III and the activation of capital buffers make it harder for credit institutions to fulfil their core task of providing adequate credit to the economy,”

he remarked. Especially at the present time, the capacity of institutions is very important: both the politically desirable environmental and digital transformation of the economy and the federal government’s housing offensive require massive investments in the coming years, and the corresponding funds must inevitably be provided to a very large extent by the banking industry. Credit institutions also have a key role to play in supporting the real economy, which continues to feel the effects of the COVID-19 pandemic and now has to deal with additional hardships in the wake of the Ukraine war. Not least against this background, the vdp suggests a reassessment of the capital buffers:

“We call upon BaFin to look again at suspending the activated capital buffers and thus avoid limiting institutions’ lending capacity still further.”

Sustainable finance:

vdp supports institutions in proving taxonomy compliance

At the annual press conference, Tolckmitt pointed out that Pfandbrief banks have been incorporating green and social criteria into their business strategies for many years – long before politicians and supervisory authorities discovered this topic. The establishment of minimum standards for Green and Social Pfandbriefe, which serve as a guide for issuers and investors, is a direct consequence of these early activities in the field of sustainable finance, he said.

The recently presented benchmarking system, which helps lending credit institutions to prove compliance with the EU taxonomy in real estate financing, is equally helpful. Specifically, benchmarks are defined to determine whether existing buildings fulfil the ‘top 15%’ criterion, whereby they are considered to comply with the EU taxonomy if they are in the top 15% of the building stock in terms of primary energy demand. The vdp commissioned the consulting firm Drees & Sommer to determine which criteria properties have to meet in order to make a significant contribution to achieving the environmental goal of climate protection. Criteria have been defined for single and multi-family houses and for commercial and logistics properties.

“By defining benchmarks, we are giving credit institutions an important tool to facilitate their property financing business,” said Tolckmitt.

Given the level of complexity now reached by the EU taxonomy and sustainability regulation as a whole, he called for a sense of proportion in the regulation of sustainable finance, saying that the now considerable bureaucratic burden on credit institutions must be reduced. Especially with the planned expansion of the taxonomy to include social and brown criteria, he believes it is important to learn the right lessons from previous experience with the green taxonomy.

“Excessive sustainability regulation is unhelpful,” said Tolckmitt.