Property prices: Pfandbrief banks see no risk to financial stability

  • Renewed growth for Pfandbrief banks’ new business in property finance, though momentum slackens considerably
  • vdp President Dr. Louis Hagen: “Despite strong demand and rising prices in the property market, lenders and borrowers continue to put safety first”
  • Pfandbrief remains important part of the funding mix

From the perspective of the Association of German Pfandbrief Banks (vdp), the ongoing price upsurge in the German housing market does not currently pose any risk to financial stability. “Even though exaggerations are certainly visible in individual sub-markets, there is no threat of disruptions in the banking sector. Neither among borrowers nor among the lending banks are there any signs of a systematic build-up of risk propensity,” said Dr. Louis Hagen, President of the vdp and Chairman of the Board of Management at Münchener Hypothekenbank.

According to data provided by analysts at vdpResearch, prices in the German real estate market most recently rose unabated both for residential properties and for commercial properties. However, strong regional differences in the extent of the rise are to be observed, depending on the socio-economic attractiveness of the respective location. In the housing market, demand continues at present to be driven not only by the low interest rates but also by the positive demographic development, the persistent trend towards urbanization, employment growth and rising incomes. Particularly in metropolitan regions and attractive university towns, where the numbers of inhabitants and households advanced most strongly of late, this demand contrasts, however, with a very limited supply in the market for existing properties. Building permits and construction backlogs give rise to expectations of strong growth in new construction activity; but the delays in production typical for the construction sector and high capacity utilization levels will only ease this situation with a time lag. For this reason, given the prevailing market dynamics, further rent and price increases have to be expected in the short term, although they should gradually weaken somewhat.

No loosening of credit standards

Current developments are unlikely to harbor any unusual risks for banks provided lending practices stay safety-oriented. All in all, there is currently no discernible loosening of credit standards by the lending banks. Rather, the share of borrowed funds, for example, has hardly changed over time in relation to the purchase prices of the properties serving as collateral. Nor are borrowers taking on any significantly higher risks. As interest rates have fallen in the past few years, so borrowers have made use of the resulting financing advantages to secure longer interest lock-in periods and make higher initial repayments. “Lenders and borrowers alike continue to put safety first,” said Dr. Louis Hagen. “Above and beyond that, long-term financing at a fixed interest rate, which is common practice in Germany, ought to give private and institutional investors sufficient planning security to enable them to manage these risks adequately.”

Property finance remains on growth path

The current buoyancy of the real estate market is also reflected in the figures of the Pfandbrief banks. New mortgage commitments dominated last year; they accounted for four-fifths of new lending and advanced from €131.3 bn the previous year to €139.4 bn. This is equivalent to a year-on-year increase of 6.1 per cent. Following an increase of around 18 per cent in 2015, growth in new commitment activity therefore lost some momentum in 2016. Residential property finance accounted for €71.7 bn of new commitments (+6 per cent). New commitments in commercial property finance rose to € 67.7 bn (+ 6.2 per cent).

In public-sector lending, on the other hand, the consolidation trend already observed in previous years continued: in 2016, new loan commitments dropped by 13.2 per cent to €15.5 bn. On balance, Pfandbrief banks’ new commitment activity rose by 2.3 per cent to €167.8 bn last year

Pfandbrief an important component of the funding mix

Over one-third of existing properties accounted for by the German Pfandbrief banks are held in cover. “The stable performance of the Pfandbrief makes it the unrivalled benchmark in the European covered bond universe and an important funding instrument for banks where long-term financing is concerned,” said Dr. Louis Hagen. “At the same time, the policy of the European Central Bank continues to have a considerable impact on the covered bond market, for example through TLTRO II and, above all, the covered bond purchase program. It is not yet clear what the process of a possible exit will look like, but it is crucial that investors and issuers receive relevant signals as early on as possible.”

Issuance activity consolidating

After a pronounced expansion of issuance volume in the previous year, Pfandbrief sales consolidated in 2016. The volume of newly issued Pfandbriefe contracted from €58.1 bn to €45.4 bn. Of that total, Mortgage Pfandbriefe accounted for more than two-thirds at €35.1 (2015: 40.4) bn. The business of public-sector lending continues to lose ground in the current economic and regulative setting. Sales of Public Pfandbriefe receded from €15.5 bn in 2015 to €10.3 bn. Ship and Aircraft Pfandbriefe continue to play only a very small role in the prevailing market situation.

As at December 31, 2016, the total outstanding volume of Pfandbriefe stood at €373.8 bn (down from €384.4 bn in 2015). This is due, in particular, to the ongoing decline of the Public Pfandbrief.

Regulation remains an important topic for Pfandbrief banks

Specialized institutions like the Pfandbrief banks remain exposed to considerable regulatory pressure in the current market and competitive environment. The revision by the Basel Committee of capital requirements for credit risk remains an important issue for banks. The negotiations have yet to produce a result, and the biggest obstacle is still the introduction of an output floor which, in the vdp’s view, would have the effect of disproportionately raising capital requirements in real estate finance.

A second topic of great relevance for the Pfandbrief and its issuers concerns the Euro-pean Commission’s goal of achieving a greater harmonization of the national covered bond regimes of the European Union member countries. The Commission is expected to present its decision in the summer of 2017. The vdp approves of these efforts in principle, as harmonization can further boost investors’ perception of the asset class as a whole. Additionally, the high, uniform quality standards that this would produce would be a vital foundation for the permanent preferential regulatory treatment of what have proven themselves to be the most crisis-resistant covered bonds in international financial market regulation.

Observe the principle of subsidiarity

However, the proposals submitted to the European Commission by the European Banking Authority (EBA) at the end of last year overshoot the mark – in some cases considerably – in the vdp’s view. The Association believes that some of the proposals are so heavy on detail that they present the danger of over-regulation and, consequently, of weakening the Pfandbrief. Thus, the vdp continues to advocate a principles-based approach to harmonization, making the technical design the responsibility of the national legislators.

“Interventions in existing, successful markets must only be made by taking a measured approach. It has to be ensured that successful covered bond regimes like the German Pfandbrief Act are given sufficient leeway so that national practices that have proven their worth over decades are preserved. It would be unfortunate for all concerned if the project were to fail due to excessive ambition,” said Jens Tolckmitt, Chief Executive of the vdp.