vdp anticipates stable year on Pfandbrief market – Pfandbriefe attract new issuers and investors

  •  vdp Chief Executive Jens Tolckmitt hails Pfandbriefe as a strategically important refinancing instrument for a growing number of banks and as a safe haven for investors
  •  Stable growth in Pfandbrief sales forecast in current year
  •  vdp believes recent regulatory measures recognise quality and security of Pfandbriefe and focuses on new regulatory challenges

Against a background of continued uncertainty on the capital markets, the Pfandbrief is increasingly establishing itself among German banks as an indispensable element of the refinancing mix. Last year, the number of Pfandbrief issuers rose by another five to reach 72. In fact, the number has risen by nearly a quarter over the last four years. The Association of German Pfandbrief Banks (vdp) expects even more banks to issue Pfandbriefe over the course of this and the next few years. “According to our observations, enthusiasm for Pfandbriefe continues to grow among both domestic and international banks. Particularly given the lessons learned during the financial crisis, the reliability and attractive conditions that characterise Pfandbriefe are making them a strategically important refinancing instrument for a growing number of banks representing all the different banking groups and all size categories,” notes the Association’s Chief Executive Jens Tolckmitt.

At an international level, too, the clear trend towards further expansion of secured refinancing based on the Pfandbrief model remains firmly in place. Over recent years, numerous countries have introduced new laws on covered bonds. The legislative process is currently underway in the US, Canada and South Korea, while laws on covered bonds are being drafted in Brazil, Singapore and Morocco. “More and more issuers are choosing to emulate the underlying principle of the Pfandbrief – secured refinancing backed by stringent legislation,” observes Tolckmitt. “Even so, given that the transparency and quality of German Pfandbriefe are recognised all over the world, I believe they will further consolidate their status as a qualitative benchmark in the global covered bond market.”

Pfandbrief asserts leadership role in covered bond market

The Pfandbrief’s leadership of the covered bond market is clear, not least from the sheer number of large-volume issues and the attractive yields offered by Pfandbriefe compared to other covered bonds. In the large-volume category, there were 22 benchmark and three Jumbo Pfandbrief issues in 2012, while yield premiums fell significantly over the course of the year. For the first time since the financial crisis, we even saw the re-emergence of benchmark issues with refinancing terms below the swap curve. The sheer number of large-volume transactions was unmatched on other covered bond markets. “Especially at times of uncertainty on the capital markets and in the current low-interest environment, Pfandbriefe are particularly attractive as a safe haven for investors looking for a crisis-proof alternative to government bonds that nevertheless offers an attractive yield premium,” explains Tolckmitt.

Mortgage Pfandbriefe continue to attract growing share of total Pfandbrief sales

Despite these generally positive developments, the total volume of Pfandbriefe issued in 2012 actually fell from EUR 72.8 billion to EUR 56.5 billion, mainly due to the two large-scale ECB tenders, which significantly affected demand from the banks for other refinancing instruments, and a continued structural decline in the issue volume of Public Pfandbriefe that began some years ago and gathered pace in 2012. Gross sales of Public Pfandbriefe stood at EUR 14.3 billion compared to EUR 31 billion in the previous year. This trend reflects the decision by many Pfandbrief banks to withdraw from public sector financing in the wake of new regulation that has made this area of business much less attractive for those banks. At the end of 2012, as a result of high maturities not being replaced, the volume of Public Pfandbriefe outstanding fell from EUR 355.7 billion to EUR 301.1 billion.

By contrast, despite the challenging market environment, sales of Mortgage Pfandbriefe remained stable, with just a small overall decline from EUR 40.9 billion in the previous year to EUR 38.5 billion in 2012. The volume of Mortgage Pfandbriefe in circulation also fell slightly by EUR 7.7 billion to EUR 216 billion due to higher maturities. Despite the shipping crisis, the volume of Ship Pfandbrief issues rose from EUR 0.9 billion to EUR 3.2 billion in 2012 due to non-recurring bank-specific factors. The volume of Ship Pfandbriefe in circulation ended the year at EUR 7.3 billion, up from EUR 6.6 billion in the previous year. 2012 also saw the first issue of an Aircraft Pfandbrief totalling EUR 0.5 billion – three years after their introduction as a fourth category of Pfandbrief.

According to the vdp’s Chief Executive, “The accelerated decline in Public Pfandbriefe and the fact that sales of Mortgage Pfandbriefe remain very solid indicate a continued structural shift in favour of Mortgage Pfandbriefe. In the medium to long term, it is likely that this will become the dominant category. Overall, in the context of widespread uncertainty on the capital markets, the two ECB tenders and the long-term structural changes in the lending business of Pfandbrief banks caused by regulation, the level of Pfandbrief sales achieved over the last year should be seen as a decent result.”

Real estate financing again dominates new business for Pfandbrief banks

In addition to the factors mentioned above, the decline in Pfandbrief sales was also due to weaker lending by many Pfandbrief banks in response to increased capital adequacy requirements and sluggish demand from clients. This situation underlines the clear link between Pfandbriefe and the real economy. Last year, banks involved in real estate financing approved new loans totalling EUR 92.5 billion, a moderate decline of just 4 percent in the light of regulatory changes. At 74.4 percent (2011: 70 percent), real estate financing still makes up the lion’s share of new business for Pfandbrief banks. By contrast, public sector financing was again marked by the process of consolidation that began some years ago, primarily on account of the eurozone debt crisis and the measures adopted by the banking industry to strengthen balance sheets. New loan approvals in this area declined by 17.7 percent from EUR 29.4 billion in 2011 to EUR 24.2 billion in 2012.

“Given the challenging market conditions and changes in the operating environment, I think the new business situation as a whole was satisfactory in 2012,” argues Jens Tolckmitt. “New loan approvals were again at a very positive level. That shows the Pfandbrief banks are meeting their economic responsibilities to clients as a reliable source of financing – even in these difficult times.”

vdp anticipates solid market performance and stable Pfandbrief sales in 2013

Over the current year, the vdp anticipates a buoyant level of new business in the residential property market through a combination of consistently strong demand and historically low interest rates. The Association takes the view that there is no sign of overheating in the German residential property market. Price movements are still in line with fundamental market conditions. In 2012, residential property prices only rose substantially in relatively few areas as a result of particularly favourable demographic and economic data.

New approvals of commercial property loans in 2013 are expected to remain on a par with the previous year, both on the domestic and international markets. The vdp anticipates stable demand in Germany, while the trend towards regional differentiation may well continue elsewhere, with banks adopting an even stronger focus on those markets that remain unaffected or at least largely unscathed by the real estate crises of recent years.

The public sector financing business will again be dominated by regulatory changes in the year ahead. At the same time, the ongoing structural adaptation of business models to the new framework will again lead to a decline in volumes. We are likely to see a continuation of the tense market in ship financing both this year and next, although globalisation and increasing world trade mean that the long-term prospects for this particular area of business should be good. New business in the field of aircraft financing is expected to remain at the same level as 2012. Here, too, the medium- and long-term outlook is positive on account of growth in the international aviation industry.

Reflecting these solid trends in the lending business, the Pfandbrief banks expect Pfandbrief sales to remain stable this year, with spreads also remaining low. The forecast for gross sales lies in the region of EUR 60 billion. As in 2012, Mortgage Pfandbriefe should again account for over two-thirds of the total volume. The vdp believes that the total volume of Pfandbriefe in circulation will fall below EUR 500 billion at the end of the current year due to high maturities.

 “To summarise, the overall sentiment among Pfandbrief banks is optimistic,” believes Tolckmitt. Despite changes in the regulatory framework, the outlook for Pfandbriefe is good. Furthermore, there is unlikely to be any change in their strategic importance to issuers and their appeal to investors over the current year and beyond.”

Asset encumbrance – the new regulatory challenge

The vdp believes that the most important regulatory initiatives launched in recent years properly acknowledge the high level of stability offered by covered bonds. By way of example, Basel III and CRD IV have secured the preferential status of Pfandbriefe. On the one hand, Pfandbriefe are given preferential treatment in terms of risk weighting; at the same time, they are regarded as qualifying assets as part of the future liquidity buffer stipulated for banks. The new regulatory regime for insurers (Solvency II) also takes account of the specific characteristics of the Pfandbrief by stipulating a preferential weighting for AAA- and AA-rated Pfandbriefe. Pfandbriefe may also benefit from an exemption to the EU crisis management directive (EU bank recovery and resolution directive), which envisages a so-called “bail-in” of creditors in the event that a bank is threatened with collapse. Under the proposals, secured liabilities such as the Pfandbrief would be exempted.

 “In the regulatory initiatives discussed so far, the regulators have acknowledged the quality and security that are specifically offered by the Pfandbrief, the only method of refinancing that has consistently worked and continued to offer attractive terms on capital markets shaken by the financial crisis. Why? Because investors trust the legal mechanisms that protect these securities. So far, we have been able to maintain the preferential treatment of Pfandbriefe under the new system of regulation, and we are confident that that will remain the case,” explains Tolckmitt.

The vdp’s main focus is now on a forthcoming set of new regulatory initiatives, above all the current debate about asset encumbrance, i.e. the allocation of a bank’s assets to specified creditors (as in the case of Pfandbriefe with their cover pools). In light of the greater importance now attached to secured bank refinancing, some policymakers have expressed concern that in case of insolvency there might not be enough free assets to service unsecured creditors and especially private investors. Some have called for a limit on the issue of Pfandbriefe to ensure they do not exceed a stipulated percentage of the bank’s total balance sheet assets. The vdp believes this is misguided. Given the many non-transparent forms of asset encumbrance, any such limit would not provide the crucial easing required. Viewed in isolation, Pfandbrief creditors are not in direct competition with investors. That is equally true of universal banks (where Pfandbriefe only account for a small part of total refinancing when measured against total balance sheet assets) and specialist Pfandbrief banks.  Furthermore, a ceiling on Pfandbrief issues would cut banks off from a source of refinancing that has proven the most crisis-resilient in recent years.

“This narrow focus on Pfandbriefe and covered bonds with regard to asset encumbrance falls short of what is required. The issue of asset encumbrance needs to be examined as a whole rather than in terms of individual asset classes. The first priority is to put together a clear overall picture for all forms of asset encumbrance by establishing a level of transparency comparable to that of the Pfandbrief. If we are going to specify ceilings at all, they should apply to the total volume of asset encumbrance, not just to the Pfandbrief,” maintains Tolckmitt.

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