Since the subprime virus began to spread, the markets for Mortgage Backed Securities (MBS) have dried up und the markups investors demand for unsecured bank bonds have increased. This has also made access to capital more difficult or considerably more costly for German financial institutions.

However, the situation facing the Pfandbrief issuers differs substantially from that of other banks in that, thanks to the Pfandbrief, the former have capital market access at favorable conditions at all times. This is because the Pfandbrief’s special level of safety and high market penetration make it a safe haven for investors, even when times get rough.

Pfandbrief shores up banks’ liquidity

The credit history of Pfandbriefe is impeccable. Not one case of Pfandbrief default has been recorded since the Mortgage Bank Act, the predecessor of the Pfandbrief Act, entered into force over 100 years ago. Because the Pfandbrief’s credit quality is recognized at home and abroad, issuers are also able to raise liquidity in more difficult times; not so with Mortgage Backed Securities. The Pfandbrief market as a “market of last resort” mobilizes liquidity in situations in which it is otherwise not available, or available only at appreciably less favorable conditions.

In addition to the benchmark issues of EUR one billion upwards (Jumbo Pfandbriefe), Pfandbrief banks issue large volumes of traditional bearer and registered Pfandbriefe, which are in constant and high demand from investors. This is due to the deep-rooted and long-standing tradition the Pfandbrief has among its buyers, which include insurers, banks as well as pension and investment funds, on the German market. Alone in the months August to December 2007 – after the subprime crisis flared up – the Pfandbrief banks raised a total of EUR 50 bn on the market with traditional bearer and registered Pfandbriefe. Including Jumbo issues and add-ons, the aggregate amount came to EUR 58 bn.

It is remarkable that during this period, funding costs barely rose compared with the first seven months of the year 2007. Pfandbriefe continued to trade 10 basis points below Euribor as the mean for all maturities, whereas securitizations and a number of foreign Pfandbrief-similar products (Covered Bonds) saw spreads widen by between 40 and 80 basis points.

All this is the result of the statutory quality requirements, the Pfandbrief banks’ disciplined and investor-friendly issuing behavior as well as the unique market-making and product support provided by the issuers, which bundle their strength within one common association.

Pfandbrief Act protects investors

The Pfandbrief Act offers Pfandbrief investors a tight-knit safety net. The leitmotif of the legal framework for the issuance of Pfandbriefe is the principle of investor protection. Financial institutions must satisfy stringent requirements in order to receive a license to issue Pfandbriefe. The Mortgage, Ship and Public Pfandbriefe outstanding must be covered by mortgage, ship mortgage or public-sector loans of at least an equal amount. These cover assets are entered into separate cover registers. In the event of an issuer’s insolvency, the claims of the Pfandbrief creditors are privileged by a preferential right in respect of the cover assets in the registers. Pfandbrief business is subject to special supervision by the Federal Financial Supervisory Authority (BaFin). In addition to the ongoing supervision on the basis of the German Banking Act, a Pfandbrief department monitors fulfillment of the provisions set down in the Pfandbrief Act. The obligation to disclose key data concerning the cover pools on a quarterly basis makes the composition of the cover pools transparent and comparable over time. The standardization as a result of the Pfandbrief Act gives the Pfandbrief market, which weighed in at approx. EUR 890 bn as at end December 2007, a depth that is exceeded only by the market for public-sector bonds.

Subprime risks ruled out by conservative credit standards

When the subprime crisis hit, holdings of residential property cover assets in the USA totaled € 200m or approx. 0.01% of all Mortgage Pfandbrief cover assets. The rigorous credit standards that apply under the Pfandbrief Act prevent inferior credit qualities from finding their way into the Pfandbrief issuers’ cover pools. With Mortgage Pfandbriefe, only 60 % of the prudently calculated mortgage lending value of financed properties is eligible as cover and refinanceable through the Pfandbrief. When there is a risk of falling prices, the issuers are required to examine whether the value of the properties and ships lent against is affected.

Where public-sector lendings are concerned, strict selection criteria ensure that the value of the cover assets remains stable on a long-term basis. In this way, only claims on public-sector debtors from the European Union, the EEA states as well as the USA, Canada, Japan and Switzerland may be included in cover, and only if the existence of state liability is beyond doubt.

Summary

Even when the credit and capital markets are in a state of general upheaval, the Pfandbrief market is open to issuers at all times. The rigorous credit standards under the Pfandbrief Act keep subprime out of Pfandbrief issuers’ cover pools.
Thanks to its legally stipulated standards of quality, its transparency and its well-developed market infrastructure, the Pfandbrief has matured to become a capital market product that is in international demand. With a volume outstanding close to EUR 900 bn, the Pfandbrief is today the benchmark of a European Covered Bond market in its own right that boasts a volume outstanding of nearly EUR 2 trillion.