One of the main reasons why domestic and international investors choose Pfandbriefe is their most important characteristic feature: the top-notch credit quality. Pfandbriefe afford investors a degree of safety comparable only to that offered by a number of sovereign issuers. The Pfandbrief’s high standard of safety is borne out by the ratings awarded by the main rating agencies, which have rated most Pfandbriefe Triple-A.

Special legal framework as foundation of the Pfandbrief’s safety

This top-notch credit quality is to be explained by the legal framework and the special supervision to which the Pfandbrief banks are subjected. In addition to the general provisions of the German Banking Act (KWG), which governs the operations of all German credit institutions, the Pfandbrief banks are subject to the provisions of the German Pfandbrief Act (PfandBG).

Special requirements made of Pfandbrief banks

Up to July 19, 2005, mortgage banks as the most important group of Pfandbrief issuers were bound by the specialist bank principle and were permitted to engage only in public-sector and mortgage lending activities. Since the abolition of the specialist bank principle and the entry into force of the Pfandbrief Act, any institution may now issue Pfandbriefe provided it has core capital of at least EUR 25 million and meets the requirements set forth in the PfandBG with regard to the management, monitoring and control of risks. Since in order to engage in Pfandbrief business a license is needed from the Federal Financial Supervisory Authority (BaFin), the institution must moreover submit to BaFin a business plan that convincingly states that it intends to engage in Pfandbrief business on a regular and sustained basis. Only real estate-secured mortgage loans are eligible as cover assets for Mortgage Pfandbriefe, whereby the property serving as cover must be located in an EEA state, the USA, Canada, Japan or Switzerland. A further precondition for inclusion in the mortgage cover pool is proof that the Pfandbrief bank has the necessary expertise in the respective market. For Public Pfandbriefe, loans to EU member states, the other G7 states and Switzerland as well as to their regional and local authorities qualify as cover assets. Loans granted to other European OECD states may also serve as cover.

Cover principle

Pfandbriefe are covered at all times by loans equal at least to the nominal value, calculated according to the net present value method, of all issues outstanding and yielding at least an equal interest return. In the case of Public Pfandbriefe, cover assets are loans to the public sector, whereas Mortgage Pfandbriefe are covered by loans secured by first mortgage. Moreover, Pfandbrief banks are required under the Net Present Value Directive to keep excess cover of at least 2% of the volume of Pfandbriefe outstanding in the cover pools.

Separate cover pools

Mortgage loans and public-sector lendings, which are funded through Pfandbriefe, are kept in two separate cover pools. The cover assets contained in the pools serve first to satisfy the Pfandbrief creditors, and in the event of a Pfandbrief bank’s insolvency do not participate in the insolvency proceedings. Assuming the cover pool is sound, the Pfandbrief investors’ claims are satisfied as planned out of the cover pool in keeping with the terms of the respective issue. To guarantee this, the competent court at the seat of the Pfandbrief bank appoints a cover pool monitor, whose responsibility it is to continue managing the cover pools and to coordinate the due servicing of the outstanding Pfandbrief issues in terms of interest and redemption payments. The cover pools may then be used to satisfy claims other than those of the Pfandbrief creditors only if the latter have already been satisfied in full and cover assets still exist. In the event that the claims could not be satisfied punctually in terms of interest payment and principal redemption because a cover pool is insolvent, special insolvency proceedings would be instituted in respect of the cover pool in question. However, given the stringent demands made on the quality of the cover pools, the management of risks and the high standard of transparency, even under the German Mortgage Bank Act (HBG) – the predecessor law of the Pfandbrief Act – there was never an insolvent institution or an insolvent cover pool.

Low loan-to-value ratios protect against losses in asset value

The PfandBG provides for further protective measures, particularly for holders of Mortgage Pfandbriefe. These include the limitation of the loan-to-value ratio of a mortgage serving as cover to a maximum of 60% of the prudently calculated mortgage lending value. This safety cushion offers Pfandbrief holders comfortable protection against depreciation caused by cyclical fluctuations of the market value of the assets in the cover pool. The comparatively low risk of a portfolio comprising residential and commercial property loans is reflected also in the 50 % equity weighting for mortgage loans with a loan-to-value ratio of up to 60 %.

Credit quality of the Pfandbrief acknowledged throughout the EU

The especially high level of safety of investments in Pfandbriefe has also received recognition at EU level. The strict safety requirements made of Pfandbriefe have found their way into many EU regulations. These include regulations concerning the investment policy of investment companies (Art. 22 IV UCITS Directive), the Solvency Ratio Directive, according to which a preferential risk weighting of 10% may be applied, and also with regard to the depositing of Pfandbriefe by commercial banks as Tier 1 collateral for the monetary policy operations of the European Central Bank. The ECB also accepts unrated Pfandbriefe as collateral for open market transactions. And within the scope of the Capital Requirements Directive (CRD), too, there are signs that the capital backing requirements under Basel II may be reduced.