The first-class credit quality is one of the main reasons why domestic and international investors choose Pfandbriefe. Pfandbriefe afford investors a degree of safety comparable only to that offered by a number of sovereign issuers.

Special legal framework is the foundation of the Pfandbrief’s safety

The first-class 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 to be met by 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 specialist bank principle was abolished and the Pfandbrief Act entered into force, any institution may now issue Pfandbriefe provided it has core capital of at least EUR 25 million and fulfills the requirements of the Pfandbriaf Act with regard to the management, monitoring and control of risks.

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.

Cover principle

Pfandbrief Banks are required to keep a statutory overcollateralization of at least 2% of the volume of Pfandbriefe outstanding in their cover pools on a net present value basis. Moreover, Pfandbriefe are covered at all times by loans equal at least to the nominal value of all issues outstanding.

Separate cover pools

Mortgage loans, public-sector lendings, ship mortgages and aircraft mortgages, which are funded through Pfandbriefe are kept in 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.

Pfandbrief investors’ claims are satisfied as planned out of the cover pool in keeping with the respective issue terms. To guarantee this, the competent court at the seat of the Pfandbrief bank appoints a cover pool administrator, whose responsibility it is to continue managing the cover pools and to coordinate the due servicing of the outstanding Pfandbrief issues with regard to 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 interest payment and principal redemption claims cannot be satisfied punctually because a cover pool is insolvent, special insolvency proceedings are 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 has never been an insolvent institution or an insolvent cover pool.

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

The Pfandbrief Act provides for further protective measures. 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.

Further risks addressed

Besides the credit risk, the interest rate and exchange rate risk as well as the liquidity risk are also addressed. Thus, Pfandbrief banks must, within the scope of determining the net present value, conduct weekly stress tests that involve the simulation of drastic interest rate and exchange rate changes. Moreover, the liquidity need of the next 180 days must be covered at all times.

Credit quality of the Pfandbrief acknowledged throughout the EU

The especially high level of safety of Pfandbrief investments has also been acknowledged 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. 52 IV UCITS Directive)

  • Capital Requirement Directive, according to which a preferential risk weight may be applied

  • Preferential Treatment of Pfandbriefe within the scope of the European Central Bank’s monetary policy operations.

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