“Even though the proportion of German banks’ CRE loans to total loans is in the upper range of European economies, at 20%, when it comes to the question of whether issuers have put Pfandbriefe at risk, it’s important to point out that the relative contribution of CRE loans to total mortgage exposure in Pfandbriefe has actually reduced significantly in the past 10 years,” said Mathias Pleissner, deputy head of covered bonds. That number stands at around 37% today, compared to 47% in 2014

CRE exposure in German Pfandbriefe

Source: Scope, VDP

“Not only has CRE exposure shrunk proportionally, the mortgage collateral of German Pfandbrief banks has been relatively stable over the last decade – not indicating overly bullish underwriting,” Pleissner added.

While 60% of German CRE Pfandbrief collateral is domestic, lending to US real estate doubled to 8% by the end of 2023 over the previous 10 years. The US now ranks third after German and French CRE loans in German covered bonds. By segment, office account for a 50% share, up from 40% ten years ago.

“The focus now is on what happens with office properties,” Pleissner said. “What we are observing today for office is what shopping centres and retail experienced in the last decade – a correction of values to lower, potentially more sustainable levels. This reflects a long-term shift and a challenge to real-estate investors and lenders.”

Pfandbriefe investors are less affected as they not only benefit from the dual-recourse nature of covered bonds. In addition, Pfandbriefe benefit from very strong collateral, capped at a 60% loan-to-(lending)-value threshold. “Most importantly, lending values are assessed using prudent, through-the-cycle valuation metrics providing a strong buffer to market values when the latter are inflated,” Pleissner pointed out. At the end of 2023, the average buffer to market values in German mortgage Pfandbriefe was nearly 40% compared to less than 20% a decade ago.

“While this accurately reflects higher market values, a feature of German Pfandbriefe that was deemed a competitive disadvantage when prices rose could become an advantage today as most other European covered bond laws rely on market values,” Pleissner continued.

Download the Covered Bond Quarterly here.

Stay up to date with Scope’s ratings and research by signing up to our newsletters across credit, ESG and funds. Click here to register.