Introduction to Pfandbriefe: Secure Investment in German Bonds

What Is Pfandbriefe?

Pfandbriefe are covered bonds issued by German mortgage banks, secured by long-term assets, and considered some of the safest investment options in the German private debt market. These bonds have a long history of reliability, with no defaults over 200 years, and are backed by assets like mortgages and public sector loans. The singular term is "pfandbrief."

Investors find them attractive because they combine safety with relatively high yields compared to sovereign bonds. We'll explore the different types of Pfandbriefe, including mortgage and ship-backed bonds, and detail the regulatory framework that governs them. Find out who can issue them, and why they stand out as a secure investment vehicle.

How Pfandbriefe Work in the German Debt Market

A pfandbrief is a type of covered bond. A covered bond is a debt security that is common in Europe. It issued by a bank or mortgage institution and collateralized against a pool of assets that, in case of default of the issuer, can cover claims at any point of time. The financial institution purchases investments that produce cash, typically mortgages or public-sector loans, puts the investments together, and issues bonds covered by the cash flowing from the investments. The institution may replace defaulted or prepaid loans with performing loans to minimize risk of the underlying assets not performing as well as expected. Since the underlying loans of a covered bond stay on the consolidated balance sheet of the financial institution issuing the bond, investors holding the bonds may still receive their scheduled interest payments from the underlying assets of the bonds as well as the principal at the bond’s maturity if the issuing bank becomes insolvent. Because of this extra layer of protection, covered bonds typically have AAA ratings.

The largest market for outstanding covered bonds worldwide is the German pfandbrief, which has never defaulted in its more than a 200-year long history. The pfandbrief, which makes up the largest segment of the German debt market, is a collateralized bond with an investment-grade rating that has a yield premium over sovereign bonds. The Pfandbriefe class of debt are similar to mortgage-backed securities (MBS) in the United States.

Who Can Issue Covered Bonds in Germany?

Entities that can issue covered bonds in Germany include:

• Public sector banks which have their cover assets as claims on the public sector. Lendings cover public Pfandbriefe to the federal government and the regional and municipal authorities, or by guarantees issued by these bodies.
• Private mortgage banks which have their cover pools as loans secured by real estate liens such as mortgages and land charges. Mortgage Pfandbriefe are used for the funding of property loans.
• Ship Pfandbriefe, which are secured by ship mortgages, which may be used as cover only up to the first 60 percent of the value of the ship (mortgage lending value) established by the Pfandbrief bank.
• Aircraft pfandbriefe which are secured by aircraft mortgages. This Pfandbrief can be used by financial institutions in the German market to refinance aircraft loans.

Regulatory Framework of the Pfandbrief Act

The pfandbrief is regulated by The Pfandbrief Act, which was established in 2005. The Act provides the insolvency administrator and the cover pool administrator – appointed when insolvency proceedings are initiated against a Pfandbrief bank – with a host of options to procure the liquidity needed to warrant timely payment of the Pfandbriefe. The Act also states that the valuation to be used as the basis for the establishment of the mortgage lending value must be conducted by an appraiser who is not involved in the loan decision and who must have the requisite professional experience and knowledge in order to make mortgage lending value assessments.

Understanding Jumbo Pfandbriefe and Market Liquidity

The term Jumbo Pfandbriefe are used to refer to the larger, more liquid segment of the Pfandbriefe market and must have a minimum outstanding volume of EUR 1 billion.