It's not just since the financial crisis in 2008 that German lending banks appear sometimes obsessive about the need for stable property prices, and in particular the relationship between their permissible lendable exposure and the market value of the underlying assets - the houses themselves- over the period of the loan. After an interval of 15 years, the mechanism has recently been adjusted to take account of Germany's new housing realities.
However, the Association of German Pfandbrief Banks (VdP) is among those unhappy with the proposals to amend the Regulation on the Determination of the Mortgage Lending Value (Beleihungswertermittlungsverordnung - BelWertV), which was recently issued for consultation by the Federal Financial Supervisory Authority (BaFin), Germany's financial watchdog
“BaFin has failed to achieve its self-imposed target of adapting the BelWertV to the realities of the market,” commented VdP chief executive Jens Tolckmitt. Noting that the amendment actually achieves the exact opposite and drives a further wedge between the BelWertV and reality, he warns: “Should the rules be adopted in their current form, it would be a lost opportunity to implement an urgently needed overhaul of the property valuation process.”
The VdP is critical of the fact that many of the changes proposed by BaFin will either increase the already large amount of documentation and research required of banks when calculating mortgage lending values, or lead to even lower mortgage lending values than before. The gap between market and mortgage lending values would widen even further, while the portions of loans eligible as Pfandbrief cover assets would continue to shrink.
Under the methodology applied up to now, mortgage lending values have always had a stabilising effect on Pfandbriefe and, even in extreme market phases, such as the 2008/2009 financial crisis or the current pandemic, have been – and remain – fundamentally sound. It is therefore far from clear why so many aspects of the BelWertV now need to be tightened, especially as many of the proposed measures have one and the same outcome: a further decline in mortgage lending values. The VdP strongly rejects this approach:
“One gets the impression that the very same risk – falling property prices – is being addressed from many different angles. That cannot be right,” argues Tolckmitt.
The German banking industry, on whose behalf the VdP has assumed the technical lead in analysing the BelWertV amendment, submitted a comprehensive statement to BaFin at the end of the consultation period recently. Its main criticisms are as follows:
Criticism 1: Minimum capitalisation rates
The greatest criticism focuses on the calculation parameters, particularly minimum capitalisation rates.
“Sticking with capitalisation rates dating back to the1960s makes no sense, especially since the COVID-19 crisis – the biggest stress test the real estate sector has faced in decades – has not led to the feared slump in prices.”
The multi-year trend in real estate prices and the gap between market and mortgage lending values have remained intact during the pandemic. Today, mortgage lending values often correspond to less than 50% of market value. Also, where loans are funded using Pfandbriefe, only 60% of the mortgage lending value – in other words, only 30% of the market value – is eligible as Pfandbrief cover.
“In such a situation,” Tolckmitt points out, “it is certainly the case that the current gaps between market values and mortgage lending values – which the amendment will widen even further – are no longer justified by safety and sustainability considerations.”
Tolckmitt believes that the option of lowering minimum capitalisation rates, which BaFin initially granted only for prime real estate but is now extending to several other asset classes, leaves a lot to be desired:
“It would be entirely justifiable to reduce the basic rates for most asset classes by one percentage point each – to between 4% and 5.5%. This would still leave us nowhere near current market rates, so the safety margin would remain very adequate.”
The VdP stresses that the main reason why mortgage lending values enjoy broad acceptance is their stability in cyclical market phases, but that adjusting the minimum capitalisation rates is now justifiable:
“The long and constant rise in market values we are experiencing, which can also be explained by fundamentals, by no means indicates a peak phase in a normal real estate cycle. We are dealing with permanently changed market conditions, mainly because of the entrenched low interest rate environment. BaFin must not ignore this trend when amending the BelWertV,” Tolckmitt warns.
Criticism 2: Statistical valuation methods
The VdP is initially positive about the fact that statistical valuation methods are to be permitted, with Tolckmitt commenting:
“It's good that the BelWertV is taking account of digitalisation. It’s high time this happened. Statistical methods for calculating lending values have been standard practice for many years, especially in Scandinavian countries.” But what we do not understand is why this is limited to the small loan sector, since a considerable portion of retail business is above this limit. “Many data base-driven valuation methods are based on solid scientific foundations and vast pools of data, so should be authorised for all property types that can be standardised.”
Criticism 3: Small loan limit
The VdP welcomes in principle the increase in the small loan limit from €400,000 to €500,000. Tolckmitt notes, however, that “the new small loan limit still fails to take account of the realities in many regional housing markets. Standard home financing is well above the small loan range, so we think it appropriate to increase the small loan limit to €600,000.”
According to the VdP's home ownership survey – which covers all regions in Germany – 12.7% of loans for single- and two-family houses and condominiums would still exceed a small loan limit of €500,000, and in metropolitan areas this figure would be as high as 22.8%. Even with an increase to €600,000, the percentage of financing above this limit would still be significantly higher, at 6.8% and 13.2% respectively, than in 2009, when the limit was €400,000, as it still is today (3.4% and 5.8% respectively).
Criticism 4: Operating expenses
The BelWertV currently stipulates that at least 15% of gross income should be deducted from valuations of investment properties for operating expenses. Operating expenses include administration and maintenance costs, loss of rent risk, modernisation risk and non-allocable operating costs.
BaFin now plans to exclude modernisation risk and non-allocable operating costs from the minimum rate of 15%, so these would have to be deducted as well.
“The new rule would mean considerable additional deductions, especially for operator-run properties such as hotels and shopping centres, and ultimately lead to even lower mortgage lending values. That would be neither sensible nor appropriate,” Tolckmitt warns. “We have to ask why the adjustment is being applied to these two property classes in particular. Is the intention, again, simply to reduce mortgage lending values further? Whatever the case, we see no objective grounds for this step.”
Criticism 5: Administrative burden of revaluation
BaFin’s proposals also require banks to establish an annual mechanism for reviewing the basis on which mortgage lending values are calculated. The wording goes far beyond the requirements of the Capital Requirements Regulation (CRR) and contradicts the justification given by BaFin for this change, namely that it is simply a matter of aligning with the CRR.
“Overall, banks face a massive amount of extra administrative work,” argues Tolckmitt. This must be avoided at all costs, as it would ultimately affect financing conditions.
