List of Abbreviations
1.2 Importance of the Study
The importance of this research work becomes clear, when one looks at the following quote by Dr. Louis Hagen, Managing Director of the Association of German Mortgage Banks:
“Everybody is complaining about credit. Businesses because they cannot get it any more, and banks because they have granted too much.”63
The indications of an upcoming credit crisis in Germany are already observable64 but its influence on real estate lending is not yet assessable for the German property industry. However, there is a great uncertainty going around in the industry and companies are thriving to substitute bank funding by non-bank funding.65
Hardly any other banking subject has had such a great influence on such a broad section of Germany’s political and business community as have the new rules emerging from the new Basel Capital Accord.66 This sensitivity is closely tied to the vast significance that borrowed capital, i.e. bank debt, has for the German economy. The fear that the funds required for investments will either rise sharply in cost or may even become completely unattainable scares the German industry. Especially the commercial real estate sector is greatly influenced by this, since it has traditionally relied heavily on bank debt. But also the rest of the economy relies heavily on loans secured by mortgages (almost every other bank loan in Germany is collateralized by mortgages). In comparison to the US and the UK, German companies rely a lot more on bank lending than on alternative lending sources.67
The relevance of this circumstance is very well documented Figure 3:
International Comparison of Capital Markets Financing Utilization.
63 Hagen (2003), p. 11.
64 Even though the Basel Capital Accord does not come into effect until the end of 2006, the banks are urged to start following the Basel II Guidelines, if they want to choose the Internal ratings-based (IRB) approaches. Cf. Basel Committee on Banking Supervision (2003b), p. 1.
65 Cf. Wolf (2004).
66 Cf. Pitschke (2004), p. 273.
18% 82%
10% 90%
71% 29%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Germany
UK
USA
Bank Loans Capital Market Financing
Figure 3: International Comparison of Capital Markets Financing Utilization68
In Germany the share of bank loans vis-à-vis capital market financing is up to seven times higher than in the UK and about 4 times higher than in the USA.
71% of all financings are bank financings, whereof mortgage loans make up 31% and other bank loans make up 40%. Hence, in an international comparison Germany is a straggler and is having difficulties to follow the trend from credit to capital markets.
Apart from the effects of Basel II, there are other factors that influence the credit commitment of the German Banking System. Traditionally German Banks have been very strong in loan underwriting, so that no alternative financing sources for debt finance could evolve. So the German Mortgage Banks have not only underwritten a lot of loans, but they have also priced those loans so competitively that no other instrument could compete.69
This was only possible because of the Pfandbrief as the primary funding tool.
This funding tool was a peculiarity of the German mortgage funding market that
67 Cf. Hagen (2002), p. 41.
68 Cf. Hagen (2002), p. 41.
69 Cf. Day and Moore (2003).
until the emergence of the UK covered bond market70 only existed in Germany.
Thus, German banks and especially the Landesbanks (having a government guarantee) could always fund their loan commitments at very low rates and this explains, why the German real estate borrowing rates were always lower than in the neighbouring European countries.71
So, in the aftermath of the extensive loan-underwriting phase of the 1990’s the German banks have lost a lot of money and are today sitting on a huge non-performing loan exposure that is weighing heavy on their balance sheets.72 Even though the German banking industry has for a long time not admitted to this, the non-performing loan problem in the German banking market is bigger than previously expected.73The expected total volume ranges from €100 to € 300 billion,74 which could be an enormous boost to the Securitisation market, if the loans got securitised as in the case of the US.75
The situation is best described by the following quote:
“They [the German banks] are looking wounded and their competitive slim margins are expected to widen as they look to improve their cost of return on equity. Their performance will be further affected by problems of non-performing
loans at home and regulatory changes, such as the Basel II Accord, which is forcing banks to adjust the levels of reserves they are obliged to hold.”76 Therefore, the increasing cost of capital that German banks are incurring now is supporting other forms of lending, like Securitisation.77 But also the lending
70 The European covered bond market evolved in the UK and really only exists since 2000. Until recently there was not even a legal framework in the UK. Cf. Day (2003), p. 74; Dreesbach (2003), p. B6.
71 Cf. Weber (2003), p. 3.
72 Cf. Morris (2002), p. 52.
73 Cf. Anonymous (2003i), p. 1.
74 Cf. Schmid and Maier (2005), p. 19.
75 Cf. Anonymous, Die Welt (07 May 2004).
76 Cf. Anonymous (2003a), p. 35.
77 Cf. Anonymous (2003a), p. 35.
industry is increasingly turning to Securitisation to reduce their loan exposures and to lower the regulatory capital required under the Basel Capital Accord.78 In addition to the effects of Basel II and non-performing loans, the consolidation in the German mortgage banking market is also an indicator for rising real estate financing margins in the future. Because the competition between the mortgage banks is declining, there will be a greater concentration, less competition and higher margins will be achievable for the lending institutes.
Only a few years ago mortgage banks started to consolidate when HypoVereinsbank merged three of its mortgage banks to create HVB Real Estate. Rheinboden and Allgemeine Hypothekenbank also merged, while Eurohypo was formed from the mortgage banking divisions of Deutsche Bank, Dresdner Bank and Commerzbank.79
An empirical study that was conducted for this dissertation thesis in 2003 came to the conclusion that the recognition of the Securitisation and the Real Estate Securitisation concept among most German Real Estate Lenders is high;
nonetheless the understanding of Real Estate Securitisation is quite low. The name recognition of Securitisation is very high with 94.1%; however, the market penetration of this concept is relatively low with only 37% of the responds admitting to use Asset-Securitisation. With Real Estate Securitisation the name recognition is also very high – 78.7%, nonetheless the understanding is mixed and concentrates on Mortgage-Backed Securities and Pfandbriefe, whereas the Securitisation of Real Estate Cash Flows is underrepresented. This leads to the conclusion that there is no common definition of this term. Hence, there is a need to derive one.80
Moreover, 40% of the surveyed lenders expected less loan commitment in 2003 compared to 2002 and even 52% believe that the new Basel Capital Accord (Basel II) will push them to restrict their loan commitments in the future. Given this result, it is important for German property companies to diversify their
78 Cf. Friedrich (2004), p. B5.
79 Cf. Anonymous (2003a), p. 35.
80 Refer to Chapter 5.1.
funding sources and to find new ways of financing real estate, in case the bank lending capacities will decrease even more.81
Japan, for example, a couple of years ago were in a similar position that Germany is in today. The restructuring of corporate Japan, which has forced some companies to adopt a new approach to their real estate holdings, as well as the well-documented ‘credit crunch’ caused by the problems engulfing the nation’s banks, has also forced many borrowers to look at previously-untried funding sources. This has led to a functioning Real Estate Securitisation market.82
The same observations can be made in the three case studies (Singapore, USA and Europe) that are analyzed in the international comparison of this thesis.