Pfandbrief to the rescue?

25 Jul 2016 | Richard Kemmish

Napoleon is usually wrongly credited with describing the British as a nation of shopkeepers – which always struck me as one of the more bizarre insults in the long and mutual tradition of cross-channel shouting. Certainly there are a lot of shopping malls in the UK. What is rarely recognised about them though is how much of the debt that funds them is in pfandbriefe cover pools. According to the VDP British commercial property in cover pools is nearly €8bn making it the second largest non-German exposure after, ironically, France.

How will this be impacted by Brexit? Louis Hagen of the VDP recently suggested that it would be easy to modify the pfandbrief law to allow British assets to be included in the pool in less time than it will take Britain to actually exit the EU under article 50 of the Lisbon treaty. His comments assume that Britain doesn’t join the EEA which would make such a change unnecessary.

The change would not be particularly radical, already assets from countries such as Japan, Canada and the US are allowed to be included in cover pools without restrictions.  Adding the UK to that list is easy.

There is also the rule that the total of non-EU based assets that come from countries that do not recognise that pfandbrief have a special claim in insolvency is capped at 10% of the cover pool (why of the cover pool? Surely it would be more rational to be capped at 10% of the liabilities. Otherwise you can get the absurd situation that adding a new asset to a compliant cover pool can suddenly make it non-compliant. Non-sensical). But it is reasonably safe to say that the UK should be outside the scope of the 10% limit.

So, no change then?

Not quite. Obviously pfandbrief investors and supervisors will want to get themselves comfortable with the impact of Brexit on the credit value of the assets. It is unlikely to be a problem given the credit safeguards inherent in the pfandbrief system but it might be seen to be bad-marketing to be the most-UK exposed cover pool in Germany.

There is also the effect of the recently witnessed FX volatility on the euro value of the British assets. Pfandbrief pools have to stress test these FX rate moves (see my post of 12th February for more details on this) but more sterling denominated pfandbrief issuance would be a natural hedge of this.

But more importantly, maybe the assets are going to start looking a lot more lucrative. The problems of UK property funds having to restrict redemptions after the Brexit vote were well reported. Whether this is a temporary aberration caused by the shock of the referendum or is a sign of a more long term difficulty in raising funds for UK real estate is, as yet, unclear. But what is clear is that yields on the next refinancing round are going to be significantly higher than they were previously. Or are in Germany. 

It is quite possible that a revitalised post-Brexit commercial mortgage securitisation market will satisfy much of the funding needs. But don’t underestimate the commercial opportunities for pfandbrief issuers of funding the British national shopping obsession.

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