Property value drives sustainable growth

Regulatory principles in accordance with CRR III

Due to the extensive nature of the changes, the redesign of the framework for assessing real estate collateral in Article 229 CRR has not yet been widely adopted in institutional practice. The concept of ‘property value’, i.e. sustainable real estate value, has been adopted from the Basel III proposals:

This has been binding for new business since 1 January 2025. The handling of existing business must be regulated by the end of 2027.

European and national implementation

The European Central Bank (ECB) commented on the new value concept in its Supervision Newsletter dated 14 August 2024. In it, it highlights the need for cautious and conservative valuation of real estate collateral and emphasises the need to continuously monitor value development on the basis of market data.

This is also addressed in Article 208(3) CRR, according to which credit institutions must monitor market fluctuations in property values in order to identify significant losses in value and the need to adjust the value of collateral.

The national banking supervisory authority has stated that there are two possible approaches to operationalising ‘property value’ in Germany, see vdp presentation: Property value in accordance with Article 229 (1) CRR III – vdp – Association of German Pfandbrief Banks

• The mortgage lending value in accordance with Section 16 (2) sentences 1 to 3 of the German Pfandbrief Act (PfandBG) in conjunction with the BelWertV (Mortgage Lending Value Regulation) fulfils the requirements of Article 229 (1) CRR in all cases.
• Alternatively, market value can be used as a basis. In a step following the market value determination, this value must be reviewed to determine whether an adjustment is necessary to meet the requirements of Art. 229 (1) letter b) CRR III. While the market value is determined on an object-specific basis, this review and, if necessary, adjustment of the market value can be carried out on a portfolio-specific basis based on statistical evaluations of relevant market data.

The new value concept therefore does not represent a completely new calculation logic, but rather provides the framework for a methodology that combines individual market value with consistent market data analysis:

Compared to the mortgage lending value, this results in potential. In the event of significant market fluctuations, the property value must be reviewed. In summary:

Methodology of vdp and vdpResearch

The vdp and vdpResearch GmbH have developed a discount method that enables the application of a market data-based discount to the individual market value of a property. For different types of properties, such as condominiums or office buildings, quarterly discounts can be obtained that are based on current market developments.

When deriving the discounts, the basic idea is to break down the property time series into a trend and a cycle component in order to filter out cyclical fluctuations. In addition, a conservatism buffer in the form of a hypothetical decline in market value is already taken into account when deriving the parameters to ensure that, in the event of a real decline in market value, the vdp discount remains valid as long as there is no pronounced market crisis.

Benefit analysis of property value

1. Individual loan perspective:

The advantages of property value are illustrated below using the example of a loan for a single-family home. The following framework applies:

Table 1: Sample calculation of property value for an individual loan

We expect a 10 % discount on the property value, which is a conservative estimate in the current market phase and would withstand a significant market downturn of over 20% based on the vdp methodology.

In the standardised approach to credit risk, the secured portion of the claim is assigned a risk weight of 20 %, while the unsecured portion is assigned a risk weight of 75 %. 55 % of the collateral value can be recognised as the secured portion. If the different collateral values are taken into account, the mortgage lending value results in a privileged volume of € 257.8 thousand, while the property value results in € 309.4 thousand. If the risk weight is now calculated by combining the secured and unsecured portions, the result is approximately 46.6 % for the mortgage lending value and 41.0 % for the property value. This means that in this specific case, approximately € 28.4 thousand in RWA savings can be achieved.

Further aspects:

• When granting large property-backed loans in the corporate receivables class, the savings potential increases because the unsecured portion is assigned a risk weight of 100 %.
• Commercial property offers lower savings potential than residential property, as the secured portion may only be weighted at 60 % risk. Nevertheless, switching to property value can still be worthwhile in this case.
• In the context of WIFSTA reports, BaFin criticises the continuing very conservative approach in Germany. The exclusive use of the mortgage lending value often leads to economically implausibly low values. In view of this, too, the use of the new European standard is an obvious choice.

2. Portfolio view

As expected, the savings potential in relation to the overall portfolio view depends considerably on the portfolio structure and is higher the more real estate-backed positions there are in the portfolio. In addition, the structure within the real estate-backed portfolio plays a decisive role. Our analyses show that for a bank with approximately 25% exposure to real estate-backed positions, RWA savings at the overall portfolio level of around 5 % are realistic. This assumes that the original retail and corporate exposure classes occur with approximately the same frequency in the property-backed business and that the discount on the property value compared to the mortgage lending value is as shown above.

A precise analysis based on the specific portfolio structure can be determined using the specially developed msg RWA Analyzer.

Implementation in banks

3. Discount calculation:
   When using vdp discounts, the relevant discount must be applied to determine the property value, depending on the property segment and date of valuation. It is advisable to specify a fallback.
4. Retroactive usability:
   The retroactive usability of the property value must be checked on the basis of data quality analyses. The type and quality of the property valuation reports, the quality of the data stored in the security system and the review process in accordance with Art. 208 CRR III with regard to the past play a role here.
5. Transitional periods:
   For existing business (until 2024), the transition to property value can be completed by 31 December 2027. For privileged new business from 1 January 2025, the valuation method chosen for the first application is binding, i.e. if the mortgage lending value is used, no change is possible.
6. Technical consideration:
   The process for taking vdp discounts into account must be defined and their use in regulatory reporting ensured. In savings banks, largely automated system-based use is already possible.

Conclusion

Property value offers institutions with large portfolios of real estate collateral in particular the opportunity to achieve significant RWA savings. This improves the usability of scarce equity capital, resulting in growth and earnings potential. The reduction in capital tied up opens up new pricing scope in new business, which can be used to expand market position and increase margins.

Due to the existing transitional arrangements, it is advisable to address this issue promptly, as the savings potential decreases with each passing day and will be completely lost by the end of 2027 at the latest. Conversely, the current situation offers all institutions the opportunity to benefit in the long term and position themselves successfully in the competitive environment by taking decisive and orderly action.