German Mortgage Lender Faces Crisis as Souring US Commercial Property Loans Surge
German mortgage lender Deutsche Pfandbriefbank (PBB) is currently facing a major crisis due to a surge in souring loans linked to US commercial property. This has resulted in the bank becoming one of Europe’s most bet-against stocks. Despite PBB’s assurance that its capital ratios remain above regulatory requirements, its shares have experienced a sharp sell-off, declining by 39% this year. Hedge funds, including Millennium, Qube Research & Technologies, Wellington Management, Caius Capital, and Kite Lake Capital, have increased their negative bets against the stock.
PBB’s significant exposure to the troubled US commercial real estate sector has made it particularly vulnerable to the drop in the value of previously prime US locations. Experts believe that the bank is only just starting to feel the impact of this situation. The collapse of Silicon Valley Bank in March 2023 due to lenders’ exposure to US commercial real estate has further fueled concerns. The sector has been affected by higher refinancing costs and the rise of remote working.
Several other banks, including Japan’s Aozora, Deutsche Bank, and New York Community Bancorp, have also reported potential large losses due to their exposure to the US office market. According to a survey by Bank of America, this issue has surpassed US shadow banking as the most likely source of a “systemic credit event.” PBB estimated in November that approximately 80% of the market correction in the US had already occurred. However, since the end of 2020, the bank has nearly doubled its US office exposure. As of November, it had €691 million of non-performing US loans on its books, a 129% increase from the end of 2022.
The bank’s shares have reached an all-time low, and the yield on PBB’s single additional tier 1 bond has surged above 40%, up from 14% at the beginning of the year. The spreads on some of the covered bonds, known as Pfandbrief, have also widened significantly. Aareal Bank, another German lender exposed to US commercial real estate, has also been affected, although to a lesser extent.
PBB’s cover pool, which consists of assets backing its covered bonds, is primarily composed of commercial real estate mortgages, with approximately 15% exposure to US offices. While PBB’s relatively small deposit base makes it less vulnerable to a bank run, it heavily relies on covered bond financing. Analysts suggest that the bank is currently unable to offset elevated funding costs with higher margins in the lending business.
German banks have historically sought improved returns abroad but have a track record of making poor credit decisions in the US. However, analysts believe that the capital buffers of major players are much stronger this time around. Additionally, Germany’s real estate market is also facing its own challenges, with commercial property prices experiencing significant declines.
PBB’s recent difficulties can be attributed mainly to its exposure to the US, while spreads on other German lenders’ bonds have tightened in anticipation of central bank interest rate cuts. Despite investors’ preference for bank bonds, PBB’s and Aareal’s bonds have not been well-received.
In conclusion, Deutsche Pfandbriefbank is currently grappling with a crisis caused by souring loans tied to US commercial property. The bank’s exposure to the troubled US real estate sector has resulted in a significant decline in its shares and increased negative bets from hedge funds. While other German lenders have tightened their spreads, PBB’s bonds have not been favored by investors. The situation highlights the challenges faced by the bank and the broader German real estate market.