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A small German mortgage lender has become one of Europe’s most bet-against stocks as it battles a surge in souring loans tied to US commercial property.
Deutsche Pfandbriefbank, which has a market value of €511mn, this month warned it was facing the biggest crisis in the real estate sector since 2008. Its assurance that capital ratios remain “well above” regulatory requirements failed to prevent a sharp sell-off in its shares, which are down 39 per cent this year, or its usually staid covered bonds.
PBB’s difficulties over recent months have drawn the attention of big-name hedge funds, who have upped their bets against the stock this year. Short interest hit a record high of 17 per cent last week and is now just below those levels, according to data from S&P Global Market Intelligence. That compares with 1 per cent early last year.
Among the funds to have built up negative bets are Millennium; Qube Research & Technologies, one of London’s biggest computer-driven hedge fund firms; Wellington Management; Caius Capital and Kite Lake Capital, according to regulatory filings.
The bank’s outsized exposure to the troubled US commercial real estate sector means it has been hit particularly hard by a steep drop in the value of previously prime US locations.
“We think the pain is only just starting to hit,” said Malte Schmitter, investment associate at Petrus Advisers, a former longtime shareholder in PBB that is now shorting the stock.
PBB’s warning last week, which was accompanied by an increase in provisioning against losses for last year, has added to fears that emerged in March 2023 following the collapse of Silicon Valley Bank over some lenders’ exposure to US commercial real estate. The sector has been hit by higher refinancing costs and the growth of remote working.
In the past three weeks, Japan’s Aozora, Deutsche Bank and New York Community Bancorp have all flagged potentially large losses due to their exposure to the US office market. The issue overtook US shadow banking this month as the most likely source of a “systemic credit event”, according to a survey of fund managers by Bank of America.
PBB — whose chief executive Andreas Arndt will shortly complete his term and be replaced by Kay Wolf, who was chief information officer at PBB’s parent company Hypo Real Estate between 2007 and 2010 — estimated in November that about 80 per cent of the market correction in the US had already played out.
Spun out of a bank nationalised by the German government in 2009, PBB has almost doubled its US office exposure since the end of 2020. It had €691mn of non-performing US loans on its books as of November, up 129 per cent from the end of 2022. Its credit rating was downgraded by S&P Global last week.
The bank’s shares have sunk to an all-time low while the yield on PBB’s single additional tier 1 bond, a debt instrument designed to take losses during a crisis, has surged above 40 per cent, up from 14 per cent at the start of the year. Spreads on some of the covered bonds that are called Pfandbrief and give the bank its name have widened by as much as 0.80 percentage points this year.
“These are [spreads for a German bank] I haven’t seen in my life as a covered bonds analyst,” said Joost Beaumont at ABN Amro. Bonds issued by Aareal Bank, another German lender exposed to US commercial real estate, have also been hit, though to a lesser degree.
Roughly 80 per cent of PBB’s cover pool — the collection of assets backing its covered bonds — is made up of commercial real estate mortgages. That includes a roughly 15 per cent exposure to US offices.
PBB’s relatively small deposit base leaves it less vulnerable to a bank run but means it relies heavily on covered bond financing, say analysts. DZ Bank analysts said in a note to clients that the bank is “currently unable to offset elevated funding costs with higher margins in the lending business”.
German banks have historically tended to look abroad for improved returns, but have a record of bad credit decisions in the US.
IKB Deutsche Industriebank, WestLB and Sachsen LB were hit by the blow-up of the subprime mortgage market in 2007-2008. Analysts say the biggest players’ capital buffers are far more robust this time around.
Meanwhile, Germany’s real estate market faces a reckoning of its own. Commercial property prices there dropped 12.1 per cent year on year and by 4.9 per cent quarter on quarter in the final three months of 2023, both of which are the largest price declines ever recorded.
PBB has been caught up in the broader downturn, having extended loans to Austrian property group Signa before its collapse late last year. It had also done business with German property companies Gerch and Centrum Group, both of which slipped into insolvency over summer.
But PBB’s recent travails stem almost entirely from its exposure to the US, according to analysts, with spreads on other German lenders’ bonds having tightened in recent months in anticipation of central bank interest rate cuts.
“The story this month has been that investors do like bank bonds, just not PBB’s or Aareal’s,” said Beaumont.