German bank faces challenges due to empty US offices

Deutsche Pfandbriefbank has garnered significant attention due to its investments in US commercial property, which have been met with negative publicity. Unlike numerous European banks that have refrained from engaging in such ventures, this German bank has actively embraced them. What happens next?

Concerns regarding US commercial property are causing unease for Deutsche Pfandbriefbank (pbb), a German bank. The bank, which specializes in commercial real estate loans in Europe and has a significant investment in America, is facing a substantial problem. The vacancy rates for offices and business premises in the US have reached their highest levels in years, largely due to the impact of the COVID-19 pandemic and the shift towards remote work. Additionally, factors such as stricter lending practices, higher interest rates, and inflation have made the construction and real estate sectors less appealing.

Currently, pbb holds customer loans totaling just over €49 billion ($52.9 billion). About 44% of its real estate financing associates with commercial real estate in Germany, while it ties around €5.4 billion, or 15%, to commercial real estate in the US. However, the US market is particularly uncertain when it comes to valuations of commercial real estate, as highlighted in a recent report by S&P, a credit rating agency.

As of September last year, problematic loans in the US accounted for 12.8%, significantly contrasting with the estimated 0.3% ratio for German risk exposure, exacerbating the situation. Vladislav Krivenkov from nordIX, a Hamburg-based specialist in bonds and derivatives that advises institutional investors, emphasized this substantial difference.

Assessing the situation amid plummeting stock values

German bank faces challenges due to empty US offices

As the stocks plummet, it is worth noting that while many other German banks have investments in real estate, their businesses are generally more diversified. On February 14, S&P downgraded pbb’s long- and short-term outlook due to its significant exposure to commercial real estate, including offices, retail, logistics, and hotels. The rating agency expressed concern over the bank’s “limited range of business lines.”

Investors reacted swiftly, causing the bank’s share price to reach an all-time low. Since the beginning of January, the stock has declined by 40%.

Anticipating this outcome, the bank had previously issued two statements in an attempt to reassure investors about its overall financial health. It emphasized that despite the challenging real estate crisis, pbb remains profitable thanks to its financial strength, even in the face of the worst crisis since the financial crisis. Additionally, the bank assured that it has sufficient cash reserves to handle a downturn in the US.

Jens Tolckmitt, the CEO of the Association of German Pfandbrief Banks (vdp), acknowledges the challenging situation for commercial real estate in the US, particularly for office properties. However, he stresses not to assess the entire real estate industry uniformly, as different property types and locations experience distinct impacts.

Despite the distress in the sector, some investors remain hopeful. Krivenkov, a portfolio manager at nordIX, asserts that the current situation represents more of an asset repricing than a bubble burst, akin to the subprime crisis in the US in 2007. He also emphasizes not to interpret the challenges of a relatively unknown mid-sized German bank as indicative of a broader financial crisis. Furthermore, the market could potentially stabilize soon, potentially through anticipated interest rate cuts.

Securing Stability through ‘Pfandbriefe’

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The discovery of security in ‘Pfandbriefe’ is a positive development for pbb, given that real estate finance contributes significantly to its profits. Preliminary results for 2023 show pre-tax profits amounting to €90 million, marking a substantial decrease from €213 million in the previous year and €242 million in 2021. Despite this decline, S&P anticipates the bank to remain “moderately profitable” throughout the current year.

Tolckmitt remains optimistic about the future, stating that this does not signal the onset of a new systemic financial crisis. He highlights that since the 2008 financial crisis, stricter regulations have subjected German banks to better capitalization, resulting in increased equity and enhanced resilience.

Furthermore, pbb specializes in the German Pfandbrief, a specific type of “covered bond” used to finance loans. Tolckmitt emphasizes the safety of Pfandbrief-based financing for investors, noting that it follows conservative practices in determining loan-to-value ratios and typically finances only 40-50% of the market value.

Is real estate a vulnerability or weak point?

Real estate has recently faced various crises, ranging from residential property issues in China to the collapse of luxury property developer Signa in Germany and Austria. However, what concerns investors the most is the impact of workers staying at home. Empty office buildings, businesses downsizing their spaces, and shops shutting down are all causes for concern. S&P highlights that approximately 65% of the bank’s real estate finance portfolio is concentrated in the office, retail, and hotel sectors.

While COVID-related vacancies are not a new phenomenon, long-term leases have caused a delay in addressing the issue. Owners who initially hoped to wait it out are now confronted with a new reality. Vacant buildings are dragging down property values, with many assets no longer holding their previous worth. When owners go bankrupt, lenders are left with the consequences.

Krivenkov told the Diplomat News that despite the differences between Credit Suisse and Silicon Valley Bank, bank CEOs greatly fear insolvency resulting from a bank run—their common ground.

Although this scenario may seem distant, the current situation will reveal the effects of increased regulation, a shift in risk perception, and the true resilience of German banks, he concluded.