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Deutsche Pfandbriefbank (Pbb), one of Europe’s leading commercial real estate financiers, reported a substantial decline in profits for the second quarter of 2024, reflecting the ongoing challenges in the global real estate market, particularly in the United States.
The bank’s pre-tax profit dropped by 74% to €11 million, down from €42 million in the same period last year. This steep decline was primarily driven by a 13% increase in non-performing loans (NPLs) in the U.S., where Pbb has significant exposure to the beleaguered office real estate sector. The continuing rise in interest rates and the shift toward remote work have left office spaces underutilised and property values depressed, compounding the difficulties faced by the bank.
Pbb Deutsche Pfandbriefbank holds a pivotal position in the European real estate finance landscape. As a specialist lender with origins dating back to the 1860s, Pbb has become a key player in financing commercial real estate across Europe and North America. The bank was restructured from the remnants of Hypo Real Estate (HRE) after the 2009 financial crisis, emerging as a stable entity within a sector known for its cyclical volatility. However, the current challenges in the real estate market, particularly in the U.S., have once again put Pbb in the spotlight, testing its resilience and strategic direction.
Sale of NPL portfolio provides some relief
In response to the deteriorating situation in the U.S. real estate market, Pbb made several strategic moves to manage its risk exposure and strengthen its balance sheet. One of the most significant actions was the sale of a non-performing loan (NPL) portfolio to Blackstone in the spring of 2024. This portfolio, with a total volume estimated at around $1 billion, included distressed loans tied to U.S. and U.K. real estate, particularly office spaces that have been hit hardest by the pandemic-induced shift in work habits and rising interest rates.
The sale to Blackstone was a critical step in Pbb’s strategy to offload high-risk assets and reduce its exposure to markets that continue to face significant uncertainties. However, while this move provided immediate relief to the bank’s balance sheet, it also highlighted the severity of the challenges Pbb faces in its U.S. portfolio. Despite this, Pbb has indicated that it expects the commercial property market to "enter calmer waters" in the second half of 2024, with transaction volumes potentially picking up as market conditions stabilize.
In addition to managing its portfolio of distressed assets, Pbb has also been active in the Pfandbrief market as part of its refinancing efforts. During the first half of 2024, the bank issued €1.2 billion in Pfandbriefe, surpassing the €0.8 billion issued during the same period in 2023. This was followed by the issuance of an additional €750 million, bringing the total Pfandbrief volume to around €2.0 billion, already exceeding the bank’s planned refinancing needs for the full year. The strong demand for these covered bonds, issued at solid acquisition costs, underscores the bank’s robust liquidity position and the confidence that investors continue to place in Pbb’s long-term stability despite its current challenges.
New CEO Wolf sees 'strengthening profitability' as key
CEO Kay Wolf, who took charge in March 2024, has been clear about the challenges facing the bank while maintaining a cautiously optimistic outlook. “Our operating result remains robust, meaning that we are still in a position to shoulder the excessive risk provisioning,” Wolf stated. The bank’s operating income increased by 7% to €278 million in the first half of the year, buoyed by a 14% rise in net interest income to €246 million. However, the significant increase in risk provisions—€56 million in the second quarter alone, up from €19 million a year earlier—continues to weigh heavily on profitability.
The bank’s difficulties are largely concentrated in its U.S. portfolio, where four additional loans totaling €243 million became non-performing in the first half of 2024. This led to a substantial increase in the bank’s risk provisions, which now total €103 million for the first half of the year, a sharp rise from the €21 million set aside during the same period in 2023. In light of these challenges, Pbb has halted new lending activities in the U.S. and is actively reducing its exposure in both the U.S. and U.K. markets.
Commercial real estate to stabilise by year-end
Looking ahead, Pbb’s mid-term outlook remains cautious but focused on strategic adjustments aimed at improving profitability and navigating the current market turbulence. The bank expects the commercial real estate market to stabilize in the latter half of 2024, which could lead to a moderate increase in transaction volumes. However, the impact of the ongoing writedowns and elevated risk provisions on future lending cannot be overlooked. The bank has already scaled back its new business volume to €1.9 billion in the first half of 2024, down from €2.5 billion in the same period last year, reflecting a more conservative approach to lending.
One of the key pillars of Pbb’s strategy moving forward is the increased utilization of its real estate platform. The bank has been expanding its activities in asset management and green financing, areas that are expected to contribute more significantly to its profitability in the coming years. By the end of the first half of 2024, over 25% of Pbb’s portfolio was classified as green loan-eligible, with plans to increase this to over 30% by the end of 2026. This focus on sustainability aligns with broader market trends and investor demands for more environmentally responsible investments, which could help Pbb differentiate itself in a competitive market.
Additionally, Pbb has recently transitioned to the Foundation Internal Ratings Based Approach (F-IRBA) for the majority of its real estate finance (REF) portfolio, a move that is expected to enhance the bank’s risk management capabilities. This shift is part of a broader effort to adapt to the evolving regulatory landscape, particularly in anticipation of Basel IV. However, the transition has also temporarily reduced the bank’s CET1 ratio to 14.0% as of June 2024, down from 17.2% under the standard model parameters, highlighting the ongoing balancing act between regulatory compliance and maintaining a strong capital base.
Future lending likely to be constrained
The significant writedowns in the U.S. portfolio and the increased risk provisions will likely constrain Pbb’s lending capacity in the near term. The bank’s cautious stance on new lending, particularly in high-risk markets, suggests a strategic pivot towards more stable and lower-risk opportunities in Europe. This shift could include a greater emphasis on core European markets where the bank’s expertise and relationships provide a competitive advantage.
Pbb’s recent focus on refinancing through the Pfandbrief market also indicates a strategy aimed at strengthening its liquidity position while managing funding costs. The success of these issuances, despite the broader challenges in the real estate market, reflects the bank’s ability to leverage its strong reputation and investor confidence to secure favorable terms.
As Pbb prepares to present its updated strategy at the Capital Markets Day on October 10, investors will be looking for clear indications of how the bank plans to navigate the current challenges and reposition itself for future growth. The emphasis on green financing, asset management, and enhanced risk management suggests a more diversified approach that could help mitigate some of the risks associated with its traditional commercial real estate lending activities.
REFIRE: Pbb Deutsche Pfandbriefbank remains an important player in the European real estate finance market, but its recent struggles shine a light on the risks associated with concentrated exposure to volatile sectors like U.S. office real estate. The bank’s ability to successfully navigate these challenges will depend on its strategic adjustments, including reducing exposure to high-risk markets, expanding into asset management, and leveraging opportunities in green financing.
The recent sale of the NPL portfolio to Blackstone, along with successful refinancing efforts in the Pfandbrief market, are positive steps towards stabilising the bank’s balance sheet. However, the impact of ongoing writedowns and elevated risk provisions will continue to weigh on profitability in the near term. Investors and stakeholders will be closely watching Pbb’s upcoming Capital Markets Day for further insights into how the bank plans to restore trust, strengthen profitability, and position itself for long-term growth.
