(Bloomberg) -- With weeks to go before stepping down as chief executive officer of Deutsche Pfandbriefbank AG, Andreas Arndt is facing a reckoning.
Investors have been fretting over the firm’s loans to US commercial real estate since it cut its profit forecast in November. A hedge fund that only a year ago owned its stock is now betting against it. Things came to a head last week, when its bonds and shares slumped to record lows, after rising defaults in the US property market hit two lenders in New York and Tokyo, sparking contagion fears.
To calm investors, the 65 year-old Arndt issued a statement saying PBB would still post a profit for last year, despite what the company billed as “the greatest real estate crisis since the financial crisis.” The shares plunged 5.7%.
The market jitters have put PBB, whose predecessor was bailed out in the financial crisis, at the center of concerns that troubles in the US property market are spreading to Europe. Operating from a suburb of Munich, Arndt has racked up an exposure worth roughly $5 billion to US property borrowers since the German government sold much of its stake in his little-known firm. Now the former Deutsche Bank AG executive faces his biggest test as he seeks to salvage his legacy.
Arndt declined to comment through a spokesperson.
PBB isn’t alone in taking hits from the real estate upheaval. Bonds of Aareal Bank AG and LBBW, which acquired a Berlin-based lender in 2022 with large exposure to German developers, were also hit last week as investors scrutinized their estate exposures. The sudden and rapid reversal from a long period of record low borrowing costs has put developers under pressure and deflated real estate prices across the globe.
But within the global malaise, US office properties — where PBB has loaned heavily — fared particularly badly. More than half of the bank’s loans in its dominant real estate finance unit were to office buildings, as of June last year. The unit’s US exposure, at €4.8 billion ($5.2 billion), far exceeded the lender’s total equity of €3.3 billion.
Arndt, who joined the management board in 2014 and became CEO two years later, made the expansion into the world’s largest economy a cornerstone of his strategy, opening a New York office in 2018. Within a few years, the firm’s exposure to US commercial real estate rose from zero to 15% of its total real estate finance volume.
The push proved ill-timed when the Covid-19 pandemic fueled a trend toward hybrid work arrangements and raised questions about how many offices are still needed. PBB’s share price hit a high just before the pandemic started roiling markets four years ago, only to plunge about 60% in the following weeks. Last year’s increases in interest rates made things worse.
PBB’s expansion into the US office market “came very late” in the cycle, activist investor Petrus Advisers said in a public letter addressed to PBB Chairman Louis Hagen in December. The outcome of that push has been “disastrous” as credit provisions shot up.
Petrus was a shareholder in PBB earlier last year, with a stake of around 3%, but has since started to bet against it, one of several investors to do so. Short interest in the stock surged to more than 17% at the end of last week, according to data compiled by S&P Global.
A spokesman for the bank said PBB expanded into the US “as part of its geographical diversification strategy,” adding that its activities in the countries are limited to “a few cities.” Its office loans are all for properties that take into account the changes since the Covid pandemic, the spokesman said. They also have “high” occupancy rates.
PBB problems don’t end with its US exposure. The firm also made loans to the failed real estate and retail empire Signa Holding, once run by Austrian tycoon Rene Benko. Signa’s insolvency filings show that the bank has lent to at least five developments across Germany and Austria, Bloomberg News has reported.
It’s a bitter experience for PBB. The lender was created in 2009 from the functioning parts left behind by the collapse of Hypo Real Estate, a mortgage lender that became Germany’s biggest casualty of the financial crisis. The country’s bank-rescue fund eventually took full ownership in 2009.
The government sold much of its stake in PBB through a public listing in 2015 and divested completely in 2021. As a public company, the lender faced heightened investor scrutiny of its growth and profitability targets. But increasing competition and falling margins in its home market, where the European Central Bank for the first time in its history introduced negative interest rates, limited the firm’s prospects.
PBB responded by expanding abroad. A first effort to grow in the UK was thrown into uncertainty when the country voted to leave the European Union in 2016. PBB’s US expansion kicked off shortly after.
“As a mortgage lender with international aspirations, you have to be in the US, it’s one of the biggest markets,” said Dieter Hein, an analyst at research firm AlphaValue who has a buy recommendation on PBB. However, “there’s a risk from being in a market you don’t know as well as your home country.”
Investors now wonder whether PBB will still be able to pay a dividend this year. After issuing the profit warning in November, Arndt said he’d announce a decision on payouts along with fourth-quarter results, which are scheduled for March 7.
The “prudent decision” would be to scrap the dividend, said Filippo Alloatti, head of financials at Federated Hermes. He said the bank may need to continue provisioning as supervisors at the ECB watch developments very carefully.
The ECB has been leaning on lenders after finding that they aren’t doing a good enough job of looking for signs of deterioration in their real estate loans. It has repeatedly highlighted commercial real estate as an area of concern, and has recently been signaling to lenders that they may face higher capital requirements if they have an insufficient handle on those risks, Bloomberg reported Friday.
Last year PBB received the single highest increase in capital requirements from the ECB among the more than 100 lenders it supervises directly. The firm has said it’s “well above” its regulatory capital requirement.
The big question for Arndt now is just how bad the situation on the US office market will get before it improves, especially since the recent turmoil may have made it harder to tap fresh funding. The company expects commercial real estate prices to “bottom out in the second half of 2024,” according to the spokesman.
In another statement, the company on Thursday said it has a liquidity cushion that should allow it to operate without new capital market funding for more than six months.
“There are no imminent liquidity risks, as the bank’s funding is mostly longer-term on the capital market as well on the deposit side,” said Sonja Foerster, vice president at Morningstar DBRS. It’s also got “a large covered bond franchise and has been growing term deposits in 2023.”
Still, “refinancing in the unsecured wholesale market will be more difficult,” she said.
--With assistance from Neil Callanan.
(Adds short interest in 11th paragraph.)
©2024 Bloomberg L.P.