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Like Hansel and Gretel, Deutsche Bank is set deep in the jungle. The German real estate lender was attracted by the prospect of lucrative returns on commercial real estate. Now it is suffering due to an interest rate shock and a collapse in demand for office buildings.
U.S. real estate risks are the biggest concern. PBB shares have lost more than half their value over the past year. Valuations of U.S. office buildings have fallen sharply, with vacancy rates hovering around 20%. Results last week showed PBB's U.S. nonperforming loans will double to 600 million euros by 2023.
Optimistic PBB CEO Kay Wolf said funding needs for the next six months are already in place, backing up that statement with €6 billion of liquidity and a CET1 ratio of nearly 16%. He expects reserves to fall this year and profits to rise.
PBB also confirmed it will continue to make discretionary coupon payments on its AT1 capital buffer bonds. If a bank's CET1 ratio falls below 7%, these banks will start absorbing losses. Bond prices doubled to 40 euro cents as concerns that payments would have to be canceled eased.
But Wolf is betting on a soft landing in Europe, where valuations have adjusted more slowly than in the United States. Germany is PBB's largest market, accounting for 44% of its commercial real estate loans, many of which are to office building owners. The office vacancy rate in Germany is approximately 5%. But the signs of stress are there.
Its development portfolio – in which some €3 billion of loans are tied to land and building sites – looks particularly troubled. The riskiest projects were started when interest rates were at their lowest and valuations were at their highest. Once projects were halted, loan losses soared.
Last year, such loans added about 400 million euros to total bad debts to 1.5 billion euros. These will test PBB's claims that it has the expertise to address these issues and avoid dumping assets into falling markets. Both will be difficult. The loan-to-value ratio for development NPLs has not been disclosed, so it may have exceeded 100%.
Current supplies still look weak. If traditional UK shopping center loans are excluded, the total non-performing loan coverage ratio is only 17%. By comparison, the European bank average is over 30%. The coverage ratio for development loans that are more difficult to recover is only 12%. Citi believes that bringing these figures closer to the average may require spending €200 million in new provisions.
That's nearly as big as the total impact of loss provisions on profits last year. Don't expect a fairy tale ending for PBB.
andrew.whiffin@ft.com
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