(Bloomberg) — Losses in the commercial property market, which have already sent some banks in New York and Japan into a tailspin, moved to Europe’s biggest economy this week.
Bonds issued by real estate-focused German lenders slumped after Morgan Stanley analysts recommended clients sell senior bonds issued by Deutsche Pfandbriefbank AG because of its exposure to the CRE market in the US, according to people with knowledge of the matter who spoke on condition of anonymity.
PBB’s junior bonds suffered a record slump on Tuesday but recouped some losses after the bank said on Wednesday it raised risk provisions and reported preliminary pretax profit for the full year that met estimates.
The plunge came as Treasury Secretary Janet Yellen said that losses in commercial real estate are a worry that will put stress on owners, adding that she thinks the problem is manageable. One reason for concern is that appraisers have yet to fully mark down the value of business properties in the US after interest rates rose, according to analysts at Green Street, who said a further writedown of as much as 15% may be needed across the sector this year.
“Appraisal values remain much too high, and further asset value declines are necessary for values to catch up with reality on the ground,” the Green Street analysts wrote in a note. “Lenders that base their decisions on these appraisals have greater odds of taking impairments” and some could face “strain” as a result.
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Investors have been nervous since New York Community Bancorp reported a surprise loss last week and slashed its dividend. Smaller and regional banks are the biggest providers of CRE finance in the US, but some European lenders also have exposure.
Beyond PBB, which has been the biggest loser in a Bloomberg index of euro-denominated bank bonds in recent days, a €750 million AT1 by Landesbank Baden-Wuerttemberg and a €300 million note by Aareal Bank AG slumped on Tuesday and continued their decline on Wednesday.
“We see risks that PBB might have to further increase loan loss provisions and, thus, put pressure on its already subdued profitability,” wrote Marlene Eibensteiner, an analyst at Deutsche Bank AG, in a note distributed on Tuesday. She says this is mainly an issue of profitability and not solvency thanks to the bank’s capital buffers.
PBB spokesperson Grit Beecken said the firm’s earnings forecast given in third-quarter results took into account all known and relevant facts, including those relating to risk provisioning. “As things stand today, there is no reason to deviate from this,” Beecken said in emailed comments on Tuesday. Morgan Stanley declined to comment.
Representatives at Aareal and LBBW didn’t respond to requests for comment.
Investors spooked by the downturn in CRE have been attempting to sell PBB bonds in recent days without success unless they offer sizable discounts, according to market participants.
PBB’s bonds also took a hit last November after the lender missed earnings expectations and cut its full-year forecast. In an earnings call at the time, chief executive officer Andreas Arndt flagged a “sizable increase in risk provisions.”
Its January issuance, which matures in 2027, priced some 31 basis points wider than an earlier issue maturing in the same year, highlighting the widening in the borrower’s spreads.
“Both Deutsche Pfandbriefbank and Aareal Bank are German issuers with one of the highest commercial real estate exposures relative to their total lending,” Marine Leleux, an analyst at ING, wrote in a note last month.
“This is not without consequences as the construction and real estate sectors are expected to continue to suffer from the higher interest rates. We would therefore be more cautious on banks with larger exposures to these sectors.”
Short interest in PBB stood at more than 17% last week, the highest level since at least 2015, according to data compiled by S&P Global. Short sellers borrow stock and sell it, betting they can profit by buying it back at a lower price later.
LBBW is looking to raise €500 million with the offering of a 10-year covered bond on Wednesday, a safe type of debt secured by a pool of assets.
(Updates with latest bond moves in third paragraph. A previous version corrected a reference to state ownership.)
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