DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long- and Short-Term Issuer Ratings of Deutsche Pfandbriefbank AG (pbb or the Bank) at BBB (high) / R-1 (low). The trend on pbb’s long-term and short-term ratings remains Stable. pbb’s intrinsic assessment (IA) was maintained at BBB (high). The support assessment for the Bank is SA3. A full list of ratings can be found at the end of the press release.
KEY RATING CONSIDERATIONS
The confirmation of pbb’s ratings is supported by the Bank's well established franchise and expertise in commercial real estate finance, conservative underwriting, and solid capital cushions above regulatory minimum requirements. The ratings also take into account pbb’s sound funding & liquidity profile, which largely relies on covered bonds, supplemented by other funding sources and supported by its access to ECB funding. These factors are partly offset by the Bank’s moderate profitability, its limited earnings diversification and risk concentration in the cyclical commercial real estate (CRE) sector.
The Stable trend acknowledges that the operating environment for CRE has become more adverse with a likely impact on pbb’s earnings and credit quality metrics. We note that pbb does not benefit from rising interest rates due to its funding profile, and can therefore not offset the loss of the TLTRO III benefit, which expired in November 2022. However, at this point we believe that pbb will continue to generate reasonable levels of profitability and that an increase in nonperforming loans will not necessarily translate into outsized credit losses due to conservative underwriting.
An upgrade of the ratings is unlikely, given the limited business diversification and the deteriorating environment for commercial real estate. The ratings would be upgraded if the Bank significantly improves profitability, while maintaining a conservative risk profile.
The ratings would be downgraded in case of a marked deterioration in credit quality, a significant drop in profitability, or a material drop in capital levels.
Franchise Combined Building Block (BB) Assessment: Good / Moderate
Until 2022, the Bank’s two core business segments were Real Estate Finance (REF) and Public Investment Finance (PIF). The Bank also operated a non-core Value Portfolio (VP) segment which includes the Bank’s non-strategic assets such as the legacy Public Budget Finance portfolio, and has gradually been wound down. Starting in 2023, the two public finance segments have been combined into a non-core unit and will be gradually wound down. In addition, the Bank disclosed its intention to expand its fee generating business by offering real estate investment management services in partnership with renowned fund managers. The goal is that fee revenues should account for 5-10% of total revenues by 2026, up from 1.5% in 2022. We note that this new fee-generating business is capital-light and helps reduce pbb’s reliance on net interest income. However, given the currently challenging operating environment for CRE, it is not clear how long it will take for this business to meaningfully add to earnings. Even if pbb succeeds in growing fee revenues, in our view, the Bank will largely remain a monoline business.
Earnings Combined Building Block (BB) Assessment: Moderate
pbb’s profitability is somewhat modest when compared to international peers. In addition, income streams lack diversification due to a business model centred on commercial real estate lending and public finance, and consisting almost entirely of net interest income. With the creation of a new fund management business, fee income will increase but the profit and loss account (P&L) remains exposed to the CRE cycle. 2022 net profit was down by 17% Year-on Year (YOY) to EUR 187 million from EUR 228 million in 2021 despite stable core revenues and lower loan loss provisions (LLPs) due to much lower early termination fees from early repayments by clients. The Bank reported a Return on Equity (ROE) of 5.5% in 2022 down from 7.0% in 2021. Q1 2023 earnings were also weaker with pre-tax profit of EUR 32 million down from EUR 42 million a year earlier, due to the loss of floor income and the TLTRO III benefit. This was only partially offset by growth of the REF portfolio, higher new lending margins and lower LLPs. For 2023, revenues continue to be impacted by the loss of TLTRO III and floor income, while expenses should increase, reflecting the strategic initiative. At the same time, we expect modest portfolio growth, margin expansion, low credit costs, and the benefits from higher deposit funding to partly offset these negative trends.
Risk Combined Building Block (BB) Assessment: Good / Moderate
We believe that pbb has generally managed its credit risk conservatively and has reduced exposure to riskier areas such as retail. However, the Bank’s intrinsically high credit concentration risk to CRE has exposed the Bank to the pressure that the sector has been experiencing since Q4 2022, due to factors such as higher rates and lower demand for office space. This has been reflected in a rapid increase in the non-performing loan (NPL) stock to EUR 953 million at end-Q1 2023 from EUR 580 million at end-2021.. This translates into an increase of the gross NPL ratio as calculated by DBRS Morningstar (including loans in forbearance) to 2.5% at end-Q1 2023 from 1.5% at end-2021. The main driver for this asset quality deterioration was US office property loans. We note, however, that US NPLs were largely driven by covenant breaches and less by failure to pay interest, and provisioning needs in relation to these loans have been minor, so far. We expect the CRE sector to remain challenging in 2023 and NPLs to increase further as higher rates pressure some borrowers’ capacity to service debt and increases refinancing risk, while valuations are expected to decline.
Funding and Liquidity Combined Building Block (BB) Assessment: Moderate
pbb is predominantly wholesale funded, with a high reliance on covered bonds, reflecting its asset mix. In our view, this adds to the resiliency of pbb’s funding profile, given the stable and conservative profile of the German covered bond “Pfandbrief” market. The Bank also has some utilisation of unsecured debt, customer and retail deposits, and liabilities to banks. pbb also took advantage of TLTRO III funding, but repaid EUR 5.75 billion by end-2022 after the preferential treatment ended. Currently, an amount of EUR 2.65 billion is still outstanding. Since March 2022, the Bank’s costs for unsecured funding have increased considerably. This, in combination with the loss of the TLTRO III funding advantage, prompted the Bank to expand its retail deposit franchise. Throughout 2022, the deposit volume increased from EUR 3.2 billion to EUR 4.4 billion and further rose to EUR 5.4 billion at end-Q1 2023, and most of the deposits are term deposits. Pbb plans to bring this number above EUR 8.0 billion by 2026. In our view, this does not materially change the wholesale funding nature of the Bank, but helps diversify funding and lower funding costs to some extent.
Capitalisation Combined Building Block (BB) Assessment: Good / Moderate
We view pbb’s capitalisation as solid, though possibly weakening. At the end of Q1 2023, the Bank’s phased-in Common Equity Tier 1 (CET1) ratio was 16.6%, down somewhat from 16.9% a year earlier as RWAs increased from EUR 16.7 billion to EUR 17.1 billion. The CET1 ratio already incorporates regulatory changes with regards to Basel IV, and compares to a CET1 SREP ratio requirement as of 1 March 2023 of 9.31% (including an anticipated additional buffer of 90 basis points (bps)). This provides the Bank with a CET1 buffer of 729 bps. From 2023 to 2025, the Bank plans to pay out a dividend of 25% in addition to its regular dividend policy of 50%, while maintaining a CET1 ratio of at least 14%. Given the concentration risk and the cyclicality of the CRE business, maintaining healthy capital cushions is an important rating factor. In currently deteriorating environment for CRE, we will be monitoring the maintenance of the Bank’s capital cushions closely.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/414468.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022)
All figures are in EUR unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations https://www.dbrsmorningstar.com/research/398692 (23 June 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/ in its consideration of ESG factors.
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies
The sources of information used for this rating include Morningstar Inc. and Company Documents, pbb 2018-2022 Annual Reports, pbb 2022 and Q1 2023 Presentation, pbb 2022 Disclosure Report. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.
With Rated Entity or Related Third-Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO
DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/414467.
This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Sonja Förster, CFA, Vice President - Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Global Head of Financial Institutions
Initial Rating Date: July 19, 2006
Last Rating Date: May 27, 2022
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