DBRS Morningstar Revises pbb’s Trend to Negative, BBB (high) / R-1 (low) Issuer Ratings Confirmed

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 for all ratings was changed to Negative from 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 Negative trend reflects DBRS Morningstar’s view that the Coronavirus Disease (COVID-19) pandemic is likely to have a negative impact on pbb’s more cyclical real estate lending and that the Bank has limited business diversification to offset this impact. While the full extent of the impact from COVID-19 cannot be assessed at this point, we expect rents and valuations for commercial real estate to decline, resulting in a potential increase in credit losses with the associated effects on earnings and capital.
The confirmation of pbb’s ratings takes into account that the Bank's underwriting and risk profile is well-managed and that the Bank’s capitalisation levels, even after taking into account changes in the regulatory framework, still provide healthy buffers over regulatory minimum requirements. Specifically, the Bank’s capital levels now incorporate the Targeted Review of Internal Models (TRIM), changes in EBA guidelines and the expected effect of Basel IV on risk weighted assets (RWA). The ratings also reflect pbb's solid liquidity profile, supported by the Bank's established Pfandbrief (covered bond) funding programme, as well as access to ECB funding.

RATING DRIVERS

An upgrade of the ratings is unlikely given the limited business diversification and the expected negative impact from COVID-19.
The ratings could be downgraded due to factors such as i) marked deterioration in credit quality, ii) a significant drop in profitability, or iii) an unexpected drop in capital levels.

RATING RATIONALE

In DBRS Morningstar’s view, the economic slowdown and uncertainty created by COVID-19 will pressure pbb’s earnings for 2020 and possibly beyond. pbb’s earnings power is constrained by its narrow business focus, which is concentrated on commercial real estate lending. As such, revenues almost entirely consist of net interest income, and asset quality is linked to the commercial real estate cycle. pbb’s portfolio is geographically diversified, however, given the global nature of the pandemic DRBS Morningstar expects a weakening in earnings across all regions.
As a consequence of COVID-19, pbb expects the biggest impact on earnings to come from higher provisioning needs. On the revenue side, new business volumes are expected to drop due to lower investment activity, but this is mitigated to some extent by higher margins in real estate lending (up to approx. 170 bps in Q1 2020 from approx. 155 bps for FY2019) and lower prepayments. In terms of provisioning, the company had already started to add to provisions in Q4 2019 to reflect increased macroeconomic risk as well as a price decline in UK retail properties as rents had already started a downwards trend. In Q1 2020, pbb incurred EUR 49 million in COVID-19 related expenses, of which EUR 32 million accrued to risk provisioning and EUR 13 million to fair value adjustments. Management expects the latter to revert over time, as they mainly originated from exposure to German Federal States.

In DBRS Morningstar's view pbb has maintained a sound risk profile. However, credit concentration risk, arising inevitably from its CRE business model, has the potential to deliver outsized credit losses, particularly if real estate markets deteriorate, which is currently happening across all geographies as a result of COVID-19. DBRS Morningstar is of the opinion that credit risk represents the biggest risk for pbb related to COVID-19. The Bank’s main credit risk lies within the Real Estate Finance (REF) portfolio, which constitutes about half of pbb’s total portfolio. Sectors most at risk since the start of the COVID-19 pandemic are the retail sector (16% of REF), the hotel sector (5% of REF), as well as development loans (16% of REF). Another area of concern has been the U.S. market (9% of REF), which is a relatively new market for pbb. DBRS Morningstar believes that conservative underwriting as demonstrated among others by an average LTV of 53% and high interest service coverage rates help mitigate the risk. However, the expected drop in real estate demand resulting in lower rents and valuations is likely to cause significantly higher nonperforming loans and associated higher provisions.
DBRS Morningstar considers the Bank’s funding and liquidity profile as good. The balance sheet is predominantly wholesale funded via secured mortgage and public sector Pfandbriefe, which DBRS Morningstar considers to be a more stable form of market funding and, to a lesser extent, via unsecured funding. As a result of the COVID-19 pandemic, costs for unsecured funding have increased considerably. However, pbb had already reached its H1 2020 funding goals by the end of March and is not under pressure to access the market. Going forward, lower issuance in the unsecured market could be offset by increased funding in the Pfandbrief market, access to ECB facilities, and the expansion of retail deposits. The Liquidity Coverage ratio (LCR) was strong at 285% at end-Q1 2020, comfortably exceeding the 100% minimum requirement.
DBRS Morningstar views pbb’s capitalisation as good, while noting that higher capital ratios are appropriate given the Bank’s business model, especially considering RWAs might increase due to COVID-19 related impact. At the end of Q1 2020, the Bank’s fully phased-in Common Equity Tier 1 (CET1) ratio was 16.3%. This number already incorporates regulatory changes such as an asset risk weight recalibration related to TRIM as well as changes in EBA guidelines and anticipation of Basel IV, and compares to a pre-crisis CET1 SREP ratio requirement for 2020 of 9.95% (including the countercyclical buffer). The ECB's Banking Supervisory Committee's decision to temporarily lower CET1 requirements and the suspension of the countercyclical buffer resulted in total capital relief of 154 bps for pbb.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

The Grid Summary Grades for Deutsche Pfandbriefbank AG. are as follows: Franchise: Good/Moderate; Earnings Power: Moderate; Risk Profile: Good; Funding/Liquidity: Good; Capitalisation: Good

Notes:
All figures are in EUR unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (8 June 2020) https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

This is an unsolicited 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 sources of information used for this rating include pbb 2019 Annual Report, pbb Q1 2020 Earnings Presentation, pbb Q4 2019 Earnings Presentation and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are 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: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/362621

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Sonja Förster, Vice President – Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director - Global FIG
Initial Rating Date: July 19, 2006
Last Rating Date: June 19, 2019

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