DBRS Morningstar Confirms pbb’s Ratings at BBB (high) / R-1 (low), Trend Remains Negative

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 remains Negative. 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 takes into account our view that the Bank's underwriting and risk profile is well-managed and that the Bank’s capitalisation levels, that already reflect various changes to the regulatory framework, provide healthy buffers over regulatory minimum requirements. Specifically, the Bank’s capital levels 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.

The Negative trend reflects DBRS Morningstar’s view that the COVID-19 pandemic could 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 due to unprecedented support measures from governments, we expect demand and therefore rents and valuations for certain commercial real estate segments to decline, resulting in possibly lower lending volumes, and likely credit deterioration with the associated effects on earnings and capital.

RATING DRIVERS

An upgrade of the ratings is unlikely given the limited business diversification and the expected longer-term pressure on certain CRE segments. The trend would revert to Stable if any credit deterioration can be absorbed without a notable impact on capital ratios.

The ratings would be downgraded due to factors such as a marked deterioration in credit quality, a significant drop in profitability, or a material drop in capital levels.

RATING RATIONALE

pbb operates as a well-established specialist lender focused on commercial real estate (CRE) and public investment financing with core operations in Germany, the United Kingdom, and France complemented by operations in the Nordic Countries, Central and Eastern Europe (CEE) and the US. More than half of pbb’s portfolio consists of CRE lending, which is also the biggest contributor to earnings. pbb’s earnings streams are constrained by its narrow business focus and consist almost entirely consist of net interest income. Asset quality is linked to the commercial real estate cycle. The limited scope of pbb’s activities highlights the importance of maintaining strict credit discipline in originating new business.

DBRS Morningstar believes that the economic slowdown and the possible structural changes resulting from the COVID-19 pandemic could pressure pbb’s earnings for 2021 and beyond. In FY2020, net profit was EUR 117 million, down from EUR 179 million a year earlier, reflecting the negative impact on net income from risk provisioning, which increased to EUR 126 million from EUR 49 million a year earlier, mainly driven by the COVID-19 pandemic. In DBRS Morningstar’s opinion, the Bank’s ROE of 3.4% in FY2020 and 5.7% in FY2019 still compares favourably with German peers, but less well with international peers.
pbb’s earnings metrics showed some recovery in Q1 2021: on a group level, net income was EUR 42 million, up from EUR 2 million in Q1 2020. NII increased to EUR 123 million from EUR 111 million, driven by lower refinancing costs, the TLTRO III impact and improved floor income. Loan loss provisions declined to EUR 10 million from EUR 34 million a year earlier. Expenses from bank levies and similar dues increased markedly to EUR 28 million from EUR 21 million a year earlier.
Going forward profitability could be adversely affected by lower demand for CRE, which could result in lower loan volumes and a deteriorating credit profile of pbb’s customers, possibly requiring loan modifications and elevated provisioning levels.

In DBRS Morningstar's opinion, pbb has maintained a sound risk profile. However, credit concentration risk, arising inevitably from its CRE-centric business model, has the potential to deliver outsized credit losses, particularly if real estate markets deteriorate. While we consider pbb’s average LTVs for CRE loans of 52% to be conservative and the portfolio well diversified by sector and geography, we note, that certain segments could pose elevated risks. These include the retail and hotel sector, as well as development loans. In addition, there is uncertainty regarding the office market. For Q1 2021, pbb reported a NPL ratio of 0.9% and NPLs of EUR 503 million. However, 73% of non-performing loans pertain to the UK, mostly shopping centres, demonstrating the risk that can arise from a small segment.

DBRS Morningstar considers pbb’s funding profile to be resilient. Reflecting its asset mix, the Bank’s funding profile is predominantly reliant on wholesale funding. The Bank has an online retail deposit platform, however, at EUR 3.2 billion in Q1 2021, the deposit base, does not materially change the wholesale funding nature of the Bank. Nonetheless, the stability of the German Pfandbrief market even during the financial crisis enhances the resiliency of pbb’s funding profile. As a result of the COVID-19 pandemic, costs for unsecured funding increased considerably in FY2020. However, pbb had already reached its H1 2020 funding goals by the end of March, and participated in EUR 7.5 billion of TLTRO III, keeping funding costs low. By the end of Q1 2021, unsecured funding costs were close to pre-crisis levels.

DBRS Morningstar views pbb’s capitalisation as good, while noting that higher capital ratios are appropriate given the Bank’s business model, especially considering risk-weighted assets (RWA) might increase further due to rating migration. At the end of Q1 2021, the Bank’s fully phased-in Common Equity Tier 1 (CET1) ratio was 15.4% down from 16.3% a year earlier as RWAs increased by EUR 1.0 billion to EUR 18.3 billion. The RWA increase resulted from portfolio growth, rating migration and regulatory and liquidity adjustments. The CET 1 ratio already incorporates regulatory changes such as an asset risk weight recalibration related to TRIM (Targeted Review of Internal Models) 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 a temporary CET 1 ratio requirement of 8.86% for pbb. This provides the Bank with a CET1 buffer of 654 basis points.

ESG CONSIDERATIONS

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/373262.

The Grid Summary Grades for Deutsche Pfandbriefbank AG are as follows: Franchise: Good/Moderate; Earnings Power: Good/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 . Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021) https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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

The sources of information used for this rating include pbb’s Q1 2021 Presentation, pbb’s Q4 2020 Presentation, pbb’s 2020 Annual Report, 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.

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.

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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/379365.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Sonja Förster, Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of European FIG and Global FIG
Initial Rating Date: July 19, 2006
Last Rating Date: June 12, 2020

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