To judge by the senior and covered bond markets, concerns about banks being fried in a meltdown of the commercial real estate market — particularly in the US — look overblown. But this is just the tip of the capital stack iceberg. Banks with real estate problems face costly — and most likely tricky — capital refinancings.
Falling commercial property values have sent shockwaves through the bank bond market over the last year. Spreads for banks with large exposures have widened, while a pair of specialist German lenders highly exposed to the US market — Aareal Bank and Deutsche Pfandbriefbank — were downgraded earlier this year.
German banks are in the crosshairs, as they have the second highest commercial real estate exposure in the eurozone after those in France, according to the European Banking Authority's July risk assessment report, published last week. Of the €284bn of commercial real estate exposure on these banks’ balance sheets, more than €50bn is in the troubled US market.
But investors have shown recently they are more than happy to load up on senior exposure to these specialist banks.
Last Wednesday, Aareal Bank — with €32.5bn of commercial real estate exposure at the end of 2023 — attracted €1.6bn of orders for a €500m 3.25% May 2029 4.8 year mortgage Pfandbrief.
Aareal’s outcome was a million miles away from what it achieved with its last covered print in January. Then, it could only rustle up €375m of orders for a €500m 2.875% May 2028 4.3 year bond, data from GlobalCapital’s Primary Market Monitor show.
Meanwhile, Hamburg Commercial Bank — €7.8bn of CRE loans at new year — swooped into the senior non-preferred market on Tuesday. Its €500m 4.5% July 2028 four year bond got a €1.7bn book.
Of course, HCB has a smaller share of its commercial real estate loans in the US, at only 4%, compared with Aareal’s 25% or Deutsche Pfandbriefbank’s 15%.
But all these recent deals are senior: investors are shielded from any property losses. Buyers of Aareal’s covered bond, enjoy a dual recourse structure and triple-A rating.
Capital concerns
What will stretch banks like these much more is refinancing their capital deals. That will be a true barometer of how far investors' appetite for property-exposed banks has recovered.
Aareal and Deutsche Pfandbriefbank (PBB) have not had the best of luck in recent years when refreshing their capital stacks.
Although this was not blamed on property concerns, more than two years ago PBB was forced to pull a planned refinancing of its €300m 2.875% call June 2022 tier two capital bond. As of July 2024, PBB has yet to refinance it.
And both Aareal and PBB have skipped calling additional tier one capital issues in recent years. Although for both, there were extenuating circumstances, neither has returned since to refinance.
Pfandbriefbank had the misfortune to have an AT1 come up for call amid the fallout from Credit Suisse’s collapse last spring.
The €300m 5.75% note was not redeemed when its April 2023 call arose. Instead, dismayed by the cost and poor market conditions for a refinancing, PBB let its coupon reset to 538bp over five year euro mid-swaps.
Meanwhile, Aareal has now skipped the April call on its €300m 7.625% AT1 note four times since 2020. Like Pfandbriefbank, Aareal found itself in an uncertain market, this time racked by coronavirus volatility. However, despite improving conditions, the bank has yet to attempt a refinancing.
Investors seem more than happy to pour into senior deals from these banks. For instance, covered bonds — the cockroach of the capital markets — seem destined to survive any crisis thrown at them and no covered bond has ever defaulted. But the same cannot be said about capital deals, which leave investors directly exposed to the issuer's risk.
If — and when — these banks pluck up courage to refinance their beleaguered capital notes, only then will the market get a handle on just how deep go investors' worries over commercial real estate exposures.
For now, these concerns appear skin deep — but will investors show the same appetite at the bottom of the capital stack as they have for the top?