Parent bank opts for IPO rather than trade sale for real estate lender, writes Lauren Parr
Why Hypo Real Estate changed track in its sale of pbb Deutsche Pfandbriefbank is not known. Last month the German government-owned bank (and pbb’s sole shareholder) said it would list real estate lender pbb in July, after inviting bids for the bank by the end of May.
According to The Wall Street Journal, bids were expected to value pbb at €1.2bn-1.8bn, with China’s Anbang Insurance Group, and Blackstone, thought to be possible bidders. HRE had always said that financial advisers Citigroup and Deutsche Bank would explore a sale or initial public offering (IPO), but it is unclear whether it chose an IPO because the bids it received were considered too low.
The government believes an IPO “will bring the best result compared with a sale”, said Jutta Doenges of the German Financial Markets Stabilisation Agency. HRE chairman Dr Günter Bräunig said pbb was “flotation-ready in every way”, as its management team “has successfully positioned the bank on the lending and funding markets”.
HRE plans to sell at least 71.5% of shares, with the German government retaining a minimum 20% stake for two years.
Pbb is profitable: pre-tax profit rose from €124m in 2012 to €174m in 2014, not including negative one-off effects related to Austrian bad bank HETA Asset Resolution. Net interest income rose from €296m in 2012 to €421m in 2014, when pbb wrote €10.2bn of new business, mainly real estate, making it one of Europe’s top property lenders.
Yet the IPO could be challenging for a number of reasons. One is that pbb failed to hit its returns on equity (RoE) target – a key profitability metric for banks. Pbb’s 2014 results showed post-tax RoE of 3.4% (without valuation adjustment relating to HETA exposure), down from 7% in 2013, below its ‘high single-digit’ mid-term target.
The bank also admitted in its Q1 2015 results that margins are being squeezed.
Margins come under pressure
One competitor says margins generally are under pressure as banks’ capital requirements are growing. “Two or three years ago people started to write back losses, creating additional profitability. But net margins on new business now are half what they were 24-36 months ago; there’s been a massive decline in new business profitability.”
Pbb says its average gross real estate finance margins were over 200 basis points in 2014, compared with 225bps in 2012. In the public finance sector, gross margins were lower, “in a range of >140bps and >75bps annually during the same period.”
“I’m struggling to understand why anyone would want to own a pure real estate lender that has a low RoE,” a source with financing experience says.
He adds that pbb’s public sector book will be another challenge. “It is using a tiny amount of equity now, as it’s viewed as low-risk, quasi-sovereign debt. But when Basel III leverage ratio rules are fully implemented soon, it will be tough for pbb to meet the 5% or 6% assets versus equity required of big banks,” he believes.
Last year, the government’s bail-out fund Soffin overruled a planned €320m sale of that part of pbb to US-based investor Leucadia and its partner Massachusetts Mutual. This surprise decision prompted the resignation of pbb’s chief executive Manuela Better. She was replaced by co-CEOS Andreas Arndt and Thomas Köntgen.
The bank continues to finance public sector investments such as infrastructure projects and provides government-backed export finance. It has a ‘non-strategic value portfolio’ of public budget finance assets (mainly bonds), which is being wound down.
Fitch Ratings has a “negative view of pbb’s plan to maintain public investment finance as a big part of its activities. These assets’ low margins dilute the bank’s modest return on assets and tie up significant regulatory capital”, Fitch said when it downgraded pbb’s credit rating in May.
The third challenge is the scale of the flotation, which will require a strong market. “How much demand is there for real estate banks?” asks the competitor lender. “Real estate markets are very strong and improving, but half the assets are German [the rest are international], a market in which lending is less profitable in terms of margins.”
When announcing the IPO, pbb’s Arndt said investors would benefit “from pbb’s sustainable business model in a growing market and an attractive risk/return profile.”
Whether investors agree is about to be tested