Despite unstable financial markets and increasingly strict banking regulations, the privatization of the nationalized Deutsche Pfandbriefbank (PBB) has begun under a European Commission mandate that requires the transition to be completed by the end of 2015.
PBB was formed in June 2009 when the failed mortgage lending banks Home Real Estate Holdings AG, also known as HRE, and its Irish subsidiary, DEPFA, were merged and renamed in the most expensive bank bailout in German history. The government has owned the bank since October 2009.
“We began with the privatization about eight weeks ago,” said Andreas Arndt, PBB’s chief financial officer. He said the bank has created a steering committee with the Federal Finance Ministry and the Special Financial Market Stabilization Funds, a government program created in 2008 to restore confidence in Germany’s financial sector during the global economic meltdown. Still to be decided is whether the bank will be privatized through a sale of stock or by a sale to a strategic investor.
The process is politically tricky. The bailout cost German taxpayers dearly as the government poured €9.8 billion ($13.1 billion) into the troubled bank while disposing of a problematic portfolio, estimated at €174.1 billion ($233.1 billion), accumulated by FMS Wertmanagement, the so-called “bad bank” of HRE, for which market stabilization funds so far have paid out €9.3 billion ($12.5 billion) in compensation for losses.
Alexander Plenk, a financial analyst at Munich-based BayernLB, acknowledged the obstacles facing the sale of the bank, saying it will be an “extremely difficult undertaking.” PBB is a proper bank operating in stable markets, he said, “but its return on equity is comparatively low.” He believes the only way to sell PBB is at a price well below its “book value,” which is defined as the value of net assets. The problem for the bank, he said, is that it has an owner that “is looking for quite a high price.”
“It would be important for PBB to find a good boss, particularly because PBB will never be measured against Aareal Bank and its strong executive officer.”
On a positive note, PBB’s pre-tax profits rose by more than a fifth to €83 million ($111 million) and the bank hopes to earn more than €140 million ($187 million) in 2014. It owes the increase in profits, in particular, to significantly lowered administrative costs, but also to higher credit margins.
New business is growing. PBB issued new real-estate credits valuing €3.7 billion ($4.9 billion) and €600 million ($803 million) in loans involving public infrastructure – close to a record amount. Yet the bank’s financial statement reveals the return on equity before taxes was an unimposing 4.9 percent.
By comparison, Aareal Bank Group AG, which also focuses on the commercial real estate and housing industries, enjoys a return on equity of 23 percent, which admittedly is skewed by a special item. But even when the special item is removed, the bank still doubles PBB’s return with 9 percent. So, although PBB is doing better and is the larger bank, it is still less profitable.
Low profitability is only one reason why investors are demanding a discount on the book value. Guy de Blonay, lead manager of the British-based Jupiter Financial Opportunities Fund and deputy manager of the Jupiter International Financial Funds, said a discount on the PBB price can be justified not only by comparison with Aareal Bank, but also because PBB is not involved solely in financing commercial real estate. “It would be well-advised,” Mr. de Blonay said, “to get rid of its non-commercial real estate business.”
In the case of Aareal Bank, the market value is approximately equal to the net assets with a price-to-book value ratio of 95 percent. For PBB, however, financial professionals consider a price-to-book value ratio of only 50 percent more realistic. The question is whether a discount on the book value is politically feasible since the government would be selling the bank for less than its net worth.
The comparison with Aareal Bank is not always flattering for PBB, yet in one aspect, its competitor also is a blessing.
“With Aareal Bank, which is quite successful at the moment, you have a prime example of a business model that can function,” says Guido Hoymann, co-head of research at Bankhaus Metzler.
Equally important to a sale is to address the vacuum at the top levels of management. In June, chief executive officer Manuela Better exited after the federal government halted the liquidation sale of DEPFA. The search for a successor continues. Much depends on who is selected to lead the bank.
“It would be important for PBB to find a good boss, particularly because PBB will never be measured against Aareal Bank and its strong executive officer,” said Mr. Hoymann. “The new head of management must embody in a credible manner the fact that PBB is more strongly-oriented toward profitability and is lowering costs relatively significantly.”