European Bonds Gain Attractiveness as Deutsche Pfandbriefbank Falls Short on Bond Buyback

Key Takeaway

• Deutsche Pfandbriefbank's bond buyback fell short, repurchasing only €58 million out of a targeted €300 million, signaling investor confidence in holding the debt.
• Analysts at Deutsche Bank predict rising corporate default rates due to higher interest rates, ending a two-decade era of low defaults.
• European bonds, particularly German ones, are becoming more attractive due to recent yield increases and ECB's cautious stance on rate cuts.

Deutsche Pfandbriefbank Bond Buyback

Deutsche Pfandbriefbank AG (Deutsche PBB), a prominent German real estate lender, recently attempted to repurchase some of its bonds but fell short of its target as investors chose to retain their holdings. The bank managed to buy back approximately €58 million ($62 million) of notes across three instruments, despite offering to accept up to €300 million, according to corporate filings. The price offered for one of the notes was 96.75 cents on the euro, while the pricing for the other two bonds was to be determined based on market terms and a repurchase spread. For these two bonds, investors put up only €5 million combined for sale.

A buyback at a discount versus face value is typically a strategy for a borrower to reduce its debt while saving money. It also signals to the market that the borrower has sufficient cash reserves to undertake such an optional exercise. Earlier this year, Deutsche PBB became a notable example of European banks affected by concerns that issues in the US commercial property markets might spread to Europe. The lender experienced a significant drop in its shares and bonds before recovering some of the losses.

However, the scope of this buyback was limited. The maximum amount Deutsche PBB was willing to repurchase was €300 million, a small fraction of its total debt, which exceeds €20 billion, according to Bloomberg data. Looking ahead, the European Central Bank (ECB) is expected to urge several German lenders to increase their reserves against property loan defaults, which could impact their profits. Banks like Deutsche PBB, with substantial commercial real estate loan portfolios, are a primary focus of the ECB's efforts.

Deutsche Bank on Default Rates

Analysts at Deutsche Bank AG have indicated that the era of low corporate default rates over the past two decades is coming to an end. The increase in interest rates is expected to lead to a higher number of borrowers failing to repay their debts. In a note published on Monday, Deutsche Bank analysts, including Jim Reid and Steve Caprio, stated that default rates will rise, although a significant surge may still be avoided. "For 40 years, virtually all fixed-rate borrowers across the economy could refi at a lower rate than they’d previously achieved," the analysts wrote. "This changed after 2022, but the full impact could still be slow to be felt. So there is perhaps a ‘boiling frog’ analogy here where the market doesn’t notice it, until it does."

The central banks' efforts to raise rates to combat inflation have made borrowing more expensive for many riskier companies, leading to an uptick in defaults globally. Despite hopes for a return to low-default conditions, Deutsche Bank analysts doubt that the next few years will be as stable. One factor that could exacerbate the situation is the number of maturities in the coming years for lower-rated borrowers. More than 20% of sub-BB borrowers face a maturity in the next three years, according to the research.

While defaults have not yet reached the levels many anticipated, last year's Deutsche Bank report predicted a surge in defaults due to a US recession. However, the analysts revised their outlook at the start of 2024 due to a more optimistic US growth forecast. They still believe that structurally higher default levels will persist over the next few years.

European Bond Market Insights

Bill Gross, a well-known bond investor, has expressed optimism about the attractiveness of European bonds, particularly German bonds, due to recent yield increases. Yields in Germany, France, and Italy have risen by around 40 basis points this quarter, with euro-area bonds experiencing even more significant increases since the start of the year. This trend contrasts with the expectations of investors who anticipated policy loosening from the European Central Bank (ECB) at the beginning of the year.

The ECB, led by President Christine Lagarde, has completed one interest rate cut but is pushing back against the notion of successive reductions. The ECB's policy decisions are influenced by the Federal Reserve's stance, as German and euro-area bonds are highly correlated with US Treasuries. The ECB has less room to cut rates compared to the Fed, especially with inflation projections remaining above 2% until 2026.

While euro-zone bonds appear attractive from a long-term perspective, timing is crucial. Gross himself has experienced the challenges of timing in the bond market, famously calling German bunds the "short of a lifetime" in 2015, a prediction that proved premature.