One corner of the Additional Tier 1 (AT1) market stands out in the global bond selloff, where rising rates are squeezing banks with large property-lending businesses, hammering their riskiest debt. AT1s issued by Germany's Landesbank Baden-Wuerttemberg are indicated below par on Friday for the first time in more than a year, based on data compiled by Bloomberg. Those sold by Deutsche Pfandbriefbank AG, or PBB, fell below 80 cents on the euro, making them the worst performers in Europe's AT1 market in September.
Rising government bond yields — supercharged by high energy costs and expected central bank rate hikes to tackle inflation — have slashed returns for AT1s. Property-exposed lenders have been hit especially hard because of the industry's sensitivity to rates, while the structure of AT1s amplifies losses. Concerns about the Iran War taking longer to resolve than expected started pushing energy prices higher in August. That set off a broad bond selloff as a hawkish tone from Federal Reserve Chairman Kevin Warsh undercut the US administration's efforts to support long bonds through buybacks.
An index of euro-hedged AT1s flipped from gains to losses, with the gauge now down 2% in total return terms since August. LBBW's €750 million ($844 million) issue, callable in 2030, is down twice as much. PBB's €300 million bond, which moved past its first call date three years ago, has lost more than 9% over the same period. Investors don't need long memories to recall the last time this played out in the AT1 market. Concerns about the US commercial property market hit banks from US to Japan and Europe in early 2024.
"It echoes 2023 and 2024," said Sebastien Barthelemi, head of credit research at Kepler Cheuvreux. Back then, dealers were quoting PBB's AT1 at 20 cents on the euro. "Investors in AT1s are familiar with the correlation" between higher rates and how they spill over onto bonds of banks with big real estate exposures, Barthelemi said. Representatives at LBBW and PBB declined to comment. PBB called commercial real estate financing "the backbone" of its business in its latest annual report. Real estate accounts for almost a fifth of LBBW's exposures, according to a presentation to investors earlier this year. Real estate is a debt-heavy business, making it particularly vulnerable to higher rates that depress property values and weaken borrowers' credit metrics. For banks, that can mean greater stress on existing loans and fewer opportunities for new lending. The pain is being felt beyond AT1s. Net Zero Properties Sarl, a firm that buys neglected apartments in Germany, recently dropped plans to borrow €500 million after failing to convince investors with sweetened terms. That comes as subordinated debt issued by landlords has fallen sharply in value. Commercial real estate at some European banks, especially those in Germany, was getting weaker even before the latest selloff in bonds, said Jakub Lichwa, portfolio manager at Twenty Four Asset Management.
"Absent a recovery in the rates market, I would expect the mix of these factors to contribute to the underperformance of CRE-focused AT1s versus the index," he said.
Source: Bloomberg Markets · Summarized by HeadlinesBriefing