A Slow-Motion Property Crash in Germany Is a Bigger Threat to Banks Than US CRE
- A long-term view of property values has shielded banks so far
- That could change soon if more forced sales hit the market
By Jack Sidders, Nicholas Comfort, and Neil Callanan
February 27, 2024 at 5:00 AM UTC
As fears about US commercial real estate roiled German banks this month, their message was clear: don’t worry, the vast majority of our property exposure is domestic.
That may not prove the comfort it seems.
While the country has so far avoided the rapid market corrections that rattled the US, experts argue that reflects arcane accounting practices shielding its lenders and investors from taking immediate hits. Relatively modest adjustments and benign provisions obscure the fact that German lenders are more exposed to commercial real estate than most of their European peers and, according to one study, extended loans more aggressively.
The result is a slow-motion property crash that threatens to accelerate as property owners such as Rene Benko’s Signa group of companies or landlord Adler Group are forced to sell, burdening smaller and mid-sized lenders that were just hitting their stride after bail-outs in the financial crisis. Some senior officials at the European Central Bank say the country will inevitably be a special focus as they examine CRE risks at banks across the region.
“This is definitely not just a US problem,” said Valeriya Dinger, a professor of economics at Germany’s University of Osnabrueck. “I wouldn’t be surprised if we see a wave of loan loss provisions for German banks on their domestic commercial real estate exposure,” she said, even if there’s no systemic risk.
German banks have the most commercial real estate loans in the European Union, along with their French peers, but they have classified a relatively small portion of those loans as non-performing. Recently, however, that share has been rising while it declined in several other countries.
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German Banks’ Commercial Property Loans Are Souring
Germany’s bad loan ratio in the segment is rising as that of peers stabilizes
The low level of loans marked as non-performing is in part because real estate valuers in Europe’s biggest economy use a long-term approach that smooths shifts in pricing on the basis that most investors don’t sell in a falling market. German banks also update valuations of buildings they have financed less regularly than peers in the US or UK, so problems can be masked for longer. Sometimes, they offer measures such as quarterly waivers on breaches of the loan agreement.
“There is nowhere to hide a covenant breach in the US,” said Keith Breslauer, founder of private equity firm Patron Capital Advisers. “That’s just not the case in Germany.”
Visibility is reduced further by rules that give smaller banks leeway in marking some securities to their market value, which can make it more difficult for investors to get an up-to-date picture of their financial state. The practice, however, also limits writing up unrealized gains, meaning individual lenders may actually be in better shape than they look.
Regulators have been urging lenders to prepare for potential losses, with the ECB pushing them to use some of last year’s bumper profits to build provisions. But accounting rules designed to stop banks from dodging taxes mean lenders are actually limited in how much they can set aside for souring debt.
Local watchdog BaFin for now sees the problem hitting individual lenders’ earnings, rather than threatening their solvency, in part because the troubles are concentrated in a smaller part of the market than they were during the financial crisis. And while higher rates are to blame for falling CRE values, they’ve also handed banks profits that should help absorb hits, said Birgit Rodolphe, executive director for bank resolution at the regulator.
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