Rising risks among lenders, particularly among German banks with their strong exposure as commercial real estate financiers, are becoming increasingly worrying, warns rating agency Moody’s in a recent note. COVID-19 is threatening a wave of payment defaults, and a decline in the quality of collateral. While German banks are watching the situation carefully, their reactions are differing widely, says Moody’s.
German banks’ exposure to commercial real estate lending can be seen in last year’s figures where, of the €1.6 trillion invested in the European Union in commercial real estate loans, German banks were involved in 27% of that lending.
Moody’s analyst Christina Holthaus said: "A decline in commercial real estate prices in the various asset categories will affect the collateral level and the loan-to-value ratios in the banks' portfolios." Depending on how long the COVID-19 crisis lasts, she said, the suspensions of payments, defaults and declining collateral levels could lead to a deterioration in asset quality, an increase in non-performing loans, higher risk provisioning requirements and lower income.
Not surprisingly, the Moody’s analysts have focused in primarily on hotels, non-food retail and offices – the sectors most threatened by closures and insolvencies, and where repayment of the underlying financing is most endangered.
Of the German banks, Moody’s looks at Aareal Bank, Berlin Hyp, Deutsche Hypo and Deutsche Pfandbriefbank (pbb), which are particularly active in commercial property financing. The analysts in their note concede that these institutions generally possess a "strong solvency profile", which "to a certain extent mitigates the risks".
The Wiesbaden-based Aareal Bank is proportionally the most active internationally, with 32% of its lending portfolio is located in North America, with the same amount in western Europe. Only 12% of the financing is in Germany. The bulk of the bank’s lending (34%) is in hotels, with 30% in offices and 23% in retail.
The bank saw its profits shrink sharply recently, and bad debt provisions were upped strongly in both the first and second quarters of 2020. However, despite the current enthusiasm for home office working, Aareal Bank believes "that high-quality office space will continue to be needed in the future - especially in the top locations of the cities where we finance". The bank views hotels as facing a "restrained gradual recovery, although this differs from region to region", but sees many of its customers as having accumulated sufficient liquidity over the past few years to weather the downturn. It also plans to continue financing retail on a selective basis.
Also very active internationally, Munich’s pbb Deutsche Pfandbriefbank has a 48% weighting towards German investments. Great Britain and France follow at a distance, with a weighting of 11% each. Among asset categories, office financing dominates with 47%, residential with 18% and retail with 16%. pbb had been already reducing its new commitments in shopping centers and the non-food sector before the pandemic, and neither in retail nor in hotels has the bank made any new commitments in the second quarter of 2020 – apart from extensions.
Hanover-headquartered Deutsche Hypo has a stronger focus on Germany than Aareal bank, with 53.1% of its financed real estate is located here, 17.7% in Benelux and 13.9% in the UK. In terms of property types, office and administrative properties dominate with 37.4%, followed by retail properties with 31.3%. The residential share is 18.2% and hotels play a rather minor role with 7.8%.
Deutsche Hypo CEO Andreas Rehfus said in a recent media interview with trade journal Immobilien Zeitung that while his bank is not immune to the effects of the virus crisis, it IS bolstered by its own conservative financing structures. “Nonetheless, Deutsche Hypo's volume of new business shrank significantly in the first half of 2020 to €765.5 million, compared to the previous year’s, €1.5 billion”, he said. He expressed optimism about the office sector, where he saw market demand remaining high. The top rents in top locations are "stable to slightly rising at a high level", he says. He has not observed any reductions in rents so far, and sees upside potential for offices to counteract current corona-induced trends.
Likewise, Berlin Hyp has a greater focus on lending in its home market, with 70% of its commitments in Germany. Office and commercial buildings account for 43% of the portfolio and residential properties for 23%. Hotels play only a minor role with 3%. "Despite the fact that credit risks have not yet materialised, we have formed extensive contingency reserves and further strengthened the special item for general banking risks," according to a spokeswoman, adding that the bank is well prepared for a possible downturn in the real estate market. In the retail sector, the food segment, local supplies and specialist retail centers remained attractive. In the office segment, the bank is relying on a compensatory effect in terms of usage. The lower demand for space could be offset by increasing hygiene requirements, distance rules and new space demands, it said.
