German Debt Project: Lenders fear further margin decline

Downward pressure on German real estate loan pricing could persist, with a survey of the country’s lenders showing that an 8 basis points (bps) decline is expected this year.

The 2016 German Debt Project report, compiled by the International Real Estate Business School at the University of Regensburg, showed that net margins for new lending across the sample could drop to an average 111 bps by the end of the year.

The report was based on interviews with 23 German lenders holding an aggregate property loan book of €183 billion.

Net margins for new lending fell by 11.5 bps during 2015 across the sample, bringing pricing to an average 118 bps. The decline was sharper than in 2014, when pricing fell on average 4 bps.

Commercial real estate margins dropped by 8 bps, while residential financing margins were down almost 20 bps.

Interviewees expressed the hope that pricing would bottom out in 2017, although some questioned how competitive pressure will be eased.

Loan-to-values across the portfolio were 68.2 percent, up marginally from 67.8 percent. The report also noted that covenants are coming under competitive pressure.

“Operating margins are only risk-congruent if the real estate market risks persist at their current level and the need for risk provisioning thereby remains low – and regulation does not continue to intensify, although this is a clear possibility,” said Markus Hesse, CEO of the business school and one of the report’s authors.

However, most full-service banks are allocating increasing resources to real estate financing, due to the continued profitability of the sector. Insurance companies and pension funds are also increasing their commitment to real estate equity and debt.

The new business growth rate was 19.8 percent during 2015, more than double 2014’s growth. Total new lending was €137.2 billion, up from €114.6 billion in 2014.

Growth continued into the first half of 2016, with new business up by around 20 percent during the six month period. The organisations surveyed anticipated volume growth of just 6 percent for full-year 2016, although the authors said this was “unduly cautious” despite noting that CRE transaction volumes dipped in Q2.

“Business is becoming ever more complex,” commented Tobias Just, head of scientific research at the business school. “What is noticeable is the strong growth in the financing of operator real estate, properties outside of the top cities and in project financing.”

During 2015, new business growth for commercial real estate including commercial project financing was 37 percent, while lending to institutionally-held residential fell by 8 percent. Banks are increasingly focussing outside of Germany’s ‘A’ cities, with 57 percent new business growth outside the top seven cities.

Growth in development financing was 22.6 percent (€7 billion in absolute terms) versus 18.9 percent growth (€17 billion) in the financing of existing properties during 2015.

Overall, lenders’ loan books continued to grow. Portfolio growth across the sample was 5.9 percent. Growing their loan books enabled lenders to achieve growth in profits in 2015, despite margin pressure, the report said.

The volume of non-performing loans held by German lenders continued to decrease. NPLs fell from €19.1 billion (4.4 percent of the portfolio) in 2010 to €6.8 billion (1.5 percent) in 2015.

On the subject of the UK’s EU referendum result, the report said that some lenders who had planned to set up or expand their business in the UK were “wrong-footed” by the Brexit vote and some have put plans on hold.