The outcome of a “severe stress test” of European real estate lenders, conducted by researchers at Natixis Corporate & Investment Banking, shows two major German lenders are at risk of needing to be recapitalised in the event of a loan loss rate of between 5 and 12 percent occurring across banks’ commercial real estate exposures.

The French bank said in a 6 July webinar that Wiesbaden-headquartered Aareal Bank and pbb Deutsche Pfandbriefbank, based in Munich, could be undercapitalised in the occurrence of its stress test scenario, which it said would equate to a €50 billion loss across European bank lenders’ aggregate property loan books.

While Aareal Bank officials declined to comment, officials at pbb strongly disputed the analysis Natixis CIB presented in the webinar.

Under its extreme stress test scenario, Natixis CIB said Aareal’s Common Equity Tier 1 capital, which is regulatory capital that banks set aside to absorb potential losses, would decrease by 1,129 basis points. For pbb Deutsche Pfandbriefbank, in the same situation, its CET1 would decline by 762 basis points, Natixis said.

These projected losses, it explained, would leave the CET1 ratio – which compares a bank’s capital against its risk weighted assets – so low that neither bank would have enough provisions required by regulators to be able to distribute dividends to shareholders.

The total value of Aareal and pbb’s exposure to real estate loans, according to Natixis, currently exceeds its CET1 capital. It added that the average proportion of commercial real estate loans to regulatory capital across the European lenders it covers is 83 percent.

Samy Lakhdari, a bank analyst at Natixis CIB, told Real Estate Capital Europe: “In this stressed scenario, this would imply a need for recapitalisation.”

However, pbb raised what it said were major concerns about the accuracy and scope of the analysis presented.

“These assumptions and figures are inaccurate,” the bank said in a statement. “There seem to be some major misinterpretations; for instance, neither loss absorbing capacity from profit generation nor stock of risk provisions seem to be considered.”

The statement continued: “pbb is traditionally selective with focus on strong risk parameters and covenant structures. pbb’s average loan-to-value [ratio] is at 51 percent. We set strong focus on portfolio monitoring and risk management. Finally, even net of these gross misunderstandings, pbb would not trigger an MDA [maximum distributable amount] threshold.”

Additionally, a market participant familiar with the banks said on the basis of European prime real estate value declines of five to 10 percent by the end of 2024, Aareal’s LTVs, which are below 60 percent, would provide a sufficient buffer for such a market development. “Therefore, I cannot reconcile the assumed increased pressure on Aareal’s capital ratios,” the source said.

Inadequate capital provisions

Lakhdari, however, also warned other banks needed to consider increasing their capital provisions. He said that, despite commercial real estate accounting for the highest share of non-performing loans for European lenders, the NPL coverage ratio for the sector – a metric which indicates a company’s ability to cover losses – was lower than for other types of NPL.

Lakhdari explained: “For us it is counter-intuitive given the risk ahead on commercial real estate, so clearly banks do not, for us, have the current provisioning, it is not adequate due to potential risk and future losses.

“Banks will have to set aside provisions to cope with potential losses in the short-to-medium term. There is a crying need for banks to increase provisions, as commercial real estate accounts for the highest share of non-performing loans in Europe for banks.”

Swedish banks, Lakhdari added, were also among other lenders exposed to further price declines due to twice the average exposure to commercial real estate in their loan books than the seven percent average for European banks.

Start of price correction

Natixis CIB outlined that, against a backdrop of a 60 percent decline in investment volumes for Q1 2023 compared to the same period last year, prices were only at the beginning of a correction.

“It always starts with a fall in investments, and then this is followed by a six-to-nine-month line of a drop in prices,” said Thibaut Cuillière, head of real asset and sector research at the investment bank. “We are starting to see the fall in prices for European commercial real estate assets.”

Natixis CIB also said REITs would face refinancing pressure in 2024 and 2025 as the bond markets – a key source of debt capital for such companies – remain averse to the sector.

Cuillière explained: “The bond issuance of euro-denominated real estate companies has fallen from €10 billion per quarter to only €2 billion, with investors being really cautious about what the impact of depreciation of assets on credit quality will be.”

He predicted that real estate companies will face more than €15 billion of bond redemptions in 2024 and “it will be even worse in 2025”, adding: “This poses the question of the refinancing capacity for most real estate companies.”