(Bloomberg) — Problems in the U.S. commercial real estate market, which have already affected banks in New York and Japan, have reached Europe this week, raising concerns about a broader outbreak.
The latest victim was Germany's Deutsche Pfandbriefbank, whose corporate bonds tumbled on concerns about its exposure to the sector. In response, the company issued an unplanned statement on Wednesday saying it had increased its reserves due to “sustained weakness in the real estate market.”
The newspaper described the current turmoil as “the biggest real estate crisis since the financial crisis.”
Lenders are increasing provisions for debts owed to property owners and developers as rising interest rates erode the value of buildings around the world and stymie loans. Treasury Secretary Janet Yellen said Tuesday that commercial property losses are a stressful concern for owners, but she added that she believes the problem is manageable.
The value destruction is particularly acute in U.S. offices, where the return to work after the pandemic has been slow and less substantial. And some predict that the full impact may not yet be fully factored in. GreenStreet analysts said a further writedown of up to 15% could be needed this year.
“Valuations remain too high,” they wrote in a memo. “Lenders that make decisions based on these assessments are likely to be impaired” and some lenders may face “strains” as a result.
The plunge in German financial institutions' bonds was the latest in a series of warning signals. New York Community Bancorp was forced out of business by Moody's Investors Service after citing real estate problems, and Japan's Aozora Bank posted its first loss in 15 years due to provisions for loans to U.S. commercial real estate.
“There are serious concerns about the U.S. CRE market,” said Rabobank credit strategist Paul van der Westhuizen. “It's not a problem for the big banks in the US or Europe, but the smaller banks in Germany, which are focused on real estate, are feeling some pain. But at the moment it's more a profitability issue than a solvency issue for them. They are well capitalized and are less exposed to the threat of deposit runs than pure retail banks.”
Read more: $560 billion real estate warning hits banks from New York to Tokyo
Deutsche Bank posted a provision for U.S. commercial real estate losses in last week's results, more than four times the amount from a year earlier. He warned that refinancing poses the biggest risk to the struggling sector as asset values fall.
Elsewhere in Europe, Switzerland's Julius Baer Group announced it would cancel a huge loan to bankrupt real estate company Cigna. While this was a specific issue, it was joined by broader concerns about real estate and how far the problem could spread.
“Investors are very concerned about individual institutional exposure right now,” said Mark Decker, head of equities at Quintet Private Bank. “Some banks have certainly been more affected by this market issue than broadly based universal banks. But investors are now very sensitive.”
bond plunge
Morgan Stanley held a call with clients on Tuesday and recommended selling Deutsche PBB's senior debt. Since then, the 2027 bond has gained more than 5 cents and now costs about 97 cents, according to CBBT data compiled by Bloomberg. Meanwhile, the bank's AT1 notes fell 14 cents to 37 cents between Tuesday and Wednesday.
Germany's PBB announced on Wednesday that it had increased its loan loss provisions for the year to between 210 million and 215 million euros. “Thanks to our financial strength, we remain profitable,” the company said.
Concerns about PBB have spread to other banks with exposure to commercial real estate. Aareal Bank AG's bonds have fallen about 11 points over the past two days and are currently trading at 75 cents to the euro. In November, it was reported that the amount of non-performing loans in the United States had more than quadrupled from the previous year.
Bafin, the country's banking regulator, said it was closely monitoring the CRE turmoil and declined to comment specifically on Germany's PBB.
Germany's central bank last year warned of risks surrounding commercial real estate, saying a “significant adjustment” could occur that could lead to more defaults and credit losses.
“The German banking system has granted relatively few outstanding loans to the U.S. commercial real estate market, but it is relatively concentrated in individual banks,” the Bundesbank said.
Germany's state banks are also feeling the pain over their exposure to commercial real estate. In the first half of 2023, the main state-owned banks (Heraba, Bayern LB, LBBW, Nord LB) posted provisions totaling around EUR 400 million.
If CRE losses spread to Europe through small German banks, it would be a repeat of the 2008 global financial crisis. At the time, it was the State Bank that found itself in trouble after its exposure to US subprime loans caused billions of euros in writedowns.
“We need to be careful because we don't know exactly where the bottom will be,” said Raphael Tuin, head of capital markets strategy at Tikehau Capital. “We recognize that more pain is likely to come for commercial real estate.”
–With assistance from Steven Arons, Stephan Kahl, Jeff Black, and Helene Durand.
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