European Banks Might Need Extra €30B As Stress Tests Put Real Estate Loans In The Spotlight

European banks might need to set aside €30B to cover losses on commercial real estate loans, and some might need to raise new capital from shareholders, banking analysts said this week. 

At the same time, the Bank of England said the UK’s largest banks could withstand a 45% drop in commercial real estate values and not incur significant losses, although it flagged the sector as one with heightened risk. 

The stress tests come as law firm Weil, Gotshal & Manges said commercial property is the most distressed sector of Europe's economy based on the drawback of liquidity in the market. 

French investment bank Natixis said in a research report and on a webinar that European banks would face increased pain because of falling commercial property values, Real Estate Capital reported.

Investment volumes fell 60% in the first quarter of 2023, which will inevitably lead to value declines, Natixis said. 

It said it expects European office values to fall 20%-30%, logistics values to fall 13%-23% and shopping centre values to drop 9%-20%.

Those decreases would, in turn, put pressure on European banks, Natixis said.

Commercial property makes up about 7% of European banks’ loan books, which is less than U.S. counterparts, and the average loan-to-value ratio of those loans is 49%, compared to 75% in 2010, reducing the risk coming from the sector. 

But banks will still have to set aside €30B to cover losses on these loans, Natixis said, which will have a negative impact on their core Tier 1 capital ratio of 80 basis points — the capital banks are forced by regulators to put aside to insure against potential future losses.

Natixis said on the webinar that potential losses on property loans in a “severe stress test” scenario could mean two German banks with big real estate divisions, Aareal and PBB, would have to be recapitalised. In this severe scenario, these banks would not have enough capital on hand to set aside the money needed to assuage regulators.

Aareal declined to comment to Real Estate Capital, while PBB disputed the analysis.

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

It added that its loans are at low LTVs and it has a strong focus on risk management. 

In the Bank of England’s annual stress test of UK banks, it said that commercial real estate loan portfolios are insulated by the fact that values had risen so much between 2018 and 2023 and LTVs are lower than in the run-up to the Global Financial Crisis.

UK banks can still expect to take losses from their commercial property loans, however, the BoE said. Losses for the banks tested ranged from £200M over a five-year period for Barclays to £700M each for NatWest and Lloyds Banking Group.