ECB Steps Up Scrutiny of Banks’ Commercial Real Estate Loans

Jack Sidders, Nicholas Comfort and Neil Callanan
Tue, October 10, 2023 



(Bloomberg) -- The European Central Bank has asked property valuers to explain how they compile estimates as concerns grow that banks in the region have been too slow to mark down the value of their commercial real estate loans.

The concern stems partly from a deal drought that has lasted for over a year now, making it hard to compare property values to actual transactions, according to people familiar with the matter, who asked not to be identified as the discussions are private

Banks frequently rely on estimates from property valuers. While many lenders have taken hits on their commercial real estate loans, they may be forced to set aside more money for losses if those valuations turn out to be too optimistic, said some of the people.

An ECB spokesman declined to comment. The watchdog has previously highlighted commercial real estate as a focus point for supervisors.

Several European banks piled into CRE lending over the last decade to buoy revenue as negative interest rates eroded profitability. But the asset class was already hit hard by the rise of work from home and online shopping during the pandemic, before rapid increases in interest rates depressed demand further. Prices have plunged in the US and UK and have started to decline in eurozone markets including Germany.

“Fragilities in the CRE sector are a major source of credit risk for the financial sector,” the International Monetary Fund said in a report on Tuesday. The IMF said global prices could decline by more than 10% over the next year across several segments in a tail scenario, with “significant effect” on smaller lenders.

The exchanges with valuers over the past few months are part of the ECB’s wider efforts to detect potential hits at lenders, according to the people.

CBRE Group Inc., Jones Lang LaSalle Inc., and Cushman & Wakefield Plc are among the largest providers of property valuations in Europe.

Valuers typically take recent comparable deals into account when appraising properties, but a lack of deals has made it harder to judge where values should be set. That’s because sellers have been reluctant to accept prices that are significantly below book values.

Regulators are concerned that appraisers and banks have been slow to mark prices down as a result, the people said.

The ECB said last year that its inspections at lenders showed the valuation of collateral “is a blind spot for many of the banks,” with some firms failing to update appraisal reports. In some cases, the banks accepted valuations provided by clients rather than seeking an independent report.

German valuations take a long-term view of the market, meaning prices tend to be less volatile than those in the U.S. and U.K., which have already seen sharp adjustments as a result of rising borrowing costs. London office valuations are down by more than 17% in the year through June, more than twice the decline in Frankfurt, according to BNP Paribas Real Estate.

Some lenders have moved to recognize mark-downs in the collateral. Deutsche Bank AG saw “continued weakness” in commercial real estate in the second quarter and said related impairments contributed to an almost doubling of loan-loss provisions at its investment bank. Germany’s so-called Landesbanks built about €400 million ($423 million) of reserves in the first half.

Transactions in other markets have also plunged, with sales of Paris commercial real estate in the third quarter hitting the lowest level in more than 13 years, according to statistics provider Immostat.

(Updates with comments from IMF in sixth paragraph, Paris transactions in last)

Most Read from Bloomberg Businessweek