Non-Performing Loans: The Worst Is Yet To Come
Finally some good news! The European Central Bank (ECB) has lowered its key interest rates for the first time in almost five years, following ten consecutive rate hikes. At least that’s probably what many in the property sector are thinking. However, it is still too early to sound the all-clear on the real estate market. Construction costs remain high. Transaction activity is sluggish, with few deals being closed. Achievable price-to-rent ratios have also taken a bit of a tumble and are no longer always above 20 –in some cases they can now be as slow as 10 or 15, even for perfectly appealing, easily marketable properties.
Furthermore, financial institutions continue to be cautious in providing financing for real estate ventures. This reluctance from banks suggests that a return to pre-crisis “business as usual” is improbable. In fact, it looks as if lenders are more likely to step on the brakes in the near future and make their lending criteria even more stringent.
Banks are having to act slowly
One significant factor is the increasing number of non-performing loans (NPLs) on banks’ balance sheets. Then there’s the pressure regulatory authorities are exerting on banks in relation to property financing, which is also steadily increasing.
In response, the ECB has launched a programme of Targeted Reviews und On-Site Inspections. Similarly, the German Federal Financial Supervisory Authority (BaFin) is conducting special audits under the German Banking Act. Of particular importance is the strict monitoring of risk management requirements (MaRisk) and Loan-to-Value (LTV) risk, which involves an analysis of loan collateral in relation to the value of any loans. As property market values decline, banks are gradually seeing these impacts reflected in their loan portfolios, and they are being forced to take defensive action.
Non-performing commercial property loans up by 129 per cent
Regarding NPLs, the latest data from the European Banking Authority (EBA) indicates a clear upward trend. At the end of the first quarter of 2024, the total volume of non-performing commercial property loans in Germany amounted to 14.2 billion euros, marking a significant 129 per cent increase compared to the previous year. The overall volume of NPLs in Germany also rose by 25 per cent to 39.8 billion euros during the same period.
And this trend is not expected to end anytime soon. This is because refinancing has become far more expensive, despite recent interest rate reductions. Particularly affected are loans acquired approximately seven to ten years ago, many of which are set to mature between 2024 and 2026. The challenging refinancing landscape means we are likely to see even more property companies experiencing financial difficulties. According to our estimates, there should be around 60 billion euros in NPLs in the German market as a whole by the end of the year, representing a more than 50 per cent increase compared to the end of the first quarter. And this number may continue to climb as a significant volume of loans from the previous economic boom phase reach maturity over the next couple of years.
To some participants in the property market, the outlook may be bleak. For others, however, there are also opportunities on the horizon. The increasing volume of non-performing loans is expected to result in an uptick in real estate asset sales. Currently, many sales are still taking place below the 100-million-euro threshold. It is only really above this threshold that Anglo-Saxon private equity and hedge funds become interested.
Ongoing reluctance to buy NPLs
Offers for these “smaller” NPL sales are currently being very closely examined by single and multi-family offices – and sales are being conducted with maximum discretion and confidentiality. Despite this interest from family offices, German institutional investors have been holding back on NPL purchases, potentially missing out on a favourable entry point, as they did in the years around 2003, and again in the wake of the global financial crisis.
Successful NPL sales require robust restructuring concepts and consistent workout strategies, expertise that is no longer available in many banks. As a result, market participants, whether investors or credit institutions, are reliant on partners who can provide the necessary expertise and management support.