ECB to Demand More CRE Loan Provisions From Some German Banks

The European Central Bank will soon push several German lenders to build up higher reserves against property loan defaults، in a move that would cut into their profits.

Banks with large portfolios of commercial real estate loans such as Deutsche Pfandbriefbank AG and some regional lenders jointly known as Landesbanken are one focus of the ECB’s effort، though it’s not clear which will ultimately face demands for higher provisions، people familiar with the matter said.

The review is focused on firms that are heavily exposed to commercial real estate، rather than the country’s top banks، which have broader business models. The ECB has also scrutinized banks from other countries but German lenders will be among those most affected، the people said، asking to remain unnamed as the watchdog’s deliberations are private.

An ECB spokesperson declined to comment، as did a spokesman for Deutsche Pfandbriefbank.

Shares in PBB، as the company is known، fell as much as 4.5% in Frankfurt.

A downturn in global commercial real estate

The ECB has long been pushing banks to shield themselves better against a downturn in global commercial real estate markets، especially in the US. The slump threatens to burden lenders with loan losses after they built up domestic and international real estate lending to boost returns during a decade of record-low and even negative interest rates.

The euro area’s top regulator will communicate its demands to banks in the coming months، the people said. The resulting increase in provisions is likely to affect this year’s profitability، they said.

German banks with large CRE portfolios including PBB last year started raising their loan loss reserves dramatically، which has eaten into their profitability. Several others have also built provisions for credit they extended to a now-insolvent real estate conglomerate known as Signa.

Eleven of the country’s biggest banks last year set aside €2.5 billion ($2.7 billion) to offset actual CRE loan defaults and protect against potential ones، Bloomberg calculations show. Many still managed to post rising profits as income from lending soared on the back of higher interest rates.

The higher provisions notwithstanding، the ECB is concerned that several banks still haven’t set aside enough money to appropriately reflect the decline in property prices caused by rising rates and new ways of working، the people familiar with the matter said. It’s also dissatisfied with some of the risk management practices employed by several German banks، one of them said.

Not all lenders agreed with the ECB’s approach and instead defended their current level of provisioning، said the people. In some cases، they have been able to convince the regulator to reduce the amount of extra money that it initially deemed necessary، said one of the people.

Banks have to hold money to shield themselves against loan defaults. The reserves can’t be used for any other purposes، meaning they cut straight into earnings when they’re made.

The ECB about three years ago started a review into the CRE exposures of 32 banks. The watchdog subsequently narrowed the group to 15 lenders from countries including Germany، France، Italy، Cyprus and Slovenia، said the people familiar with the matter. The ECB has said it looked at various factors including the effects of higher construction costs، rising interest rates، and the valuation gap between buildings in prime locations and less coveted ones.