 German lender Deutsche Bank's US headquarters on Wall Street is among the many New York office properties that may experience a fall in value. Source: Spencer Platt/Getty Images News via Getty Images. |
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European banks increased their exposure to the $6 trillion US commercial real estate debt market in the first half of 2023 amid growing concerns about the potential for a surge in bad loans from the sector.
European lenders' aggregate exposure to US commercial real estate (CRE) edged up 3% in the six months ended June 30 to total almost $36 billion, S&P Global Market Intelligence data shows. The loans cover a variety of property types as well as loans for construction and land development.
The increased lending comes as investors fret about the impact of rapidly rising interest rates on the sector, as well as the effects of remote working on office property income and e-commerce on retail property income. Banks' exposure to commercial property topped the list of worries among investors in a poll during a recent S&P Global Ratings webcast.
"We expect losses to be incurred across all property types but very much concentrated in office assets," Darin Mellott, vice president of capital markets research at US real estate services firm CBRE, said in an interview.
Spanish banking giant Banco Santander SA's US business had the largest volume of CRE loans of the four European banks, with material exposure to the sector at $18.2 billion in the second quarter, up more than 10% since the end of 2022, Market Intelligence data shows.
Switzerland's UBS Group AG and the UK's HSBC Holdings PLC both recorded declines in their US CRE loans books during the first six months of the year, to $7.1 billion for UBS and $6.13 billion for HSBC. Germany's Deutsche Bank AG saw an increase of more than 9% to $4.42 billion.
Declining values
The value of the properties underlying many of these loans has likely fallen in the last six months and is expected to continue. US commercial property prices fell between 10% and 15% on average in the first three quarters of 2022 alone, with a further 5% to 7% decline forecast for the 12 months to the end of September 2023, according to CBRE.
The decline across the sector is uneven, with the value of some assets falling much further than the wider market, said Richard Christopher Whalen, US banking expert and chairman of Whalen Global Advisers.
"There are large chunks of commercial real estate in established [US] cities where the asset value has been cut in half," Whalen said in an interview.
European banks have been "a pretty active lending source for larger office transactions in New York" in recent years, David Heller, senior managing director of the capital markets group at real estate services firm Savills, said in an interview. New York is among the "gateway cities" — markets favored by international investors — where demand for office space following the COVID-19 pandemic remains a problem, Heller added.
Rising risk in multifamily
Certain types of multifamily properties are also expected to face distress in the coming quarters. Loans to multifamily residential properties accounted for the largest category of European banks' US CRE lending at almost $16 billion, or 44.5% of the total, Market Intelligence data shows. Santander, Deutsche Bank and UBS have all significantly increased their US multifamily loan books since 2019.
"There's been a big inflection in multifamily in the last five years," said Whalen. "It's gone from being a sought-after, no-brainer kind of asset to an asset that you have to be very aware of price and risk — it's a huge change."
Santander had the largest exposure to US multifamily among European banks in the second quarter at more than $10.85 billion, or almost 60% of its total US CRE exposure, according to the data. The coastal markets of San Francisco, New York and Philadelphia — areas European lenders tend to target, said Whalen — recently accounted for three of the top four US cities for multifamily delinquencies, according to securitized mortgage data provider Trepp.
Deutsche Bank was one of three European lenders identified in an Aug. 8 stress test report by Morgan Stanley as potentially experiencing the biggest impact from a correction in the global CRE markets. France's Crédit Agricole SA and Ireland's AIB Group PLC were also highlighted. The banks' relatively high CRE exposure and higher share of office assets in their loan mix were the primary factors for their poorer performance, the report said.
Deutsche Bank CFO James von Moltke assured analysts and investors in April that the bank's €33 billion property portfolio is "well diversified across regions and property types" while acknowledging the increased risk posed by the sector in the US.
"We recognize the market is under pressure, especially in the US, where lending markets have tightened with further uncertainty caused by recent turmoil in the regional banking sector," von Moltke said during a first-quarter earnings call.
In comments to Market Intelligence, Santander said that almost 70% of its CRE exposure in the US is multifamily, including construction loans and Deutsche Bank said 50% of its €33 billion in CRE exposure as of March 31 was in the US. HSBC declined to comment.
Manageable risk
The risks posed to European lenders' by CRE are generally considered manageable by the region's regulators. The European Banking Authority's annual stress test of its largest banks, which was published in July, found that real estate would perform better than all other sectors under its adverse scenario in terms of an increase in provisions for bad loans.
While real estate activities accounted for the largest share of exposures among the large European lenders assessed by the European Banking Authority, the banks have generally reduced their exposure to CRE in the past decade following the Global Financial Crisis. Greater regulatory scrutiny of CRE exposures since then has led to much tighter lending standards and a reduction in exposure to the sector compared to smaller and regional banks.
Outside of the US exposure, eurozone lenders' share of CRE financing fell to about two-thirds from as much as 95% in the last 10 years, according to the Aug. 8 report by Morgan Stanley. CRE comprises 5% of loans on average at eurozone banks, with some lenders as high as 15%, the report said.
European banks are unlikely to increase exposure to US CRE to any significant degree in the coming quarters as lenders proceed "very cautiously" due to uncertainty around interest rates and the wider economy, CBRE's Mellott said.
Still, the retrenchment of larger and more active players in the market could offer European lenders roles in deals they would typically struggle to attract, Mellott added.
"A lot of their US counterparts are so conservative at the moment," Mellott said. "So there may be some interesting opportunities for European banks at the right time."
