ECB steps up scrutiny of banks’ commercial real estate loans

THE European Central Bank has asked property valuers to explain the methodologies they use, as concerns grow that banks in the region have been too slow to mark down the value of commercial real estate (CRE) loans on their books.

The exchanges over the past few months are part of the ECB’s wider efforts to detect potential hits at lenders, according to people with knowledge of the matter, who asked not to be identified as the discussions are private.

While banks have made provisions for losses on commercial real estate loans, they’re likely to face further impairments if valuations are shown to be out of date, some of the people said.

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

Some European banks piled into CRE lending over the last decade to buoy revenue as negative interest rates eroded profitability. But the asset class was hit hard by the rise of work from home and online shopping during the pandemic, while rapid increases in interest rates depressed demand further. Prices have already 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 (Oct 10).

CBRE Group, Jones Lang LaSalle, and Cushman & Wakefield 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.

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

Some lenders have moved to recognise mark-downs in the collateral. Deutsche Bank 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 US$423 million of reserves in the first half. BLOOMBERG