Germany: Europe’s bad-debt Goliath

Louise Bowman
Published on:

As banks in the UK, Ireland and Spain accelerate their disposals of non-core loan portfolios, one European country is conspicuous by its absence – Germany.

Bank balance sheets groaning under the weight of too many bad loans are not the preserve of Europe’s periphery – no matter how much the continued focus on Spain and previously Ireland might suggest this. In mid-October Spain’s economy ministry announced a €90 billion limit on the size of the bad bank that the country is to establish to deal with the fallout from its soured real estate boom (a total of €180 billion in bad real estate assets sits on the balance sheets of Spain’s banks). Contrast the situation with that of the country that is pivotal to Spain’s fiscal fortunes – Germany. In Germany €273 billion of assets have already been transferred to bad banks from just two lenders: WestLB and Hypo Real Estate. And there could be much more to come. When it comes to bad real estate debt in the eurozone, Germany is top of the heap.

German banks were notorious for being on the wrong end of many of the deals that soured after 2007 and some astonishingly poor decisions were made – particularly in structured credit. The lion’s share of the problem loans that the banks need to deal with are, however, in real estate. Despite this, large-scale loan sales remain few and far between. The assumption of large volumes of bad debt by two state-owned vehicles and state-backed asset guarantees for the Landesbanken have kept a lot of assets out of the market. And thanks to little pressure from regulator BaFin, activity by private-sector banks has so far been muted as well. According to PwC €4.3 billion of non-core asset sales have taken place in Germany so far this year after negligible activity in 2010 and 2011. Compare this with the UK, where there were €7.5 billion of sales in 2010, €8.8 billion in 2011 and €3.6 billion in 2012.

Analysis by PwC shows Germany topping the non-performing loan rankings in Europe from 2008 to 2011 with €196 billion outstanding, so there is growing expectation that something will have to give – both in performing and non-performing loan sales. According to global real estate adviser CBRE, over €7.5 billion of commercial real estate loan sales had been completed by European banks year to date by September 2012. But of the 14 transactions tracked, six were sales of loan portfolios where the assets were solely located in the UK and Ireland, where there has been a lot of pressure from the regulator to shed assets. CBRE estimated that over €11 billion of loans, divided into nine portfolios, were being marketed by Europe’s banks. But how many of these include German assets?

Recently the European market has been rife with suggestions that a large portfolio of German assets is up for sale. When Euromoney spoke to market participants in October it became clear that at least two portfolios of German assets were being actively marketed, but by non-German banks. One is thought to be a €300 million pool of predominantly corporate loans that is being sold by an Austrian lender; the other a roughly €500 million portfolio that includes real estate assets, again from an international bank. There is certainly no shortage of investor appetite for such assets and if these deals complete successfully many in the market believe there could be more.

Ralph Winter, founder and chairman at Switzerland-based specialist private equity firm Corestate Capital
Ralph Winter, founder and chairman at Switzerland-based specialist private equity firm Corestate Capital
A recent discussion paper published by the Real Estate Management Institute and the EBS Business School calculates that €125 billion of distressed real estate assets will fall due over the next four years in Germany. "There is a lot of pressure on lenders," says Ralph Winter, founder and chairman at Switzerland-based specialist private equity firm Corestate Capital. Corestate recently published an investor survey on the back of the REMI/EBS discussion paper findings to establish appetite for distressed real estate debt in Germany.

"The momentum is bad and this has a negative impact on the market, leading to a bottleneck of debt," Winter tells Euromoney. "The lending environment in non-core cities has changed over the last four to six months and things are getting worse and worse. Banks are no longer willing to finance these types of assets. And even if a portfolio is in a healthy condition today banks will no longer extend loans at maturity."

Winter expects that the situation will deteriorate unless the fundamentals in Germany improve. Of the investors Corestate spoke to, 58% estimated that distressed debt made up between 0% and 10% of their outstanding real estate loans, but that this figure was expected to rise sharply over the next two years. According to the REMI/EBS paper, 82% (€301.5 billion) of funding to Germany’s commercial real estate market comes from domestic banks, with 13% funded via CMBS, 3% from foreign banks and 2% from insurance companies. So this distress will overwhelmingly be felt in the domestic banking sector.