Are real estate bankruptcies now causing the banks to fail?

Management warns of serious sustainability risks. The banks’ buffers are not enough.

Vienna. It is an expert group that is currently tapping the fingers of the banks: high-ranking experts from the Ministry of Finance, the Crown Council, the Financial Market Research Authority (FMA) and the Austrian National Bank (OeNB) on Thursday in the Financial Market Stability Committee (FMSG) to make key decisions so that the Austrian financial market does not slide into crisis. To this end, deputy governors, FMA board members and economists took a close look at the National Bank’s systemic risk analyses. And this led to a greater need for discussion. The so-called KIM regulation, which limits the granting of real estate loans, is not only a responsibility of the banks. At the same time, there are supervisors in Austria because of the violations of Signa, Imfarr and BBB. Could the real estate bust bring down the banks?

Also international directors of the European Systemic Risk Board (ESRB), the European Central Bank (ECB) and the International Monetary Fund (IMF) have been looking at the commercial real estate market for some time, including Austria. The rise in interest rates in 2022 has caused serious concern for the industry, which mainly uses debt financing. Several international bankruptcy reports made headlines. But the FMSG’s urgent tone and new measures are new.

Banks need more buffers for systemic risks

In the future, banks should set aside more money to finance commercial real estate. The industry-specific risk buffer should amount to at least one percent of the funding amount. This accumulates the equity capital of the banks. The fact that banks had too little capital was one of the main reasons for the financial crisis. Since then, the rules have been tightened considerably. Recently, the banks criticized too many regulations. And the new measure is unlikely to be well received either.

At the last meeting in June, the Financial Market Stability Board noted that loan defaults in this sector could pose a greater threat to the stability of the financial market in Austria. Banks have therefore been asked to “retain a significant portion of their high profits to improve capitalization and build risk provisions in a forward-looking manner,” he said in the release at the time. Austria in the field of commercial real estate financing is extraordinary in international comparison based on the collateral perspective,” wrote recently Stefan W. Schmitz, head of the macroprudential management group at the National Bank. In the EU-In comparison, Austria is in fifth place with a share of about 13 percent of the total on the accumulated balance. In addition, defaults on commercial real estate loans are increasing significantly – also in comparison with the EU.

Almost all banks are open to commercial real estate

But how big is the risk of these loans? Austria’s de facto banks not only have commercial real estate loans, but these also represent a large part of the business with corporate loans for many banks They make up 61 percent of banks’ loan portfolios Austria for non-financial companies (as of June 2024). This means that there are approximately 127 billion euros. Special sectors, financing in the real estate and housing sector, real estate construction and special construction are included.

According to a narrower and more common international definition of commercial real estate loans, in which the repayment​​​​​​​​ and the income in case of failure are based primarily on the income that came from the building, they only made up 34 percent of the loan portfolio, which is accordingly. to the extent of 70 billion euros corresponding. However, when analyzing risk, economists use the broader definition.

Residential real estate risks come into play as well

When considering financial market stability, 130 billion euros for private residential real estate loans are also included. Although the regulatory authority makes a strict distinction between commercial and residential properties, in past crises the two lending categories were often intertwined. However, primary rates on residential property loans have not increased significantly in Austria since mid-2022, despite a level of higher living costs and higher interest rates. According to OeNB economist Schmitz, the relationship between commercial and residential properties is currently low. He justifies this, among other things, with the KIM regulation and the government measures already taken to compensate for the higher cost of living.

In commercial real estate, the proportion of non-performing loans increased (NPL) from one percent to four percent from the second quarter of 2021 to the second quarter (graphic). By mid-2024, 30 percent of commercial real estate loans exceeded collateral value or had no collateral. Banks are strengthening their risk provisions, but these are lagging behind defaults. Thus, the loan loss provisions in relation to the underlying loans (coverage ratio) have fallen from a high of almost 40 percent (third quarter of 2021) to below 30 percent (second quarter of 2024). The National Bank foresees “significant losses” in the Austrian banking sector in “unfavorable” macroeconomic conditions. Therefore, the FMSG experts had to intervene and put banks under stricter supervision when they were providing commercial loans for buildings.