Stefan W. Schmitz
The commercial real estate sector has been increasingly the focus of public interest both in Austria and internationally since the interest rate hikes in 2022. The Financial Market Stability Board (FMSB) stated in its last meeting on 10 June 2024 that potential loan defaults in this sector may pose an increased risk to financial market stability in Austria. At the international level, commercial real estate loans in Austria are also receiving increased attention from the European Systemic Risk Board (ESRB), the European Central Bank (ECB) and the International Monetary Fund (IMF).
As part of the series of blog posts by the Austrian National Bank (OeNB) on the topic of “Real estate loans and financial market stability”, the next posts will therefore be devoted to the methods of the OeNB’s systemic risk analysis in the area of commercial real estate loans, on which the FMSG’s assessment mentioned above is based. The starting point for measuring their importance for financial market stability is their definitional differentiation from other loans and the level of the resulting exposure of Austrian banks.
Commercial real estate loans – a distinction
Defining commercial real estate loans is not an easy task. Depending on the data source and the perspective applied, their volume can vary considerably. For the OeNB’s systemic risk analysis, it is necessary to clearly distinguish commercial real estate loans from private residential real estate loans or other corporate financing. It should include those loans that are used to finance similar business models (construction/rental/sale/operation/management) in the “commercial real estate” sector and whose default probabilities and collateral values therefore react similarly to real economic shocks. There are basically three definitions available for this:
- Collateral perspective: It includes all loans granted by Austrian banks to domestic non-financial companies that are secured by commercial or residential real estate (including unused credit lines). This results in a volume of around EUR 141 billion and corresponds to a 68% share of Austrian banks’ loan portfolio to non-financial companies (unconsolidated level; as of June 2024). This very broad definition also includes loans that are not used to finance the “commercial real estate” business model and whose probability of default and collateral values therefore react differently to real economic shocks (e.g. commercial loan secured by a residential property for the purpose of expanding the vehicle fleet of a logistics company). It is therefore less suitable for the OeNB systemic risk analysis.
- Purpose perspective: This includes loans (including unused credit lines) to domestic non-financial companies with the purpose of “construction/purchase of a residential or commercial property”. These account for a volume of around EUR 89 billion, which corresponds to a share of 43% of the loan portfolio to non-financial companies (as of June 2024). This also includes loans that are not used to finance the “commercial real estate” business model (e.g. a bakery is building a new branch). The purpose of use perspective is therefore less suitable for the OeNB systemic risk analysis.
- Special financing for income-generating commercial real estate: This narrow definition of commercial real estate loans, in which the repayment and the proceeds from the sale in the event of default are primarily based on the income generated from the property, is also common internationally. In Austria, this volume is estimated at around EUR 70 billion, corresponding to a share of 34% of the loan portfolio to non-financial companies (unconsolidated level; as of June 2024).
- Sector perspective: To assess systemic risk, the OeNB uses the sectoral perspective, which takes into account all loans granted to domestic non-financial corporations in the specific NACE sectors “real estate and housing” (L) and “building construction” (F41) and “special construction” (F43). They amount to EUR 127 billion and correspond to 61% of the loan portfolio to non-financial corporations (unconsolidated level; as of June 2024). These sectors are highly interlinked. They have similar business models and balance sheet structures and use similar loan collateral. This is reflected in the high correlation of the indicators for non-performing loans (NPLs) and in the mutual dependence of intermediate inputs from the “real estate and housing” and “construction” sectors in the value added of the Austrian economy. In addition, this definition of commercial real estate loans allows us to focus on a relatively homogeneous group of companies, as the NACE sectors are defined to reflect similar business models.
The sector perspective is the most appropriate definition for the OeNB systemic risk analysis in the area of commercial real estate loans.
Commercial real estate loans are of great importance for financial market stability in Austria
Commercial real estate loans represent a high proportion of Austrian banks’ domestic loan portfolio to non-financial companies. Even if it is necessary to distinguish between commercial and residential real estate loans for the purposes of the OeNB’s systemic risk analysis in the commercial real estate sector, the default rates of both types of loans were often correlated with each other, especially in historical crises. Together with private residential real estate loans amounting to around EUR 130 billion, “Real estate and financial market stability” therefore involves around EUR 257 billion, or around 60% of all loans from Austrian banks (unconsolidated level) to Austrian companies and households. The stability of both loan segments is of great importance for financial market stability in Austria. Default rates on residential real estate loans have not risen sharply in Austria since mid-2022, despite a phase of increased living costs and interest rates. Unlike in historical crises, their correlation with commercial real estate default rates is low. In addition to the Credit Institutions Real Estate Financing Measures Ordinance (KIM-V), government measures to compensate for the increased cost of living and the relatively low unemployment rate despite the recession have also contributed to this positive development.
Not only do practically all Austrian banks hold commercial real estate loans, but for many banks these represent a large part of the corporate lending business. They are therefore of great importance for financial market stability in Austria. An Austrian special feature is the importance of the non-profit building associations (GBV), which grant around 20% of domestic commercial real estate loans, with the largest share being in the “real estate and housing” sector (as of June 2024). GBV have higher equity and a significantly lower credit risk than profit-oriented commercial real estate borrowers. This is also reflected empirically in significantly lower default rates.
Commercial real estate loans with dynamic default events
The exposure of Austrian banks in the area of commercial real estate financing is striking in an international comparison based on the collateral perspective: In an EU comparison, Austria ranks fifth with a share of around 13% of the consolidated balance sheet total. In addition, defaults in this credit segment are rising sharply – even in an EU comparison.
The graph shows that the NPL ratio (left axis) rose from 1% to over 4% from the second quarter of 2021 to the second quarter of 2024. In mid-2024, the loan amount exceeded the collateral value or there was no collateral for 30% of commercial real estate loans. Banks are strengthening their risk provisions, but these are lagging behind defaults. As a result, the coverage ratio (loan risk provisions in relation to NPLs; right axis) is falling from a high of almost 40% (third quarter of 2021) to now below 30% (second quarter of 2024). The OeNB’s systemic risk assessment based on internationally established methods shows that unfavorable macroeconomic scenarios can lead to significant losses in the Austrian banking sector. The FMSG and international institutions have identified increased systemic risks for financial market stability in Austria (ESRB, ECB and IMF). Against this background, the FMSG macroprudential measures to increase the ability of banks to absorb potential losses in this important credit segment.
The views expressed do not necessarily reflect those of the OeNB or the Eurosystem.
