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Commercial Real Estate: Europe: Difference between revisions
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=== CRE Bank Exposure === | === CRE Bank Exposure === | ||
Across the European banking industry, CRE accounts for as much as 30% of NPLs. <ref name=":3">https://www.bankingsupervision.europa.eu/press/publications/newsletter/2022/html/ssm.nl220817.en.html</ref> | |||
From the collection of data from 32 of the most CRE-exposed banks, 26% of total corporate exposures are commercial real estate, of which 32% are office and retail. This confirms that CRE is a relevant exposure class for banks.<ref name=":3" /> | |||
=== Banks Risks Found by ECB Banking Supervision === | |||
==== Loan origination ==== | |||
* Several banks have '''no underwriting criteria and pay insufficient attention to cash flows''', also in bad times. | |||
* Several banks '''lack processes for ensuring that sponsors are directly invested in these projects''' so that they have adequate “skin in the game” | |||
* Quite a few banks with high share of loans that have a large balance falling due at maturity (known as "bullet" or "balloon" loans) '''failed to apply a debt yield ratio''' | |||
==== Monitoring ==== | |||
* Quite a few banks do not have commonly defined basic CRE risk metrics, such as the loan-to-value ratio. Neither do they have an overview of the loans subject to refinancing risk (particularly relevant for bullet loans and loans with high balloons), nor of the location of the assets financed (prime versus non-prime). | |||
* Banks have in general not sufficiently performed sensitivity analyses on CRE exposures, especially to measure the potential impact of an increase in interest rates. Scenarios developed in the sensitivity analyses are in general too soft. | |||
* Several banks have not considered off-balance sheet items in their analyses, even though these items represent a large part of CRE exposures. | |||
* Banks did not consistently using borrower financial information in each part of the cycle, while some banks did not have automated covenant monitoring tools embedded into processes | |||
==== Accounting practices ==== | |||
* Criteria for identifying NPLs leave too much room for interpretation, or do not consider the specificities of CRE finance, these risks are often underestimated | |||
* Several banks did not sufficiently capture the forward-looking perspective of borrowers’ financial position when assessing forbearance and unlikely to pay (UTP). | |||
* Many banks had a deficient framework for identifying speculative lending exposures, which are subject to higher risk-weighted capital requirements. | |||
* Inspection teams have identified shortcomings in setting triggers to mark a significant increase in credit risk (SICR), such as the use of a quantile approach | |||
==== Collateral valuation ==== | |||
* CRE inspectors identified basic shortcomings such as the '''failure to update appraisal reports according''' to the Capital Requirements Regulation (CRR) at least every three years. | |||
* Banks also '''failed to perform an ad-hoc revaluation when market conditions changed.''' | |||
* Certain banks also exhibited '''weaknesses in selection of appraisers'''. | |||
* In several banks, the content of the '''appraisal reports was not satisfactory'''. For many asset valuations reviewed, the valuation approach and the calibration of parameter values were not adequate, also leading to significant asset value overstatement. | |||
* Several banks have '''not set up a quality review framework for valuers'''. They do not scrutinize key parameters such as the vacancy status of the property, the capitalisation rate of the project , the contractual rents or the maintenance cost of the building, the discount rate or the methodology used. | |||
==== Emerging risks ==== | |||
* Construction costs | |||
* Normalisation of interest rates | |||
* Bifurcation of the CRE market (prime vs. no prime) | |||
* Climate transition risk | |||
== Germany == | == Germany == | ||