Sailing Smoothly: German banks find CRE waves milder than shipping loan storms
In the shadow of concerns about the German commercial real estate (CRE) sector sparking systemic contagion, Akinn Group’s perspective offers optimism both for holders of risk and for potential investors focused on the long-term intrinsic value of these assets as an extended macro hedge.
In this article we assess the four main drivers (Low Demand, Oversupply, Bank Incentives, and Intrinsic Collateral Attributes) of the shipping crisis from 2008-2018 and their applicability to the current CRE market.
Echoes of the Shipping Crisis?
Drawing from the echoes of recent history and the invaluable lessons from past crises, including our team's pivotal role in navigating the deleveraging of shipping loans and real estate exposure during the eurozone turmoil, Akinn is uniquely positioned. We're not just witnessing history; we're applying its lessons, comparing the tumultuous times of the Shipping Crisis to today's CRE challenges in order to identify a path forward for German banks and investors alike. This is not just another chapter in the story of global finance but a testament to the resilience and adaptability that define the future of investment in Germany's commercial landscape.
During the shipping crisis from 2008 to 2018, German banks were heavily invested in the shipping sector, accounting for close to $100 billion of the global $400 billion shipping debt in 2008[1]. This left them more exposed to non-performing loans (NPLs) in this sector than banks from any other country.
The downturn in the shipping industry, exacerbated by overcapacity and a decline in global trade, led to significant losses for these banks. The shipping industry faced a prolonged downturn due to overcapacity, weak global trade, and declining freight rates, which led to a significant deterioration in the creditworthiness of ship owners and operators. According to data from the German Bundesbank, the peak-to-trough decline in the value of shipping loans held by German banks was approximately 40-45% between 2008 and 2016[2]. They faced challenges in managing these NPLs, including (towards the end of the cycle) regulatory pressures to increase capital reserves against potential losses.
Comparing this to the current situation with CRE losses, the shipping loans generally suffered from much higher leverage (hardly any equity) driven by seemingly forever increasing vessel values, funding mismatch with loans primarily in USD against local euro funding base, a dwindling pool of financing banks, and were backed by portable assets which eventually incentivised lenders to pursue enforcement actions.
The current CRE loan situation carries a different risk-reward profile, and the magnitude of the impact is not yet as severe as the shipping loan crisis. According to recent data from the German Bundesbank[3], the peak-to-trough decline in the value of CRE collateral against loans held by German banks has been around mid-teens percentage since the onset of the COVID-19 pandemic in 2020. However, the impact is negligible in certain sub-sectors such as hospitality and logistics so cannot be seen as a general CRE market decline. The CRE sector has been affected by factors such as the shift to remote work, changes in consumer behaviour, and the overall economic downturn, which have led to increased vacancies, rent reductions, and financial distress among certain CRE borrowers.
Even so, CRE loans generally have lower Loan-to-Value (LTV) ratios, and the properties are not movable, which affects the banks' ability to offload and re-deploy distressed assets quickly. The lower leverage in CRE provides banks with more incentive to manage these loans through to recovery, especially in a context where regulatory and market conditions may favour loan restructuring or support measures in partnership with non-bank investors. Lenders are therefore also more incentivised to take a longer-term view towards CRE value.
The incentives for banks are also substantially different this time around. As the great investor Charlie Munger noted, “show me the incentives and I will show you the outcome”. During the height of shipping crisis and the years following, German banks were slow in adopting proactive strategies in refinancing underlying loans, repossessing collateral, partnering with non-bank investors, or exiting via sales to non-bank investors. In many cases, they held on for too long in the hope that the market would eventually turn in their favour which resulted in significantly higher losses being incurred by the banks when a resolution was finally imposed on them, or in some cases when enough of a buffer had been built up from other segments to afford a solution.
A primary reason for such passive behaviour was due to the principle underlying the old IAS 39 standard where impairments were only recognised on an incurred loss basis, and which remained in effect until the start of 2018. As a result of IFRS 9, banks are now incentivised to proactively find providers of alternative capital to refinance at-risk exposures. Where necessary, this exit may be at a small discount since a Stage 2 loan would otherwise require them to immediately book the full lifetime expected loss on an asset. And this is the whole point of IFRS 9 – it shifts from a reactive to a proactive approach, and forces banks to recognise losses before economic conditions bottom out. This has material impact on likelihood of eventual default and with regards CRE will make it unlikely in our view to see a sudden deluge of distressed opportunities and/or defaults other than with certain esoteric property developers.
In summary, as we assess the trajectory of the German commercial real estate (CRE) sector, it is clear that the historical precedents set during the shipping crisis provide valuable insights into navigating current challenges. Despite fears of systemic risks, the robustness of CRE as an asset class — highlighted by lower average Loan-to-Value ratios and more diversified portfolios — offer a buffer against widespread downturns. German banks, equipped with lessons from past financial disturbances, are now better positioned to capitalize on these strengths. They can adopt proactive strategies that leverage long-term demand for CRE, enabling them to forge resilient partnerships with investors and strategically align with market dynamics. This forward-looking approach not only mitigates the risks associated with economic fluctuations but also maximizes the potential for sustainable growth. By emphasizing strategic asset selection and management, German banks can transform current challenges into lucrative opportunities, ensuring the CRE sector remains a cornerstone of stability and profitability in the financial landscape.
Contributors: Zam Khan, Thomas Chambers, Ruben Figueiredo, Thomas Rodermann, Roger Thomson and Tom Tyler
[1] Bundesbank Financial Stability Review, 2016
[2] Bundesbank Financial Stability Review, 2016
[3] Bundesbank Financial Stability Review, 2023