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Private equity-owned German real estate lender Aareal Bank warned there was “more to come” after one in four of its US office loans went into default last year.
The warning highlights how the strains in US commercial real estate are being felt outside North America, as higher interest rates have made loans more expensive and falling demand for office space has hit valuations.
Aareal, which is owned by Advent International and Centerbridge Partners, and its listed German peer Deutsche Pfandbriefbank have been particularly hard-hit by their exposure to US commercial property. This month, shares in Deutsche PBB became one of Europe’s most heavily shorted stocks.
In the fourth quarter of 2023, Aareal increased its loan loss provisions eightfold to €179mn, compared with just €22mn in the same period a year earlier.
The increase caused an unexpected hit to operating profit. In early November, the bank confirmed it was on track to generate an operating profit of at least €240mn in 2023. But on Thursday, it reported a 38 per cent decline in annual operating profit to €149mn.
There was an unexpected slide in the US office market in the final weeks of the year, said chief executive Jochen Klösges. “Two or three issues materialised that we previously did not have on our radar screen,” he said, adding that the overall situation on the US office market continued to be “very challenging”.
Aareal said it was sitting on €1bn of non-performing US office loans, out of a total US office portfolio of €4bn.
“Are we expecting that more cases are yet to come? Yes,” said Klösges, adding that the lender did not believe the market was turning around quickly.
He said he was nonetheless confident that the anticipated future increase in non-performing loans would be lower than the €1bn of last year, as momentum started to slow. The bank had not been hit by any new defaults in the first two months of the new year, he said.
The bank earmarked €350mn for loan loss provisions for 2024, compared with €441mn last year.
Aareal said it expected profits to rebound this year, forecasting an operating profit of €250mn to €300mn. The bank’s common equity tier one ratio — a key benchmark of its balance sheet strength — stood at 19.4 per cent of risk-weighted assets by the end of last year, 0.1 percentage points higher than a year before.
