Germany's Aareal warns one quarter of U.S. office loans bad

By Tom Sims and John O'Donnell

FRANKFURT (Reuters) -Troubled German lender Aareal said on Thursday that a quarter of its 4 billion euros ($4.3 billion) in loans for U.S. offices were likely to go unpaid and that there could be worse to come as a property rout takes hold.

The bleak message underscores the severity of a property slump, hitting the value of empty offices hard and rattling investors on both sides of the Atlantic.

"Will the market turn around? It doesn't look like it," Chief Executive Officer Jochen Kloesges told journalists.

"2024 will remain challenging. We expect that the U.S. office market will stay in flux for longer," he said, adding that some U.S. offices had plunged 50% in value.

Aareal, based in Germany but operating globally with a quarter of its business in the United States from New York to San Francisco, is aiming to pare down about half of the 1 billion euros in so-called non-performing loans by the end of March.

It said it wouldn't need fresh capital as it navigates the crisis.

The sector has been undermined by factors ranging from rocketing interest rates to post-pandemic working-from-home, sapping demand for offices in the United States and Europe. Investors worry this could trigger wider economic problems and spill over to banks.

Aareal is one of the biggest property lenders in Germany, Europe's largest economy, and together the nation's banks are among the continent's heaviest lenders for the stricken commercial property sector.

Investors are worried about banks' lending to the sector, especially in the United States, where refinancing difficulties and lower office occupancy have hit commercial real estate in recent months, raising concerns that loans will go unpaid.

In another sign of the malaise, Aareal earmarked 441 million euros in provisions for soured loans in 2023, the most in at least a generation and surpassing a recent peak at the height of the pandemic.

DOMESTIC BLUES

Aareal's domestic market of Germany, where it has 7% of its loans, is also in its worst real estate slump in decades - characterized by insolvencies, halted construction and a freeze in property deals.

Commercial property prices fell 10% in 2023, in a sharp acceleration of their decline this decade.

Its domestic competitor Deutsche Pfandbriefbank (PBB), which like Aareal is almost exclusively focused on property financing, has come under particular pressure in recent weeks.

PBB's shares have slumped nearly 40% this year as it doubled provisions for soured loans and got a credit rating downgrade to a notch above "junk". It has issued a series of statements to assure investors.

PBB, which gets a new CEO on Friday, reports its earnings next week.

Aareal last year removed itself from the stock market after a buyout group took the bank private, but it issues bonds.

One of its riskiest bonds - its so-called AT1 - has slumped in value, though not as steeply as PBB's.

Credit-rating agency Fitch recently cut Aareal's rating and warned that it would suffer if there is "additional severe stress in the U.S. office property market, or spill-over to European property markets".

Last year, Aareal flagged potential credit losses of up to 210 million euros but ended up doubling its forecast as the year progressed. ($1 = 0.9217 euros)

(Editing by Miranda Murray, Gerry Doyle and Keith Weir)