Bundesbank Says Banks Risk Property Loss If Economy Sags

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German banks may suffer “significant” losses from their mortgage loans if the economy worsens, according to the central bank.

In cities where prices are rising quickly, about a third of mortgages issued by German banks cover more than 100 percent of a property’s appraised value, the Bundesbank said in its annual financial-stability review today. That indicates that lenders are “structurally vulnerable” to real estate crises. Home prices in Germany’s biggest seven cities are about 25 percent overvalued, the central bank said, unchanged from February.

“If problems in the property market arise in isolation, in an otherwise stable economic landscape, banks should be able to compensate for mortgage losses through profits elsewhere,” the Bundesbank said. “However, because property crises are often accompanied by a macro-economic slowdown, the aggregated losses could significantly impair banks’ ability to cope with risk.”

The assessment is based on a survey of 116 banks in 24 cities where the Bundesbank says home prices are rising particularly quickly. The survey was conducted from 2009 to 2013.

The German economy grew by 0.1 percent in the three months through September after a contraction in the previous quarter.

Price Gains

German home prices rose by 5.2 percent in the third quarter from a year earlier, led by city apartments, according to data compiled by the VDP Association of German Pfandbrief Banks. Investors are buying real estate to improve returns amid slim yields in fixed-income markets, and are taking advantage of record-low borrowing costs.

Prices are rising most quickly in Germany’s seven biggest cities: Berlin, Hamburg, Frankfurt, Munich, Cologne, Dusseldorf and Stuttgart.

There are indications that price gains have started to slow since autumn 2013, the Bundesbank said. Overall, German banks are lending prudently, and there is “hardly any evidence” that lending growth and price increases are feeding off each other, or that banks are behaving recklessly.

The Bundesbank conducted stress tests to help measure banks’ vulnerability in case of a sharp decline in property values. German lenders could incur writedowns of as much as 5.5 billion euros ($6.8 billion) per year, equivalent to about 40 percent of their pretax profit, in a property crash, the Bundesbank said.

Sluggish Growth

Regulators can implement policies to counter risks to the residential property market if they begin to jeopardize financial stability, the Bundesbank said.

Better data about mortgage lending would help improve banks’ and regulators’ ability to predict risks. At the moment, much of the information about lending standards gathered by regulators relies on subjective assessments, the Bundesbank said.

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