18.12.09

By James Whitmore

Ratings agency warns of losses on property for maturing 2006/07 loans

European banks’ exposure to commercial property will remain a “material credit issue” in 2010 and become a “particular concern” in 2011 and 2012, when a high volume of property loans fall due, ratings agency Fitch warned this week.

The risk is biggest at British, Irish, Spanish and German banks, whose property exposure remains very high relative to tier 1 capital, the core measure of a bank’s financial strength from a regulator’s point of view.

“Many banks have not yet reported substantial losses on their commercial real estate portfolios, despite significant declines in asset values in certain markets and segments,” said Gordon Scott, managing director in Fitch’s financial institutions team.

“This is partly due to timing and serviceability — as long as loans are being serviced, banks are unlikely to report the loan as non-performing.

“However, with a large proportion of loans in negative equity, we expect pressure on borrower cashflows and increasing loan covenant breaches to result in further losses.”

Corporate defaults typically peak after an economic contraction ends, suggesting that loan losses — which themselves will lag default — might not peak until into 2010, Fitch said.

Lenders may be protected to varying degrees by their underwriting standards, particularly those whose exposure is in good locations, with good-quality tenants, and longer leases. Loans written before 2006/07 at lower loan-to-values (LTVs) will be better placed to withstand additional pressure. A prolonged period of economic weakness and/or further asset value declines could result in a significant rise in defaults.

“Banks are adopting a more conservative approach in terms of new underwriting and pricing of commercial property loans,” said Scott. “Many banks are also under significant pressure from regulators, shareholders, politicians and other market participants to derisk their balance sheets, which has the potential to reduce the overall supply of credit to the sector.

“All of these factors will severely limit borrowers’ refinancing options for the wave of European property loans with high LTVs that mature in the four years from 2010.”

Irish banks’ property exposure remains very high relative to tier 1 capital, and they are particularly exposed to development finance.

In the UK, exposure has risen sharply since the early 1990s and is high at the state-backed Royal Bank of Scotland and Lloyds Banking Group.

Spanish banks’ property lending has quadrupled since 2002. Most medium-sized and large cajas (regional savings banks) and medium-sized universal banks have high exposure to property — around 30% of total lending.

In Germany, property exposures also represent a high proportion of tier 1 capital at many landesbanks and specialist property lenders. Exposure to the most stressed markets — the US, the UK and Spain — might pose a serious challenge, Fitch warned.

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Source: Property Week (www.propertyweek.co.uk)