15 December 2009
Fitch Ratings says that it expects European banks' commercial real estate (CRE) exposures to remain a material credit issue through 2010, and refinancing will be a particular concern in 2011 and 2012 when a high volume of property loans fall.
This may lead to further negative rating action on European banks relating to their commercial real estate exposure, though action is likely to be limited in scope.
Gordon Scott, Managing Director in Fitch's Financial Institutions team, says:
"Many banks have not yet reported substantial losses on their CRE portfolios, despite significant declines in asset values in certain markets and segments. 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, Fitch expects pressure on borrower cash-flows and increasing loan covenant breaches to result in further losses."
Corporate defaults typically peak after economic contraction ends, suggesting that loan losses (which themselves will lag default) may not peak until into 2010. 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 prior to 2006-7 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.
Scott says:
"Banks are adopting a more conservative approach in terms of new underwriting and pricing of commercial property loans. Many banks are also under significant pressure from regulators, shareholders, politicians and other market participants to de-risk their balance sheets, which has 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' commercial 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 relative to tier 1 capital at the two state-backed banking groups (Royal Bank of Scotland Group and Lloyds Banking Group, both rated 'AA-'/Outlook stable) though recent capital-raising initiatives will reduce this.
Spanish banks' CRE lending has quadrupled since 2002. Most medium and large sized cajas (regional savings banks) and medium sized universal banks have high exposure to the property sector (around 30% of total lending) making them vulnerable to further adjustments.
In Germany, CRE 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 - may pose a serious challenge for individual banks' asset quality. More than 40% of German banks' CRE exposure is international, according to Fitch.
Rating action is possible for banks that Fitch considers to be most exposed to downside risk from continued adverse market developments, particularly if in the agency's opinion loan impairment reserves appear inadequate and/or capital appears to lack sufficient buffer to deal with potential problems.
It should be noted, however, that many of the European banks most exposed to CRE already have low or weak Individual ratings; while their stronger Issuer Default Ratings are driven by support. This is likely to limit the number of potential negative rating actions.
The report, "Banks' Exposure to European Commercial Real Estate," is available at www.fitchratings.com. Fitch is undertaking a more detailed bank-by-bank analysis and will provide further commentary as more data is available.
