Europe’s banks may lack enough loan loss cover for property slump, says Moody’s

By Iain Withers

LONDON (Reuters) – European banks may not be sufficiently provisioned for property loan defaults if severe pressure leads to rapid growth in problem loans, a report by Moody’s (NYSE:MCO) Ratings said on Thursday, but judged lenders likely had strong enough capital buffers to cope.

Property owners across the region have been squeezed by slumping prices and higher borrowing costs, raising the risk their bank borrowings will go unpaid, although central bank interest rate cuts have started to provide some relief.

Moody’s modelled for a significant deterioration in the quality of 21 highly-exposed European banks’ commercial real estate loans, with a scenario based on the stress that hit banks in the wake of the 2008 global financial crisis.

The banks included were those with the highest exposure to commercial real estate relative to their capital strength. More than half of the lenders were German, most of them real estate specialists, with the remainder from countries including Sweden, Austria and Denmark.

Moody’s applied a loan loss reserve level of 40%, the average reported by large European banks over the last five years. But it noted the actual average in the first quarter this year was lower at 33.5%, reflecting growth in problem loans had risen faster than provisioning.

“While a shift toward better quality assets might justify lower coverage, we see an increased risk that banks are insufficiently provisioned,” Moody’s said in its report.

The comment echoed a warning from the European Central Bank last month, which found that euro zone banks had been too optimistic in valuing commercial property, potentially masking a deterioration of loans.

The potential strain would be greatest for banks with high exposure to U.S. and British offices and mildest for those lending to housing projects, Moody’s found, but added that all the lenders surveyed would remain above their minimum capital thresholds.

“Our tests necessarily include simplifying assumptions, but they suggest there would be no breaches of minimum regulatory capital levels under the modeled scenarios,” Moody’s said.