European banks may not have enough loan loss coverage for property downturns, says Moody’s By Reuters

By Iain Withers

LONDON (Reuters) – European banks may not have enough provisions for mortgage defaults if severe pressure leads to a rapid rise in problem loans, a Moody’s (NYSE: ) Ratings report said on Thursday, but they believed lenders they probably have strong enough capital buffers to cope.

Property owners across the region have been squeezed by falling prices and higher borrowing costs, increasing the risk that their bank loans will default, although central bank interest rate cuts have started to provide some relief.

Moody’s modeled 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, the rest from countries such as Sweden, Austria and Denmark.

Moody’s applied a level of loan loss provisions of 40%, the average reported by major European banks over the past five years. But it noted that the actual average in the first quarter of this year was lower at 33.5%, reflecting growth in non-performing loans grew faster than provisioning.

“While a shift to higher quality assets could justify lower coverage, we see an increased risk of banks being underinsured,” Moody’s said in its report.

The comment echoed a warning from the European Central Bank last month, which found that eurozone banks were too optimistic in their valuation of commercial property, potentially masking a deterioration in credit.

The potential strain would be greatest for banks with heavy exposure to US and UK offices and lightest for those lending to housing projects, Moody’s found, but added that all lenders surveyed would remain above minimum capital thresholds.

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