The European Central Bank’s Asset Quality Review (AQRs) has identified a further €52.8bn in real estate non-performing loans (NPL) among the 130 participating banks, taking the total real estate NPLs as of the end of 2013 to €371.1bn.
As part of the ECB’s comprehensive stress testing of the 130 participating banks’ balance sheets, a further €135.9bn of performing loans were re-classified ‘non-performing exposures’ (NPE) from €743.1bn to €879.1bn (see table at end of story).
This was as a result of the harmonising of NPE definitions on a comparable basis, including the examination of forbearance as a trigger of NPE status.
Of this €135.9bn of additional NPEs, €52.8bn was the composite of ‘real estate related’ exposures and ‘residential real estate’ exposures, split €36.7bn and €16.1bn, respectively. These two categories are comprised of investment and development loans.
These increases take the total real estate related and residential real estate NPE exposures to €236.5bn and €134.6bn, respectively, and the aggregate exposure of all outstanding non-performing real estate exposures as of the end of 2013 to €371.1bn.
The newly re-classified real estate NPLs are partly explained by the degree to which participating banks were carrying real estate assets at overvalued levels, most commonly due to inconsistent valuation methodologies and poor quality of information.
In total, the AQRs identified €29.5bn in overvalued real estate held by banks, reflecting 62.1% of the €47.5bn in total adjustments to asset carrying values.
Of this €29.5bn linked to real estate, the largest single component was attributed to commercial real estate, which required a €11.6bn downward adjustment in carrying value, reflecting almost a quarter (24.4%) of total adjustments across the ACR.
Land was second, with a €9.5bn overstatement, followed by residential property, at €7.0bn, while miscellaneous made up the balance, at €1.4bn, taking the aggregate for the asset class to €29.5bn.
The majority of real estate over valuations arose from AQR-revaluations on assets in the Mediterranean region where downward adjustments stemmed from the use of inconsistent valuation methodologies between banks.
The ECB’s stress test showed 25 banks of the 130 participating banks had capital shortfalls in aggregate of €24.6bn under the “adverse scenario” applied to banks’ balance sheets as of the end of 2013.
But the outcome for the banking sector is one of muted optimism, with 17 of the 25 banks identified already having deemed to have taken sufficient action in recent months to redress the situation, having raised €18.59bn in eligible capital already.
This leaves just eight banks with additional capital to raise. Of these, four were Italian banks, one Austria, one Portuguese and one Irish.
Monte dei Paschi di Siena was identified as the single weakest bank according to the tests and need to raise €2.11bn, has seen its share price tumble 18% on the news today so far. Citigroup and UBS have been hired to advise on its options, according to the Financial Times.
Elsewhere, a further seven banks need to raise a further €4.24bn, taking the tally of additional capital which still needs to be raised to €6.35bn between eight banks.
With the scale of NPEs and capital shortfalls now publicly visible, and real estate assets consistently marked to market, banks can progress legacy workouts with a greater degree of clarity.
There is finally consistency between banks on the value of legacy assets, allowing banks to make more informed decisions over the nature of future de-leveraging.
Indeed, since the date of these tests at the end of 2013, asset values in many markets and sectors have risen, would could imply better prices than the AQRs suggest, which could act as a trigger for further loan portfolio sales.
Certainly, with as much as €371.1bn in real estate NPEs, the era of loan portfolio sales is likely to be with us for years to come, as banks continue to re-capitalise their balance sheets in a conveniently low interest rate environment.
Dr Neil Blake, head of EMEA Research at global real estate advisor CBRE, said: “The benefit of the AQR is that the true extent of banks’ non-performing loans is now out in the open and banks can now consider setting off parts of their loan books in order to meet the capital shortfall.
“Before the AQR, selling off loan books would have meant admitting that they were not properly valued in the banks accounts. On the back of this, and ongoing improvements to real estate values, we can expect to see an increase in loan sales over the next year.”
He added: “This has already started to happen in some cases, notably Irish bank Permanent TSB, which has an identified €0.85bn capital shortfall according to the ECB. Encouraged by a big pick up in Irish property values so far this year, they have already announced they intend to sell off two of their loan books.
“Similarly, Banco Commercial Portugues has started to take advantage of the property market upturn with increased property sales and further direct or loan book sales, which are a likely way of plugging the capital gap.
“Although the recovery in property values seen in Ireland has not been repeated in Italy, values have at least shown signs of levelling off, and Italian banks still look likely to try and sell off some of their non-performing loan books rather than to issue new capital to plug the gap.
“Hitherto, they have tended to only sell of low value unsecured non-performing loan looks and, now that the AQR has cleared the air, this looks set to change.”