DBRS on CRE Risks for Italian Banks
Manageable Compared to European Peers
The commentary focuses on the Italian Commercial Real Estate (CRE) sector, providing an analysis of CRE exposures of banks and insurance companies.
Overall, the CRE sector has become more vulnerable given the convergence of various factors such as the increase in building material costs, rising interest rates, as well as climate change and post-pandemic structural adjustments (e.g. remote working).
Italy is the fourth largest CRE bank loan market in Europe, according to the European Banking Authority's (EBA) data at end-March 2023. CRE loans accounted for around 11% of Italian banks' customer loans as of end-March 2023, slightly above the EU/EEA average. Unlike other European countries, outstanding CRE loans have declined in Italy. This reflects the balance sheet clean-up of the banking sector, reduced appetite for the CRE sector, and modest level of new construction. Asset quality has improved, however the NPL ratio for CRE remains higher in Italy compared to the EU average. Italian banks have recently tightened lending standards for new loan originations in CRE.
On the insurance side, we note that insurance companies are generally exposed to this asset class in the search for higher yields during the low interest rate environment, and the long-term nature of real estate investments which is in line with the maturity profile of the insurance liabilities of most companies. Nevertheless, Italian insurers are, on average, less exposed to real estate than their EU peers, also taking into account that a significant portion of their exposure on balance sheet is held for their own use.
Higher interest rates and increasing building material costs are weighing on the performance of Italy’s CRE market amid the economic slowdown. This is causing prime segment valuations to contract while the investment flow is falling, particularly from foreign investors, who appear more risk adverse. The steady recovery from the pandemic, that led total corporate investment to return close to 2019 levels, has stopped since mid-2022. According to Nomisma, total investment in the CRE market declined by 68% in H1 2023 compared with the same period last year with investors waiting for the return of the positive spread between prime office yields and Italy 10yr sovereign bond yield .
Moreover, the number of transactions in the CRE market also declined by 2.5% Year-On-Year (YoY) in Q1 2023 (Exhibit 2). Prime segment valuations related to offices in Milan, which tend to be leading indicators, are contracting and this could also occur in other parts of Italy. This would result in yield decompression, the pace of which will likely affect the market recovery.
Italian Banks' Exposures to CRE Are Moderate but Lower Quality than EU Peers
CRE represents a large industry in Europe and banks are the major lenders to the sector. The general EBA definition is based on the European Systemic Risk Board's (ESRB) guidance and considers loans secured by immovable properties (CRE loans); this also includes owner-occupied properties, that do not generate rental income. As of end-March 2023, European banks within the EBA perimeter disbursed around EUR 1.3 trillion of CRE loans 1 , with the major markets represented by France (21% of total), followed by Germany (20.6%), Netherlands (13.1%), Italy (10.4%), and Spain (9%) (Exhibit 3). While CRE loans have increased by 6% in Europe from end-March 2020 to end-March 2023, they were down 22% in Italy in the same period (Exhibit 4). In our view, this mainly reflects the sizeable loan clean-up process executed in Italy as well as reduced appetite for new lending in the CRE industry which has typically entailed higher risk than other industries.
According to EBA data, Italian banks' CRE loans accounted for around 11% of customer loans 2 as of end-March 2023, slightly above the EU/EEA average of 10% but lower than 14% median value in Europe (Exhibit 5). However, with an NPL ratio of 7.7%, CRE asset quality seems weaker compared to the European average of 3.8%. Nonetheless, the coverage ratio for CRE NPLs was around 54% at end-March 2023, above the EU average of 38%.
Link alla Ricerca:
https://www.dbrsmorningstar.com/research/417642
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