European banks' exposure to commercial real estate has come under renewed scrutiny amid the wider worries around the sector and weakness in US office REITs due to refinancing challenges.
Banking sector share prices came under fresh pressure on Friday as a spike in the cost of Deutsche Bank’s credit default swaps (CDS) sparked renewed concerns about the stability of the sector.
European real estate stocks were also down.
"If the real estate sector continues to slump then it could be the next amplifier of risk for banks and the overall market," said Saxo Bank strategist Peter Garnry.
While banks underwriting standards have tightened in the last 15 years and loan loss provisioning is now on an expected basis rather than incurred, a deteriorating macro is likely lead to higher loan losses, said Nick Anderson at Liberum.
"One area of concern, emerging in the US at least, is commercial real estate. Even if European CRE is more robust, financial linkages mean that losses in US CRE could find their way onto European bank balance sheets."
Lloyds Banking Group PLC (LSE:LLOY) and Santander have the lowest exposure to commercial property, banking analysts at Credit Suisse said in a note on Friday, while Svenska Handlesbanked has the highest exposure but with a low level of non-performing loans.
"CRE has historically been an exposure which has seen elevated losses in periods of stress. While European banks have reduced and diversified their risks over time, outsized exposures are an area of investor interest," the analysts said.
On average, commercial real estate is 10% of European bank lending, but can be higher especially for some Nordic banks.
On average, 6% of CRE exposures are nonperforming, the analysts said, with the provision coverage on those non-performing loans averaging 32%.
While Scandinavian banks have a higher percentage of CRE in their loan portfolios, but a "very low" level of non-performing loans compared with the sector average, they added.
Smaller banks (less than $250bn of assets) account for 43% of all commercial bank lending in the States, ING's Carsten Brzeski noted, up from 30% in 2008, so "have become more important for the US economy".
"If they pull back, it is doubtful that large banks can completely fill the void.
"Moreover, small banks account for more than two-thirds of all outstanding commercial real estate lending and more than a third of all outstanding residential real estate lending.
"Should price falls for these assets accelerate, the balance sheet position of the small and regional banks could look even more strained and intensify the turmoil."