Fitch Thinks of Down Rating Euro BVanks with Too Much Commercial Property Exposure

European banks, including those in the U.K., Spain and Ireland, have high exposure to the crisis-hit commercial real estate sector, and some of them could face negative rating actions as loan losses peak next year, Fitch Ratings said in a report today.

"Fitch believes that there will be instances of banks being over-optimistic about economic recovery prospects and future asset price trends, and may be somewhat reliant on sentiment improving before leases (and to some extent loans) fall due for renewal," the agency said.

"A prolonged period of economic weakness and/or further asset value declines could therefore result in a significant rise in defaults and losses," it said.

According to the report, the U.K. banks have the highest exposure to commercial real estate, with Royal Bank of Scotland Group Plc's put at 106 billion at the end of September, followed by Lloyds Banking Group Plc, with a 100 billion exposure at June.

HSBC Holdings Plc comes in third with a 1 billion lending exposure at June, and Barclays Plc with 43 billion at the end of June.

In Ireland, the bank with the highest exposure to the market is nationalized Anglo Irish Bank Corp., with 56 billion at the end of March. In Germany, Commerzbank AG is first with 82 billion.

Although it didn't provide a list of banks for Spain, Fitch said the Spanish economy has had a greater reliance on the construction sector than its european peers, including Iceland and Ireland.

"This has made the Spanish economy and banking system more sensitive to the construction cycle and to a collapse in the property market," it added.

However, it said the two largest banks, Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA, have lower exposure to the property sector among country peers when measured by the proportion of their businesses.

The firm also said that although some banks have high exposure to commercial real estate, potential damage from falling asset values will mostly depend on the underwriting standard they have employed, where the properties are located and the quality of the tenants.

Fitch said it is in the process of collecting data from banks, and it will conduct a stress test that could lead it to changing the rating at some companies.

"Since market dynamics remain fragile and the outlook for the sector generally remains uncertain, there is justifiable concern that some banks may be storing up problems for the future," it said.

On the two banks with the highest exposure to the sector, Fitch said RBS is somewhat protected against severe losses, as almost 40% of its exposure to commercial real estate will be protected against losses by the U.K. government through an asset protection scheme.

On Lloyds, the firm said most of its problems "derive mainly from its acquisition" of mortgage lender HBOS. On the contrary to RBS, the bank isn't participating in the government's insurance scheme, leaving it "dependent upon its own resources to deal with continuing pressure in CRE markets."

Fitch also said corporate defaults typically peak after economic contraction ends, which suggests that loan losses are unlikely to peak until into 2010.

"Refinancing will be a particular concern in 2011 and 2012 when a high volume of property loans fall due," it said.