Banks put through commercial property ringer in stress tests

Like the Tokyo Olympics, European Banking Authority (EBA) stress tests were delayed by a year in 2020 in the hope that we'd be the other side of the Covid-19 crisis before they went ahead. But just as the pandemic is casting a shadow over proceedings in Tokyo, it looms large in the economic scenarios banks must prove they can cope with as stress-test results are published on Friday evening.

Looking at scenarios for gross domestic product (GDP) across the EU, the EBA is working off an adverse case of Irish GDP contracting 3 per cent between 2021 and 2023, slightly better than the average 3.6 per cent being assessed for across the bloc.

It’s a similar trend when looking at unemployment data. And even on the house prices front, Irish banks are being assessed in an adverse scenario against valuations falling 13.2 per cent over three years, whereas banks across the wider EU are being tested against a 16.1 per cent decline.

However, while the baseline forecasts are for Irish commercial property prices to grow in each of the three years, the adverse scenario envisages a 32.5 per cent slump in values. Although the Irish worst case is not much out of line with the EU average being assessed, the deviation between the Irish base and adverse case is 40.1 per cent, compared to 32.8 per cent for the wider EU.

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Regulatory conversations

Fortunately for the Irish banks subject to the stress tests – AIB and Bank of Ireland – their commercial property portfolios are a fraction of boom-time levels, even if the Central Bank of Ireland has been highlighting the knock-on consequences of risks in the leveraged property funds sector of late.

Unlike crisis-era European stress tests, current EBA assessments – usually carried out every second year since 2016 – do not have pass or fail thresholds. But they do feed into regulatory conversations with banks on capital, dividend distributions and bonuses. Even ahead of the results, the European Central Bank said last Friday that it would end pandemic-era restrictions on shareholder payouts in September.

Analysts Davy and Goodbody Stockbrokers, which are set to become units of the two main banks before too long, expect AIB (buying Goodbody) and Bank of Ireland (buying Davy) to fare well in the stress tests, given their high starting capital ratios and the high level of loan-loss provisions they set aside last year. This should pave the way for a return to dividends to shareholders – led by the State – early next year. Or that’s the hope.