Maltese banks' heavy reliance on real estate collateral is a cause for concern, according to a major credit ratings agency, since any recession-driven decline in the property market could jeopardise their asset quality as well as affect ratings.
Moody's Investors Service says in its new Banking System Outlook for Malta that the domestic banking system has remained highly concentrated. But, nevertheless, it continues to record good performance thanks to growth in household credit.
The agency says that in recent years banks have increased their exposure to the construction sector, which has been booming on the back of rising real estate prices.
"Despite improvements in loan vetting processes, we believe that banks should remain mindful of their reliance on real estate collateral. However, there are no signs that Maltese banks' asset quality has so far been impacted by the reported slowdown in the property market," analyst Stathis Kyriakides told The Sunday Times.
Household and personal lending has been the main driver of credit expansion in recent years. In particular, low interest rates and higher household income have led to growing demand for home loans and rising real estate prices.
Although available data until the first quarter of 2007 suggests that on aggregate real estate prices continue to rise, they have been doing so at a steadily decelerating rate. The 12-month residential property price growth rate peaked in 2004 at an extraordinary 35 per cent and since then has decelerated to just three per cent in the first quarter this year.
Operating within the confines of Malta's small and highly concentrated environment limits domestic banks' lending opportunities, according to Moodys, while introducing an element of industry risk to their loan books, primarily in the manufacturing, tourism and construction sectors.
Moody's remains sceptical over the long-term sustainability of the increase in real estate prices and the prudence of relying significantly on property collateral, as its value and potential recovery are somewhat difficult to quantify.
Around 60 per cent of banking system loans are real estate collateralised, while provisioning coverage is particularly low as banks provide only for the portion of the loan that is not covered by collateral.
The speed of court decisions - which, despite a slight improvement, remains less efficient than in other markets - represents another concern, as does the execution of these decisions in the event of a bank choosing to take legal action against non-paying borrowers, Moody's said.
Mr Kyriakides would not be drawn into making any forecasts over the fact that there are over 53,000 unsold properties in Malta.
"The type of vacant properties would be a consideration, as would the possibility of such vacancies resulting from a seasonal drop in demand."
"In the event of a real estate oversupply and a subsequent pressure on prices, it is likely that banks with material exposures to the construction sector would be the first to experience rising asset quality pressures," he explained.
Turning to the sector in general, Moody's says that the highly concentrated and duopolistic nature of Malta's domestic banking market remains a "drawback" for the system, marginalising the ability of the smaller players to tap any of the few good lending credits.
On a positive note overall, in recent years, Malta's banking regulation and supervision functions have continued to improve and strengthen in an effort to bring them in line with EU standards.
"We view the country's impending adoption of the euro as positive in promoting further alignment with more advanced supervision practices. It should also shelter Malta's economy from external financial shocks, remove most domestically oriented banks' (already low) currency risk and eliminate transfer risk," Mr Kyriakides said.
As interest rate margins appear to have stabilised, Moody's expects banks' overall profitability levels to remain adequate, sustaining the banking system's consistent track record.