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Bank of Italy scrutinises banks' property valuations

* Property asset valuations key source of uncertainty in ECB review

* JPMorgan analysts apply 70 pct haircut on Italian banks' collateral

* Banks' capital raising bill seen at up to 20 bln euros

MILAN, March 7 (Reuters) - The Bank of Italy is hiring up to five real estate consultants to assess whether banks are correctly valuing property used as loan collateral amid depressed market prices, potentially forcing them to set aside more cash against defaults.

Collateral valuations are one of the biggest sources of uncertainty for Italy's banks as they prepare for a Europe-wide review of the sector, starting this month, with seven banks already planning to raise more than 7.5 billion euros ($10 billion) to shore up their balance sheets.

A doubling of bad debts in Italy since the end of 2010 means that many experts are already saying the capital raising bill could rise to as much as 20 billion euros with the question of collateral valuations adding to the pressure.

Most banks are currently working on updating their valuations of real estate collateral ahead of the European Central Bank's review, industry sources say.

"The issue of the correct valuation of collateral is still open and is a very sensitive issue," a senior banker told Reuters on condition of anonymity.

"Banks have already written down the value of collateral but they are wondering: is this enough? At the same time, excessive prudence could have catastrophic consequences, as it would further depress the real estate market," the banker added.

Small and medium-sized enterprises put up properties such as warehouses and factories as collateral for loans but a 25 percent drop in Italy's industrial output since a 2008 peak, thousands of company bankruptcies and a slide in property sales have cut the price of these assets, in some extreme cases close to zero, and made others hard to value.

To help with valuations carried out as part of the ECB review, the Bank of Italy has put a tender notice up on its website seeking real estate advisers.

The Bank of Italy is drawing up a short-list from 12 property firms admitted to the tender, an industry source said. Another source said a final decision on who will be chosen was expected mid-April.

Bidders include Prelios Valuations, part of property group Prelios, and U.S. commercial property adviser CBRE . Both companies declined to comment.

BIGGEST SOURCE OF UNCERTAINTY

The ECB is reviewing the balance sheets of the euro zone's largest banks before it takes over as their supervisor in November. The review is due to end in June and the banks will then be subject to stress-tests. Overall results will then be published in October.

The head of the European banking watchdog told Reuters this week that euro zone banks could be forced to disclose any major balance sheet gaps discovered in the health check before October.

Rocco D'Acunto, a partner at Bain in Italy, said he expected fresh valuations of properties held as collateral against loans to start impacting banks' balance sheets around June-July.

"We expect this might have a negative outcome in terms of additional coverage and provisions for the banks, but it will also increase transparency and help reduce the price gap that now holds back sales of problematic loans," D'Acunto said.

Analysts at JPMorgan said in a note they were applying a 70 percent haircut on all collateral held by Italian banks.

"The reason why we apply such a big haircut to the value of collateral is that this is the biggest source of uncertainty for Italian banks, according to both banks' management and the Bank of Italy," they said.

JPMorgan said that a 60 percent drop in the number of property sales peak to trough during the crisis made real estate valuations problematic.

Of the 15 Italian banks that are under scrutiny by the ECB, only UBI Banca answered a Reuters request for comment on its collateral valuations.

"Our group traditionally has a careful policy of conservative coverage of non-performing loans," UBI said. "We update every six months the fair value of collateral in a further proof of the attention we pay to the coverage issue."

Italian banks have already set aside billions of euros to cover loan-loss charges partly in response to the Bank of Italy's demands to hike provisions since late 2012.

Bad debts are forecast to keep rising in coming years topping 190 billion euros in 2015, from 156 billion euros last December, even as the economy slowly returns to growth, banking group ABI said.($1 = 0.7225 euros)