16 July 2010 | By Lucy Scott

The Basel III rules will make it even harder for banks to lend to property companies and investors

This week, the Basel Committee on Banking Supervision met to thrash out the details of its latest proposals to overhaul the global banking system.

Basel III, which will come into effect in 2012, will create new and even more difficult hoops for lending banks to jump through, in the form of much higher liquidity and capital requirements.

In their quest for more rigour in the financial markets, world leaders are determined to ensure that risky practices that relate to leverage, inadequate liquidity and poor underwriting are never repeated (see box, below).

But there are fears that Basel III will be a leap too far for an already tight property lending market. Some bankers claim the measures will knock 5% off global growth, and UBS estimates that banks may need to raise $375bn globally to meet the new requirements.

For the property industry, this means that banks have less money to lend and the cost of capital for banks will rise. This will, ultimately, lead to more expensive loans for borrowers.

“Basel III will certainly make it harder for property companies to get finance from banks,” says Gareth Lewis, the European Public Real Estate Association’s director of finance.

Detailed policy measures will be decided in November at the G20 summit in Seoul, but property bankers and the industry are already beginning to fear the changes. The reforms, they argue, will disadvantage institutions with large lending businesses, curtail the amount of capital available to lend to real estate and deter them from undertaking high-risk lending.

Moreover, questions are being asked about the extent to which these new capital requirements will impact on the swathes of problem property loans sitting in banks, as Basel III is likely to demand they find capital to set aside against them. Prospective buyers of the £2bn-£3bn of property loans for disposal, that the Royal Bank of Scotland was revealed to have earmarked last week, would certainly have to consider the new rules.

More tiers

At the crux of the Basel Committee’s measures are changes to the quality and amount of capital that banks hold to protect themselves against losses, impairing their ability to lend.

The Swiss-based organisation, which informs the regulatory agenda for the G20, wants to substantially raise this capital requirement (known as tier 1 capital), to make banks more robust in the event of financial shocks. It also wants to restrict banks’ ability to pay dividends to its shareholders if its capital ratio drops below a certain level, introduce an overall leverage ratio for banks’ balance sheets and for banks to maintain higher liquidity ratios.

Although commercial real estate lending is not being targeted as such, experts argue that the broad policy measures of Basel III could mean it is more costly for banks to undertake risky business such as development lending.

Patrick Fell, director and head of capital regulation at PricewaterhouseCoopers, says: “There are still a lot of important decisions that need to be taken, but the key thing is that Basel III will require banks to increase the level of capital they are required to hold.

“There is a lot of discussion about the amount of extra capital that might be needed, but it will determine what business they do, the cost of loans they make and how much lending they undertake.”

Tauhid Ijaz, partner at Hogan Lovells, who specialises in commercial real estate finance and structured finance, says the rules could have a greater impact on property than other sectors.

“The rules will bite down harder on property lending,” he says. “Bankers will have to think about the nature of the assets they hold on their balance sheet and the capital requirements that this attracts.”

Basel III has not prescribed which types of lending are more risky, but experts believe that higher-risk lending activities will be most exposed to the new rules. This could include investment in secondary property or where income is volatile, as in speculative development.

Juergen Fenk, general manager of real estate lending at German bank Helaba, says: “Everything that is seen as higher risk means the capital requirement will be much higher. This will either mean increases to the cost of loans for borrowers, or banks may choose not to do the business at all.”

Andrew Goodbody, head of the London office of German property lender DG HYP, agrees. But he believes new rules could result in weak appetite for secondary property persisting for some time.

“If banks are penalised for more risky lending because they have to set aside more capital to cover it, then that makes some business potentially unprofitable,” he says.

Securitisation blanket

Property securitisation is also likely to become more costly and more regulated. The Basel committee is likely to impose higher capital charges on banks when they undertake this type of lending.

It may also force lenders to be more open about deals, requiring them to list the securitisations they have undertaken, the ratings they have been given and the assets backing the loan.

Banking analyst Matthew Maxwell, senior credit research analyst at Société Générale, says this will make it more onerous for banks and that it is “a safe bet increased capital charges will be applied, which means costs for the borrower will increase”.

If Basel III is imposed, could it be economically inefficient to lend

Ian Marcus, Credit Suisse

Paul Leatherdale, consultant to Cushman & Wakefield’s real estate recovery arm, C&W Resolution Group, believes that the reforms will also restrict banks’ ability to refinance problem loans. The higher costs of funding may determine how a loan is restructured or whether it is sold.

“For conservatively structured business, the banking market will still be there, but at a price,” he says. “Everything is pointing to increased costs for borrowers. The terms of any new lending will be tightly controlled, so the supply will be restricted and loans will undoubtedly cost more in the future. Generally, tighter rules on bank funding arrangements and increased liquidity requirements will mean that new lending is likely to have shorter maturities than in the past.”

Leatherdale also argues that, although formal implementation is likely to be in 2012, most banks will begin to adopt more rigorous lending practices before then, to prepare themselves for the new regime. He says that banks’ own risk management and credit committees are already putting pressure on banks to downsize their property loan books, and the pressures imposed by Basel III is a continuation of that trend.

“We know the shape of the regulations and we can therefore expect to see the impact of them ahead of time,” he adds.

Banks may complain that the rules will restrict their ability to support economic growth, but banking analyst Maxwell believes there is a little room for manoeuvre.

“The Basel committee will make far fewer changes than bankers expect, although there is likely to be material discretion at national level as to how the final proposals are applied,” he says.

Bankers argue that Basel III is unworkable.

Some say the rules are so damaging that they will have to be changed.

Ian Marcus, managing director in the investment banking division of Credit Suisse, is also a critic, calling the proposals “self-defeating”.

“If the government wants banks to start lending again, then the proposed regulations will hamper that,” he says. “The question is, if it is imposed, could it be economically inefficient to lend?”

The latest research by Société Générale suggests that, aside from restricting the money available for property loans, the new measures could force some banks to raise new capital because they could face capital shortfalls if proposed measures on liquidity are implemented. BNP Paribas, Eurohypo’s parent Commerzbank and Deutsche Bank are lenders that would be forced to raise new money to plug the gap, says the bank.

But with Europe’s sovereign debt crisis hanging over lenders, some bankers believe Basel III is only one of many obstacles to an increase in financing for the property sector.

“There are too many uncertainties for banks to properly implement medium- to long-term lending plans. Banks are working on a short-term basis,” says Mark Titcomb, Deka’s head of representative office, London.

“The market has to expect that there will be a reasonable level of debt finance for quality property, but there is currently very little prospect of lenders broadening their interest away from that – with or without Basel III. Until the sovereign debt issue looks more comfortable, banks will be concerned about their capital positions. If a big crisis were to happen in southern Europe, then there will be a lot of banks needing public injections of capital. Until banks can get confident again, it can’t be responsible for them to increase lending activities significantly,” he adds.

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Source: Property Week (www.propertyweek.co.uk)