Banks in business |
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By Daniel Thomas 21/05/2010 The annual De Montfort bank lending report shows that banks have opened their doors a crack — but investors must not become complacent
Banks are back in business, but the extent of legacy problems from the wasteful lending of the previous boom is only just being recognised, the annual De Montfort report into UK property lending shows. The resolutely robust investment market over the past 12 months has been helped by the return of lending, and there is evidence of competition again among the UK’s leading institutions for the right sort of deals. Margins may not be pushed below 200 basis points very often, or loan-to-value (LTV) ratios above 70%, but investors are finding the door open once again when they want to make acquisitions. But this year’s De Montfort University survey — the only bellwether research that comprehensively covers the lending to the industry — shows starkly why these banks are only willing to countenance discussions on the safest deals, and the more reliable of counterparties. They are still clearly in a great deal of trouble with bad debts made during the height of the boom — loans in default and breach of terms now account for a fifth of reported outstanding debt. Although the purse strings are loosening, it would also be too much to say that banks are back to their former profligate form. The total estimated amount of money outstanding to the UK property industry has increased, but only marginally (graph 1). De Montfort’s research shows that total property lending — covering commercial property as well as lending secured by social housing — reached £247.7bn across the 59 lending organisations in the UK (graph 2). The value of outstanding bank debt secured by just UK commercial property rose by 1.2% to £228.3bn at the end of 2009, the lowest annual increase on record. The researchers estimate that responses capture between 90% and 95% of the market, which means that the true market size is estimated at between £240bn to £254bn. There is also £50bn of debt outstanding in the commercial mortgage-backed securities (CMBS)market, based on data from Fitch Ratings, which takes the total market size to as much as £306bn. The sharp spike in problem loans within this total is troubling. The combined value of loans in default and breach of financial covenant rose to around £50bn at the end of 2009, which represents a fifth of the reported bank debt on commercial property. The value of loans in breach of financial covenant accounted for the lion’s share at £28.3bn (table 1, opposite), almost three times the £10.7bn reported in 2008. The rise in loan defaults was even starker. There was a six-fold increase to close to £22bn during 2009. Just £3bn was reported in 2008, showing the lag between the decline in the value of property and the rise in incidence of default (table 2, opposite). Identification parade Bill Maxted, the author of the report, says that this shows most banks needed the time to simply identify the impaired loans. He believes that this process is progressing, which means the 2009 figures begin to show for the first time the real losses to the banking sector. He says lending organisations are mainly retaining impaired loans on books and dealing with situations by a combination of extension and restructuring that has led to a limited level of reported write-offs. There have been surprisingly few fire sales and administrations, although this is beginning to change, as some of the biggest lenders take action on the poorer-quality assets and owners that are carrying very high LTVs. “The management of the institutions have spent 2009 sifting through loan books to see what was in trouble. There has been a sorting-out and they can now see what the problems are,” says Maxted. “These may be the fullest extent of the bad loans being experienced by some of the banks, although there are others that tell us that they are still not testing covenants. "A fifth of outstanding debt looks pretty frightening but is not surprising, given the boom and bust of the last few years.” Another problem is how much debt is coming up for maturity, as fears of a vast debt funding gap emerge. Setting aside whether or not there is the money to cover the necessary refinancing — and some agents say there is, given the strength of demand for real estate from global institutions — the extent of the maturing debt looks severe. Just more than 70% of outstanding bank debt is due for repayment over the next five years (graph 3, overleaf). This equates to £161bn, a sum nearly twice the size of Scotland’s annual GDP, and does not include the £17bn of CMBS also due to expire. In 2010 alone, there will be £52.6bn of debt held on balance sheet due to mature, and £2.4bn of maturing CMBS. This has increased from the £32.6bn that had been set to expire this year when valued in 2008, reflecting the extent to which banks have extended loans due for repayment. De Montfort estimates that a further £29bn of loans that should have matured in 2009 have had been extended into later years. There is now £34.7bn and £32.4bn that is likely to mature in 2011 and 2012 respectively (graph 4, overleaf). Maxted says: “The typical length of extension is now approaching three years, rather than just one year, as it tended to be in 2008. "This shows that lenders are willing to push their views forward to the medium term when market conditions may have changed more — although also that it is not just a 2010 problem, but for many years after.” Dominic Reilly, partner at King Sturge, a sponsor of the report, says: “We haven’t really addressed how the banks are going to refinance this backlog but it is undeniably rolling up fast. I think this could be the biggest problem for banks going forward.” Even so, Maxted says banks have indicated that they are happy to keep the loans rolling over, as long as the borrowers are not “no hope cases”. This could mean that there is potentially less debt available for new lending, however. The lack of activity in dealing with problem loans in a more wholesale fashion helps to explain why the amount of outstanding debt to the sector has yet to reduce, despite the market crash. De Montfort’s report supports anecdotal evidence that banks are lending again, and on some of the most competitive terms since 2007 for the right sort of property and to the right lenders. For all the losses being carried, banks have also recognised that lending to a sector in recovery at high margins on safe assets is a money-spinning opportunity. Reilly says: “We can now expect to receive multiple quotes from banks on well-let properties. Lending terms are still mostly near historic highs, however, and this represents a big opportunity to make money for the banks.” In 2009, £15.1bn of loan originations was recorded — a decrease of 69% from the £49.2bn of originations in 2008 and the lowest on record since the survey began in 1998. This excludes extensions to loans that should have matured, however, which was included in last year’s data. Taking the £15.1bn of loans originated in 2009 and placing it against the £55bn of loans due to mature during 2010 provides a snapshot of the magnitude of a potential debt funding gap. Four organisations accounted for almost half of this new lending, which shows how thin the market was in competition (graph 5). More than a third of organisations reported no loan originations. However, sentiment is improving. Fifty-six per cent of organisations intend to increase loan originations — more than double the 23% that expressed an intention to do so at the end of 2008 (table 3, opposite). The renewed competition among banks has also led to an improvement in the terms being offered to borrowers — again supporting what investors are finding in the market. There was a decrease in average margins in the second half of 2009, but they remained higher than those recorded at the end of 2008. For example, the average margin on loans secured on prime office property increased from 213.5 basis points at the end of 2008 to 245.2 basis points at mid-year 2009 — the highest ever recorded — then decreased to 219.7 basis points at year-end 2009 (graph 6). Coming to terms There has also been a modest improvement in the level of LTVs for loans secured on prime property, although perhaps not surprisingly, ratios for secondary retail and industrial, as well as residential investment, continued to fall throughout 2009 (graph 7). Arrangement fees continued to increase, albeit at a less dramatic rate during 2009 than that recorded in 2008 (graph 8). Maxted adds that this does not capture the fact that many banks simply will not lend on property at any LTV or margin that is not seen as safe, however. One interesting new finding in this year’s report is that 57% of outstanding loans have interest rate hedging in place. Although this might seem a technical point, the existence of these derivative positions has ramifications on how banks have been able to pursue the workout of problem loans. The cost of breaking such swaps can be hugely prohibitive, effectively preventing some banks from defaulting on loans in certain situations. There is talk among bankers that the losses on certain arrangements are more than the negative equity position. It all adds to a complicated picture for the UK lending market. On one hand, banks still report high impairments because of bad debts, and on the other hand, lending teams want to start to deploy newly grounded balance sheets in the market again. The positives should not be overlooked, given the importance of debt to the sector — but nor should the borrowers from the boom times feel complacent about the tough conversations in the months and years ahead.
Source: Property Week (www.propertyweek.co.uk) |
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