Banks set for losses as clock ticks on £300bn commercial property loans

Published 27th Jul 2009

British banks are expected to follow their American counterparts into real estate losses amounting to billions of pounds


Banks could be heading for a second wave of big losses as financial institutions begin to tackle the crippling legacy of £300 billion in lending to the UK commercial property sector.

British banks are expected to follow their American counterparts, which are already having to bite the bullet on commercial real estate losses.

A collapse in values of more than 40 per cent in less than two years means that almost every British commercial property loan granted since 2004 is under water, according to Savills, the estate agency.

This gloomy forecast was reinforced by another report that confidence in global commercial property markets has deteriorated in the past three months as rents — regarded as a key property market indicator — dropped by the steepest amount on record.

The Royal Institution of Chartered Surveyors said that — despite a slower pace of decline in prices and a surge of interest from investors hoping to mop up cheaper assets — the outlook on rents remained depressed.

Almost three quarters of surveyors said that rents were falling. The percentage reporting a fall, rather than a rise, went up from 66 per cent in the previous quarter to 71 per cent in the past three months.

The rout in the commercial property sector has hit American banks. Last week, Ben Bernanke, Chairman of the Federal Reserve, acknowledged “the very real risk on the side of foreclosures and the problem of commercial real estate”. As he spoke, US banks, including Morgan Stanley and Wells Fargo, announced poor results because of real estate problems.

Wells, which inherited the mortgage book of Wachovia when it took over the troubled bank in December, announced a surge in profits and revenues but its share price dived as it admitted that non-performing commercial property loans had risen by 65 per cent.

Key Corp, another big US deposit taker, which revealed a quarterly loss last week, said that it had $1.2 billion (£730 million) in non-performing commercial property loans.

“They [American banks] are pretending that everything is OK and are extending the maturity of loans. Banks can only afford to take losses if they have enough equity and earnings.” said Stephen Blank, a fellow of America’s Urban Land Institute.

British banks are adopting the same strategy of turning a blind eye to loan covenant breaches.

However, UBS analysts expect Lloyds TSB to suffer a £6 billion first-half loss after charges against its loan book of £13 billion.

There is also mounting concern about exposure to European commercial mortgage-backed securities (CMBS) — bonds issued on the back of securitised commercial real estate loans. Royal Bank of Scotland was active in arranging CMBS in Europe, including a £500 million securitisation for Dunedin, a property group that went into administration last year.

At the same time, the high street banks made big loans to private equity property vehicles set up by American and European investment banks. “Many of these deals were very highly geared. They will be under water in terms of loan to value and some may be having problems paying interest. Rental values are falling and it is hard to maintain income,” said Jane Roberts, editor of EG Capital, a property finance journal.

Half of the UK’s £300 billion commercial real estate loan book needs to be refinanced over the next two to three years, said Savills but, it adds, there is only capacity in the market to absorb £20 billion per year.

The situation does not look much better in the US. According to Mr Blank, American banks need to refinance about $300 billion in commercial property lending every year for the next three years. He estimates a capital shortfall of more than $100 billion a year for the next three years. American commercial property values are falling but — unwilling and unable to refinance loans to commercial real estate owners — the banks are turning a blind eye to the valuation deficit.

Source: ' Times '

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