Poor-quality assets create an £80bn refinancing headache

CBRE calculates that £80bn of debt is backed by seriously flawed assets, reports Jane Roberts

Almost £80bn of outstanding UK property debt is secured on poor-quality property that investors will struggle to refinance because it is so impaired, CB Richard Ellis estimates. The firm is one of the first to attempt to calculate the makeup of what it estimates to be £280bn of outstanding debt, with £150bn due to be refinanced by the end of 2012.

CBRE overlaid De Montfort bank lending report statistics for the past seven years with its own UK investment deal and valuation data for that period, in particular the prime/secondary breakdown of deals, then divided the loans into five types (see pie chart). The report concludes: “Loans from 2006- 07 that were secured against secondary real estate will leave lenders with a headache for years to come. The fundamentally weak real economy is likely to significantly delay the recovery in poorer quality properties.”

CBRE adds that lenders should pay most  attention to loans secured against poor-quality property to minimise losses and recoup most value. At 27% of the total, this is the biggest category of the five identified. As well as the £79bn secured on poor- quality assets, a further 16% – the £43bn of debt outstanding on 2006/07 loans secured on good-quality assets – could be in trouble, making a total £122bn of potential problem loans. This is because the £43bn of loans mature in the next few years and have high LTV ratios and aggressive lending terms.

CBRE calculates that of the £280bn outstanding, there is an aggregate mark-to-market loss of £53bn, as of November 2009, mainly in loans originated in 2006-07 (see bar chart). But an equity injection of more than as much again would be required to refinance it all at once today; investors buying assets secured on underwater loans would have to inject £68bn, as lenders now won’t lend at above 60% loan-to-value ratios.

Robin Hubbard, a director at CBRE Real Estate Finance, says it is vital to understand rent rolls and where to focus finite human resources to minimise losses. “It is essential to good portfolio management to understand which assets to sell now because the net present value of redeploying that capital today is better than trying to recover a small amount of incremental value,” he says.

However, most of the remaining £158bn in the other three categories should be performing well enough to be refinanced – if one agrees with CBRE’s assumptions. Hubbard says the £51bn originated before 2005 is less problematic, as LTV ratios were lower then than the 80% 2006-07 average, while capital values have fallen less than 20% since then.

CBRE believes the collateral would have had to be better quality to compensate for its longer-term (five-year-plus) financing. Similarly, while most of the £66bn that matures after 2015 was originated in 2006-08, when leverage and capital values peaked, CBRE says “it seems unlikely that even at the top of the market lenders would have granted loans of eight years or longer against poor-quality properties”.

But the firm admits that definitions of good and poor-quality assets have changed and underwriting standards slipped in this period, as lenders competed for clients, especially for CMBS debt, a lot of which falls into this time-frame category.

On the question of whether lenders are focusing on loans secured on poor-quality property, Hubbard says the feedback from CBRE’s valuation team is that banks “are being more systematic” and have stepped up valuations in recent months, especially  on larger deals, which may result in sales to take advantage of strong demand for stock.

“This report gives people a general feel; we see demand for prime property spilling over into good secondary,” says Hubbard. But he adds that banks may not be ready to lend on the bulk of secondary property deals yet, except in the form of vendor financing.

The good, the bad and the ugly of UK property debt

In UK Commercial Real Estate Debt – a Two-tier Market, CBRE divided up outstanding debt into five categories by the year loans were made, average initial leverage levels in those years, and quality of underlying property lent on.

The assumptions about origination dates, volumes, loan-to-value ratios and tenor of outstanding debt are based on averages and De Montfort reports were the main source. But it was harder to estimate the prime/secondary asset breakdown.

CBRE Real Estate Finance director Robin Hubbard says: “CBRE probably covered 80% of the market and made assumptions about the rest. We know the market’s size; the challenge was judging the cut off point between good-quality property and the rest.”