Total outstanding property debt has fallen for the ﬁrst time in the 10-year-old report’s history
Its ofﬁcial: the great deleveraging has begun. For the ﬁrst time since the survey began a decade ago, De Montfort University’s twice yearly UK Commercial Property Lending Market report shows that overall net debt secured against UK commercial property fell in the ﬁrst six months of this year.
The ﬁrst step on a long, hard road has been taken. But a sharp increase in loans in default indicates the difﬁculties that will have to be faced along the way. The Mid-Year 2009 report, by Bill Maxted and Trudi Porter, shows that net debt fell by £1.4bn from £225.5bn at the end of 2008 to £224.1bn in June 2009 (see graph below). This was the result of banks starting to deal with the legacy of excessive lending during the boom, rather than writing new business, and looking to reduce their property exposure in line with targets imposed by boards and governments.
The report also reveals a startling collapse in new lending, with only £7.4bn of loans written – by far the lowest in the survey’s history. However, the period covered includes the ﬁrst quarter of 2009, when there were widespread fears of another Lehman Brothers-style collapse. “The organisations we talk to that are still in the market are not undertaking new lending or looking for new business,” says Maxted. “All their energies are focused on managing their existing books. Importantly, it’s where their capital is tied up as well.”
Peter Cosmetatos, director of ﬁnance policy at the BPF, which sponsors the report, adds: “I think the drop in debt shows that we are in the early stages of a lengthy restructuring that will take several years.” Taking into account debt secured against social housing and UK commercial mortgage-backed securities, the total debt is £300bn – the same as last year.
Anonymous comments from the 61 lenders that replied to the survey underline the fact that a long and drawn out process of deleveraging is likely, with debt secured against the sector continuing to drop. “We have substantially reduced our activities,” one respondent said. “But as we are in a strong funding position, we can choose what business to do. Having said that, we are passing on some good opportunities due to our general reduced appetite until we have full visibility of any future problems coming through the existing book.”
UK banks have biggest slice
Of the £224bn of debt outstanding, the largest slice, 55%, is still held by UK banks, but their proportion fell from 61% as a result of the reclassiﬁcation of former UK lenders Abbey and Alliance & Leicester as ‘other international’, following their takeover by Spanish bank Santander (see pie chart).
Correspondingly, the ‘other international’ category’s market share rose from 17.5% to 23%. German banks’ market share rose from 10.5% to 11%, probably reﬂecting their prominent role in what little new lending there was in the ﬁrst half of this year. Building societies’ market share remained steady at 9%, as did the 2% market share of North American lenders, who retreated from the UK because of their inability to securitise new loans; they appear to be stuck with the £4.5bn they had on their books last year.
New lending virtually came to a standstill, at £7.4bn, in the ﬁrst half of the year – only 30% of the £24.6bn of new debt extended in the ﬁrst half of 2008, and only 15% of the £49.2bn of new debt in all of 2008. Even of that, only £3.4bn was new lending £4bn was reﬁnancing This collapse is likely to be due to fears about the instability of banks and ﬁnancial markets in the ﬁrst quarter, as well as the paucity of deals. Lending has since picked up along with deals in the second half of the year, which will be reﬂected in the 2009 full year report when it is out next year.
However, all this points to the fact that there has been little easing in the pressure for loans of varying quality to be reﬁnanced in the next three years. The mid-year report does not contain updated reﬁnancing ﬁgures, but the 2008 report showed £43bn was due to mature in 2009 and £32bn in each of 2010 and 2011 – a total of £107bn.
In addition to the £4bn of reﬁnancings reported by banks in the £7.4bn new lending ﬁgure, which Maxted says he assumes ‘were proper new loans on a solid basis, probably on new ﬁve-year terms”, banks reported a further £5.3bn of loans that they extended, or extended and restructured. This makes a total of £9.2bn of debt extended or reﬁnanced, which De Montfort presumes to have been maturing this year or next.
If it is assumed that half of the £42bn of debt due to mature in 2009 was due in the ﬁrst half, then the £9.2bn is under half the £21.4bn due. Maxted and Porter account for the ‘missing’ £12bn in this way: “By considering the value of new lending and the aggregated loan book sizes at the end of 2008 and mid-year 2009, we estimate that around £5bn of loans have been repaid or written down and a further £7bn of loan extensions have been undertaken, but not captured by this research.”
Reﬁnancing gap to bridge
Dominic Reilly, partner in the corporate ﬁnance team at report sponsor King Sturge, says: “There’s a big gap between the amount of new lending and that which needs to be reﬁnanced. Banks are going to have to get more capital and lend more actively, but it will be difﬁcult to bridge that gap. We need new entrants to the market and could see that from groups such as the Canadians, who are in a robust position because they were not lending at the top of the cycle.
“But I also suspect we will see existing banks come back to the market, because of the stabilising affect of government bodies such as the Asset Protection Scheme and the National Asset Management Agency, and the fact that now is a proﬁtable time to lend because margins are so high.”
This is supported by positive news that the proportion of lenders willing to lend against commercial property rose from just 23% at the end of 2008, in the market’s darkest weeks after the collapse of Lehman Brothers, to 50% this June. The ﬂip side of this is that 13% of lenders said they plan to pull out of property lending. This has led to a concentration in the number of banks undertaking new lending, with 12 lenders accounting for 83% of new lending; this compares with a previous high last year of 12 lenders having a 68% market share.
In the ﬁrst half of 2009, CMBS lending was non existent. However, in the second half of 2009 there were two securitisations by Tesco and one by Land Securities. Reilly says the return of this market could be an important factor in assisting the reﬁnancing of property. “I don’t think there is anything inherently wrong with securitisation, it is just the pricing and structure that were wrong. This market will come back and it will be a useful tool for banks.”
As Reilly points out, now is a proﬁtable time for banks to lend. In relative terms, debt got more expensive for property investors in the ﬁrst half of 2009 and 79% of lenders said they had increased their level of pricing. While bank interest rates at a 300-year low have helped mitigate the effect, interest rate margins on property loans rose sharply, by 37 basis points, with average prime ofﬁce margins rising from 213.5bps to 245.2bps (see graph). Arrangement fees are around 100bps for prime property lending.
The rise reﬂects banks’ need to rebuild capital positions decimated by provisions against defaulted loans. Again, banks are shying away from the risk of ﬁnancing secondary property. “Compared with the end of 2008, the gap between average interest rate margins for prime and secondary property of the same type has widened from 19.9bps to 32.7bps for ofﬁces, while the gap between average margins for retail has widened from 22bps at the end of 2008 to 39bps,” Maxted says.
“This data supports anecdotal evidence that there is little appetite for funding projects secured by secondary property.” This conclusion is borne out by the fact that less than half of banks said they would consider lending against secondary assets. This lack of interest in secondary property will hamper the market’s recovery. As Mark Titcomb, head of DekaBank’s London ofﬁce, says: “A lot of banks are not interested in lending against recovery stock. There is very little prospect of a recovery in the commercial real estate ﬁnance sector. “Banks are not getting any prizes for taking greater risk. Markets are improving, but banks are going to be locked into high real estate exposure for years to come.”
Banks loosen LTV ratios
While margins have soared, the pressure on loan-to-value ratios has eased. In 2007-2008, the average LTV ratio offered by lenders plummeted, as conservative banks tightened the proportion of debt they offered to pre-empt falling values damaging new loans.
But in the ﬁrst six months of 2009, that tightening eased and the average LTV on prime ofﬁce property (used as a benchmark for LTVs by De Montfort) edged up 0.6% to 65.9%. Three quarters of lenders were willing to offer LTVs in the 65%-79% range, compared to 67% at the end of 2008, with lenders taking the view that prime values had reached a trough.
Only ﬁve (or 8%) of the 61 banks surveyed were willing to fund 50%-prelet developments, down from an already low 10% at the end of 2008. The amount of the development cost and value those banks were willing to ﬁnance rose – but the price developers had to pay for their funding rose even more sharply.
Overall, 42% of lenders were willing to fund fully prelet development. As one respondent said: “We can theoretically do development, but [only in] staged drawdowns and revolving credit, which involve intensive use of our staff that is not efﬁcient.”
So while the second half of the year is likely to have seen an increase in new debt, as both a cause and a result of renewed conﬁdence in the market, there are still signiﬁcant challenges to be faced. One respondent summed up the inherent danger: “We are a long way from being out of the woods and it concerns me that some seem to think that as the worst is over, we can breathe a huge sigh of relief and move onwards and upwards.”
Only way is up after all-time low for new lending
Max Sinclair, co-head of Eurohypo’s UK division, says of the £3.4bn lent on new deals in the ﬁrst half of 2009: “We expected it to be low, but not so low. The report shows the total withdrawal of liquidity in the ﬁrst quarter of this year. You have to remember what a time of crisis the ﬁrst quarter was and there was virtually no new lending.
“But I am conﬁdent that things have picked up in the second half, and the ﬁrst half was a trough for new lending. I expect new lending in 2009 to be down around 50% on 2008 overall.” That would put it at £24.5bn, including new reﬁnancings. Jones Lang LaSalle is predicting that total UK investment deal volumes this year will reach £22bn-£23bn.
The number of lenders who lent nothing in the ﬁrst half of 2009 was 22. Seven of the 61 respondents, including Kaupthing Singer & Friedlander, Dunfermline Building Society and Northern Rock, said they had pulled out of new lending and were in run-off mode.
Once more into the breach as banks fight off a wave of loan defaults
Banks are ﬁghting a major battle against breaches of covenant and defaults on existing loans. According to De Montfort’s report, 4,308 loans with a value of £18.6bn were in breach of covenant in June.
This represents 8.6% of all debt, up from 6.5% at the end of 2008, but is artiﬁcially low as banks have avoided testing covenants. The number of loans in default where repayment has been accelerated has risen more steeply – four fold – to £11.8bn, meaning that a total £30.5bn, or 14%, of outstanding loans are in trouble. Before 2008, the ﬁgure was around 3%. However, as not all lenders gave this information, De Montfort’s ﬁgure is a minimum estimate.
“In most cases, banks let loans run as long as interest is being paid,” Maxted says. “The strength of a bank’s balance sheet is key. There is a real question as to whether banks should sell distressed stock, which could depress the sector further.”
In terms of this policy of turning a blind eye one respondent said: “We have LTV issues with all loans, but all our loans are performing. We can waive the LTV covenant; it just warns that an asset is under pressure, but if the whole market is gone, it is not really helpful.”
Half-year results from banks such as Lloyds Banking Group show large writedowns on the value of property loans, but Lloyds feels that loan loss impairments have peaked. But Maxted is not sure this is the case for all real estate lenders. “From talking to the survey’s respondents, I expect rising defaults to be an issue for the next 12 to 18 months,” he says.
“However, it is important to remember that about half of the defaults we have seen so far have been linked to residential development loans, rather than just commercial property loans, where schemes have not sold for the prices anticipated or could not sell at all.”