Boring is beautiful for cautious banks in 2010

Many property lenders are asking whether recent increases in property values are sustainable. This is a genuine concern because, although yields have fallen sharply in the past five months, the UK economy is still in recession and rents still falling. The present rises in value are fuelled by scarcity, not by underlying fundamentals, and there is a limit to how long that can continue.

Concerns about underlying prosperity will overshadow property lending decisions during 2010. The lender’s job is that of risk assessment, and these concerns are adding to uncertainty in lending decisions. Many banks are also still working out bad loans made in better times, which have defaulted after steep falls in value in 2007-08.

I believe availability of debt finance will remain broadly flat over 2010, if not beyond. It is true that new lenders are entering the market: institutions such as Axa, Pru and Mass Mutual; and overseas banks from China, Spain, Norway, the Middle and Far East, Austria and Canada. Perhaps half a dozen will enter the market next year. However, I believe these new arrivals will not even add 10% to the total availability of liquidity.

It is also true that a number of banks that temporarily withdrew will return in 2010. But the credit committees and boards of these (and most other) lenders will still tread the path of caution, despite their loan officers’ enthusiasm in London.

I believe now is a brilliant time to lend on the strength of more conservative loan-to-value ratios and high margins, leading to well-secured lending on profitable terms; property is now very suitable for financing. But this may not persuade lenders who have had their fingers burned; few will return to the volumes of lending seen in the past.

One unknown is the lending ambitions of the nationalised or part nationalised banks that were  very active in the past, both in the UK and Ireland. Their government masters will seek stability, which may include a return to property lending, but I believe not in significant volumes.

Total lending volumes for 2009 are likely to  be £20bn-£25bn, while I believe there will be relatively small increase in 2010 to £25bn-£30bn.  But that is still only around one-third of annual lending for 2005-07. It is also perhaps only 50% of what is needed to refinance expiring loans. In the past two years, many banks have extended loan terms by one to three years, or more; this will further increase financing requirements.

Another challenge will be to refinance very large lot sizes, even though some lenders are increasingly prepared to advance sums in excess of £100m. Banks are also forming syndicates for large lot sizes, particularly German lenders, but most of this lending is against best-quality assets.

The suggestion that loan-to-value ratios may be rising and margins reducing, while true to some extent, is generally not the case. Prime lending
(and buying) opportunities are scarce and when they arise, competition between lenders (and investors) will push terms to a new level. Also, truly prime assets are rare and lenders will continue to exercise caution for quite some time to come.

I very much doubt that securitisation (or some equivalent) will return as a new lending source in 2010, or for some years. I would say the same for development finance, but I recently attended a seminar at which several lenders expressed confidence that it would become available again in 2010, in particular for good-quality, prelet projects.  I hope that will be the case, otherwise skills sets will be lost from the development process.

As to the problems facing existing securitised debt, I do not believe they will destabilise the market, despite much comment to the contrary. In summary, I believe property lending will remain flat until rental growth returns to large parts of the occupational market. So much depends on the macro economic outlook; because of banks’ concerns about underlying prosperity, they will continue to adopt a cautious approach until the way forward is clearer. I make no apologies for this analysis, as boring is beautiful in today’s climate.