Derivatives hedges could offer shelter to overexposed banks

The scale of RBS’s problem loans is mind-boggling: £69bn already in default or at risk were transferred to the Asset Protection Scheme; 56,650 loans; more than £10bn due to mature this year.

The 100-page Treasury report is full of numbers just too large for anyone to get their head around – and this is just the property book. Obviously, this is what is meant by a bank that is too big to fail.

Straight away the RBS figures call into question the £30bn of troubled loans  reported by banks to De Montfort and featured in its latest mid-year lending report.

Bill Maxted’s view that £30bn is a minimum is surely something of an understatement when RBS alone has twice as much – although admittedly, only RBS knows how many of the APS loans are already in default or just on a watch list in case of a severe downturn.

But hopefully De Montfort can get  better figures out of the banks for the next survey. What would also be very useful would be some information in the report about how much debt banks are rolling forward, and till when.

RBS’s exposure to property came to mind in a recent debate about the potential development of the property derivatives market.

At a Property Derivatives Interest Group meeting last week, expert Paul Ogden said that the clearest example of a group that should be using derivatives to hedge risk is the banks, because of their huge property exposure.

But they don’t, because  the property derivatives market is still relatively small and they think it’s not worth bothering with. Ogden says there was a similar situation in the US in the mid 2000s, when CMBS hedging indices were developed from scratch by the banks precisely because of their level of exposure and risk.

Because they could see the benefit, they took the step of building a platform and putting out prices to sell, and then the buy side came in. In other words, an alternative to building a market from the bottom up is to have one side commit and then market to the other.

Ogden argues that if banks get favourable capital treatment for getting rid of risk, they can afford to sell that risk at a competitive price. It wouldn’t matter if RBS or any other bank couldn’t hedge the whole amount if some hedge is better than no hedge at all.

No doubt there’s a catch, but if RBS were to take such a step, the beauty would be that there are plenty of investors trying to get property exposure.

Fresh outlook for 2010

This month we unveil our new name, Real Estate Capital. Next year we’ll introduce some fresh ideas, while continuing to provide accurate, in-depth coverage of how property is being financed.

Some of the topics we will be covering in 2010 are listed on page 10 – please get in touch if you want to contribute.