UK bank lending to the commercial property sector is unlikely to be significantly affected by increased capital requirements in the wake of the UK’s vote to leave the European Union, according to a new research paper published by CBRE.
Provided that property values do not decline by more than 10 percent, the impact on risk-weighted assets (RWA) relating to domestic banks’ commercial real estate lending is likely to be “manageable”, CBRE said.
Potential provisions on the £76.6 billion of CRE loans held by UK banks and building societies – as estimated by the De Montfort University report – would be in the order of £250-£500 million, less than a quarter of one year’s income from CRE lending overall and a small fraction of the £25 billion of write-offs from the value of the loan book from 2008/2009.
However, a 15 percent drop in market values would have more of an impact, the agent said. Such a fall in capital values would lead to RWAs increasing by 16 percent, a £10.1 billion increase across the UK CRE loan book, its modelling of potential scenarios showed.
Falling real estate values would push up loan-to-value ratios across banks’ loan books, meaning additional capital would need to be held against loans. Existing loans would therefore be less profitable and banks may have reduced availability of funds for new lending.
CBRE analysed a range of potential scenarios to test the impact on UK banks’ CRE lending. Based on the recent drops in REIT share prices, the impact of capital value falls of 5 percent, 10 percent and 15 percent were modelled. The agent noted, by way of contrast, that values fell by 45 percent peak-to-trough from 2007-2009.
The firm’s analysis found that:
- Under the base scenario, total RWA for UK bank CRE lending is estimated at £63.5 billion.
- Assuming capital values fall by 5 percent, the figure rises by £1.5 billion to £65 billion, with a provision of £300 million for loans entering default.
- Under the 10 percent value-fall scenario, RWA rises by £3.1 billion to £66.6 billion, with a £500 million provision.
- The rise in RWA is much more significant if values dropped by 15 percent, with a £10.1 billion rise to £73.6 billion and a £900 million provision.
“A fall in capital values and consequent rise in LTVs on existing lending could push up capital requirements, making historic lending less profitable and diminishing the availability of funds for future lending,” said Dom Smith, head of debt analytics at CBRE.
“However, in analysing some of the more adverse anticipated market scenarios, we find that any capital shortfall is likely to be minimal – a minute fraction of that facing the industry in the 2008/09 crisis,” he continued.
The impact on banks’ potential return on risk-weighted assets (RoRWA) is relatively marginal under the 5 and 10 percent value-drop scenarios, but more noticeable when assuming a 15 percent drop. For example, RoRWA of 3 percent in a base scenario falls to 2.93 percent and 2.86 percent with a 5 and 10 percent fall in values, respectively. However, if values were to fall by 15 percent, RoRWA would fall by around 40 basis points to 2.59 percent.
CBRE said that it would be “understandable” if UK banks took a more wary approach to CRE lending in the aftermath of the Brexit vote and attempted to off-set falls in profitability with improved margins on new lending. However, it said that falling swap rates may offset the impact on borrowers, keeping total borrowing costs low by historic standards.
The consultancy said that the analysis does not take into account the regulatory response and that the Bank of England’s announcement of the removal of the counter-cyclical capital buffer will free up £5.7 billion of capital requirements on banks, acting as a damper to the rise of RWAs.
“Bank lending to commercial real estate will not be significantly curtailed by capital constraints brought on by post-vote market jitters. Furthermore, recent action by the Bank of England to reduce the counter-cyclical capital requirement will in effect act to dampen the impact of rising RWAs on balance sheets,” Smith said.
“Of course, other factors may influence lending behaviour on the part of the banks, but restructuring in the UK lending market means that borrowers are far less exposed to one type of lender than was the case a decade ago,” he added.