CRE exposure remains high The pre-crisis increase in debt in the corporate sector was primarily used to Lending to UK Real Estate Activity raise leverage for CRE companies CRE lending reached £250bn between 2008 and 2009 to decline by 3% in 2010 to circa £243bn Real estate lending in the UK accounts for circa 50% of total exposure of UK banks to non-financial firms Sharp falls in property prices have led to a rise in write-offs on lending but they Source: Bank of England remain below levels witnessed during the recession in the 1990s (graph) Considerable credit risks remain
Write-offs are expected to rise in the future Indices of CRE prices fell by more than 40% to 1997 levels between 2007 and 2009 IPD UK Quarterly Property Index (Sept 2011) Indices remained at 35% below their peak at December 2010 The quality of banks’ exposure has deteriorated considerably Total arrears increased from 1.4% (mid- 2007) to 7.6% (Sept 2010) An estimated £34bn of loans are in breach of financial covenant and £20bn in payment default (June 2010) Source: Investment Property Databank
Risks to be considered (1)Arrears YieldsCommercial property arrears Commercial property prime and secondary yields Source: FSA Source: CB Richard EllisTotal arrears increased from 1.4% (mid-2007) The value of lender’s collateral has fallen,to 7.6% (Sept 2010) causing many borrowers to breach their loan- to-value (LTV) covenants
Risks to be considered (2)Variations in capital values Breach of covenant causesCapital value changes from trough to January 2011 Commercial property prime and secondary yields Source: CB Richard Ellis Source: De Montfort UniversitySecondary property values fell more than Almost 50% of breaches are due to “fallingthose of primary properties during the market below an LTV covenant”.crash and have hardly recovered or fallenfurther.
Survival strategy: ForbearanceWhat? Why?Alternative to foreclosure or Reduces expected losses insolvency where the terms by providing greater of a loan are renegotiated flexibility to borrowers in or relaxed in response to an breach actual or prospective Reduces probability of breach defaults – Loan restructuring Avoids selling collateral at depressed price and – Payment holidays incurring a loss – Switch to interest-only loan Delays making write-downs until banks’ capital position is stronger
Risks from forbearanceLoan extension exits Change in economic conditionsCRE debt maturity profile at end-2007 and end-2009 UK GDP growth profile Source: De Montfort University Source: ONS, Cambridge EconometricsForbearance is contributing to a Rising prices are not guaranteed. A slower-concentration of refinancing requirements in than-expected recovery could make athe next few years but sources of funding at strategy of forbearance unviable and lossesthat time are still uncertain on loans would result in a reduction in bank’s capital
Conclusion Banks should ensure they fully understand the composition of theirUK banks’ CRE exposure still loan books and in particular theposes a considerable amount of strength of the cash flows and therisk borrower’s ability to meet their obligationsSome bank’s have resorted to The pricing of risk is distorted andforbearance to protect their capital lenders need to ensure that theirposition provisioning practices reflect realistic estimates of future cash flowsForbearance can enhance Bank’s should have a workable exitfinancial stability but it is a strategy in place and ensure that it istemporary solution consistent with realistic market assumptions