Banks' property loans still on shaky foundations

A new report apparently suggests that almost £200bn worth of loans to the commercial property sector are already in breach of their covenants....

by James Taylor
Last Updated: 19 Aug 2013
An alarming report in today's Times: apparently a new Bank of England report on the UK commercial property market suggests that owners and developers are in breach of their covenants on four out of every five loans taken out, because of the fall in rental incomes. Since the industry as a whole is in hock to the tune of £243bn - £150bn of which comes from UK banks and building societies - that's an awful lot of money potentially at risk. Particularly since there's a good chance of a vicious circle developing...

The figures come from the as-yet-unpublished report from the BoE Commercial Property Forum, which acts as the Bank’s eyes and ears on the property market. And what it’s seen and heard isn’t too pretty: it says such the sector owes a total of £243bn to lenders, only 3% less than at the peak of the cycle in 2008. What's more, many of the loans are still exposed to the same sort of risks as they were in 2009 - i.e. borrowers are struggling to pay the interest on their loans because rental incomes are down.

To make matters worse, borrowers also have a refinancing issue. 54% of these loans are set to mature by 2014 – and the Bank is warning that, with the banks pulling in their horns and new sources of debt scarce, borrowers are going to have trouble refinancing them. As a result, they're often having to extend the loans, on less favourable terms. Which may just make the problem worse, especially for those with the dodgier properties.

The danger, of course, as the Bank points out, is that a ‘negative feedback loop’ could develop - so if banks start foreclosing on some of these loans, rents will sink even further, making it even harder for borrowers to service loans - which means more foreclosures, more expensive lending rates, and lower property values. Ugh.

Another rather ominous problem, as the BoE points out, is that these loans are quite concentrated: 57% of all outstanding real estate debt rests with six banks, while another six banks are responsible for the next 22%. In total, British banks and building societies are shouldering £150bn of the burden. So if lots of these loans do go bad, it's going to hit a relatively small number of institutions very hard.

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