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Property industry faces debt refinancing challenge as Eurozone crisis hits bank lending

Debt held against UK commercial property fell again during the first half of 2011 as the property finance market continued to show resilience in the face of global economic turmoil and stagnant UK growth.

The influential UK Commercial Property Lending Market mid-year report by De Montfort University, published today, found that the value of outstanding, on-balance-sheet debt fell from £208.4bn to £201.3bn in the six months to June 2011, a reduction of 3.4%.

However, it also delivered a stark warning of the scale of the challenge facing property lenders, revealing that around a half of this debt, in a range of £85bn-£114bn, could not be refinanced on current market terms and that one quarter was secured on a loan-to-value ratio of more than 100%.

The study, the largest of its kind to look at UK commercial property debt, estimated total UK debt of between £280bn and £292bn at midyear 2011 (down from £288bn to £298bn at the end of 2010) including £46bn outstanding in the CMBS market and an estimated £19.9bn held by NAMA – Ireland’s “bad bank”.

This continued the measured reduction in debt seen during 2010 that has so far avoided a fire sale of property assets and a collapse in capital values. Report joint author Bill Maxted said the “process of deleveraging continued at a modest pace during the first half of 2011”.

However, the report found that the uncertainty triggered by the deepening Eurozone crisis and the lack of growth in the UK economy had exacerbated the ongoing lack of liquidity and increasing costs of capital in the property lending market.

Investigating the loan-to-value ratios of lenders’ loan books for the first time, the report found that 41% - 56%, or £84 to £114bn, of loans “may not be refinancable on lending terms available in the market at mid-year 2011”.

Falling investment values meant that one quarter of this debt (24%) had a LTV ratio of above 100%, while just one fifth (21%) had an LTV ratio of less than 60%.

Lenders have been willing to extend maturing debt on non-market terms, with £48.4bn of these loan extensions recorded by the research since 2009.  Consistent with that, a recent FSA survey found around 33% of commercial property loans, representing £66bn, to be in some form of forbearance.

The lending market also continued to contract. Two-thirds of lenders (66%) said commercial property was an asset class against which they were willing to lend, but the proportion intending to increase the size of their loan books fell from around half (46%) to one third (35%) at mid-year 2011.

Almost all of those willing to lend (64% of respondents) would do so against a prime office property, compared with just 29% for a loan secured by a secondary office.

And further regional disparities were also highlighted by respondents. London and the South East were seen as being in “recovery mode” while “recovery in the provincial markets could take six years or perhaps longer to achieve with much pain during this period” – a gap described as “enormous” and “unbelievable” by respondents.

Development finance remained challenging. Those willing to lend against a fully pre-let development fell from 52% to 31%, and those willing to lend against speculative development fell from 17% to 15%.

Bill Maxted said: “Lending organisations commented that the existing liquidity crisis had been made more acute by the problems of European sovereign debt and the unknown extent of contagion between banks.

“Respondents have suggested that only an increase in confidence in the UK economy, demonstrated by a number of quarters of sustained growth in UK GDP, would signal a recovery in the commercial property market in the UK.”

Liz Peace, chief executive of the British Property Federation, the leading body representing developers and investors, said: “These figures underline how critically important it is for government to use all of the tools at its disposal to help tackle this overhanging property debt.

“This means encouraging new debt buyers in to the market – something that we think reform of the real estate investment trust regime to allow the creation of mortgage reits would help to achieve.

“It also means finding ways to encourage new investment and spur economic growth. One easy way would be to stop charging full business rates on empty commercial properties, something that is a considerable disincentive for landlords who wish to invest in premises for small and medium firms.”

ENDS
 

For more information on the UK Commercial Property Lending Market survey, visit the De Montfort University website.

Given below is a summary of the main findings of the latest mid-year report for 2011, prepared by De Montfort University, which examines the UK Commercial Property Lending Market.   This mid-year report analyses the lending activity of the major commercial property lenders operating within the UK during the first two quarters of 2011.  It is the eleventh mid-year report to be published by De Montfort University and is part of the sequence of biannual surveys and reports produced since 1999.

• Lending organisations commented that the liquidity crisis driven by European sovereign debt, the unknown extent of contagion between banks in the banking system and uncertainty over regulation goes to the heart of bank funding for all business sectors.  This unprecedented uncertainty makes it extremely difficult to lend.
• At mid-year 2011, active lenders were reporting less competition in the market place whilst potential borrowers have been withdrawing from the market on the expectation of another correction in capital values of commercial property.
• For improvements to occur in the UK and European economies, the issues surrounding sovereign debt and strategies for banking regulation need to be seen to be resolved by the wider global economy.
• By mid-year 2011, the value of outstanding debt secured by UK commercial property was estimated to be in the range of £280bn to £292bn (comprising of £212bn to £224bn on balance sheet, £46bn outstanding in the CMBS market and an estimated £19.9bn (valued at par) acquired and held by NAMA).  This compares with a range of £288bn to £298bn recorded at year-end 2010 and shows a reduction of 3.4%. 
• For the first time, the research recorded the reasons for a reduction in loan book size before new loan originations are included.  A total of £16.7bn of reductions were reported and allocated; 37% scheduled amortisation and repayments, 26% customers paying down, 25% bank/lending organisation influenced sales, 5% as values of loans written off, 5% of loans sold and 2% swapping debt with equity.  This suggests that lending organisations have become more proactive in managing both scheduled and unscheduled repayments in attempting to restore the health of their balance sheets.
• By the end of the second quarter of 2011, £12.3bn of ‘new’ loan originations including refinancing was recorded.  This compares with and shows an increase over £9bn of ‘new’ loan originations being similarly reported in the first half of 2010.
• In addition £3.2bn of extended loans was reported and it is estimated that an additional £2bn of extensions to maturing loans had been completed but not reported to the research. Thus, during the first half of 2011 approximately £17.4bn of gross lending had been undertaken. This value compares with gross lending of £21.7bn completed in the first two quarters of 2010 but this value includes £12.7bn of extended loans.
• With specific regard to the £12.3bn of new lending on commercial terms during the first half of 2011, 63% of this was originated by 6 organisations and 79% by 12 organisations.  In contrast, 24 institutions completed no new loan originations during this period.
• Included in the value of £12.3bn of loan originations is £285m of loans securitised in the first ‘true’ CMBS issue secured by UK investment property since 2007.  Also included is £310m of syndicated lending and £3bn of club deals. 
• An additional amount of £187m of mezzanine finance was reported to the research.  This had been contributed, by non-traditional property lenders, to transactions in which participants to this research took part.  The value of £187m is relatively modest compared to the amount of mezzanine finance that has been reported elsewhere as being available in the market.  It is believed that the return required by the potential mezzanine providers is considered by borrowers to be too expensive.  This is preventing these facilities from having a bigger impact on the market.
• Together that gives a range of £85bn to £114bn of debt that may not be refinancable on current market terms.  In the past, lenders have been willing to extend the maturities of such lending, contributing to an estimated one third of property lending in some form of forbearance.  A risk going forward is lenders ability and/or willingness to continue to forbear falls if balance sheet constraints bite or the economic deteriorates.

• Lending intentions decreased by mid-year 2011. Overall 43% of lending teams are intending to increase loan originations compared with 57% who expressed their intention to do so at the end of 2010. Thirty-five percent intend to increase the size of their loan books compared with 46% at year-end 2010.
• Twenty organisations (representing 34% of all lenders) indicated that they were currently not lending.
• A new area of investigation within the research concerned the current level of loan-to-value ratio across the outstanding loan books of participating organisations.   The responses showed that only approximately 21% of the value of outstanding debt can be allocated to loans that have a current loan-to-value ratio of 60% or less.  Eighteen and a half percent of outstanding debt had a current loan-to-value ratio of between 81% and 100% and a further 24% of outstanding debt had a current loan-to-value ratio of above 100%.  Thus, it could be construed that at least 42% of outstanding debt (representing £85bn) has a loan-to-value ratio in excess of 80% and is not refinancable by senior debt and mezzanine terms available in the market at mid-year 2011. 
• In addition, a further 37.5% was recorded as having a current loan-to-value ratio of between 61% and 80%.  This proportion equates to approximately £76bn of outstanding debt.  This bracket of loan-to-value ratio will contain those loans originated since 2008 when typical loan-to-value ratios available in the market declined, on average, to between 60% and 65%.  During the three subsequent reporting periods for this research and where data is available for 2009, 2010 and mid-year 2011, the combined value of new loan originations on commercial terms has been recorded at approximately £47bn for the whole sample of organisations.  Thus, the difference of £29bn (£76bn less £47bn) may represent the maximum value of loans in this bracket whose current loan-to-value ratio exceeds that typically available in the market at mid-year 2011. 
• Together that gives a range of £85bn to £114bn of debt that may not be refinancable on current market terms.  In the past, lenders have been willing to extend the maturities of such lending, contributing to an estimated (by the FSA) one third of property lending in some form of forbearance.  A risk going forward is lenders ability and/or willingness to continue to forbear falls if balance sheet constraints bite or the economic deteriorates.
• Loans in breach of financial covenant and loans in default at were reported to the research at mid-year 2011 with a combined outstanding value of £41bn.  This represents approximately 20% of the total value of outstanding debt held in loan books and reported to the research. At year-end 201, £37.5bn was similarly reported to the research.
• Lending organisations reported an increasing frequency of weakening cash flow due to, tenants not renewing tenancies, tenants renewing tenancies at lower rents and tenant default, all combing to cause further reductions in capital values and resulting in loans to breach a number of financial covenants, or, to be declared in default. 
• With regard to loan terms, at mid-year 2011 interest rate margins for loans secured by all types of commercial property investments were at the highest level recorded by the research.    Fifty-five percent of organisations reported that they anticipate that their level of pricing would increase again during the second half of 2011.  Loan-to-value ratios for loans secured by all types of investment property declined from those recorded at year-end 2010.  Typically, for all loans secured by commercial property investment projects, average loan-to-value ratios available in the market were recorded at 65.5% or below.
• The average level of arrangement fees reported at mid-year 2011 was higher for all sectors than at year-end 2010.  For example, the average arrangement fee applied to loans secured by prime office property increased from 94.7bps to 97.8bps whilst that for secondary office increased from 106.7 bps to 112.5 bps.
• At mid-year 2011, just two organisations were prepared to specify terms for loans secured by speculative development.  For residential development projects, 18% of lending teams (12) provided loan terms.

For further information please contact:

Bill Maxted, De Montfort University, on 0116 257 7428 or bmaxted@dmu.ac.uk

Patrick Clift, Media and Public Affairs Manager, British Property Federation, on 020 7802 0128 or pclift@bpf.org.uk

Felicity Young, PR Manager Marketing, Jones Lang Lasallle, on 020 7087 5108, 07976 323151, or felicity.young@eu.jll.com

De Montfort University gratefully acknowledge the generous financial support provided by Allen & Overy, Association of Property Bankers, British Property Federation, Canada Life Ltd, FitchRatings, Helaba, Jones Lang LaSalle Corporate Finance Ltd, Kingfisher Property Finance Limited, Nationwide Building Society and Savills.
 

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