In-class presentation (Property lending and risk strategies)

1. Credit Risks on UK
Commercial Property
Lending
APRO705 Lending and Risk Strategies
Emefa Anthony-Sikpah
7th December 2011

2. CONTENTS
I. The story so far
II. The risks to be considered
III. Risk strategy: Forbearance
IV. Conclusion

3. THE STORY SO FAR...

4. 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

5. 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

6. THE RISKS TO BE
CONSIDERED

7. Risks to be considered (1)
Arrears Yields
Commercial property arrears Commercial property prime and secondary yields
Source: FSA Source: CB Richard Ellis
Total 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

8. Risks to be considered (2)
Variations in capital values Breach of covenant causes
Capital value changes from trough to January 2011 Commercial property prime and secondary yields
Source: CB Richard Ellis Source: De Montfort University
Secondary property values fell more than Almost 50% of breaches are due to “falling
those of primary properties during the market below an LTV covenant”.
crash and have hardly recovered or fallen
further.

9. WHAT IS BEING DONE?

10. Survival strategy:
Forbearance
What? 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

11. Risks from forbearance
Loan extension exits Change in economic conditions
CRE debt maturity profile at end-2007 and end-2009 UK GDP growth profile
Source: De Montfort University Source: ONS, Cambridge Econometrics
Forbearance is contributing to a Rising prices are not guaranteed. A slower-
concentration of refinancing requirements in than-expected recovery could make a
the next few years but sources of funding at strategy of forbearance unviable and losses
that time are still uncertain on loans would result in a reduction in bank’s
capital

12. Conclusion
Banks should ensure they fully
understand the composition of their
UK banks’ CRE exposure still loan books and in particular the
poses a considerable amount of strength of the cash flows and the
risk borrower’s ability to meet their
obligations
Some bank’s have resorted to The pricing of risk is distorted and
forbearance to protect their capital lenders need to ensure that their
position provisioning practices reflect realistic
estimates of future cash flows
Forbearance can enhance Bank’s should have a workable exit
financial stability but it is a strategy in place and ensure that it is
temporary solution consistent with realistic market
assumptions

13. QUESTIONS?

14. Savills research
CBRE research
Investment Property Databank (IPD)
Office of National Statistics (ONS)
Cambridge Econometrics research
Bank of England data
FSA data
De Montfort University research
SOURCES

15. And I hope you enjoyed the goodies.....
THANK YOU

21. 2009 2010
60%
50%
40%
30%
20%
10%
0%
Interest wholly or partly unpaid partly unpaid covenant breached
Principal wholly or Combination
LTV Other