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Bank of England warns of double dip for UK commercial property
Over exposure to the commercial property sector could pose a serious risk to British banks, which will need to shore up their balance sheets substantially over the coming years, the Bank of England warned today in its biannual Financial Stability Report (FSR).
The Bank of England has warned of a vicious circle of panic-selling of commercial property by banks, potentially triggering a ruinous double dip in values. There is also a risk that worsening economic conditions will lead to widespread loan defaults by UK real-estate companies. Commercial property prices have already fallen 50% from the market's peak in July 2007. Some so-called prime assets have recovered in the last six months.
But the Bank suggests today that the recovery could be short-lived. In its FSR, the Bank notes that vacancy rates have risen sharply to 12.6% – up 3.6% in the year to October. At the same time, rents have fallen sharply, leading to plunging income for property firms and raising the possibility of more of them failing to repay loans.
The banks' need to refinance loans worth £160billion is just as serious a concern. Outstanding commercial property loans reached over £250billion at the end of September – six times higher than in 1999. Banks have so far held back from selling real-estate assets they have inherited due to covenant breaches or clients going bankrupt. Fear of crystallised losses have meant banks even delaying the revaluation of properties to protect prices, according to the Stability report.
Banks holding commercial mortgage-backed securities will be caught in a "possible" rise in impairments. Loan defaults, warns the Bank, will lead to "the probability of rating downgrades across the capital structure ... increasing associated capital requirements" and a new wave of mark-to-market trading book losses for banks.
Senior property executives expect increased sales from banks in 2010. However, the structure of many loans which have been securitised with different tranches of creditors, will complicate decision-making by banks. In addition, many of the "secondary" assets are so far underwater that banks will still be reluctant to sell outright, preferring to form long-term, profit-sharing joint ventures with developers.
Although banks’ core Tier One capital ratios are now at pre-crisis levels of 9.6%, the Bank says financial institutions must increase their capital equity buffers substantially to protect themselves from commercial property exposure and other potential destabilisers – including the need to refinance £1 trillion worth of wholesale funding by 2015.
Given that banks will face higher capital requirements on trading assets and securitisations from 2011, the FSR urges banks to take the opportunity to strengthen balance sheets by reducing leverage, extending the maturity of funds so they are not dependent on short-term money and repaying public sector support.
The Bank of England has warned of a vicious circle of panic-selling of commercial property by banks, potentially triggering a ruinous double dip in values. There is also a risk that worsening economic conditions will lead to widespread loan defaults by UK real-estate companies. Commercial property prices have already fallen 50% from the market's peak in July 2007. Some so-called prime assets have recovered in the last six months.
But the Bank suggests today that the recovery could be short-lived. In its FSR, the Bank notes that vacancy rates have risen sharply to 12.6% – up 3.6% in the year to October. At the same time, rents have fallen sharply, leading to plunging income for property firms and raising the possibility of more of them failing to repay loans.
The banks' need to refinance loans worth £160billion is just as serious a concern. Outstanding commercial property loans reached over £250billion at the end of September – six times higher than in 1999. Banks have so far held back from selling real-estate assets they have inherited due to covenant breaches or clients going bankrupt. Fear of crystallised losses have meant banks even delaying the revaluation of properties to protect prices, according to the Stability report.
Banks holding commercial mortgage-backed securities will be caught in a "possible" rise in impairments. Loan defaults, warns the Bank, will lead to "the probability of rating downgrades across the capital structure ... increasing associated capital requirements" and a new wave of mark-to-market trading book losses for banks.
Senior property executives expect increased sales from banks in 2010. However, the structure of many loans which have been securitised with different tranches of creditors, will complicate decision-making by banks. In addition, many of the "secondary" assets are so far underwater that banks will still be reluctant to sell outright, preferring to form long-term, profit-sharing joint ventures with developers.
Although banks’ core Tier One capital ratios are now at pre-crisis levels of 9.6%, the Bank says financial institutions must increase their capital equity buffers substantially to protect themselves from commercial property exposure and other potential destabilisers – including the need to refinance £1 trillion worth of wholesale funding by 2015.
Given that banks will face higher capital requirements on trading assets and securitisations from 2011, the FSR urges banks to take the opportunity to strengthen balance sheets by reducing leverage, extending the maturity of funds so they are not dependent on short-term money and repaying public sector support.
Fri, 18th Dec 2009