Despite the largenumber of borrowers breaching debt covenants and therefinancing cloud hanging over the market -including €23bn of CMBS loans between 2009 and 2011, according to Barclays Capital -banks insist that they are helping their clients and are not looking to foreclose on property.
There are several ways in which banks can address problem loans and few banks have so far resorted to drastic measures. In many situations, lenders are extending or rolling over loans, renegotiating terms as part of the deal. As a result,the level of distressed assets dumped onto the market by the banks has been lower than expected.
Two major property lenders – Lloyds Banking Group and Royal Bank of Scotland – predicta rise in the number of assets they bring to the market through foreclosures, although it is unlikely there will be a “tsunami” of forced sales.
Speaking at the Estates Gazette Investment Summit in September, Nick Robinson, managing director of real estate corporate banking at Lloyds, said: “The truth is that banks have a massive interest in working with their customers and will continue to do that in over 90% of cases. In fact, there are very few assets thatwe genuinely control. It’s not in our interest to start pushing assets into the market.”
Stephen Eighteen, head of global property restructuring at RBS, said the reason that the flow of assets reaching the market has been minimal is partly owingto lengthy work-out processes and the effectof interest-rate swaps attached to loans. The flow will increase in 2010, he said, although it is not in anyone’s interest to flood the market with stock.
Another reason that assets have not been traded by banks could be because a large proportion of those they hold on balance sheet are not of investment-grade quality and therefore have not attracted interest from potential buyers. Speaking at a separate property breakfast event in London, Nick Leslau, owner of newly AIM-listed Max Property Group, explained: “The constipation helps banks because every basis point drop in yield means that loan-to values [LTVs] come down. The majority [of property thatbanks are holding] is crap, or beyond crap. Only about 20% is good stuff. The other stuff is going to take years to work out.” Thus, even if banks wanted to sell some of these assets, they probably couldn’t.
However, the attitude expressed by Lloyds and RBS is being echoed throughout Europe (seepanel below, left) and is very different to the approach taken by lenders during the last financial downturn. In the early 1990s, banks were quickto call in loans if borrowers were not keeping their end of the agreement, and as a result, the banksended up owning swathes of real estate. But this time it is different and banks’ actions have been less aggressive to date.
Difference between then and now
“The fundamental difference between then and now is the fact that the day-to-day cost of funds for banks is effectively zero today. In the 1990s it was 10-15%, so every day they were bleeding – they were getting no net cash in and it was costing them a fortune to hold loans. Now most of the loans are meeting their interest-cover ratios,” explains John Edwards, managing director at JC Rathbone Associates.
Part of the reason banks are reluctant to foreclose is because it is not in their business model to own property. They want to reduce their exposure to real estate, and therefore risk – several banks, including RBS, are winding down their real estate activities – and willtake back the keys of a property only as a last resort.
Banks don’t have to treat loans that have broken theirLTVcovenants as impaired and many are choosing to ignore LTV breaches. They can take a view that the value of a property will recover by the time the loan is due to mature, although they usually hike the fees and interest rates they charge. Unless they are certain they won’t get their money back, banks are mostly unwilling to cut ties with borrowers and repossess loans because forced sales depress market values and could jeopardise the value of collateral on other loans.
“We have done some foreclosures, but not many,” explains Axel Wieandt, chief executive of Deutsche Pfandbriefbank, formerly known as Hypo Real Estate. “Our approachis to engage with borrowers at an early stage. The earlier we are able to identify a possible avenue for restructuring and improving the overall risk position, the better.
“If we don’t find restructuring alternatives or can’t come to an agreement, then we might have to find a new asset manager or even foreclose, but our preferred option is to restructure and work with the borrower.”
From banks’ perspective, it would be a bad idea to break trust with their clients because at some point in the future they are likely to want to increase their lending to property again. “We’re still a bank that services customers and the last thing we want to do is be seen to be leaving scorched earth behind, because that will come back to the bank,” said Robinson. “Even in areas in whichwe’re saying,’In the future, we don’t want to have major exposure to this sector,’ there is still going to be a very managed process thatwill stretch out for many years.”
However, the reassuring message that banks are trying to convey to borrowers has not convinced some investors, who are doubtful that this approach will last.
Pressure to reduce risk exposure
“There is pressure for banks to reduce the size of their balance sheets and risk exposure and that’s not going to go away. The more that can be seen to be done to bring their balance sheets in line and return a profit to taxpayers is going to put pressure on banks to take action, particularly on some of the more complicated situations,” saidRichard Croft, chief executive of M7 Investment Management, at the conference.
