Hello again from Mr Gloomy. This week I’m joined by the financial policy committee of the Bank of England, financial ratings agencies Fitch and Moody’s, and last, but not least, by Joe Valente, head of research and strategy at the European real estate group at JP Morgan Asset Management.
Two weeks ago I intimated that the 2015 Savills Property Finance Survey contained bad news on the loosening of lending strictures. The above people agree. Warnings on lax commercial property lending were ignored in the mid-noughties. Same today.
A précis of what these far more credible sources are saying follows, listed in rising order of credibility. We’ll start with the Old Lady of Threadneedle Street.
On 7 April the committee, chaired by governor Mark Carney, raised an unnoticed yellow flag. His following remarks apply to supposedly tightly regulated banks, not to the surge of non-bank lenders spotted by Savills.
“The UK banking system currently appears resilient to stress in the leveraged loan market… however, if the recent loosening in underwriting standards were to continue, major banks could face increased risks in stressed and illiquid market conditions, particularly if forced to retain loans intended for distribution to investors.”
In other words, if the CMBS and syndication markets seize up, beware.
Which brings us to concerns being expressed on CMBS lending in America by Fitch and Moody’s. Both rating agencies saw their reputations shredded in 2008-10 when loans they graded AAA turned out to be ZZZ. Both have been waving yellow flags for more than a year. The pair are being locked out of deals by CMBS issuers, who consider Fitch and Moody’s too conservative. Instead issuers are paying agencies with more relaxed criteria to rate their bonds.
Bloomberg said last week that “Fitch Ratings is joining Moody’s in warning that the credit quality of bonds backed by real estate debt is slipping at the same time underwriters show reluctance to strengthen safeguards against losses.” The wire service reported that “the majority” of a $1.15bn (£738m) CMBS sale by Goldman Sachs “involved riskier loans that only required borrowers to make interest payments and not pay down principal”.
Happy days. Takes you back to 2006, as described in Michael Lewis’s book, The Big Short. CMBS was going to bring a “paradigm shift”. Splitting loans and selling slivers would disperse risk and therefore minimise systemic shock. But because the CMBS market was thought to minimise risk, more and more risk was taken on. The very thing designed to create that “paradigm shift” accelerated the crash.
On 28 June 2006 the then long-time head of research at DTZ, Joe Valente, shocked 300 guests at a Dorchester luncheon held to celebrate the firm’s Money into Property report. “Is this a bubble?” he asked startled diners. “No,” he concluded. “But it’s the top of the market.” Joe is now 58 and has been working at JP Morgan for five years. The asset managers have a pretty fancy client list. Joe knows what they are thinking. What does he have to say now?
“The Bank of England is saying that lending is getting too loose again. At the same time, we are seeing office development proposals in regional markets. I’m thinking, whoa, here we go again. I don’t understand why development finance is available in these smaller UK markets. There will be a correction here, it’s inevitable. I am less concerned about central London. But sooner or later there will be a correction.” A bit later, thanks to quantitative easing, says Valente.
Pumping financial adrenaline into the monetary circulation system has kept bond rates low and made real estate yields attractive, he says. “Without QE, most people would be calling the top of the market now. With QE, I think confidence will be prolonged for another 12-18 months.” One snag. The bond market has spotted the end of QE in Europe, slated for September 2016. “What is happening now is that interest rates have been rising and bond rates have spiked over the past four to six weeks. QE will need to be extended,” says Valente.
If not… you decide.
