Highly geared investors to face refinancing issues as £20bn of debt matures
Alerting property investors to the potential problems of a raft of refinancings that are scheduled to occur over the next few months without causing outright alarm is a difficult balancing act to perform. But it is one that I would at least like to attempt.
Today’s much less favourable economic conditions derive entirely from the global credit and liquidity crunch that hit the world last summer. Credit has quickly become noticeably scarcer, in terms of both quality and quantity, as lenders have rushed to tighten their lending criteria and reduce the loan-to-value ratios they were previously prepared to consider. Illiquidity persists in the interbank market, banks are nervous about making new loans or even rolling over existing ones, and companies are finding that they cannot simply move their business to another institution, as they might have in the relatively recent past.
In a climate where the words “sub-prime” and “Northern Rock” dominate both conversations and headlines, times have become very challenging indeed for property investors. In the second half of last year, according to IPD, capital values fell by nearly 12%. The scale and pace of the decline has shocked market players and observers.
The most recent figures available from De Montfort University’s annual survey of the UK commercial property market give an idea of the scale of the problem awaiting investors with debt maturing over the next few months. These figures, published in 2007, suggest that around £20bn of property finance is due to mature this year, with a further £22bn maturing in 2009. Experience from elsewhere suggests the impact could be harsh.
Sub-prime retail borrowers in the US and in the UK have already felt the effects of the much tighter terms of trades being levied on their tainted borrowing. Corporate and institutional borrowers too must face up to the facts, and do what they can to brace themselves for what could be tough conversations with their bankers, and address a number of key questions.
What, for instance, is the risk that there will be tighter loan-to-value covenants when a loan comes up for refinancing? Will there be a requirement for the borrower to inject further equity before the banks will re-lend? How prepared are borrowers for the potential distress they face? Highly geared developers can look forward to a particularly awkward time ahead.
The end of securitisation
Commercial mortgage-backed securities, until recently a major source of liquidity for banks, reached a record level of issuance of £18.2bn in 2006, equivalent to 10% of estimated total outstanding debt at the time. That market ground to a halt virtually overnight last summer and is unlikely to return as a significant form of funding.
But it would be wrong to overstate the problem. The amount of commercial property debt falling due over 2008 represents only around 10-11% of the total outstanding (£193bn at 31 December 2007 said Bank of England last week). Looking at the IPD index, one only needs go back to January 2006 for average commercial property values to be lower then where they are now.
It seems likely, therefore, that in the absence of further falls in values (albeit a dangerous assumption to make) that even after the most recent falls, the majority of property secured on loans maturing this year (assuming a three to five-year typical term) will have appreciated since loan inception.
So the problems, for now at least, are likely to be specific rather than systemic, and probably focused on the secondary market and higher risk assets such as speculative developments.
Anyone holding potentially distressed debt and trying to navigate these tricky waters without the help of an experienced pilot could find themselves in even greater difficulty. The changes that have taken place in debt market conditions in recent months means they might need to deal with a debt workout team whose priority is to put the lenders first and foremost, rather than a friendlier relationship team.
In such a scenario, it must surely be preferable to issue a timely call for help now than to wait until it is time to shout: ‘Mayday!’
Michael Lindsay is head of real estate corporpate finance at KPMG
