Banks are relaxing safeguards as they boost lending to commercial-property developers in the U.K., fueling concern they’re sowing the seeds of another real estate collapse.
“Banks are falling into that same old cycle of loosening their underwriting standards,” Joe Valente, head of research and strategy at JPMorgan Asset Management in London, said in an interview. “They’re doubling up on risk because they’re increasing development activity in smaller regional markets which, until now, have had very little in the way of liquidity.”
The decision to ease loan standards means lenders are less resilient to any downturn in values, according to financial-stability officials at the Bank of England. Britain spent about 1 trillion pounds ($1.6 trillion) propping up the banking system during the financial crisis, which ended a decade-long commercial-property boom.
The BOE’s Financial Policy Committee would consider “appropriate action if underwriting standards threatened to evolve in an unsustainable way,” the panel said last month.
Banks and credit providers are now willing to offer senior debt to property developers at loan-to-value ratios of 70 percent, compared with 60 percent three years ago, London-based lender Laxfield Capital Ltd. said in an April report. Before the 2007 crash, the ratio was 75 percent to 80 percent.
Some lenders are loosening debt terms to win business, according to John Feeney, the global head of commercial real estate at Lloyds Banking Group Plc.
“Borrowers who are in strong negotiating positions have been willing to push on some fundamentals of covenants,” Feeney said at a Loan Market Association conference in London last week. “Other lenders have been willing to give on what we would see as quite fundamental protections.”
With interest rates at historic lows and the European Central Bank’s bond-buying program crushing returns on fixed-income securities — euro-region sovereign debt still yields less than 1 percent — the higher yields available from real estate are making the market attractive to investors. The amount of new capital targeting commercial property globally is now a record $429 billion, broker DTZ said in April.
Not everybody is concerned. TH Real Estate, which manages $23 billion, is advising investors to include commercial real estate debt in their holdings.
Senior loans are being priced from 125 basis points to 225 basis points more than the London interbank offered rate, it said in a May 12 report. That compares with a spread of 90 basis points that British Land Co. paid to borrow 485 million pounds in February.
“The provision of whole loans and select junior loans in the U.K. market offers a compelling risk-return profile,” Christian Janssen, head of debt at TH Real Estate, said in the report.
The U.K. market for commercial mortgage bonds, which are secured by loans on commercial properties, is still struggling to recover after being shuttered during the financial crisis when there was a 40 percent peak-to-trough decline in real-estate values.
Legal battles involving investors, loan managers and CMBS issuers have become commonplace in London courts. A dispute over whether investors in bonds secured by commercial real estate in London’s Canary Wharf district are owed 169 million pounds is due to be heard in July.
With BOE officials reluctant to increase benchmark borrowing costs, and the ECBboosting its bond-buying program, the loosening of lending standards is likely to accelerate over the coming months, according to JPMorgan’s Valente.
“Banks have got this incredible knack of losing money in every single cycle,” he said. “We’re going to be in this bubble of quantitative easing for two three or four years and inevitably as investors take on more risk some will get their fingers burnt.”