IPF’s Zombie bank paper: More than £59bn high LTV loans still left to work through

UK property lenders are not out of the woods yet with still more than £59bn of high loan-to-value (LTV) legacy loans set to take up to four years to work through based on the recent pace of loan portfolio sales, new estimates show.

The IPF published yesterday a short paper, entitled Zombies and Beyond, in which author, Peter Clarke of Recept Consulting, wrote: “Significant progress has been made, with a headline reduction of £36bn in high LTV loans since 2011.

“However £59bn remains to be dealt with, which represents 37% of ‘DMU’ real estate loans. The overall face value of these loans, factoring in CMBS, may well be higher than that.

“There is thus still a long way to go before the UK returns to an entirely ‘normal’ real estate lending environment.”

Slotting requirements typically require UK banks to hold greater levels of regulatory capital against high LTV and defaulted loans which, over the last five years, has motivated banks to restructure or sell property loans.

The latter is more efficient, freeing up banks’ regulatory capital quicker, while buyers – the private equity and hedge funds – can restructure loans without the same regulatory burden of holding capital against non-performing loans.

The pace of loan portfolio sales, therefore, has in part been dictated by banks’ ability to absorb the burden of onerous regulatory capital requirements.

Clarke wrote in the IPF paper: “Loan portfolio sales will continue to provide an exit route for banks.

“Having spoken to a number of purchasers and potential purchasers of loan portfolios in the UK, this market is now well-established and transparent. Purchasers are not expecting to achieve significant discounts to underlying property valuations.

“However, the lower cost of capital for non-bank loan purchasers still provides an opportunity for good returns to be made.

“These purchasers tend to have greater flexibility than the traditional banks, as they can more easily purchase assets from borrowers or provide additional capital where required.  However, that is countered by a greater unwillingness to ‘blend and extend’ and, generally, no mandate to provide new lending.

“Purchasers are attempting to undertake consensual deals to avoid the costs of enforcement.

“Purchasers are also more able to take a ‘portfolio’ view and will expect there to be winners and losers. They will measure returns at a portfolio level rather than on a deal by deal basis.”

With the UK property market currently so attractive to investors, buyers of these loans have been able to achieve consensual deals with borrowers and so avoid enforcement costs.

This process is rapidly cleaning up the balance sheets of lenders to clear the way for new lending but a significant rump of loans remain more difficult to refinance on current market terms remain, which still leaves a large number of borrowers in an uncertain situation.

Clarke writes: “An example of this is those borrowers who took a loan from Anglo Irish Bank, where the liquidation and subsequent loan portfolio sales process meant that many borrowers to whom we have spoken were unable to get consent to sell or re-let properties even where it appeared to be advantageous.

“However, the recently concluded Project Rock and Project Salt loan sales to Lone Star are likely to change the position for those particular borrowers.

“The long term over which workouts have been conducted/executed has had an impact on the property market. The lack of evidence in some sub-sectors may be attributable, in part, to the slow rate of workout and to the consequent valuation uncertainties.

“The extraordinarily low interest rate environment (it has been five years since the Bank of England set Base Rate at its current 0.5%) has been a further factor in preventing more income defaults – even when additional costs are factored in – although, in some cases, the use of interest rate swaps has negated that benefit.

“The DMU study backed this up when stating that ‘lenders continue to identify the crucial importance of low interest rates that keep historic loans profitable’.

Malcolm Frodsham, director, real estate strategies and chair of the IPF Project Steering Group that oversaw production of this research, said: “Crushed from above by a fall in property values and undermined from below by rising LTVs, a large group of borrowers are finding that they are undesirable clients to capital constrained banks. 

“Hope for some borrowers may come from rising asset values and an improved letting market; the reality for many is that their increasingly poor quality assets will lose further value as remaining tenants seek to upgrade their accommodation as their leases expire. 

“Like any marriage, the break-up of borrower and lender is a costly process but UK banks have provisioned hard in recent years and given themselves the flexibility to cut their losses and seek new lending relationships elsewhere.  This report explores the solutions employed by the banks to dispose of their high LTV loans and the options for the borrowers to salvage what they can.” 

jwallace@costar.co.uk

About CoStar News

Finance Editor, CoStar News
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