Seven of the UK major commercial banks would suffer a collective £8.7bn three-year cumulative impairment charge on their commercial real estate (CRE) portfolios under the Bank of England (BoE) stress test scenario published this morning.
As much as two-thirds of this theoretical CRE impairmant charge is purely attributed to Lloyds Banking Group and Royal Bank of Scotland. Another £1.1bn of the seven-bank total charge would be Nationwide’s.
The BoE’s adverse stress scenario was designed specifically to assess the resilience of UK banks and included loan-level and portfolio-level analysis of the seven banks’ CRE and housing mortgage books.
These results formed part of the broader stress testing exercise of the UK banking system – comprised of eight banks and building societies – and carried out by the BoE’s Prudential Regulation Authority (PRA) Board.
Commercial real estate data collected from the seven participating banks for the purposes of this adverse scenario comprised: UK CRE lending exposures as at the end of 2013; a complete qualitative questionnaire; and detailed data on a sample of over 1,900 loans, representing around 50% of the seven UK banks’ total UK CRE lending.
The projected cumulative three-year impairment charge rates for UK CRE corporate lending over the stress scenario for each bank was projected as follows:
- Lloyds Banking Group – £3.1bn
- The Royal Bank of Scotland Group – £2.7bn
- Nationwide – £1.1bn
- HSBC – £0.5bn
- Santander UK – £0.5bn
- Barclays – £0.4bn
- The Co-operative Bank – £0.4bn
“The analysis of the loan-level and portfolio-level data revealed that, across several metrics, there had been a marked improvement in the average quality of those books since the previous review carried out by the FSA in 2012 (on 2011 Q3 data),” wrote the BoE in the report entitled Stress testing the UK banking system: 2014 results. The report can be viewed here.
“In addition, the size of CRE books of the seven banks had fallen by over a third over the same period.”
The reduction in the amount of vulnerable loans reflects an upturn in the UK CRE market with: capital values recovering and rental incomes stabilising; low interest rates improving debt affordability; write-offs and disposals of vulnerable loans; and relatively limited new lending, underwritten at stricter terms and conditions than loans originated prior to the recent crisis, the BOE wrote in the report.
Notwithstanding the improvement in asset-quality metrics across nearly all banks, there was still considerable variation across banks. The BoE used the loan-level data to test independently the resilience of banks’ CRE portfolios — including the level of provisions held against non-performing loans — to the UK stress scenario.
In addition, a range of sensitivities was also considered. The analysis found that, in aggregate, projected impairment charges on banks’ CRE portfolios in the stress were lower than during the recent crisis.
This reflects, in part, the reduction in the size of these books and is also consistent with the improved quality of banks’ portfolios, the significant impairments that banks have already taken on their legacy CRE portfolios and the smaller nominal CRE price fall in the UK stress scenario than that observed in the crisis.
While these results do not imply any present risks in the above banks’ CRE loan portfolios, the results represent an important first step in comprehensively tracking the ongoing robust capital strength of the UK’s banks in the advent of future systemic shocks, whether born out of domestic or overseas risks.
The BoE report stated: “The UK CRE market has seen strong price increases and rising activity since the 2014 UK stress test was initiated, and is an area that the Bank continues to monitor closely. As a result, risks to CRE portfolios are likely to be a feature of future stress-testing exercises.
“At the individual-bank level, the results were used to challenge and cross-check banks’ projected CRE impairment charge rates. The value of the review of UK CRE books in supporting the stress test underscores the importance of loan-level data in informing the Bank’s understanding of risks from the CRE market.
“The Bank is currently considering how best to gather and analyse such data in the future as part of a wider assessment that encompasses other asset types.”
The scope of this exercise excluded: Standard Chartered, which does not have a UK CRE portfolio, social housing associations, lending secured on property to non-CRE corporates, unsecured lending to property companies and CRE in Northern Ireland.
Broader market stress test results – Lloyds and RBS pass narrowly, Co-op only bank to fail
Lloyds and RBS only narrowly passed but in light of their additional risk-weighted asset de-leveraging throughout 2014 and their ongoing commitment, were both spared from being required by the PRA to submit a revised capital plan.
The Co-operative Bank was the only bank which failed the stress test and has already submitted a revised capital plan to reduce its risk weighted assets by £5.5bn over the next four years to the end of 2018.
The Co-op warned the market at its interim results in August that it was likely to fail today’s stress test. At this time, the Co-op reported a remaining non-core commercial real estate loan book of £1.7bn. In May, the Co-op bank raised £400m equity.
“It is not a surprise for the Co-op, but it is of course very helpful evidence to provide [sic] what needs to happen next,” Andrew Bailey, deputy Governor of the Bank of England said this morning in a press conference.
“The revised plan that they have given us is all about taking stronger action to provide the necessary buffers against those severe states of the world.”
Bailey added that the Co-op’s revised acceleration of the downsizing as bank centres around the disposal of its so-called optimal residential mortgage book. “De-risking that book, and selling the risk exposures, is at the heart of the plan… which brings the size of the bank down to fit the presence they want to have in the future.”
The Co-op also confirmed in its revised turnaround strategy that the group is expected to make a loss three years inclusive of 2014.
More broadly on the scope and nature of this maiden and future UK bank stress tests, Mark Carney, Governor of the Bank of England, said at this morning’s press conference: “Part of what is discussed is how contagion is spread from less liquid markets – and particularly from markets that, up until very recently, appeared to be very liquid but in fact weren’t – and how that contagion can spread into core markets and thereby affect the United Kingdom.
“The process of financial repair is virtually completed for all institutions. There are some that have a bit more work to day, but it is completed for the system and now it is about further building strength against tail risks.
“One of the main purposes of the FPC [Financial Policy Committee] is to ensure the system as a whole has this type of resilience so that we can withstand a shock, continue to lend to households and businesses.
“And so by ensuring that our banks are appropriately capitalised to those types of shocks, we can help ensure that that is what happens and that means that those shocks – if they happen – particularly if they come from outside our shores, have less of an impact, and are not amplified by the banking system which is what happened during the course of the last crisis.”