Under the Bank of England’s hypothetical scenario, which included a 30% drop in commercial real estate values, the Co-operative Bank – the only bank to fail the broader stress test – would have to write off 19.1 percent of the value of its loans, Nationwide 16.3 percent and Lloyds 16.1 percent, as reported by PDI sister title Real Estate Capital. The central bank also released research pointing to an easing of credit standards by non-bank real estate debt funds.
The results show a strong improvement compared to the state of these institutions before the global financial crisis in 2008. But they also highlight the work that is still necessary when it comes to continuing their real estate deleveraging drives in order to reduce the risk the sector poses to the broader economy.
“There is no need for the banks to do anything over and above what they have already been doing in as far as disposing of commercial property loans,” said Neil Blake, head of EMEA research at CBRE. “The world has of course overtaken this somewhat as the property market has been so healthy in 2014 that it’s been a good time to offload loans and if banks have needed to offload loans they have easily been able to do so.
“I don’t think there will be a change in strategy as plans are already in place and the speed at which they do so will depend on the strength of the market rather than pressure from the regulator,” he continued.
The other four banks that had their real estate books examined fared better, with Royal Bank of Scotland notably less exposed than its fellow part state-owned cousin Lloyds. RBS was expected to make an 11.2 percent write off under the bank’s assumptions with HSBC expected to encounter a 6.5 percent loss, Santander 5.4 percent and Barclays only 5 percent.
In terms of the quantum of potential write-offs, Lloyds and RBS still hold the property loan books that pose the biggest potential problems for the UK economy. Under the stress test scenario the amount of write offs by Lloyds would be £3.1 billion and for RBS, £2.7 billion, whilst Nationwide would also see a significant impact with a potential £1.1 billion loss.
Whilst the Co-op’s book is proportionately the most volatile, as a result of it being smaller than the likes of RBS, Lloyds and Nationwide, it would only expect to see a loss of £0.4 billion under such conditions. Santander and HSBC would be expected to lose £0.5 billion and Barclays £0.4 billion from their portfolios.
The results are a snap shot of the state of the institutions at the end of last year and the recapitalisation made by banks this year, through real estate deleveraging and other means, has not been taken into account. Given the improvement in the property market, the subsequent improvement of the banks’ real estate portfolios and the subsequent sales they have been able to make, the picture painted by the results is likely to be somewhat worse than the current reality.
Despite the relatively positive results the bank highlighted its concerns over the dramatic price changes within the commercial real estate market and said that it would continue to keep a close eye on the sector.
“[Real estate] impairment charges were projected to be lower in the stress scenario than those seen during the recent crisis… These results, however, do not suggest that there are no potential risks in the commercial real estate market… The UK commercial real estate 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 commercial real estate portfolios are likely to be a feature of future stress-testing,” the report stated.
The Bank of England also released its financial stability report for December today, highlighting the increasing importance of non-bank lenders to UK commercial real estate and their involvement in lending on higher risk assets.
“In the United Kingdom, lending to real estate companies fell by £15 billion during the past year. Greater lending by non-banks offset part of the fall in banks’ lending to commercial real estate companies in the United Kingdom. Non-bank lenders provided 20 percent of the aggregate senior debt (£30 billion) and more than 90 percent of the aggregate junior debt (£1.3 billion) borrowed by commercial real estate companies during 2013.
“Market contacts suggest that non-bank lenders’ underwriting standards may have eased recently, as debt funds have lent to riskier borrowers — possibly reflecting the need to achieve target returns promised to investors. So far, that trend appears to be confined to the non-bank sector. And a recent Bank of England review of UK banks’ commercial real estate loan portfolios indicated that asset quality has improved since 2011,” the financial stability report stated.
The paper also reiterated that it was considering how best to take forward the recommendation of the Real Estate Finance Group that a loan-level database for commercial real estate loans should be established.