Financial Times Article - Commercial Property Fears Deepen

December 17, 2008

The value of commercial property loans in breach of their agreed terms more than trebled in six months as rapidly falling real estate prices hit a heavily leveraged sector struggling under almost £208bn of debt.

With more than £76bn of debt needing to be refinanced before the end of 2010 and increasing numbers of loans slipping into default, the findings of an influential survey of property lending, to be published on Wednesday, will add to warnings that commercial property could be a timebomb for banks that supported the real estate boom.The value of total debt secured by commercial property rose slightly to £207.9bn in the six months to July 2008, according to De Montfort University, the smallest half-year increase ever recorded by the survey at 3 per cent.

About three-quarters of new loans were undertaken by just 12 organisations, according to the survey, which covers about 95 per cent of the lending sector.

While the survey reveals that the banking industry has almost closed for new real estate business, it is the number of property investors slipping into breach and default of loans that will cause most worry.

Meanwhile, the value of loans in breach of financial covenant was about 3.3 per cent of the total loan book by the end of June - almost £7bn when applied to total debt - and more than treble that reported at the end of 2007.

The number of organisations holding loans in breach of financial covenant almost doubled by mid-year 2008 - to 78 per cent of organisations, compared with 45 per cent at the end of last year - while 43 per cent of organisations put loans into administration, up from 33 per cent during the whole of 2007. Financial covenants are the terms governing lending such as the loan to value ratio.

In total, the report says that an estimated £600m of loans defaulted during the first six months of 2008. Although the number remains low as a share of total lending, banking sources suggest the scale of the problem could be much larger given the reluctance of lenders to check that borrowers are meeting their terms and foreclose on loans.

A decline in cash flow caused by failure of tenants and the subsequent vacant units with no prospect of re-letting was the most commonly cited reason for loans to default. Bankers expect defaults to rise rapidly next year as the recession bites into retailers and office occupiers after early casualties such as Woolworths and MFI.

By the end of the second quarter of 2008, £24.56bn of gross new lending had been completed, about half of the same period last year. Much of this was refinancing and the withdrawing of promised funds, however, rather than new lending.

With margins and fees spiraling higher, organizations have been restricting lending activity to core business clients only.

In many instances, agreed lending facilities are being withdrawn.