Lenders pile on the debt

Posted On Monday, 01 July 2002 10:01 Published by eProp Commercial Property News
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Over the past two years, while returns on equities have headed south, real estate's true charms have sparkled

David ClementiBricks and mortar may be among the less glamorous assets when stock markets are soaring. But over the past two years, while returns on equities have headed south, real estate's true charms have sparkled.

And nowhere have they sparkled more than in the balance sheets of lenders who have been piling on the debt to real estate with ever-greater enthusiasm.

Bank lending to UK property companies as a percentage of total commercial lending rose to 11.8 per cent at the end of the first quarter of 2002, up from 10 per cent at the end of 2001, according to DTZ Research. Real estate loans are now at their highest percentage of total commercial lending since 1992, says DTZ.

In the US, bank lending to commercial real estate has also risen steeply, although it has slowed in the aftermath of the September 11 terrorist attacks. However, it remains high enough to concern bank credit analysts at Moody's Investors Service, who have warned that the rising concentrations of real estate loans could lead to downgrades of some bank credit, or stop some banks from achieving upgrades.

Bank lending to real estate has been strong enough to catch the eye of the deputy governor of the Bank of England, David Clementi. Noting that lending to commercial property companies had been growing at an annualised rate of more than 20 per cent for the previous 18 months, he spelled out the Bank's intention to 'continue to monitor and assess property market developments closely', paying particular attention to risks from financial innovation.

But property developers want to borrow and bankers want to lend. Is there a solution to the growing mountain of bank debt?

If there is, analysts say, it probably lies in the capital markets.

Last week, UK investment bank NM Rothschild announced it is to join the small but growing number of banks seeking to carve out a niche in the commercial mortgage backed securities (CMBS) market.

In the US, the CMBS market is both deep and, at 10 years old, surprisingly mature. CMBS are bonds backed by secured loans against real estate, in which investors receive interest payments from the interest and principal repayments on the loans. Because the loans are secured against the properties, lenders, and consequently investors, have even greater comfort that they will be repaid.

Some 65 per cent of all US commercial real estate loans are estimated to wind up in securitised loan pools.

In Europe, the market is far less developed.

However, according to data from an annual review of property lending from De Montfort University, loan securitisation is a rapidly growing business, with 30 per cent of respondents in the UK saying that they intend to participate in the business in 2001, up from 18 per cent the year before.

Bill Maxted, senior lecturer at De Montfort and author of the report, expresses a certain scepticism about whether a European CMBS market is on the verge of take-off.

And, when seen against the backdrop of CMBS issuance in the US, the European market is puny.

Darrell Wheeler, director in charge of CMBS research at Salomon Smith Barney in New York, says that when comparing European and US issuance it is important to remember that the genesis of the market was the US banking crisis in the early 1990s, when real estate lending led so many banks to insolvency. The capital markets, he notes, were the only way to get non-performing loans off banks' balance sheets. Over time, investors became comfortable with them and a market took off.

Europe, however, is quite another story. The banking crisis, particularly that linked to real estate lending, was never as acute as that in the US and, many lenders with the largest loan losses in Europe were either state-owned or had state guarantees. Indeed, the remnants of those state guarantees are one of the reasons why there is, by comparison, so little property loan securitisation in Europe.

With governments as shareholders, banks have had little incentive to improve returns on equity and investors in Europe have been less demanding of bank managements. This has allowed lenders to extend real estate loans on margins so fine that there is little to be gained from selling the loan into the capital markets.

German mortgage banks in particular have been able to raise very cheap capital through the Pfandbrief market that allows them to borrow very cheaply.

Andrew Radkiewicz, head of real estate financing at Rothschild, says the bank believes that as banking reforms erode this source of financing, securitisation will become a more attractive option for borrowers and lenders.

Lenders say that German banking reforms and demands from shareholders for higher returns are already making German lenders less competitive. The De Montfort study shows that German lenders' market share fell to 25 per cent of the UK market in 2001 from 33 per cent two years earlier.

However, when comparing Europe and the US, there is one striking difference; while US borrowers are content to see their lenders sell their loans on to third parties for repackaging as securities, European borrowers are not.

In the US, the CMBS market has received a huge boost from the growth of so-called loan originators, who purchase loans for repackaging into pools and from an entire industry of loan servicers.

While relationship banking remains strong in Europe, it is unclear how long that will last. For if cheaper finance can be obtained in the capital markets than in the banking markets, surely the customer cannot be too far behind.


Last modified on Wednesday, 21 May 2014 19:27

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