Commercial Property Lending? No Stress.
A year ago we wrote how the UK banking sector had, over the space of the preceding ten years, become much less exposed to commercial property risk. Last week’s publication of the 2018 Bank of England Stress Test results provides opportunity to revisit our analysis.
Figure 1 shows the key impairment related outputs of the 2017 and 2018 Stress Tests and compares them with data on impairments witnessed in the Global Financial Crisis (GFC) sourced from Deutsche Bank. Although much has changed relative to the GFC, little has changed over the last 12 months:
- Total impairments in the 2018 Stress Test (£71.7bn) are much lower than in the GFC (£121.5bn).
- The balance of risk has passed from business to consumer: lending to individuals accounted for 39% of GFC impairments, but 65% of 2018 Stress Test impairments.
- Impairments from commercial real estate lending fall from £18.6bn in the GFC to £3.1bn in the 2018 Stress Test, a decline of 83%.
- The share of impairments from commercial real estate lending falls from 15% in the GFC to 4% in the 2018 Stress Test.
Although this implies little change in the commercial property impairment position between the two Stress Tests, many things have altered – mostly for the better. Figure 2 shows, at the individual lender level, the amount and rate of impairment under the 2017 and 2018 Stress Tests. Three key points emerge:
- Overall, impairment declined from £3.8bn in the 2017 Stress Test to £3.1bn in the 2018 Stress Test, a fall of £0.7bn or 18%.
- All six lenders (Standard Chartered is not included as it has no UK commercial real estate exposure) saw the level of impairments fall in the 2018 iteration of the Stress Test.
- Five out of six lenders (the exception being Barclays) saw the impairment rate fall in the 2018 iteration of the Stress Test.
So lenders seem to have de-risked their books over the course of the last year. This may simply be through reducing LTVs or increasing covenants, or both. However lenders are also increasingly taking out forms of what is effectively “first-loss insurance”, which could also have reduced impairment in a Stress Test scenario. CBRE Capital Advisors has advised on a number of such transactions in the UK in 2017 and in 2018, employing a variety of structures, including CMBS, whose ultimate purpose was to protect lenders from the initial impact of default. While seemingly expensive at first glance (premia can typically be high single digits) such insurance protects against downside risk, and reduce regulatory capital by improving Slotting treatment, and thus improves key measures such as Return on Risk Weighted Assets. Though the confidential nature of the Stress Testing regime makes it impossible to be certain, we suspect this form of protection has improved 2018’s results.
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