What might bank losses on property loans mean for you?

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Tomorrow, Lloyds Banking Group, which now owns HBOS, will reveal results for the six months to 30 June, and on Friday Royal Bank of Scotland will provide updates to the market with a trading statement. JP Morgan estimates that Lloyds will reveal losses on property loans of around £4.5bn, and a survey of analysts undertaken by Bloomberg indicates that losses from bad property debts at RBS could rise as high as £6.4bn for the full year.


For the property industry, the big point of interest is what happens to loans that have already been deemed impaired, or sit on the ‘watch lists’ banks create. There is a hope that alongside the banks’ results there will be further info on the UK government’s Asset Protection Scheme, into which Lloyds and RBS are expected to put £118bn of UK property and construction loans, according to Citi – basically their entire UK property exposure. The banks are liable for the first 10% of losses on loans insured by the APS, and then after this ‘first loss piece’ is surpassed the Government pays for 90% of all subsequent losses.


And the industry seems worried by the scheme 

With the APS, the worry is that losses on loans are likely to be much steeper than the first loss piece that banks have to stump up for themselves, so once the Government is paying the insurance, there is no incentive for the bank to keep the loan on its balance sheet – just flog it at the market price and reduce the balance sheet.


Now I’ve done a fair bit of work on this in the last few months, having written a research paper for the Investment Property Forum (see link below) on how the banks are dealing with property loan books. The noises coming out of banks of all stripes, as well as the Government and their advisers, are encouraging. In the UK, it would seem, the political will is to avoid unwanted headlines about a slew of property coming on to the market, and the Government paying billions in insurance to stop losses on commercial property. The pressure will be put on banks to hold property loans over the long term to keep losses to the minimum possible.


But some investors are still worried, and one I have spoken to pointed out that, since the start of the year when the APS essentially kicked in (losses made on property after 31 December 2008 will be insured by the Government), there have been a series of big administrations involving former HBOS borrowers like Mountgrange, Paul Kemsley’s Rock and Modus.


This investor even went so far as to undertake a study into the potential effects of the APS, the conclusions of which are interesting. It did not ultimately decide on which of two polarised scenarios (flood of forced sales or stagnant market due to banks hoarding the assets secured against unprofitable loans), but one element caught my eye. Under the terms of the scheme, losses from loans that are restructured, such as an extension of maturity or amended LTV covenant, are guaranteed by the scheme.


To me it seems that this gives banks a pretty free hand – some bankers had suggested to me that in order to trigger losses and collect the insurance money from the Government banks might have to bring in receivers or administrators. If this is not the case, and restructuring is good enough to see losses covered, then there will be no need for banks to push assets on to the market.


But before borrowers get complacent, it also means that it will be easier for banks to restructure loans and oust failing management teams, safe in the knowledge that they are covered against the losses that this process might entail. If you’ve not been pulling your weight and sweating your assets these past few years, expect your bank manager to replace you with someone who will.


IPF Short Paper1 – UK Real Estate Debt.pdf


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