UK sees ‘sharp rise’ in underperforming loans during Covid

Underperforming loans have risen rapidly in the UK during the Covid pandemic, according to the latest annual UK Commercial Real Estate Lending Report.

The report finds that outstanding loans in breach or default ‘rose sharply’ last year from 4.8% to 8.6% - which is a new post global financial crisis peak.

The number of lenders reporting defaults and breaches is back at the 2009 level seen in the aftermath of the GFC. In 2020 48 lenders said they had some level of default in their book, compared with 49 in 2009. The number reporting breaches has surpassed the GFC period, with 54 in 2020 compared to 37 in 2009.

The amount of loans that have gone from breach into default increased from 3.2% at the end of 2019 to 4.6% in December 2020.

Dr Nicole Lux, senior research fellow at the Business School (formerly Cass) and the report’s author, cautioned that the figures for the number of lenders reporting some level of distress are not directly comparable, as the 78 respondents taking part this time is slightly higher than the number taking part in 2009.

Hinting that there may have been some under-reporting or reluctance to report in the years after the GFC, she told PropertyEU: ‘The lenders now have been good at reporting them, as they should, rather than being slow to admit it or not wanting to report it. It is happening rather quickly with the number having nearly doubled.’

The survey also shines a light on how loan book quality differs ‘substantially’ across different lenders. ‘It has become particularly apparent that lenders with smaller loan books, up to £1 billion, have been particularly affected. They have generally lent against assets of lower quality,’ Lux said.

‘Some 43% of lender loan books are above 70% LTV, 48% of loans having an interest cover ratio of below 2.0x, with 7.5 per cent of their loans reporting defaults.’

It is not only small debt funds making up the most affected lenders: Lux said the split was 50:50 between non-bank and bank lenders and includes some of the challenger and regional banks.

‘It is not surprising, but they are the organisations with less infrastructure and work-out capabilities and are often also overlooked by the regulator. The regulator checks the big institutions all the time..that is where I do see an issue,’ she added.

Lux said the most cited problems were LTV covenant breaches and missed interest payments, as well as non-payment or non-prepayment of the full loan at maturity, resulting in an extension. While some impairments have been taken by banks, LTVs are generally still low and she predicts these impairments may be released at a later point when the amounts have been recovered through repayment on sale of the property. This would then free up capital again.

German lenders have a relatively high exposure to retail in the UK, a sector which has seen the average LTV of a property financed five years ago at 60% rocket to 90% LTV by December 2020.

Big drop in hedging
One other potential problem picked up in the full report is a dramatic shift away from hedging floating rate loans against changes in the interest rate.

‘About 50% of the total book is now unhedged floating rate - again with smaller lenders hedging less,’ Lux observed. ‘Of course, this will only cause a problem when interest rates increase - and we all believe at the moment that interest rates are going to stay low forever.

‘The UK used to be a five-year hedge loan market and now its a floating rate market. In the last crisis, it would have been 80%+ fully-hedged.’

The survey confirms the previously observed trend of a decline in originations in the UK, but at an accelerating rate. New loan origination in 2020 was down to £33.6 bn, a 23% drop from 2019’s £43.8 bn. In 2018 the statistic was £49.6 bn.

This lending activity was dominated by loan extensions and refinancing which accounted for 57 per cent of all new lending. Extensions (many short-term) have moved the maturity profile of loan books, with 56% of loans coming up to maturity between 2021 and 2023.

The survey found a number of other continuing trends, including:

  • A continuing rise in margins and fall in LTVs. Margins rose across all property types by between 20 and 80 basis points apart from logistics. Margins for all retail and secondary office are at historic highs. Meanwhile, new loan to values are at a historic low of 50%-55%, coupled with extra amortisation and cash reserves.
  • While there are 40-50 active lenders for prime assets in each sector, retail is an exception with 13. Only three lenders included shopping centres.
  • Residential development lending has risen in the last five years, especially for the private rental sector and the pipeline stands at £16.7 bn. Most lenders target mid-sized projects and just five said they would lend on projects over £100m GDV.


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