Corporate News

Debt deleveraging and lending: what's the next step?

The predicted glut of distressed retail properties hitting the streets through bank foreclosures has never transpired, despite the collapse in property values and a spate of landlord administrations.

However, banks are looking to further reduce their £200bn exposure to commercial property this year and improve capital in proportion to their assets. One senior property figure has called this the biggest threat facing the high street, so what does this mean for retail in the UK?

Mark Williams is chairman of the Distressed Retail Property Taskforce, the private sector-led body set up in the wake of the Portas Review, and director of Hark Asset Management. The organisation has been tasked with identifying struggling retail centres and developing solutions. He says: "This is a serious threat - potentially the biggest threat. Without the smooth running of efficient debt, efficiently priced town centres will grind to a halt."

According to De Montford University's UK commercial property lending report 2012, lending fell by almost 7% last year to a little more than £212bn - 41% of this being secured by prime property. It is anticipated that this trend will not only continue, but accelerate.

Certainly there has not been - to date - a wash of retail properties brought to the market.

According to CBRE, in the first half of this year there were only £137m of secondary property investment sales, including a £40m sale CBRE handled itself. "The long-anticipated glut of distressed assets has not materialised - so far," says Peter Arduino, senior director of retail capital markets at CBRE.

However, he believes that his banking clients and contacts are "more willing to be entrepreneurial and very keen to find out where the equity pools are". This behaviour is interpreted by the market as banks gearing up to deleverage.

With the low-hanging fruit gone - such as Glasgow's 1m sq ft regional shopping centre Silverburn, and the 375,000 sq ft Ealing Broadway centre in west London - a question mark remains over what the banks' next step will be.

Much of the retail debt left on banks' books is unserviceable, with blown-out loan-to-values in struggling centres, located in distressed towns - the problematic residue.

According to De Montford's report, all property sectors except secondary retail were better placed in 2011 to meet their interest repayments. It says: "Between 2010 and 2011, secondary retail's average income-to-interest cover fell from 1.88 to 1.86, whereas prime retail's increased from 1.5 to 1.65.".

The Financial Services Authority is increasing pressure on banks to categorise the risk of its commercial property loans using standardised models - so called slotting - in an effort to prevent banks understating the risk on their balance sheets.

Although the longer-term effects are regarded as positive, in the short term banks will be forced to ask retailers and landlords to buoy their debt through recapitalisation, at a time when they are sinking like a stone. These players cannot refinance, for obvious reasons.

Banks will be forced to sell at rock-bottom prices, but secondary assets are not typically purchased by institutions. They are bought by property companies. These outfits are usually debt driven but, in the current climate, they find it difficult to secure loans.

"That is a pretty toxic combination. In that scenario, the asset needs to be sold at market price to a new owner with the vision to make something happen," says Williams. This is easier said than done.

Financial institutions have been resorting to loan-book portfolio sales, which have tended to be a mixture of debt to all types of properties, including retail. Big equity players are in the market for these, epitomised by Blackstone's £1.36bn Project Isobel purchase from RBS at the end of last year.

One senior London agent, who did not want to be named, said that Lloyds has £35bn of debt to sell, and that an individual asset can take six months to find a buyer and "doesn't really shift the needle". Its issue is to make the write-offs and cut values back to proper market levels. But that has, so far, proved anathema for all banks over-exposed to comprop.

Nigel Shilton, partner at Deloitte, was involved with the disposal of Silverburn to Hammerson at the end of 2009. He says: "Once the banks have poor assets off their books, they can then lend again to better covenant customers. Because the economic situation has gone on for longer than anyone anticipated, the banks recognise that they have to deleverage property. They don't want to flood the market, but they have to up the pace."

Secondary retail investment values have fallen by up to a quarter over the past year, and are anticipated to fall even further. Given the underlying occupational difficulty, this is the sub-sector most at risk. Williams is succinct in his appraisal of the UK's high streets: "We have too much retail space or, rather, too much of the wrong type of retail space."

Many secondary centres risk obsolescence through a lack of investment as banks withdraw debt from those perceived as risky. In response, retailers exit underperforming town centres and new jobs are not created.

Shilton expands on the classic two-tier dichotomy, essentially between the South East and everywhere else. Anything in London or the South East is probably sellable. The middle tier is properties with re-gearing or releasing potential within three to six months that can add value, and could be anywhere in the UK.

De Montfort University says in its report that £51bn of loans were due to mature in 2012, with £153bn by the end of 2016 - 72% of all outstanding commercial property debt.

And a swathe of institutional leases signed in the late 1980s and early 1990s are due to expire, meaning many retailers will desert underperforming town centres. "It is the perfect storm," says Williams.

However, simply dumping retail stock onto the market would drive values down to ridiculous levels, depressing the market further, and have the countervailing effect of degrading banks' capital adequacy.

"A lot of people think that deleveraging is just achieved through insolvencies," says Shilton. "But for every insolvency, there are three or four others where the borrower has worked with the bank, sold the asset at a reduced price and the bank has written-off the remainder."

Key Points

of De Montford University UK
commercial property lending report 2012

  • UK lenders held 66.5% of debt retained on balance sheets and secured by commercial property. German lenders held 12%, North American lenders held 1.5% and other international lenders held 20%.
  • The research recorded £339m of junior debt/mezzanine finance provided by non-traditional lending organisations.
  • By year-end 2011, Nama held assets valued at around £21.5bn located in the UK, which was not reported to this research.
  • Approximately 13% of aggregated outstanding debt had a loan-to-value ratio of 50% or less, 37% had LTV between 51% and 70%, 16% between 71% and 85%, 14% between 86% and 100%, 9% between 101% and 120% and 11% had LTV of 121% and above.
  • The value of loans in breach of financial covenant at year-end 2011 reported to the research was approximately £22.8bn, representing 12% of the total.
  • The combined value of loans in default and breach of financial covenant is estimated to be approximately £48.3bn and represents around 23% by value of total reported debt.
  • During 2011, lending organisations reported weakening cash flows due to defaults and tenants not renewing leases or renewals at lower rents. This caused further declines in capital values, loans in breach of covenant and default.

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