Under-performing loans growing but lending markets are still well capitalised

The latest Business School (formerly Cass) UK Commercial Real Estate Report shows total market activity suffered a 23 per cent year-on-year decline on previous origination volume in 2019.

Despite some improved origination activity in the second half of 2020, the market lagged behind volumes reached in 2019, reaching just £33.6 billion.

Findings from the report, which covers data up to year-end 2020, revealed:

• New loan origination suffered a second consecutive period of decline, dropping 23 per cent from 12 months ago to £33.6 billion.
• Margins rose across all property types by between 20 and 80 basis points (bps) apart from logistics. Prime office margins ended at 229 bps in December 2020.
• New loan to values (LTVs) reached a new historic low with an average of between 50 and 55 per cent, coupled with extra amortisation and cash reserves.
• Under-performing loans rose sharply from 4.8 per cent to 8.6 per cent of outstanding loans.

While the first half of 2020 had already indicated considerable dislocation in lending markets, the continued impact of business lockdowns during the pandemic continued to slow down market activity into the second half of the year.

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 per cent of loans coming up to maturity between 2021 and 2023.

While most prime property sectors find at least 40 to 50 lenders actively lending in each sector, secondary retail was only considered by 13 lenders in total (three of which included shopping centres). There was generally less interest lending against secondary assets, with only 20 to 25 lenders across the different asset types on average.

The residential development pipeline still remains high, especially for the private rental sector – with a total pipeline of £16.7 billion. In total 20 per cent of lenders’ loan books are backed by some form of residential asset and 28 per cent by office property.

At year-end 2020 non- or sub-performing loans had also reached a new post-Global Financial Crisis peak with 8.6 per cent of outstanding loan books experiencing some form of breach or default. The most cited problem was LTV covenant breaches 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, these may be released at a later point when the amounts have been recovered through repayment on sale of the property. The amount of defaulted loans increased from 3.2 per cent at the end of 2019 to 4.6 per cent in December 2020.

Author of the report, Dr Nicole Lux, Senior Research Fellow at the Business School (formerly Cass), said:

“Loan book quality differs substantially across different lenders, and it has become particularly apparent that lenders with loan books up to £1 billion have generally lent against assets of lower quality.

"Forty-three per cent of lender loan books are above 70 per cent LTV, 48 per cent of loans having an interest cover ratio of below 2.0x, with 7.5 per cent of their loans reporting defaults.

“We predict that real estate lending will become more expensive and require further capital for borrowers across the next two to five years due to increasing maintenance and improvement requirements to meet Environmental, Social and Governance standards, necessary conversions or repurposing and increased capital costs of banks.”

For more details about the report and further individual data sets please contact Hamish Armstrong.