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Don’t take upturn for granted

Indicators in the US point to a possible commercial lending crisis so in the UK we should hope for the best while preparing for the worst, says Paul Walshe, partner and head of lender services at Moore Blatch

Paul Walshe
Paul Walshe

Summer’s here and everything in the garden is rosy. We have a fresh government and the economy is showing signs of recovery so the worst is over. Or is it?

The good news is that latest data from the Council of Mortgage Lenders shows that repossessions and mortgages in arrears both fell in Q1 2010.

The number of repossessions was 9,800, down from 10,600 in the previous quarter and 13,200 in Q1 2009.

But this is by no means a reason for complacency. Many home owners remain vulnerable to economic uncertainty and austerity measures under the coalition administration.

The fall in repossessions is more marked for those with low arrears which might suggest that low interest rates and measures brought in by the last government have done the trick.

But a number of factors could undermine this fragile recovery, including a continuing rise in unemployment involving additional public sector job losses and private sector employees who may also be affected as outsourcing contracts are pulled.

If the recent rise in inflation is not an oil-related blip the Bank of England will have to raise the base rate, and with so many individuals having opted for variable rate mortgages in recent years the impact of this will be immediate.

Some of the schemes brought in by Labour to help struggling home owners stay in their homes and avoid repossession are due to come to an end this year. If they are not extended by the new government we could see the level of repossessions increase.

The base rate will inevitably rise above the current low of 0.5% and borrowers will need to consider how this will affect their mortgage repayments.

The CML, Shelter and Citizens Advice have all emphasised the need for continuing government support to help those in financial difficulty.

Looking further afield
But while the UK is an island nation our economy is underpinned as much by global events as those within our coastline. So it’s worth looking further afield to see if we can detect any factors that could undermine our domestic property market.

Our attention should first turn to the US which was the catalyst for the global residential property market collapse. Here, my concern is not the residential property market which has for the most part collapsed, found its bottom and taken its casualties with it.

As you will know, mortgage-backed securities are a good indicator of future issues due to their transparency compared with balance sheet lending.

As in the US, in the UK the bubble first began to burst in the residential market involving residential mortgage-backed securities, with balance sheet lending following shortly thereafter. My concern with the US, and thus the UK too, is for the commercial property market which has thus far managed a controlled correction. In the US, commercial mortgage-backed securities account for roughly a quarter of the market whereas in Europe it’s between 10% and 20%.

And as with anything across the pond, the numbers are huge. The US Congress estimates that between 2010 and 2014 some $1.4trillion in commercial real estate loans will reach the end of their terms, and nearly half of these are presently under water.

From a residential perspective does a commercial collapse matter? Yes, as lenders would have to shore up balance sheets which have already taken a hit before they could consider new lending

A recent Congressional paper – which I would recommend all readers to take a look at – makes fascinating if worrying reading. It can be found at http://cop.senate.gov/documents/cop-021110-report.pdf.

In this document the largest commercial real estate loan losses are projected for 2011 and beyond, while it states that losses for banks alone could go as high as $300bn.

While the authors accept that it is difficult to predict either the number of foreclosures or which institutions will be most immediately affected, in the worst-case scenario they state that hundreds of community and mid-sized lenders could face insolvency.

In Europe we are faring much better, with approximately 7% of commercial loans in default at the end of 2009.

Not unlike in the UK, lax RMBS underwriting was part of the problem in the US, as were rising LTVs. In the late 1990s only about 9% of the loans in US CMBS transactions were interest-only. By 2005 that figure had climbed to 48% and by 2006 it was 59%.

Warnings from special servicers
In the UK similar warnings are being issued by our counterparts in the commercial mortgage world, the special servicers. Europe’s largest such company, Hatfield Philips, recently warned that the Financial Services Authority’s 2010 risk outlook underestimates the scale of the commercial property crisis.

In common with Stateside warnings Hatfield Philips says a substantial number of the 60% of outstanding CMBS loans set to mature by the end of 2012 are unlikely to be able to refinance or repay their debts.

But from a residential perspective does a commercial collapse really matter, ignoring obvious market confidence issues? The answer is yes, as lenders would have to shore up balance sheets which have already taken a residential lending hit before looking at new lending, with inevitable consequences for borrowers already in trouble.

Closer to home, a period of enforced austerity across Europe will affect many sectors and the Greek crisis will inevitably reverberate throughout the UK residential market in some way.

So we must continue to apply the lessons learnt from the past two years to support our borrowers. And we must also be prepared for challenging times ahead as I dearly hope but cannot necessarily predict that we have seen the worst of this grim period.

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