HUNDREDS of property firms could be pushed into bankruptcy if the Financial Services Authority pushes ahead with a new “slotting” regime that will force banks to be more transparent about the state of their commercial property loan books, according to property industry leaders.
Banking and property sector sources suggest that, if the FSA’s “slotting” proposals are enacted, UK banks would need to raise £20 billion to £40bn in fresh capital to cover prospective losses on their bad and doubtful property loans. That could easily require further government-funded bailouts.
Under the FSA’s regime, currently out for consultation, banks would have to compartmentalize their commercial property books into five categories or “slots” – ‘strong’, ‘good’, ‘satisfactory’, ‘weak’ and ‘default’ – and attach different ‘risk-weightings’ to each category, within a complex matrix. Property loans that borrowers are unable to refinance “on current terms” would automatically be classified as “weak”.
Carla Antunes da Silva, an analyst at Credit Suisse, estimates that “slotting” would add £10bn to the risk-weighted assets on Lloyds Banking Group’s £85bn commercial property loan book. She said it would also cause a sharp rise in the risk-weighted assets of RBS, to the extent that the capital-bolstering effects of the Edinburgh-based bank’s current restructuring programme would be all but wiped-out.
“The FSA is proposing too much too quickly, and without having given sufficient thought to the knock on effects,” said Charles Wordie, chief executive of Glasgow-based Wordie Properties. “There’s a danger these proposals will further weaken the banks and that even well-managed and secure property companies will be severely impacted.”
“One likely outcome is further polarisation between prime and secondary markets, widening the pricing differentials between London and the rest of the UK.”
According to Monfort University £114bn of UK commercial property loans currently fall into this category, implying that UK banks would have to raise a further £30bn in fresh capital. That is just under half the £62bn the banks received from UK taxpayers in the bailouts in October 2008 and February 2009.
The FSA intends to bring in slotting regime in response to Basel II and Basel III, as part of a global push to standardize procedures and boost transparency across global banking sector. Goals include to force banks to be more candid about their risk exposure in the commercial property market.
At the moment they are widely using “forbearance”, “extend and pretend” and opacity to flatter the perceived health of their balance sheet and to minimize capital requirements.
The extent of “forbearance” and “extend and pretend” in the sector – which involve banks turning a blind eye to breaches of covenant and extending maturities to make it easier for beleaguered borrowers to repay their debts – are a matter of concern to the Bank of England.
Chris Dun, banking partner at law firm Maclay Murray & Spens, said: “My concern is that the regulator is over-reacting. By introducing “slotting” and increasing capital requirements to very conservative figures, there’s a risk that they’re doing too much to protect the banks and not enough to protect the economy as a whole.”
David Melhuish, director of the Scottish Property Federation, believes it’s time the FSA gave the banking sector a break. “Slotting is exactly what was needed when the market was overheating in 2005-06. The phrase ‘locking the stable door after the horse has bolted’ springs to mind.
“It will make lending to commercial property much more expensive. If our economic recovery is to take effect, there must be a case for regulating appropriately for the needs of today and the future, rather than the past.”
He said the banking sector has been struggling to resist the reforms because of an enfeebled position in Westminster and Whitehall. “The banks are now in a very weak political position. They do not have many cards left to play.”
An edited version of this article was published in the business pages of the Sunday Herald on May 13th, 2012