Debts & Loans

Close to £43bn of loans to the commercial property sector are due for repayment this year, threatening default for property companies struggling to raise new money and piling further pressure on the UK's banks to support corporate borrowers.

There is risk of a multi-billion pound funding gap, given indications that many banks will continue to retreat from lending on risky commercial property this year as the market continues to go through its worst slump on record.

The scale of loans in default and in breach has already accelerated fast, according to the influential De Montfort University survey of the real estate banking sector, which will be launched next week.

There has been a sixfold increase in the value of loans in breach of banking agreements, worth an estimated £15bn, while the number of loans in default jumped 800 per cent to 3,230. This equates to about £6bn of loans when applied across the sector, according to the report's authors.

Nine in 10 organisations reported loans in breach of covenants - double the previous year. About two-thirds put loans into administration during 2008, compared with a third in 2007.

The total value of outstanding debt to the real estate sector increased by 8.5 per cent to £225bn by the end of 2008, showing that some banks were still lending to existing clients even in the depths of the slump.

The record level of outstanding debt shows how exposed the banking sector is to commercial real estate, which has seen values drop by almost half in the past two years.

Given average loan-to-value ratios of more than 80 per cent over most of the past decade, according to De Montfort, many banks now admit that loans made in the past few years could have all equity wiped out.

Banks are being asked to refinance or extend loans where possible, given the market slump and the shortage of cash available to repay. The Bank of England warned yesterday that the economy could be hampered if such private sector banks did not have lending capacity to fuel the recovery.

Liz Peace, chief executive of the British Property Federation, said: "The volume of outstanding debt illustrates just how significant commercial property lending is in the overall scheme of bank finances."

She called on the government to consider the impact on commercial property - and consequently on the progress of the wider economic recovery - when working on the final details of its asset protection scheme. Lending to the sector has increased by 450 per cent in less than a decade, from £49.8bn in 1999.

Bankers say that the silver lining for the sector is that it is too big to fail, with banks facing greater problems if they call in loans and are forced to sell property assets at low prices than if they roll debt over.

While defaults have increased significantly, they are still a small proportion of outstanding debt and there is no sign of the mass foreclosure of loans that some have been warning. The early 1990s slump was exacerbated after banks took a hard line on real estate debt problems, sending many property companies into administration.

While banks have been rolling over loans, they are taking the chance to raise margins and fees.

Terms now being demanded are the most punishing on record - the highest fees and margins above base rate, and the lowest level of debt against the value of the property.

Bill Maxted, author of the report, said: "Banks have been reluctant to flood the market with properties when the market is in such a depressed state but instead work with their borrowers."

Dominic Reilly, partner in charge of property finance at King Sturge, a sponsor of the research, added: "It has so far been very different from the early 1990s, as there have been very few property portfolios pushed on to the market as long as the interest is being paid."

More than two-thirds of outstanding debt is due for repayment between now and 2013, raising potential problems for the sector in the next few years.

Furthermore, banks gave clear indications that the pace of lending would slow again in 2009. Only a quarter of organisations intended to increase originations, down from more than half at the end of 2007, while half of organisations intended to become less active.

One banker told the survey: "Level of maturing debt is scary - nothing with which to replace it. We are not getting enough of our money back so off to central bank and ask for help."

The survey also confirms that the commercial mortgage-backed securities market in effect closed last year. In 2008, there was only CMBS issue of £1bn, compared with £9bn in 2007 and £18bn in 2006, despite about £6.4bn of loans on balance sheet that lending organisations had earmarked for securitisation.