British banks have been playing a delaying game with questionable real estate loans for quite some time now, yet even 'extend and pretend' has its limits.
A De Montfort University study has found that British banks have 300 billion pounds of commercial real estate loans on their balance sheets, of which 50 billion is in breach of covenant.
Yet British banks haven't recognized these effectively impaired loans in their financials, since they've just been allowing borrowers to roll over loans, hoping for some kind of future rebound to save them.
This game is soon finished, says Jeremy Warner:
Banks have been waiving covenant breaches and extending facilities to avoid forced sales. Rentals are generally still being paid and property loans are therefore being serviced. The upshot is that banks don't have to count many of these loans as non-performing, even though they may be in breach of loan to value covenants. Yet the day of reckoning may be fast approaching.
At the peak of any boom, commercial property tends to account for some 11pc-12pc of UK bank balance sheets, which is obviously way too high. In the subsequent deleveraging, this will typically be whittled down to 5pc to 6pc, a process which usually takes around four to five years.
So how far through the "normalisation" are we this time around? Bad news, I'm afraid. It hasn't even started. But begin it will. As banks better understand their exposures and regulatory pressures build, the big unload – a minimum of £50bn of property coming onto the market – cannot be postponed much longer. For big property players with continued access to finance, this ought in theory to provide a buying opportunity.
Note the same could be in store for American banks, since they've been using a similar 'extend and pretend' strategy.
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