The FINANCIAL — London-06 June 2011 — Fitch Ratings says that the reduction in the balance of outstanding UK commercial property debt reported in the 2010 De Montfort UK commercial property lending market study is consistent with observed trends in UK CMBS.
However, the agency believes that CMBS structures may force an even faster reduction of the outstanding UK CMBS loan balance.
The De Montfort study reported a significant decline in the balance of outstanding loans, by 9.4% to GBP206.9bn in 2010. To a certain extent, the decline is accentuated by the transfer of non-performing loans to the National Asset Management Agency (NAMA). However, even when including the estimated GBP19bn of UK-backed loans held by NAMA, the outstanding loan balance still registers a decline of just over 1%. UK loans securitised in Fitch-rated CMBS transactions have also seen a decline, with the outstanding balance dropping by 5.6% over 2010 and a continuation of this trend being observed in the first months of 2011.
The maturity profile of balance sheet lenders is significantly front-loaded, with just over half of the loan balance scheduled to mature before the end of 2013. The balance of loans maturing in 2011, in particular, has significantly increased (by 32.3% over the past year to GBP45.9bn) due to the extension of loans that were originally scheduled to mature in previous years. By comparison, approximately one-third of the outstanding UK CMBS loan balance is scheduled to mature by the end of 2013. Despite GBP369m of loans having been extended to 2011, only GBP262m of this total remains outstanding and the overall balance of loans maturing in 2011 has decreased by 8.4% over the past year to GBP2.6bn. These maturing CMBS loans represent less than 5% of the total UK commercial property debt (including loans held by NAMA) due to mature this year.
Servicers administering loans in CMBS transactions have fewer options open to them than banks servicing loans on their balance sheets. The legal final maturity of the issued notes restricts the flexibility of CMBS servicers to extend the loans for a prolonged period. Additionally, CMBS structures hamper a servicer's ability to fundamentally restructure existing loans, particularly those that have not technically defaulted. It is unclear to what extent the restrictions on CMBS servicers will ultimately result in greater losses, but it seems that the stock of CMBS loans outstanding will continue to shrink faster than the stock of debt secured on commercial property on bank balance sheets. Fitch expects the reduction in the volume of the outstanding debt stock to continue to accelerate for both CMBS loans and balance sheet loans as servicers demonstrate increased willingness to enforce against borrowers or sell collateral.
The volume of loans in CMBS is not large enough to affect the performance of the wider market for debt secured on UK investment property, but the availability of new debt from financial institutions will be a key determinant of the performance of CMBS in the coming years. As in the previous year, the De Montfort study highlighted the scarcity of debt for secondary-quality properties. This remains a key issue for UK CMBS loans, the majority of which are secured by secondary quality assets, both by number of loans (80.7%) and by securitised loan balance (65.1%). The increasingly restrictive bank lending criteria reported in the study – particularly for lower-quality collateral – lead Fitch to conclude that less than 15% of the outstanding UK CMBS loan balance could be refinanced without additional equity contributions by their sponsors.
Leverage is the key constraint on borrowers refinancing their outstanding debt rather than the income generated by collateral. Approximately 90% of the loan balance in CMBS is estimated to be secured by collateral that generates sufficient income to meet current market interest coverage ratio requirements for new loans. By contrast, a similar proportion of the loan balance fails to meet market standard loan-to-value ratios. Secondary and particularly tertiary quality assets are unlikely to see a strong recovery in value in the short- to medium-term, so loans secured on these asset types will continue to be difficult to refinance.