Banks could lose £12bn from commercial property portfolios, Moody’s

In its report, Moody’s said its stress tests had shown RBS, Lloyds, Santander, Nationwide, HSBC and Barclays could lose 14% of their gross exposure to commercial property if investor interest in the asset class slumps further and the country’s economy declines.

Under its less-stressed scenario – assuming economic growth of 1.8% – banks would lose about 10%, the agency said. However, they would likely be able to partly offset any credit losses through profits and other management actions, it added.

RBS and Lloyds had the largest exposure to UK commercial real estate (CRE) of around £25bn and £20bn respectively at the end of June 2016, according to Moody’s. Santander UK had the largest exposure as a proportion of its fully-loaded regulatory capital buffer, at 94%.

However, banks have markedly improved their position since the last crisis, according to Moody’s, which means any deterioration in the sector would be less severe than in the last financial crisis.

The agency estimated the six largest UK banks had reduced their aggregate UK commercial real estate lending exposure by about 40%, from £138.9bn at the end of 2010 to £84.6bn at end-June this year. Their regulatory capital buffers had also increased.

Moody’s Investors Service senior vice president Andrea Usai said: “Pressures on the UK CRE market mounted in early 2016 amid uncertainty about the outcome of the Brexit referendum. And following the actual vote to leave the EU, we have seen the collapse of some large CRE deals, as well as the suspension of redemptions at some UK property funds. These events signal a sharp change in investor sentiment.

“Though banks may be better placed to deal with a CRE slump than they were a number of years ago, a severe stress would certainly erode capital, and materially in some cases.”

Moody’s said it expected negative investor sentiment to continue into the second half of the year, particularly among foreign investors, despite the stark fall of the pound in the immediate aftermath on Brexit, which would allow them to buy property more cheaply.

Since 2009, foreign investors have accounted for more than 45% of total UK commercial real estate transactions, according to Bank of England estimates. Recent data showed inflows of foreign capital into the sector more than halved this year, suggesting market sensitivity to the referendum announcement, said Usai.

“Although a weaker sterling could make this type of investment more appealing to foreign investors, we believe that the Brexit vote is likely to exacerbate the negative sentiment that developed in the first half of the year,” he said.