Wednesday, September 10, 2008

The real estate credit blowout

The further you dig into the balance sheets of UK banks, the more disturbing it gets.

Take, for example, lending corporate lending to real estate companies. No, we are not talking about mortgages. We are talking about lending to companies "undertaking the development, buying, selling or renting of real estate".

In the decade between 1997 and 2007, the outstanding stock of bank loans to these companies increased by 479 percent. Back in 1997, UK banks had about ₤33 billion outstanding; by December 2007, it had increased to almost ₤200 billion.

It wasn't just the absolute amount of lending that was increasing, it was the proportion of total corporate lending. Back in 1997, lending to real estate companies account for ₤5 out of ₤100 of corporate lending. By 2007, that proportion had reached over ₤11.

What exactly are these companies? We are talking about about basic types; property developers; estate agents and letting agencies. Think about it for a moment; 11 percent of total corporate lending went to these jokers. What were the banks thinking?

However, there is a more disturbing number. In the first six months of this year, lending increased a further ₤39 billion to reach a staggering ₤232 billion. While the housing market was crashing, UK banks were still pouring out a massive amount of new credit on an industry that was basically imploding. This ₤39 billion represents about 2.8 percent of GDP.

I just don't understand what is going on here. Somebody help me. Have I got the numbers wrong? Did I make a mistake? Or are the banks really this stupid?

As an aside, take a guess at the total stock of loans to manufacturing. As of June 2008, it was just ₤33 billion. To give this number some perspective, the total stock of UK manufacturing loans was less than six months of new credit to estate agents and property speculators.


  1. Today, Lehman's CEO (Dick Fuld) stated that Lehman did NOT anticipate any deterioration in comercial real estate values. Moreover, Lehman's turn-around plan is largely based on this ASSumption.

    Personally, I have no doubt commercial real estate values will fall. CAP rates were stupid low on nearly every big deal over the past few years. Some cap rates on large deals were ZERO. No joke.

  2. It sounds like there are a lot of property companies in big trouble. The evidence is slowly emerging with these type of companies reporting losses or very small profits.

    It is correct to question why the banks would keep on lending to companies which may not be financially viable once the property prices have bottomed out. I mean the cost of building properties may now be artificially high because builders can argue that the developer will make X amount of money from each property and therefore negotiate a better contract/pay deal. But once property prices have fallen then you are left with expensive building contracts/employees where there is no hope of making a profit from the properties being built. The developer perhaps has the option to stop the projects. In which case you could have half built buildings everywhere (like in Spain!). Perhaps the reason the loans are so high is that the development contracts can not be stopped due to strict terms. Hence this might be one reason for large loans being required to fulfill the contracts at a time when there isn’t much money coming in from sales of properties.

  3. When you add in the BTL and regular housing mortgages, the exposure of banks to property must be huge.

  4. All that money on estate agents, where did it all go?

  5. "just don't understand what is going on here. Somebody help me. Have I got the numbers wrong? Did I make a mistake? Or are the banks really this stupid?"

    The builders will have negotiated lines of credit with their bankers in the good times. Unsurprisingly, the builders will tap these before they go away.

    Although they have expiry dates, they are contractual, and the banks can not refuse.

  6. Wichita Homes by Larry Lane
    Isn't it the same story every time? The books are boiling away and one day someone says "Hey! the pool's all dried up!"

  7. This is a good description of what went on before the Swedish banks went bust in the early 90's.

    It was a mega disaster.