January 16, 2013 8:45 pm

Bank rules hit UK property developers

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UK commercial property developers are facing sharply higher costs and are likely to have to scrap many projects outside London as a result of tough new capital rules being imposed on British banks by the City watchdog.

Property companies and bankers to the sector have warned that the rules, which will force banks to hold substantially more capital against loans secured on offices and shops, risk derailing the prospects of recovery in commercial real estate values.

“In the near term it will have unintended and potentially dire consequences in terms of capital reaching parts of the regional property market – the very places where finance is most needed,” said Peter Cosmetatos, director of finance at the British Property Federation.

The move is a byproduct of the Financial Services Authority’s drive to make banks safer and prevent them from using unreliable models to cut their capital requirements.

All UK banks have been told to switch to a capital calculation method called “slotting” for their commercial property loans unless they can demonstrate their models for determining the riskiness of their holdings are accurate and conservative.

The process, which is expected to raise the cost of lending, is already under way and must be finished by the time the banks report their half-year results this summer.

Andrew Bailey, the FSA’s top bank supervisor, highlighted the move in testimony to a parliamentary committee this week.

He said: “We are withdrawing the right of modelling for commercial property because the models are so ropy . . . We are saying: put your loans into simple buckets. Don’t do pyrotechnics.”

Under slotting, all performing property loans are assigned to one of four “buckets” – categories with risk weights ranging from 50 to 250 per cent. Risk weights then determine how much capital must be held against potential losses on each loan.

The system is expected to be particularly tough on landlords in the regions, where economic uncertainty and a lack of foreign investment have pushed vast swaths of property into the high-risk category.

Previously banks had a choice between assigning a 100 per cent weight to all commercial property loans or of using their own models, with most big banks opting for the latter because it allowed them to assign most loans a much lower risk weight and so hold less capital.

One senior banker to the sector warned that the tighter rules could double the cost of borrowing for property companies from the existing range of 2 to 4 per cent above the base rate.

Paul Coates, head of real estate at Royal Bank of Scotland, said higher costs stemming from the rule change would push down property values in all but the best locations.

“We are already seeing a much greater spread from higher-quality assets to lower-quality assets,” he said. “People are getting nervous because it will mean there is not enough debt, but the reality is there was too much debt before.”

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