UK banks should prepare for £12bn losses due to UK property crisis: Moody’s

UK banks should prepare for £12bn losses due to UK property crisis: Moody’s

Losses totalling £12bn across the six largest UK banks, due to the commercial property crisis brought about by Brexit, have been predicted in a special stress report by the UK-based financial research team of US ratings agency Moody’s.

The Commercial Real Estate (CRE) sector in the UK is set to weaken further over the coming quarters following the country’s vote to leave the European Union, but the large UK banks will be better placed to cope with a deterioration in the sector than they were during the 2008/09 global financial crisis, according Moody’s Investors Service special report published today.

RBS and Lloyds had the largest exposure to UK commercial real estate of around £25bn and £20bn at the end of June 2016, respectively, while Santander UK has the largest exposure as a proportion of its fully-loaded Basel III Tier 1 capital at 94%, as at the same reporting date, according to the report.

Under a severe stress scenario, Moody’s said that its stress test results in “meaningful losses totalling £12bn across the six large UK banks”, accounting for 14% of their gross commercial real estate (CRE) exposures, as of the end of June 2016.

40% lending drop

Moody’s report, entitled “Banks – United Kingdom: Large UK Banks Are More Resilient To a Weakening Commercial Real Estate Sector Than In the Financial Crisis,” released earlier today, also pointed that a drop off in lending by the banks across the last six years by 40% could help stave off a global financial crisis similar to 2008/2009.

“We estimate that the six largest UK banks have reduced their aggregate gross UK Commercial Real Estate lending exposure by around 40%, to £84.6bn at end-June 2016 £138.9bn at the end of 2010,” said Andrea Usai, senior vice president at Moody’s. “Reduced exposures to UK CRE coupled with stronger capital buffers means that large UK banks should be better positioned to handle a deterioration in the sector than during the 2008/09 global financial crisis.”

Brexit referendum

Sia added that 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, there has been the collapse of some large CRE deals, as well as the suspension of redemptions at some UK property funds – signalling “a sharp change in investor sentiment”.

But 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, according to the ratings agency. As noted earlier in August, Moody’s said that its base-case scenario foresees average UK CRE values declining by up to 10%, depending on type, quality and location.

In a hypothetical adverse scenario, where Moody’s assumes the UK economy is in recession, the rating agency expects significantly greater property price declines albeit unlikely to be of the magnitude witnessed during the previous financial crisis when they fell by around 45%.

Moody’s notes, however, that the UK’s largest banks would likely be able to partly offset massive credit losses under the adverse scenario through profits and other management actions.