PIA warns of slotting’s ‘negative property value feedback loop’

By James Wallace - Monday, July 23, 2012 15:33

The Property Industry Alliance (PIA), a body of seven separate trade associations, has warned that a hasty implementation of ‘slotting’ could lead to banks enforcing on defaulted loans backed by poor quality commercial property creating a “negative property value feedback loop”.

PIA, in its annual update on UK commercial property debt risk, warned a viscous circle could emerge from the increased capital requirements for weakest loans prompting banks to enforce against secured properties – much of which is poor secondary and tertiary stock – perpetuating a value spiral where the market is already in the most distress and where refinancing is most challenging.

The Financial Services Authority has attempted to calm fears over an ‘Armageddon scenario’ yet clearly significant cross-industry fears still persist.

While such worst case dystopian nightmares will be averted, the slotting regime inherently deepens stress at the already most distressed part of the market – at loan level for banks, and at asset level, which could destabilise prices.

There is also an unintended consequence for capital charges against high quality property loans, argues the PIA, relative to equivalent quality loans secured by other asset classes. “This could result in both an artificial distortion of the market away from safer income-producing real estate (IPRE) loans in favour of riskier loans to other sectors, as well as the overpricing of safer IPRE loans.”

As a result, UK banks “desire to support the real estate market might experience an over correction, with wider implications for both sectors and economy”.

Furthermore, the FSA’s ‘slotting’ regime does not apply to all banks’ lending in the UK, which could result in domestic banks at a competitive disadvantage in UK property lending, hastening the already apparent bank lending retreat.

The PIA wrote: “There is a widespread perception in the property industry that banking, insurance or pensions regulators are altering the relative cost and attractiveness of different asset classes without fully explaining (or even understanding) the implications of doing so.

“Before slotting is implemented, we suggest that there should be a full impact assessment on the banking and real estate markets and economy as a whole, to avoid a potentially unnecessary, but foreseen, dramatic impact on the banking and real estate markets.”

The PIA – who are comprised of AREF, BCO, BCSC, BPF, IPF, RICS and ABI – said the focus on bank capital requirements as “is too narrow”, recommending a medium term review “to develop a vision for real estate financing”.

Such a review, the PIA said, should:

  • Consider the desired spectrum of financing of the market and might have the objectives of (a) ensuring a portfolio of lender types, each adequately capitalised, and (b) embedding a brake on real estate lending, perhaps as markets enter above trend valuation levels.
  • Review the incentives and other factors which drive the property and lending market, particularly how property/ property lending market bubbles are caused and fuelled.
  • Consider the tools potentially available to lenders, borrowers, regulators and how they can best be used to manage the overall markets.
  • Identify options for developing market transparency, and in particular how market data can be collected.
  • Involve representatives from all constituents of the market, including investors, banks, insurance companies, regulatory bodies etc.

Peter Cosmetatos, director of policy, finance at the BPF, said: “Unfortunately, a multitude of different regulatory pressures is giving rise to further costs and uncertainty, giving people even more reason to be risk-averse at just the wrong time in the cycle. 

“In the absence of any coherent strategy for the regulation of property finance markets, there is a real danger that regulatory interventions will create negative feedback loops in fragile markets and cause a build-up of new systemic risks. 

“Because of its particular focus on real estate finance, slotting stands out as a change that needs to be managed very carefully.  It may be that property markets would benefit from a short, sharp adjustment – but the wider consequences of a shock of that kind are difficult to predict and the negative feedback loop risk is serious.”

jwallace@costar.co.uk

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