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Posts Tagged ‘Finance’

Lehman Brothers

I‘m not going to write much about Lehman’s demise because there will be thousands of column inches out there (most ignoring the equally important news of the BoA purchase of Merrill Lynch and the problems at AIG). Lehman’s British companies have mostly been put into administration. All I want to note is that in a live interview with the Administrators (PwC) it was stated that some of the best assets left in the UK companies were real estate assets, held in special purpose companies and joint ventures. This shows that – despite the current hand wringing about property markets and reference to ‘toxic’ real estate involvements in the Media – owning real estate assets is safer than lending on them. This is a point I will return to in a future post.

HBOS

Amongst the carnage on the Stock Exchanges around the world yesterday, HBOS shares took a huge battering again in the UK. Quite why still baffles me, although this article suggests that one reason is that the bank is ‘ so exposed to the mortgage market and falling house prices ‘.

In the current climate, the relevance of falling house prices in relation to HBOS is not that important – the ability of mortgagees to meet their payments is the critical issue. Over the life of a mortgage, a house value can fall below the amount of the mortgage (known as ‘negative equity’) and rise well above it. It has happened to me. This is not a cause for concern so long as the borrower can make payments. Therefore, interest rates and the job market should have a greater impact on HBOS’s position, rather than the state of the housing market. When panic spreads throught markets, logic and common sense seem to go out of the window.

The same applies to commercial property loans, but since they are for a much shorter period, the state of values and the market is relatively more important than for residential mortgages. Nevertheless, so long as a borrower can meet their income payments, only a foolish or desperate bank will force the sale of properties in a weakening market. It will only make things worse – for them and everyone else.

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Bankers’ bonuses get mentioned in the media again and again and again and again and yet again. Much gnashing of teeth and wearing of hairshirts isn’t going to solve the problem, although it is better than ignoring the problem altogether. Whilst it is good that UBS has acknowledged that bonuses should be based on profits, rather than income earned, I find it depressing that in these articles no-one is focussing on two of the points I made in my previous post:-

  1. The differentiation between investment and lending bankers. Not only are their activities quite different and need to be remunerated accordingly, but their contribution to profits (more on that in another post) is quite different.
  2. Any changes must be made across the whole of the financial services industry – not just the banking sector, So long as those who manage capital funds who invest in (and alongside) banks are rewarded with bonuses based on short-term performance, they have no interest at all in seeing changes in the way bank bosses and employees are remunerated.

The BBA have some right to ask that discussions take place behind closed doors (but there is always the suspicion that they might be protecting bank bosses, who they effectively represent), but their implication that any changes must be global is the crucial point: any one country bringing in tightening of regulations can expect to see their financial services industry moving to another country pretty quickly.

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One of the most critical components of a downturn in property values is a fall in liquidity. Bank lending has been the largest component in market liquidity for a long time in the UK, usually leading institutional investment and independent equity (frequently from overseas investors, but often with a component of bank loans involved). So a decision to ‘ turn off the tap ‘ by banks is a major factor in a market turndown, as well as an accelerator of a fall in values.

This may seem an obvious statement, but few appreciate all the reasons for this, particularly the banks themselves. Banks tend to see themselves as ‘ lenders to the property market ‘ rather than realising that they are an integral part of it. Their actions affect not only other players in the market, but often also harm themselves.

Before the creation of APB, I would regularly address meetings of creditor banks to point out that precipitous action in liquidating property companies would harm the market and cause presently secure loans to become risky. On one occasion, a colleague pressed me back in my seat as I rose to speak and announced “Can we take it as a given that Richard has made his ‘responsibility to the market ‘ speech ?”.

It was then that I decided I had to go ahead with the creation of APB – an idea that had been in my mind for years. If the message had become routine – and therefore in danger of being ignored – another way of making it had to be found. Whilst there were a number of reasons for starting the Association of Property Bankers, one of my intentions was to make the banks understand their involvement in property markets and therefore to consider carefully their actions when fuelling a boom and exacerbating a crash. It has to be said that I have failed, but I still live in hope.

So what is it about ‘ turning off the tap ‘ that causes problems ? Consider these reasons:-

  1. It makes new purchases difficult .

    The obvious one. It is what most people think of when one talks about liquidity and severely restricts what Economists call ‘ real demand ‘. Less credit available means less organisations able to buy property investments or owner-occupied property.

  2. Banks finance both supply and demand.

    The often forgotten one. Buildings are primarily a factor of production and have a secondary function as an investment product. Before banks face financing the purchase of them as an investment, they finance their construction and also lend to the companies that wish to occupy them. A halt to new building arising from a restriction of available finance may eventually help counterbalance a downturn in values, but any cut-back on general lending immediately affects the ability of occupiers to take new space and may even threaten their ability to pay for the space they already occupy. Tenants going out of business is not uncommon in a recession, affecting returns and undermining confidence in the commercial property sector.

  3. Borrowers are unable to refinance existing loans.

    The generally unappreciated one. Most commercial property loans are for 3 to 5 years and sometimes 7 years. When they reach maturity, the borrower can find the bank is unable/unwilling to renew the loan and alternative sources of finance are unavailable. This can force investors to sell at the weakest time in the market and perfectly stable property investment companies can become vulnerable. Furthermore, since past increased market activity produced a lot of new lending, loan maturities can come in large clusters, forcing a lot of property on a market at a time when there are few purchasers, tipping a falling market into periods of freefall.

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This blog was first conceived some time ago, long before the word ‘blog’ came into common usage. The first few posts had been mapped out, explaining why a commercial (and residential) property crash was inevitable and how it would manifest itself. The mechanics were to be explained and emphasis was to be placed on how unexpected it would be (a prerequisite of any rapid downturn).

It was going to anticipate the inevitable scoffing and complaints that would arise in reponse to such a prediction (as happened when I did make such forecasts on various Forums).

Given my background, the importance of the role of banks and finance in booms and crashes was to be explained, with particular emphasis on the inevitable ‘ turning off the tap ‘ of finance that would precipitate a more rapid fall in property values. I’m certain that I would never have thought of the term ‘ Credit Crunch ‘, I’m afraid.

NOW, IT’S TOO LATE !

Nevermind, in forthcoming posts I will cover much of this ground in rather more detail and – no doubt – have many more interesting things to say.

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