Building societies improve commercial real estate management

A report from Fitch Ratings says that UK building societies are less likely to face further capital erosion from commercial real estate (CRE) than last year, as they have improved management of their exposure to this sector.

However, the agency warns that single-name concentration in many of the commercial real estate portfolios suggests large losses could still occur.

Fitch notes significant concentration risks exist due to the size of some loans relative to capital. CRE represents a moderate proportion of building societies' overall lending, but loan losses can have a disproportionately large negative impact on societies, especially given their mutual business model and limited ability to raise core capital.

This concentration is less of a risk at societies such as the larger Nationwide, Skipton and Norwich & Peterborough, which have relatively granular portfolios. Fitch also recognises several mitigating factors for societies, including the generally better quality of lending and relatively conservative underwriting than some banks.

Building societies with a Stable Outlook are expected to experience limited rating movement in the short-to medium-term deriving from their exposure to CRE.

Three societies have a Negative Outlook and for these societies, Nationwide, Newcastle and West Bromwich, the performance of their CRE loans is likely to be a major determinant of any subsequent rating action.

Leeds and Nationwide have reported pre-impairment operating profitability robust enough to absorb larger loan impairment charges.

Newcastle, Norwich & Peterborough, Principality and Skipton have reported minimal levels of CRE impairments and consequently smaller CRE-related loan impairment charges.

Only West Bromwich has made a loss on CRE that contributed to a loss of capital.

Coventry and Yorkshire have minimal or no exposure to CRE and the exposure of the rest of the rated sector varies up to around 20% of overall lending.

Fitch-rated societies’ portfolios have generally performed better than the estimated 9.6% default rate for the UK CRE lending market.

CRE prices in the UK have fallen by more than 30% from their peak, which has resulted in some breaches of loan-to-value covenants. Fitch believes that any further declines in values should be relatively modest. Variable-rate borrowers continue to be supported by low interest rates, especially for the proportion of loans that are non-amortising.