Britain’s Lehman Moment: How HBOS And RBS Lost £45B On Commercial Real Estate

For those in U.K. property, the collapse of Lehman Brothers was dramatic. But the dancing with death of HBOS and Royal Bank of Scotland was the truly seismic event.

This October marks a decade since Lloyds Bank bought HBOS to stop the Scottish bank collapsing, and the government was forced to step in and save RBS with a massive injection of cash. In his 2011 book on the financial crisis, then Chancellor Alastair Darling recounted receiving a phone call from RBS saying that it was about to run out of money, an event that would have led to a run on the British banking system.

The government eventually nationalised Lloyds and RBS, a situation which has only been unwound recently with the government’s stake being sold down. The main factor to the near-collapse was a disastrous push into commercial property lending in the last boom.

In the years following the financial crisis, Lloyds reported losses of £30B from commercial property, mostly resulting from loans made to HBOS, according to reports from the Financial Services Authority and the bank itself. For RBS the equivalent figure was £15B.

For Lloyds/HBOS, this figure accounts for the vast majority of the losses it reported between 2008 and 2013. For RBS, its largest losses came from the sub-prime mortgages it inherited when it bought Dutch bank ABN Amro, but an FSA report in 2011 said that commercial real estate was the second largest source of losses.

Some of the examples of risky lending take the breath away today, in a world where, according to CBRE Capital Advisers, the maximum banks will lend to U.K. commercial real estate is about 60% of the purchase price.

When Glenn Maud and Derek Quinlan bought Santander’s HQ in Madrid for €1.9B — the day after Lehman Brothers collapsed in 2008 — Royal Bank of Scotland didn’t just provide €200M of junior debt for the deal. It also lent the pair €75M for their share of the equity, meaning the investors put just €25M of their own money into the deal, 1% of the overall cost.

Fellow Scottish bank HBOS’ Uberior division regularly took equity stakes in properties and companies it lent to, meaning its exposure would regularly top 90%.

HBOS got into trouble because while other lenders looked to distribute risk by syndicating loans or selling them as commercial mortgage backed securitisations, HBOS kept the majority of its real estate loans on its own balance sheet to try and maximise profits. An FSA report into the bank said that more than half of its corporate loan book was made up of property debt when the crash arrived, much higher than at other banks, making it more exposed.

It had a property loan book of £88B in 2009, and it also failed to pull back its lending when others were starting to see danger signs — in early 2008 the bank’s corporate lending chiefs gave an interview saying that rather than reducing their lending, they wanted to fill the gap left by frightened rivals.

RBS was bigger at its peak, with a £91B loan book, and it did distribute risk, but it came a cropper as a result of lending to complicated deals involving property being split off from operating companies in sectors like hotels, car parks and care homes, and also by making a push into Irish property very late in the cycle — the bank’s results showed that once the Irish market crashed, the property it had lent against in the country was worth about half of the total debt it had provided.

The destruction of value in some individual cases was enormous. HBOS/Lloyds had to undertake the biggest debt-for-equity swap in U.K. history when it converted £650M of the £1.8B it was owed by Alternative Hotel Group into a stake in the company in 2010.

It lent around £300M to developer Thornfield Ventures to build a 570K SF shopping centre and hundreds of apartments called the Rock in Bury, North West England, but when it sold the loan secured against the scheme in 2012 as part of a wider portfolio it priced the asset at just £65M.

RBS lent investor Glenn Maud around £900M to refinance 13 assets called the Blade portfolio in 2007, a loan it had intended to sell through the CMBS market.

That market closed before the bond issuance could be undertaken. In 2010 RBS brought in Delancey to manage the portfolio, by which time its value had fallen by more than £450M. Maud’s company had bought the East Kilbride shopping centre in Scotland for £400M in 2007, and it was sold for just £180M in 2014, with the value having fallen to £120M when Delancey took over the portfolio.

Fortunately, banks and regulators seem to have learned the lesson of this excess. As CBRE noted, loan to value ratios on U.K. loans are much lower today. And the variety of lenders in the U.K. market is much higher, according to the authoritative Cass report into U.K. real estate lending, with the market no longer reliant on a few banks like HBOS and RBS.

That is partially a result of more stringent regulation, which means banks have to put aside much larger amounts of capital on high-LTV loans to insure against potential losses.

Ten years on the collapse of two banks would be damaging, but unlikely to send such shock waves through the U.K. property sector.