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Second credit crunch could trigger due to level of bank debt in UK commercial sector

They face a potential £140 billion price fall and a £125 billion debt refinancing bill over the next fours years, according to Close Brothers, one of Europe's leading independent corporate finance advisers.

Close Brothers believes the scale of this issue has not been fully appreciated and is likely to trigger further write-downs and, combined with the impact of a worsening wider economy, a second credit crunch in due course.

'The commercial property world has not seen a significant downturn since the early 1990s when the financing structures deployed were much simpler and less aggressive. Banks adopted a strategy of selling assets into a distressed market however; this caused a death spiral with ever decreasing prices,' explained Gareth Davies, Managing Director in Close Brothers' European Restructuring and Debt Advisory Group.

'Therefore, alternative solutions to restructure the indebted sector are required this time round, for example debt conversions, new third party investment or partial asset sales,' he said.

Close Brothers predicts that by the time the market has bottomed in late 2009 or early 2010, pricing will have fallen by 50% to 60% and the combined factors of no available debt finance and a limited number of investors with equity to fund acquisitions means that any property which needs to be sold will only realise distressed values.

With such a rapid fall off in valuations, most LTV covenants across the sector have been breached already rendering equity investments now worthless, analysts reckon. Given the number of cases involved, the banks are unlikely to take action on an LTV breach, preferring to either waive the breach or re-set the covenant, they predict.

Borrowers needing to refinance over the next four years face a tough environment in which to do so. These include significantly higher interest rates and higher upfront fees.

'Whilst in the 1990s banks took possession and sold assets when investments hit difficulties, past experience shows this is not always the optimal strategy. Selling property into a distressed market causes a death spiral of falling prices and ever widening losses on the remaining portfolio. Quite often, however, banks do not want to consolidate property on their balance sheets and therefore they are also reluctant owners,' Davies concluded.