Banks face double property crash

By James Saft

LONDON (Reuters) - British banks are facing big difficulties, as what amounts to a crash in both housing and commercial real estate threatens to devastate their loan portfolios.

The most probable outcome is a long strength-sapping credit crunch alongside repeated dividend cuts and capital raisings. At the least it will be a headache for policymakers and at worst will tax severely government budgets that are already stretched.

Commercial property developers and house buyers both drank deeply at the well when loans were being made freely in past years, using increasing amounts of leverage despite the fact that the income the asset could generate was often not enough to cover the payments.

Both markets have now come unstuck spectacularly.

British house prices are down about 11 percent from the peak and derivatives markets are pricing in another 20 percent fall from here.

It is if anything a bit worse for commercial property, where derivatives traders are pricing in a fall of about a third from the peak in June 2007 to the end of 2009, according to Morgan Stanley calculations.

While the borrowers will of course take the first hit, increasing numbers will default, forcing writedowns by banks.

"We have an ongoing process of writing down and raising fresh capital. That is going to be demanding for a very, very long time," said Marc Ostwald, strategist at Monument Securities in London.