Low leverage best protection for lender, IPD conference told

The quality of a property and security of income are key to determining its risk profile, Malcolm Frodsham, director of research at IPD, told the annual IPD conference in Frankfurt last week in a session entitled 'Analysing loan risks'.

'What do you need to understand about the collateral to extend the loan? Quality matters,' he said, pointing to a study to determine the risk profile of hypothetical portfolios. 'The quality of the asset and security of income are related. Quality assets tend to have longer leases.'

Frodsham pointed out that no historic data exists on risk profiles of lending portfolios, but that the current downswing in the cycle is throwing up some useful pointers. Market risk is the overwhelming risk in the downturn, he said, but added that many lenders don't know what they've chosen to lend on. 'Only low leverage can really protect the lender,' he concluded, adding: 'I hope that will filter through in new regulations.'

Frodsham said risk had not been correctly priced in the boom years and that new regulation was being introduced in a bid to rectify the situation. But 'bad regulation' could cause additional contagion, he warned. 'Regulators must not overdo it, otherwise there will be unnecessary contagion. There's definitely a risk of that and that will lead to a knock-on effect.'

In addition to Europe-wide legislation, regulators in individual countries are also seeking to tighten their grip on the sector. The danger, he said, was that there would be no level regulatory playing field. 'Regulators need to understand the market and risk; and risk needs to be correctly priced.'

At the same time, new regulations such as Solvency II and Basel III would spark innovative changes, Frodsham predicted. Pointing to sovereign wealth funds, he said: 'They are not affected by all of that...Some players can choose to be a borrower or a lender at a particular point in the cycle. It's a fascinating new world.'