Aims to investigate the reliability of two of the criteria commonly used by banks in assessing the risks associated with lending on a commercial property project. The two criteria to be examined are loan to value and income to interest cover covenants. In the light of the research, suggests improvements and modifications on how these and other criteria are used to aid lenders in their decision‐making process. The time period chosen for this study is 1984 to 1994, a decade which saw the banks enter and then retreat from the property lending market on a scale hitherto unknown in the UK, with a number of these institutions incurring unprecedented losses. Compiled initially from an analysis of published property statistics on yields, capital values and interest rates, theoretical conclusions were then made on the reliability of the two criteria under discussion. Having identified the years 1984, 1987 and 1989 as being key turning‐points in the property cycle, these conclusions were “tested” by empirical research. Between May and July 1994 13 interviews were carried out with banks that had been active in commercial property lending for all or part of the relevant period. The interviews were based on a questionnaire which established the banks′ attitude to lending at each of the specified dates. Thus it was possible to identify how the banks′ attitude changed and how reliable the covenants proved to be in practice. First, demonstrates the fluctuations in interest rates, yields and capital values between 1984 and 1994, which resulted in the reliability of loan to value and income to interest cover covenants being examined. Second, presents the findings of the interviews with the banks for each of the years 1984, 1987 and 1989. Third, reaches conclusions and makes recommendations as to the use of the two covenants under discussion as well as considering additional criteria that are important to commercial property lending.
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