London: Britain’s financial regulator is examining Royal Bank of Scotland’s portfolio of troubled commercial property loans, as the European debt crisis injects fresh volatility in property prices, industry sources said.

The Financial Services Authority (FSA) wrote to the head of RBS’s Global Restructuring Group (GRG), Derek Sachs, last week after sending over officers to quiz staff, assess the potential risks posed by market turbulence and monitor the business.

One source familiar with the situation said the FSA was keen to understand taxpayer-owned RBS’s exposure to real estate through GRG, which holds about £40 billion ($62 billion) of troubled commercial property loans among other businesses in intensive care, and through its West Register unit.

“A letter was sent last week," the source said. “The FSA wants to know what happens if commercial real estate completely drops, what the risk position is."

RBS declined to comment.

Pedestrians walk past a branch of RBS in London. Photo: Bloomberg

Instead, the bank sells distressed properties to West Register, allowing RBS to avoid crystallising losses, since the assets remain on its group balance sheet. Several market sources have estimated West Register is about £1 billion in size.

A second source familiar with the matter said the FSA wanted to understand how and why some commercial property assets were moved into GRG and West Register, which holds many lower quality assets outside prime city business hubs, while others were not.

“West Register is not working very well -- they have severe capital costs restraints, and the FSA is not very happy with the whole concept," the second source said.

A spokesman for the FSA, which has stepped up its so-called “intrusive supervision" of the banking industry in the wake of the last credit crisis, declined to comment.

Bricks And Stones

RBS, once a small Scottish retail bank, staged a meteoric rise over two decades with an aggressive expansion into wholesale banking and commercial real estate that was brought to an ignominious end as the unfolding credit crisis sent property values plummeting in late 2007 and 2008.

The bank, now 83% state-owned, remains one of the most active in Britain in real estate as the global and UK commercial property markets teeter back from the brink after a recession in which commercial property prices plunged 45% and defaults surged on loans held by bailed-out banks such as RBS and Lloyds Banking Group.

Undaunted, RBS remains on the acquisition trail. It is close to seizing control of the UK’s Jarvis Hotels and in June took control of 42 Marriott hotels across Britain, appointing Ernst & Young receivers of the £1 billion asset.

Real estate prices have remained subdued, with a muted recovery in prices being led by prime-grade assets.

However, secondary-grade property -- on the fringes of and outside key business centres -- forms a substantial chunk of the assets on GRG’s books, and this remains the worst-hit and most volatile part of the commercial property market.

Reuters reported earlier this week that a £1.4 billion deal between RBS and Blackstone to rid the bank of some of its problem loans on secondary property portfolio “Project Isobel" could fall apart, robbing the industry of a template for similar transactions.