Keeping the property funding door open
The door to property finance may appear to have slammed shut but Simon Watson weighs up the options for navigating the new lending environment.
Six years ago, the world was a very different place. When you wanted to increase the gearing on your property portfolio or indeed dip your toe into the ever-increasing property market, rarely did you need to go further than the end of the high street: the top-tier banks were keen to get your business. Back then, 100 per cent funding, "hunting facilities" (to acquire unspecified assets) and limited covenants were the norm. Property finance was an open door and all were invited.
Roll on six years and that same door is firmly closed with new strict entrance requirements. An exit door has been created for those who find themselves in a "non-core" portfolio, and strong negotiation is now required to gain entry into and indeed stay in the building.
A changed landscape
Let's recap: the Global Financial Crisis, bank liquidity issues, property market correction, reduced appetite for property loans (and the creation of non-core property books), tighter lending criteria, banks attempt forceful exits of non-core customers through insolvency/enforcement, conduct issues become widespread and public, interest rate product mis-selling emerges, banks sell large swathes of non-core loans to private equity, new banks appear in the market, the same non-core banks rediscover some appetite for property and the underlying borrower is left bewildered, trying to figure out where they are and what they can do to secure finance for their business.
The property senior debt landscape has changed on so many levels. Borrowers are still trying to play by the old rules and traditionally their accountant has always been the first port of call for guidance on how to steer their way through the new lending environment. So what's changed?
The first major change concerns lending criteria. We now find ourselves back in a traditional lending environment similar to that experienced pre-2003. Generally speaking, loan to value (LTV) is now much lower than pre financial crisis levels; 60-70 per cent maximum (versus 80 per cent plus before the crisis) and finance offers depend on the type of property, tenant quality and appetite of the lending bank.
Appetite across the banks is much more selective. Banks are picking and choosing their favourite asset classes and adjusting LTVs and length of terms offered to suit. Interest-only is rare and appetite also shifts within regions as capital is focused on asset classes across the country.
Crucially, those who borrowed on new deals in 2006 to 2008 – often new entrants to commercial property and those borrowers who find themselves in non-core or private equity portfolios – cannot refinance without significant LTV improvement or new equity.
Senior debt holder strategy
The second significant change is senior debt holder strategy, be it bank or private equity fund. This is less predictable than it used to be, and its availability depends on whether the bank was subject to government intervention, what stage they are at in dealing with their non-core lending books and their investment horizon in the case of private equity debt purchasers.
We find ourselves in a curious position where some banks are refinancing other banks' non-core customers (even with their own sizeable non-core books); where they are offering 25-year commitments to new borrowers but managing existing non-core customers out over a one-year timeline (with the same type of property assets); and refinancing the same customers and assets they sold to private equity investors not 18 months before.
dd to this mix a range of new smaller bank entrants into the market (often foreign backed) with differing approaches and criteria as well as the rise of private equity loan books and you have a lending landscape that is radically different to that six years before and, so far, is in a state of constant change.
Private equity interest in the sector was a reaction to the need for liquidity immediately after the financial crisis. This has now morphed into a search for property exposure in a perceived undervalued asset class. It has become the exit route of choice for non-core portfolios for several banks following a period of heavy provisioning immediately post financial crisis. Rather than deal with a borrower within traditional models – distressed management and enforcement – it is becoming more efficient to assign the debt for a price to new entrants and exit completely.
New debt holders find themselves free from reputational/conduct risk and focus on a more commercial returns-based approach when dealing with borrowers – this can often be to the betterment of the underlying customer's position (debt forgiveness can be easier to achieve), but requires borrowers to change their approach and tactics.
Interest rate hedging products add a further dimension to the market as banks find themselves unable to formally enforce their positions due to FCA commitments – consensual workouts with remaining non-core customers are now the norm. Outcomes and offers of redress for mis-sold products are intertwined with future strategy and add a further variable in the equation that has to be managed.
It's no surprise that borrowers need help understanding where they sit in this new landscape, how best to navigate through it and, more importantly, how they secure a funding strategy that suits their business.
Borrowers can often be ill-prepared for this. They are unaware of the macro changes in the lending markets and they can't always clearly articulate their position to the senior debt holder or present a strong case for support and a new refinance.
Often without the "luxury" of a finance director, basic financial information can be missing, formal asset management plans can be incomplete and essential property documents are not readily available. These are now key foundations for any refinance or new assessment of their position by banks and, without them, the borrower is in a poor negotiating position.
The change in lending criteria and varying appetite across banks coupled with the evolving internal bank strategies gives rise to a property finance landscape that needs constant monitoring if a borrower is to get the best deal.
New environment, new approach
There are some basics that borrowers must get right before they approach banks or private equity debt holders in order to secure an exit or a new refinance.
It is important to have a clear, realistic strategy. What is the optimum debt strategy that matches the needs and timeline of the business and borrower? Only by understanding what banks and debt holders are looking for (and where they are in terms of their internal strategy) can borrowers achieve this.
By clearly articulating the current position of the business, the strategy and the risks, the borrower can have constructive discussions with incumbent banks paving the way for resolution of difficult legacy relationship issues and creating an exit. The same process also helps solvent businesses achieve a competitive refinance offer. Pre-empting and answering all likely questions from the banks in advance leaves no uncertainty on the table and improves the overall negotiating position of the borrower (whilst also establishing credibility). Banking is a risk business and borrowers need to consider and address those risks.
Recognising that emotion can play a central role in incumbent bank discussions, on both the borrower and bank side, is important, as is remembering that banks are commercial organisations seeking best return. Both should be central to any consideration of tactics and negotiation strategy.
Seldom do borrowers manage to engage all of the basics unless they have professional help. Going into the negotiation without that help can mean they end up leaving value on the table for the bank, whether the incumbent bank or the new funder.
The 'Holy Grail'
Debt forgiveness is very much the 'Holy Grail' in terms of a refinance or exit. All borrowers want it, and all think they can get it, but very few actually do. This is despite the fact that many advisers will claim that they can get it for them.
There is no "magic bullet" solution. Simply asking for debt forgiveness will not work, unless the demand is supported by a reasoned argument based on the fact that the bank's overall return from keeping the debt would be poor, or on the fact that any likely enforcement costs would be uneconomic. The banks are still commercial businesses, so any pitches for discounts must have a commercial rationale. Repeated requests for debt forgiveness are likely to result in a breakdown in momentum and can often sour any chance of meaningful agreement.
Many borrowers (and advisers) underestimate the difficulty in persuading a bank to write off a debt, especially if there is personal recourse through a partnership or personal guarantees. Even if it is granted, rarely do the borrowers consider the tax implications post-forgiveness, which can often create even bigger problems.
Lost in translation
The art of any successful negotiation is understanding the behaviours, context and strategy of your counterparty. Property finance is a specialism that borrowers usually dip in and out of, meaning that there is much lost in translation. Borrowers do not understand where banks are and fail to alter their approach and tactics to suit. What works with one bank will not work with another. What worked with the old bank will not work with the private equity debt holder, and borrowers need to keep pace with this change. Seeking specialist advice to assist with this process is essential in order to achieve an optimal outcome.