News from the Coalface

Firstly, a happy, healthy & prosperous 2021 to you! As in 2020, I hope to continue sharing valuable content with you throughout 2021. Now, more than ever, we need to work together to pull through to the light at the end of this dark Covid-19 tunnel.

Now, in case you’re one of those readers who gets their news by just reading the headlines & sub-headings (tut! tut!), the short answer is yes, lenders are still lending. Thought I should answer this immediately just to avoid a panic! The devil however, is very much in the detail so do read on.

A large part of my clients are SME property developers, those doing small conversions and building/converting up to 10 or 15 units. I do act for a few larger developers but I have an affinity for SME businesses. The work I do for my clients starts from commenting and tweaking the first draft of their offer letters or Heads of Terms, all the way through to completion of build/construction and onward sale or refinance of the developed site. I am even asked to consult on the planning side - negotiating S. 106 agreements or assisting with planning appeals.

A big part of what I do to help my clients is finance - primarily secured lending from property finance lenders. This will include finance to acquire the site, development finance to build out the site and exit on to term finance, either with the same lender or more commonly, with another lender. In property, as in most types of businesses, it is a lifeblood that allows businesses to grow.

Shifting Sands

In the past 9 to 12 months, perhaps even as far back as 18 months, I have noticed a change with finance lenders, particularly their credit underwriting function and in their legal processes. I thought I should update you with what I’m witnessing in the coalface, to help you prepare, especially if you are looking at a finance related transaction some time this year or onwards.

Arduous Credit Underwriting

Whilst I have brokered private finance from High Net Worth Individuals & SSAS pension funds, I do not broker finance from mainstream lenders so my experience of credit underwriting is based on my conversations with my clients’ finance brokers and feedback directly from my clients on what they are experiencing. I am frequently asked by my HNWIs & SSAS trustees to consult during their underwriting stage, drawing from my own property investing & trading experience. So I have some first hand underwriting comparative experience. There is a marked difference in approach.

There are certainly heightened requirements by the underwriting teams at financial institutions. In addition, they have also become much more stringent and rigid in their requirements. There are a great deal more hoops to jump through and the ‘computer says no’ is something my clients frequently encounter. 

Most of this is not surprising in the aftermath of the Mortgage Market Review and the move to more prudent underwriting following 2008/9 but it has made a number of my clients wonder whether the lenders actually still want to lend. Some of the main issues my clients have experienced include:

• Delays with valuations

• Down valuations

• Delays with monitoring surveyor’s report

• Duplication of requests for credit related information

• Very detailed and in-depth review of source of funds & whether there is any element of debt associated with these funds (for e.g. use of Bounce Back Loans or intra-company loans to fund the equity in a deal or even SSAS loan backed by a floating charge)

Now, there is nothing overtly wrong with any of the above. In fact, arguably, it is better for finance lenders to be diligent and thus prudent. However, when property deals have time pressure, either due to the seller’s circumstances or the presence of multiple interested buyers or the deal is heavily discounted but only for a quick sale, these delays could mean the deal falls through or you incur late completion penalties. More likely, it is a combination of these factors. The additional hoops the developer must jump through to secure terms from these finance lenders causes a lot of friction on the deal. I have personally seen such delays jeopardise quite a few deals, many of which my clients and I have had to salvage pretty much by the skin of our teeth.

For one of my clients - a 50/50 joint venture between a local (meaning England based) experienced property developer and a newly arrived resident (meaning ordinarily resident in India but now permanently resident in England), there were a whole host of issues. The former Indian resident is a seasoned developer but all his developments - mainly large, automated warehouses for the likes of Amazon - were all in India. Here are just some of the issues my client faced:

• Detailed source of funds for the local developer. As a 3rd generation developer, one who had usually developed with his family, digging out years worth of financial statements on deals completed and sold/refinanced and his share in these deals just to prove his source of funds was arduous to say the least

• The former Indian resident developer had no income in England so had to produce accounts from his companies in India, translated where necessary, along with evidence of remittance of these funds to England

• A bounce back loan had been raised by the borrower company to fund the purchase of another development site but although wholly unconnected with the property that was being offered as security to the lender, the lender went to some length asking the borrower to prove the BBL funds would not be used on the property that the lender was funding. Sounds easy enough, except that the other development site was still being negotiated and the purchase was no where near completion so how do you prove that the BBL funds would be ring-fenced in that way? (As a side point, the mantra of only having 1 development site in a SPV limited company rings true - my client should have borrowed the Bounce Back Loan through another SPV limited company, that will purchase the other development site.)

Legal Friction

One of my personal bugbears at the start of the legal process, once a borrower has cleared underwriting and a term sheet has been issued, is the request for security for the lender’s legal fees, payable whether or not the loan is completed. Legal fees of about £3,500 - 5,000.00 + VAT is now common (a marked increase from about £1,500 - 2,000.00 + VAT a mere 12 - 18 months or so ago). 

Apart from the eye wateringly high legal fees, which in itself makes a borrower question whether lender finance is the best way to proceed (more on this later), the position that most lenders and their lawyers take - namely that they won’t even issue the final facility offer letter and security documentation until security for their legal costs has been provided and their lawyers have completed the full legal due diligence - has made me question the process. There remains the real risk that the lender’s lawyers may not sign off on the legals to the lender, thus frustrating completion of the loan but more importantly, they may ask for a whole plethora of conditions precedent to be satisfied that could, at best delay completion of the loan or at worst, lose the property deal altogether because matters have taken too long. So potentially, apart from wasted valuation and arrangement fees, there could be wasted legal fees. This is a huge consideration on whether this level of outlay is worth it for this type of finance.

To increase profitability and streamline the volume of cases, most of these files are handled by paralegals or junior lawyers who are tasked with adherence to a strict set of requirements and procedures. There is little room to maneuver and thus I have repeatedly experienced a ‘computer says no’ situation, despite the requirements being nonsensical to the property or the deal in hand. 

One example is insisting that the local authority search includes the additional enquiries relating to Houses in Multiple Occupation licensing when the property is a vacant former assembly/community hall. For another client, it was the lender’s lawyer’s insistence on an asbestos survey despite the fact that the transaction was a refinance (coming off the first bridge) and my client had already stripped out the property ready for conversion. I saved the best for last - the example that takes the biscuit is a lender’s lawyer asking for a fire risk assessment when the property being offered as security was vacant land!

Having run my own high volume conveyancing law firm several years ago, I fully understand the need to streamline processes and allocate the lowest skilled/qualified person to the matter in order to maximise profitability on each file. However, when considered against the backdrop of a tripling of legal fees in a mere 18 months, it does beggar belief. This absolute adherence to process and requirements by a junior lawyer without the depth of knowledge and experience to think laterally has frequently caused friction in satisfying the lender’s legal requirements.

One explanation for this shift - to process driven due diligence, higher legal fees and exacting requirements is the lender and their lawyer’s perception of the increased risks inherent in property development projects. We have all read or witnessed and for some of us, personally experienced losses arising from failed development projects - either directly or indirectly by investing in them. Some high profile, crowdfunded projects have failed to deliver (which I have written about in the past). Against this backdrop, the lender’s and their lawyers are, unsurprisingly, right to be cautious. However, behavioural economics will tell you that the pendulum can sometimes swing too far in the opposite direction, especially when coupled with herd mentality, in the guise of a corrective prudence. In my view, it very much has and we need some form of equilibrium if developers are to continue working with finance lenders.

Alcatraz Level Security

The amount of security that a finance lender now requires on such loans is a concern. A first legal charge, with a debenture and personal guarantee are to be expected, especially if the borrower/purchaser company is a newly formed SPV limited company and thus has no real value. There are however 2 particular issues I want to share with you on this point.

The first is the range of the security. So if a first legal charge, debenture and personal guarantee are to be expected, the need for a share charge, i.e. a charge on the entire shareholding owned by the shareholders in the borrower company along with a deferment of any loan funds introduced into the company is, in my view, overzealous. This is especially so where there is a low LTV. The lender is in effect taking more than 100% security compared to the amount of their loan.

By way of example, let’s say the purchase price is £500,000.00 and the lender is lending £225,000.00, so about 45% LTV. The shareholders have loaned the balance £275,000.00 + acquisition costs to the borrower company. The lender takes a first legal charge on the property, a debenture over the assets of the company (so already ramping up their security onto the equity slice) along with a personal guarantee by the directors (more on this below). In addition, the lender wants a charge over the shareholders’ shares in the borrower company and a deed of subordination of the shareholders’ loan to the borrower company so that the lender’s interest ranks first in terms of security. The share charge in effect means the lender has taken security over the equity slice. Now, in effect, the lender is made the first in the creditors queue if things go pear-shaped. The shareholders’ equity is thus heavily relegated.

Second, is the level or depth of cover. I find it is increasingly uncommon for there to be any cap on the exposure. Where in the past I used to see limits of exposure/security in the debentures or personal guarantees, these have become uncapped. A personal guarantor could thus be on the hook, individually or jointly, for the entire loan amount along with associated interest, costs & expenses. 

A cap on the exposure, especially on the personal guarantee should always be requested. Never accept a flat ‘no’ from the lender. Always negotiate, ask what else they need in order to agree to limit the exposure. This should be done during the application/underwriting stage so as to avoid delays during the legal process.

The Hoopla of Hoops

The number of pre-completion requirements that most lender’s lawyers now request have also increased. It used to be limited to title information, searches, replies to enquiries, pre-completion searches and signed security documents (which could be held by the borrower’s solicitor). Now, personal guarantees must be signed in the presence of an independent solicitor (which given prevailing social distancing measures makes this difficult), other security documents must be witnessed by the acting solicitor, various company formalities - including board resolutions & minutes approving the entering into the loan documentation (known as corporate ancillaries) and all original signed security documents and corporate ancillaries must be held by the lender’s lawyers before they will even submit their report on title to the lender. It is only after that, that the lender decides finally whether they will lend!

In a recent transaction I was involved in, one of the senior lawyers in the lender’s legal team said to me “Tariq, it’s all a bit of nonsense, but we need to be seen to be doing our part.” That team of lawyers went on to charge my client about £50,000.00 + VAT in fees on a loan of about £4M, (including development finance)! The spike in fees was sprung on my client 2 days before the deal was about to be lost with the seller. My client was livid but had to lick their wounds and accept.

So, are the banks still lending?

A couple of my clients have commented:

“We’re getting the feeling they don’t actually want to lend to us and just raising more and more issues to put us off.”

“Absolutely horrible experience and we will never use them ever again” - indicating both that specific lender but also this type of finance more generally.

“This is why developers we know much prefer working with private lenders/HNWI/SSAS funds”.

In conclusion, yes they are but there is definitely a disconnect between what their marketing teams are telling brokers and prospective borrowers, and the reality of their credit underwriting and legal processes. It is difficult to access these funds - great expense must be incurred and much hassle must be endured. I would go as far as saying, do not exchange contract and agree to a fixed completion date until you’ve got the legal side of your lender finance fully signed off. Otherwise, you run the risk of missing your fixed completion date and incurring penalties or worse, losing your deposit and facing a compensation claim.

What has been your experience? I would love to hear your thoughts. Comment below or Get In Touch