UK Property Lenders' Patience Is Going To Be Stretched, But It Won't Break

For the last decade or more, lenders have been forbearing in their approach to nonperforming property loans. Unless there are exceptional reasons to foreclose, they would rather wait patiently for values to rise than sell at a loss. 

Today, pressure on lenders is slight — even if their expectations of consumer debt problems in the future are high. There is also concern about the global repercussions of China’s looming debt crisis.

The bad news is that with inflation rising, and their own balance sheets under more pressure, that could change.

The good news is, that it probably isn’t going to be soon, thanks to new ways to hedge debt and a focus on equity.

Bisnow spoke to the experts, and their expectation was that lenders have no reason to act hastily.

Most Property Sectors Come With Lower Risks

James Bannister, head of special servicing at Mount Street Group, is vigilant, but not alarmed. “We are yet to see any evidence of stress across the loans managed by Mount Street, but are cognisant of the pressures facing borrowers,” Bannister said. Mount Street specialises in loan servicing, agency and security trustee services and surveillance for performing, subperforming and nonperforming commercial property loans.

“You cannot paint all property loans with the same brush. For investment loans the loan-to-value ratios in recent years have been significantly more conservative than what we experienced during the Great Financial Crash," he said.

Therefore, it is far less likely a lender will have major exposure and they should obtain a par recovery. So, this time round it is more of an equity issue than it is a lender issue, the issue being how much equity remains within the investment, which will dictate how hard the borrower/sponsor will work to retain that equity.

The story is less good for development finance. Profit margins of 20% are quickly eroded.

Bannister is keeping his eye on risk in the sectors most exposed to a collapse in consumer confidence — retail, hotel, leisure. With little prospect of further government intervention to support them, there is sure to be pain for investors and developers who gambled short on this sector. “The knock-on effect will inevitably be more distress and defaulting on loans,” Banninster said.

New Ways To Reduce The Dangers

The same generally upbeat view is taken by Georgia Contogoulas, director at real estate finance advisory and asset management platform BBS Capital.

“There is a credible argument that the rising cost of debt will push down asset prices as investors cannot access cheap debt to fuel their returns, thus impacting the value of existing mortgage collateral held by lenders," Contogoulas said. "Will lenders start asking themselves if this is now the time to look into property values and LTV covenant compliance? Perhaps not yet.” 

Downward pressure on property values and falling transaction volumes are widely publicised, Contogoulas said. But so are the dynamics of a real estate sector that is materially less leveraged than in previous downturns and the significant amount of equity capital still looking to deploy into real estate.

Hedging is also playing a part, thanks to a decade of diversification in sources of debt capital. “Pre-Great Financial Crash most real estate loans were hedged via swaps, almost always provided by the same institution as the underlying loan, effectively adding extra leverage to that lender’s exposure to the collateral," Contogoulas said.

"In the last few years, a significant portion is hedged via interest rate caps rather than via swaps. As caps are essentially an insurance product, once the premium has been paid by the borrower there is no impact on the collateral or the leverage calculation from the lender’s or borrower’s perspective.” 

The effect is to cushion the blow of an economic shock. “In previous periods of interest rate volatility, particularly when rates were moving downwards, the hedging aspect was an additional pressure on the bank lenders to act and try to limit their losses. But in the current environment, with a significant amount of lending being provided by lenders who are not under regulatory pressures to mark-to-market the value of their loan collateral, and hedging structures which allow borrowers to continue to service their debt, so we may find that there is less urgency from lenders to act, at least for the time being.”