Lessons learnt in lending

02 Aug 2019

Will Scoular

Investec Structured Property Finance

We may argue about when or why, but we can all agree that property values fall as well as rise. We are now 11 years on from the Global Financial Crisis with all the real estate world’s key markets having seen structural corrections in value.

Retail and central London residential have shown significant declines, whilst offices and logistics are trading at record capital values highs.
 
Lessons have been learnt. Lending banks have implemented safeguard polices to protect against a market crash. The entire culture of lending has changed as much as risk appetites. Today a Senior debt loan is unlikely to exceed 50- 60% loan to value as opposed to 2007 when 85% wasn’t unusual.
 
However, there is no room for complacency. This was highlighted by former Hermes chief Rupert Clarke in a report he published last year. He showed that that the losses from over-lending on commercial real estate at the end of a cycle traditionally wiped out all banking profits from the previous boom years.
 
So, with some warning lights flashing red in property, how are we at Investec Structured Property Finance approaching lending towards the end of the cycle?
 
Our stance is informed from experience within our own bank, where after the Global Financial Crisis we took a long-term view and, as far as possible, worked with our clients to optimise the recovery of the equity and debt. Here then, is my 10-point checklist for lending in uncertain times:
 
1. The client/lender relationship is crucial. There was heavy and justified criticism of banks who took a short-term view ten years ago, pulling the plug on borrowers at the first sign of trouble. It is much better to roll with the punches and work in concert on the business plan to recover debt and equity. We look for clients with a proven track record, sufficient capital to meet their obligations, and integrity. Borrowers should be looking for exactly the same attributes in their relationship bank.
 
2. Don’t lend money if the debt ultimately can’t be serviced. Non-income producing assets such as strategic land with a planning upside often take far longer to unlock than original business plans envisage. The borrower in this instance needs to be well capitalised and prepared for the long haul. By contrast, well diversified income which is repeatable if short term, delivers a revenue stream that can weather a down turn. At Investec, we are increasingly looking to alternative markets where diverse repeatable income can be relied upon. These include student housing and build-to-rent as well as more traditional multi-let offices and industrial.
Don’t believe in “new paradigms” or people saying “it’s different this time”. 
3. Don’t allow a bull market to force loan to value ratios higher than prudent, squeezing margins below sensible risk weighted returns. Simply put, it is better to have the courage to step back from providing a loan than book building.
 
4. If the market crashes and levels of defaults rise, it is vital to establish a “legacy team”. This moves the relationship away from the origination team so objectivity can be maintained. Populate the legacy team with a combination of skills, working on the mantra of “know what you know, know what you don’t know and know
who to ask”. Don’t be afraid to employ from outside the bank to augment the required skills – building surveyors, general practise surveyors, lawyers and accountants bring invaluable additional knowledge.
 
5. Check that the bank’s security against an asset is what you think it is, and remedy any identified defects.
 

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6. Put in place a business plan or capital repayment strategy, working as closely as possible with the borrower in order to recast the business plan to reflect current circumstances. This is best achieved by breaking the plan into attainable  milestones: we were greatly influenced by a lecture from mountaineer Joe Simpson on his book ‘Touching the Void’, telling how he lifted himself out of a crevasse after falling in the Peruvian Andes, and managed to crawl five miles with a broken leg by setting himself small but achievable goals.
 
7. There really is no substitute for a good location: you can do many things to ease a problem loan, but you can’t move the asset.
 
8. Don’t believe in “new paradigms” or people saying “it’s different this time”. The fundamentals of property lending in the UK rarely change.
 
9. Banks must think of lending money as investing their own money at a lower risk return than is applied to the client’s equity. However, there always is a risk and that risk should be priced correctly taking all factors into account.
 
10. Without clients, banks don’t have a business – treating your client fairly not because the regulators tell you that you must, but because it is the right thing to do has to be the best approach. As one of my former senior South African colleagues likes to say: “Always do the right thing, even if you think no one else is looking.”
 
The true test of relationship banking is when the chips are
down. A good relationship is a two-way thing and prospective borrowers when obtaining funding quotes would be well served by considering the culture of the bank from which they borrow as much as the percentage on the interest rate.
 
This article originally appeared in EG Magazine.