P2P exhibits numerous shortcomings

Whilst the P2P model gained traction rapidly following the financial crisis, it exhibits a number of shortcomings.

Firstly, retail clients and investors are often simply driven by yield, not evaluating the risks sufficiently.

In some cases ‘mom and pop’ type investors are not sophisticated enough to analyse the risks, looking only at the headline rate of interest they believe they will receive.

Several P2P platforms also do not provide sufficient information to their investors for them to make a proper assessment of each individual loan, even should the investor be qualified enough to do so.

This information asymmetry between P2P platform and investor is easy to understand from a GDPR perspective, but it does make the investor very dependent on the assessment that has been made by the platform.

A key concern is that many P2P platforms position themselves as an intermediary, but then, unlike any other type of lender, they do not invest themselves into their own loans.

This can cause a lack of alignment with the retail investors and means that the platform risks comparatively little in relation to the investor.

Arguably it also means that some P2P platforms have less incentive to ensure that each loan is underwritten as diligently as it might otherwise be if the platform or lender had its own money involved.

The loan may also be managed less prudently as a result, this is clearly not the case with every P2P platform, but the failure of Lendy does highlight the shortcomings of this model.

With many P2P platforms competing for the same retail investors, the platforms often pursue the highest yield deals, which tend to be the riskier loans.

Lendy is a good example of this, but naive investors may well be oblivious to the fact that this is why they are promised the higher returns.

Finally, a number of P2P platforms also provide access to institutional investors at preferred terms. The question is, what downside such “preferred nation status” deals could cause for the retail investors.

There are obviously a number of high-quality P2P platforms out there, and the demise of Lendy has somewhat unfairly tarnished the image of this entire sector.

However, it is questionable whether a number of the P2P platforms can get to the necessary scale to operate profitably and to play a meaningful role in the lending landscape.

One could expect many sub-scale P2P platforms to have challenges and we expect further P2P lenders to disappear both this and next year.

Financing UK development projects through Spanish holiday homes

Many developers who need additional finance to help fund new development projects have substantial equity tied up in Spanish holiday homes, but cannot take advantage of it as it is nearly impossible to get leverage against such assets from Spanish banks.

Very often the developer needs the money for a specific project in the UK for no more than three years, but the amount they can borrow or raise from property in the UK is insufficient to finance the entire project. While developers could raise mezzanine debt or preferred equity, the cost of such debt is often prohibitively expensive.

Borrowing against Spanish holiday homes

However, many UK developers own Spanish holiday homes, frequently at the top end of the market. As Spanish real estate prices have recovered, a lot of equity can be tied up in such properties. Spanish banks find it difficult to lend against them for two reasons: first, they do not have access to the credit profile of the UK owner, and second, as the owner has no regular income in Spain, other than occasional rent from their home, the Spanish banks would categorise such a loan as a commercial one. At the moment, Spanish banks are still reducing their commercial loan books, therefore, they are not eager to grant such loans. 

However, there is a solution. A small number of UK bridging lenders now offer loans against Spanish holiday homes. Typically with LTVs up to 50% of the RICS valuation and interest rates at levels similar to those in the UK bridging market at around 0.8% per month and a loan term of up to three years.  

Multiple drawdowns and repayments are often available, reducing the overall financing cost to the borrower as such facilities allow the borrower to ‘right size’ the loan amount at any moment in time. 

Personal guarantees are typically not required, although the lender will usually look for a corporate guarantee from the UK company using the funds for the development.  

The loan is secured by a mortgage taken in front of a Spanish notary and, in many cases, by a share pledge over the shares of the Spanish company holding the property. As the property is in the eurozone, the loan will typically be in euros.

A great advantage of the Spanish market is that conveyancing is much more straightforward and quicker than in the UK. A look at the ‘nota simple’ will give immediate insight into the land registry and planning status of the property.  

One challenge can be to get the valuation done rapidly, but when working with the right local valuers, it usually takes no longer than two weeks. If the borrower is efficient in providing all requested information, time from application to drawdown does not need to exceed three weeks.

Structuring aspects and foreign exchange

The loan can be granted directly to the Spanish company with a back-to-back loan to the UK development company, but can also be granted directly to the UK company.  

The advantage for UK borrowers who extract equity from their Spanish real estate is that the pound sterling is currently undervalued against the euro. This means a euro loan over Spanish property yields a larger amount of sterling than it would have done perhaps three years ago. Assuming sterling strengthens again in the coming years, the amount needed to pay off the loan could be less than the amount extracted today. Of course, for borrowers who do not want to take a foreign exchange risk, there are a large number of inexpensive foreign exchange hedging instruments available.

From my personal experience, I have been surprised by how many UK developers own holiday homes in Spain, and demand for the solution described above has been very strong.

Funding lines: The risk of excessive risk parameter harmonisation

Many bridging lenders are financed by a funding line provided by a bank or specialist debt fund.

Typically, these funding line providers will finance between 70–90% of the loan, with the remainder being financed by the equity of the bridging lender or through a junior funder.

While most bridging lenders use such funding lines, some are financed on a different basis. An alternative funding route is the P2P model, very popular a few years ago, but maybe less so today. The greatest risk with this is regarding investors’ money, rather than for the lender, which has increased FCA scrutinisation and the recent confirmation of new rules for P2P platforms.

Another alternative funding model is direct institutional funding, such as pension funds and institutional investors taking a direct stake in the loan book, but as there is no fixed template for this model, it takes longer to set up. Finally, there is the route of securitisation, but for such structures to be efficient, a large loan book is required. 

For that reason, many bridging and alternative lenders go for the traditional funding line model. There are many providers, it is a well-known template and it allows new bridging lenders to get out of the starting blocks easily. The problem is the funding lines are all quite similar in what they can offer, which restricts the options available to the borrower. 

In fact, many banks and credit funds have been attracted by the healthy returns of such funding lines and have been eager to find more interested bridging lenders.

The providers of the funding lines typically impose restrictions on the type of loans — for instance, the type of real estate, the loan term, loan size etc — that can be funded with the funding line and impose further risk parameters on the overall loan book. This is normal, after all, they are exposed to the risk of the loan book. Where the losses on the loan book exceed the equity buffer provided by the bridging lender, the provider of the funding line can start losing money.

Some restrictions stipulate that the lender has to buy back the loan after a period of time, say 90 days. In this case, the risk is greater for lender than for the supplier of the funding line. These restrictions mean the lender would need sufficient capital to be able to buy back the loan while continuing to support its business, as well as a robust internal process on the underwriting and servicing side.

Such risk management techniques become somewhat self-defeating, though, if all funding line providers impose similar risk parameters, creating a particular segment. This results in more money chasing bridging loans than the natural market demands in this segment, leading to an erosion of LTVs and interest rates. 

We believe that this is what we are currently witnessing in the UK market. Risk-return characteristics for bridging loans substantially improve when one moves outside of the segment that is backed by funding lines.

Where does the name ‘Fiduciam’ come from?

 ‘Fiduciam’ is Latin for “mortgagee” and the accusative singular of fiducia, which has as its root fido, which means “I trust/I rely upon”. 

Fiducia cum creditore (which should not be confused with fiducia cum amico) was one of the earliest types of Roman mortgage, in essence the property would have been transferred to by the borrower to the lender on trust as security in order to demonstrate good faith (bona fides). Today we might use the term bona fide to mean “genuine”, however a more technical translation might be “reliable/reliability”. 

The fiducia cum creditore created a system of mutual trust between borrower and lender because: 

  • under the pactum fiduciae the lender agreed to return the property when the debt was satisfied; 
  • the lender had possession of the property, their ownership of which would be perfected if the loan was not repaid; and 
  • there was a further clause requiring the sale of the property in the event of default from which the lender, as trustee, would deduct the debt from the proceeds of sale, so that the lender would not be able to keep property with a value of more than the debt owed. 

For this to work there had to be a trustworthy borrower and a trustworthy lender. 

So successful was fiducia cum creditore that despite the advent of pignus (a “pledge”) it not only survived until the late Roman Empire, but it has more or less survived into the modern Dutch law, as bewind, and German law, as treuhand, and in 2007 fiducie was reintroduced into the French Civil Code in a form which require the property to be held by an independent trustee; Fiduciam sometimes uses fiducie when lending against security in France . 

This concept of fides or “trustworthiness”, “faithfulness”, “confidence” (which itself derives from the Latin for “with faith/faithfulness”), “reliability” or “credibility”, was so essential to Roman law that it became a principle virtue of the Roman moral code (the mos maiorum/“ancestral custom”) and deified into a goddess with a temple on the Capitoline Hill, near the Temple of Jupiter right in the spiritual centre of the ancient city between the Forum and the Field of Mars. Fiduciam seeks to embed this virtue right at the very core of who we are and what we do, right in the DNA of the company. A reliable borrower will always find in us a reliable lender with whom they can deal with consistently from one transaction to the next. 

The growing need for part development funding

There appears to be a growing trend of borrowers looking to refinance a development before it is completed.

This could be due to multiple reasons – the current facility is expiring and the lender does not want to carry on; there have been cost overruns which the lender is unwilling or unable to fund, or because the borrower is looking for a discounted interest rate.

Developments can be challenging even under the best of circumstances, and a ground up development carries a different set of risks to refurbishment or conversion works, while new build extensions are slightly different again. Even the best planned development undertaken by the most experienced of developers can experience issues.

On refurbishments or conversions, there can be issues with the building, including underpinning requirements, asbestos, or structural issues with the property.

On ground up developments, there is ‘in-ground’ risk including potential contamination on brownfield sites – while all developments can suffer from the need to increase specifications on developments.

Issues with developments such as these, can result in cost overruns associated with the build and also cost overruns from time delays.  Time delays can become a real issue when they extend beyond the term of the loan with the developer still building when the loan term runs out.

From a lender perspective, it is important to make sure the developer has the extra time needed to complete their development as this presents the best opportunity for a successful outcome for both the borrower and the lender.

Despite this, some lenders are unable to roll, or extend, their development loans, or may be unwilling to do so.

Across the market there is anecdotal evidence that some credit lines are tightening.  Sometimes therefore, the best solution for a borrower can be to refinance the part-complete development with a new lender.

Lenders such as Fiduciam are happy to lend on part-complete developments, and we have on multiple occasions provided funding for this type of scheme both in the UK and abroad.

However, it is important the developer can show that the works to date are in good shape and that they have the ability to complete the remaining works.

If a developer wants to take this route, the new lender will want to check that the development works to date are compliant, with both planning permission and building regulations.

If you have a client in the situation of refinancing a part-built development therefore, it is wise to advise them to have a building surveyor and their architect ready to provide this evidence.

Often, a new lender will be happy to take this advice from the current lender’s monitoring surveyor.

The role of brokers has arguably never been more important than it is currently, in understanding who the savvy lenders are: which are the ones that truly understand what is involved in a development and have the financial strength to support the borrower.

While rate is important, what is more so is for a borrower to be with a flexible lender who understands the risks, can help a borrower to complete a development if they hit difficulties and who is flexible enough to ensure that they have a loan term that really is long enough for a project to be completed, no matter what unforeseen events may befall.