Category: Blog

The phrase ‘know your customer’ (KYC) is bandied about across many industries, but in the financial world it is mostly used in terms of identity verification and money laundering.  However, knowing your customer is important for other reasons.

From a lender’s point of view it is much easier to make decisions if we can really get to know our customers, understand their needs and work together for our mutual benefit.  However, with many of life’s necessities available at the click of a button it appears that relationships between providers and their clients are becoming a rarer and rarer. At Fiduciam we believe there is little substitute to knowing our borrowers well and understanding their businesses. Our relationships with our clients and their agents are what make us stand out from the crowd and are a major factor in the amount of repeat business we enjoy. Fostering long term relationships is therefore at the heart of our business, which is ultimately about helping our clients grow theirs.

Over the last few years, we’ve assisted a number of developers to organically upscale their businesses.   From a credit risk perspective, we like to see repeat borrowers build a niche of projects and experience. Those who know their market and seek to expand on it.

Growth can come from gradually upscaling the projects taken on and carefully building the capital required to invest as equity.  However, as a lender we can also work with developers to accelerate this cycle and increase the number of projects undertaken.

In one recent transaction we helped a client who had originally come to us several years ago for a £200k development loan.  Since then he has continued to expand his business, working on bigger projects that require different types of funding.  We recently completed a £1.6m loan for a permitted development facility in South London with this client using our ‘Stepping Stone’ loan.

Having just completed a scheme, but not yet sold the available units, he was ready to start a new project.  However, without the sale of units he didn’t have the funds to move on.  Knowing this client, and his development capabilities, over a period of years meant we were confident in his business and wanted to ensure he was able to move forward and continue to grow.

Using the ‘Stepping Stone’ development loan we enabled the borrower to transfer equity from the recently completed development to his new project without the need to wait for sales. This meant the new project could start earlier, and the developer would be able to take on more projects.  The borrower therefore grows by simply using the same capital more efficiently.

As COVID-19 slows the sale of completed projects it is also likely to generate attractive opportunities to purchase new sites.  The ‘Stepping Stone’ development loan ability to transfer equity from one project to the next is something that could keep projects flowing more easily. Importantly, it starts with really getting to know our customers.  That way we are not only providing creative borrowing solutions and mitigating credit risk, but we are helping businesses to grow and cycle forward.

It goes without saying that the Covid-19 pandemic has caused significant upheaval in the lending markets, with many lenders impacted in terms of their ability to lend, particularly bridging lenders, many of which pulled out of the market for a period of time, but in the medium term the bridging market is likely to do well due to Covid-19.   

In the immediate term, we have seen disruption due to some lenders being unable to lend or their funding appetites changing due to the uncertain risks during this time. 

During the lockdown, new valuations have been difficult to obtain and solicitors’ response times have slowed, while some small solicitor firms appear to have shut down, all creating issues for lenders.  So funding right now is difficult and likely to be for the immediate future whilst the country gets moving again.

In the economy in general over the short term, it appears we are looking at a contraction which has not been seen in the UK for centuries.  The reduction in economic activity has already been compared to the Great Frost of 1709, and the bursting of the South Sea Company Bubble in 1720. 

I believe that the recession is likely to be a “V” shape contraction, with a sharp increase in economic output once business gets back up and running.  However, the right-hand side of the “V” i.e. the recovery, will probably be lower than the left-hand side – we are yet to see by how much.

Not all areas of the economy are impacted equally due to Covid-19.  For example, whilst the hospitality industry is being devastated, supermarkets have seen an increase in sales.  So what property will make for good lending security in the medium term? 

Take the classic bridging for refurbishment in order to let out a property.  I think that demand for this product may fall in some of the larger cities, such as London, as a number of holiday lets come back onto the market as standard rentals (due to a reduction in tourism requiring fewer holiday lets) – which will in turn reduce the housing shortage. 

In general, areas relying on large numbers of foreign tourists are likely to suffer the worst so we could see a sustained impact for example, if social distancing is required long term in bars, clubs, restaurants, theatres, a lot of these businesses will fail. 

On the other hand, domestic tourism is likely to rise when the government allows people to travel in Britain, so hotels focussed on the domestic market will probably outperform overall, particularly in British holiday resorts. 

Where I see more demand for bridging is where businesses require funding to fit the new demand – for example hospitality businesses serving domestic tourism i.e. cafes, pubs, hotels in UK resort towns.  Banks generally aren’t keen to support new businesses, so bridging finance is likely to be key here.  Towns serving domestic tourism are also likely to buck the trend and see an increase in refurbishments as people convert houses to holiday lets to accommodate the additional demand in these areas.

Refurbishment for longer term lets may rise in the medium term as prospective homeowners find it harder to buy now so rent for longer. Residential property in general should hold up better than some other property classes, but not all residential is the same.  Affordable residential in higher-employment areas is likely to outperform other residential.  An exception to this potentially, is London prime and super-prime; my view is this was under-priced from an international perspective prior to Covid-19, so this micro-market might hold up well.

Good security for bridging loans in the medium term are supermarket and minimarket retail with good tenant covenants.  This subset of retail is currently performing well, with the larger players reporting increases in sales.  

Industrial and distribution businesses are also likely to perform well, particularly as retail declines. Particularly those business with modern, good quality properties and well located.

Amongst the most difficult property types is general retail.  Retail has been on the decline for years, and Covid-19 will make this worse.  A combination of internet sales and high rents and business rates will continue to squeeze retailers and we will see a lot more vacancies in our local high streets. 

In the short and medium term, I think bridging lenders will see more enquiries.  I suspect some banks will look to leave some sectors, and so businesses will need to refinance their loans, and bridging lenders are likely to fit those gaps nicely. 

The key issue for these businesses is that banks might be concerned because of poor business performance, so understanding that poor performance is short term only is important.  In these instances, introducers could ensure that borrowers have a workable plan in place to improve business performance, so they can go back to the banks once the market improves.

Overall, as and when the banks won’t lend to businesses and developers, it is the bridging lenders which step in to help.

Fiduciam has started 2020 with a substantial increase in new Irish bridging loan business, both north and south of the border, and is bullish about the prospects for rest of the year. 

It aims to lend €50 million in Ireland this year, an increase on its original projection and building on the strength of its Irish bridging loan offering.  Fiduciam will also start offering Irish development loans and be opening a Belfast office.  The company has already hired a new Irish case manager to help with the increase in enquiries. 

Overall, the Irish property market has been improving with property price rises seen in the main centres. This is now spreading to commuter towns and some of the key county towns throughout Ireland. Northern Ireland, which is in a unique economic and political situation, should benefit significantly from Brexit and is likely to continue to perform well over the next couple of years.

Although the main banks in Ireland are still negotiating debt settlements with borrowers, Fiduciam has been proactive in providing exit solutions for many of the thousands of borrowers left in debt following the financial crisis.

Fiduciam began lending in Ireland in early 2017 and to date has loaned a total of €72,244,088 in the Republic and Northern Ireland, across residential property, hotels, farms, care homes and other commercial enterprises.

Kenneth Duffy, country manager for Ireland, says: “From an Irish perspective, the past three years have been incredibly challenging. The country has navigated Brexit and is now dealing with an outbreak of the Coronavirus. Throughout all the economic uncertainty, Fiduciam has remained fully committed to the Irish bridging loan market. Fiduciam’s investment in Ireland continues into 2020, our team is growing, we are introducing Irish development loans as part of our offering, and we are opening a Belfast office.

“Our commitment has paid off thus far, our market share has increased year on year and we fully expect this will continue into 2020, when Coronavirus has run its course”.

I recently found myself staying in a provincial budget hotel which, given the number of bugs flying around, was an experience I prefer not to repeat. I have encountered many cheap (and nasty) hotels on my travels and, especially as I hate spending money on accommodation, it upsets me that I continue to encounter them. The rise of Airbnb and other internet-based operators, that are offering rooms in private houses, means that lower starred establishments such as these are facing a new risk. Often private accommodation is superior and, as a result, some hotels are closing down and being converted to residential properties.

According to PwC research, hotel revenue per available room (RevPAR) is expected to rise slightly in 2020, but it is likely that much of the increase will come from hotels with better standards of accommodation. “Flying bug” hotels are unlikely to see an increase in revenues and will continue to lose market share to higher quality hotels and the likes of Airbnb.

One way to prevent this deterioration is for the hotelier to spend money to upgrade, to look at the hotel as a whole and assess how best to improve. Can they alter the configuration, increase room numbers and improve the overall standard of the hotel? If so, they can potentially increase revenue as well as the value of the hotel. The first step is design, then, assuming planning permission is obtained, funding needs to be put place to finance the works.

There are a large number of lenders who like to lend on hotels (although I have seen evidence some are leaving this market), and a sizeable number that are happy to lend on development works. However, the number of lenders willing to lend on ‘hotel developments’ is relatively few, particularly if the hotel continues to trade during the works. Fiduciam is a lender willing to provide hotel refurbishment loans to hotels operating during upgrades but, as a prudent lender, we also like to know that the works are properly managed and the risks associated with the works are mitigated.

Borrowers should engage with their lender at an early stage and this is when a lender can add real value. For example, we have in the past worked with architects, planning consultants, contractors and even have fire engineer contacts and have a suite of professionals who have worked successfully on previous hotel developments. Whilst we, unfortunately, can never make recommendations to our clients, we are happy to put them in touch with people we have worked with before, and provide suggestions on how a transaction may be structured and works undertaken to best suit the hotel owner.

For hotel owners that know it’s time to upgrade the most important step is getting a hotel refurbishment loan in place. Find a lender, like Fiduciam, that will work with them to engage with professionals, plan the hotel upgrade and fund the works through to completion. At the end of this, the owner should have a better hotel, with more stable revenue and they can share in some of the expected RevPAR growth that PwC is forecasting for 2020.

Here at Fiduciam, we lend on care home assets when the underlying business model is strong, where experienced management is in place, but often due to special situations high street banks have vacated the playing field. Often these SMEs find it difficult to finance their expansion or are abandoned in times of short-term operational or financial difficulties, even though the issues faced by the business are generally resolvable in the medium-term. Fiduciam will take the time to analyse the business plan to determine how an expansion can best be financed.  Equally Fiduciam will take the time to understand any underlying issues and endeavour to provide the business the short-term liquidity required to bridge their way back to sustained growth.  Put simply, through our short-term finance, experienced entrepreneurs are able to grow and protect the equity which they often have built up over many years.

For example, Fiduciam was approached to refinance a loan a family-owned care home group had with a high street lender which was seeking to foreclose the loan despite the business still being in profit. A 24-month bridging loan from Fiduciam allowed the care home group to rectify their issues with the Care Quality Commission (CQC), improve their profitability and then, in fact, re-finance with a bank at lower interest rate after only c. 12 months. If the previous high street lender had proceeded to sale by administrators, the principals would have lost c. £8m in equity built up over twenty years of trading. Furthermore, by keeping the care homes operating, numerous jobs were saved and much-needed patient beds maintained. 

Fiduciam also provides care home bridging loans in other situations where high street banks have limited appetite. Our team will work with borrowers who are expanding an existing care home or seeking to establish or acquire a business.  Individuals experienced at operating care homes can approach us to fund their new projects, even if the borrowing entity does not have an established trading record.  Fiduciam would also lend against a care home asset when the borrower is not the operator but has a formal lease in place with an experienced care home operator.  Our care home finance is available to borrowers throughout the UK, including Scotland, and throughout Ireland.

From an underwriting perspective, there are several unique risk factors we consider when conducting our credit due diligence on a specialist care home asset:

Experience of UBO / Care Home Manager

One of the key elements we look at is experience of the underlying principal(s) of the transaction in the highly specialised care home sector. If the principal does not manage day-to-day operations, we also carry out due diligence on the care home manager to ensure he or she has the relevant experience to run a care home successfully.

We have seen many examples in which a care home business runs into financial difficulty because of operational mismanagement of the care home, which in turn leads to problems with the regulator – the Care Quality Commission (CQC).

Care Quality Commission (CQC)

CQC regulates all health and social care services in England, which also includes care homes.  A common breach in covenants for a care home business with their high street banks is the downgrading of their CQC rating, which range from “outstanding” to “inadequate”. If, after a site inspection by CQC, the care home gets downgraded to “inadequate” then potentially they will not be able to enrol new patients to the care home. Naturally this will have a material and adverse impact on their cash flow / profitability. 

Fiduciam is happy to support care home businesses where they run into short-term difficulties with CQC but have a plausible and detailed strategy / plan to improve their CQC rating; we will take the time to understand the proposed strategy and work closely with all parties to ensure this is achieved during the term of the loan.  

Vacant Possession Value vs Open Market Value

Fiduciam will lend against the trading or Open Market Value (OMV) of a care home asset, but given we are a short-term asset lender, we still need to ensure we are comfortable with the vacant possession (VP) value and not just the OMV value of the care home asset. 

Given the above, Fiduciam generally prefers lending to care home assets where they are located in good areas where this is a proven demand for properties.

Cash flow – Capital Expenditure (CAPEX)

Given the specialist nature of care homes, they will tend to have a significant annual capital expenditure  (CAPEX) requirement which needs to be factored into the overall cash commitments (compared to say a standard residential property); Fiduciam will always carry out due diligence on what the CAPEX requirements are for a care home business to ensure it is realistic and sufficient to ensure it continues to be compliant with the CQC.

As a broader point, Fiduciam will also carry out in-dept due diligence on the cash flow of the care home to ensure it is sufficient to service the debt over the term of the loan. 

Supply side risk of quality staff

The potential impact of labour market shortages on staff supply (and consequential use of agency staff) in the care home sector is a risk factor that Fiduciam will always assess by evaluating whether the borrower is recruiting and retaining staff of the right quality, and also to understand how they incentivise their staff to stay.   

Given the highly regulated nature of care homes, we would also check whether there are formal training plans in place for all staff.

Generally speaking, if there is a heavy reliance on agency staff and we note that this is a high percentage of the overall staff payroll expense, then we would consider this as a material adverse warning sign.   Use of agency staff tends to add significant extra cost to a P&L, and by itself has been known to make a care home financially unviable.

Concluding notes

Our care home bridging loans are in strong demand in the care home sector and generally serve to finance acquisitions, refurbishments, expansion plans and corporate turnarounds.  Our specialized underwriting team has built up extensive experience in this area.  All our care home loans have performed well, which is also thanks to Fiduciam’s practice of developing a productive relationship with the care home operators during the term of the loan.