25 June 2019

Funding lines: The risk of excessive risk parameter harmonisation

By Johan Groothaert - CEO of Fiduciam

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.

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