By Clint White
Last year, we suddenly received an increase in loan applications from developers in the midst of projects who wanted a new loan.
Such applications make us wary as typically a borrower looking for a new loan in the midst of a project means something has gone wrong. We soon discovered the reason was that the borrowers could no longer make further drawdowns under their existing facilities as their lenders had funding issues.
The press has widely reported the fate of Amicus, but we have also seen other lenders which seem to have funding issues. As everybody may remember from the RBS small business loans controversy, a lender with problems can destroy a lot of businesses.
There are principally three types of lenders that can threaten a borrower: those that lose their funding, and those that are either not sustainable or not ethical.
Lenders who lose their funding
Some bridging lenders depend on bank funding lines, some on P2P funding and some on institutional funding. Bank lines can be pulled easily, while P2P funding can dry up rapidly as a consequence of negative press and herd behaviour.
This will usually happen at the worst moment for a borrower: when it is difficult to get a loan from another lender. It may leave a borrower with a half-finished development, unable to make drawdowns or with an inability to extend their loan if the exit is delayed. The consequence is enforcement with a loss of equity in the process.
For borrowers, it’s often impossible to understand a lender’s funding model, but brokers frequently have this insight. Lenders with non-diversified funding and loan book performance problems are most at risk of losing funding.
The fintech and P2P boom meant a lot of venture capital came flowing into our sector. This meant a lot of lenders were able to pursue a cash-burn business model.
The problem arises when venture capital investors run out of patience before the lender has become cash flow positive. A lender fearing something like this happening can create a vicious circle: the lender, knowing it needs to demonstrate growth to meet its original business plan projections, grants loans it should never have granted and portrays a much rosier picture than reality — until the card house collapses.
An enormous number of bridging lenders have been established over the past few years, and not all of them will prove to be sustainable. The broker plays an important role here, as he or she knows from industry gossip who is doing well and who is in trouble.
Unfortunately, we believe that some lenders’ business models are based on making money out of defaults or, even worse, lend-to-own. This does not mean they break the rules. It is easy enough for a borrower to have a project or exit delay, or to fail to comply with an administrative covenant. Indeed, the loan documentation is typically drafted to protect the lender, allowing it to easily declare a default.
Ethical lenders will work with the borrower to resolve the issue; others find it hard to resist the temptation to charge default interest and hefty fees. We continue to be amazed by the number of borrowers who fall into this trap. Clearly, more education is required on an industry level, although associations such as the ASTL have done good work to improve standards.
In part two we will look at why, particularly in 2019, knowing your lender is important, and give some practical steps for avoiding lender risk.