Over the last few weeks we have seen a lot of uncertainty in the real estate finance market and at the start of March it seemed there were almost daily changes in sentiment. Although much uncertainty remains – in particular how long and how severe the impact of COVID-19 will be on real estate and real estate debt – over the last couple of weeks, and now with the benefit of data from the last IPD payment date, lenders seem to have determined their own strategy for moving forward in the short term. Many lenders have confirmed to us they still have an appetite to lend.
We have seen a number of themes emerging in the real estate finance market over the last few weeks:
- Whilst some lenders are pulling back or focusing on supporting their existing clients, other lenders are proactively seeking new opportunities and in some cases stepping into deals where the original lender has pulled out
- Our lender and borrower contacts have reported a high level of 'nervousness' in the market – even for deals where both sides remain very keen to transact. Despite this, deals have still completed
- Lenders are adapting their strategies to target new opportunities and work within the constraints of their own funding sources and availability
- Expect underwriting of deals to be more challenging and all deals to take longer to due diligence and complete
- Our experience is that lenders are generally adopting a case-by-case review of existing loans now with the benefit of information about payment (or non-payment) from the recent IPD and in practice we have seen a range of approaches with a lender focus on their borrowers' short term needs
- If the impact of COVID-19 continues for a few months only, lenders may well be prepared and able to continue to support their borrower clients. A more protracted impact starts to raise questions.
A number of the pension and insurance fund lenders seem to have put in place a moratorium on new lending for the timing being and, on a debt advisory mandate on which we were recently instructed, were the first to explicitly say they could not currently consider providing finance. Other lenders, such as retail banks or those with large legacy books, have communicated to us that their short term priority is to support existing clients and manage their legacy book rather than to consider new deals. Lenders have even asked some clients to approach them first if other lenders pull out of deals. Such lenders have provided differing time frames for when they might be able to next issue new terms or a commitment, from a fortnight to a couple of months. Like many market participants, we expect that in practice such lenders will adopt a 'wait and see' approach going forward.
At the other end of the spectrum, a number of lenders – including bridge finance providers, whole loan and senior lenders and those with preferred equity or special situations strategies – have proactively approached us to confirm they are very much open for business and also interested in new opportunities that arise as a result of an existing lender not being able to complete deals it had committed to in principle.
We are aware of a number of situations where a new lender has taken over from another lender. An alternative lender reported that it had, within a period of two weeks, stepped into the shoes of an insurance fund lender which had provided terms for a senior loan but pulled out after the sponsor had exchanged and its deposit was on risk. The debt fund was able to step in and provide a 12-month bridge loan with pricing to reflect the short time frame and deal risk. Similarly some of our borrower-clients have seen lenders pull back when terms had been agreed and even occasionally where the loan was already in documentation – however another lender has then stepped into the breach and taken over the financing, subject to negotiating appropriate pricing changes to reflect the risk. For the most part, lenders have communicated to us that they have been internally mandated to complete deals that they have committed to in principle or are in documentation on – with the exception possibly of some which are very heavily impacted by the lock down such as restaurants and hotels.
Certainly, of the lenders who say they are very much 'open for business', many are opportunistically looking to achieve pricing in the short term which reflects the short term market driven risk on assets that they view as fundamentally robust. However others are looking for the opportunity to become new long term financing partners for sponsors that have traditionally been banked by other lenders. It is also the case that some lenders that want to be seen as active, have in practice pulled back, and in some cases pulled out of deals with long term sponsors.
Sponsor clients have approached us where they have concerns that the lender(s) to whom they have been speaking may no longer have appetite to do the deal – although this has not been formally communicated to them yet. In such cases, we can speak with our wide network of lender contacts to provide the client with market feedback on which lenders may have appetite to lend on their property should their preferred lender fall down, and as appropriate make introductions to such lenders.
Our lender and borrower contacts have also reported a high level of 'nervousness' in the market – even for deals where both sides remain very keen to transact. Despite this, deals have still completed.
Some lenders are reportedly refocusing on their core business strategies rather than further developing new lending strategies which they had previously been starting to expand. Lenders may also be constrained by their own source of funding. It is important for prospective borrowers to understand how this might impact the capital available for their relationship lenders to provide future financing.
Unlike in the US, European lenders may be less vulnerable to mass margin calls on mark to market accounting, which underpins the repurchase agreement financing mechanism used by mortgage REITS and debt funds in the US and which has been widely commented on in the US real estate finance market. However European lenders that rely on corporate lines as part of their capital may find it harder to access these. Such lenders who have structured products that rely on loan on loan financing to make their return hurdles may focus on other strategies. For example, one lender explained that rather than focus on their stretch senior product which is reliant on loan on loan financing to make the required returns, they would focus in the short term on rescue or bridge financing opportunities.
Borrowers should ask themselves whether their proposed lender has ring-fenced capital that is currently uncommitted and sterling denominated. We understand at least one lender with a proven fundraising track record has prudently decided to hold off launching a new fundraise this year. If other lenders follow suit, those that have mostly or fully committed funds will have less capital to finance new deals. This may also give those lenders with smaller legacy books and plenty of dry powder a big advantage in snapping up financing opportunities.
Lenders remain, as they were well before COVID-19, very cautious on retail financing as a whole. Securing new financing for trading assets, in particular hospitality and leisure, is also likely to be very challenging. That said, some asset classes are bucking the trend. A good example are data centres and we have just seen ICG Longbow close a £25m loan to Proximity Data Centres. Similarly residential investment and development assets are likely to be seen as long term assets for which demand will continue post COVID-19, due to the well-known supply demand imbalance. However, any borrower looking to secure a development facility will need to factor in a longer time frame to reflect lender concerns about potential supply chain disruption and resourcing issues, particularly if there are any formal government restrictions on worksites. A construction project which pre-COVID-19 might have taken 12 months may well require 16 to 18 months to complete, and lenders will want to ensure their borrower clients have sufficient flexibility on timing and lead time to deliver the project.
Underwriting new deals is also expected to take longer. One alternative finance provider commented that if a short time frame was typically one month, now it would likely take two months to complete a deal. Anecdotally our lender contacts report that remote working for the most part is going well, but we have noticed some understandable delays on even simple matters such as signing of NDAs, which has taken longer as teams are remote and/or have limited access to scanning equipment. As for all market participants, there seems to be a broad understanding and acceptance that generally deals will likely take longer.
Many lenders are expecting some degree of longer term correction to asset values and also, potentially, asset use. There has been some discussion, for example, around whether the use of office assets might change dramatically now that many businesses and workers have been forced to get used to agile working practices.
Determining valuations of assets in the current market could also be challenging – a lack of recent transactions and certainty about what the future might hold will make the job of valuers harder and in the immediate term property inspections may also be difficult. However, lenders that weathered the GFC advised us that they are confident that they can draw on lessons learnt then to underwrite new opportunities effectively. This may involve taking into account pre-COVID-19 income/ NOI, extrapolating from the impact of the 2008/09 crisis on the asset or asset class, and ultimately looking at the fundamentals of the specific asset – is it a well-positioned asset in its class and sector that is likely to bounce back after COVID-19?
Our experience is that lenders are generally adopting a case-by-case review of existing loans now with the benefit of information about payment (or non-payment) from the recent IPD. We would expect that lenders will carefully consider which of their borrowers are genuinely experiencing difficulties arising from COVID-19 impacted trading, rather than perhaps looking to exploit the situation. Lenders are also trying to assess whether the underlying income streams will likely bounce back or be permanently impacted, and if the latter by how much.
Lenders will no doubt be expecting sponsors to step up to support borrowers. However, one lender commented that the COVID19 impact doesn't seem like just an "equity" risk and therefore it is appropriate that lenders and sponsors share some of the downside pain.
In practice, we have seen a range of approaches with a lender focus on their borrowers' short term needs. Some lenders are holding off providing formal waivers whilst in practice not looking to accelerate or enforce – this lack of certainty is often unnerving for borrowers. Some lenders have issued a reservation of rights letter whilst allowing financial covenant holidays and non-payment of interest. Others have started to agree more formal amendments to allow deferral of principal repayments until the next IPD and capitalisation of interest. Where it is agreed that interest due to a mezzanine lender will also be deferred, this will likely not be paid until the final repayment date.
Although lenders are, in some cases, cautiously reviewing their security packages to understand what their longer term options may be, there seems to be no particular desire by lenders to immediately precipitate lots of loan enforcements with the recognition that this could be challenging both practically and from a reputational perspective. There is also a fair amount of Government pressure for lenders to continue to support borrowers such as the letter from the CEO and Deputy Governor of the Prudential Regulatory Authority on 26 March, providing guidance to bank lenders including on the treatment of borrowers who breach covenants due to COVID-19 with the aim of ensuring that banks continue to support the real economy and provide loans.
Some have expressed concern that once one lender starts to act aggressively, many others will follow suit, but so far the lending fraternity seems to be holding its nerve. There is also a sense that how any market participant (whether that be landlord, employer or lender) behaves during this crisis, will be noticed and marked for better or worse. If the impact of COVID-19 continues for a few months only, lenders may well be prepared and able to weather the storm. A more protracted impact starts to raise questions.
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