Taking Stock and Planning Ahead
SOURCE: SCOTTISH BANKER, OCTOBER 2008
The Credit Crunch is having an adverse effect on everyone involved in the finance industry, and the lending market is undergoing a correction to loan to value rates, and the cost of borrowing money. During the correction process, when the volume of lending will be less, you ought to do what you can to preserve the value of your security, so that you are well placed when the market returns.
A combination of lack of capital, and a more prudent view of risk, has seen loan to value rates plummet back to the historic norm of around 70-75% - some new deals will be at higher rates, but they will be few in number, and will have to be to very special customers. Margins are increasing, and now relate to LIBOR, which more accurately reflects the cost to the banks of committing the money – as with any other industry, banks are seeking to recover the increase in cost of its raw materials, which as a concept, is not unreasonable.
The optimistic view is that once all those involved in the market (being banks, borrowers and advisors) fully acknowledge the correction and the new lending parameters, then the market will start to return; but this will take some time, and when you are not lending, you need to be generating value elsewhere.
The business model of a bank relies on the value of its security exceeding the amount borrowed, and the interest being serviced (or covered) throughout the loan. The credit approval will insist on certain security being provided and certain conditions precedents being satisfied prior to the money being released; and when this is achieved, and the borrower proceeds as per the credit paper, usually all is well.
However, in the current market, it would be prudent for the bank to review any existing commitments that have not progressed as originally envisaged.
An obvious area to review is where banks have allowed the securities and/or conditions to be satisfied post completion – now is the time to ensure that these have been dealt with, as opposed to when you are seeking to enforce the security that you may not have!
Another consequence of the current market is that a number of borrowers are not progressing with the projects within the original timescales. Often this is because the proposed end-users (e.g. a purchaser of a new flat; or a retailer in a new shopping centre) are not demanding the product. This is another risk area for a bank, and a detailed review will be required to ensure that there are not any time critical issues which need to be addressed.
Planning permissions are time critical, and these are very important in this market where borrowers may seek to delay the development, and may decide not to implement the planning permission. Historically, planning permissions were often extended, but be aware that under The Planning etc. (Scotland) Act 2006 (which should be in force in 2009), extensions will no longer be available, and if permission is allowed to lapse, a new application will have to be made under the new legislation, which arguably will be more onerous.
We have been asked to undertake a number of security reviews to protect the bank. These ensure that the bank has effective security, and highlight any potential issues that may now arise due to the transaction not proceeding as originally envisaged, including advising on the impact of any relevant time periods, and other adverse conditions. This has enabled the bank to preserve the value of its security, and "encourage" the borrower to take appropriate action, which often is also in the best interests of the borrower.
AUTHOR: Alex Innes
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