Ring-fencing regulations are pushing many high street lenders out of the sub‑£1m loan market, but new challenger banks are filling the void. Stuart Buchanan of Acuitus Finance explains the new rules and how they affect property investors
Changes are happening within UK clearing banks this year that will have a significant effect on property borrowers.
Many investors – and particularly private individuals looking for smaller scale loans – usually go to their high street bank in the first instance when looking to finance a property purchase or refinance an existing asset. In these situations, banks normally offer terms that are either attractive or not – depending on whether the property is aligned with their lending policy.
The changes currently underway at clearing banks relate to the ring-fencing of retail deposits. Many of us will have seen news stories about banks being ring-fenced, but what that actually means for property investors is probably less well-known.
The ring-fence rules apply to all banks that had core deposits of more than £25bn when this process began, meaning that HSBC, Barclays, Royal Bank of Scotland, Lloyds Banking Group, Santander UK and the Co-operative Bank are all affected.
Each clearing bank is effectively being split into two separate banks. Clients will be placed in the entity that is aligned with the value of the property assets that they own. The immediate bad news about this transition is that change within banks costs money, which is recouped from the bank’s borrowers. The ring-fencing is also shaping the future lending policy of the clearing banks.
Exodus from the market
What this means for property investors is that clearing banks are effectively removing themselves from the sub-£1m investment loan market. Some banks are quite clear that their minimum loan is now £2.5m. Others are exiting in a more subtle manner by either pricing themselves out of the market, or by implementing debt service covenants that are so restrictive that borrowers look elsewhere.
The better news is that a new breed of alternative – “challenger banks” – is stepping into the gap left by the clearers. Some examples of active challenger banks and specialist lenders within the sub-£1m investor loan arena include Norwich & Peterborough BS, Metro Bank, Handelsbanken, Secure Trust, Market Harborough BS, OakNorth Bank and Aldermore Banks.
To illustrate the restrictive debt service covenant and how the challenger banks are stepping, let’s look at a commercial investment generating an annual rent of £50,000 and five years remaining on the lease. A challenger bank offered a loan of £600,000 against the property, while the clearing bank would go no higher than £275,000.
A second example was a client renewing an existing loan with a clearing bank. The investment property was valued at £1.2m, and carried a loan of £470,000. His existing rate was 2.9% over Bank of England base rate, with a 15-year capital repayment profile. When he came to renew the loan, instead of receiving an interest rate margin to reflect a conservative loan to value, the new margin was 4% over BOE base rate, owing to clearing banks’ reduced appetite for smaller loans. He was able to refinance with a challenger bank at 3.5% over the BOE base rate and restructure his loan to part interest only and part repayment, to increase his cashflow.
One of the large clearing banks has stopped most of its real estate lending since the start of the summer because its property loan book is full. Its lending has been further restricted by the slow rate of redemptions of development loans, particularly in London and the South East. I have been told that they may be out of the market for 18 months.
The pros and cons
So what does this mean for smaller property investors? Unlike in the past, smaller investors will now have to get used to their first port of call being “challenger banks” or specialist lenders. There are advantages and disadvantages for borrowers in this new world.
The advantages can include higher loan-to-value ratios, longer-term loans, lighter amortisation or interest-only products. Some challengers are also more flexible regarding impaired borrowers and secondary properties.
The drawbacks can include virtually mandatory personal guarantees for limited company loans, while some lenders place more importance on clean credit reports and the absence of previous company liquidations. In addition, some challenger banks/specialist lenders are more focused geographically and may not lend in your location.
If you find yourself in the position where your clearing bank no longer values your business, you may find it easier to seek professional help through an independent broker.
Challenger banks and specialist lenders have wildly different lending policies from each other. You may find it a frustrating exercise to try to find the correct lender on your own.
What is certain is that the face of British property lending is changing and, for the present, it will be increasingly facilitated by new lenders instead of the household names to whom most borrowers had grown accustomed.
Stuart Buchanan is head of specialist property lending at Acuitus Finance
Case study: OakNorth
New lender on the block OakNorth wants half of all its lending to be to property borrowers.
The challenger bank, which launched in 2015, is already meeting this target, with between 50-55% of its £710m loan book tied to real estate deals.
Ben Barbanel, the bank’s head of debt finance, says: “We cover the market from £250,000 to £22m. The sub-£20m deal is where our market is, and we feel that is where the market is underserved.”
The big lenders have decided that sub-£10m deals are too expensive to underwrite and have also “de-skilled” their local branch teams, taking away the corporate bankers, Barbanel explains. “The opportunities are there, at this end of the market,” he says. His bank issues loans at interest rates of between 4% and 8% with a maximum term of seven years.
Founded by entrepreneurs Rishi Kosla and Joel Perlman, OakNorth likes to boast that it isn’t run by bankers. In other words, they understand the issues faced by business people because that’s what they are.
Focus on residential
The bank is focused on residential and prefers to work with experienced developers and investors, to the exclusion of non-professional investors.
It will consider small deals. For example, a £340,000 loan was approved for a buy-to-let property. It was the last one to be sold in a block and the developer was letting it go for 70% of the normal price.
The average time taken by the bank to approve a loan is three weeks, with decisions to decline lending taken more quickly. Only 10% of the loan applications are considered by the bank’s credit committee, and 80% of the deals that go to the committee are approved. Each applicant is asked to attend the committee and meet the decision makers.
“We are geared up to make it happen, when a lot of lenders would say it is not possible,” says Barbanel. The bank is picking up business where people are saying their usual lender is taking far too long to process an application.
“We don’t have reams of tick-box forms, and we don’t have set credit committee days, so we can sit whenever we need to. We are nimble enough to make things happen as quickly as necessary.”
OakNorth has a policy of closely monitoring development projects once funding has been granted, sending project managers to visit sites regularly. This allows the bank to monitor progress and alert clients if something is going wrong.
The firm has not been involved in financing many deals at auction. It sees auctions as the territory of short-term bridging loan providers, but Barbanel says it is an area the bank could look at more closely in the future.
OakNorth’s lending so far has covered projects ranging from “micro-units” designed for students, key workers or young professionals to hotels and care homes.
Avoiding a distressed situation
In one case, a developer had secured finance to build a care home in Essex, but when it was 95% complete it became clear it would not meet the requirements for vulnerable residents. The existing lender would not help with the additional £8m required, but OakNorth was able to step in and provide the money when other banks would have considered it a “distressed situation” and kept away.
Other lenders were not interested in funding luxury homes developer Fusion Residential’s plan for new flats in Radlett, Hertfordshire, Barbanel says. But OakNorth took a different view despite the lack of comparable projects in the area, and spent extra time looking at Fusion’s performance on developments elsewhere. It loaned £9m.
At the larger end of the scale, OakNorth stepped in to a provide a £22m senior loan for a high-end residential scheme in Hampstead, NW3. This allowed developer Godfrey London and its partner Cogress, which arranges equity through a network of private investors, to refinance and lower its borrowing costs by paying off an £11m mezzanine loan first. Tal Orly, chief executive of Cogress, said that most traditional banks would have been reluctant to support this project owing to the complexity of the funding structure, or would have taken far too long to get the funding off the ground.
Barbanel says there are signs the property market is slowing down as people grow more cautious. But he doesn’t believe there is a crisis. “I’m not seeing any signs that things are going south. It is about backing the right people,” he says.
