Potential clients who find fresh equity to refinance taxpayer-backed loans pose more than just financial questions for lenders
More and more we are being approached by potential borrowers seeking to refinance debt held by Lloyds, RBS or even Nama.
For the most part, this is ideal from our perspective – except when the potential customer advises us that they either have already secured or hope to secure a haircut on the debt from the incumbent bank. This presents some difficulties regarding valuations and what number we should lend against.
But aside from the practical issues, there are also moral ones. Let’s say the potential customer approaches us to support them in refinancing what was £50m of property assets bought with £45m of debt.
Let’s say that the assets are now valued at £40m and that therefore the bank has had an element of control for some time and a couple of years ago made a provision of £7.5m against potential losses from the loan.
The customer has found this out or has guessed at the figure and calculates that if the bank gets back any more than £37.5m then they’ll feel that they have done quite well. Let’s assume they calculate correctly.
Please also note that the customer has made clear to the incumbent bank that there was no fresh equity available to reduce the debt from £45m to a figure even just a bit closer to the valuation.
Despite this, the customer still really believes in the property assets and thinks they would be a steal at £40m – forget about anything lower. They therefore open negotiations with the bank involved and in principle have agreement that the assets could be “bought” for £39m.
From the viewpoint of the bank involved this is a better outcome than it would get if it took the assets to market and allows it to “claw back” £1.5m of provisions.
60% loan-to-value proposal
Next, we at Santander are presented with a proposal that would see us provide £24m, assuming a 60% LTV on a £40m portfolio.
Equity comes from either the initial owner or from a group of investors that includes them. Their contribution is invariably a few million pounds.
Our analysis shows that the potential customer is correct in that valuations come in strong, sometimes even in excess of the £40m assumption.
So we find ourselves assessing a proposal that on the face of it makes sense. And then I go and have a nasty bout of morals in two main areas!
The first is with why and how a borrower who could not find equity to reduce the debt with the incumbent bank can suddenly find cash equity when their debt of £45m is repaid for £39m, a £6m saving?
You could argue they have done nothing other than be good at business and negotiation.
As a lender, however, you could also worry that it goes towards the character of the borrower and is indicative as to how they would react should similar problems happen again.
They did borrow £45m after all and had I lent them the money I’d have expected them to be good for their word and do everything they could to reduce the debt, even to the extent of using unrelated equity to do so. To find out they had cash available the whole time would have been disappointing.
A second consideration, of course, is why the incumbent bank considers it reasonable to let over £40m of assets walk out the door for £39m!
New equity found
Furthermore, there must be an awareness that to enable the transaction, new equity has been found that wasn’t available previously to them.
This is a more complicated situation and I accept that there are lots of factors that can come into play and that each situation is unique.
I am just as “red-blooded” a banker as you’ll find but I just can’t help looking at it from the perspective of a taxpayer and wondering why banks in which I have a stake would accept this.
Of course, the funding arrangements of each bank are an influence on their position in such matters and we have to assume that the fact they are a willing seller indicates they are happy with the price being paid.
Scott Stuart is MD, specialised lending and commercial real estate, at Santander
