Autumn 2022: The Latest Lending Changes

 

Finding the Right Finance When Inflation & Interest Rates Rise

The purpose of this update is:

• To provide a snapshot table of the latest lending options
• Analyse the changes to lending since the mini-Budget crisis
• To debate whether a fixed or variable rate is the right type of finance to take
• Provide borrowers with questions to ask lenders
• Provide borrowers with a series of next steps

The main takeaways are:

• Rates are up, but some strong fixed products exist
• Leverage has not dropped, and risen in some cases
• Your view of the future economy will determine whether you select fixed or variable lending
• Use savvy ways to restrict costs, such as using lenders who compound interest quarterly

 

Snapshot Table

Below are 25 lending options, sorted by the lowest “All-In” rate at 65/70/75% of GDV.

This data is based on calls with senior decision makers at all lenders, and our experience of sending enquiries to them.

* Right click on image and open in browser/new tab to get an easier version to see or..
* email me here to get a blown up version of the table
 

Caveats to the Snapshot Table

1 - The data is correct as of 8^th October 2022; 

2 - The table is for all loans with a minimum of £500k and under £10m.

For any loans over £10m, other products exist

3 - Arrangement/Exit fees – these have not been included as they are generally 2-3%.  More detailed total cost analysis is done at a more advanced stage of consultation

4 - No 180 day Valuation lenders – these lenders have been excluded, because 70% of GDV on a 180 day valuation is not the same amount of funds as 70% of GDV on an Open Market Valuation (OMV); it is often much lower.

180 day valuations can be the same as OMV, but in a volatile market, 180 day valuations are often the same as block discount valuations, with discounts to OMV of 15% - 20% common.  

 

Explanation of the Snapshot Table

* Right click on image and open in browser/new tab to get an easier version to see or..

* email us here to get a blown up version of the table




Going across the table from left to right:

Leverage

Lenders/Rates sorted at 3 leverage points:

• 75% of GDV (Gross inclusive of finance costs)
• 70% of GDV
• 65% of GDV

Minimum Lend

The smallest loan that lender will do on a net advance basis

Rate Components

The Total “All-In” Rate is then broken down into its 2 components:

1 – The Lender’s Margin

2 - The Base Rate used (Bank of England or Sterling Overnight Index Average (SONIA))

* Note that they there are at least 3 different interpretations of SONIA, currently from 1.63% to 3.23% as shown in the snapshot table.  

All in Rate %

Both rate component figures are added together to get the "All In" Rate % 

Fixed or Variable

Some lenders do both, where they either fix the rate at the point of each drawdown, or they fix the rate for the life of the loan at the point of completion of the loan application. 

Interest Compounding

The less frequent the compounding, the less interest is charged, and the cheaper the interest element is.  Therefore, those lenders who compound quarterly, are quite a lot cheaper than those lenders who compound interest monthly, if both lenders have the same All-In Rate.

 

Analysis

We know developers’ margins are being hit from every angle (rises in land price, build costs, and extra contingency). 

Base rate rises aren’t helping with finance costs ether.

So how do you limit the damage?

Start by understanding the changes to today’s products, broken down into:

• Leverage
• Rate
• Day 1 Advance
• Fixed/Variable products
• Interest Compounding

Let’s first look at leverage.

 

Leverage

Can you now borrow more or less?
 

When economic conditions worsen, lenders tend to retreat.  They either pause lending, or they reduce their leverage, from say 65% of GDV to 60% of GDV.  

Add in rising rates, and the mix of more expensive finance and a reduced net advance mean more equity is needed, and a hit to overall profit margins.

On this occasion, interestingly not many lenders have lowered their leverage.  In fact, some are offering more, and this has been a general trend since the Covid lockdowns and inflation hit.
 

Why?  Rising project costs across the board.


Lenders (that need to get funds out of the door) are realising that if they don’t offer more funds, they will be unable to complete enough transactions. 

They also know that project costs are rising during the loan terms, so contingencies need to be larger, and some room needs to be left in case of substantial unforeseen cost increases. 

Certainly, a couple of 65% of GDV lenders, who historically lent at 62%, are now pushing 70%+, albeit with their own higher rate to reflect the increased risk.
 

*We have to be careful here that we are not talking about reckless or irresponsible lending.  The rises I see are usually only 5% of GDV, and are based on necessity, be it the borrowers cost requirements rising, or the lenders non-utilisation requirements forcing them to lend.

Some people may consider anything over 60% of GDV as irresponsible, and will take mezz to top up.  However, mezz still gets you to the same leverage, and is arguably more damaging than the 70% plus debt products. 

Mezz is first in and last out, meaning in a slow sales environment, it is impossible to get rid of expensive mezz first, because the main debt lender, as 1^st charge holder, won’t allow it to be paid off as priority.

I have seen Mezz wreck the profits of several developers.
 

Not all Lenders are chasing - There are plenty of lenders, who don’t need to get funds out of the door at all costs, and prefer to keep “their powder dry” for better days.  Horses for courses and nothing wrong with that. 

It just means the borrower, in order to use those lenders, will need to come up with more equity, with increased finance costs to boot.

So leverage in the main has risen, or at least has not fallen drastically like in many crises.  There are plenty at 65%, at least 10 lenders at 70%, and at least 3 lenders at 75% of GDV.  Whilst leverage has risen, a few lenders have retreated, and a couple have paused lending altogether.

 

Rate

The reality is rates have gone up, typically in line with the base rate rises of the last 6 months i.e. around 2% per annum.

Some lenders have swallowed some of their margin to remain as near to their old rates as possible, but the vast majority have not. 

What the market is tussling with, is whether to bring in more fixed rate products, and there are mixed responses from lenders. 

There are some strong fixed options, as variable lenders have become more expensive, but most fixed products are variable products with future base rate rises priced in.

Rates have gone up, and if you need financing soon, now is about limiting the damage based on your view of Rate rises, which we shall discuss shortly.

 

Day 1 Advance

Day 1 has only dropped for lenders retreating, who cannot offer as much on Day 1 as they used to.

Increased contingency (10% up from 5%) has also had an effect, but with the extra leverage, most lenders can hit around 70% LTV on Day 1. 

One lender is even happy to fund less than 100% of the works so more can go into the Day 1.

 

Interest Compounding Variations

This is an area that is often overlooked, and can cost you, or save you, thousands.

If all else is the same between 2 lenders (same rate, same fees, etc), but one lender compounds their interest quarterly, and one compounds their interest monthly, the quarterly compounding lender will be significantly cheaper.

There are two lenders in the marketplace compounding quarterly, and are highlighted in red in the above snapshot table.

 

Fixed or Variable?

This is the million dollar question and depends on your view of the economy going forward, and what might happen to the Bank of England Base Rate...

 

Why your view on the Economy, and Base Rate rises, matters..

Your decision on whether to fix a rate, or take a variable, will largely be driven by your view of the future economic conditions.

 

Currently, there are two schools of thought:

1 – Central Banks like the Bank of England have lost control of inflation and will try to tame it by constantly increasing interest rates, until inflation returns to 2%.

2 – It is hard to see Central Banks continuing to increase rates, given the damage only a small relative rise in rates has already done.

 

Central Banks’ only mandate is to keep control of inflation, with their target 2%. 

Their major weapon to reduce inflation is using higher interest rates, but it comes with increasingly horrendous consequences for the economy including rising homeowner mortgage defaults, and rising unemployment. 

The current economy is built on mountains of 0% debt, so a 2% increase in rates is now a huge deal for the general public, businesses and the national government debt alike, as is further increases.
 

Governments, however, are unlikely to want the Central Banks to increase rates, as the consequences will be lost votes.

Central Banks, in contrast, don’t want lower interest rates because it will be seen as a failure of their mandate to keep inflation under control. 

Therefore, a natural clash between the UK Government and the Bank of England is likely to occur here, whether in private or in public.

The mini-Budget tax cuts didn’t cause the problem, it was the spark that followed previous rate rises, with the tax cut implying that larger tax liabilities would now be underfunded. 

Tax cuts at 0% base rates would not have caused a stir.

So, Governments and Central Banks are faced with a dilemma, and so are we.

If your view is that rates won’t rise much more, then is a fixed product at a higher rate worth it? 

If you think that Base rates will continue to rise, then a fixed product is very much worth it.  A type of insurance policy if you will.  

However, if base rates drop during the life of the loan, and you’re on a variable, the cost of your finance should drop too (subject to any floor rate the lender has specified).  If you’re on a fixed, you won’t benefit from any rate drops.

What you think is very much up to you. 

Caution may win out, but the future is far from clear cut.

 

In summary

• Rates have gone up, but some decent fixed rates exist
• Leverage in general has not gone down, as it usually does in stressed markets.  In many cases over the last 12-24 months, leverage has gone up to accommodate inflation
• As a result, how much equity a borrower needs to find has remained relatively stable
• What you think about the economy will drive your decision towards a fixed or variable rate, with a mix of products available.

 * Right click on image and open in browser to get an easier version to see or..
* email me here to get a blown up version of the table

Questions to Ask A Lender

Below are a list of questions you can ask your current lender, or any lenders you’re assessing, to understand what they’re currently offering:

 

• What’s your minimum loan size?  (So that you know you qualify on deal size)
• Do you use Base Rate, SONIA, or fix the interest rate?
•  If you use SONIA, which type of SONIA, and what do you view as the current rate?

           * There are different interpretations of SONIA, usually the Chatham curve, or the ICE data versions.  SONIA currently varies between lenders from 1.63% to 3.23%!

• How often do you compound your interest?  (Usually monthly or quarterly)
• Have you reduced your margin to offset rate rises?
• How are you as a lender funded? (Typically, either institutionally on base, by private investors on a fixed return, or private equity with a high IRR profit requirement)
• Do you have a fixed rate product, and if not, are you planning on one soon?
• Do you have the right to change your offer if base rates rise prior to completing the loan?

 

 

Next Steps

1 - If you have a current lender, make sure you understand exactly what they are offering.  Use the questions above to assess them.

2 - If you don’t have a current lender, or are reviewing your options, ensure you know exactly what the market is offering, and how it is has changed.  Hopefully the above snapshot and analysis gives you that.

3 - If you need more funding, decide whether you will put in more equity (from yourself or a third party), or whether you will seek more debt leverage instead.

4 - Decide whether you would prefer a fixed rate or remain on a variable.  That is largely driven by what you think the economy is likely to do in the next 12-24 months. 

Or you might decide that the risk of rates going up is just too much, and therefore a fixed rate at least fixes your finance costs.

5 - If you want to discuss your situation further with us, email us by clicking here