Since the credit crunch took its grip the term ’funding drought’ has been bandied about on an almost daily basis. Everyone in the finance industry is feeling the pinch as lenders struggle to raise liquidity and hold on tight to what little they have.
Of course, consumers looking to obtain mortgages are more aware than most of the problems a lack of funding can cause. But one area in particular is witnessing the chaos that can ensue when lenders can’t or won’t lend – the bridging sector.
Bridging lenders provide short-term loans often used by clients to secure a property while waiting for their mortgage, although loans can also be used to raise funds against an asset on a short-term basis. The terms of loans can be anything from a day to a year.
The funding drought has had two significant effects on the bridging industry, one positive and the other negative. With securing finance from lenders proving difficult the need for short-term finance has never been greater, but the clue to the downside is in the name – this is finance for the short term so what happens when a bridging loan reaches the end of its term and no lender is willing to refinance it?
“Mainstream banks have withdrawn their support from the sector and with it the working capital of most of the biggest operators,” says a spokesman for Goldcrest. “Banks no longer have the liquidity to support it as a result of the substantial losses they suffered following the fall in property values and their losses on loans to the bridging sector.”
As a result, there are limited exit routes for bridging finance companies and, according to Goldcrest, a lack of confidence in the market.
“There has been a big reduction in the amount of buy-to-let mortgage lending along with the number of products available,” adds the spokesman. “And these are only available for the best clients rather than those who are slightly outside prime.”
Indeed, this is a problem the whole sector has had to grapple with since the financial crisis began, and lenders’ LTVs are of great importance.
“We are lending at 75% LTV based on open market value so we need to ensure the asset class we are lending against does not fall dramatically in value,” says Christian Faes, co-managing director of Montello Private Finance. “We focus on the residential sector – primarily in the South-East – so we keep a keen eye on that part of the property market. There’s a strong argument to be made that the m
rket is stabilising in the geographical region we focus on but this is something that must be closely monitored.”
But Roger Morris, sales and marketing director at Affirmative Finance, says his company is reluctant to lend above 65% LTV.
“If a client wants to use The Mortgage Works as a buy-to-let exit its product is at 80% LTV,” explains Morris. “If for some reason this drops to 70% LTV and you’ve lent at, say, 75% LTV – which a lot of our competitors do – the client may not have an exit route.”
Morris says since Affirmative changed its criteria 18 months ago it has had no problem with clients finding exit strategies
“This is because we’ve stuck to our principles,” adds Morris. “Some of our competitors have tried to raise their LTVs which is brilliant, but they’re experiencing problems with exits because banks are still reluctant to lend.” Morris says his firm also builds in a two-month extension to its loans in case clients cannot refinance by the date planned, for some reason.
But others in the industry think the problem is easing. Laurence Goodman, managing director of Bridgebank Capital, says clients who took out loans around the time the credit crunch began or just before are likely to have seen defaults, but this should not be the case with more recent cases.
“A bridging lender’s underwriting should be sufficient to understand what remortgage products are available as well as applicants’ criteria,” he says. “We’ve seen few if any defaults so our bridging loans have performed as expected.”
Goodman says responsible bridging lenders must carry out due diligence on applicants to assess whether they will be able to redeem the loan. But we’ve all heard horror stories of consumers being stuck paying huge sums of interest on loans they can’t refinance, or even being repossessed. So what happens if a lender doesn’t assess the likelihood of an exit strategy adequately?
“If a bridging lender doesn’t extend its underwriting to make that assessment it’s irresponsible lending,” says Goodman. “And if there’s clear evidence of irresponsible lending that lender is leaving itself open to attack by the Financial Services Authority.”
He argues that even if the loan in question is unregulated the lender still leaves itself open to censure because it is accepted in the industry that all lending has to be responsible.
“The fact that a loan is unregulated doesn’t mean the lender can just look at the property asset and its LTV,” he says. “It still has to make an experienced and educated assessment.”
Most of the bridging sector is unregulated by the FSA, which only oversees bridging loans where the property is residential and at least 40% is used by the owner. In March the previous government announced that secured loans would be regulated by the FSA, which could include bridging if this is extended to second charge lending.
Of course, since then the Labour government has bade farewell and the FSA only has so much fuel left in its tank. In 2012 a new organisation will be in place, so what will this mean for the sector?
“The changes of the past two to three years that have been implemented by the FSA will stay but when it comes to proposals for the future it will be interesting to see what is introduced,” says Goodman.
But he believes that it’s only a matter of time before some form of regulation is brought in for all types of lending.
“There will be no such thing as an unregulated loan,” he says. “Commercial lending will be regulated, although to a lesser extent than residential.”
Aside from impending regulation and the funding drought the bridging sector, like much of the industry, is also facing the problem of fraud.
While funding is tight desperate times tend to produce desperate measures, so the sector is facing a battle to combat criminal behaviour.
“Fraud seems to be a big issue in the UK generally,” says Faes. “And as bridging finance could be seen as operating at the pointy end of the market the lenders involved have to be particularly cautious with regard to borrower fraud. We go to great lengths to verify all aspects of our loans and have an extensive insurance policy that covers us for fraud perpetrated by borrowers or their solicitors.”
Goldcrest says fraud is particularly an issue where it’s difficult to verify the real contract or purchase price.
“Fraud has been a serious issue for a long time,” says Goodman. “You’ve got to make sure you run your business armed with as much weaponry as you can muster to ensure you can carry out fraud detection processes.
“There are lots of systems designed to cut out identity fraud, and we also put the onus back on introducing brokers and the solicitors acting for applicants so we probably triplicate some of the proof of identify work we do,” he says. “Then again, sophisticated fraudsters are bound to get through every now and again.”
But it’s by no means all doom and gloom in the bridging sector. On the contrary, many believe there are significant opportunities to be had.
“It’s such a dynamic product,” says Morris.” I run workshops all over the country showing people how to buy from auction and how to get properties cheap – particularly ones that haven’t got kitchens and bathrooms. I tell attendees how they can make a profit within eight months. I also look at how to do development and renovation finance as well as self-builds and conversions. The industry we’re in is brilliant which is why there are small entrants coming into the market all the time.”
He adds that there’s currently a greater need for short-term lending than ever. Goodman agrees the opportunities are huge.
“But we have to strike a balance,” he says. “We won’t now do deals we might have done three years ago because they don’t stack up, but that’s more than compensated for by better quality applicants who would probably not have turned to the bridging sector in the past. So the quality of bridging lending has vastly improved.”
With signs that the market is improving one wonders what the future holds for the bridging sector. Will the opportunities on offer mean boom times for the niche sector? Here, unfortunately, the funding problem rears its ugly head again – this time in terms of bridging firms funding their own businesses.
“Most bridging companies are funded by third party sources such as lines of credit from banking institutions or other funds,” says Faes. “If a bridging company relies on external sources for funding, while the banks are taking a far more conservative view on the markets this is bound to flow through to it. This was one of the reasons we sought to set up our own proprietary funding source earlier this year, with our Montello Income Fund.”
Indeed, Goodman says research suggests the demand for bridging finance outstrips the availability of funds.
“I think this situation will continue,” he says. “If a bridging lender can get access to funds there’s growth potential. But the other challenge facing bridging lending is the source of funds. Getting a substantial source of bank warehouse credit is tough at the moment, and will probably remain so. We all need to look at sources outside of traditional bank facilities.”
Matthew Anderson, director at Fincorp, says the funding problem is down to mainstream lenders becoming more prudent.
“A lot of firms rely on bank finance to operate what is known as on-lending, whereby an organisation lends money it has borrowed from another firm or person. But on-lending has now become a dirty word among high street banks,” says Anderson.
“A few have come a cropper with high profile losses on doorstop bridging. A lot of banks now take the view they are struggling to lend money themselves so to give it to somebody else to lend isn’t exactly an attractive proposition.”
Anderson says this situation will gradually change but in the past few years he’s seen banks become increasingly reluctant to provide on-lending because they don’t have sufficient control over it.
“We went to private investors – of whom there are plenty – because we can offer them attractive rates,” he adds.
One area in which bridging lenders are seeing improvement is broker introductions. Advisers are becoming more knowledgeable when it comes to recommending bridging finance to their clients, but there’s still more to be done.
“There’s a learning process involved for mortgage advisers,” says Goodman. “We’ve come a long way in the past 10 years in terms of introducers understanding when to use bridging loans but there’s a long way to go.
“There also has to be a closer working relationship between bridging lenders and mainstream mortgage providers. Our attitude to risk is more relaxed than that of institutional lenders.”
Guy Garrard, head of business development at Tiuta, says it’s up to providers to train brokers in short-term finance.
“But there’s also an argument that brokers should seek more from the sector,” he says. “This means asking the right questions and doing due diligence before choosing a provider.”
The industry we are in is brilliant which is why there are small entrants coming into the bridging market all the time
As brokers become better at discussing the benefits of bridging finance the reputation of the sector will improve.
“In the past bridging finance has been seen as a bit of a dirty secret as there are some unscrupulous operators, but there also are a number of professional, smart and ethical operators and hopefully the market will come to reflect the calibre of these,” adds Garrard.
For the next 12 months at least it looks likely that times will remain tough but educating people about the benefits of bridging finance will be key to ensuring the sector remains robust and ready to make the most of the opportunities on offer.
Change brings opportunity
chief executive officer
As with the rest of the mortgage market the bridging finance sector has not escaped the impact of the credit crunch and property crash, suffering from a lack of liquidity for both refinances and bridges.
But if there’s been one glimmer of light in the past two years it’s been the low Bank of England base rate. For professional investors with equity and cash behind them, cheap money and property add up to a great opportunity to add to their portfolios using bridging finance.
In the coming months much will depend on the direction of property prices and interest rates. The base rate is still on hold for now but hawks are beginning to circle. They will have been encouraged by recent gross domestic product figures showing growth of 1.1% in Q2 2010.
eanwhile, a VAT increase is looming which will place further upward pressure on interest rates.
But while higher rates will naturally add to the headwinds facing borrowers and the property market they are a necessary evil and an important step towards a more normally functioning economy and lower inflation.
The important thing is that the upturn, when it comes, is managed smoothly to avoid shocks and allow the economy, markets and borrowers to adjust.
Increasing supply and falling demand, driven to a great extent by the difficulty of securing finance, could place downward pressure on property prices in the months ahead. There’s still a substantial funding shortfall that is unlikely to be made up for some time.
But cash buyers or those who can secure mortgage finance will still be calling the shots. At one point in late 2009 the balance of power started to swing towards sellers but now they are now on the back foot again and I expect this trend to lead to increased activity among portfolio investors.
Looking forward, for bridging loan companies the key is to continually develop their strategies in a volatile marketplace. For example, we have started focussing more attention on high-end properties, particularly in sought-after areas, as these tend to be more resilient to peaks and troughs in the market while lower LTVs offer more security.
We have completed £130m in loans in the past 12 months, largely in this higher price bracket, so we’re putting ourselves in a good position to grow alongside the recovery.
It’s also important that lenders are flexible. Just because an application drifts slightly out of the tramlines should not mean it is instantly denied.
Many perfectly acceptable borrowers are being shown the door by traditional lenders at the moment. Of course, this represents a big opportunity for lenders like us that take an old-school, bespoke approach.
A safe haven that provides generous returns for wealthy investors
Business development manager
In pre-credit crunch times bridging lenders were widely thought of as lenders of last resort. How things have changed. Now, bridging finance is an important weapon in the armoury of introducers and with interest rates likely to remain low and mainstream lenders unwilling to dip their toe in the high LTV, adverse or second charge water, bridging lenders have a big customer base to aim at.
Clients and brokers are looking at where they can place deals that do not fit with traditional lenders. Auction purchases, below-value sales, adverse credit histories and second charges are the mainstay of today’s bridging finance provider.
With more lenders entering the market the bridging sector is clearly a smart place for wealthy investors to put their capital as it’s a relatively safe haven that provides generous returns.
We are continuing to look at fresh ways of developing our relationship with our client base and listening to feedback. We know it’s only by understanding what the market wants and providing solutions that we will prosper.
Due to the speed at which transactions are processed in our industry we must always be vigilant for fraud. It seems that hardly a week goes by without a story breaking about a client or broker who has been caught in the act. While the economy continues to skate on thin ice underwriters and processors must remain on the lookout for suspect transactions.
The future of bridging finance is bright. In years to come the lending industry will be a different animal from that we were once familiar with, and introducers, packagers, networks and brokers will remember the dark days of 2008 along with the organisations that supported them in their time of need.
A lender that lends is one you want on your side at all times. Although products and criteria are always changing, this business often comes down to supporting those who were there for you when times were hard.
Lenders attracted to sector
head of finance
With a lack of mainstream funding in the market the role of niche lenders such as bridging finance providers has become increasingly important in recent years. These firms can provide loans on a short-term basis to facilitate a significant number of transactions that would otherwise not be able to take place.
Bridging lenders have the experience and ability to evaluate deals and make informed lending decisions after taking relevant information into account. Although lenders have stated criteria, each bridging loan is assessed on its merits to see whether it makes sense from the perspective of the borrower and the lender.
If deals make sense bridging finance providers do their best to make funds available as quickly as possible – often within days. This is not something that mainstream banks and mortgage providers seem to have much appetite for at the moment.
In the past 18 months we have seen many deals that make perfect sense when assessed on their merits but where borrowers have been unable to obtain mainstream finance for whatever reason.
We have seen deals that make sense but borrowers have been denied access to mainstream finance
Bridging loans have traditionally been used either in situations where individuals are seeking to buy new properties before the sale of their current ones, the security properties concerned are unsuitable for mainstream mortgage purposes or there are time constraints involved in transactions.
This is still the case, but at the moment the opportunities for bridging lenders are more wide-ranging than this, given the restricted nature of lending in the mainstream market.
This is clear from the number of new entrants and re-entrants in the bridging finance space in the past 12 months or so. The barriers to entry for investment property-based transactions are not high and lenders are attracted by the number of opportunities there are to lend money as well as the margins to be made in a low interest rate environment.
The Financial Services Authority’s Mortgage Market Review proposals are unlikely to directly affect regulated bridging lenders such as us, as we always adopt a common sense approach to assessing all aspects of loan enquiries. But it’s almost certain that further lending opportunities will arise as a result of the MMR.
There will always be a need for money and if retail banks and mortgage lenders are unable to satisfy this it follows that there must be significant chances for others. The key for bridging lenders is to be able to adapt their products and criteria as changes occur in the wider mortgage market so they keep their offerings competitive and relevant.”