If the government want more houses built but banks aren’t lending enough money, where can housebuilders turn? Mezzanine financing from the wealthy might help – if the safeguards are right, says Gilbert Green of Thomson Snell & Passmore
HOUSEBUILDERS ARE BEING encouraged by the government to build Britain out of recession. Most would be delighted to do so if they could obtain funding. However, banks are not at present proving as willing as before to lend money, or the same amount of money. Only a handful of large, often publicly owned, housebuilders have sufficient cash reserves to fund the gap. One solution is the mezzanine lender.
The mezzanine lender can help by providing top up funding, often known as junior debt. Although secured by a charge over the land, the loan is not without risk, as invariably the loan provided by the bank (known as senior debt) will take priority. Understandably the bank wants to have first call on the property for repayment of its loan. However, problems arise where the housebuilder has other borrowings from the same bank for other projects.
Standard bank documents are invariably on an all monies basis – ie the charge over one specific property providing security for all money owed by the borrower to the bank on any account and for any project. Potentially, this puts the security being offered to the mezzanine lender at risk.
Usually, where there is to be junior debt, the bank will enter into a deed with the mezzanine lender which will govern how each loan will be repaid. This will provide for the bank to be given priority and therefore be repaid first. Often the bank is prepared to limit its priority to a specified amount. Provided that leaves sufficient equity in the property, the mezzanine lender should be adequately secured.
However, the standard deed of priority adopted by most high street banks does not limit the bank’s priority to the funds loaned for the specific project which the mezzanine lender is also funding.
By way of example: A, a housebuilder, proposes to buy and develop Blackacre. B, a clearing bank, agrees to lend 60 per cent of the purchase price and construction costs (£4,000,000). A agrees to borrow the remaining 40 per cent from C, a wealthy individual. A is to give C a second charge over Blackacre. B agrees to limit the priority of its loan to £4,400,000 (the amount of the senior debt facility plus a 10 per cent contingency).
The gross developed value of Blackacre is estimated at £12,500,000. C, on the face of it, has sufficient margin for repayment of his loan. The deal proceeds, B lends £2,400,000 on completion (60 per cent of the purchase price) and C provides the balance of the purchase price, £1,600,000 (40 per cent).
HOWEVER, A ALREADY has borrowings of £10,000,000 from B in relation to other projects. One of those projects fails and B calls in A’s debts. B is left with a shortfall of £1,500,000 after the other properties are sold. Blackacre therefore becomes security for £3,900,000 owed by A to B (the original Blackacre loan of £2,400,000 plus the shortfall of £1,500,000). If, at that stage, B requires Blackacre to be sold to repay A’s debts, with Blackacre still only worth the original purchase price of £4,000,000, C is left with nothing.
The solution is simple, although hard (often impossible) to agree with banks. If B initially limits the priority for its loan on Blackacre merely to the money advanced for the Blackacre project, and only after C has been repaid does Blackacre secure A’s other borrowings, both B and C would have recouped their investment in Blackacre.
The role of the mezzanine lender is important in this difficult market. The housebuilding industry is a major player in the road to economic recovery. If we are to build Britain out of recession then the banks need to take a more realistic approach to mezzanine lenders, and allow them sufficient security to ensure their continued, and vital, participation in the construction industry.
Gilbert Green is partner and head of the Commercial Property team at Thomson Snell & Passmore