54REAL ESTATE

ARAB BANKER

Finding Property Finance
Solutions in a Difficult Market
Five years may have passed since the failure of Lehman Brothers ushered in the darkest days ofthe global financial crisis, but banking markets are still suffering from its effects and from thecontinuing poor conditions in the global economy. All types of financial activity have been affectedby the reduced availability of bank debt in recent years.
In the following article, Raed Hanna, the Managing Director of Mutual Finance, the largest boutiquefinancial intermediary in the U.K., considers the challenges that difficult economic conditions
and lack of bank finance have presented to the Real Estate market and he gives two examples ofinnovative solutions that can be used overcome those challenges.

I

n recent years, market conditions have meant that someborrowers have – through no fault of their own – foundthemselves in breach of their loan covenants. This might
be due to breaking a Loan-to-Value (LTV) ratio or a shift in
asset values. Alternatively, the breach might arise in a debt
service covenant because a tenant is having problems andthen fails to pay rent. In many instances the loan taken out
by the borrower is still performing, but it is nonetheless inbreach of covenants, and that is a serious matter.
Mutual Finance has been working with banks andborrowers for over 20 years and has forged strong
relationships built on trust, honesty, and high quality
execution. As a result, the firm has been successful inworking with banks to reach amicable solutions for problems

facing borrowers today.
Working with banks to cure or solve covenant breaches isa “two way street” and requires a willingness by all parties toco-operate in finding a solution. Mutual Finance’s “can-do”
attitude has been a key factor in our ability to cut throughdifficulties.
There are many ways, other than a simple cash or equity
injection, to resolve debt problems. The examples below
show how it can be done through capital restructuring or
though an interest rate swap.
Example One: capital restructuring to cure breaches ofloan covenant
The client purchased a shopping mall in a strong retail

Raed Hanna, Founder and Managing Director of Mutual FinanceREAL ESTATE 55

AUTUMN 2013

location in 2006, paying £120mn for the asset. Bank debt wasreadily available at the time and the client borrowed £100mn
towards to purchase. The loan was provided with a sevenyear tenor on an interest-only basis.
On revaluing the asset in 2011, it was found the value had
fallen to £80mn, resulting in an LTV ratio of 125%. As aresult, the loan facility covenants were breached.
Mutual Finance worked with the client and the bank toagree the following strategy:
The client produced a five year business plan showing how,with prudent asset management, the shopping mall could
be improved both in terms of rental income growth and interms of tenant profile. At a time agreeable to the bank andthe client the shopping centre would be sold at a profit.
The bank agreed to provide a new five-year committed
facility for £65mn. The client would inject £15mn. The
bank would have to write down or “postpone” £20mn of theoriginal facility. Any surplus income from the shopping mallwould be used to amortise the bank’s new facility.
With the bank facility now reduced to £65mn, the LTV
ratio was reduced to 81%.
It was also agreed that the client’s £15mn injection would
attract 7% interest and that the following “waterfall” ofpayments would take effect after the sale of the shoppingmall:
1.	Repay bank debt of £65mn, after taking account of any
amortisation.
2. Repay client’s injection of £15mn.
3. Pay the interest on the client’s injection.
4.	Split the remaining profit of the sale 50:50 between theclient and the bank.
This arrangement – and variations on it – have worked
well in practice and enable both the client and the bank torecoup losses without the need to appoint a receiver and see
proceeds from the sale of the asset diminished by legal andother professional fees.
Example two: “blend and extend” interest rate swap
Interest rates are a crucial factor determining the viabilityof a loan facility and in the years before the global financial
crisis many clients arranging leveraged facilities relied on
fixed interest rates to secure the highest LTV rates for theirtransactions.
Regardless of a client’s sophistication as a property investor,
their understanding of structured interest rate products isoften limited, and this often leads to misunderstandings
about the cost of maintaining and, if necessary, breaking
interest rate agreements.
In mid-2007, a client purchased a hotel portfolio for £65mn.
The financing was agreed and a £50mn five-year term facility
provided for the client along with a ten-year interest rate
swap priced a 5% plus margin.
In 2012, the banking facility expired and was due forrepayment. Unfortunately, the client’s decision to overhedge the facility left him with a significant “break cost” thatmade repaying his debt by selling the asset or by refinancing
the asset impossible: the hotel portfolio had fallen in value
and the break cost to get out of the interest rate swap wasprohibitive.
The bank agreed to provide the client with a new facility
over ten years. The remaining interest rate structure (thatMutual Finance arranged the £260mn senior debt for Standard
Chartered’s worldwide head office in London.

had five years to run) was blended with the current interest
rates (which were lower than the original 5% rate) to produce
a new 2.85% rate plus margin.
This process is known as “blend and extend.”“Blend and Extend”
10%Year 1

Year 25%
Year 3

7.5%
Average rate

Year 4

Year 5

Assume that you have a mortgage priced at 10% with 2½ years
to run and that current interest rates for a new five-year term
are 5%. If you were to renew your mortgage today for a new fiveyear term, the new mortgage would extend 2½ years beyond theoriginal maturity date. You would still suffer the 10% rate for thefirst 2½ years and then enjoy the lower 5% rate for the remaining
2½ years. But rather than actually charge you this, your financial
institution will “blend” the two interest rates into an average rate
for the 60 month term.
With a reduced interest rate on the facility the client’s
amortisation profile was changed to allow for more rapid
repayment. There were no losses and the client regained
control of the asset. There was no need to involve third
parties and incur fees and other costs.
The real estate financing market is starting to recover
The banking market for real estate finance is starting torecover although lenders continue to want to secure loanson prime property, and particularly London property, andon assured and stable income. This means that there are
significant elements of the property market that banks stilldeem “off limits”, especially property that is outside London
and in less attractive sectors.
The U.S. commercial mortgage backed securities (CMBS)
market also offers some promising signals, with margins on
AAA-rated securities now as low as 80 basis points (0.8%).
The margin on equivalent securities in the U.K. is threetimes higher at around 250bps.
We at Mutual Finance do see light at the end of the tunnel.
New lenders are coming into the market while others arereturning after an absence of some years. Nonetheless, westill have some way to go before the volume of transactions
returns to that seen in 2003–2007. n
Mutual Finance is the largest boutique financial intermediary inthe U.K. and is based in Old Park Lane, London. It was foundedby Raed Hanna over 20 years ago. www.mutual-finance.co.uk