From CVAs to FCRs – are we in for more distress?

COMMENT: The CVA, as a process to restructure business, is firmly embedded in our retail landscape. But are we in for a return of the fixed charge receiver, an instrument well used by lenders throughout the global financial crisis to recover non-performing debt on property? The retail market continues to dominate the headlines with the ongoing flow of CVAs and growing anxieties over the future of high streets and shopping centres. But what of the rest of the market and what do we expect for the remainder of 2019 with Brexit uncertainty continuing? The traditional commercial asset classes are holding up well, offices and industrial are reporting steady occupational performance, while the logistics sector continues to thrive. Capital markets are feeling the frustrations of a slowdown on transactional volumes as the markets take stock with a “wait and see” approach. Residential is the notably exposed sector. We have seen a slowdown of offshore investors, pressures on household incomes, onerous stamp duty, rising personal debt figures and negative sentiment. So it is unsurprising that this is where we are seeing insolvency rates start to increase. While perhaps few of us expected it so soon, it was inevitable in a cyclical real estate market that insolvency rates would again start to increase, with FCR appointments rising from less than five a month last April to a consistent run rate of 20 per month since the New Year. An uptick but not exactly moving the dial. The widespread property insolvencies of the global financial crisis seem unlikely given the recent context of low interest rates and benign economics but as many of the most successful long-term investors have repeatedly pointed out, it is precisely these macro investment conditions that flatter and encourage the most risky and commercially inadvisable transactions These statistics should not come as a surprise. Although there are increasingly pockets of distress in the market, our restructuring activity has concentrated on working out these issues without the need for a formal insolvency appointment. This might be through delivering a restructure and refinance of existing debt, or “hand holding” a developer through the final stages of a problematic development (which also gives the lender the confidence to see a development through to completion with the support of expert third-party input and advice). It is perhaps unfortunate that the cyclicality of real estate markets is exacerbated by the cyclicality of the debt markets. Both are fundamentally auctions, with both buyers of assets and debt lenders competing in a similar way. To secure a transaction, asset buyers have to bid the highest price for the income stream, and lenders have to bid the lowest margins, highest loan to value, and loosest credit terms to win a funding mandate. Therefore, the winner in both cases often ends up with the worst commercial position that the market will determine (but critically has the ability to participate in the market). While the traditional high street banks active in the last cycle have retreated from property, they have been replaced by an array of some 200 alternative lenders and funds, many of which are start-ups. Each new lender has competed to grow a lending book from scratch and, given the need to gain scale quickly and earn initial fees, competed aggressively. Against this backdrop, even conservative lenders have a difficult choice: meet the more aggressive terms the market dictates in order to win debt auctions and grow a lending book; or withdraw to some extent from the market. For a growing start-up lender, this dilemma is critical and tends to lead to continued new lending on an increasingly risky basis. Rather like the fund managers of 2005-08, whose financial viability relied upon initial fees, the option of retreating from what is a known overheated market does not in practice exist. The question is what happens when this position normalises, as it is now doing, with reports of substantial arrears and defaults at some of the new generation of fintech lenders. Our restructuring team is already seeing a steady increase in the number of receivership appointments in line with the opening statistics but these are mainly confined to high-end London residential investments and failed housing development projects managed by inexperienced borrowers. Many more projects are known to be in distress, but with proactive action being deferred in the hope of a soft Brexit resolution and quick market recovery. While sectors such as retail are undergoing painful permanent and long-term change, our view is that insolvencies will increase at only a modest rate, and mainly in traditional situations, such as breakdown of the lender/borrower relationship, or commercial conflict with personal or corporate guarantors (which can in turn impact the efficient management of the underlying asset). The widespread property insolvencies of the global financial crisis seem unlikely given the recent context of low interest rates and benign economics but as many of the most successful long-term investors have repeatedly pointed out, it is precisely these macro investment conditions that flatter and encourage the most risky and commercially inadvisable transactions. We are in a market that needs to be watched closely by lenders and stakeholders and the key is to spot the warning signs as early as possible. Ros Goode is a principal and managing director of the London office for Avison Young