"While cycles are painful, they are also manageable, provided lenders look at the situation in the round and take a practical approach"
In an environment of stubbornly high-interest rates, uncertain asset values, rising construction costs, contractor insolvency and stalling unit sales as a consequence of high mortgage rates, development lenders are now facing a perfect storm of challenges.
This combination of factors has the potential to lead to distress and defaults on a scale that has not been seen since the aftermath of the 2008/2009 global financial crisis.
For some lenders, this will be their first experience of a significant downturn.
While cycles are painful, they are also manageable, provided lenders look at the situation in the round and take a practical approach.
Here are five top tips for development lenders grappling with the downturn:
1: Don't see enforcement as an admission of defeat. There is risk involved in any lending scenario and that risk is priced into the cost of the loan.
When the market moves against a borrower or developer, that risk becomes a reality – and that is just part and parcel of lending.
But that is not a reason to sit back and let matters take their course. Proactive engagement with borrowers can enable lenders to take control of borrowing entities and their schemes and prevent cash leakages and/or panicked decision-making, which risks undermining the viability of the scheme.
It can also provide vital breathing space to enable decisions to be made in a less reactive environment and control unit sales processes, which may have been compromised.
2: Don't be afraid to seek advice on a rescue plan, and to ask around to find out who can provide the best support.
Depending on the circumstances, the best adviser may be an asset manager, lawyer, project monitor, independent director, workout specialist or insolvency practitioner – or a combination of these.
Assembling teams of professionals who know each other and who have worked with each other before can be beneficial.
3: Engage with peer groups. Development lenders are all in the same boat to a greater or lesser extent, and the experience of previous cycles suggests that most will be willing to exchange war stories and share intelligence.
Problems shared are not necessarily problems halved, but knowing what the market is doing and how competitors are reacting puts you on a level footing with your peer group.
4: Engage with professionals at the first sign of trouble. Identifying underlying issues with key professionals involved in the scheme (particularly when it comes to non-payment) is essential to keep them onside.
Replacing a contractor mid-project is complicated, can be expensive and give rise to risk issues. This can be avoided if problems are identified and dealt with early on.
There may be alternatives such as switching from a design and build (D&B) contract to a construction management arrangement, which may be better for a partially complete scheme.
On the legal side, a review of security documentation and title due diligence can also influence what steps are taken further down the line in terms of enforcement, particularly where there are key contracts or leases which are terminable in the event of insolvency (or even a pre-insolvency) event; or, where step-in rights exist that would ensure continuity of the project.
There might also be bonds or guarantees that are time-limited and which need to be called before they expire.
5: Choose lawyers and advisers who have a track record in dealing with distressed projects.
This may involve switching from the lawyers who advised on the origination particularly if there are any issues which arise from a security review which may then lead to a professional indemnity (PI) claim further down the line.
Advisers who may be able to advise on potential routes that avoid an insolvency process will generally form an early view as to whether a scheme can be rescued.
Most professional advisers will be prepared to give some complimentary advice in early discussions as part of the client relationship.
