Trimont’s View – A Review of 2023 to Date

Now that we are through the end of April, and the completion of the first full interest period of the year, it feels like an appropriate time to look back on the last six to nine months and reflect on the key things that we have seen in the market. The level of transactional activity slowed down significantly from Q3 2022 onwards, as lenders considered the impact of the increase on interest rates and adopted a “wait and see” approach to new lending opportunities.

Commercial Lending is Increasingly Competitive

We have noted a continued “flight to quality” from lenders for the most attractive transactions (whether that be driven by sponsor quality, property quality or a combination of both). This has led to increased competition amongst some lenders for certain deals, and pricing for these deals is very competitive amongst those lenders who are willing to transact, albeit at lower gearing levels than 12 months ago, as the increase in the cost of finance starts to have a notable impact. On the flip side, there are proposals for which there is limited or no lender appetite, irrespective of pricing. Lender willingness to consider proposals for development finance or transactions in less favourable jurisdictions is also notably lower than we have seen during the preceding 18-24 months.

We have also been asked on a number of occasions to act as agent, but on the understanding that the transaction will close in a shorter timeframe than we would typically expect to see. This suggests to us that refinance conversations between borrowers and lenders are not always proceeding as anticipated, or borrowers are unable to satisfy the loan extension conditions, thereby resulting in borrowers seeking alternative financing terms, sometimes at short notice.

Management of Existing Loans is a High Priority for Lenders

Whilst we have seen signs of “stress” across a number of loans that we look after, relations between lenders and borrowers remain largely consensual and we are yet to see widespread “distress.” Borrower reporting is also being provided in a timely manner, as is the receipt of rental income into agent-controlled accounts. However, we have noticed some timing related payment issues in relation to the receipt of hedging proceeds, particularly on transactions where the hedging proceeds are needed to fund part of the finance costs. Any delay in the receipt of hedging funds, which are often contractually received on the same day as the Interest Payment Date, results in the borrower having to provide equity to cover the finance costs shortfall or the lender agreeing to defer receipt of their interest payment until the hedging proceeds are received.

Additionally, we have seen increased lender focus and more in-depth analysis of borrower reporting, particularly in relation to projected income and sponsor business plans. Lenders are also reunderwriting their loans more frequently and there is heightened focus on the treatment of surplus cash and projected finance costs, particularly for those loans with less than 12 months to loan maturity.

We have witnessed a greater level of scrutiny on development loans, with all costs and contingency usage reviewed on a line-by-line basis before approving monthly draw requests. There is also much greater analysis of projected finance costs, particularly if developments are taking longer to complete than originally envisaged.

Notwithstanding all of the above, we have not seen widespread calls for updated valuations from lenders. We believe one reason for this is that lower transactional activity during the last 3-6 months means there is limited comparable evidence; lenders have therefore elected to “wait and see” how the market performs before calling for a valuation, thus keeping their options open. We have observed that valuations instructed already have been scrutinised very closely by both lenders and borrowers, particularly in relation to comparable transactions used by the valuers. However, the recent uptick in transactional activity during the last 4-6 weeks will prompt some lenders to consider that there is now sufficient comparable evidence, and we anticipate further valuations will be instructed next quarter. We anticipate that this could cause more issues for the CRE finance sector, particularly for those loans that are due to mature in the next 6-12 months. We are starting to see some pressure on asset values and this, coupled with increased finance costs that may remain elevated for longer than expected by some market observers, may mean that borrowers will need to provide additional equity or face the prospect of selling their assets at loan maturity.

Greater focus on ESG and Sustainable Investing

In March we attended the MIPIM conference where sustainable investing continued to be a major discussion point. We noted a change in mindset amongst many investors and lenders, some of whom are seeking to align their investments with ESG criteria, with more focus on green buildings and energy-efficient developments.

In Europe, there has been a surge in ESG lending, with more lenders offering incentives to borrowers who meet certain sustainability standards, a trend we expect to continue.

European panelists on a recent ESG discussion highlighted the increasing focus on ESG in the US and discussed how the US is outpacing global markets in its ESG efforts. Going forward, sustainable investing is becoming a key driver of real estate investment decisions as investors look to align their portfolios with industry-wide frameworks. Our colleague Rebecca Percossi wrote an article in March which covers sustainable investing in more detail and can be found here ESG’s impact on investment ratings and valuations.

Service Providers’ Role in the Market

One thing that is clear is that, as we move through this economic cycle, lenders are increasingly looking to their loan service providers to help them proactively service and manage their loans. By working closely with service providers who are responsive, experienced and have a deep understanding of the market, lenders can better manage their existing loans and mitigate their risk exposure.

Relationship Building is Paramount in the Current Environment

Building and maintaining relationships is key in the current market environment. At Trimont, our experienced, dedicated, and responsive teams are able to work with lenders as trusted partners and better help them navigate the challenges of the current market.