An Investor's Guide to Loan Security

Posted June 3, 2019

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An Investor's Guide to Loan Security

The point of lending is to not end up in control of a distressed loan. Any loan that ‘performs’ is one where the principal, interest, and fees are paid in full by the borrower. Due to Fitzrovia Finance’s experience, strong track record and parent company involvement, our Investors can trust our internal processes and ‘7 Step Risk Control process’ to mitigate defaults and enable a robust and reliable return.

Sometimes investments don’t go as planned, and in extreme circumstances, Fitzrovia has the ability to take possession of the borrower’s property. At this point, it’s crucially important to understand a loan’s security and why you, as an investor, will benefit from this ‘collateral’.

Understanding the difference between unsecured and asset-backed lending

Although many forms of lending can be unsecured, lending which is secured on property has certain defensive features. If we consider some online lenders, you’ll observe that they provide unsecured loans. This means that in the event of a distressed situation – a default – the investors will likely have to pursue the borrower as an unsecured creditor, hoping to get repaid. In lending to small and medium-sized enterprises, there is arguably extra security in place (beyond an unsecured loan) in that many business owners are asked to offer up what’s called a debenture – in effect, a guarantee for a specified sum which in turn may or may not be secured against a property (a director’s, usually) or other assets. But again, most SME loans are in effect only one step up from unsecured lending, with real assets offered up as ‘collateral’, but on many occasions, these are ‘second charges’ only able to be accessed after a bank has had their loan repaid. Secured property lending, by contrast, is explicitly undertaken with a view to securing collateral against real estate, usually buildings or land and in Fitzrovia’s case always first charge security. The precise nature of that lien – a legal right granted by the owner of a property, acquired by a creditor – or security backing will, of course, vary with the underlying structure of the property project.

To understand this let’s first remind ourselves of the ways of owning a property: freehold, leasehold and less commonly commonhold. In most cases, a secured property loan is charged against this freehold or a leasehold interest. The title to most real estate, regardless of the structure, is registered at the Land Registry which allows a legal charge to be taken (and registered) over a property. In a situation of distress where insolvency is evident – the borrower is unable to pay – most types of security will ensure that the lender gets all net proceeds (after insolvency costs) from the building (or asset) as a priority compared to other unsecured lenders or creditors (who have no explicit guarantee). In Fitzrovia’s view, the secured loans are those which have a legal first charge over the subject property (and/or a charge over suitable alternative support security), at a reasonable loan to value.

Looking at the wider context of this point, most secured property loans are advanced against a specific project (or development), most frequently involving a new building (or perhaps a to-be- refurbished property).

In many cases, these developments are structured by way of what is known as a special purpose vehicle or an ‘SPV’. This will normally be registered as a company at Companies House and be focused on developing only one project. This vehicle may boast several different lenders, many of which will be structured in a very formal manner based around the seniority of the loan. There will normally be a primary lender and it is not uncommon to subordinate some lenders as junior lenders compared to the senior lender – this means that one class of lender (the senior) will have first priority over assets compared to other creditors (the junior or mezzanine lenders and shareholders).

This structure is usually agreed at the outset when the company initially borrows and different levels of security (senior and junior) will receive different levels of interest from lending and the basis of the relationship should be generated by an agreement (an intercreditor deed or deed of priority).

Our tried and tested 7 Step Risk Control process aims to minimise risks

Obviously, the borrower – in this case, the company – will be party to a loan agreement which will have explicit security built into it, but normally separately documented in a debenture. It is common to take security over the shares of an SPV borrower (also by way of a debenture), but Fitzrovia always takes security over the subject property. At Fitzrovia, we normally require an additional borrower guarantee of up to 25% of the loan amount. This, combined with a detailed property and borrower due diligence process, helps inform our unique Fitzrovia 7 Step Risk Control process, and ensure our loans have an appropriate level of security. You can learn more about managing risk here.

Whatever the structure of a loan, there are some common characteristics across all borrowers, including development, investment or bridge loans. The first is that there will be a loan-to-value ratio measure in operation. Fitzrovia insists that all projects have 1.5 times asset cover – that means every £100 of loan value will be covered by at least £150 of gross development property value. Crucially, Fitzrovia always maintains active oversight of borrowers’ projects, working closely with borrowers when times are good, and working intensively to work out loans should distressed situations occur. This active approach sets Fitzrovia Finance apart from other property lending platforms who may take a more passive approach to investment oversight.

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