Run for cover - How do you refinance in a collapsing market?
15 December 2009
Phillip Oldcorn, Senior Vice President, FAF International
'The lack of money is the root of all evil.' So said the American writer and satirist Mark Twain, with his characteristic prescience.
The global crisis we are going through is unique in the severity of the breakdown in relationships and trust between the banks, and the resulting drying up of liquidity. And the lack of affordable debt hurts anyone trying to secure or refinance corporate loans. The speed with which we have descended into this bleak situation has been breathtaking. It was just over 18 months ago that I sat with a banker client of ours, who told me a blue-chip borrower of his, to whom he had made an exceedingly good loan offer, had just come 19th in the bidding war for a property in central London.
To quote another writer and wit, this time from the other side of the Atlantic, George Bernard Shaw once said that 'both optimists and pessimists contribute to society. The optimist invents the aeroplane, the pessimist the parachute.' My company subscribes to the optimistic view - that, despite the gloom, there are ways to help companies whose corporate debt is secured by mortgages on their properties. Over the next weeks, and indeed months, quickly securing new funding will be a recurring headache for many finance directors. But there are ways to reassure banks about property ownership in a few days and avoid either tangible or intangible funding penalties where there is perceived risk.
Get it together
For a company that needs to remortgage, its minimum requirement is to ensure that its property affairs will stand up to the bank's due diligence. This means collating up-to-date valuations and ownership documents - although this is easier said than done if the properties have been bought by different holding companies, are mortgaged to different banks or are spread across different international locations. The bank will always want to check values and ownership pedigree itself. But if the portfolio is large, it will usually take a sample for due diligence and make assumptions about the remainder. The bank will then draw its conclusions based on its findings and its general approach to risk - and most banks are becoming increasingly risk-averse.
Property can be a notoriously illiquid asset when it comes to securing debt. It always helps if the title on a company's mortgaged property can be shown to be in good order.
Title insurance may seem unnecessary in the mature markets of western Europe, but this is because the term 'title insurance' is a terrible name for a more general product that covers most things concerning legal ownership. Title insurance does cover pure title issues, and in recent years this has reduced the costs of debt and smoothed the eventual exit for some smart investors in central and eastern Europe. It will provide the same function when an Indian title insurance market starts up, hopefully in the first quarter of this year. But in Europe, it provides far more than this basic Risk protection. It can also be extended to cover judicial review to help get contractors on site more quickly - this an be crucial if project financing is running to a tight business plan. Rights-of-light cover provides peace of mind.
Many deals across Europe experience delays or price adjustments because of common ownership defects, such as issues concerning covenants or easement (the right of others to use the land). A title issue can impact on the ability to trade from a property or on a tenant's right to occupy and continue its business. Consequential loss extensions form an integral part of title insurance. Over the last decade, investors and their lenders have used title insurance to supplement traditional legal services, and it has speeded up the purchase and mortgaging of property portfolios. When Barclays Capital and Citi undertook the €5.4bn (£4.6bn) commercial mortgage-backed securitisation of Deutsche Annington's 164,000 German properties in August 2006, they used title insurance to issue the bond at least eight months earlier than if they had used traditional methods. Without title insurance, the deal would have been sealed just as the financial crisis started. In hard times, the product does not change but the way it is used and the reasons for its use can change. Being able to give a bank insurance over all of a property owner's assets can enable it to secure new debt in a couple of days.
It may also prevent the bank discounting assets it is unsure of, or that it has not had the time or money to assess properly. This is likely where property records are not readily available or the owner is working with a systemic problem, as is the case with banks' approach to legal ownership issues in central and eastern Europe, and could have a positive effect on loan-to-value ratios. It also applies in Germany if the borrower is mortgaging commercial properties that are leased. The German civil code contains a comprehensive set of rules about how a commercial lease must be constituted if it is to be valid. A common stumbling block is the time lag between landlord and tenant's signatures - anything more than 10 days could mean that the tenant has amended the contract, and that its signature is a counter offer, rather than acceptance of the terms that have presumably been thrashed out over a period of time. The result is the tenant can serve six months' statutory notice to end the lease at any time, regardless of the actual remaining term. The list of potential flaws is long, and some lawyers estimate that the civil code affects as many as 70% of all German commercial leases. However, the bank can insure against the drafting issue resulting in lease terminations that would damage the borrower's ability to service its loan.
Rest assured
The insurance may at lease provide the lender with some reassurance. And, in these more risk-aware times, it may prevent it from discounting the cash value of properties with dodgy leases in a bid to maintain loan-to-value ratios. Insolvency experts or buyers of distressed assets can also make use of title insurance. Basic information, often available from public records, can allow the insurer to swiftly offer insurance to buyers of distressed mortgages or property. The buyer will avoid uncertainty over the provenance of the asset they are purchasing, and the previous owner's creditors may achieve a better sale price. In 1999, the Law Society of Upper Canada established a new rule of professional conduct. If property advisers failed to give advice on the availability of title insurance and how deals could be structured to incorporate it, they would be guilty of negligence if their client would have had a gain or recovery against a policy that the adviser should have known about. If similar restrictions are introduced elsewhere, it will provide food for thought for all those with professional or fiduciary responsibilities in the times ahead, where there could be a rush to apportion blame.