Bridging and short term finance is effectively project facilitating capital, and not funding to be used for long term hold financing purposes. This type of financing carries a higher degree of risk to lenders than that of secured long term loans. Borrowers must be able to show an ability to secure a reliable and achievable exit strategy for repayment of the facility.
The nature and level of risk associated with bridging lending, imposes underwriting parameters and criteria when assessing a case, that differs drastically to that of long term mortgage lending.
Term mortgage lending is very much based on a borrower’s ability to service a loan over a number of years, and therefore the underwriting parameters are centred on the borrower’s income affordability to repay the loan. Underwriting of a bridging loan however, identifies and assesses the borrower’s ability to deliver the project and achieve the specified exit strategy. Whilst, this is the case, where a re-mortgage has been identified as the exit strategy, underwriting must also take into account the borrower’s ability to secure a long term mortgage following the bridging loan.
Bridging lending has, and always will, involve a significantly greater level of risk on the lenders part, than term mortgage lending. Bridging can in fact be considered to hold the greatest risk profile of all property lending, with the exception of top slice mezzanine finance. Mezzanine lenders, do however, clearly enjoy greater rewards (and rightly so!) in terms of rates charged.
As a result of an increased level of competition amongst lenders in the bridging space, and the power that has inadvertently been given to brokers, we are now in a position where some brokers appear to be trying to dictate terms to lenders. Lenders must however be mindful that brokers do not hold any risk. The question must therefore be asked – are lenders in the sector reaping the reward for the high level of risk that they are taking?
This debate is enhanced by the presence and actions of newer lenders who are facing an even greater level of risk through weak underwriting and ‘chance taking’ on deals that established lenders will not do, in an attempt to secure market share. This approach is flawed and will result in default loans and failing lenders, which will in turn result in a negative perception of the industry.
A debate for 2015 will therefore likely surround – What can lenders do to realign the ‘risk return’ balance and get back the level of reward that they deserve, for the level of risk in short term lending?
Short term lending requires a significant level of due diligence and underwriting for a loan that will be in place for no longer than one year. When compared to a term loan which is secured for up to 25 years, the ‘effort’ required is similar, and therefore, it is imperative that bridging lenders consider time management efficiency and the level of reward generated. Term mortgage lenders have the benefit of accruing reward for potentially up to 25 years, whereas short term lenders must be mindful of reaping rewards in a much shorter timeframe.
Overall, it should be questioned whether the short term finance industry, from both a lender and broker perspective, has lost sight of the reward that should be earned by lenders for both the risk and effort invested. – The answer is most probably, yes.
Laurence H Goodman FCA is managing director of Bridgebank Capital