UK non-performing loans face a September reckoning

Tony Guthrie says lenders in the UK are unlikely to enforce loans during the extended eviction moratorium, but that they need to be ready for its end.

After much speculation, the UK government announced on 10 March that it would once again extend the moratorium on tenant evictions by commercial landlords – by at least three months, with a ‘call for evidence’ on how it should end.

Given UK chancellor Rishi Sunak used the spring budget on 3 March to extend wider financial support until September, it is reasonable to predict that this is when the eviction moratorium will finally end too.

But what does this mean for lenders with loans secured by commercial real estate?

Since the Covid-19 crisis began, many tenants have protected their cashflows by not paying rent or reducing the amounts they pay. For some, this has been necessary for them to survive. For others, it has been opportune and has been used to give them leverage in negotiations with their landlords – often the sponsors of real estate lenders’ loans. The big question is which tenants will be able to pay their accumulated back rent, as well as their ongoing rental obligations, when the moratorium does end?

A related question is what will loan sponsors do if their tenants cannot, or will not, pay? For many sectors, demand from prospective occupiers is low and evicting tenants could merely expose the sponsor to an empty rates liability.

But relations between landlords and tenants, particularly where it is perceived that tenants have opportunistically declined to pay, have undoubtedly been damaged. This will encourage some landlords to take action through the courts to seek repayment or possession. In many cases, landlords will have possession by default as liquidators disclaim the leases. However, none of this will assist recovery in values or generate cashflow to enable to meet loan commitments.

Our experience throughout the pandemic crisis so far is that most lenders have deferred taking assertive action over non-performing loans, pending the withdrawal of government financial support and the lifting of the moratorium. Many will now further defer such action to the autumn, or whenever the moratorium does end.

The economic changes that have been caused or accelerated by the pandemic mean some sectors are highly unlikely to see a recovery to pre-pandemic levels. Retail is the most obvious example, but others will also be impacted. As the property market becomes more active and more valuation evidence becomes available, it will become evident that many loans are so impaired that borrowers will have little, if any, prospect of recovering any equity. Lenders faced with breaches of loan-to value covenants will of course press for sponsors to inject fresh equity and the impact that a failure to do so has on a lender’s confidence in the borrower will frequently be the key driver in triggering enforcement.

In other cases, lenders faced with scenarios where a further equity injection is needed – such as to complete a development project – which the sponsor cannot or will not provide, will almost invariably enforce before injecting its own equity.

There will be many different approaches to dealing with non-performing loans. Lenders with public profiles may have more concerns over the reputational impact of enforcement than some of their alternative lender peers, although the fixed charge receiver route is much less public than the appointment of an administrator. Equally, loan book sales by high street names seeking a quick exit – a process that has already started – could see assets come under the control of those more willing to take an aggressive approach.

The challenge for lenders will be that a focus on September could make the number of interventions at that time unrealistically high. That may encourage some to try to defer taking action where they can. But to prepare for eventual reckonings with their sponsors, lenders need to consider now how best to prioritise and get the right advisory teams in place.

Regulatory and reputational barriers may largely keep a lid on enforcement until the moratorium ends, but at some point, lenders will need to stop kicking the can down the road. When that happens, and September currently looks to be the likely date, those who have prepared are likely to secure the best outcomes.