FIBA 2023 (FULL) Specialist Property Finance PDF

Topic 1 Specialist property finance Introduction Watch One of the characteristics said to typify the UK is that it is a society that aspires to home ownership. This aspiration has helped to develop a sophisticated finance industry centred around residential mortgages, enabling people to achieve their goal of home ownership. However, what the mainstream residential mortgage market cannot cater for are the requirements of those individuals and businesses that want to acquire property in the UK not to live in, but to use for business purposes, for development or as an investment. This is specialist property finance and accordingly, a whole financial sector has developed to cater for such individuals and businesses. Specialist property finance, or SPF, describes the use of finance to acquire and finance UK property through a bridging loan, commercial mortgage, development finance or a buy to let mortgage. In this world of computer algorithms, automation and the internet, it is people that are at the very centre of SPF. And this is what makes SPF so interesting for those involved with the industry. This first topic introduces you to the concept of a specialist property finance loan and how it differs from a mainstream residential mortgage. We will also look at the types of specialist property finance, the types of lenders involved, who requires specialist property finance and under what circumstances this will apply. The four types of specialist property finance that this course will cover are: bridging loans development finance commercial mortgages buy to let mortgages. One of the attractions of being involved with each of the four specialist property finance products is the sheer range of complexity, from a straightforward bridging loan assisting someone to buy a home, a buy to let mortgage on someone’s first or only investment property, all the way to commercial mortgages with sophisticated commercial lease arrangements and very large developments with complex structuring. Add into that mix the range of customers, their businesses, their plans, their ages, personal situations, backgrounds and life stories, and it means that the customer – the starting point of every specialist property finance (SPF) loan – always brings something new to the professionals involved. © The London Institute of Banking & Finance 1 Learning objectives By the end of this topic, you should be able to: describe what constitutes specialist property finance and how each type of finance is different from a residential mortgage; identify who is involved in the life of a specialist mortgage, including the types of customers requiring specialist property finance and the types of lenders operating in this sector; outline the responsibilities of each party to the transaction; and understand the different legal processes between the different types of specialist property finance and mainstream mortgage lending. 1.1 What is specialist property finance? Think… Before you start this section, consider what you already know about these aspects of specialist property finance. For instance: Why might a borrower need to use specialist property finance? Why is a residential mortgage unsuitable for specialist purposes? What types of borrowers might use specialist property finance? To best understand specialist property finance, we should start with what it is not. Let’s take a brief look at residential mortgages. Residential mortgages Most people are familiar with the concept of residential mortgages, which have the following typical features: the borrower’s residential property is taken as security; long terms – they are sometimes referred to as term loans; the first charge is taken as security; interest is serviced monthly; standard terms; they are used to purchase residential property or refinance existing mortgages; the security property must be habitable; borrowers are individuals, not companies; they are provided by well-known high street lenders; and they are regulated by the Financial Conduct Authority (FCA). Lenders offer a suite of mortgage products with clearly defined interest rates and terms and conditions. At best, some brokers may have access to preferred interest rates, but providers are not up for negotiation! © The London Institute of Banking & Finance 2 Because interest is serviced monthly, there is a focus on borrowers’ ability to afford the monthly interest payments. For buy to let mortgages, this usually concerns the amount of rent being received. Specialist property finance There is no neat, universally accepted or legal definition of specialist property finance. However, for our purposes we are focusing on four products that form the basis of what most industry experts would regard as the specialist property finance industry in the UK, namely bridging loans, buy to let mortgages, commercial mortgages and development finance. Many, though not all, of the loans completed within these categories will also involve some additional complexity. Often elements of the loan, such as the borrower’s profile, attributes of the security, repayment method, requested length of term, or reason why the monies are required, do not meet the common criteria of mainstream mortgages. 1.1.1 How does SPF differ from mainstream mortgages? Mainstream residential mortgages tend to fit a familiar pattern – a borrower seeking to purchase or refinance their residence. SPF could not be more different. Each loan enquiry and application has its own story, always answering the question ‘why is the loan required and how it will be repaid?’ The borrower’s financial and personal history come into play, as do the security and property being offered. There is also the wide variety of property that can be taken as security, depending on the particular transition. Lending against land has its own unique challenges, while buy to let is a distinct subset of SPF and is covered in detail in Topic 10 and Topic 11. As well as the variation in borrowers, there is also a wide variety of lenders that offer SPF, ranging from very small ‘private’ lenders to banks. Although the enquiry may result in a straight decline, if any of the factors do not meet the lender’s requirements, many lenders often seek clarification or request further information before declining. Reflect Would working in specialist property finance require different skills compared to a career in mainstream mortgages? 1.1.2 How is specialist property finance used? The vast majority of specialist property finance is used to facilitate the purchase and refinance of property. However, within the four products we are covering, there are distinct features, as follows: © The London Institute of Banking & Finance 3 Bridging loans These may facilitate the acquisition or refinance of property not acceptable to high street lenders, raising funds to refurbish property before selling or refinancing or the urgent acquisition of a property. Many bridging loans involve facilitating the purchase or refinance of the borrower’s home. Although most bridging loans are secured on residential property, some lenders may offer products that enable the purchase of and securing against commercial property. Development finance While these loans are principally used by developers to fund the costs of developing a site or property, they are also often used to finance the acquisition (or where already owned by the developer, the refinance) of the security property. Again, there is tremendous variation with these loans – developments can range from one or two houses to the building of whole estates. Separately, high rise developments have a unique set of challenges and complexity for both borrower and lender. As you can see, the sheer range of property involved and the subsequent potential complexities make SPF a challenging and fascinating area of property finance, requiring a variety of skills from those working in the sector. Commercial mortgages As the name suggests, these loans are used to facilitate the purchase and refinance of commercial property. There is a huge range of commercial property that these mortgages service, from relatively straightforward units such as small shops to larger properties including shopping centres, distribution centres and industrial plants. Buy to let mortgages These loans are used to facilitate the purchase and refinance of investment property, not the borrower’s residence. Many of these loans used for refinance will involve multiple properties known as a portfolio. Check your understanding 1. Which of the following are features of a typical residential mortgage? Select all that apply. a) Borrowers are usually individuals. b) The security property must be habitable. © The London Institute of Banking & Finance 4 c) The terms and conditions are negotiable. d) They are regulated by the FCA. Feedback: the typical features of residential mortgages include: the borrower’s residential property is taken as security; long terms – they are sometimes referred to as term loans; the first charge is taken as security; interest is serviced monthly; standard terms; they are used to purchase residential property or refinance existing mortgages; the security property must be habitable; borrowers are individuals, not companies; they are provided by well-known high street lenders; and they are regulated by the Financial Conduct Authority (FCA). (See section 1.1.) 2. Which of the following are possible uses of specialist property finance? Select all that apply. a) Financing the purchase of commercial property. b) Funding the development of a housing estate. c) Assisting with the purchase of a borrower’s family home. d) Refinancing the funding of a buy to let portfolio. Feedback: specialist property finance can be used to facilitate the purchase or refinance of a broad range of property. This includes investment and commercial property as well as development sites. (See section 1.1.2.) 1.2 Types and features of specialist property finance Think… Before you start this section, consider what you already know about the types and features of specialist property finance. For instance: Who might require this type of finance? Why might they require this type of finance? How might they go about accessing this type of finance? © The London Institute of Banking & Finance 5 The following are the main types of specialist property finance and their features. Bridging loans Bridging loans are short-term loans with a duration of up to 18 months. They are often used where there is urgency required and can be both regulated (where the borrower’s residence is part of the security) and unregulated. In the context of private residential lending, bridging loans are used to finance the purchase of a property when the buyer has not yet been able to complete the sale of an existing property – it ‘bridges’ the gap in finance for a short term. Features of bridging loans include: short-loan terms of only up to 18 months; interest is usually either retained or rolled up into the facility so that borrowers don’t have to make monthly payments; interest rates are described on a per month basis; a minimum amount of interest is payable (known as an early repayment charge); the security property does not have to be the reason for the loan; and they are mainly used for the purchase and refinance of a security property, but have a wide variety of other purposes. Development finance Development finance is used by developers to fund the costs associated with development projects. These projects may be new property developments, conversions, renovations or regeneration projects. These loans may also be used to facilitate the purchase of a new development site or refinance an existing site, but crucially, they are always used to finance all or part of the development works. Features of development finance include: terms range between six months to two years – the duration of the loan is based on the scale and nature of the development; interest rates are lower for developers with demonstrable successful experience of similar projects; the lender’s ongoing monitoring of the development finance facility and project being financed through engagement with monitoring surveyors and/or quantity surveyors; development work costs are typically refunded to borrowers on either the production of invoices and/or updated reports from surveyors. © The London Institute of Banking & Finance 6 Commercial mortgages Commercial mortgages are term mortgages secured on property that is not the borrower’s residence, and so include business and commercial properties. Commercial property and commercial mortgages are as equally varied as residential properties but are perhaps even more challenging, as business tenancies and rents may have to be factored in among a number of complex issues where such property is being offered and taken as security for a SPF loan. The differences between commercial mortgages compared to residential mortgages are covered in Topic 8, but essentially the value of the land or property is usually much larger for commercial mortgages. Features of commercial mortgages include: the security property cannot be residential; the terms range from three years (or less) to 25 years; most commercial mortgage products are designed for businesses; the loan terms and headline interest rate will be heavily reliant on how much revenue the business produces and how in demand the borrower’s product or service is; interest is always serviced, but may be payable quarterly rather than monthly; valuation reports are commissioned from specialist commercial property valuers. Moneysupermarket (2023) Buy to let mortgages These are for those wishing to invest in residential property and to receive an income from that investment as a business. Security is taken over residential property, which the mortgagor, ie borrower, rents out – it is essentially an investment. For example, if the borrower wishes to buy a property for rental purposes as an extra income source, they will need a buy to let mortgage. Features of buy to let mortgages include: the maximum loan amount is linked to the amount of rental income the property generates; a requirement that the expected rental income is a stated multiple of the monthly interest payments on the loan usually expressed as a percentage in excess of 100% – lenders are required to look for a minimum interest cover ratio (ICR) of 125% (PRA, 2016); a minimum deposit requirement of the security property’s value (although it can vary depending on the type of property, the borrower and the lender; and products can be either interest only or capital and repayment. © The London Institute of Banking & Finance 7 ICR The ratio of gross rental income to mortgage interest repayments (PRA, 2020). Consumer buy to let mortgages These are relatively new BTL mortgages that are designed for: Accidental landlords, ie those who didn’t initially intend to rent out a property. This could be because they inherited the property, are temporarily relocating or are moving into a partner’s property but want to keep their own. People who want to rent a property to their family. Another feature of consumer buy to let is that these mortgages are regulated by the FCA, like a residential mortgage. This is because accidental landlords are seen as more vulnerable and so the extra protection of FCA regulation is designed to mitigate this. Traditional BTL mortgages are unregulated. More information about consumer buy to let can be found in Topic 11. Second charge loans for business purposes These loans involve the borrower: providing a second charge security over their home; and demonstrably utilising the loan monies for a business purpose. As with regulated second charge mortgages, these loans may form part of some borrowers’ strategy to repay their specialist property finance. These loans are exempt from the FCA’s consumer credit regulations as they fulfil the exemption criteria as defined in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001: “A credit agreement is an exempt agreement if: a) the lender provides the borrower with credit of £25,000 or less, b) the agreement is entered into by the borrower wholly for the purposes of a business carried on, or intended to be carried on, by the borrower.” (legislation.gov.uk, 2020). There may even be an international element. For instance, the borrower may reside abroad or the repayment strategy may involve the sale of overseas property or the realisation of foreign investments. Note that most lenders offering these loans will only lend to limited companies to avoid any confusion regarding the purpose of the loan, ie to ensure that it is for a business purpose. © The London Institute of Banking & Finance 8 Limited company An organisation set up to run a business. It is responsible in its own right for everything it does; its finances are separate from personal finances. Any profit generated is owned by the company. 1.2.1 Range of property acceptable as security As will be clear by now, each specialist property finance product has its own main types of acceptable property, but within each of these there is a range of property and what is acceptable will vary from lender to lender. Bridging loans Bridging loan lenders offer the broadest range of acceptable security property of all specialist property finance products. Although most bridging loans are secured against habitable residential property, the range of acceptable security is much broader and typically includes: the borrower’s residence (only FCA regulated lenders) as well as investment residential property, eg flats; residential property that is unmortgageable and requires refurbishment – here the repayment is often a buy to let mortgage; residential property that requires refurbishment, conversion and/or an extension, but which does not require a development loan facility; semi-commercial property, eg a flat above a shop or restaurant; Grade II listed property; farmhouses without agricultural restrictions. In addition, some bridging lenders will accept the following as security: flats in high rise (often regarded as over six storeys) apartment blocks; houses of multiple occupation (HMOs); residential properties operated as guest houses or holiday lets; some types of commercial property; land with planning permission; Grade I listed property. Development finance With this type of finance, the acceptable security property is determined by the nature of the development, ie what the developer intends to build and the location of the property. These include: Land with existing full or conditional planning permission and land without planning permission. These can be brownfield or greenfield sites. © The London Institute of Banking & Finance 9 Brownfield site Previously developed land in the UK that is not currently in use. It is often land that has been used for industrial or commercial purposes, and may even be contaminated. Greenfield site Undeveloped land in the UK, usually in a rural area. Where there are existing buildings on the development site, these are commonly: dilapidated or outdated property, both residential and commercial; buildings occupying a large undeveloped site; or existing office buildings that can be converted to residential use. Commercial mortgages Although there is a very wide range of what constitutes commercial property, the most common types that provide security for commercial mortgages include: high street shops and those in less favourable locations, known as secondary or (where on the outskirts of a town) tertiary locations; warehouses and other distribution units – these have become more important with the growth of online shopping; Light Industrial Units and small workshop premises; HMOs; restaurants and takeaway establishments; offices – remember to distinguish between purpose-built units and offices above shops, etc; medical establishments, such as GP and dental surgeries. In addition, some commercial lenders will accept the following as security: care and residential homes; hotels; buildings used for religious or charitable purposes; farms or property with agricultural restrictions; petrol stations and garages; industrial plants; sports facilities or stadiums; and farms or properties with agricultural restrictions. Buy to let mortgages Buy to let mortgages are designed for residential investment property, so there is a more limited acceptable security property type. © The London Institute of Banking & Finance 10 The one common requirement is that the security property must not be inhabited by the borrower or their immediate family. Therefore, acceptable security property is typically: habitable houses; habitable flats – either purpose-built or above shops/food establishments; multi-unit freehold blocks (MUFB); or HMOs (some lenders). 1.2.2 Multiple properties Often, borrowers require specialist property finance because they are offering multiple properties as security. There may also be differences in the types of property being offered, eg a combination of residential and commercial property. In many such situations, the borrower offers a principal or main property as security plus other property known as additional security. This may be for a number of reasons including: The loan to value (LTV) is too high without the additional security. By offering additional security and lowering the LTV, the lender is able to offer the borrower a lower interest rate. Even where not necessary for LTV purposes, the lender needs to take security over the property being purchased with the loan monies – this is known as ‘following the money’. Even where not necessary for LTV purposes, where possible, the lender also needs to take security over the property being sold or refinanced to repay the loan – this is known as ‘securing the exit’. Where the borrower owns adjacent property on different titles, the lender may insist on taking security over adjacent property to ensure contiguity of their security and/or to prevent their principal security property from being surrounded by land owned by the borrower over which they have no indirect control by way of a charge. LTV The advance required and the percentage of the purchase price this represents. Specialist lenders are able to assess and consider loans where multiple properties are offered as security, even where there is a variety of property being offered. Where a borrower is offering more than two security properties, the security properties are often referred to as a portfolio. 1.2.3 Borrowers’ circumstances The borrowers’ circumstances and, to an extent, the types of borrowers applying for the finance will vary greatly depending on the specialist property finance product in question. © The London Institute of Banking & Finance 11 If there is a potential problem identified from a headline answer about the borrower’s circumstances on an application form, the lender will make proper enquiries. Very often, the borrower will need to provide evidence to support their explanation to ensure the lender is satisfied. Bridging loans Just as with acceptable property types, you will find the greatest variety of borrowers’ circumstances as compared to the other specialist property finance products. Borrowers’ circumstances will include: owner-occupier individuals leaving their home and refinancing it as an investment property (requiring consumer buy to let); investors seeking a short-term solution for their investment property needs; businesses and partnerships; borrowers with a poor credit history; borrowers with exceptionally complicated background stories; borrowers where there is a broader, often cross-generational element; and borrowers with complex repayment strategies. Commercial mortgages The two main users of this type of specialist property finance are: businesses seeking a commercial mortgage on premises from which they operate, ie owner-occupiers and investors (individuals or companies) that hold commercial property as all or part of their property investment portfolio. Development finance The principal users of development finance can broadly be categorised as: developers with some experience, but not of the project in question; developers with appropriate experience of projects similar to that being funded; or larger scale developers with experience of building moderate housing estates. The largest development companies are often referred to as “house builders”. Buy to let mortgages Customers seeking buy to let mortgages will range from those who find themselves in the position of being a landlord to sophisticated corporate businesses that own and run a portfolio of properties. This includes: © The London Institute of Banking & Finance 12 The small portfolio landlord – these are landlords who have a small portfolio of rental properties from which they derive or supplement their main income. They will be more sophisticated than the accidental landlord, with some experience of buy to let mortgages. The properties are often owned by the landlord in their own name. The sophisticated investor – these landlords have large portfolios with properties often owned in companies. They may have several lenders across their portfolio and are extremely familiar with the buy to let mortgage market. Running the portfolio can be their main business and main source of income. The accidental landlord investor – these landlords may have had to move with their job, have been left a property or their partner already had a property before they started co- habiting. Therefore, these landlords have an excess property they did not plan for, so they may require consumer buy to let (see section 1.2). They could potentially also return to live in the property at some point in the future. 1.2.4 Greater flexibility Flexibility is an important feature of specialist property finance due to the very wide range of security types and borrowers’ circumstances that the various products cater for. Bridging finance The greatest flexibility can be found with bridging finance. As you have seen, these loans encompass the widest possible types of property as security and there is significant variation on repayment strategies (discussed in section 1.2.5). Bridging loans are underwritten on a bespoke individual basis usually by, or under the supervision of, experienced underwriters and the sector is dominated by specialist lenders and dedicated departments within smaller banks who have the ability to consider (within reason) each case on its merits. Commercial mortgages Although the security for these loans must be commercial property, there is tremendous variation within this category of property. In addition, lenders will come across many types of businesses applying for a commercial mortgage, ranging from sole traders to multinational public limited companies (PLCs). PLC A company that is able to sell its shares to the public via a stock exchange. When underwriting, commercial mortgage providers need to understand the businesses they are lending to and where property is let and the financial strength and trading of the tenant, often referred to as the strength of the tenant’s covenant. © The London Institute of Banking & Finance 13 Because of this potential variety, commercial mortgages call for a professional degree of flexibility to reflect the realities of landlords, businesses and tenants. Development finance Given the sheer range of the types of development projects, how they are run and the experience of the developers seeking finance, it is no surprise that flexibility is a feature of development finance. Lender’s flexibility will take into account not just the size and complexity of the project, but also whether there is an element of contribution to the purchase price or refinance of the site as well as providing funds to cover the cost of works. In addition, there will be a wide range of how the development is run, eg either by the developer directly or through the use of contractors and subcontractors or a combination of the two. Each development will also have its own planning and building regulations to contend with. Lenders need to take the use of professional surveyors and how funds are released into account when structuring their facility. These factors therefore call for a degree of flexibility as the loan is structured to the particular development, the developer, professionals and build etc. Buy to let mortgages This product has the least flexibility due to the underlying requirements that: i. the rental income derived from the security property usually must be sufficient to service the interest together with the specified built-in margin (see section 1.2); and ii. the security property must be residential and occupied or intended to be occupied by tenants. However, provided this is satisfied, there is a degree of flexibility over the sophistication of the tenants. For more complex and sophisticated borrowers, lenders may also be able to include flexibility when structuring loans, for instance taking additional or cross security over other assets. 1.2.5 Repayment strategies All mortgages, whether high street residential or specialist property finance products, must of course be repaid. Repayment strategies are therefore a critical part of all mortgages and specialist property finance loans. Specialist property finance lenders are able to consider a broad range of alternative repayment strategies, including those that are more unusual or complex, such as: the sale or refinance of the security property; © The London Institute of Banking & Finance 14 the sale or refinance of other property assets, including property portfolios and overseas assets; the realisation of financial investments, both UK and overseas; the sale of a borrower’s business; equity release mortgages; gifts of money; lump sum divorce payments; and inheritance. The repayment of development loans may be affected by the completion of the development scheme being funded by the specialist property finance. For schemes where multiple units have been constructed, repayment may be achieved by: the completion and sale of individual units – where units are sold off on an individual basis, some development loan facilities permit the borrower to retain a proportion of the sale proceeds; or refinance of the completed scheme or remaining unsold units – developers are often keen to refinance completed schemes to release funds for their next development. Development loan A loan used to finance property development, including land purchase and construction costs. 1.2.6 Brokers It is important that borrowers have the best possible outcome when obtaining specialist property finance. However, many borrowers are unfamiliar with the lenders who provide specialist property finance. This is why the services of the broker should always be considered by borrowers. It is best practice for brokers to consider all types of lenders, although there are some lenders who work from a restricted panel of brokers. Non-panel brokers can only access these lenders through specialist mortgage packagers, who are normally assigned by the lender for that specific role. Most lenders will also expect brokers to have FCA permissions. Mortgage packer Mortgage packagers process mortgage applications for submission to lenders, often on behalf of brokers. They are able to negotiate mortgage deals with lenders that may not be directly available to the broker. To understand why the professional services offered by brokers can be so advantageous to borrowers, it is helpful to provide some context by examining the advantages and © The London Institute of Banking & Finance 15 disadvantages of the various options available to potential borrowers when seeking specialist property finance. Approach a lender or multiple lenders directly Pros There are no additional fees to pay. The lender is obliged to offer you their most appropriate solution. If you are an existing client (eg high street or challenger bank) the lender may personalise an offer of funds. Cons Lenders can only discuss their own products. Knowledge of the specialist lender market is difficult to find. Sourcing tools are not as sophisticated as the residential mortgage market. Many specialist lenders only accept deals introduced by an intermediary. Approaching multiple lenders will be time-consuming. Comparing offers may be difficult for a non-finance professional. Talk to a trusted contact Examples of trusted contacts include accountants, solicitors or independent financial advisors (IFAs). Pros Any guidance offered should be independent. There is already a relationship in place. Cons The lender market is not their primary professionalism so any guidance will be limited to existing contacts. May be influenced by commercial arrangements in place. Talk to a friend or colleague Pros Any guidance would be independent. Cons © The London Institute of Banking & Finance 16 Unless they are a finance professional, any guidance or advice would be of limited value. Review lenders online Pros Global reach so borrowers should be able to access most lenders. Comparison sites put many lenders together allowing borrowers to filter and compare options. Convenience of using a laptop/mobile for research. Cons Comparison sites are not necessarily whole-of-market. Some comparison sites may be biased. Inexperienced borrowers may not describe their funding needs accurately and may arrange the wrong solution or miss a much better option. Impersonal service – a chatroom facility does not replace a telephone or face to face conversation. Some lenders can only be accessed via the broker market. Talk to a commercial finance broker Note: It is recommended that the broker is a professional independent FCA-regulated commercial finance broker holding at least credit broking permissions. Pros A broker will assess the client’s needs. A broker may specialise in property finance and can provide expertise. A ‘whole of market’ broker will find the best deal from their entire lender panel. A broker will be able to provide advice on available options. A broker knows how to present lender applications and therefore has an increased chance of success. By assessing the whole of the market on behalf of the client, they will save time by not approaching lenders who will not lend, and money by ensuring they find the best deal from the lenders who will. Cons © The London Institute of Banking & Finance 17 A broker fee is an additional cost, although many professional brokers only charge a fee after an initial assessment and only take on cases where they believe they can add value. Although borrowers may be reluctant to add to the cost of raising finance by paying a fee to a broker, the value of the broker when compared to ‘going it alone’ is evident as they are in a unique position to: understand the needs of the client; assess the application; advise on the most appropriate solution across their entire lender panel; assist with the application and submission to the lender; and ultimately ensure the best outcome for the client. 1.2.7 Structuring SPF loans High street mortgages are essentially packaged products that the customer must qualify for and accept– they are not tailored to the circumstances and requirements of the borrower. Some SPF products, on the other hand, require considerable structuring or tailoring of the loan so that the finance meets the requirements of the borrower and protects the interests of the lender. Bridging finance It should now come as no surprise that bridging loans involve the most bespoke structuring simply because of the range of potential uses, types of borrowers, the variation of security property acceptable across all the different lenders and of course the variety of possible repayment strategies. Where multiple borrowers and/or security properties are involved, lenders will need to consider who is putting up the security and consider if the benefit of the loan and the risk of taking the loan is properly reflected. Lenders need to ensure that all parties receive legal advice that reflects the nature of their participation in the loan. Accordingly, when structuring the loan, lenders need to consider who the borrowers are, and ask questions such as: Are guarantors required? What is the principal security and is additional security required? With short-term bridging finance, there is significant focus on the repayment strategy. The lender may require security over the property being sold or refinanced to repay the loan. © The London Institute of Banking & Finance 18 Development finance Development finance will involve considerable structuring. Elements to consider include whether the borrower is an individual, partnership or limited company, but the main focus will be on structuring how and when monies are released to finance the works. For instance: Are monies released before or after the work is undertaken? Will monies be released to fund items that need to be paid for in advance, such as windows? What ongoing monitoring is required? How are building control and planning conditions monitored and dealt with? How are payments due to the local authority dealt with? What penalties or consequences will there be if the works are delayed? If there are multiple units, how can these be sold before the entire development is complete? Will the developer be allowed to retain some of the unit sales proceeds before the entire facility is repaid? Commercial mortgages Commercial property mortgages are generally classified either as investment or owner- occupier. Lending and lenders’ criteria differ depending on which type of mortgage is in question – this is discussed further in Topic 8. In short, if the property is tenanted, structuring is likely to focus on how and when rental payments are made by the tenant and how these are utilised by the borrower for the purpose of making the interest payments. Where the borrower occupies the security property, ie is an owner-occupier, the lender needs to ensure that its loan and security documents enable the lender to take control or possession of the security property. Bearing in mind that the borrower may continue to run their business from the property, many lenders will take additional security in the form of a debenture from the borrower, which provides the lender with certain rights to control the business in the event of default. Debenture A security instrument that can only be granted by companies and limited liability partnerships and gives a charge to the lender over most or all the borrower’s assets. Buy to let mortgages For the majority of buy to let mortgages there is little structuring, as these are the closest to being ‘off-the-shelf’ of the four main SP F products. © The London Institute of Banking & Finance 19 However, for the most sophisticated and complex borrowers, eg corporations holding significant portfolios with existing borrowing across multiple lenders, there will be a requirement to assess in depth the characteristics of the portfolio including: geographic distribution and concentration; the types of property within the portfolio; the quality and condition of those properties; the average LTV and how LTV varies across the portfolio; the rental income derived and the number and extent of empty properties/voids; and the borrower’s financial track record and intention. All these, along with the ownership structure of the borrower, are factored into how much the lender will advance, its terms and security taken. Check your understanding 1. Which of the following could be acceptable as security for specialist property finance but not mainstream finance? Select all that apply. a) Restaurants. b) Grade II listed buildings. c) Third charges. d) Buildings with issues regarding the legal title. Feedback: Specialist property finance is more flexible regarding what can be accepted as security for the loan, including restaurants and flats above food outlets, buildings with issues regarding the legal title and even third charges in some circumstances. (See section 1.2.1 and section 1.2.3.) 2. Providing more security property may result in: a) more risk for the lender. b) a lower interest rate being offered. c) a higher LTV. Feedback: Providing more security property lowers the LTV and risk to the lender, allowing them to offer a lower interest rate to borrowers. (See section 1.2.2.) 3. Repayment strategies are less important for specialist property finance as lenders are more flexible. Is this statement true or false? a) True. b) False. © The London Institute of Banking & Finance 20 Feedback: All mortgages, whether high street residential or specialist property finance products, must be repaid, so repayment strategies are therefore a critical part of all mortgages and specialist property finance loans. (See section 1.2.5.) 1.3 Customers and lenders Think… Before you start this section, consider what you already know about the customers and lenders involved in specialist property finance. For instance: What types of businesses might apply for SPF? How might corporate guarantees be linked to SPF? Why do you think there might be a very large range of SPF lenders? As we have learned, specialist property finance is characterised by a very broad range of requirements, including what is offered as security and how the loans are to be repaid. This naturally results in an equally broad range of potential customers and lenders, which we will now examine. 1.3.1 Types of customers There are various types of customer that may apply for SPF, from individuals to large companies. Individuals There is no reason why people cannot apply for specialist property finance in their own names. Where the security property includes their or their immediate family’s own homes (or holiday homes) then the loan will be a regulated loan subject to the rules of the FCA under the Mortgage Conduct of Business (MCOB). Sole traders The key difference between a sole trader loan application and that of an individual is that the sole trader loan usually involves a business purpose and quite possibly a business property as all or part of the security. A sole trader may apply for a specialist property loan using their trading name as part of the application process, but in terms of their legal liability to repay the loan, it is no different to that of any individual who applies for a loan. Partnerships While partnerships may of course apply for a specialist property loan, partnerships have no separate ‘legal personality’ in England, Wales and Northern Ireland, so the partners are personally liable just as much as a sole trader or individual borrower. © The London Institute of Banking & Finance 21 Note: this is not the case in Scotland as Scottish limited partnerships do have legal personality (GOV.UK, 2022). Legal personality The ability to undertake legal actions including, but not limited to, entering into contracts, owning property, suing and being sued. Individuals, businesses and organisations can have legal personality. Limited liability partnerships A limited liability partnership (LLP) is a separate legal entity from its members (partners), who – in the critical distinction from a ‘traditional’ partnership – are only liable for the amount of money they invest, plus any personal guarantees. The partnership is incorporated at Companies House and can only be used by profit-making businesses. Limited liability partnerships differ from traditional business partnerships and the limited company structure and are regulated by various pieces of legislation including the Limited Liability Partnership Regulations 2001. Professional firms such as solicitors and accountants often choose to set up as limited liability partnerships, but the structure can also be a beneficial option for other types of business. Companies Many users of specialist property finance are companies. Loans to companies and limited liability partnerships are often supported by personal guarantees from shareholders and members/partners. Some loans to companies are supported by corporate guarantees, often provided by the parent company of the corporate borrower. 1.3.2 Types of SPF lenders There is a wide variety of specialist property finance mortgage lenders ranging from banks to very small businesses managed by just one or two owners. Bridging finance There is a wide variety of lenders who provide bridging finance. These are: Small owner-managed lenders Sometimes known as private lenders, these businesses tend to have a low profile and do not engage in significant marketing of their services. The capital often comes from the owner(s) and/or high-net-worth individuals. These businesses have relatively informal processes and the most flexible approach to lending. Their cost of capital and relatively modest lending volumes tend to make them the most expensive in terms of cost to the borrower. © The London Institute of Banking & Finance 22 Non-bank specialist lenders These lenders comprise the majority of the bridging finance market. They have a high profile and engage in extensive marketing and broker-related activities. Their funding typically comes from banks, which enables them to offer lower interest rates than the smaller owner-managed businesses. However, these lenders have more clearly defined products and processes and less flexibility than the smaller private lenders. Some, but not all of these lenders will be regulated by the FCA and undertake regulated lending. Specialist banks There are several UK specialist banks that offer bridging finance. Some, but not all, raise monies by taking customer deposits. These banks are known as specialist banks as they have a limited range of specialist products and do not have a mass market for their products or branches like the high street banks. By taking advantage of their lower funding costs, specialist banks tend to be able to offer the most competitive interest rates. However, because they are highly regulated, they may have less flexibility when it comes to being able to complete loans that fall outside their product criteria. Some specialist property finance lenders will not accept enquiries directly from prospective borrowers and require them to use the services of a broker. Development finance Given that developments can range from building a single house to tall tower blocks or very large estates requiring significant infrastructure such as roads and social amenities such as schools required as part of the planning permission, there is an extreme range in the value and complexity of development finance that may be required. This is reflected in the range of lenders: specialist lenders and specialist banks tend to fund the smaller and moderate sized developments, while the largest developments will be funded by high street and international banks. Some developments will be funded by more than one lender. Commercial mortgages Unlike bridging finance, the commercial mortgage market is dominated by the large high street banks. Some specialist banks and specialist lenders also provide commercial mortgages. Interest- only loans, for example, tend to be provided by peer-to-peer lenders or private funders. Accordingly, there is less choice for customers and brokers when it comes to seeking a commercial mortgage. © The London Institute of Banking & Finance 23 Buy to let mortgages Buy to let mortgages are generally provided by high street banks, specialist lenders or commercial lenders. This variation in the types of specialist property lender means that, depending on the product sought, borrowers will experience differences in: loan size; maximum LTV; the types of property acceptable as security; interest rates; acceptable repayment strategies; the underwriting process and customer experience, including the use of technology; the approach to credit risk; and loan and legal documentation. Therefore, specialist mortgage brokers play a very important role in ensuring that the most appropriate lenders are approached for each customer and their specific specialist loan requirements. Otherwise, the borrower (and possibly lender) risk wasting valuable time and incurring costs. Occasionally, such delays can have extremely serious consequences such as a borrower failing to purchase a property or, if refinancing, incurring penalties from their existing lender. Check your understanding 1. When is a specialist property loan regulated under the FCA’s MCOB rules? a) When the borrower is a company. b) When it is a second charge loan for a business. c) When the security property is the borrower’s holiday home. Feedback: Where the security property includes the borrower’s (or their immediate family’s) own homes or holiday homes then the loan will be a regulated loan subject to the rules of the FCA under the Mortgage Conduct of Business (MCOB). (See section 1.3.1.) 2. Lenders providing specialist property finance vary in: ______. Select all that apply. a) their approach to credit risk. b) size. c) type. d) product offering. © The London Institute of Banking & Finance 24 Feedback: There is a wide variety of types of specialist property finance mortgage lenders ranging in size from small owner-managed banks to non-bank specialist lenders and specialist banks. There is therefore a variety of lender risk appetites as well as product offerings for borrowers. (See section 1.3.2.) 3. Which type of SPF lender is likely to offer the lowest interest rates to borrowers? a) Small owner-managed lenders. b) Non-bank specialist lenders. c) Specialist banks. Feedback: Specialist banks have lower funding costs, so tend to be able to offer the most competitive interest rates to borrowers. (See section 1.3.2.) 1.4 The life of a specialist mortgage Think… Before you start this section, consider what you already know about the loan process. For instance: Why do you think a lawyer might be involved in a transaction? Can you explain why a broker might be needed for a loan? Can you outline the differences between report on title and certificate of title? In this section we will explore the main components of the loan process. This will include looking at who is involved in the life of a specialist mortgage and understanding their responsibilities. 1.4.1 Borrowers Although every loan requires a borrower, it is worth noting that some loans will have more than one borrower and, on occasion, the borrowers may be a combination of individuals and companies. There is no upper limit on the number of borrowers in a loan transaction, but more borrowers will make processing the loan more complicated, as formal know your customer (KYC) and financial crime prevention due diligence will have to be undertaken for each borrower. KYC A process of obtaining information about the identity and address of customers to ensure that services are not misused. © The London Institute of Banking & Finance 25 FACTFIND To find out more about KYC, visit the following link. GOV.UK: ‘Know your customer’ guidance, accessible version Where a loan involves a trust, it is important to remember that unlike a company that has legal personality and can borrow under its own name, a trust has no legal personality, and so the borrowers will be trustees. Trustees may be individuals or companies. Responsibilities A borrower’s fundamental responsibilities are to: use the loan monies for the intended purpose; comply with their loan conditions during the term of the loan; and repay the loan within the original term or extended term (if extended). The best borrowers make full disclosure of all facts – negative and positive – to their broker (if one is acting) and to the prospective lenders at the earliest opportunity. This enables the broker to place the enquiry with the most suitable lender, and the lender to properly assess the case, make a decision and impose conditions based on full facts. Failure to make full disclosure runs the risk that a loan completion may be delayed or the lender withdraws from the loan. This can be either because facts come to light that require the loan to be restructured or the lender becomes unwilling or unable to complete the loan, eg if they discover something that ought to have been disclosed, they can become concerned the borrower is withholding other pertinent information and may choose to withdraw. Most loans come with conditions. The borrower should comply with their loan conditions and engage with their lender when they foresee or encounter problems in complying with those conditions. 1.4.2 Guarantors One of the advantages of limited liability companies for shareholders is that their liability in respect of company business is limited to the value of their shareholding. Accordingly, if a company defaults on its loan and the lender is unable to recover all sums owed to it from the sale of the security property, the lender would only be able to seek to be repaid from the other assets of the company. The effect of this is that the shareholders have no personal liability for the loan and could, in theory, simply absolve themselves of all responsibility. © The London Institute of Banking & Finance 26 Lenders naturally prefer for people to have personal liability for a loan as a means of encouraging responsible behaviour and repayment of the loan by their corporate borrower, so that a failure to repay the loan to a company will personally impact individuals. This is usually achieved by shareholders providing a legally binding guarantee, guaranteeing the repayment of the loan and potentially putting their own assets at risk if there is a borrower default – just as a personal borrower’s assets are at risk. Guarantors will usually seek to limit their liability under the guarantee either to the amount of the loan capital, interest and costs (including legal and others incurred by the lender recovering sums due) or alternatively have liability capped at a certain negotiated amount, ie a guarantee could be for a certain fixed sum or calculated by reference to a percentage, eg 10% of the amount outstanding. In some cases, the guarantor may be another company, for instance the parent company of the borrower, which may have more assets and a greater worth than the borrower company. These are known as corporate guarantees. Some loans may even involve a combination of personal and corporate guarantees. You may also hear the expression of ‘standing as surety’ to describe a guarantor. Lastly, although guarantees are usually provided where the borrower is a company, it is also possible for guarantees to be provided where the borrower is an individual. A typical example is where a parent stands as guarantor for a loan to their child. Responsibilities As a non-principal actor in a loan, the guarantor can be regarded as passive until called upon by the lender to fulfil their obligation under the guarantee that they have provided. In reality, however, many guarantors are shareholders in (as well as directors of) the borrower company and so will be active in the business of the borrower company and in ensuring that the loan and its repayment are running smoothly. Whatever the guarantor’s relationship to the borrower, they should be monitoring the progress and repayment of the loan to ensure that they are aware of how likely, if or when they might be called upon to fulfil their obligations under the guarantee that they have provided. 1.4.3 Lenders Every loan needs a lender and, as we saw in section 1.3.2, there is a very broad range of active specialist property finance lenders. Responsibilities Lenders have a wide variety of responsibilities. These include: © The London Institute of Banking & Finance 27 ensuring that they have the correct regulatory authorisations before processing the loan; ensuring that all appropriate KYC and financial crime prevention due diligence are undertaken; ensuring that they are acting responsibly by granting the loan; ensuring that the loan is properly conditioned and satisfying themselves that the borrower fully understands the conditions of the loan; using their best endeavours to ensure that the loan completes on time or completion is not delayed by inadequate procedures and processing; staying in regular contact with the borrower and managing the loan; working with the borrower if there are issues and considering if further advances and/or term extensions are appropriate, if requested by the borrower; and managing the borrower’s expectations as to what they need to provide and when the loan is likely to complete. 1.4.4 Brokers Although there are no published authoritative statistics, it is likely that most specialist property loans involve the services of a broker. Also known as intermediaries, brokers are instructed by and act on behalf of the borrower – they are not an agent of the lender. Responsibilities Brokers also have a wide variety of responsibilities. These include: ensuring that they have the correct authorisations before processing the loan; ensuring that all appropriate KYC and financial crime prevention due diligence are undertaken; ensuring that they are acting responsibly by accepting the borrower’s instructions; always acting in the borrower’s best interests, eg placing the loan with the lender most suitable for the borrower and not being influenced by the amount of commission they will receive; ensuring that the borrower properly understands the conditions of the loan; working with both the borrower and lender to ensure that the lender receives the information it has requested; managing the borrower’s expectations as to what they need to provide the lender and the anticipated completion date; and if appropriate, staying in regular contact with the borrower during the loan and assisting with the repayment and any term extension. © The London Institute of Banking & Finance 28 1.4.5 Lender’s solicitors The extent of the involvement of the lender’s solicitors in any specialist property finance transaction will vary case by case and much will depend on the complexity of the case, eg the number of borrowers and security property and whether there are any legal or other issues with the title to the security property. Responsibilities The following are the key responsibilities of lenders’ solicitors: The single most important responsibility is to ensure that the borrower’s security (the charge over the security property) is enforceable. This is often referred to as ‘the lender having good title’. In most loans, before the loan completes, the solicitor firm produces a report on title/certificate of title (ROT/COT). This is a document by which the solicitor guarantees to the lender that the lender has good security over the security property in the form of a charge and that if the borrower defaults, the lender will be able to sell the property in order to effect repayment. It is restricted to legal issues and is not a guarantee that the lender will not have any issues or problems with the property. Problems arising from the condition of the property and/or the borrower’s behaviour are not covered by a ROT/COT. Ensuring that the standard terms in the loan agreement are enforceable. Note that some lenders have their solicitors draft the loan agreement, in which case the solicitors will also be responsible for ensuring that the loan’s specific conditions are appropriate. Liaising with the borrower’s solicitors in a timely and constructive manner to ensure that the borrower’s solicitors are aware as to what information and documentation the lender’s solicitors require. Ensuring that the lender’s charge is registered at Land Registry within the priority period (a period of time whereby the rank of the lender’s charge is guaranteed, eg that it will be a first ranking charge) and if the lender has also taken a debenture over the borrower company’s assets, that the debenture is registered with Companies House no later than 21 days from creation. 1.4.6 Borrower’s solicitors As with the lender’s solicitors, the extent of the involvement of the lender’s solicitors in any specialist property finance transaction will vary case by case. The level of their involvement with the case will depend on the complexity of the case, eg the number of security property and whether there are any legal or other issues with the title to the security property. © The London Institute of Banking & Finance 29 Responsibilities The borrowers’ solicitors’ key responsibilities include the following. Perhaps the borrower solicitor’s most important responsibility is to ensure that they are satisfied that their client understands: ─ the terms and conditions of the loan they are entering into; and ─ the risks involved if their client fails to repay the loan or commits a breach of the loan conditions. Much will depend on the sophistication of the borrower and the complexity of the transaction. The advice and assistance provided by a solicitor to an individual borrower offering relatively straightforward security for the loan will differ greatly from that where they are acting for a large company, which may even have its own in-house legal team assisting. The borrower’s solicitor should also liaise with the lender’s solicitors in a timely and constructive manner to ensure that the lender’s solicitors are provided with the information and documentation they have requested. 1.4.7 Surveyors Surveyors (also referred to as valuers) are a key service provider in most specialist property finance loans. Although some specialist property finance loans utilise the services of automated valuation models (AVMs), which use modelling and data to determine the value of the security property offered as security, AVMs are most appropriate where the property is fairly standard (such as one of a row of terraced or semi-detached houses) to provide sufficient comparable evidence for the modelling. AVMs will be covered further in Topic 6. Responsibilities Lenders place tremendous reliance on valuation reports as the value of their security underpins the loan. The valuer is expected not only to provide confirmation of facts, such as the number of bedrooms and the size of the property, but also make the lender aware of issues or concerns with the property such as the condition and whether there are any factors that might affect its saleability. Most valuation reports also provide some commentary on the immediate neighbourhood. For example, the near presence of overhead power lines or the property being on a busy road might detract some potential purchasers, making a property much harder to sell. Valuers should always justify their valuation figures by reference to comparable property sales or state when and why this is not possible. © The London Institute of Banking & Finance 30 Valuation reports are usually accompanied by photographs, with some lenders specifying precisely what they want to be photographed. 1.4.8 Panel managers Most lenders have lists of valuer firms that are acceptable to them. These lists are also known as panels and the surveyors on the list are known as panel surveyors or panel managers. Organising valuers to attend properties can be complicated and time-consuming, with borrowers needing to arrange payment as well as a suitable time and date for the valuer to attend. On occasion, finding a valuer can prove problematic, especially in more rural locations. Accordingly, some specialist lenders make use of panel managers to manage the appointment of surveyors. Portals and other internet-based tools are often used in the instruction process. Responsibilities Panel managers take on the responsibility of arranging the valuation report. Where the lender has certain restrictions or requirements, such as how far a valuer can be based from the subject property, the panel manager will ensure that only a qualifying firm is instructed. They also undertake due diligence on the valuer firms, for instance ensuring that they have adequate professional indemnity insurance to meet lenders’ requirements. Panel managers may also undertake quality control audits of valuation reports. 1.4.9 Monitoring surveyors Most development loans involve the release of sums of money at various stages (stage payments). Before the payments are released, it is common for lenders to be satisfied that the development is progressing to plan and that the monies are being released either to reimburse the developer for costs they have incurred and/or to put the developer in funds, for instance to purchase windows in advance. Responsibilities Monitoring surveyors ensure a development project is being completed to the required standards and expectations. They: ensure project specifications are adequate; monitor project timescales; ensure the build quality is sufficient; © The London Institute of Banking & Finance 31 deal with any issues or variations to the contract; sign off on interim payments; and conduct a final defect inspection. Ultimately, monitoring surveyors ensure that development work is properly executed and that the lender’s investment is protected. 1.4.10 Funders If a lender is not a bank that raises funds by taking customer deposits, then it will need its own funder(s). Funders include wealthy individuals, loans and very large international investment banks. Smaller specialist lenders often require their own funder to approve loans. Some funders may need to approve every loan. Others may need to only approve loans above a certain amount or where there is an exception being made. The extent and frequency of the funders’ involvement and/or requirement to pre-approve loans will depended on each funding agreement (also known as the funding line). Responsibilities Ultimately, what the lender requires of their funder is confidence that the funds will be available for the lender to complete the loan. Funders should communicate their requirements and any concerns in a timely manner to the lender. If a funder decides to decline to fund a specific loan, then they should advise the lender at the earliest opportunity so that the lender can communicate to the borrower or broker a decision not to proceed with the loan. The earlier the borrower or broker receives a decision to decline a loan, then the longer they have to seek funding elsewhere. Check your understanding 1. What is another term for brokers? a) Agents of lenders. b) Intermediaries. c) Trustees. Feedback: Also known as intermediaries, brokers are instructed by and act on behalf of the borrower – they are not an agent of the lender. When a loan involves a trust, the borrowers (individuals or companies) are the trustees. (See section 1.4.1 and section 1.4.4.) 2. Who is responsible for ensuring that a lender’s charge is registered? © The London Institute of Banking & Finance 32 a) Land Registry. b) The borrowers’ solicitors. c) The lender’s solicitors. d) Guarantors. Feedback: It is the lender’s solicitors’ responsibility to ensure that the lender’s charge is registered at Land Registry within the priority period. (See section 1.4.5.) 3. Which of the following applies to panel managers? Select all that apply. a) Assisting lenders in finding valuers to value properties in remote locations. b) Undertaking due diligence on valuer firms. c) Justifying valuation figures by reference to comparable property sales. d) Monitoring project timescales. Feedback: assisting lenders in finding valuers to value properties in remote locations and undertaking due diligence on valuer firms are some of a panel manager’s responsibilities. Surveyors are responsible for justifying valuation figures by reference to comparable property sales and monitoring surveyors are responsible for monitoring project timescales. (See section 1.4.7, section 1.4.8 and section 1.4.9.) 4. Guarantees can be required for loans to corporate borrowers and loans to individuals. Is this statement true or false? a) True. b) False. Feedback: Although guarantees are usually provided where the borrower is a company, it is also possible for guarantees to be provided where the borrower is an individual. A typical example is where a parent stands as guarantor for a loan to their child. (See section 1.4.2.) 1.5 The legal process Think… Before you start this section, consider what you already know about the differences between mainstream lending and specialist property finance. For instance: Why might the legal process for SPF be more complex than that of mainstream lending? How might professional indemnity insurance be an important aspect of the legal process? Why might the developer and landowners need to enter into legal agreements? This section will explore the legal process of mainstream lending and SPF. © The London Institute of Banking & Finance 33 1.5.1 Mainstream lending The legal process for mainstream loans reflects their relatively uncomplicated nature, although there are differences where the loan is being used for a property purchase and where it is a refinance. Mainstream purchase mortgages For purchases, the borrowers will usually have their own solicitor firm to represent them, with another (panel) firm acting for the lender. A third firm of solicitors will act for the vendor. The conveyancing process for most loans is standardised with a set of questions known as requisitions flowing between the firms. Conveyancing The legal transfer of property rights from one owner to another. The borrowers will usually attend their solicitor’s offices for the purposes of KYC, having the mortgage explained to them and having certain legal documents executed in the presence of the solicitor. Mainstream refinance mortgages Mainstream refinance transactions typically involve only one firm of solicitors, normally chosen from the lender’s solicitor panel who represent and act for both lender and borrower. There is usually less legal work involved because the borrowers already own the security property. In such cases, the mortgage documents are typically sent electronically to the borrower, who does not attend to the solicitor’s offices. 1.5.2 Specialist property finance transactions As we have seen, specialist property finance is characterised by complexity and, in many cases, the borrowers are also financially sophisticated. In almost all specialist finance property transactions, the borrower is represented by their own solicitor firm, as with mainstream purchase mortgages. It is also common for the solicitor firm acting for the borrower to have a pre-existing relationship with the borrower, perhaps having acted for them in several transactions. For larger or more complex loans where specific expertise is required, both lenders and borrowers may instruct the services of solicitor firms that have specialist departments and very large amounts of professional indemnity insurance. © The London Institute of Banking & Finance 34 Professional indemnity insurance An insurance product designed for individuals or businesses that provide advice or instructions. Professional indemnity insurance provides cover to the policyholder if the advice supplied results in financial loss for clients. It is worth noting that for all specialist property finance loans, solicitors produce a report on title for the lender confirming that the lender is obtaining the security it requires over the security property. Looking at each product in turn: Bridging finance Although most loans will involve the borrower being represented by their own solicitor, some lenders offer a dual-representation product for more straightforward cases where one firm will act for both lender and borrower. Many bridging lenders will use title indemnity insurance whereby they undertake limited investigation into the legal title of the security property. The lender will be covered for any losses if there is a problem with the property title in the future. The use of title indemnity insurance can also speed up the process as solicitors do not have to obtain local authority searches and – together with the lender – may be able to take commercial views on certain issues that would otherwise require a lengthy investigation. Development finance There are two particular areas of legal focus on development finance. The land – in addition to the usual title investigation, solicitors need to ensure that the developer (and the future occupiers) will have access to the site and the ability to lay down services, such as electricity, gas and broadband, and connect these to the various grids. Often this will involve access to or involvement with adjoining land and require the developer to enter into legal agreements with those landowners. Structure of the loan facility – as seen above, many development loans involve structuring of matters such as: Precisely what development costs will be funded? When will monies be released? This may require considerable legal input and drafting expertise. Who is responsible for the payment of the various fees and charges of third-party professionals such as quantity surveyors, monitoring surveyors and other experts whose input may be required during the course of a (especially larger) development? © The London Institute of Banking & Finance 35 Where there are multiple units, how will the sales process be dealt with? For instance, will the developer be allowed to keep all or some of the sales proceeds? Or must they wait until the facility has been repaid in full? Commercial mortgages The legal process for commercial mortgages is similar to residential mortgages. The main difference is that most residential purchases include the freehold, meaning the buyer owns the property forever, whereas many commercial properties are leasehold, where the property is owned for a finite amount of time. It will focus on the obligations of tenants to maintain, repair and insure the property. Solicitors will also check the basis upon which rent is charged and the mechanism for future rent increases as well as the various charges that might be imposed on tenants. Commercial leases also involve setting out who is responsible for the condition of the property at the end of the lease, eg to repair the property or reinstate it to the condition it was in at the beginning of the lease. What are dilapidations? You may come across the term ‘dilapidations’, which is the term for: the process a landlord needs to follow to recover any loss they may have suffered as a result of the tenant's failure to return the property to [them] at the end of the lease having reinstated any items of damage or disrepair in accordance with the repairing standard. lindsays (no date) Buy to let mortgages For most buy to let mortgages, the legal process is relatively straightforward as the security property is, by definition, residential. Legal complexity is likely to arise where there are larger portfolios with complex ownership structures. Lenders will take some comfort from the fact that a borrower has a pre-existing relationship with their solicitors. This is because it reduces the risk of identity fraud and the solicitor may have material knowledge of their client’s business affairs and the transaction to which the loan relates, which enables the lender’s solicitor to assist with the borrower’s solicitor’s questions and concerns. For specialist property finance transactions, the requisitions are likely to include transaction-specific questions alongside the more standard ones. Because of the nature of specialist property finance transactions, the legal aspects can become complicated, and this will be reflected in the legal documentation. For instance, © The London Institute of Banking & Finance 36 loans to companies are likely to involve the lender requiring a debenture – essentially a charge over all of a borrower company’s assets, and not just a charge over the primary security property – as well as guarantees. Where the borrower has other pre-existing loans with other lenders, this may also require an additional amount of legal work and documentation. Borrowers are very likely to need to attend their solicitor’s offices, perhaps on multiple occasions. Where the borrowers are individuals, the lenders may require the borrowers to obtain formal legal advice in connection with the loan and to sign a document or certificate confirming that they have received such advice. The main exception is short-term bridging loans where some lenders have products in which the lender offers dual representation, ie one firm acts for both lender and borrower. Check your understanding Lenders will generally view the fact that a borrower has a pre-existing relationship with their solicitor as: a) Positive. b) Negative. Feedback: Lenders will take some comfort in the fact that a borrower has a pre-existing relationship with their solicitors as it reduces the risk of identity fraud. (See section 1.5.2.) Activity 1.1: case study Sita and Anil wish to purchase their first house but there are several complicating factors. Sita’s elderly mother, Roopa, wishes to move into the annexe and has offered to contribute around 50% of the purchase price. This is in addition to the sale proceeds of overseas investments via an inheritance, which will make up their contribution to the purchase price with the balance coming from a mortgage. None of them are sure if, for inheritance tax purposes, it is better for Roopa to be a co-owner of the new property. Anil has resigned from his job and is currently on gardening leave. He will start his new job in six months’ time, but they need to complete the purchase as soon as possible or risk losing the property. The property they intend to buy has a large rear extension, which was added several years ago, but the owners at the time did not obtain planning permission. Sita and Anil are concerned that this issue may affect their ability to obtain a mortgage for the property. Sita and Anil think they may be able to pay off all or at least part of their mortgage finance when © The London Institute of Banking & Finance 37 the balance of the inheritance monies is received, which may be in the next 12 months. They are uncertain what to do. 1. Who should Sita and Anil approach for assistance? a) A solicitor. b) A lender. c) A finance broker. Feedback: There are many issues concerning Anil and Sita, including Anil’s employment status, Roopa’s involvement, the source of funds for their contribution to the purchase price and the planning issue, which make it unlikely that they would be able to apply online or even qualify for a residential mortgage. Further, Sita and Anil are uncertain what to do. In such a case, it would make sense for them to seek the assistance of a broker with specialist property finance experience and expertise. The broker may also be able to put them in touch with someone who could separately advise on any inheritance tax issues and use that advice when structuring the mortgage. 2. What are some of the considerations that might apply to the structuring of the purchase and the mortgage? Select all that apply. a) The term of the loan. b) Anil’s employment situation. c) The repayment strategy. d) Roopa’s contribution. Feedback: The broker working alongside the lender(s) needs to consider how Roopa’s contribution to the purchase price is acknowledged. For instance, should she also become an owner (proprietor) of the purchase property? They also need to consider how Roopa’s contribution and residing at the property affect the lender’s security. The term of the loan is also an issue as there is a possibility that they may be able to repay the loan within a relatively short time. All lenders will have to understand Anil’s employment situation and how that affects the monthly interest payment affordability. They might decide that a short- term bridging loan – where monthly payments are not required – is appropriate, but they need to consider whether the repayment strategy is viable and consistent with such a loan. 3. As the property has a large rear extension that was built without planning permission, it is definitely not mortgageable. Is this statement true or false? a) True. b) False. Feedback: Specialist lenders will be able to consider whether the lack of planning permission is still a live issue with the local authority after so many years. A specialist lender could also consider whether they could insure any risk concerning the lack of planning permission. © The London Institute of Banking & Finance 38 They could also obtain the advice and professional opinion of the valuer who attended the property to undertake the valuation report. Conclusion Think again… Now that you have completed this topic, how has your knowledge and understanding improved? For instance, can you: identify the characteristics of specialist property finance that differentiate it from mainstream residential or commercial mortgages? explain why different types of customers require specialist property finance? identify each party in a specialist property finance transaction and describe their main responsibilities? understand the role of specialist mortgage brokers and explain why they are so important? identify the main lenders that offer specialist property advice? Test your knowledge 1. Which of the following applies to both SPF and residential mortgages? a) Property is used as security. b) A very broad range of repayment strategies. c) Terms that are 18 months’ long. Feedback: Residential mortgages and SPF are both loans taken out by borrowers that are secured on property by way of charges and require repayment according to their respective terms and conditions. However, specialist property finance lenders will typically have broader ranges of acceptable property types, uses of the loan (for example short-term bridging loans with 12-month terms) and repayment strategies. (See section 1.1, section 1.1.1 and section 1.2.) 2. The legal definition of a specialist property finance loan is ‘a loan secured on property that falls outside the normal parameters of a residential mortgage’. Is this statement true or false? a) True. b) False. © The London Institute of Banking & Finance 39 Feedback: There is no legal definition of what constitutes a specialist property finance loan. (See section 1.1.) 3. Which of the following can have legal personality? Select all that apply. a) Individuals. b) Businesses. c) Organisations. d) Trusts. Feedback: Individuals, businesses and organisations are all able to enter into contracts, own property, sue and be sued, and therefore all have legal personality. A trust has no legal personality. (See section 1.3.1 and section 1.4.1.) 4. What does HMO stand for? a) House of mainstream owner. b) House of multiple occupation. c) High mortgage offer. Feedback: Specialist lenders of some bridging loans, commercial mortgages and buy to let mortgages will accept houses of multiple occupation (HMO) as security. (See section 1.2.1.) 5. Which type of SPF is not provided by high street banks? a) Bridging finance. b) Development finance. c) Commercial mortgages. Feedback: Bridging finance is provided by small owner-managed banks, non-bank specialist lenders and specialist banks. (See section 1.3.2). 6. Disclosing all facts, both positive and negative, is a main responsibility of the: a) lender. b) funder. c) borrower. Feedback: The borrower should provide full information to the lender. Failure to make full disclosure may cause the loan completion to be delayed, or the lender to withdraw from the loan. This can be because facts come to light that require the loan to be restructured or should have been disclosed earlier, making the lender concerned that the borrower is withholding other pertinent information and therefore the lender becomes unwilling or unable to complete the loan. (See section 1.4.1.) © The London Institute of Banking & Finance 40 7. What can a guarantee cover? Select all that apply. a) The full loan capital. b) Accrued interest. c) Legal costs. d) Liability is capped at a negotiated amount. Feedback: Guarantees are usually for the full amount of the loan, interest and costs (including legal costs), but it is also possible for a guarantor to negotiate the guarantee to be for a certain fixed sum. (See section 1.4.2.) 8. The report on title (ROT) also known as a certificate of title (COT) is a guarantee that there will be no problems or issues with the property. Is this statement true or false? a) True. b) False. Feedback: ROT or COT is restricted to legal issues and confirms that the lender will have good security in the form of a charge over the property. Problems arising from the condition of the property and/or the borrower’s behaviour are not covered by a ROT/COT. (See section 1.4.5.) 9. Who should be in regular contact at certain points during the life of a specialist mortgage? Select all that apply. a) Borrower and lender. b) The borrower’s solicitors and the lender’s solicitors. c) Funders and lenders. d) Broker and surveyor. Feedback: Borrowers and lenders should stay in contact so the lender is aware of any problems and can manage the loan. The solicitors of the borrowers and lenders should liaise with each other to ensure all required documents and information are shared in a timely manner. Funders should communicate their requirements and any concerns in a timely manner to the lender. If appropriate, brokers should stay in regular contact with the borrower during the loan to assist with the repayment and any term extension. (See section 1.4.1, section 1.4.3, section 1.4.4, section 1.4.5, section 1.4.6 and section 1.4.10.) 10. Which type of loan usually requires the borrower to attend the solicitor’s office? Select all that apply. a) Mainstream purchase mortgages. b) Mainstream refinance mortgages. c) Specialist property finance transactions. Feedback: Borrowers will usually attend their solicitor’s office for KYC, to hear explanations about the mortgage and for the execution of legal documents when they are applying for a © The London Institute of Banking & Finance 41 mainstream purchase mortgage. There is less work required for mainstream refinance mortgages as the borrower already owns the security property; therefore they do not need to attend the solicitor’s office and the documents can be sent electronically. Specialist property finance transactions are much more complicated than mainstream mortgages, so borrowers are likely to attend their solicitor’s office multiple times. (See section 1.5.1 and section 1.5.2.) References GOV.UK (2022) Policy paper: factsheet: limited partnerships [online]. Available at: www.gov.uk/government/publications/economic-crime-and-corporate-transparency-bill- 2022-factsheets/fact-sheet-limited-partnerships legislation.gov.uk (2020) The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 [online]. Available at: https://www.legislation.gov.uk/uksi/2001/544/article/60C/2020-05-04 lindsays (no date) Dealing with dilapidations – the repairing liability at the expiry of a case [online]. Available at: www.lindsays.co.uk/news-and-insights/insights/dealing-with- dilapidations-the-repairing-liability-at-the-expiry-of-a-lease Moneysupermarket (2023) About commercial mortgages [online]. Available at: www.moneysupermarket.com/business-finance/commercial-mortgages/ PRA (2016) Supervisory statement: underwriting standards for buy to let mortgages [pdf]. Available at: www.bankofengland.co.uk/-/media/boe/files/prudential- regulation/supervisory-statement/2016/ss1316 PRA (2020) Buy to let mortgages: how do lenders account for tax when assessing affordability? [online]. Available at: www.bankofengland.co.uk/bank-overground/2020/buy- to-let-mortgages-how-do-lenders-account-for-tax-when-assessing-affordability © The London Institute of Banking & Finance 42 Topic 2 Regulation of lending activities Introduction Watch In this topic we will explore the different types of regulation with regard to lending activities, what regulated advice means, when it is needed and who can provide it. We will also cover key principles related to dealing with customers and explore considerations with regards to financial crime. Learning objectives By the end of this topic, you should be able to: outline the difference between prudential and conduct regulation and the FCA and the PRA; identify when a mortgage will be regulated or non-regulated; understand the permissions needed to advise on, introduce or place different products; outline key principles around customer protection and the legal environment; understand the basics of financial crime. 2.1 Regulation Think… Before you start this section, consider what you already know about regulation with regard to lending activities. For instance: Do you know the names of the two regulators responsible for the regulation of UK financial services? What permissions might be required in relation to regulated mortgages? What arrangements might not require a regulated mortgage? There are two types of regulation in the context of financial services: Prudential regulation covers the financial strength and stability of financial firms whose collapse or financial weakness could be detrimental to the UK financial system. It aims to ensure large firms have sufficient capital to carry out their business activities and adequate systems to manage any potential risks. An example would be the requirement to hold sufficient funds in an appropriate form (separate © The London Institute of Banking and Finance 1 from any funds supplied by depositors) to cover any losses due to borrowers defaulting on the repayment of loans. Conduct regulation covers the way firms design, market and administer their products, and provide advice and service to consumers. It aims to ensure consumers have products that suit their needs and that fair value is provided. It covers areas such as business practices, honesty and integrity, disclosure of relevant information, competence of management and staff, and marketing practices. 2.1.1 The regulators There are two regulators responsible for the regulation of UK financial services: the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). The PRA is part of the Bank of England and is responsible for the prudential regulation of banks, building societies, insurers and major investment firms, looking at the bigger picture with a view to identifying and understanding the main threats to the stability of the financial system. The firms it regulates are those whose financial problems would have the greatest negative impact on the financial system as a whole. The FCA is a company limited by guarantee with statutory powers conferred by various pieces of legislation. The FCA’s board, which makes its policy decisions, is appointed by the Treasury, which has overall responsibility for the UK financial services industry. The FCA is responsible primarily for the conduct of wholesale and retail financial markets, particularly in relation to providing products and services to customers. The FCA also has responsibility for the prudential regulation of around 49,000 smaller businesses not subject to PRA regulation, such as financial advisory firms, brokerages and smaller investment firms (businesses whose financial problems would not impact on the stability of the wider market). In simple terms, the PRA is responsible for the way in which large firms manage their assets and maintain financial stability, and the FCA is responsible for the way all firms market and sell their products, and how smaller firms manage their assets and maintain financial stability. Firms such as banks and building societies that market their products to the general public will be ‘dual regulated’. This means the PRA is responsible for their prudential regulation and the FCA for their market conduct. 2.1.2 Authorisation and permissions In order to provide financial services in the UK, firms must be authorised by either the PRA or the FCA, depending on the type of business engaged in. Once a firm is authorised, it will be given permission to carry out certain regulated activities relating to regulated products. A firm cannot enter into regulated activities for which it does not hold specific permission. Regulated activities and regulated products © The London Institute of Banking and Finance 2 Regulated products are the individual products that are regulated, such as investments, pensions, mortgages and loans. Regulated activities are the actions and activities a firm can undertake in relation to regulated products. With regards to lending, the FCA has listed a number of activities that require specific permissions and are defined as regulated home finance or consumer credit activities. 2.1.3 Regulated home finance (the regulated activity) Regulated home finance activities cover mortgages and other arrangements for buying property as a residence. They are subject to regulation under the Mortgage

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