The evolution of bridging

The bridging market now bears little resemblance to that of ten years ago.  In a recent survey by EY Financial Services Corporate Finance team, 79% of lenders surveyed believe the market size to be more than £3billion with 29% estimating it to be over £5billion.

The actual size of the bridging market cannot be measured as it comprises a large number of smaller lenders across the country with no formal register of who is lending. But 60% of those surveyed by EY expect the market to continue to grow over the next six months.

Historically bridging may have been seen as lending of last resort but this is no longer the case. Many firms are now as respectable, and well run, as any mainstream mortgage lender.  And, there is a growing awareness of the valuable role that bridging and short-term lending plays, not only for home owners but particularly for businesses and developers.

The Association of Short Term Lenders has played a big part in this growing respectability. While there were always reputable bridging lenders, the ASTL’s code of conduct and Values Charter, helped raise standards across its membership and in turn across the market.

What did not change as quickly was the perception of bridging as a place to make quick money.  The credit crunch, followed by the implementation of the Mortgage Market Review (MMR), saw returns in the mainstream market plummet as readers of MFG will be well aware. The bridging market meanwhile, with its flexible underwriting and case-by-case lending, remained relatively buoyant.

There has consequently been an influx of new lenders over the past few years, each viewing the bridging industry as the way to make the returns no longer available either on the High Street or the stock market.

However, both small and larger lenders entering the bridging arena have discovered bridging is not the easy money it may appear to be. The rewards may be accompanied by risks, well known and catered for by professional bridging lenders through stringent due diligence. This has caught out many unwary smaller lenders, while larger names have discovered that, in order to put sensible measures in place to mitigate any risks, the returns are no longer what they expected. Hence, we have witnessed challenger banks particularly, coming into bridging, then leaving again.

Where some larger lenders have been more successful is in funding existing bridging lenders. This mitigates many of the risks while also providing higher returns that cannot be achieved through mainstream lending.

Purpose of bridging loans

Bridging has long since moved on from its original purpose as either a vehicle for auction purchase or for people buying a home before selling their existing one. While these are, of course, still valid uses of a bridging loan, far more prolific now is its use by developers, landlords and property investors to buy, refurbish and/or develop property.

Many businesses also turned to short-term lenders to provide them with finance, driven by a lack of commercial lending by high street banks. Consequently, businesses of all types now use bridging as a fast source of additional capital, borrowing against existing property to fund business acquisition, expansion or take advantage of other opportunities.

The EY survey conducted in March this year, found 32% of bridging loans were now for business use with 29% for refurbishment. Interestingly, almost a fifth (17%) were used for mortgage delays.

So, far from being the lending of last resort, bridging is increasingly the first-choice option, meeting a very specific need.

What hasn’t changed is the need for bridging and short-term loans to be both fast and flexible. This still calls for individual underwriting with each case looked at on its specific merits with a turn-around time of days if not hours. Achieving this while carrying out thorough due diligence both on the property and the borrower is key to success.

Exit routes are king

Responsible lending for bridging lenders is not about a borrower’s ability to make monthly payments but more about exit routes.

Unlike a twenty-year repayment mortgage, paid off in instalments over the term, bridging loans have more in common with interest-only with the entire sum paid off at the end. Only, in the case of bridging, it is more usually a loan term of between three and 24 months.  Therefore, the most fundamental issue affecting all bridging lenders is: what is the exit route and do I stand a realistic chance of having my funds returned within the set time period?

Key questions are: Is the borrower intending to move onto a longer-term loan or sell the property? Often a developer will buy a property in a state of disrepair, or one to adapt into flats or a house in multiple occupation (HMO), then take out a buy-to-let mortgage to let-out the completed properties.

Other property investors will plan to sell the property or properties once any work has been completed.  Consequently, a bridging lender has to weigh up how realistic that sale or refinance will be both within the forecast time period and for the amount the borrower is expecting to achieve.

Bridging lenders therefore need to understand more than just their own sector when looking to grant a loan. Every prudent bridging lender will want to know up front, the likelihood of their borrower obtaining a longer-term mortgage or sale.  They therefore also need to be in touch, both with the underwriting policies of mainstream lenders and the predicted movement of property prices in the region they are considering lending.

Of course, even over six months to a year, much can change and much can and will go wrong; it is therefore wise for the lender, the borrower and their broker to have contingency plans in place.

Default interest rates

The subject of default interest rates, is currently a hot topic. Default rates are a deterrent to help ensure borrowers pay their loan back on time. They can be charged from the day after a borrower reaches the end of their term if they haven’t paid back their loan.

Default rates can be anything from 0.6% to circa 5% per month, although it is hard to quantify exactly how much as few are declared publicly. As in all things, not all default interest is created equally however.

One factor is whether interest is charged daily or monthly. A low default interest rate does not save as much as it may appear if it is charged for a month on a loan paid back after just a few days.

The lower the LTV on a loan the more leeway a bridging lender will usually have. Because, typically, interest on a bridging loan is rolled up, on a higher LTV loan it can be unaffordable for a lender to extend a loan as this could lead to there being little equity left in the property.

It is this that makes almost any bridging loan over 75% LTV such a risk and why most prudent lenders will actively lend at lower LTVs unless they know the borrower well. Typically, it is the newer lenders who don’t appreciate this and move further up the curve to gain business and make a name.

Competition lowers rates

This brings me to the recent influx in competition. Both big names and small have entered the bridging arena over the past few years and while some remain, others have disappeared again, realising that bridging is a specialist area of lending that requires experience and skills to do it well.

There are still a number of new firms entering the sector however and the continual influx has done much to reduce rates.  Rates that were easily 1.5% per month a few years back can now be 0.6%pm or even lower.

The Association of Mortgage Intermediaries (AMI) spoke recently of anecdotal evidence that arrears were rising at bridging firms; this can only be the case if the lender lends imprudently or does not carry out sensible due diligence.  While no lending is risk free, established bridging lenders, focused on being here for the long term, will not take the level of risk that a newer firm trying to get established might.

P2P lending

The collapse of Lendy Finance recently raised questions over the role of this form of funding in bridging and its effect on the sector.

While P2P lenders do sometimes offer short-term lending, it is wrong to put these lenders in the same category as bridging when they often have very different lending practices, sometimes without the level of experience, due diligence and reserves that an established bridging lender will have.

All investment and lending types can be good when done well, but P2P needs sophisticated investors who understand that while rewards may be high it is because this is a riskier area of investment. Few investors will have any idea of the due diligence required to help secure returns when used as a bridging loan.

To regulate or not to regulate?

How to judge a good bridging lender from a bad one, and perhaps more importantly, how a broker or borrower can establish this fact, is a perennial problem.

Whether to regulate all lending types, including bridging and P2P, is an issue that has been debated for a number of years.  Following the MMR, any bridging lender carrying out ‘consumer’ loans had to become regulated in the same way buy-to-let was affected. All lenders carrying out any type of consumer lending therefore became regulated. Because of the badge of respectability that regulation held, a number of other lenders also raised their standards to those required by regulation and spoke to the FCA about becoming regulated, Hope Capital among them.

However, the FCA made it clear that it is only interested in regulating firms that carry out regulated business. So, a number of prudent bridging lenders who carry out business in a transparent and ethical way may not become regulated because they do not carry out regulated business.

The FCA’s rationale is sensible: developers, landlords or business owners who are borrowing against property as an investment or for a source of business income, do not require advice in the same way as a homeowner who intends to live in the property.

A look into the future

At the time of writing the three key topics pervading the bridging press are: default interest, whether peer-to-peer is tarnishing the reputation of the bridging industry and the regulation issue.

It is almost inevitable that more loans will end up being regulated. Whether it is good for the end borrower or not is a moot point, the belt and braces approach will almost inevitably see regulation creep into areas such as bridging at some point in the future.

The positive of a spotlight on this, should be that any lender still taking unreasonable risks will have to either raise their game or leave the market. Anything that improves the reputation of bridging still further will help raise its profile as a very real option for the right borrowers. This can only be of benefit to the sector and borrowers alike.

Hope Capital and other ethical, transparent lenders are helping to drive standards upwards, helping to inform and educate brokers and provide a good return for mainstream lenders who do want to enter the bridging market.

The speed and flexibility that bridging lenders bring has to be commended. The more automated solutions are introduced in the mainstream market, knowing there is a sector of lending where every loan is looked at on its own merits by a qualified individual, will continue to fill a much-needed gap in the market.

In terms of lender funding, technology will continue to drive new and innovative ways of raising capital. Some may well be for the better, but the FCA will have its hands full to identify and regulate every new line of lending and funding while still enabling the necessary innovation, to ensure lending in the UK remains at the forefront of the world.