In a banking crisis, it pays to be upfront with lenders

After the Liz Truss/Kwasi Kwarteng debacle, Rishi Sunak and Jeremy Hunt have steadied the ship. Although I do not agree with parts of the recent Spring Statement, they are doing what they believe needs to be done to get the UK back on the growth ladder. My own view is that we need to see a growth agenda – and sooner rather than later.

Meanwhile, we have had a mini banking crisis to contend with, with Silicon Valley Bank UK sold for a £1, a significant part of Signature Bank in the US sold to New York Community Bank for $2.7bn and Credit Suisse rescued by UBS for $3.25bn. Will there be more casualties?

There might be, as some depositors might be thinking twice about keeping their money in smaller banks. JP Morgan and BlackRock have already confirmed a recent boost to their funds, a good deal of which came from smaller banks. President Biden publicly stated that the US will stand behind depositors, but is that sustainable and will it matter?

The position is somewhat different in the UK. I happened to be in Newcastle for a meeting with the city council on the day that huge queues of people formed outside the Northern Rock Building Society in September 2007. On the way from the station to our meeting, I asked some of them why they were worried as the government had agreed to guarantee all deposits. It fell on deaf ears. We were witnessing the first run on a bank since the 1860s and this was nothing other than panic.

Many small businesses both in the UK and the US use smaller lenders, but as Irwin Stelzer, writing recently in the Sunday Times, pointed out, some of them have already rolled up the welcome mat.

In my view, credit in the UK could begin to tighten as banks move to bolster their capital and give themselves an increased liquidity buffer, so how do we approach this?

We have seen a very significant rise in building costs in the last three years and with increased borrowing costs, this means land values could only go one way, which is not up.

If one is a borrower, say, against a residential or commercial development site and bought in the good times at top value with cheap money at a floating rate, with the fall in value, distress might well have arrived. What does one do, if with a residential site, there is no prospect of a change in use to a more lucrative alternative asset class? In respect of a commercial site, particularly in the regions, current rental values make many office schemes unviable.

What does the bank do? They can force a sale and crystalise a loss, do nothing and wait for better times or agree to work with their borrower, if there is a realistic prospect of a gross development value that allows the bank to retrieve all or nearly all of their monies. This would mean that they would have to advance additional funds, credit conditions permitting, and accept that rents are likely to rise.

In 1989, my then partner and I bought a freehold office building at auction for £805,000 in Kentish Town, London, near the station. It was a 6,000 sq ft property let to the Secretary of State for Social Security for four years at the low rent of £42,750 per annum. They had been there since 1946 and we were pretty sure that that they would renew on expiry at a higher rent. We secured a loan from a clearing bank, but to protect our position, we sought and obtained planning permission for a new office building of 11,000 sq ft.

In the early nineties, the market went into a severe downturn and the value of our property declined significantly. What made matters worse was that the tenant had advised us that they wished to surrender their lease, so they would not be renewing in 1993. Our position was rather dire, to say the least, but we kept our cool.

I have learned to be 100% up front with our lenders. They are used to bad news, so if you have any, tell them.  Needless to say, the bank wanted the loan repaid, as by this time the loan was in excess of the value; yes, LTV well in excess of 100%.

We were not in a position to do so, but I told them that we would continue to pay the interest if they would give us more time to see what we might achieve with our tenant.

The tenant wanted to surrender their lease and offered us all the rent up front, all the rates, estimated running costs and some monies for dilapidations. We turned it down as it would only repay the bank about 50% of their loan and I did not want an empty building in Kentish Town in a downturn. However, we told them that we would release them if another government department took a pre-let of our proposed new building.

There are always government requirements around and lo and behold, the Department of Employment had a 10,000 sq ft Camden office requirement at the time. With rental values having fallen to low levels, our scheme was in theory unviable. However, as a former office agent, I have always observed that, if a tenant wants a building, they will pay the rent even if it is in excess of current rental value. We told them the rent we needed to make it work for us, as with the expected recovery in the economy, rental values would rise.

We agreed a 25-year lease with them and because we had always been transparent with our bank, they agreed to advance further monies to carry out the development notwithstanding credit was tight.

We completed the scheme in 1993, repaid the bank in full and then refinanced, subsequently selling the property in 1996. They renewed their lease in 2008, continuing to occupy it as a job centre. The property is now owned by Wittington Investments Ltd, which is controlled by the Garfield Weston Foundation.

I was CEO of Palace Capital plc for 12 years and was very proud of the strong and fruitful relationship we had with our lenders. If there was a problem, which was rare, we told them and that is the only way to go.

Our industry is in for some hairy times in the next year or two as distress is coming to the fore, but our banks are stronger now than in 2008. There is a worry when you hear from Morgan Stanley that $1.5tn of loans in the US will need to be refinanced by 2025. This of course will have some effect here, but maybe not as much as people fear.

As usual, the IMF recently talked the UK down. Fortunately, they are usually wrong about the UK, which always punches above its weight. In our industry, if lenders and borrowers can work together, much pain will be avoided. However, there needs to be trust on both sides.