Beginning with top-line loan categories, Jason explained that senior debt takes priority, usually secured by a lender’s first charge over tangible assets. Junior debt is subordinate to senior debt in an insolvency event or asset sale, and may be unsecured. Mezzanine debt sits between senior debt and equity in terms of repayment.

Loan pricing is assessed on a risk-reward basis, with senior debt the least risky and thus the cheapest. An intercreditor agreement should always be in place, to determine the underlying security and the priority of repayment between different loan classes.

An overdraft is a line of credit, allowing a borrower to withdraw funds up to an agreed limit, normally for a maximum of 12 months and repayable on demand. If there are no default events, a bank will give notice if the facility is to be withdrawn, normally 30 days. Often there are no subsequent conditions and/or covenants, as arguably, compliance with these requirements removes the lender’s right to ask for repayment upon demand.

A term loan is the most common for property transactions. It can run from three months to 30 years, and usually requires monthly or quarterly repayments. These could be interest only, capital and interest, or ‘bullet’ repayments. A loan agreement will usually contain conditions/ covenants detailing how the loan will operate.

Covenants

Common covenants include a maximum loanto-value percentage and minimum debt-servicing ratio. Others cover management information – tenancy schedules, monthly management accounts and audited annual accounts. Arrears and/or breaches of the covenants/conditions are a default event, allowing the lender to demand immediate full repayment.

A development loan

A short-to-medium term facility to assist with property development funding, structured on a ‘cost to complete’ basis, and usually advanced as initial funding towards land purchase, with further funds released as stage payments for development costs. A borrower puts in their stake/equity before the initial drawdown, future drawdowns are conditional (usually against quantity surveyor reports), and the loan repaid from the sale proceeds.

A revolving credit facility

is similar to an overdraft, but for an extended term and usually secured by a suite of core security. Borrowers can buy and sell properties without having to apply for a new loan on each occasion, provided the underlying conditions/ covenants are met. For instance, a maximum purchase price or maximum loan-to- value. Breach of the covenants/ conditions is a default event, allowing the lender to call in the facility.

Since 2007, the cost of capital has been the main driver in how banks Jason Martin, senior manager of Leonard Curtis Business Solutions Group, offered a detailed overview of loan terms and structures. Goodbye LIBOR, Hello SONIA Jason Martin - Leonard Curtis structure loans. It is a complex area, regulated by three bodies:
  • The Prudential Regulatory Authority (PRA)
  • The Financial Conduct Authority (FCA), and
  • The Basel Committee on Banking Supervision
A typical real estate investment loan secured over income-producing real estate is dubbed a ‘specialised lending exposure’ by the PRA and subject to a ‘slotting’ regime, which requires the bank to hold a set percentage of capital against the loan.

Banks use a borrower’s rating, security and loan term to judge minimum pricing and interest rate. The longer the term, and higher the loan’s risk, the more capital a bank has to hold to absorb potential losses.

We now see loans where full amortisation no longer takes place over the term, so for instance, a five-year term loan might require 15 years of capital and interest payments to get repaid in full.

Other influences determine loan pricing models, notably the security borrowers offer. Cash is always king. Banks don’t value stocks and shares much because of volatility. Property is good (depending what kind you have) and trade debtors have a value.

"As strange as it sounds, banks don’t like to lend against Bank of England (BoE) base rate, as it doesn’t accurately reflect their own capital costs. For a long time, banks have borrowed or lent money to each other based on LIBOR (the London Interbank Offered Rate)," said Jason.

LIBOR scandal 

"This is a globally accepted benchmark, calculated using data from 20 major banks on a daily basis, and the average rate becomes the LIBOR. However, because of the scandals regarding manipulation of LIBOR, the FCA plans to end that method from the end of 2021.

"The most likely replacement is SONIA, (the Sterling Overnight Index Average), administered by the BoE. Effectively, it’s the overnight interest rate paid by banks on unsecured transactions, so it is real world data."
The cost of capital is also the main driver behind lenders diluting their Commercial Real Estate (CRE) exposure via loan book sales. Selling a distressed and/or lowpriced portfolio frees up regulatory capital for the lender, even though the loans are sold at a discount to par.

The bank can then lend new funds at better margins, with improved profitability and spend less time and expense managing non-performing loans. Typically, the buyers are private equity firms or hedge funds, whose cost of capital is calculated differently.