Opinion
Should bridging lenders apply stress tests? The value of modelling risk factors when making the decision to lend Natalie Jones Business Analyst Bridge Invest
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tress testing is high on the agenda of banks, which is largely driven by regulatory requirements. Extensive data mining techniques are common practice and market insights are sought upon to manage the risk of a bank’s loan book. The type of stress testing that should be considered depends on the type of lending that the business does. Not all bridge lenders are wholly principal lenders and therefore they may wish to only apply stress tests to their on-balance sheet positions. Alternatively, they may be prudent in extending their stress tests to include their investor’s exposure. Bridge lenders that apply leverage (such as bank funding lines), should stress interest rates on these liabilities especially if they are long-term committed facilities that are tied to LIBOR or other variable benchmarks. In recent years, the UK residential property market has had marked differences according to region; for example, Wales and London have been trending in opposite directions. Within the same region, some sectors such as commercial property have been behaving differently to residential and even within commercial property, retail has been performing different to office space. Land or heavy refurbishment loans may be subject to other risk factors – such as steel prices – that can wipe out contingency costs. Land prices are volatile as a fall in gross development value by say 15% could easily make a project unviable. Econometric modelling techniques requires extensive data collection and, in most cases, econometric software, in order to generate forecasts to be relied upon. More simply, scenario analysis can be performed on a spreadsheet by identifying material risk factors and stressing
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them individually or simultaneously. Such scenarios can be based on actual historic data – see the 1989 UK property crash – or hypothetical scenarios such as a 30% fall in residential property, a 40% fall in commercial property and a 50% fall in land value over say a 12-month horizon. Unlike mortgages, bridging loans are short duration and an exit strategy is known at the outset. This should limit the market risk of the security. Additionally, bridge loan valuations are generally based on a 180-day or 90-day restricted marketing period, rather than open market valuations. Even this is irrelevant if the lender intends to repossess and liquidate at an auction within 30 days. Co-founder of Bridge Invest, Vivek Jeswani, shared his view that: “Residential valuations in London have been falling during the entire time we have been lending. As there is now less downside risk, we have taken a conscious decision to increase loan-to-values.” Modelling of risk factors such as interest rates, region and property type are imperative at the outset of the loan when making the decision to lend. If strong covenants are in place and loan extensions in a downward trending market are subject to revaluations, then the risks can be well managed throughout the loan without any need for complex statistical regression analysis.
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Unlike mortgages, bridging loans are short duration and an exit strategy is known at the outset. This should limit the market risk of the security