Concerns over breach of loan to value covenants

Following the liquidity issues of SVB and Credit Suisse that were reported in early 2023, we noticed a sudden increase in clients’ concerns about being in breach of their loan to value covenants and the lender requiring repayment of the loan in full.

It is a standard term in facility agreements for a breach of loan to value covenants being an “Event of Default”, and so entitling the lender immediately to demand repayment of the loan subject first to the borrower being given a fixed number of grace days to cure the position (which it can do by deploying enough so as to bring the loan to value back in accordance with the covenant).

There are three steps – one being proactive and two being reactive – that we would recommend:

1. Reactive: Is the lender’s valuation on which it relies to assert a breach of the loan to value covenant correct. Borrowers may wish to obtain their own valuation to assess whether there is in fact an Event of Default. Borrowers wishing to challenge the bank’s valuation should however check whether the facility terms require the borrower to disclose any valuations they obtain to their lender. This can, of course, potentially put the borrower in a more precarious position if the borrower’s own valuation provides a lower valuation than that which was obtained by the lender.
2. Reactive: Should the borrower refinance? Many of our clients make use of our sister business Walgate Debt Solutions for their refinancing options, although we would encourage an early discussion to avoid the risk of a lender enforcing a charge where there is an Event of Default by the relatively straight forward appointment of receivers.
3. Proactive: The maintenance, or in some cases enhancement, of capital values and therefore the risk of a breach of loan to value covenant may be avoidable if closer and early strategic considerations are given to the future options of a property portfolio. At Fladgate LLP, we work extremely closely with property investors and asset managers strategically to ensure that the right step is taken at the right time. As a very straight forward example, could investor landlords recover a greater yield from their investment on a simple lease renewal? Whilst rental valuation is a key component of that, so is the lease term. Rather than accepting a short-term lease in a renewal just because this is what “the market suggests” (that reason often being a misunderstanding of the law in renewals), are there grounds to seek a longer lease term? For a different and perhaps more complicated example, might it be possible to modify or remove an onerous restrictive covenant preventing a more substantial redevelopment scheme by making an application under section 84 of the Law of Property Act 1925?

In times where the unpredictable market conditions are causing difficult investor decisions, we would encourage speaking to our Real Estate Dispute team early on to see if it is possible to maximise asset value (and how that might be achieved). And if investors with debt finance do start to feel exposed to being in breach their loan to value covenants and therefore risk receivers being appointed and losing their asset, we can explore with you whether the breach can be challenged and in the meantime discuss alternative funding options via Walgate Debt Solutions.