Property development loans make up 11% of our active loan book. This category of lending has performed in line with expectations to date, with 61 development schemes completed without issue and, while we are not complacent, there is no indication that the performance is about to change. It is in this context we have identified changes to the way the Provision Fund deals with property development loan defaults, that we think will help us deliver the best outcomes for lenders.
Currently, property development loan defaults are treated like all other RateSetter loans. This means the full outstanding balance is charged off from the Provision Fund, which repays lenders and then seeks to make recoveries by selling the uncompleted development. However, given that all property development loans are secured against the property at a maximum loan to value of 65%, a default does not automatically mean a loss. Additionally, in the case of a partially completed development, our current approach could mean that the Provision Fund misses out on recovering maximum value through the sale of a partially completed development project, without the option to complete the scheme and then sell it, if that would maximise returns to lenders.
We have looked at adding more flexibility into our approach and concluded that this would deliver better outcomes for lenders and would be consistent with the approach already used in the wider finance industry.
Under this approach, RateSetter would examine whether maximum value would be delivered via an immediate sale or by completing the development and then selling it. If an immediate sale is the best option, we would proceed with that. In the scenario where maximum value would be delivered by completing the development, RateSetter would immediately step in to take control of the development; we would charge off the expected loss from the Provision Fund (rather than the full outstanding balance. The expected loss for property development loans is updated on a monthly basis); and we would complete the development as quickly as possible, then sell it. If additional finance is required to facilitate the completion and sale of the property, that would come from the RateSetter market, with a ceiling for total lending of 80% of the property’s post development value (this threshold would be kept under regular review).
We are publishing updated Lender Terms (which can be viewed here), along with an updated summary of changes to Lender Terms since October 2015 (here). We are giving Lenders one month’s notice that these Lender Terms will come into effect to implement this change on 1 December 2017.
If you would like to know more about RateSetter’s property lending team, we published a Q&A with Neal Moy, our Head of Property Finance, here.
Does this change the risk of lending with RateSetter?
This change gives us a better chance of maximising recoveries, which could deliver more money back to the Provision Fund. We do not believe that this update affects the risk of lending via RateSetter.
What does this mean for lenders?
This change means that that lenders could in future be matched to a defaulted loan, which is fully secured against a property. Every individual lenders’ risk will still be spread across the whole active loan book by the Provision Fund, so we would encourage lenders to keep up to date with the Provision Fund Coverage Ratio and associated metrics which are published and updated in real time on our website.
Does this change RateSetter’s Expected Future Loss calculation or the Provision Fund Coverage Ratio?
This does not change Expected Future Losses, as this already takes account of the security that sits behind property development loans. There is no impact on the current Provision Fund Coverage Ratio, but the new approach means that if a property development loan were to default, the full outstanding balance would not be charged off from the Provision Fund, rather the expected loss would be charged off. This means a future property development loan default would have a smaller impact on the Coverage Ratio.
Under the new approach, when the expected loss is charged off from the Provision Fund how is that allocated to lenders?
This will be allocated according to the order that lenders were matched to the loan, with the first matched being repaid first.