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Wednesday, 24th April 2024 |
| Asset revaluation - challenges for property developers and others |
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The level of asset revaluations in the market has triggered serious issues for property investors, particularly where leveraging with third party financing is involved.
Michael Quinn looks at the difficulties faced and some of the options open to property developers and secured lenders alike. |
The business pages are replete with stories of negative equity, to an extent that has not been seen for over a generation in this State. For many years the appetite of mortgage lenders for repossession and other enforcement action has been very limited, although the climate is definitely changing and every week there are new reports from the Courts of increased activity in repossession proceedings. Initially this activity only arose from lenders of last resort, or those whose criteria for lending was less stringent. Now the lists feature repossession actions by virtually all Irish lenders, faced with their own pressures on their loan books. The level of asset revaluations in the market has triggered serious issues for property investors, particularly where leveraging with third party financing is involved. | | Michael Quinn |
Revaluations
On the commercial property side, lenders and all stakeholders are being forced to update valuations. Not surprisingly, the results have confirmed what all suspected, that the freefall in property valuations continues. Undoubtedly the credit crunch is causing a certain degree of artificiality in that there is so little movement in the property market that valuations are themselves not based on current activity, but each valuer’s view of the trends. Whether this illustrates that values were inflated in the first place, or that they are moving to more realistic levels, is an interesting debate. What is clear is that where the properties are held by companies, whether they are exclusively property development companies or whether the property is merely a core asset retained on their books, the directors are faced with tough decisions arising from the impact of a very different balance sheet.
In many cases the property will have been acquired with the benefit of bank funding secured by a legal mortgage over the property. In those cases, in recent years, where a borrower has encountered difficulty in servicing the loan, lenders have been relatively low-key about enforcement, knowing that the property had a value which would ultimately yield a full return on sale, both for the principal amount of the loan and for any interest arrears. This has all changed. Even where the original loan to value ratio was comfortable for lenders, falling values have eliminated that comfort and now the lender and the borrower are faced with tough decisions.
In most cases the obvious direct remedy for the lender will be to enforce its legal charge, possibly even by appointing a receiver. Up to now this has not been happening because of the comfort zone of equity based on original values which were assumed only to rise. In very recent times the option of a forced sale was unattractive because of the total standstill and an absence of purchasers in the market even for distressed sales. But as the loan books of all banks came under closer scrutiny, this is starting to change again and, in many cases, they are forced to declare the default and invoke their legal remedies, including receivership.
Directors duties
From the perspective of the directors of companies facing these new realities, they owe duties not just to the company and its shareholders but to all stakeholders, including third party creditors. The directors in those cases have a duty to act in the best interests of the creditors of the company as a whole, and this means ensuring that they do not allow themselves to have regard only to the interests of one creditor.
In cases where revaluation of the assets brings the balance sheet into deficit, the immediate issue for directors is to establish whether it is possible to achieve a restructuring. Where the company has other trading activities, this will include an assessment of whether the trading prospects are sufficiently strong that the balance sheet can be restructured over time and with the agreement with all interested parties. In cases were the revaluation is so radical that there is no prospect of trading through the difficulties, it will be necessary to open restructuring negotiations with all stakeholders.
Restructuring
It can be possible to agree a formal scheme of arrangement outside of Court processes. However, such arrangements are fraught with difficulties principally because any dissenting creditor, including for example the Revenue Commissioners, can still pursue enforcement proceedings for the entire amount of its debt and of course secured lenders can at any time invoke their own direct remedies in relation to secured assets.
In certain cases an application to the High Court for Court protection and the appointment of an examiner will be merited. Such a process should only be followed in cases where the borrowing company has a going concern business which is capable of surviving in the long term if restructured through examinership. It also needs to be remembered that examinership is costly, and that a scheme of arrangement cannot be used to disregard the priority and rights of the holders of security.
In cases where the borrowing company’s only asset is a property which is the subject of a fixed charge such as a legal mortgage, discussions between the company and the lender will be relatively simple because the charged asset is essentially the property of the bank. The remedy of receivership is available to the secured lender in default cases, but there may be good reasons for the borrower and the lender to collaborate on a workout rather than a forced sale of assets through receivership particularly in a ‘frozen’ property market where buyers are rare.
Examinership
In cases where the bank holds not only a fixed charge over defined assets, but also a debenture over all the other assets and business of the company, discussions may be more complex. In those cases the directors should take advice as to whether examinership would provide a solution, at the very least to allow the breathing space in terms of time for a solution to formulated and agreed with the interested stakeholders. As a general rule examinership is unattractive to secured lenders, as it deprives them of the control which they would usually be in a position to exert through enforcement of their own security. However, there have been exceptional cases where a secured lender will support an examinership if the workout proposals are realistic and can generate a better return for all concerned in the long term. Examinership has been used successfully in a number of cases of property development companies and construction companies. However, it is inadvisable to enter into an examinership without the company having available to it the funds to operate during the course of the examinership, and have identified an investor willing to provide the funds to support the restructuring. It also should be remembered that the examinership cannot be used to disregard the bank’s security and the support of major creditors is a key ingredient of most successful examinerships.
The fact that a revaluation gives rise to a deficit on the company’s balance sheet does not of itself mean that the company should be immediately put into a formal insolvency process such as liquidation, receivership or examinership. However, there is a heavy onus on the directors to immediately establish whether a workout can be formulated and agreed with all of the stakeholders on a timely basis, failing which they may have no alternative but to initiate liquidation or, in certain cases, examinership proceedings.
The effects of revaluation of property assets are already appearing in that secured lenders are finding they have no alternative but to take enforcement steps, rather than awaiting an improvement in the market. The Financial Regulator’s examination of the loan books of Irish banks is clearly a factor in this process. As always, a critical factor is identifying where we are in the cycle. The broad assumption at this time is that property values have not yet hit their lowest point, and this heightens the dilemma for property developers and secured lenders alike. |
Michael Quinn is a partner at William Fry.
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