Our recovery from a global pandemic, coupled with the war in Ukraine, as well as socio-economic and political upheaval in the UK, is creating an environment that borrowers find difficult due to the sharp rise in global interest rates .
Earlier this month, inflation hit a multi-year high of 10.1% and forecasts indicate it could hit 18% soon. Consumers are paying the price for rising wages and material costs in the current inflationary cost-push environment, and as global monetary policy attempts to control inflation, commercial and consumer borrowers are starting to feel the pinch. effects.
In order to eliminate interest rate risk for commercial real estate loans, many borrowers acquire caps at a substantial upfront cost – which must now be factored into the initial transaction cost analysis. Alternative hedging solutions, such as interest rate swaps or fixed rate loans, now also bear the brunt of rising global rates, with five-year EURIBOR and SONIA swaps rising by 45 basis points respectively. and 96 basis points in the last month (at the time of writing this article).
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The effects of higher debt costs don’t just impact investor returns; borrowers are also forced to renegotiate their positions on previously agreed covenants to ensure that sufficient flexibility is available in interest coverage and debt service ratios.
This does not mean that borrowers have no more options. On the contrary, the debt market has undergone profound transformations over the past ten years. A wave of new alternative lenders and debt funds provided much needed liquidity. In addition, the attitude of lenders towards financing has become more collaborative. We have seen several debt providers open to the suggestion of restructuring terms and covenants to account for rising swap rates.
As we navigate this period of uncertainty, lender appetite should remain fluid.
We are starting to see some lenders, who have already exceeded their annual lending targets, confirming that they are content to do nothing in the short term. For these lenders, they will be very selective in deciding which borrowers and which lending opportunities to support in the final months of 2022. However, with such a wide range of debt strategies and debt providers currently active in the market, it is expected that, overall, the appetite will remain strong. We have to remember that the market is robust enough to allow a handful of lenders to pull out temporarily.
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With interest rates expected to continue their upward trajectory before peaking in 2023, volatility will persist in the swap market. On the margin side, ‘price discovery’ will continue as lenders seek to assess risk against other investments available to them – particularly in the case of funds that price debt based on the concept of relative value.
It’s time for borrowers to take a two-pronged approach. My advice is to stay close to those relationship lenders who have been supportive through tough times. Long standing relationships with lenders will prove beneficial and should never be overlooked or underestimated.
My second recommendation, which is slightly contradictory to the first, is not to be complacent. While it is important to stay close to proven lenders, also seek out new relationships to ensure the terms received are competitive. Many lenders are still active and looking to deploy funds, despite fears the debt market could contract.
We have enjoyed a long period of being able to obtain debt at incredibly low rates over the past ten years. A painful period of rebasing will take place in the short term, but in the long term, the debt market will continue to show resilience. There is no need to panic – there is light at the end of the tunnel, which could be reached sooner than you think.
Lisa Attenborough is Partner and Head of Debt Advisory at Knight Frank