For borrowers, this unfortunately coincides with a period when it is significantly more difficult — or at least expensive — to return to the debt markets.

This is reflected in loan maturities.

Although we are still early in the year, we have already seen 15% of maturing loans refinance with new lenders with 52% extended and the remainder stuck in negotiation with an existing lender.

In this context, anyone forced to consider their asset refinancing options over the coming months will likely be hit by a triple whammy.

Firstly, there is a general debt shortage — meaning lenders are being far more cautious than in recent years.

With both valuation and economic uncertainty in the market, we can expect to see a general tightening of covenants and a lowering of available LTVs.

Valuation movements are pushing certain assets into LTV territories that neither the borrower nor lender are comfortable with.

And lastly, with interest rates having soared to levels not seen in over a decade, debt is simply less affordable.

There will be competition for the best opportunities but if you tick the boxes on the following, then there will be an array of lenders keen to issue terms:

— good sponsor
— good asset class
— good assets
— good location
— good business plan

Fail to fulfil one or more of these criteria and you might struggle to secure any terms at all, and the ones that are available are unlikely to be particularly favourable.

We believe that certain asset classes and locations are going to struggle over the coming years, especially office properties that do not have strong and long leases, are not located in a prime location, are CapEx intensive and do not meet the highest ESG standards.

It is therefore inevitable that many lenders will find themselves in a situation where a borrower cannot secure new debt, which leads to the question of "extend or enforce?"

There are pros and cons to both options.

Extend

The advantage with extending a loan — ideally on modified terms and for an additional short-time period of one-three years for a pre-determined fee — is that there is already familiarity with the asset and the sponsor, which has tremendous value.

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However, the fact that the sponsor is unable to find alternative lending should ring alarm bells.  
On this basis, a detailed underwrite is required including a close look at the asset and its future business plan.

We would recommend that undertaking due diligence, as you would with any new loan, becomes a condition of the extension that is covered by a fee.

Enforce

Forcing a sale is not something that most lenders want to do, but it is worth considering that in some cases the asset may hold more liquidity and value now than it may in the future.

With lenders generally being more conservative with initial LTVs — even with the substantial shift in yield and sentiment we’re seeing in some sectors — there may still be a strong equity cushion in the cap stack, even in a fire sale scenario.

In this case enforcing security may be the most sensible solution, regrettable as it may be for the borrower.

Whichever route is chosen, the decision shouldn’t be taken lightly.

Now more than ever a detailed approach to underwriting and due diligence is imperative.

Don’t allow familiarity to blind you to the fact that the documented due diligence was done in a completely different market environment years previously and ensure that business and CapEx plans account for realistic future positioning of the asset.

Our recommendation to lenders and borrowers alike is to address upcoming refinancing options as early as possible.

Initially we would expect the sponsor to take a detailed look at their loans, assets and business plans and to ideally seek a third-party opinion on whether they are ‘debt ready’.

Gaps in business plans and potential risk items can then be addressed in advance of any negotiations.

From the lender point of view, we recommend undertaking fresh due diligence and underwriting, or at least a detailed review of what is available, as soon as, or even in advance of, opening discussions.

It is vital to ensure that the sponsor’s business plan is rock solid and that the forecast cashflows and CapEx accurately reflect what will occur.

It is also worth referring to what sponsors promised to deliver in previous business plans.

If there was ever a time to challenge business plans, to monitor sponsors and to hold them to targets, it is now.