A Sydney-based fund manager says non-bank lenders are facilitating deception by failing to register and disclose mezzanine debt and secondary loans on commercial property assets.
Speaking at a media lunch in Sydney last week, Metrics Credit Partners managing partner Andrew Lockhart said the recent collapse of property developers like Ralan and Steller Group sends a clear warning about the risks to investors of what he calls the “poor market practices” of non-bank lenders operating in the real estate market.
“If you’re a property developer and you want to borrow money from the bank, the bank will lend you a certain amount as a first ranking secured lender,” Mr Lockhart explained.
“The banks have a policy that if you borrow more money you have to disclose it. The bank needs to be aware of that. Say the bank is lending you 60 per cent of the capital structure, they think that 40 per cent of that is equity.”
However, without any equity of their own, property developers are being targeted by non-bank lenders that offer mezzanine debt. But according to Mr Lockhart, these lenders are providing additional funds as an unregistered second-ranking charge, which presents investors with a real risk.
“I think it is a poor market practice because a borrower has an obligation to expose the second loan. These lenders are facilitating deception on the part of the borrower by not disclosing that. The other thing they are doing is making it difficult for investors. If that second mortgage isn’t registered, then there is no security.
The former NAB director said the practice has become “very widespread” among non-banks and believes it is being driven by both the borrower and the lender.
According to Mr Lockhart, banks as senior secured funders will not want to negotiate an intercreditor deed with a non-bank lender.
“We are one of the few lenders in the market that has been able to negotiate with the banks on intercreditor deeds,” he said.
“The lender providing unregistered lending knows full well that if the borrower was to disclose the loan the banks would pull the senior funding. Those lenders are doing that because they are offering investors a certain return. The only way they are able to provide those returns is by doing things like this.”
Mr Lockhart said Metrics Credit Partners competes with many of the non-bank lenders that also raise capital from investors.
“If investors allocate capital to those funds and those funds are achieving a return that is different to the return that we are achieving for our investors, but we are actually taking a lower risk, does the investor really understand what’s occurring in the market?”
Mr Lockhart also questioned the ethical and governance implications of failing to disclose additional loans to senior funders.
“The banks and other first-ranking mortgagees want to know who are the other parties to the transaction. As a lender, if you think your borrower has 40 or 50 per cent of the capital structure in equity and all of a sudden you find out that they don’t, you are dealing with a much weaker counterparty than you thought,” he said.