By Adrian Jones, corporate partner, and Roger Clarke, banking and finance partner, at law firm Trowers & Hamlins
Like their foreign counterparts, UK-headquartered banks are acknowledged to have significant non-performing loans. In its June 2014 Financial Stability Report the Bank of England noted that UK banks' non-performing loans stood at around £165 billion in 2013. With interest rates set to rise from their historic low, one must wonder whether this figure will rise.
UK and European banks have been disposing of both performing and non-performing loan portfolios to other banks and private equity backed groups for some time. This article looks at a non-performing loan portfolio acquisition from a buyer's perspective.
Understanding the assets
Conducting a thorough due diligence into the target portfolio is crucial to understanding the assets and identifying any issue which may adversely impact on the purchaser's assumptions and ultimately affect the potential realisable value of the loan book/property security. The due diligence exercise will be a combination of:
- legal investigation into the legal title of the property assets which secure the borrowers' obligations – undertaking land registry searches, investigation into any potential issues that the searches reveal and in some cases investigation into contaminated land issues and planning;
- legal investigation into the loan, mortgage and security documents – ensuring that the bank has all of the rights that a lender would expect to have against their borrowers under the loan documentation, ensuring that they have first ranking security over the main property asset and ensuring that the lender's rights are freely transferrable; and
- Commercial investigation into the property assets to assess their condition, potential on disposal and valuation.
As the number of properties and volume of banking documents are likely to be significant, it is important to have the resources to do this to a tight timetable and in a cost-effective way.
It is often the case that the bank is not aware of any matters which adversely affect the value of its security or its ability to enforce it – for example, where the bank has itself acquired the loans through merger with another lender or where there has been a turnover of staff.
The following are some of the potentially adverse issues that we have come across or would otherwise look for:
- the bank has waived some or part of the debt or has waived its enforcement rights;
- Improperly executed security documents. For example, where, in addition to the mortgage over the commercial property, the bank has received a personal guarantee, the guarantor must receive independent legal advice. If the guarantor is an individual and has not received independent legal advice, or the certificate confirming that they have done so hasn't been properly completed, then the guarantee may not be enforceable;
- the loan is a regulated mortgage contract (RMC). Due to the additional regulatory requirements involved in administering an RMC many private equity purchasers will not wish to acquire one;
- the mortgage granted by a corporate borrower, although registered at the Land Registry, was not registered at Companies House within the allowed period with the result that, whilst the lending documents remain enforceable against the borrower, the security is void against a liquidator, administrator and a creditor of the company;
- the bank has a second ranking charge but there is either no intercreditor agreement to give the bank effective priority or there is some defect in the intercreditor arrangements;
- the bank does not have security over the whole of the property, for example, part of the access may not be included, which could affect its value on disposal;
- defects in a leasehold title, issues with rights of access, restrictive covenants, planning issues/enforcement notices or possible contaminated land issues which could adversely affect the ability to dispose of a property or the realisable value.
The purchase agreement
The agreement dealing with the purchase will typically contain warranties and indemnities from the bank although with a distressed loan portfolio warranties will generally be concerned with the bank's title to what it is selling and the enforceability of its rights/security rather than anything going to the condition of the assets. As with any asset/business acquisition the seller will expect to limit its post-completion exposure to warranty claims and there is usually negotiation over the terms of such limitations and in particular any overall cap on liability. However, given that the purchaser may expect some indemnification for matters outside the ordinary course of servicing a loan book, such as claims in respect of any transferring employees, un-anticipated liabilities to borrowers etc., it would be usual to seek to carve such matters out of a liability cap unless the cap was considered sufficient to take the risk of their inclusion.
Registering the transfer
The transfers of rights which can be registered, such as the assignment of security over property in England and Wales, the assignation of standard security in Scotland, will be recorded at those land registries. The transfer of some other rights, such as charges registered at Companies House in England and Wales, cannot be recorded and the purchaser will rely on the terms of the purchase agreement and its further assurance provisions to ensure that it has the benefit of such rights.
In order to perfect the assignment of the bank's rights against the borrower the borrower will need to be given notice of the assignment. This is generally done as a letter from one or both of the parties to each borrower. Notification should also be given to the relevant receiver/administrator/trustee in bankruptcy and any other professionals engaged in relation to a property. Naturally the purchaser will also wish to contact its borrowers to deal with practical matters such as whom they should contact with any questions, the account details to which payments should be made after any transitional arrangements with the bank have expired, etc.
As the major UK banks continue to seek means of dealing with non-performing loans and given the likely effects of interest rate rises, we expect portfolio sales to continue and evolve over the coming years.