Non-bank lenders enter fray

THE CREDIT CRISIS has sparked the emergence of a new breed of alternative lenders in the United States and Britain, primarily private equity players who are offering distressed developers and commercial property owners secured, asset-backed funding on deals the banks are no longer willing to finance.

The trend is also catching on in South Africa, with private entrepreneurs starting to enter the commercial property finance sector. One such is Paragon Lending Solutions, which was founded earlier this year by former Investec Private Bank-structured lending expert Gary Palmer, following a successful buyout of the in-house finance business of auctioneer Alliance Group.

Although SA’s banks haven’t experienced the same lack of liquidity as have many of their offshore counterparts, Palmer says local banks have also tightened their lending criteria, even to creditworthy clients. “Banks have become concerned with the recovery and collection of their existing loans as opposed to granting new loans. Cash flow and the ability to service a loan have become the main criteria for granting a loan, with limited reliance placed on the quality and value of assets used as collateral.”

Palmer says that’s left a gap for non-banks – or so-called second tier lenders – to meet the short-term liquidity needs of “asset-rich but cash-flow poor” investors who may no longer have access to traditional bank funding.

Paragon’s model is based on a 12-month loan period and is primarily aimed at developers or property owners with real estate assets worth at least R1m (excluding primary or second homes). A typical client would be a developer who may be in the process of building a small hotel, a townhouse complex or office block and needs working capital to complete his project or start his next development. It could also be an investor who owns a block of flats or a factory and wants to offload some of his properties but needs capital to refurbish before selling.

Says Palmer: “We provide funds against the security of a commercial property for a maximum 12 months, which gives our clients breathing space to secure long-term funding from commercial banks or to realise assets a few months down the line.”

Paragon only lends to companies, CCs and trusts with more than three trustees. Loan amounts typically vary between R1,5m and R8m, with loan-to-value lending ratios of a maximum 60%. Palmer says interest is repayable monthly, while capital is only repaid at the end of the 12-month loan. The loans are priced at an interest rate of typically 2% to 3% above what commercial banks would charge. If there’s an existing loan against the property, Paragon will settle the mortgage debt and then register a first mortgage over the property.

Palmer stresses second tier lenders don’t compete with banks. In fact, he says banks often refer clients looking for unconventional finance solutions to the company.

Traditional property financiers say there may well be a need for short-term asset-backed lenders but caution that there could be risks involved. Frank Berkeley, head of property finance at Nedbank Corporate, says the key question is what happens when borrowers don’t have the funds to repay after the 12-month loan period has lapsed. Berkeley says in such a scenario borrowers may risk losing their properties. That could be a particular concern in cases where the financier takes possession of the property through a sale and buyback agreement.

However, Palmer says in Paragon’s case the client always retains ownership of the property, and loans can be renewed after 12 months – provided the loan covenants are still in place.