Jamie Davidson: Rise of non-performing loans bad for SMEs

For the past decade, vulture funds have been acquiring non-performing loans (NPLs) from retail banks and many of the debtors happen to be Scottish SMEs.

'If you're an SME facing pressure from one of these lenders, now is the time to clarify your position,' says Conduit Finance managing director Jamie Davidson. Picture: Contributed

The number of loans being sold on by banks has slowed, but the number of loans held by these funds still remain in the hundreds. 

NPL buyers are invariably American private equity firms or UK-based special opportunity funds. They raise their capital from investors through either listed vehicles or special opportunity funds, set up to access high-yielding special opportunities such as distressed credit.

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These lenders are unregulated and operate in a space of the market that will likely soon be regulated by the Financial Conduct Authority and monitored by the Prudential Regulation Authority. In the meantime, the loans and their new owners operate in an opaque corner of the UK banking market. 

So how does it all work? The model is simple enough. Regular loans are sold from the retail bank to the new buyer at a discount to the original loan sum owed. Discounts can be from 25 per cent to 50 per cent less than the original loan. Once the new buyer owns the loan, they apply pressure on the borrower to recover their money, with interest.

The degree of pressure applied depends on how aggressive the new loan owner wants to be – in our experience, the majority are needlessly aggressive, putting huge pressure on smaller companies that are often already facing their own financial challenges.

The loan buyers have a simple strategy – buy a loan for one price then ideally have the loan quickly refinanced by the borrowers at a higher amount, therefore creating a profit. Time is a critical factor in the process, as the funds base their financial models on internal rates of return. This metric captures the time to realise a profit and the profit sum, so if a process is lasting a long time, then loan buyers start to lose money.

There has also been increased buyer competition for NPLs recently, which has led to higher prices being paid – this often results in more aggressive demand being made of the borrowers. In short, the system is inadvertently geared to encourage aggressive loan acquisition by vulture funds.

In some cases, vulture finds have been known to put businesses into administration if they have not been able to come to an agreement with the borrower, or if they believe they need more control to realise the best value from the loan. Invariably a consensual process works best for both parties, but in many cases relations break down and there is an insolvency event. 

In a recent case highlighted by Icas, the assignation on a mortgage debt was not properly completed, meaning the lender may receive nothing, or a lot less than they had anticipated. This could be the tip of the iceberg, with many other cases likely to surface in the coming months. 

It is of course the lender’s legal right to have the loan repaid, but if the loan wasn’t assigned properly to the new lender, then it could be a game changer. If the lender moves from being a secured creditor to an unsecured creditor, then their prospects of recovery are weakened. They are then unable to apply the same pressure on the borrower and the sum they can recover is reduced.

If you’re an SME facing pressure from one of these lenders, now is the time to clarify your position – you may not be required to pay back as much as you had originally negotiated with the lender. It is worth consulting with your lawyers on this point.

Another dimension to consider, is that some of the security the lender expected to benefit from isn’t as they had expected. The lender’s security package invariably includes a standard security over a property asset, a debenture or bond and floating charge over a company and can include personal guarantees.

If the solicitor acting for the lender failed to properly put these documents in place at the time of the loan, then they have less chance of enforcing against them. Be sure to ask your solicitor to undertake a thorough review of all forms of security you have provided – lenders losing documents is not unusual! 

Jamie Davidson is the founder and managing director of Conduit Finance