Lenders – beware the risks of second charge lending

Second charge lending is where borrowers seek a second mortgage lent at a higher rate of interest in return for a subservient subsequent charge. It is typically, but not exclusively, taken by secondary bridging and peer-to-peer lenders willing to take on a higher level of risk.

However, against the backdrop of cost-of-living increases, rising interest rates, energy costs and an increasing number of bankruptcies and insolvencies, it is important for lenders to be aware of the heightened risks associated with second charge lending.

In light of the increasing number of Fixed Charge (LPA) Receivership appointments we are receiving from lenders, Partner and Registered Property Receiver, Russell Miller, explains some of the pitfalls in second charge security.

These can be severalfold – from the risk associated with decreased property values and the effect this can have on sale value, to the ability of a second charge lender to predict and recover costs and professional fees.

When an investor defaults on their repayments – usually after the accrual of at least two months’ mortgage payment arrears – an LPA Receiver can be appointed.

LPA Receivers are appointed to act independently but with the primary goal to recover the debt held by the lender.

We have a duty known as the ‘equity of redemption’ which, in effect, recognises that there is an overriding duty of care to any party that has a stake in the realisation of the charged asset.

An LPA Receiver’s powers are derived from the Law of Property Act 1925 – hence the term ‘LPA’. But they are often extend by the powers set out in a mortgage deed, and can include collection of rents, securing possession of the property, granting leases and ultimately selling the property in question.

Second charge uncertainty

Whilst a second charge lender can appoint a Receiver to help recover the debt owed to them when an investor defaults on their payments or mortgage conditions, what they are able to recover can be uncertain.

This is because the second charge mortgage is subservient to the first, which means that the first charge mortgage lender has ‘first dibs’ on any proceeds from the sale of the property sale, up to the amount of their loan redemption figure.

This makes it hard to know what the final realisation figure will be for second charge lenders, since to crystallise that position, they might have to pay some money out to professional advisers, without the guarantee that they will get it back.

To mitigate the risk, you might consider higher interest rates and fees than first charge lenders, or a higher level of equity in the property before agreeing to lend.

It might also be prudent to consider regular valuations of the property to ensure that its value remains sufficient to cover the outstanding mortgages.

You don’t want to find yourself in a situation where it is about loss mitigation, when property values are heading in the wrong direction, adversely affecting what you could recover through the sale of the asset.

More pain to come

The total number of company insolvencies registered in 2022 exceeded 22,000 – the highest number since 2009 and 57% higher than 2021. This trend will likely continue throughout 2023, indicating that there is more pain to come.

As insolvencies rise in the commercial sector, we are likely to see the number of commercial property assets with Receivers increase, as investors struggle to match rising interest payments with higher rental receipts.

Meanwhile, pressure on development land continues, resulting in less development. This, together with rising build costs, is likely to result in some partial developments heading into difficult waters, with defaults triggered by cash flow pressures, cost over-runs and contractors / builders going under.

Appoint appropriately qualified Receivers

In order to recover as much of what you are owed as possible – particularly if you are a second charge holder – it is important to appoint a qualified Registered Property Receiver.

They will consider an appropriate recovery strategy which analyses the status and occupancy of the property, as well as any issues that may be detrimental to its value that could be overcome, prior to disposing of the asset for the optimum price.

As part of this, the Receiver will look into the relationship between the bank and borrower and the financial background of the mortgage (monthly payments, arrears and balance).

In many cases, it can be possible for the Receiver to exploit opportunities to add genuine value to maximise the asset sale for the benefit of all parties – including the second charge lender.

Vail Williams’ specialist LPA Receivership team can help, drawing upon expertise from across our business to inform your case, including property valuation and lease advice, as well as development expertise.

We also work seamlessly with a team of external trusted advisors, including solicitors, independent disposal experts and insurers, to ensure you receive best-in-class advice.