Peter Levaggi, who is a partner and joint head of Charles Russell LLP’s Property Litigation Group, talks about the sometimes vexed and complex issue of property insolvencies and litigation.

Peter Levaggi, who is a partner and joint head of Charles Russell LLP’s Property Litigation Group, talks about the sometimes vexed and complex issue of property insolvencies and litigation. As ever, while the editors of this website are grateful for the use of this expert view, they do not necessarily endorse all the opinions expressed in this article.

In the financial chaos of 2008, we all would have predicted that property prices were going to be turbulent in the coming years. However, the reality of the crisis threw up many surprising factors which were perhaps impossible to foretell. Those of us specialising in property insolvency and bank enforcement have had a ring side seat as history unravelled before us.

In the early period a number of funds were created to take advantage of the expectation that there would be a large volume of  cut price property put on the market by banks and receivers. A number of these funds failed (sometimes unkindly called vulture funds). The banks were desperately trying to manage an unprecedented level of mortgage default (both residential and commercial). However, rather than authorising enforcement sales which might have severely depressed the market by dumping the distressed stock on the market in one go, the banks strategically decided to either appoint receivers over the properties or to engage with the debtor. This effectively partially warehoused the problem. 

The decision not to enforce constrained supply – large volumes of default, but little motivation to sell. Also, private sales dried up. Private sellers would choose not to sell rather than crystallise a loss and instead place their property on the rental market. Meanwhile, demand was also reduced as the conventional private buyer became unwilling to commit to a purchase with so much financial uncertainty. This resulted in a “catch 22”, low supply and low demand.

By 2011 a great pressure had built up on the banks to crystallise their losses and also realise assets. At long last we saw receivership sales increasing, and supply improving. This increase flourished throughout 2011 and into 2012.

After an initial hiatus of low demand we then saw a tremendous increase, initially in central London. The expansion was initially sparked by sterling dropping in value against most world currencies (perhaps as a result of quantitative easing and a rise in the level of sovereign debt), but London still being seen as a safe haven. Therefore, in 2009 and 2010 London property was a relative bargain for foreign investors even where paying full sterling value. Once again this took many commentators by surprise. Funds were once again launched to take advantage of this fledgling boom, now equity based (typically groups of high net worth foreign investors). 

The demand became so high that receivers became able to sell non residential distressed stock on the basis it could be developed into residential accommodation (“departments to apartments”) supported by changes in the planning regime. The demand might not have been coming from the conventional residential purchaser, nonetheless the foreign investment into the London market has created an unexpected bubble.

The market looks set to continue to boom. However, in 2012 acurve ball came from the Financial Services Authority's (now the Financial Conduct Authority review of Interest Rate Hedging Products, such as swaps.

The FSA directed all the major banks to review every IRHP product sold after 2001 to certain customers carefully and consider whether, and on a case by case basis, the debtor was entitled to redress. In this review, specific reference was made to the bank's ability to take action against debtor companies in financial difficulty as a consequence of being mis-sold the product.

This resulted in a freezing of many receivership sales and once again this has constrained supply to the market (as a large volume of property subject to mortgage default remains unsold). In many cases the banks have suspended the collection of swap payments pending the outcome of the review.

Further, the FCA have estimated that this might affect 80 per cent of defaulting mortgages. The FCA have stated: “Until the final redress payment has been determined, the banks will not foreclose on or adversely vary any lending facility (without giving prior notice to the customer and obtaining their consent), except in exceptional circumstances. To date, the banks have only invoked ‘exceptional circumstances’ on 11 occasions."

It is therefore clear that the banks are not taking enforcement action in relation to previous lending against applicable customers whilst the review procedure is underway except in limited circumstances. The knock on effect is that the number of  receiverships initiated by banks against their customers have dramatically reduced, and it is likely that this reduction will continue for the immediate future (at least until the review and redress procedure is completed).

Receiverships

A large number of receiverships had been instituted by Ireland’s National Asset Management Agency.  NAMA  has been participating in some of the largest property deals in London. The agency sits outside the problem with swap/IRHP mis-selling. Think of assets such as Battersea Power Station sold to a Malaysian fund for a reported £400 million ($645.3 million) and Citigroup Tower Canary Wharf valued at £1 billion. Largely through receivership NAMA controls a portfolio with a face value of € 74 billion ($100.1 billion), a third of which is located in Britain. NAMA was established as part of Ireland’s response to the banking crisis in the latter part of 2008. Of the 34 per cent of assets located in Britain, 71 per cent is located in central London. With the continued relative strength of the London market, NAMA also supported some of its debtors to convert commercial development plans into a selection of key residential  schemes. 

NAMA is seeking to sell large volumes of London based property and this will continue to boost supply. It has even resolved some of its more difficult issues, such as the heavily contested litigation against Ray Grehan. This well known Irish developer declared bankruptcy in the UK following NAMA obtaining judgment against him (and his brother) for a reported sum in excess  £300 million. NAMA then continued to take action alleging a wrongful transfer of One Hyde Park into a trust structure.  This transfer happened before the bankruptcy.  

However, NAMA have now agreed an out of court settlement, with Ray Grehan and the Trust agreeing to allow NAMA’s receivers to conduct the sale of the property. The speculation is that the market is now so buoyant that there is sufficient expected profit to benefit both NAMA and the Trust. The proceeds will be split between NAMA and the Trust following any remaining payment on the mortgage.

NAMA was set up to provide a formal scheme to make the failing Irish banks sell their impaired loans (into NAMA) at a discounted value. The idea being that the there would be an orderly and consistent mechanism to deal with the loans and the mortgaged property. The UK banks are not part of this scheme but they have sold  huge portfolios of distressed loans.  The purchasers of these have paid as low at 8% of the face value in some cases.  

This has meant that, instead of flooding the market with distressed assets the banks have sold to an investor at a sufficiently low price who could then either restructure or afford to wait  and see what happened to the market.

Therefore we have seen supply and demand behave in surprising ways over the last 5 years. The residential boom seems set to continue. It does raise the possibility that if more and more investment is poured into residential development (including converting formerly commercial sites) that this might eventually create a shortage of supply of commercial property (particularly when the economy at large improves).