Mount Street: ‘We had a 10-year cycle – that needs readjustment’

Paul Lloyd, co-founder and CEO at Mount Street, talks about the trend towards large-scale servicing mandates and how a challenging 2023 will impact the debt market.

This article is sponsored by Mount Street.

Last year, Mount Street delivered record growth of 72 percent to €130 billion of AUM. How did you manage to grow your commercial real estate loans under management?

Paul Lloyd

Coming out of covid, a lot of lenders were very active in deploying capital they hadn’t deployed during the height of the pandemic – that was one of the key reasons.

Secondly, because of the growth in US funds coming over that perhaps didn’t have a presence in Europe, we won certain mandates, which helped to grow the book. In Europe we also won Schroders, Ares Management as well as Aviva Investors’ asset servicing businesses. That is a clear demonstration that the outsourcing model has started to become more prevalent in our space.

You mentioned the Aviva mandate, where you were selected alongside HSBC to service its real assets business, with £50 billion (€57 billion) in AUM. Do you expect to see more large-scale servicing mandates going forward?

Yes, we do. At the moment, we are talking to potential clients that have smaller books ranging from £5 billion to £25 billion. We only closed the Aviva transaction last year, so I think people are still waiting to find out if it has been a successful outsourcing.

But the answer is yes, it has been. It is a 10-year contract and Aviva’s book is getting bigger because they can now focus on their ability to originate more transactions, as per the intended strategy.

For Aviva, there is a different skillset that we bring to the table. We can help them assess their book, help their team grow, educate the team a bit more on loan administration, on the surveillance side and the agency business side. That basically increases their efficiency.

For us, this transaction highlights to other people that there is an opportunity to help them reduce their costs and focus resource on the highest value-adding activities, with businesses across the board becoming increasingly cost and efficiencies conscious.

Did 2022 bring more special servicing as opposed to primary servicing work?

Last year there wasn’t too much special servicing around. Because everyone came out of covid and was lending a lot of money, the market was still going up. Obviously this year, with Ukraine and Russia still at war, with inflation where it is and with interest rates going up, there are a lot of problems that we are going to start seeing.

If loan-to-values increase above what they were three to five years ago, it creates a problem. If the existing lender is not getting fresh equity into the deal, then mezzanine funding will be needed, which comes in at higher rates. Then you have got to assess whether the deal can actually handle the extra outlay of the interest rates on the mezzanine loan and whether it breaches all the ICRs and DSCR covenants. We are spending a lot of time analysing portfolios for clients to see whether they can refinance the loans with extra capital coming in or extra debt coming at mezzanine level.

A lot of the deals being done have reducing rental income. Especially if you look at offices, with people taking smaller footprints, that depletes the income to pay debt service. So, we are facing a lot of deals that can’t afford to pay for debt service and additional debt this year.

Also, I think 25 percent of the market is maturing this year and the next. These are big numbers. Sponsors that cannot meet the final loan payment will have to refinance or try to extend their loans, otherwise lenders are going to have to enforce and take the keys back.

What is the impact of rising rates on your loans under management?

Interest rates are definitely going to impact transactions, as we are already seeing. Where there is a deal with a fixed rate, there is nothing you can do on those until you get to maturity. With these deals, once the fixed term is over, I think sponsors will push for extensions.

But for deals that are coming to repayment this year – and don’t have any extension – that is where there is going to be a problem if there is an inability to sustain the debt in place today without fresh equity.

Fresh equity is going to come from somewhere. If the current lender is not going to get it and that deal is going to be refinanced with a new lender, the new lender is going to say: “After a revaluation, the loan that was originally at 55 percent LTV is now at 65 percent, but we only lend at 50 percent.” So, borrowers need to put some more equity in.

How much distress do you see coming through the system?

We had a 10-year cycle – that needs some kind of readjustment and we are at that precipice now. There will be some stress; there will be situations in which capital will be used to assist with problems and there will be a lot of deals that are refinanced in some shape or form. However, we won’t see a massive amount of non-performing loans coming to market or banks selling distressed books.

A lot of banks and institutions did lower leverage loans over the previous cycle, so I think their deals are pretty safe. But there will be a lot of deals changing hands from one lender to another and a lot of new relationships will grow.

Some players will take advantage of this market. Some of the US funds in Europe, for instance, are already waiting to do mezzanine lending because new debt will be necessary for those deals that are worth saving and can afford the mezzanine positions. That will help lessen a problematic market by avoiding a fall-off-the cliff scenario.

What are the key opportunities you are seeing for 2023?

For us, it will be to continue winning more outsourcing opportunities, as a greater number of managers recognise the value we can offer to their business. We also see big growth potential in the US market. Last year, we more than doubled our book in the country, and we hope to do the same this year.

The US is a massive market, and we are getting a lot of traction from global funds and banks to look at providing global solutions to them. We have done that before by working with these funds in Europe and then replicating the same service in the US.

Now, for those clients that we don’t have in Europe but we have in the US, we see an opportunity to globalise those relationships with them, in Europe or in other parts in the world. So, we will try to globalise our service offering to our clients to make sure that, irrespective of where they are based in the world, they get exactly the same service, which further differentiates the value of Mount Street’s offering.