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HMRC internal manual

International Manual

Thin capitalisation: practical guidance: lending against asset values: UK third party practices - interest rate margins in property lending

An interest rate margin is most commonly expressed as a percentage or a number of basis points above a reference rate (1% = 100 basis points).

A reference rate is the underlying rate on which a floating rate is based. The rate used in the UK is most commonly one of the LIBOR rates (a benchmark rate). A lending rate may be expressed as LIBOR + 1.5% or LIBOR plus 150 basis points.

LIBOR (see INTM516035) and other interbank rates are available for a variety of currencies and for different periods (one day, one month, three months, etc), LIBOR itself being available in the currencies quoted in London. There is no necessity for there to be a geographic link between a banking centre and the currency of loans, for example, a LIBOR reference rate does not mean the relevant debt is in sterling. Variable rates for Euro borrowing are generally set by reference to EURIBOR. This is similar to LIBOR but set by a European panel of banks.

Some general principles on lending against property are given below:

  • lenders may be prepared to lend at lower margins when there are assets available as security.
  • loans made on investment property generally carry a lower margin than pre-let developments, with speculative development carrying the highest margin.
  • minimum interest rates are incorporated in loan offers to ensure that the lender’s rate of return is protected.
  • in considering the appropriateness of a margin it is useful to take a line from external sources, which is why De Montfort (see INTM518030) is useful. If a margin is high it may be an indication of a thinly capitalised company.

A useful third party comparator may be available where a loan has been taken out by the parent company for onward lending to the subsidiary purchasing the property. However, it will be necessary to look at the group structure and compare the security and other aspects of the original and the onward loan to check that appropriate adjustments take account of differences between the circumstances of each of the borrowers - the parent and the subsidiary.

There may be several “tiers” of loan finance, for example senior, debt (usually the first and biggest tranche), mezzanine debt and junior debt. Senior debt (see INTM519030) is the most secure and junior debt most risky, so loan amounts, repayment terms and margins will differ between the tranches, and the margin will increase as the lender’s risk increases. Margins will therefore be affected by the presence and terms of additional loans, their relationship to the senior debt and the impact they have on the borrower’s cash flow.