28 Jan 2016
Words Mike Phipps
Back to Basics - Secret Bank Business Explained!
As finance industry professionals we deal with banks every day and I suspect take much of what happens for granted. At a recent accommodation industry forum I was a bit surprised when the discussion turned to bank lending policies. It transpired that many operators (and therefore I presume borrowers) in the room though that the banks solely call the shots on what can and cannot be done when they lend you money.
Nothing could be further from the truth. It is true that banks have credit policies and those policies influence and inform the outcome of your loan application. It is also true that within the accommodation industry bank credit policies are flexible and we have a number of clients who have finance deals that have been approved outside bank credit guidelines. These transactions have been of such a quality that lenders have been prepared to provide a finance solution outside usual policy.
That means experience, strong asset backing and great debt servicing capacity.
The reality is that banks take deposits from investors and lend those funds to borrowers. This simple transaction, left unregulated, has the potential to place at risk the funds of the depositor. It’s also important to remember that bank lending and access to credit are primary drivers of economic growth and economic trends.
To no great surprise the government feels a desire to ensure that bank lending practices don’t jeopardize depositors funds or drive unfavourable economic outcomes. As such the government has a raft of legislation and a number of agencies whose responsibility is to keep an eye on the banks and ensure they play the game appropriately. A recent example is the pressure being placed on the banks to slow lending for property investment, particularly in Sydney and Melbourne. The ready availability of highly geared, low cost debt on interest only terms has, in the view of the regulators and the Reserve Bank, driven a property market that is now overheated. As a result gearing has been pulled back and rates for aggressive gearing and interest only terms are higher than lower geared P and I funding. The RBA have signalled that they may now turn their focus to businesses and commercial lending so the next 12 months could be interesting.
As a result of regulations and prudential guidelines there are a number of hoops that a borrower needs to leap through in order to achieve a finance approval on acceptable terms. In my view this is how it should be.
The critical benchmarks are equity and debt servicing. The two are intertwined and in most cases one impacts the other. The reality is that equity is king. If you don’t have enough money to pay your deposit then in most cases no amount of debt servicing capacity will compensate. Your equity needs to be cash or supporting security such as equity in property.
The more cash you put in, the better your debt servicing capacity. It’s that simple. Of course, if you can pay off debt quickly due to strong cash flows we may be able to convince a bank to lend a bit more on the proviso that the so called over-lend portion of the debt gets paid back fast.
Once you decide you have enough cash or supporting security to do the deal you need to be sure that bank benchmarks for debt servicing can be met. We run a pretty much identical process for our clients which saves the hassle of waiting for the bank to go through the process. Essentially, in order for a lender to be comfortable with the deal you need to be able to demonstrate the capacity to repay all debt on P and I over the balance term of the loan (after any interest only period) with the payments calculated at a rate 2% higher than current rates. The income used to complete this calculation will be made up of total income net of tax, living expenses, outgoings and vacancies on investment property and costs of supporting dependants.
As you can see the capacity to just pay interest on current rates will not get you home. The stress testing of the transaction is an obligation that all lenders must comply with. Government agencies such as the Australian Prudential and Regulatory Authority (APRA) are constantly reviewing and monitoring bank lending activity. Any relaxation in credit standards will quickly come to the attention of APRA and make no mistake, the banks don’t want to pop up on the regulators radar. Since the GFC there has been even more regulator focus on our banking system and the policies and activities of lenders. I don’t expect this to change any time soon.
Lastly, most lenders will conduct an annual review when you borrow more than $1M for business purposes. Diarise you review date (it’s in your Letter of Offer) and get on the front foot. Your lender will replicate the equity and debt service tests that were undertaken when your finance was approved. Best to provide sufficient accurate information in a timely manner to ensure a positive result.