It’s not you it’s me…not a good break-up line right? Unless you’re George Costanza. What if I told you that it is now a strategy for some lenders. In fact it has been deployed many times but more flagrantly since the GFC.
Cast your mind back to pre GFC days when banks were falling over themselves to win your business. Many inducements were provided to customers to get on board. Many reasons were provided as to why this bank or that was the best to have a relationship with.
Then, during the GFC, the banks appeared to turn on some of their clients. Why?
Easy, there was a global liquidity crunch. The banks’ access to wholesale funding that they could on-lend to you had dried up. What funds they could get their hands on, became very expensive. In short there was real concern that they would run out of money.
So the way to tackle the problem was:
- Increase the proportion of retail deposits by offering better interest rates (especially
on Term Deposits) – until the banks had a dangerous over reliance on offshore
wholesale funding, and - Reduce the number of borrowers – Some banks were more vigorous than others in
pursuing this strategy. One of the favoured methods was to revalue assets pledged as security – which had all dropped in value like an anvil during the GFC – and then issue the borrower with a breach notice (based on their loan to valuation ratio). This was usually followed by a letter of demand to repay the debt. - Exit various categories of lending (like trade debtors, invoice discounting etc). If you were in this category then your bank simply told you to find another provider.
- Exit various industries – particularly in the institutional world.
Many borrowers were furious. Some didn’t make it. What if it happened again? Some businesses prepared – post GFC – by hoarding cash, reducing dividends etc.
The best defense however is to avoid the situation altogether – you can do this at the time that your facilities are being documented – a kind of pre-nup if you like. Let’s use a present day example but this could easily apply to any business that has pledged property or any other asset as security.
Imagine a property developer that acquired a large block of land for $50M. Approval was granted to develop 200 units on the block. An $80M Debt Facility is approved by the bank on the basis that the developer pre-sell 100% of the units – which the developer achieves. Construction begins and six months into the project the housing bubble bursts and property prices take a 20% hit. The bank revalues the land and end project value, investors decide to forfeit their deposits and you have a problem because the bank has just sent you a breach notice and given you 30 days to remedy or pay them back. Worse, they have stopped providing construction funding and terminated the facility.
If you find yourself in the above situation, then you need to deal with the situation but what should you have done instead to avoid the above?
- Firstly you should not have gone to a bank. They make you play by their rules.
- Seek assistance from a finance broker – see if they can help structure a better
outcome. Be very clear with your instructions. - If you sought legal advice and were still presented with the above scenario, fire your lawyers immediately. If the lawyer gave you good advice and you ignored them, you should not be in business.
- Part of the funding should be subordinated to bank funding – as either equity, subordinated or mezzanine debt – to avoid the LVR trap (this is where your finance broker can help). Yes this is more expensive but given we’ve just had a massive upswing in property prices do you want to take that risk?
- Negotiate a higher deposit from pre-sales (not always possible in competitive market). Get as much as you can get so that the risk is passed onto the purchaser. Your real estate agent – who gets paid by you for their service – should be charged with explaining the risks to purchasers.
- Documentation should be a negotiation. Be very clear at the start of the relationship what you will or won’t accept. If the documentation doesn’t reflect that you should insist that it does. Remember documentation does many things but the most important are:
- To ensure you’re aware of and fulfill your obligations to the lender.
- To ensure that you’re aware of what your lender’s obligations are to you and to ensure that they fulfill them.
- If your bank can exit the relationship at a moment’s notice, work out what this means for your business. How long can you survive? Are you able to find a substitute – remembering that you will be seeking one when markets are down.
A good finance broker should be able to model a borrowing stress test that deals with many scenarios. They should also – in conjunction with your lawyers – be able to let you know what is/isn’t achievable – remember the pre-nup analogy? They’re usually requested by the party that has the most cash to lose when the relationship ends. It’s not you it’s me…
Finally, if your finance broker asks for their fees up-front, look for one that doesn’t. If they’re not confident in getting you the funding you want/need, they shouldn’t be taking your business or your money.