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Winds of Change – Adapt & Survive
When in 1835 the HMS Beagle sailed the Southern Oceans, it carried a trio of most astonishing men. It's most famous passenger Charles Darwin is well known, he used his visit to the Galapagos Islands to refine his theory of natural selection published in 1859 'On the Origin of Species'. It is less well known that one of Darwin's fellow voyagers was Sir Francis Beaufort, Britain's Naval Admiral and Hydrographer whose name is given to the Beaufort scale of wind speed and force.
Well the winds of change are blowing in our industry at hurricane force and so the lenders and intermediaries involved in commercial mortgages must adapt to survive. We only have to look at once mighty institutions, either now extinct or having been digested by larger players, to see that the market in its current stormy mode has no respect for size, reputation or history.
While the seemingly oceans of funds which were available only a year or so ago have all but dried up, the everyday requirement for business finance is still very buoyant. It is our opinion at Business Lending that in the same way that weaker banks have gone to the wall and stronger ones have survived so far, this also translates into the intermediary sector. With so little funding around, the skill of intermediaries to 'broker' the enquiries they have through to a constructive conclusion for their clients has never been so important to not only survive the current crisis but also thrive.
The theme I want to develop concerns the way that successful brokers go about their business. When we look at the whole process of providing the right advice in a 'Treating Customers Fairly' context, although the choice of funding has shrunk, the process through which a good broker engages with his client and with a lender's underwriters should encapsulate all that is right about a personal service. One that matches the needs of both customer and lender.
To stand the greatest chance of success, brokers need to think themselves into the mind of the lender and present the case in the best possible light. Lenders are hardly competing for business at present and to avoid them simply cherry picking from the 'best' deals a more proactive approach is required. One where every facet of the deal is understood and answers and proof, where needed, are all at the broker's fingertips to demonstrate to the lender why the loan should be made.
The market has switched very much from a seller's to a buyer's market. A far cry from some of the box ticking, menu driven underwriting seen in the market and popular when business was booming and property prices were always rising. Lenders are not now competing with each other for the intermediary's favour. Mortgage broking had become more a question of order taking and then choosing the 'best' deal from the many on offer. Today, the broker must be master of his brief and be prepared to work harder to match the potential borrower's enquiry to the lender's specific requirements.
Whilst I speak for Business Lending, I am sure that the points I want to make are common practice at all active lenders in the market when it comes to assessing commercial cases. These pointers should be regarded as generic and might help brokers to prepare their cases so that they have a greater chance of success.
To understand the loan risk we need to understand the Borrower's business. The key is how they generate cash, for it is cash that pays the monthly direct debit for the loan. To do this we need to understand the customer's business plan, their methodology, their process, their core product, their service features, how they market themselves, who their customers are and increasingly in this market, how good are their cost controls!
Having established these factors we look at the risks that these will change and specifically if they will deteriorate. What are the core features that make the business tick; the knowledge or skill of the proprietor and/or team, unique product features, patent or unique process, physical location of the operation, high barriers to entry for competitors, licensing or regulatory control. It can be any number of these and more besides. Having established what does make this business "tick" we stress test and factor in firstly the possibility of change and then the effect of that change.
This may all sound like a hugely complex process but often it comes down to what is commonly referred to as CST, the "Common Sense Test", using life experience to cross reference the proposal.
Whilst every case is different there is a general process we follow in our analysis, and as a broker it is helpful if you can tease out the key features under these general banners:
Background of applicants. Probably the most important feature of all, we can't run the applicant's business, we rely on them to do that. But understanding how they got to where they are, their history, skills and the background to their business. If we don't believe in the applicant and in their technical capacity to manage their operation, the transaction can never get off first base!
Allied to this is understanding the applicant's financial background and how any 'blips' in credit history are explained. An underwriter is going to be far more impressed if the introducer can demonstrate how and why any significant credit events occurred and what affect they have on the proposition.
Purpose of the loan. This might seem a little obvious but for an underwriter, the purpose of the loan is of crucial importance. For a case to succeed today, the purpose needs to be defined. For example, new premises, purchase of another business or other investment that can be defined are all fine. However, unspecified capital raising will be looked on with suspicion and debt consolidation, particularly of overdue accounts is unlikely to succeed. The important thing to remember is to ensure that the deal makes sense from the perspective of the lender who is being asked to fund it.
Property. Is it fit for purpose? Whilst many (including the owner) will look upon the property as an investment in the first instance, most importantly it is there to serve the business needs.
The property is providing the loan security and establishing the quality of the asset is an integral part of the process. Is the property in good condition, suitable for letting and/or readily saleable? Is it an unusual asset class, have limited market or alternative use, or is it located in a remote area away from major conurbations? Clearly a more modern, up to date, multi use property in or near areas of major population and industry is far less risky and therefore can outweigh other negative factors in the proposal far better.
Keep an eye on the LTV. Obviously, maximum LTVs have reduced and reflect the economic downturn but it is worth reminding clients that the greater the amount of equity they can show, the greater chance of an enquiry leading to an offer of funds.
Ability to repay. With the demise of much of the self certification market, the onus is very much on intermediaries to provide evidence to back up the proposition and show that the client has the means to repay. Historic accounts provide helpful documentary evidence but current management accounts give a more up to date snapshot of trading at the time of application. Recent VAT returns are also useful in giving the underwriters a better feel for the current health of the business and for supporting management figures or projections. An inability to provide financial records, particularly when the applicant is looking for a higher LTV, will count against them. When taking on a client, it will save a lot of time for broker and lender if supporting financial documentation has been seen by the broker before an application is made. Self certification may still be possible but only on cases where the LTV is low and the business case is particularly strong.
Risk Analysis. You may feel that this is our job and you are right! But in the current environment you should not assume that all the risk and particularly risk mitigation that your applicant has employed, will be immediately obvious. If there are key features, especially if they are individual to the transaction, make them plain to us.
Remuneration. As a final word! For all lenders, the cost of funds today is much higher than has been the case over the past few years. Risk, both actual and perceived risk, has increased and the overall economic environment will bear down heavily our case assessment in the coming months. Once we have decided that the proposal is acceptable from a credit perspective, we have to decide whether it is economically attractive to deploy our capital. Margins and fees have increased and will likely continue to do so, conditioning your clients can feel like a thankless task but it is a necessary one.
We are conscious that this represents a lot of information and analysis. But the market has changed from the more automated decisioning that had become the norm, especially in smaller credits. However the commercial lending market is still open for business, and whilst it is certainly not a roaring trade it is still possible to successfully place commercial mortgages. I'd advise the intermediary to start thinking like an underwriter and assessing the case before approaching a lender. A good rule of thumb is "would I lend my own money" if the answer is yes the chances are that a lender will think so as well!
Evolution isn't just about survival of the fittest, it's also about a species conquering its environment, finding a niche and adapting and exploiting its position within that environment. Charles Darwin provides us with the theory of natural selection, we must adapt to survive. But it was HMS Beagle's Captain Robert Fitzroy who perhaps proves the example in practice. There is an area of the Atlantic Ocean near the Bay of Biscay known for many years as Finisterre; it was an unpopular name that was the source of confusion and eventually strife. In 2002 it was renamed Fitzroy in honour of Captain Robert Fitzroy the third famous member of the astonishing crew of the HMS Beagle. However whilst the name might be changed, you can be sure the rocks and hazards are just the same!
Kevin Cooke
Sales & Marketing Director
Business Lending Ltd
8th October 2008