Commercial expose

Another 12 months have past in MPA's tracking feature on the state of the Australian commercial market.

The effects of the fallout of the US sub prime market are still being felt across the world, and to a greater extent than first anticipated, in Australia. And while the optimistic economists out there predict 2009 to be a tough year, the less optimistic ones are forecasting the market to be still bearing its teeth in 2010.

So with struggling residential mortgages set to battle a while longer, commercial lending has again solidified itself as more than just a neat diversification option. These days it is often seen as a key element in the modern broker's business survival pack.

Once again MPA gathered several of the industry's key players - and from across the commercial spectrum this time - for their thoughts on how this market continues to maximize its allure.  

Q: To what extent has your business been affected by the fallout from the global credit crisis?

Jon Moodie, division director for Macquarie Leasing: The last 12 months has seen significant challenges for all players in the leasing industry. Issues surrounding funding, delinquencies and credit quality have affected everybody to a greater or lesser extent. We have bought credit within a risk-controlled framework leaving us the time to focus more on funding.

David Gouge, managing director at Merchant Mortgages: It has had a mixed affect, which has been more neutral than negative. Being a wholesale mortgage manager we find ourself doing less full doc commercial, and more no doc commercial.

Matthew Nolan, managing director at Provident Cashflow: We are fortunate to have strong, resilient partners that have seen us unaffected by the worst of the storm.  The affect has been more felt amongst our clients and potential customers.  We've made substantial changes to serve their inventory finance needs.

Samuel Lynch, general manager at IAC Rentals: I'd have to say there's been two parts to this downturn. During the early stages, lenders, including ourselves, found it difficult to source the funds required to maintain the levels of new business that were coming in. More recently, however, the funding hasn't been the issue it has been the drop off in demand for finance that has had the greater impact.

Q: Has its affect been primarily negative?

David White, director of credit at Australian First Mortgages: Yes. Although we have noticed lenders reducing the number of accredited brokers, which means we have received more enquiry from brokers who have lost their accreditations, which is a positive spin for AFM.

Greg Charlwood, chief executive Asia Pacific, Bibby Financial Services: The global credit crisis has pushed debtor finance products into the limelight. They provide alternative working capital for businesses, particularly SME's that may no longer qualify for banking products or do not wish to use real estate to secure funding.

Softening real estate values reduce commercial lending limits for business finance facilities secured by real-estate. In contrast, flexible facilities such as debtor finance better align funding limits with the requirements of the business.

While the credit crisis has sparked greater awareness of the value of debtor funding, in the current climate there is increased risk of debtor default and business insolvency, so finance brokers have to be mindful of this.

Mark Turnbull, managing director at Horizon Finance: Not at all. To the contrary we believe it is the perfect opportunity to increase market share as some business are just not able to survive the tough conditions. As some of the competition falls over we achieve a greater presence in the market. We have also seen prospective clients become more aware of the benefits of what we do. The more the banks change margin and credit criteria, the more opportunity we get to quote and secure business that otherwise would not have been in our range.

George Sotiris national manager, third party sales at IMB Bank: It's still business as usual for us because we're still doing the things we did 12 to 18 months ago. We've always played in the SME market, with a particular focus on the smaller end. Traditionally there have been fewer players in this space so our slice of business might even have improved.

Q: Has the commercial market become more or less immune to funding increases than the residential market?

David Gouge: Less immune recently. Commercial funders have generally either not passed on the same quantum of decreases in variable rates as reductions in the Reserve Bank cash rate, or they have been slower to do so.  Variable funding costs for commercial mortgage loans however are not necessarily totally aligned to what the RBA does.

Matthew Nolan: The commercial market is less immune. Factors impacting it are comparable to other types of lending, but government support to date has primarily focused on the residential sector.

Mark Turnbull: I would say that it would generally be the same as the residential market. As competition has decreased this has been the ideal opportunity for banks to increase their margins. We have directly experienced this with new clients. In the light of the current economic climate, banks have been actively reviewing client portfolios resulting in non-profitable clients having their margins increased. We saw one client have their margin increased from 0.75% to 2.5%. We have also seen small business clients not being passed on rate cuts as the banks have sought to increase their margins. If there was genuine competition in the commercial market margins would have increased (due to genuine funding costs) but I don't think we would have seen margins increase as much as they have.

Greg Charlwood: If one focuses on interest costs, then businesses are equally vulnerable to increases.  However our experience is that recent official interest rate reductions - reluctantly passed on to residential borrowers - have left commercial borrowing rates virtually unchanged. Although the business sector has learnt to adapt to the rates of the past year, any reductions in commercial rates would be welcomed by the business community.

Q: What have been the most significant changes to the market in the last twelve months?

David White: The reduction in the number of lenders is high. We have seen rural lenders exit the market, which makes it very difficult to obtain finance for large rural properties, even at very low LVR's. Development finance is also very hard to obtain. Lenders are reluctant to provide funding for developments since it ties up large sums of funds, which could otherwise cover many individual transactions. Also the property market itself is contracted because of diminished property values. So current stock is hard to sell which is a concern for lenders and development funders.

Greg Charlwood: The credit crisis and resulting difficult trading conditions for SMEs has been the most significant change. The softening mortgage market has also created a noticeable trend: greater numbers of mortgage brokers seeking additional income streams have engaged with debtor finance. This has increased the overall distribution of the product.

Mark Turnbull: Without doubt it has been the tightening of credit along with a major reduction in the number of commercial credit providers in the market. Unfortunately we don't have the same level variety, or choice, we had 12 months ago. However I am a firm believer that this is a temporary position, especially from a long-term perspective.

Q: What is the prognosis for the rest of 2009 - and how do you think the industry will look five years from now?

Jon Moodie: I can see continued cooling in the demand side for the rest of this year, and more consolidation in the supply side of the leasing market.  In five years from now, those players who were able to survive the crisis will be enjoying the benefits of steady economic growth and strengthened relationships.

David Gouge: In the equipment and leasing sector 2009 is likely to look a lot like 2008. From 2011 and beyond, the mismatch between supply and demand for commercial funds may edge closer to equilibrium. Commercial borrower demand will remain, albeit tempered by more realistic lending ratios.  A key will be to better tap the fixed interest sector of institutional investors with smarter investment structures.

Matthew Nolan: Expect a flat 2009 with an upswing beginning after that.  In 5 years the effects of the current crisis will have largely passed, but hopefully the lessons will remain with us.

Samuel Lynch: I'm certainly of the belief the supply side of the market will recover in 2009. We're going to see lenders tentatively re-entering the market in the coming year. I'm not so confident about the demand side. However I do think for 2009 there's more downside in the economic outlook, and that means tougher trading conditions for all businesses.

George Sotiris: It will be a pretty tough year in 2009. We feel that there will be fewer players in our sector of the market. And that they will be very specific in the type of business they're looking for. Also, as brokers look to diversify and protect their income they'll give a greater consideration to the commercial sector.

Q: How does your business leverage off the residential portfolio - if at all?

David White: We do not leverage off our current residential portfolio as we have an agreement with our brokers not to market to the clients they have introduced to AFM. We refer customers back to their original broker when they request new loans as we want to ensure that we continue to have an excellent relationship with our accredited brokers.

Greg Charlwood: Because Bibby does not require real estate collateral for its facilities, we are seeing an increasing number of enquiries from business owners who are now more concerned of the risk in having their family home securing business overdrafts.

Mark Turnbull: Horizon started out as a residential broker, and this side of the business has always remained strong. We invested in an extensive database system about three years ago which assists us to identify residential property investors who could become potential commercial investors. Experienced residential investors usually look to diversify their portfolios by purchasing commercial real estate. We have always been well placed to identify and capitalize on these opportunities.

Q: Do you expect there to be an increase in the number of distributors offering commercial products in the year ahead?

David Gouge: We expect some increase by early 2010. And we anticipate some of the previous players to re-enter the market in 2010 or 2011.

Matthew Nolan: Yes we expect an increase, the current market conditions mean diversification has truly taken hold amongst brokers.

Mark Turnbull: I think that we are still going to see a decrease in the number of commercial funders available in the Australian market in 2009. There is a definite move to "old style" credit criteria meaning that there is a flight to quality not quantity. We won't see an increase in commercial funders until the credit markets open up, meaning that funds are cheap enough for new players to compete with the major banks. With that said, I don't think there is any doubt that things will improve, the million dollar question is just when?

Greg Charlwood: Tougher access to wholesale funding will make it difficult for smaller lenders to compete in the debtor finance space over the year ahead, however robust trading conditions may attract lenders to this market or encourage existing lenders to offer debtor finance products.

In terms of broker distribution, we expect an increasing number of mortgage and finance brokers to examine debtor finance offerings in the year ahead as volumes from traditional products continue to decline.

Q: What changes has your business made to its commercial products in the last 6- 12 months?

George Sotiris: It's been pretty much business as usual for us in the last year. We still offer the same products now that we did 12 months ago - even longer. We haven't made any significant changes to policy either. We're still comfortable with the type of business we've been doing in the last two years.

Greg Charlwood: In the past year we've introduced plant and equipment lines to supplement debtor finance facilities. Our most recent additions included an inventory finance supplement and a non-recourse debtor finance facility. We expect to add an import finance facility next.

Mark Turnbull: We identified invoice funding as a growth market 12 months ago. We have promoted this to accountants on the assumption that the client's accountant is their 'go-to' person when experiencing cashflow issues. Enquiries for this product have picked up substantially in the past 6 months.

Q: Aside from funding, what do you think are the biggest issues preventing further growth in the industry?

Jon Moodie: The biggest issue will be the lack of growth in the industries serviced by the leasing and finance companies. If our clients don't grow, nor do we.

David Gouge: There are two big issues. The first is a lack of business confidence. And the second is a fear factor by some brokers and aggregators to take on commercial mortgage loans.  Some of these issues are improving because of different approaches towards brokers being taken by funders and mortgage managers.

Matthew Nolan: The economic environment, as it influences both the credit worthiness and the need for additional working capital to fund growth in potential inventory finance customers.

Samuel Lynch: Quite obviously the general contraction across the wider economy will make any growth difficult. But worthy systems and business processes will promote continued business growth.

Q: Is consolidation as prevalent in the commercial industry as it is in the residential, and has the profile of the borrower changed?

David White: I don't believe consolidation is as prevalent in the commercial industry. Lenders are not joining forces however residential brokers tend now to look at commercial lending as another income stream. These brokers generally don't have the lender accreditations as they are not experienced. The profile of the borrower has not changed however only borrowers with a proven track record and strong asset base are considered.

Greg Charlwood: The debtor finance sector still remains quite fragmented, with banks and several larger independents competing alongside a large number of smaller lenders. The profile of the borrower is changing rapidly, with a number of formerly bankable transactions in terms of size now being written by independent providers. Many fast-growing SME's are also turning to debtor finance to meet their working capital needs.

Mark Turnbull: I think more than likely there have been commercial brokers leaving the market. The commercial broker market consists of smaller numbers of transactions with longer lead times. For example, you can work on a commercial transaction for 6-12 months before getting paid. With that in mind, I would say commercial brokers are somewhat more resilient in that they are used to periods of little or no pay.

George Sotiris: Lenders have changed there attitude toward low doc and no doc activity. And because there's been an extreme tightening of LVRs, clients need to provide information for renewal of facilities where they hadn't needed to in the past. And some have pulled out of the market totally

Borrowers are probably a little more cautious now, than they were. And they might delay some of those expansion programs. The other thing is some borrowers are not automatically getting their facilities renewed. Therefore they'll be looking for a broker to find another lender to take over the facility. The dynamics of the market now compared to two or three years ago are completely different.

Case Study 1: Debtor and inventory finance is hungry for specialists

Chief executive for Asia Pacific at Bibby Financial Services Greg Charlwood describes the beauty of debtor finance as it being a better provider of access to working capital funding.

'Better' because businesses that use it get more cash flow control as a result. Furthermore, a debtor finance facility has the capability to increase in tandem with sales performance. This is an important consideration since it enables companies to convert growth opportunities whilst they exist.

Besides, it comes without the risk of owners having to put personal real estate up as security.

Debtor finance has a relatively small slice of the pie, Charlwood acknowledges, but it's growing. "And it is hungry for specialists. So there are ample opportunities for brokers to create an additional income stream," he says.

Charlwood says brokers who understand the key principles of cash flow and develop the skill to diagnose issues in advance will be successful.  

Matthew Nolan, managing director at Provident Cashflow agrees that selling inventory finance primarily requires the skill of spotting the opportunities.

"And with a greater number of businesses requiring cashflow finance it certainly offers brokers a sound option to supplement income previously derived from residential lending," he says.

In addition, both Nolan and Charlwood hold the opinion that working capital finance is one of the least demanding areas of commercial finance.

Case Study 2: A base line demand for equipment leasing

According to general manager at IAC Rentals, Samuel Lynch, almost every business needs to finance equipment from time to time.

 "Let's face it," he says, "businesses are great at using equipment to make money but they're not so good at asset management and owning equipment."

For this reason, Lynch says, there will always be a base-line of demand for equipment finance.

And he feels that equipment finance is less complex than consumer finance. Despite the small issue of having to wade through years of company financial statements. Brokers that understand them will be in good shape, but Lynch believes it's not always necessary.

"What we want from our introducers is a commitment to seek information from the client and to maintain open communications with them," he says.

In addition Lynch believes that commercial equipment finance, for transactions up to say $50 000 is a great way for a dedicated mortgage broker to supplement their income.

"So much so that equipment finance should be a product all brokers provide to their client base," he says.

And according to Jon Moodie, division director for Macquarie Leasing vehicle and equipment finance is a logical string to add to any broker's bow.

 "Nearly every client, whether residential or commercial, will require vehicle finance at some point. It's easy and profitable to transact," he says.

Particularly car finance Moodie adds since is the easiest and quickest to master. 

Meanwhile director of credit at Australian First Mortgages David White believes it is the only way to go. "Brokers wanting to expand their income streams should look no further than equipment leasing. The lending principals are similar to residential with regard to simple transactions and this is an easier product suite to understand," he says.

Serviceability, security, and a clean credit history are the basics, he says. Stick with them to begin with, and grow into the more complex transactions at a rate you're comfortable with. Commercial transactions only become intricate when they involve details like feasibility schedules or council approvals for, say, development finance.

 Instead White says residential brokers need not 'market commercial', but simply ask their customers if they require commercial funding for their business. "A quick glance over the company financials will provide evidence of interest payments, or lease expenses. Once you identify these you might want to ask the question," he says. 

Case Study 3: Commercial property transactions: fully serviced and fully secured

More so now, than ever, lenders are looking to 'stay inside policy'.

So says managing director at Horizon Finance Mark Turnbull. "In the past we had been able to structure deals that strayed outside guidelines for strong applicants, due to extreme competition between the lenders."

Now banks are mainly looking for two things: full security and serviceability. According to Turnbull, if an application falls over in either of these aspects it becomes difficult to place.

It means elements in the transaction approval process like valuations, historical financial data and cash flow forecasts are brought into sharp focus.

 "The need is greater now for valuations to stack up," Turnbull says. And given the already tenuous state of buyer confidence, any value shortfall has the potential to scare them off completely.

Cashflow projections are taken less seriously. Lenders only consider the ones with valid and quantifiable assumptions. "Generally to support historical financial data only," he says.

In the past if the deal was fully secured you had more chance of getting away with relying on projections rather than historicals, however in the current climate lenders tend to focus on what the client has achieved when assessing a deal, Turnbull explains. 

In addition, he says it is crucial for commercial brokers to be adept in dealing with other parties in the transactions, like lawyers, tenants or tax practitioners. When dealing on behalf of a client brokers may be required to liaise with people from all other aspects of the transaction.

"Knowledge in these areas and the ability to communicate to different personalities is what sets a good commercial broker apart from an ordinary one. Also demonstrating your skills to people who are involved in the process will only increase your chances of obtaining a referral from these sources," he says.

According to managing director at Merchant Mortgage David Gouge lenders want to know that the borrower has their act together when they assess the credit.

"Both mentally and in terms of the application paperwork. There are various versions expressing the "Cs" of credit - including character and collateral and credit capability. The borrowers should have the ethic of making payments on time all the time," he says.

Gouge says that Turnbull is spot on that valuations are pivotal in getting commercial deals approved. And that funders take most projections with large grains of salt. Read, scepticism.

 "You don't often see poor projections for a new loan," he says.

As far as dealing with other parties is concerned, Gouge says it is significant at the 'big end of town' only. In the main commercial brokers would have fairly uncomplicated dealings with parties outside the borrowers, funders, and where applicable, the mortgage manager.

Case Study 4: Separating the wheat from the chaff: resi vs. commercial 

For George Sotiris, national manager, third party sales at IMB Bank, residential lending is straight forward.

"Fill in the form and tick the boxes," he says.

Particularly if the deal is for a pay-as-you-earn (PAYE) type of client. But commercial transactions require a better understanding of what your client does, and what kind of outcome they're looking for from the deal.

And having a clear picture of what your client's financial position is, including their cash flow position and ability to service the proposed debt, goes a long way to achieving this. 

"It's more about showing they have the capability to meet their future obligations than it is to present the applicants history of employment and the LVR," he says.

But it's a fine line.

According to Sotiris if you're after the large sized organizations it'll get complicated and you will need a full understanding of cash flows and ratios. But you don't need to be an accountant for the smaller ones.

While he admits putting even these category of deals together is not as simple as rounding up a couple of pay slips, he believes understanding exactly what your lenders are looking for is more important than analysing balance sheets, when presenting a smaller scale commercial transaction.

"Think about it," he says, "most brokers are self employed, so they should think about how their own business runs and then they'll know the same about their clients. They are not too dissimilar."

According to managing director at Intellitrain Paul Eldridge selling commercial finance calls for a more advanced level of training than that of its residential cousin.

"Unquestionably," he reasons, "ask any experienced commercial broker how long it took them to learn the ropes."

The two might be cousins, but as far as Eldridge is concerned they're distant ones. And he only needs one word to describe the difference between selling the two: diligence.

"Simply put, brokers must have the attention to detail needed to put commercial deals together. Time frames are longer and the effort required is significantly higher. So it's a good idea to start with the smaller simpler deals and then progress from there," he adds.