The fine print – buyer beware
I have written recently of the sometimes troubled relationship between banks, borrowers and regulators.
Indeed, hardly a week goes by without some fresh allegation of wrongdoing, consumer complaint or a misguided call for an enquiry. As we rush toward the dubious title of most over-regulated and over-governed country on the planet, I think we risk missing the point.
In our business, we are often approached by new and existing clients who have a perceived problem with their bank. In some cases, and despite our best efforts to educate, borrowers simply don’t seem to understand how banks work. It’s a recipe for misunderstanding at best and disaster at worst. I can’t see how ever-increasing legal and legislative obligations on lenders and intermediaries is going to solve this problem. In fact, with more regulation comes increasing and ever more complicated disclosure and compliance, which just leads to more paper, more loan clauses and in my experience less chance of the borrower actually reading and digesting all the information.
Let’s cut to the chase. Despite what the politicians, bleeding hearts and leftie do-gooders might think, the banks are not out to get you. Banks are interested in making a profit, not lending you money on the basis of some sinister plot to send you broke. Granted, most banks have serious communication issues and couldn’t speak plainly if you held a gun to their heads; however, in my mind that’s beside the point.
Ultimately, for a borrower, the primary communication you need to understand when you borrow money is the bank’s Letter of Offer. Your rights and responsibilities and those of the bank are enshrined in this document and its best that you understand the content. Most of the document will be standard bank jargon but there are a few specific clauses that you really need to take note of. When we see disputes between borrowers and banks it’s generally a result of misunderstandings in these key areas.
In no particular order, here’s a few tips for the unwary:
Loan term and interest-only periods
The bank will provide the loan over a specific term. If it’s 15 years with the first three years’ interest-only, you will go to P and I repayment after 36 months. It’s your responsibility to approach the bank early if you want more interest-only. If you don’t, the bank will do exactly what was agreed from the outset and commence P and I payments. It’s that simple and frankly I can’t believe the number of borrowers who seem surprised when the bank acts in accordance with what was agreed.
Some banks offer a short loan term of, say, three years. The loan expires at the end of the term and must be renegotiated prior to the expiry date or paid out. Make no mistake, this is not the initial term, it’s the total term. Again, if you want to extend you need to get in the front foot and negotiate the extension prior to expiry. Banks hate expired loans and some charge penalty interest so beware.
Performance covenants
When the bank lends money, it does so on the basis of certain key metrics. These include the capacity of the borrower to meet their obligations and the security coverage and gearing provided by the assets the bank takes a charge over. The Letter of Offer will include certain benchmarks that the borrower needs to meet in an ongoing basis. There will be reporting obligations for the borrower, should they become aware that they are not meeting their covenants.
Some of the more common performance and reporting requirements will relate to units in a letting pool, renewal of leases for motels, interest coverage and debt coverage benchmarks and minimum maintainable net profit. Put simply, the bank wants to know if things are not going to plan. Here’s a tip: in my experience, banks are far more likely to bend over backwards to help a client who puts their hand up than one who hides the bad news for as long as possible. If you don’t want to raise your concerns with the bank, raise them with us first and let’s see if there is a strategy for managing the situation.
Annual reviews
Most business loans are subject to annual review. The review date is outlined in the Letter of Offer and is almost always on the anniversary of the loan. It’s important to know your review date and be prepared for it. As a minimum, the bank will want your last twelve months’ financial statements, most recently lodged tax returns, an up-to-date statement if assets and liabilities and confirmation from your accountant that your ATO obligations are up-to-date. Turn up early with all this documentation and, once your banker recovers from the shock, you will certainly be extremely popular. Annual reviews used to be the bane of my existence back in the day and I reckon not much has changed. Chasing borrowers for overdue documentation while convincing the credit manager they are really good people is no fun!
Valuations
Banks worry about the value of their security, and rightly so. For most of our clients, that security value is directly related to the value of the going concern and thus the financial performance of that business. At annual review, don’t leave that assessment to the bank. As part of your annual review, put forward an adjusted profit-and-loss in a form consistent with your original purchase. Provide some recent market data and make the argument that if anything the business value has gone up. The trap here is that if the bank uses your tax returns to assess the business value at review time there will surely be grief. The bank could even insist on a revaluation by a bank panel valuer, which is an expensive process and in my view rarely worth the trouble if solid data is to hand. Remember though, under most loan conditions, banks can revalue security at any time at your cost.
Finally, a word on pricing. Business borrowers are charged an all up interest rate, which is made up of a base rate, a liquidity margin and a client risk margin. It’s mostly smoke and mirrors but the risk margin is worth thinking about. If you believe your risk to the bank has diminished since you took the loan, ask about a rate review. Nothing ventured nothing gained as they say.
When managing these matters I am often reminded of a great quote from Winston Churchill: “If you are going through hell, keep going!”
Mike Phipps has been a career banker for more than 30 years, more recently specialising in management rights and accommodation finance.
