Do you know what the most important part of the loan life cycle is? What you should think about before you’ve even applied?
These aren’t just lofty rhetorical questions.
The answer holds the key to sustainable funding that will deliver unequivocally on your needs. Like a good friend stopping you before you dive into a relationship that you probably shouldn’t, It’ll save you time, energy and heartache.
What is it?
Nailing the exit.
But first for some context, what is the loan lifecycle?
The loan life cycle is the process a borrower and lender go through from arranging finance to exiting the loan.
Looking at it from a distance, you might be tempted to think that the first stage – getting qualified, approved, and underwritten – is the most important. And from a borrower’s perspective, it is. The endorphin rush of a fast approval and the ability to move on with their plans thanks to the capital is tantalising.
But this is a short-sighted view on things.
A quick cash flow injection might come back to bite them later down the track if the loan didn’t account for the nuts and bolts of their unique financial situation. If they find themselves unable to pay down their debt, they can become entrenched with rising costs that they can’t service. These can grow into debt monsters that sink their business or make them personally liable, if they’re the director.
Now onto an example to see this in practise.
Let’s say you’re a broker in Sydney. Your client is a 38 year old property developer who wants to flip an investment property in Ashfield. It is definitely a fixer-upper, but you see potential in it. You arrange a meeting with the client to fill in their application and bring together all the necessary documents. Their income and serviceability look good. Approval is a no-brainer from the lender you have in mind.
A few months go by and everything is fine. Until things start to hit the fan.
Your client gets laid off their job unexpectedly and Pittsville, which they haven’t started developing, is too expensive for them to keep. But it’s more complicated than that. As always with finance.
They don’t want to sell as the property market has tanked since they bought in. To make matters worse, the lender isn’t keen to refinance either, thanks to falling LVRs and tightening criteria. It is the worst of both worlds.
As a broker, you are deeply unhappy, your client is stressed as anything, and you’re thinking, how could I have done things differently?
Here is how to avoid that situation.
While good brokers think of the start, great brokers have their eye on the finish line.
When assessing a borrower’s suitability for a loan you should always have the exit in mind. Borrowers are not always the best judge of their own suitability for finance. They can fall into the debt trap believing that they’re on the edge of making it.
In reality, they might be on the edge of a cliff about to fall off.
So in your initial assessment you have to consider their ability to exit a loan. This will give you a good indication on whether you think finance is actually a good choice for them. In your assessment, you should aim to get a complete picture of their finances. That includes their investments, debt burden, and company tax position. You’ll also need to have a strong backup plan for the exit, in case things don’t go according to plan.
Some common finance pitfalls: rotten investments, loan stacking, and poor accounting records. These are the things you should be scanning your client for before you get them into a loan facility.
Poor investment choices can increase the risk of a failed exit.
Investments always carry some level of risk.
However, if your client has most of their savings tied up in volatile or illiquid investments they are less able to respond to changes in their financial situation. Selling volatile assets can put you in a negative equity position if they are in a downturn and illiquid assets, like property and property funds, can take many months to redeem.
In the case of our 38 year old developer, if his portfolio were full of assets he couldn’t sell or that would be worthless upon redemption, we would be very concerned about his exit capability and might think twice about his approval.
On the other hand, clients with liquid and stable assets, like term deposits, cash, or blue-chip equities, are much better prepared for a quick exit. A diversified portfolio that retains most of its value in volatile economic times is a strong insurance against a change in their financial position. It is a much easier exit to sell to the lender.
For brokers, you want to consider whether your client has diversified assets than can be liquidated for a fair value, as this can extend their serviceability or give them more options for an exit.
Be on the lookout for loan stacking.
Loan stacking can be used well and strategically, but when used badly, borrowers pile additional loans on top of the others to cover runaway debts and expenses. It is a case of more money and even more problems, as borrowers juggle repayments and multiple schedules.
Just because a borrower is on top of their stacked loans at present, we have no guarantee of their shape in future. It is more than likely that they’ll fall behind when things don’t go according to plan. Surging interest rates, volatile consumer spending, and higher cost of business are working in tandem right now and might throw businesses with multiple loans over the edge.
So brokers should be vigilant about loan stacking and factor in the ballooning costs into prospective client’s exit strategy.
Refinancing should not be a last minute hustle.
You need to make sure you have more than just a refinancing exit strategy. Though, if refinancing is your exit, then keep tabs on your client to make sure they are not amassing credit defaults or missing tax lodgements that will put the refinance exit at risk.
Sometimes the best option is to suggest a restructuring solution or volunteer administration. That is a hard conversation but a necessary one in some cases. If it is a business, speaking with an insolvency expert might be the most painless way out. In the case of investments or property, it may be better to liquidate than continue the project or amass further debt.
That being said, refinancing is a suitable strategy if you have prepared for it.
Borrower financial statements and tax returns must be immaculate. Their management accounts need to be reconciled, and their ATO debt must either be paid or on a payment plan. They should also show no credit defaults and ensure their employee-related obligations (PAYG, super, wages) are fulfilled.
Lenders are not gamblers – they will only refinance a loan or roll one over if they believe you are creditworthy. Creditworthiness means staying in control of their finances, not just having sufficient serviceability or assets.
Brokers might need to think about new payment models.
A lot of extra work goes into vetting and checking a client’s situation before, during and after a loan is approved. Understanding if they’ll exit well will undeniably take more time on the entry. So rather than deal-by-deal payment models, brokers should consider mandates that secure a borrower for a period of time.
A great commercial broker that can add value throughout the loan lifecycle should consider multi-year contracts with clients to ensure their modelling and analysis of the client’s finances is appropriately compensated too.
It reduces your opportunity cost while ensuring you deliver greater client value. High-quality borrowers will respect you for going the extra mile for them.
To summarise.
Commercial brokers should always have the exit strategy at the front of their minds when arranging finance.
If you take away anything from today’s episode, try to have exit in mind from the get-go. In that initial meeting with clients you should be scouting for any indicators of a good exit: do they have a healthy investment portfolio, good accounting records, and manageable debts?
Knowing what to look for and making it part of your process is essential for a smooth and bulletproof journey through the loan lifecycle.
And it always pays to be prepared. Have a strong backup in place for the exit in case things change and things hit the fan.
