RBA reduces rates causing real interest rates to increase Australian Bank Funding Costs Surging . I warned this could occur in WE SHOULD THANK THE RBA FOR HIGHER INTEREST RATES . What’s concerning is how quickly rates have surged and what impact expected, future interest rates decreases may have on Bank costs. If this trend continues, we will see our Banks retain either part or all of any future RBA rate decreases.
Australia’s higher interest rates have been a huge draw card for foreign investment throughout the past 5 years of the GFC.
Despite certain media reports that Australia has now achieved the “safe haven” status among global investors (a statement that I don’t personally agree with), it’s the RBA’s sensible interest policy that has ensured that we remain an attractive investment destination for foreign capital starving for low volatility and more importantly, higher yield.
The Central Bank policies of the US and Europe, of flooding the market with cheap credit and forcing interest rate low for an extended period of time, is designed to force investors to take on risk and move their capital out of cash and into higher risk, higher yielding investments.
Despite what you may read and believe about the economic credentials of our country and the Australian dollars new “safe haven” status, the number one reason that global capital has continued to gravitate towards Australian shores, is the higher interest rates on offer in Australia, compared to the rest of the world.
If the RBA didn’t act so prudently over the past 5 years, and instead followed the desperate path of our overseas counterparts by flooding the economy with cheap credit, Australia could have found itself having to pay much higher interest rates to attract foreign capital, as it would have lost its current competitive advantage.
So be careful what you wish for and ask yourself, should our interest rates continue to drop as a means to spurring economic growth, at what point will Australia lose its appeal as an investment destination for foreign capital and what effect could it have on real interest rates, in the future ?
Con Katsiouras – Director
Folio Finance Pty Ltd
The USA, is the centre of the investment Universe and what happens in the USA dictates the mode and tempo for markets all around the world. So it is impossible for a Global Recovery to occur if it does not include a recovery in Confidence, Growth and Economic Fundamentals in the USA. As far as a resurgence in Finance and Liquidity in Debt markets, the “buck” starts and stops in the USA.
So reading yesterday in Bloomberg news that the pursuit of higher yields by investors is leading to resurgence in demand for Commercial Real Estate Collateralised Debt Obligations (CRE CDO’s) (www.bloom.bg/W3abzb) got me thinking that the markets may have finally bottomed and we could be moving into the next phase of economic cycle – growth lead by confidence and new investment (as opposed to Government funded GDP).
CDOs are packaged pools of debt that are rated and then sold to investors as Bonds. Assuming the borrowers behind the debt continue to repay their debts (i.e. a high majority of the individual loans forming part of the original pool of funds is repaid), investors receive a regular coupon on their investment (see http://tinyurl.com/d7tz6fr for more information re CDO’s)
CDO’s lost their appeal in 2007 when the Sub Prime crises caused many of the CDO’s at the time to be written down, leading to Billions of dollars in losses for investors all around the world.
Of course, a large part of the problem up to 2007 was that Credit Agencies were not adequately assessing and rating the risk associated with these investments. This resulted in an inflated amount of demand for these products, due to their perceived lower risk, high return profile. At its peak in 2006, over $520b worth of CDO’s were written alone and the sector became heavily reliant on this form of funding.
However, since 2007, the market has been defined by a low risk and much more conservative investor. This has led to many investors accepting very little and sometimes zero return on their capital whilst waiting for confidence, in a post GFC world, to rebuild. Of course, during this period, their has been very little interest and investment in CDO’s due to the stigma attached to this form of security.
It has taken a good part of 5 years but recently we are seeing “green shoots” appear in the Global Debt Markets, with more and more investment gravitating towards property secured debt instruments. In fact, many of our Banks have begun refinancing large tranches of their loan books, previously backed by Government Guarantees, with lower cost funding now available on the Global Markets ( http://tinyurl.com/b6l4byt ), a clear sign that demand for this type of product is improving.
Continued demand for Property related Securities should lead to a decrease in the cost of funds for our Lending Institutions. This will encourage Non-Bank Lenders to once again enter and compete in our local market and increase competition for our over dominant four Major Banks. Competition, particularly in the Commercial Property space, has been almost non-existent since the GFC with the Four Major Banks continuing to overcharge customers (in real terms, margins charged by the Major Banks on Commercial Loan are on average, double their pre GFC levels but disguised by the current low interest rates (See http://conkatsiouras.wordpress.com/2012/07/30/beware-of-banks-bearing-gifts/ ) without any major concern of losing market share, due, predominately to the lack of real competition.
Its competition in any market, that ensures continued innovation between competitors and guarantees that borrowers have access to the most competitive forms of funding, at the best price.
Unfortunately, borrowers, investors and SME’s today have only limited options as far as Commercial Finance goes and this, along with the current tight restrictions on Credit, are a major road block to a return in confidence, investment and sustainable growth, by Australian Business owners.
Hopefully the recent improvements and “Green Shoots” in Global Credit Markets will continue and result in resurgence in Competition, Products, Policies and overall conditions for Commercial Borrowers in 2013. I for one am optimistic that this is a positive sign of things to come.
Director – Folio Finance
Ph: 03 88445555
Recently we have seen an almost unprecedented amount of activity in sales involving Service Stations, with $100m’s worth of Petrol Station Sites going under the hammer. More recently it was Woolworths who sold 8 of its Petrol Station Sites http://tinyurl.com/9qyd64e, although prior to this, it was 7 Eleven who sold many of the sites acquired during their purchase of 295 Caltex Service Stations in 2010.
With all the volatility seen in Global Markets spilling over into most asset classes, investors have been desperate for long term, stable yield. The long leases on offer by these Service Stations, underpinned by the strong Retail Brands of 7 Eleven and Woolworths, seem to have hit the mark with these investors and pushed some of the yields down below 6%.
However, there are inherent environmental risks involved with purchasing Petrol Station sites that you need to be aware of and Banks are reluctant to take on these assets, as they could potentially create an environmental issue down the track.
In simple terms, if their is an environmental problem created from the Petrol Station, through a leaking underground petrol tank, or other means, it is you, the owner, that could be liable and become the target of any civil action . Of course, their can be huge costs involved with civil litigation, not to mention the costs involved with remediating a contaminated site, which is why Banks will go to great lengths, to ensure that i) the site isn’t contaminated when taking it on as a security & ii) that adequate monitoring is in place to ensure any future leaks or issues are detected early on.
As such the Bank will request an Environment Audit to be completed by one of their approved Auditors prior to approving a “high risk” asset as security.
The first stage of surveying will almost always entail an Environmental Audit, by way of a Phase 1 report. This report is an investigative report that examines the likely-hood of contamination on a site and the likely causes. Of course, with a service station, the likely-hood of contamination due to its use, is considered high, so the conclusion of the report will ALWAYS recommend a Phase 2 report, which involves a higher level of testing to be conducted (why they don’t simply instruct a Phase 2 report from the offset is anyone’s guess, but the fees involved with creating the reports may have something to do with it). The costs of these two reports alone can be as high as $50,000 and dependant on the findings of the reports, further sampling, research, drilling and reporting may be required. These tests, along with any of recommendations made by the audit, could add considerable costs to your purchase, literally in the $100,000’s!
So how did all the recent purchasers deal with their Banks? My gut feel is that the majority of recent sales have been completed by Professional Investors with substantial Cash Savings who didnt require assistance from a Bank or Lender.
Personally I do believe that some petrol station sites make great investments, due to their long lease profiles, as well as many benefiting from Mixed or Residential Zoning, which means many of the properties benefit from strategic/long term development potential.
But before you go out and add a petrol station to your property portfolio, do your research. Speak to your lender or Commercial Broker and ensure that you understand all the risks involved with making such a purchase. After reviewing the risks, if you do decide to proceed with a purchase, ensure that you discuss your purchase with a lender, so that you understand their expectations and what will be required to have their support and provide the funding that you require.
Director – Folio Finance Pty Ltd
Ph: 03 8844 5555
SME’s have it tough when it comes to raising finance to help their business’s grow. Even when they are approved , its normally on a take it or leave it basis with facilities structured according to the Banks strict terms and conditions and without much flexibility.
Many SME’s have Business Loans secured against residential property, yet they are sometimes paying 2-3% higher than the standard Home Loan rate. Furthermore once approved, the Business owners normally have to adhere to strict conditions that the Banks impose, post the settlement of the loan. This can include having to repay the debt over a short period of time, annual reviews and the provision of annual financial statements (to mention a few) all of which can add considerable cost and interruption to the day to day running of ones Business.
Compare this to a PAYG (Pay As You Go) Borrower with no investment experience what so over. Assuming they have been in full time employment for only two years, Banks will lend to them for the purpose of speculative investment in shares or property with little to no questions asked. Further to this, they will do so at low Home Loan Rates over a 30 year term. Cash flow tight, no problem, Banks will also allow a 5 year interest only tem and as long as you make your repayments on time, it is highly unlikely you will EVER have to verify your income over the term of the loan. Talk about double standards.
So why are SME’s clearly so unfairly treated? I believe the answer is simple lack of “competition”. With the four major Banks taking the lion’s share of Business in the market, there really isn’t an incentive for Banks to offer new products, especially to the SME market where margins are extremely high and profitable for the Banks.
Yet, recently, some Non Major and Non Bank lenders have started pushing the boundaries when it comes to lending to SME’s and things are starting to look a little better for SME borrowers.
For instance Citibank, one of the largest Banks in the world, is offering residentially secured Business Loans for SME’s at Home Loan rates, with all the benefits of a standard Home Loan, including, interest only terms, cheap set up costs and 30 year terms with NO annual reviews. This sort of product is perfect for SME’s with lumpy cash flow as it allows the flexibility to repay only interest during low cash flow periods, and to make lump sump repayments when their cash flow allows. The product also has a redraw facility attached to it meaning that once cash is repaid back into the loan, Business owners still have the access to those funds, no question asked, if and when they should require it. Citibank will even refinance an existing Business Loan on these same terms.
With volumes low in the Retail/Home Loan space, many Non Major and Non Bank lenders are looking at the SME market to prop up their loan books and following suit with their own innovative SME products. This is great news for SME clients and it has been a long time coming. My hope is that this trend will open the doors to a suite of new innovative products that will continue to evolve and benefit the SME market into the near future.
Of course, as many of these non Major, Non Bank lenders rely on the Broker Network to market and distribute their products, many of the products, lenders and options out there will not be known to the average person. So it is vital you speak to a Mortgage Professional to ensure you find the most efficient, competitive and relevant product available to you at any given time. And remember; always ask your Broker what alternatives to the Banks might exist to assist you with your goals.
Con Katsiouras – Director
Folio Finance Pty Ltd
Recently I have come across many Borrowers who were pleased about the low Interest Rate they are currently paying on their Commercial Property Loans. Many of them are paying between 6.00% and 6.50% which are historically low rates, actually lower than some current home loan rates .
But these opinions completely contradict the many recent newspaper articles that have reported claims by many members of the Business Community, of Banks passing on higher lending margins to their Business clients, to subsidise their lower margin Home Loan and Wealth Management Businesses.
So how can we have such a contrast of views from different members of the Business Community? Could it be possible that Banks really are going out of their way to offer cheap Commercial loans? If so what has inspired this benevolence from our Banks?
Generally, Commercial Loans are priced as a Bank Bill Swap Rates (BBSY or BBSW rate ) plus a margin and it is these two components that make up the actual interest rate paid by borrowers (for simplicity we have assumed that there are no other costs associated with the interest rate charged. In reality, Banks can have many fees and charges, treasury fees, line fees etc, that can impact the actual interest rates/costs associated with a Commercial Loan). Prior to the GFC when competition was at its peak, it was not uncommon to have clients priced at margins between 1.25% – 1.50% (many clients enjoyed much lower margins).
So taking the 30 day BBSW rate of 3.63% on the 27th July 2012 (Australian Financial Markets Association) and assuming a borrowing rate of 6.00% per annum, we calculate that this Borrower is being charged a Margin in the vicinity of 2.37%. From this simple calculation, we can see that despite borrowers benefiting from what may be perceived as a Low Interest Rate, the actual margin being charged above the BBSW, is well in excess of the pre GFC averages (by as much as 64% conservatively). This is a substantial increase in Margin at a time when many Businesses are doing it tough. This increase in Margin has also had the effect of further intensyfying the current economic downturn by removing much of the stimulus that would have been created from a lower interest rate environment. At the same time , it has ensured that Banks can continue to make record profits by pushing up costs to Business’s disguised behind “Low Interest Rates”.
So whilst many Borrowers may believe they are benefitting from a “Low Interest Rate”, their Banks are actually profiting from much higher Margins, justifying some of the claims of fee gauging by Banks towards their SME clients.
In finance, we refer to this as “Margin Creep” and the Banks have used this process very effectively during the current downturn in both the Home Loan (Retail Banking) and more aggressively with their Business clients. However, Business Clients have borne the brunt of these fee increases as Banks understand how difficult it can be for SME’s to refinance, making them easier targets for rate and fee increases (compared to highly transient, Retail customers who have more competition ,more options and cheaper entry and exit costs).
So next time you find yourself negotiating a Commercial Loan with your Bank, do your homework, review the current BBSW or BBSY rates and ensure the discussion focuses on your lending Margin and NOT your Interest Rate. That way you won’t give your Bank the opportunity to hide an overpriced margin behind a cheap interest rate and your facility will remain competitive over the long-term.
Should you wish to discuss any aspect of this post or any general matter, please contact me on :
I am asked regularly why has it become so difficult to raise finance and why have things changed so drastically ?
When I established Folio Finance 7 years ago, the economy was flush with cheap money and Banks, Commercial Lenders, Mortgage Trusts and Private lenders in Australia, couldn’t push their funds out the door quick enough. Commercial Finance sector in Australia was going through its own over inflated bubble. This resulted in more money chasing fewer deals, forcing lenders to take on transactions that were high risk with low return. It was an environment where investors and speculators could venture out and secure investments such as Commercial or Residential Property with little and sometimes no equity and the majority of the risk being transferred from the borrowers to the lenders. Of course, we all know this ended with many investors losing their investments in what were meant to be “secured” investment schemes with the worst impacts still being played in Europe and North America (where having a loan approved was as easy as confirming you had a heart beat). Thankfully, things didn’t get as “wild” here in Australia and the finance sector, supported by a 1 in 100 year mining boom, was able to sustain the impact of the GFC and now has to deal with some of the obstacles the GFC has created, mainly around funding , liquidity, sustainable profits and growth.
I think it’s always been difficult for SME’s to raise finance through our Aussie Banks. Reality is, Aussie banks have always been Asset lenders and never really a true supporter of small companies unless you had Real Property Security. Of course, any banker will deny this and will tell you that repayment capacity comes before security every time. This may be true but loans are rarely approved on Cash Flow alone.
Many factors influence the decisions made by banks. One of the major influences recently has been the greater Government scrutiny post the GFC . This , along with many other factors have worked in unison to create the current environment of tight credit and higher costs.
Rather than try explain them all, ill detail a few of the major issues making it more difficult for SME’s to attain Commercial Property Finance via the main stream banks.
- After the GFC, APRA (Australian Prudential Regulation Authority), our prudential regulator of all things Bank, placed larger capital requirements on our banks, stricter lending guidelines, and tighter portfolio controls than pre GFC. Specifically APRA requested the banks reduce their exposure to Commercial Property. This has created an environment where banks can “cherry pick” the best deals with the best margins without any real incentive to pursue business that doesn’t fit their criteria, simply because their portfolios are already overweight in this segment. Recently, this has resulted in a large percentage of customers being forced to refinance their existing Commercial Property Loans. With all the banks undertaking the similar “clean up” of their commercial property portfolios, many customers have found that they have no other option than to sell their property.
- Our banks fund approximately 30% of their capital requirements through deposits. For the remaining 70%, they rely on the global market for “mortgage backed securities”. Unfortunately, the over exuberant lending in America and Europe has tarnished the whole of the global banking industry and anything attached to mortgage backed lending. This has resulted in less money flowing towards this investment. With fewer investors, a higher premium is demanded to compensate for the higher perceived risk resulting in higher rates being passed to customers.
- Less Capital means that the banks have to squeeze more margin out of every dollar they have to invest. Because capital is scarce and the banks have genuine concerns about their ability to raise capital in the future, they now are chasing not only the best deals, but the best deals with the highest margins. The lack of real competition in the market, as well as the fear and publicity around the GFC and “those greedy Americans and Europeans who ruined it for all of us”, has resulted in the perfect storm for our local banks where they are able to raise rates, increase margin, and blame it all on external events supposedly “outside of their control”,
- THE LACK OF COMPETITION IN OUR MARKET IS THE REAL ISSUE. Real local competition is what keeps rates low and keeps the banks at toe. It’s what makes the banks think twice about increasing rates above and beyond those increases set by the Reserve Bank and keeps them working with clients, even when we aren’t the “perfect” prospect. There were many Commercial Lenders operating in Australia pre GFC and they were doing a great job at offering a real alternative to the banks. Unfortunately, they too relied on the global market to raise capital and were forced to close during the GFC, creating more reliance on the banks and more demand on their capital which provides the perfect environment for banks to continue to increase their profits, simply by charging a higher price for their products, without having to worry about innovation or improving their service proposition.
These are just some of the major issues influencing the local lending market and influencing the lending decisions of the banks. Thankfully, over the past 12 months, a number of Non Bank Commercial Lenders and Private Lenders, have reemerged to take on the banks and provide a variety of options for customers who wish to continue to grow and continue to invest in their future. As these lending institutions don’t have branches and rely on Brokers as their distribution channel, many of them won’t be known to you.
In the coming posts, we will discuss what some of these new funders have to offer, how their products and service proposition differ from the traditional banks, and some of the key advantages to using these products.
Of course, feel free to leave a comment or ask a question.
We are about to find out.
The folio finance blog has been created to provide up to date and relevant information with respect to Commercial Property Finance.
This blog will give you an insight into how investors and other savvy market participants, are using bank, non bank and non traditional avenues of finance, to purchase Commercial Property and improve their financial future.
Many individuals are discouraged from investing in Commercial Property because they:
a) Believe Commercial Property Investment is too complicated,
b) Think Commercial Property Investment is only for sophisticated investors with large sums of money,
c) They simply believe they will not qualify for finance.
Of course, this is simply wrong and I believe the main cause of this false perception is the lack of public information available on this topic.
This blog aims to fill this information void by providing timely and relevant information on current opportunities, threats, trends, and common strategies used by Commercial Property owners to access funding in today’s market.
My goal for this blog is:
- To provide you with the most up to date and relevant information available,
- That the information will increase the likelihood of attaining finance,
- That the information will help professionals in the Commercial Property area, to better understand and stay up to date with the opportunities in the lending markets and hopefully help them and their own clients, better meet their goals,
- To provide a forum for professionals and investors alike, to share their thoughts, ideas and experiences with other members of our community,
So if you have an interest in Commercial Property or, you know someone who is interested in this area, please register to receive regular updates and be a part of our community.