CREDIT ALERT – “THE PARTY IS OVER”
The serious impact that the current credit squeeze is having on the property development industry has been well reported by both DFP and widely broadcasted by the wider press. Globally we are all bearing witness to the volatility in markets created by sudden regulatory and monetary policy.
One such example of the effect that a sudden shift in regulatory change can have within our own local market is the shock wave created by our local prudential regulator APRA (Australian Prudential Regulatory Authority).
In late 2014 and early 2015 APRA encouraged the major banks to slow the largely unchecked residentially secured credit growth. Unfortunately, the Banks in response to demand driven by the peaking property markets in Sydney and Melbourne accelerated the rate of growth well beyond the preferred speed limit beyond 10% per annum.
The sudden and aggressive shift in APRA’s actions was due to the simultaneous macroeconomic events which continue to present real downside risk and the extremely volatility we are now seeing play out in global and domestic economies.
On one hand we have the commercial, property and corporate divisions “Property Bankers” of the Banks aggressively (up until recent events) lending to property developers in order to meet the market demand for new residential dwellings from resident and non-resident investors and owner occupiers.
On the other hand their colleagues in the retail divisions were also (up until recent events) lending aggressively on high LVR’s and lower servicing tests, so everything was going swimmingly.
The unfortunate set of circumstances the Property Bankers find themselves in, is they are being left high and dry by the Retail divisions who are being forced to decline many of the loans required to settle the presale contracts upon which the Property Bankers are relying upon to pay their loans out.
So what message do you think this sends to the approving credit officers of the Property Bankers?
The reality is settlement risk on existing presales has increased as a result of APRA clearly telling the Banks the party is over. Freely available low cost credit supplied to any market has historically driven asset values beyond what is sustainable and created the certain correction to follow.
This is what we are seeing in our market, the oxygen sustaining the property market has been in the form of cheap freely available debt and this oxygen has been partially taken out of the room by APRA. The perceived settlement risk associated with the existing non-resident purchasers has also heightened in the eyes of the approving credit officers of the Banks and Valuers who act for the Banks. The focus on the Banks and Property Valuers has shifted to look at the quality presales and the probability they will settle.
At the end of the day what you have to always realise about the Banks and the Valuers is that the banks rely upon “what happens if this all goes to mustard” i.e. sudden shift in asset values and liquidity and a significant number of the investors and non-resident purchasers walk away from the deposits and contracts and we are at peak debt and nearing expiry of the loan term? The answer always reverts back to the ability to replace the crashed contracts using local agents to replace the contract into the local market.
With the benefit of hindsight, this begs some very interesting questions to be asked of the developer and the Bank who have committed to projects for which there is a limited local market.
Anyway let’s not dwell on that thought for too long…
What does all of this mean, where is all of this heading and more importantly what are some potential solutions?
What this means is there is a heightened risk of developer’s presales not settling and difficultly replacing them at the same price and the unsold stock being harder and taking longer to sell also at the same price. This is not good news if you are the property developer and Banker who is sitting on peak debt with an expiring facility and capitalised interest facility.
The downside risk to the broader market is if sales are forced at any significant level we will see the Bank instructed valuations for completed stock start falling, which will only add serious fuel to the fire and make everything worse.
What are some potential solutions?
DFP believes it is essential for a secondary market to be created to help property developers and property bankers. The secondary market is created by giving the property developers and Bankers an alternative exit strategy of the unsold residual stock via a refinance of the residual construction finance debt.
The property developer can then either hold the stock as a long-term incoming asset or progressively sell down the stock in the market on their terms rather via a forced sale.
Historically there has been a very limited debt market that has an appetite to lend to property developers. Primarily this is due to the inability of the property developer to demonstrate recurring maintainable income streams over time (historically or forecasted) sufficient to meet the standards set by traditional debt servicing calculations. Additional traditional lending standards require lenders to value the property developer’s residual stock “In one line” and based upon “forced sale” thereby discounting any real equity in the asset making thereby making the assets very difficult to lend against at sufficient level which pays out the remaining construction debt.
It is clear traditional credit standards do not support Bank and Non-Bank lending to Property Developers to allow for the creation of the second market mentioned earlier. As experts in the industry, DFP has worked with its capital partners to create a lending product to specifically address the situation and help create this secondary market and alternative exit strategy.
We can now advise property developers on a range of low doc and NO DOC capitalised interest products at affordable rates. These products have been developed by DFP and our capital partners specifically for property developers.
As a result we are proud to have established a secondary market for Property Developers and the Banks which finance the property finance industry.
If you would like to know more about DFP’s residual stock loans please contact us.
For expert advice:
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- CREDIT ALERT – “THE PARTY IS OVER”