Is big better? The way banks respond to larger investors, you’d think probably not. As credit policies loosen a smidgen you could easily conclude that all is good in the world again. It’s not. At the retail end of banking they’re not too worried. Investors have day jobs so even if the market craps itself; borrowers can gradually earn their way out of trouble. Unlike the US, banks in NZ have a firm grasp on your short and curlies. Bankruptcy is the only way to bail out of your financial obligations, so banks can rely on Mum’s and Dad’s to pay their pound of flesh. As you become a bigger investor this dynamic changes. You become a lot more reliant on your rental portfolio for servicing and small swings in property values can quickly mess up the bank’s security position. The biggest public fall from grace so far was Don Ha but there have been others. The response from banks is to put more senior managers over investors, as they get bigger. The table below sets out the credit criteria for determining where you are managed.
|Business Unit||Credit Rule||Pricing/Products|
|Retail||<50% of income and <6 tenancies.||Retail pricing including any promotional offers.|
|Small Business||>50% of income and >6 tenancies.||Retail pricing but no legal contribution and will try to charge a fee.|
|Commercial||>50% of income and over $1.5m of exposure.||Charge fees. As exposure increases, will revert to business products.|
|Commercial Property Finance Unit||Over $10m of exposure.||Will use business products and charge at extra 0.50% on housing rates.|
As an investor gets bigger they will struggle to pass a bank’s retail credit policy. The bank policy is to take 75% of rental income and test servicing on the mortgages on a P&I basis and at a rate of 6.90%. For example a property portfolio of $10m with $6.5m of lending yielding 6% gross would generate -$5,000 per month of servicing. In this situation an investor would require at least $100,000 (after tax) of other non-property income. It is hard to have a large portfolio and pass servicing and it is reliant on your other income. Some investors have got into trouble simply from a drop in their other income and the bank losing comfort with their overall position, especially for business owners and farmers. I was recently talking to a farmer whose mortgage is being called in (due to a high LVR) and they have never missed a payment. Under commercial banking criteria the focus shifts to an interest coverage ratio of 1.25%-1.50%. This can be even tougher to pass. In conjunction with the policy shift, the bank will write the mortgages on a business product and on business terms and pricing. That usually means a 5-year term.
Early on it is easy to work with one bank. Your relationship manager loves you, the approval process is easy, and the bank prices competitively. At some point along the way, things subtly begin to change. You notice that the next approval takes a bit longer or maybe the paperwork is a bit more onerous, or someone else has also had to look at the deal for sign-off. You may have requested an extension of an interest-only term and felt like you’d been put through the wringer. The transition from retail to business can be painful. Your banker has likely tried to write the deal and been slapped by the credit department. The deal has then been passed to a business manager who is already busy and views you as an inconvenience. At some point you jump from business to commercial. The paperwork is now something to behold. Your experience with the bank at this point becomes more random. Some commercial managers are diligent (mine is beyond awesome) and some are an unorganized disaster. I’d always recommend not leaving your manager to chance. When I knew that I was going to switch into commercial I specifically asked for my new manager. At some point (and I’d recommend early on) it is also important to spread your risk and work with a second or even third lender. As a basic rule of thumb limit your exposure to any one lender to $1.5m but equally don’t go overboard. Any more than 3 lenders is overkill! Eventually you will go over $1.5m and end up in business and then further down track in commercial. Get it sorted early on. It gets harder to reorganize your banking once you’re big because everything is cross-collateralised.