When arranging development finance, we often work with clients on non-bank finance options and what they look like. The non-bank finance market often carries a bad rap with those unfamiliar with the space. We are often pressed on the costs of non-bank lenders and whether they will end up just winding the client up at the first sign of trouble.
There are, without a doubt, risks to the non-bank lending space. Non-bank lenders tend to focus more on the risk of loss as opposed to the risk of default. This therefore means that they are able to take on more risk as a lender, but can also charge more and have a shorter leash when it comes to issues.
This can cause problems. However, we do not see non-bank lenders actively looking to wind a client up without reasonable cause. It is important to understand how non-bank lenders work and their place in the funding market. Knowing this adds great value to how you engage with the lenders and manage your own risk.
Non-bank lenders tend to focus on recycling their capital every 12 – 24 months and their annual return. This is important to them as it ensures that they realise their returns (until loan repayment the return is just on paper) and manage their risk. Given they tend to lend against the value of an asset (risk of loss) they look to minimise their exposure to market cycles.
Further, many non-bank lenders will be partially funded by bank wholesale finance lines. These typically require loans not to exceed 24 months to any one borrower and therefore set arbitrary repayment profiles for loans.
This is an important consideration for any borrower as it means that they need to have a clear exit for their loan within 12 - 24 months. Long-term land banking or investment property is not typically appealing to non-bank lenders as the exit can be undefined. More often they will want a clear pathway to development or sale of assets to repay loans. Often this translates to a lender requiring progress towards an exit which may be in the form of issuance of consents, marketing of property, a sales campaign of off-plan properties or sale of other assets/completion of other developments.
If a borrower doesn’t make progress and is not willingly engaged in doing so, then a lender may take action to ensure that their position is not compromised. Effectively, if you are following through on your commitments, then this will often be avoided. If there are any unforeseen events that prevent the borrower from achieving the agreed outcomes, then a lender will often work with them to help achieve these so far as the borrower is upfront about these and engages in finding a solution. Communication is key.
During a development, beyond the assessment of the leverage from a funder, the risk around delivery is the key consideration. As above, the lender is focused on the risk of loss – i.e. can the security properties be sold for more than the outstanding debt? With that in mind, it is much more palatable to sell completed stock than a partially complete development. Lenders, therefore, will focus closely on the delivery of the development to ensure that it is on track and under control.
Up front, this may involve things like looking at the experience of the developer and their delivery team. That could include securing financials for the builder, a summary of previous projects, details of the builder’s current pipeline of work etc. It may also involve a QS reviewing the consents and contracts to provide their opinion of viability and risk.
It will also involve a detailed review of the development and the site and risks that it may face. These may involve excavation/fill and retaining, connections to services, programmes and in particular the pathway to titles and COC and many other items.
The lender will then also focus on the month to month updates, ensuring regular process is being made. This may result in monthly Project Control Group (PCG) meetings where all relevant parties meet on-site and discuss the project and its progress. It may also involve the review and comment on monthly QS reports.
If a project falls behind schedule, lenders will focus on the cause and how they can get back on track. Oftentimes, they will look to the developer (borrower) to make comments/recommendations around this and take the appropriate action. Most times, some contingency to the term required is built into the loan term so there is some room for delays However, these need to be managed to ensure they don’t stack up too much and exceed the budget.
Again, communication and behaviour here are crucial to retaining a good relationship with the funder and making sure no one defaults on their commitments. Lenders will often extend the term of a loan if needed so long as the developer has remained engaged and the reason for doing so is sound.
Development loans are funded on what is called a ‘Cost to Complete’ basis. What this means is that the lender's money is only advanced once the cost to complete the project is less than the loan amount. This ensures that there are sufficient funds held by the lender to finish the project thus managing the risk that the client runs out of money.
Because of this, a contingency allowance is built into any feasibility for a project. This ensures that any small cost overruns can be captured within the approved limit and funded.
Sometimes, however, there will be cost overruns beyond the allowed contingency. This results in the committed loan not being sufficient to cover the cost to complete. In this situation, the first port of call for a lender is to seek for the client to cover these costs to ensure sufficient balance remains to complete the project. The lender will therefore seek a Statement of Position from a client as part of their credit process to assess their ability to manage this.
A lender will often look into the reason for the cost overrun as well. If it is beyond the client's control and the client cannot cover the cost, a lender may consider their options to fund this budget extention themselves. They will, however, often take a hard line if the client is found to have been negligent or if they have managed the project poorly resulting in a cost overrun. Again, as with all scenarios, communication and transparency here is key. Engaging early with a funder will ensure that they are able to work with their clients to find a suitable solution.
These are just some of the scenarios we see that put clients at risk with their lenders, but when managed correctly, often cause no issues. If you have heard of a story of a non-bank lender winding up a client, blame will often have to be partly shared by the client as well.
The key takeaway should be that when you are working with a lender, you should keep open lines of communication and transparency. Working closely and openly with your broker is also important as they should understand the market and risks of each lender, focusing on getting the best fit for you as a borrower.
As always, if you are looking for finance and need some advice, reach out!
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