Australian Banking: Beware the Faceless Men

A new wave of optimism has swept across business with the ascension of Malcolm Turnbull; a rapid and remarkable occurrence given the short time frame.

Consumer confidence up 8.7% in a week; the natural party of (most) business is in front in many polls and, most importantly, there is an optimistic narrative from the man at the top as he signals not only a commitment to the digital economy, but that he understands the threats and opportunities to the nation at a time of structural change. That’s the good news.

But in all likelihood this optimism won’t spread to two industry sectors. For all of Turnbull’s jaw-boning, don’t expect him to lift global commodity prices; the miners will continue to do it tough. The banks, too, are unlikely to be swept up in the country’s new-found optimism.

On the latter, let me explain.

Can the ‘Malcolm effect’ overcome the banks’ regressive tendencies?

Until recently, the banks had enjoyed a turbo-charged residential property sector (especially in Sydney); with the “Big Four”, what I call the “cosy quadopoloy” enjoying about 85% of the home loan market; it was underpinning strong earnings growth.

They were enjoying the best of all worlds; sheltered from a deep economic downturn, a strong property market, and for several years after the GFC were buoyed by offshore demand for anything dug out of an Aussie mine. So good were the times, especially on the property front, that everyone, from the RBA to the OECD, was suggesting we were in bubble territory.

No longer. The combination of volatile markets and serious strong words from the regulators has had the desired effect. The banks tightened up their lending for residential investment loans which comprise the bulk of their assets) and, in the case of some banks, stopped lending to SMSFs.

Today, business owners, CEOs and CFOs, indeed, anyone attempting to broker new or renew existing lines of credit, can tell you about how the banks are tightening their belts. What I fear is that the “Big Four” will turn a retreat on the credit front into a rout. Why? As credit tightens, it brings to the fore the weaknesses of our banking system.

Our current banking system

Remember the days of “relationship banking” of “getting to understand your customer’s needs”. They’re gone. The new normal is the tried and tested return to the nameless, faceless men of the “credit” team. In good times, this is not so critical (except for the bad loans that get written), but in tough times it really works against good businesses being able to explain why they need credit. It matters little how profitable the business is, if the strict debt guidelines are not met, then the shutters come down.

Despite their glossy ads promoting client inclusiveness, the fact the “Big Four”, by international standards, remain hugely profitable, does not encourage them to change strategy. The “if it ain’t broke don’t fix it” philosophy.

The importance of our banks to facilitate effectively structured credit across Australian business sector is vital.

But having been in contact with at least three of the major banks in recent weeks on a several property development deals, there is a consistent message coming from all of them and a number of trends are clear.

Identifiable trends

There will be little appetite to bank players in the market who have no property development track record in Australia. This will create challenges for some in-bound groups who will need to review how they enter the Australian market, with greater focus on joint ventures with existing players in the market rather than “go it alone”.

The emerging new normal includes the fact that a developer’s reputation with the specific bank will be critical going forward. Lead bankers have and will look to establish a strong reputation for their clients with credit and property heads in the bank. Therefore developers must do everything to enhance their reputation via the lead banker on current deals.

It’s clear to me that loan to cost ratios will tighten to around 70-75% maximum. Some banks had been at around 80%, but that will cease, and existing term sheets may be reissued to reflect higher criteria. A corollary is that lenders are likely to be seeking increased margins on development lending.

Lenders will look for greater sponsor tie-up in terms of guarantees and cross collateralisation of cash flows from other projects/other trading activity. Greater frequency of negative pledge conditions will occur.

Also multi-bank strategies will become more important as developers will reach saturation point with their preferred lender far more quickly. In joint venture situations, lenders are less likely to fund deals where they are over exposed with that joint venture partner or that partner does not have a strong reputation with the bank.

Further, greater pre-lend due diligence is likely to occur around legal and tax risks. Developers should ensure all these aspects are well considered before presenting Information Memorandums to the banks.

The other critical issue in this market is the lack of competition; the “Big Four” dominate our market like few other developed economies. It certainly stands in stark contrast to the US and Europe. The smaller banks struggle to compete at the top end of town, and the securitisation market, so active pre the GFC, is yet to recover its former buoyancy as an alternative credit source.

If the “Big Four” go into a bunker, it does not bode well for our economy. Certainly we should all hope the newly minted optimism emanating from Point Piper percolates down to the banks’ headquarters. Quickly.

The role of Financial Advisers

In the meantime the ability of Advisers such as ourselves, and others, to assist businesses navigate their way through the thickening fog of bank hesitancy and bureaucracy has never been more relevant.

In this environment of caution and limited vision, knowing whom to approach within any banking organisation, and equally, how to craft and present the most compelling business case for funding approval sounds elementary but can actually be the difference between project take-off and failure.

With more than 250,000 clients, $21 billion under advice and an M&A record on our own PA of more than 40 successful deals in a decade we are more than confident in our ability to not only improve the quality of the conversation, but more importantly, its outcome.

View the published article online here.

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