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If it’s development finance,
we’ll get you connected.
What can you do
about it? 27of OCTOBER 2015
What’s causing the creditsqueeze?
DFP PresentationPresenter: Matthew Royal, Director DFP
Chinese Stock market BubbleBursting and GDPDowngrades
Falling Iron Ore Prices
International market volitilty
Property Bubbles in Sydneyand Melbourne
Continuing Soveriegn DebtUncertainity
What is causing the credit squeeze?
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Cheap freely available credit/liquidity fueling asset and equitybubbles
Sudden aggressive regulatorychange created by APRA’s inactionand a lack of self regulation by theBanks
Frustrated supply of land
The credit squeeze itself
Increased Bank cost ofcapital
What is causing the credit squeeze continued?
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Two Key Basel 3 & APRA Ratio’s
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1. Current Leverage Ratio
Calculated as….
Equity Capital ----------------------Credit Exposures
2. Common Equity Tier 1 capital ratio “Capital Adequacy”
• Calculated as…
Tier 1 capital + Tier 2 capital
--------------------------------------
Risk weighted assets
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Figure 1. Common Equity Tier 1 capital ratio (left)
Source APRA as at June 2015
Tightening macro prudential lending standardsAPRA threaten’s to tough:
Dec 14 - APRA announces a tightening in home lending standards particularly for property investors.
May 15 - APRA announces further tightening to more conservatively test serviceability and reduce Loan to Value ratios.
APRA has set a speed limit to the growth in lending secured by residential investments to 10% pa.
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Precesators
Benchmark stress test on servicing rises from circa 6.25% to 6.5% pa to 7%-8% pa
No longer counting:• 100 % of rental income• negative gearing benefits• dividends• bonus pay • other “uncertain” earnings
Measuring borrowers' actual spending V’s the poverty-line benchmark
Bank’s follow suit:
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What does it all mean?
• Increasing the cost of debt + increasing equity requirements = increased holding costs and decreased investors return on equity leading to correct in asset values
• Reduced & owner occupier investor confidence
• Reduced buyers in the market
• Panic selling of established product
• Sellers market turns to buyers market leading to lower auction clearance rates
Banks pressured to reduce LVR’s from 95% to 80% - the new normal
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Depressed Commodity Prices
Bank Credit Appetite &Market Confidence
The Perfect Storm
Greece & EurozoneCrises
Federal Government Budget Repair Worsening
Growing Media and Political Speculation Over Property Bubble
Local Credit Rationing
Chinese Stock market Crash
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The Banks are already preparing.
How prepared are you for the current downside risk?
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What are you doing ?
What the Banks are doing?
Raised $31b in CET1 capital via rights issues, dividend reinvestment, retaining earnings & asset sales
Passing on increased cost of debt to maintain ROE
Repricing their existing loans
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Acting on impaired assets to recycle equity and reduce cash held against provisions
What the Banks are doing?
Increased margins and line fees
Increase Cross Sales & Interlinking of Securities
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Reduced LVR’s by 5%
Increased Presales and Qualifications
What developers should be doing
now?
Reducing your Risk
Dilute your concentration with Banks
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How many of your debt facilities are expiring in the next 6 months?
Do you believe your debts are not cross collateralised with the same lender?
Do you have all of your debts with one lender?
Do you have formal conditional approval in place to finance your projects which are due to commence inside the next 3-6months?
What is your exposure to a significant percentage of your presales failing to settle?
Do you have any loan facilities due for review in the next 3 months?
Do you have undrawn approved LOC’s you can drawn down in need?
Do you have more than one or two Banking relationships?
Concentration Risk Checklist
Are you certain your Bank will continue to honour any indicative offers verbal or in writing?
Are your working capital accounts, cash reserves, rental proceeds accounts, trading and transactional accounts, term deposits, PPR loans and other personal loans all with the same Bank?
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What can you to do to reduce your risk and increase return on equity
Put firewalls between your liquid assets, sources of your cash flow and your development risk.
Restructuring your debts across multiple debt providers
Raise undrawn LOC’s against surplus security
Consider D&C Contracts
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What can you to do to reduce your risk and increase return on equity cont’
Utilise no doc capitalised interest
Keep some mystery
Consider capital partners who will consider stand alone facilities with high LVR’s, lower or no presales, less restrictive
Utilise pref equity /mezzanine
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What can you to do to reduce your risk and increase return on equity
Invest in assets with strong maintainable earnings to show interest cover and debt amortisation
Heavily prioritise interest payments and cover
Don’t burn your goodwill, keep your plans evidence based which can be reported against over time
Demonstrate a willingness to work with your bank
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The Reason Why Mezzanine Funding is Cheaper Than You Think
In instances that a project or company has more than one cost of finance, e.g. where a Senior Debt and Mezzanine Finance for Property Development are used, Weighted Average Cost of Capital (‘’WACC’’) is essentially the calculation of the overall cost of all sources of finance combined.
Because Bank funding is currently so cheap, combined with the fact that Mezzanine Debt is typically a relatively small percentage of the total debt, the WACC of Bank plus Mezz debt is actually very low.
As a simple and typical current example, if Senior debt is 65% and Mezz is 10% of the project’s GRV, with the true ‘’all up’’ cost being say 6% and 25% respectively, then the WACC would only be:
( ( 65% / 75% ) x 6% ) + ( ( 10% / 75% ) x 25% )
= 5.20% + 3.33%
So what seems expensive on the
surface, when averaged out is actually lower than what bank rates for development loans were only a few short
years ago
8.53%
WACC
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Calculating the Value of Mezzanine Debt
Item Description Bank Only Bank + Mezz
TDC $10,000,000 $10,000,000
Bank debt @ 80% TDC $8,000,000 $8,000,000
Mezz debt @ 10% TDC $ - $1,000,000
(a) Equity Required $2,000,000 $1,000,000
Dev Margin, 20% TDC $2,000,000 $2,000,000
Cost of Mezz at say 25% all up, 12mths $ - $280,732
(b) Net Project Profit $2,000,000 $1,719,268
Return on Equity ( b / a ) 100% 172%
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Value of pref equity/mezzanine debt continued…
Precious cash is free to drive the
rest of the developers
pipeline
Significantly increased IRR
resulting from circa 50% equity being recovered along
with profit in 20% less time
You can actually decrease portfolio risk by increasing diversification and
increasing your liquidity
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Bring your project to
market sooner
Lower the amount of presales required
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Credit Enhancement Strategies
Pre letting of Construction Costs
Locked Cash on TD
Push Senior Debt down the risk curve
Use Residential or Commercial LOC’s to replace precious equity with cheap debt
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Extend Loan Terms and Capitalised Interest Budget
Finance delivery under via the procurement of a DCF or Turnkey Construction Contract
Strategic use of Vendor Finance
Finance Land Settlements with Pref Equity starting as 1st Mortgagee
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Credit Enhancement Strategies continued
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Approve Take Out Finance for residual debt
Utilise Pref Equity funders in a Stretch Senior Role
Partner with your Purchasers
Contract a external DM/PM with a high end capability statement
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Credit Enhancement Strategies continued
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Always, always, always manage and prepare and instruct the Valuation & QS yourself!
Value the builder’s reputation, track record and capability statement
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Ensure Marketing Strategy Achieves Local Market Sales
Include a budget for DM fees to increase your equity contribution
Credit Enhancement Strategies continued
Higher Interest Rates across residential and commercial loans as Banks seek to preserve shareholder ROE
Basel 4 – Standardised Risk Grading
Increased settlement risk of presales
Increased mortgage defaults and pressure on Mortgage Insurance providers
Rising Unemployment
Lower consumer and business confidence
Falling site values
Downside risks to come
Valuation declines across all property sectors
More aggressive recovery action
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Further increased capital requirements
Inexperienced developers/speculators who have paid too much for sites who have been allowed to over borrow will be hardest hit.
Lifestyle and luxury markets will be most exposed to a reduction in discretionary spending and sell down to reduce debt.
Current construction industry bubble likely to be significantly impacted.
Downside risks to come
First home buyer and entry level investor product is at higher risk.
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The risk of increased sales incentives, failing sales prices, increased sales commissions, slower sales rates and rising construction costs and increased equity requirements will render many projects unviable.
So where’s theUpside
Developers and investors who position themselves well now will be able to take advantage of the beginning of the next cycle by investing counter cyclically and not under financial pressure.
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