The Banking Royal Commission: Lessons for dealing with banks

I have been listening to some of the evidence from the Banking Royal Commission on YouTube.

And in particular, there was some quite detailed testimony from a women who borrowed ~$200k to purchase a franchise (ended in liquidation), and another Perth property developer who had ~$10m in borrowings for a land development and struggled to rollover a facility (despite ups and downs with the Bank, the developer is still in business and the development is quite successful).

Putting aside the legal rights and wrongs of each of these cases, I tried to draw out a few lessons about dealing with banks. What could these borrowers have done differently? What mistakes did they make? What are some of the things borrowers can do to make a credit application/business deal run more smoothly?

Here are some brief thoughts or lessons based on the evidence from the 2 cases I watched:

1. Business owners seem to have a deep belief in their ability to make a business a success or turn around a business that may be performing poorly, often in the face of an accountant or other advisor suggesting caution and saying that the business is not worth anything like what they are paying, or that success is unachievable. For many, a belief in a business is akin to a religious conviction, and the potential purchaser is not for swaying. On the one hand, entrepreneurial enthusiasm and self belief are essential elements in running a business, but don’t forget to also surround yourself with good people, and listen to what they are telling you.
2. Don’t EVER rely of verbal OKs from Bank employees. Don’t assume anything until it is all in writing. While some applicants feel aggrieved when banks don’t honour verbal commitments, trying to press a legal case based on verbal assurances never seems to end well.
3. Careful of handoffs in the banks. Many applicants appear to be travelling well with a finance application, yet the atmosphere changes when the person goes on leave and another Bank employee takes over the file. A finance application may be going well, but things can change quite quickly.
4. Don’t always expect stellar customer service from banks. Be prepared for the occasional email that does not get responded to, phone calls not returned, or very late responses.
5. Having good advisors seems to make a difference. The successful property developer giving evidence used a loan broker, the women whose business was liquidated didn’t. She also suffered I think from having an accountant (very useful if she had listened) but not a lawyer.
6. Business complexity grows and ability to close deals gets much harder as the number of parties increase. Eg. Women was struggling to stitch together a deal that involved a bank, a franchiser, a lease agreement with the landlord (premises for the shop), and an existing business owner (existing franchisee selling). So 4 parties. And the bank will not be the custodian of the interests of the business owner, they are just representing their own interests within the law (ie they cannot of course engage in unconscionable conduct or sharp practice, but they are primarily looking after their own interests). Re point 5 above, that role should be played by the broker, accountant, lawyer, and don’t expect the bank to do it.
7. For complex credit applications, make a reasonable estimate of the time it will take to get approval, and double it as a general rule of thumb.
8. Don’t take it personally when you get less than satisfactory treatment. Banks are looking to protect their commercial interests. People in banks are human, so stuff ups also happen. Work through the problem, and stay emotionally neutral as far as possible (I admit, easy to say)
9. Plan for the worst, and hope for the best, not the other way around.
10. Plan, plan, plan, and do it early. Most problems with banks can be solved with enough time, so give yourself plenty of ‘runway’.

Just some quick observations. Keen to hear from others who may have listened to some of the evidence.

 

Brilliant summary post @Harry30 . Points 9 and 10 are especially salient, and can assist in mitigating any negatives emerging from point 1-8.

 

Just get a stellar, killer broker.

 

Because they don't understand the value of a really great broker or building a team. Before I was able to build solid relationships with some banks, I engaged (and still do) some really great brokers who found the best products for me at the time.

 

I’d prefer to wait for the Royal Commission report rather than give ‘advice’ based on a couple of hearings.

It’s easy for observers like us to give ‘advice’ (based on third degree hindsight) that people should do x y or z.

But many customers acted in good faith, and were blatantly lied to. Easy to say they should ‘have good people around them’ but most would have thought they did!

 

Great summary Harry

 

I have had problems so complex that my great broker and his boss could not sort them out.

My advice is to know exactly what you are doing and be prepared to back up your team if you need to. If I know I am right I don't take no for an answer.

When a person involved in a settlement tried to crash the settlement and my broker and hus biss could not solve it, I just pushed and pushed till I got settlement and it actually happened early.

 

Good summary.

#4 has always seemed a 'given' to me. Apart from basic stuff like opening a transaction account (or credit card), the customer service I've experienced by any bank hasn't been the best.. And I'm somewhat accustomed to it, and expect it. Sad, really.

Having an excellent broker on our team has definitely taken a lot of the 'stress' out of our transactions. Invaluable.

 

Just because a bank WILL lend you money, doesn’t mean that you SHOULD borrow it.

YOU are the one solely responsible for, one day, paying it back. Irresponsible borrowing is often going to end badly.
Marg

 

Hale-fa**en-luya for that post.

When things go well ppl are hush. When not, It's time for a RC. Such nonsense .

 

It’s not like that for farming. Seasons are not predictable at all. You can do everything right and still have a bad season. Things generally come right eventually - but need time.

In one example, the takeover of a rural bank by a non rural bank which didn’t understand farming ups and downs has been devastating for 4th generation farmers. You can hardly say those farmers didn’t know what they were doing!

Please read the testimony of the farmers before rushing to judgement.

ANZ 'empathy' too late for farmers already forced off the land by the bank

 

I really think that’s the trick @mikey7. I used to get my back up with much of the poor customer service, but now I just expect it and plan for it. Once you make that leap, it bothers you far less.

 

In that franchise one (and the music one) the take out for me was the way the loans and guarantees were structured was the classic Cross X no no and an advertisement for not having all assets and loans with the same lender. There was a much friendlier way to set up the loans that was not discussed by the commissioner nor anyone else for that matter as far as I noticed. The pain could have been minimized with a better structure.

The main crux in the franchise one was when she sold her IP the lender took 100% of the proceeds and used it to pay down her home and IP mortgages and her joint business debt with her sister leaving her $0 to live on. She only realized this a few days before settlement. She was expecting only half the business loan to be repaid thus leaving here some money to rebuild. Uneducated yes but a banker or broker could have structured it differently to ensure this could be achieved.

 

Royal Commission: Some more learnings on how to deal with banks (when you are borrowing $50m).

I was listening to more public evidence at the Banking Royal Commission on YouTube today, and thought to share some further general observations (NOT ADVICE) on some of the testimony. Given the length of this post, I have broken this into 3 parts.

PART 1: INTRODUCTION

The testimony this time was by a major property developer who had borrowed $50m from the bank to undertake a ‘mixed use’ development on a vacant block of land adjoining a 71-room hotel he owned in Tasmania. As he got close to completing the development, and despite not missing a loan repayment, the bank foreclosed, appointed liquidators to his company and pursued him for outstanding debts based on personal guarantees. As the developer put it in his public evidence to the Royal Commission, he was ruined.

Once again, I thought it useful to draw out some learnings from the case about dealing with banks. I am not expert in commercial or development finance (I write posts like this to share ideas and to learn), so interested in getting the views of those of PC who have experience in this area. To get things started, I had a go at writing down my 10 key take-outs from the case on dealing with banks.

(IMPORTANT NOTE: I am not seeking to comment on any of the legal issues in the case, or to arbitrate on the rights and wrongs of the parties. Or indeed to suggest how to reform the banking system. In reading the summary, you may wonder whether the developer had legal claims having relied and indeed acted upon verbal statements by bank employees, only to find later that the bank’s position had apparently shifted. Also, the Royal Commission takes a broader view of these issues and does not seek to test all the legal issues in an individual case, so the ‘evidence’ has limitations. While staffed by solicitors and barristers and run like a court hearing, the Royal Commission (in the main), is not conducted in an adversarial manner like a court hearing, where all evidence is vigorously challenged and tested, and where strict rules of evidence are applied. Following the developer’s testimony, the bank’s lawyer asked only a few cursory questions of the developer but did not delve into or challenge much of his evidence. In one sense, you could say we heard the developer’s side of the story and not the bank’s side of the story, so suggest you read the summary below with that in mind. To be fair minded about this, I would also say that the bank had an opportunity to lead other evidence and challenge the developer’s testimony and chose not to do so.)

With those caveats out of the way, I will start with some background. The developer was a hotel operator with extensive commercial experience. His family started off with a small takeaway shop in Flinders Lane in Melbourne and expanded from there to where they now own a number of major mixed use commercial properties throughout Australia and internationally (Fiji and USA), mostly in hospitality. At the Commission, the developer came across as commercially astute and knowledgeable. He was clearly testifying for a reason, that is, he felt he was ‘done over’ by the bank and wanted to air his grievances in a public forum.

(continued in Part 2).

 

Royal Commission: Some more learnings on how to deal with banks (when you are borrowing $50m).

PART 2 : THE LEAD UP TO THE BANK APPOINTING RECEIVERS

The transaction in question involved a major development that started in 2010. The bedrock of the project was a 71-room hotel which he owned and operated for a number of years in Tasmania. He had previously spent small amounts of money doing minor improvements, transitioning the property from a 3.5-star to a 4.5-star establishment. More recently, the developer acquired a vacant development site right next to the hotel and wanted to build a ‘mixed use’ development alongside the existing hotel, which would be refurbished further to fit in with the new development. The whole development would include a) a public car park, b) a number of retail outlets on the ground floor, c) the existing refurbished hotel, d) 8 penthouse apartments at the top level, and e) a number of serviced apartments. The ‘as built’ value of the development was estimated at around $75m, with his total borrowings with the bank at around $50m.

Under the loan Agreement, the developer was required to keep the LVR below 65% based on ‘as built’ value of the proposed development (he also gave the Bank security over another major hospitality property he owned in regional Victoria, that allowed him to achieve the 65%). The development began in early 2010, with construction proceeding satisfactorily.

Towards the end of the construction phase, the relationship with the bank started to deteriorate. The developer felt that much of this coincided with the bank assigning the file to another account lead within the bank. The developer never felt comfortable with the new account person, thought he had no understanding of hospitality, and no experience in managing larger accounts. To use the developer’s words, the new person was ‘out of his league’. This was in stark contrast to the original account manager at the bank who had built a strong relationship with the developer and was indeed responsible for bringing all of the developer’s business over the bank (prior to starting the development, the developer had all his business with one of the big 4 banks but moved to a what was a smaller regional bank ahead of financing and starting the development). Difficulties first arose when the new account lead alleged that the existing hotel was unprofitable, and lost money in a previous year. This flummoxed the developer, as the accounts clearly showed the business had made a profit in that year. So, to fix the misunderstanding, the developer sent his chartered accountant over to the bank to explain the accounts to the bank’s account lead. Three hours later, the account lead accepted that the business was indeed profitable. This was the first of many skirmishes with the bank, which increasingly made the developer nervous and concerned about the state of affairs. Apart from the questions from the account lead being distracting, they also drove more cost which the developer resented. Indeed, the developer testified that another $500k in accounting fees was incurred dealing with what he thought were ill informed questions (the $500k struck me as a lot of money for accounting fees).

To break through all the noise, and as the development was nearing completion, the developer thought to request another valuation on the property, as he felt the bank’s security had strengthened. Some pre-sales had been achieved on the penthouses, and the overall development was close to being done, so he saw the bank’s risk as reducing. The developer also had in principle agreement with a major management company to sell the management rights on the hotel, further strengthening the end value. The developer thought that with the market good, and the project’s security strengthening, another valuation and a healthy LVR would put the bank’s minds at rest.

Unfortunately, pressing for another valuation just lead to another confidence sapping dispute. This time, the developer and the bank couldn’t agree as to how the valuation should be done. While all the parties agreed the valuation should be done on the basis of ‘as built’, they could not agree over what were two alternative approaches. That is, should the value of the development be based on the realisable value of the individual parts of the development added together (let’s call it the aggregate value method), in other words, how much you would realise if you separately sold the hotel, the penthouses, then the car park, then the retail outlets, etc. Alternatively, the bank wanted to value the property on what they called an ‘in the one line’ basis. That is, the expected sale price if the entire development is put on market as a whole, and sold in a single transaction, to a single buyer (‘in one line’). So, the parties could not agree; the developer wanted one method (aggregate value method) and the bank wanted another method (‘in one line’).

The developer strongly argued to the bank that the ‘in one line’ method made little sense. A diverse mixed-use property would never be sold in a single lot. Maximum value would be realised if each of the separate components were sold individually and in different stages, so that is how it should be valued. Indeed, his intention was to sell the completed penthouses almost immediately and in fact, he already achieved some pre-sales towards the end of the development. For the hotel, his plan was to continue operating this through a management company. The service apartments would be sold off individually. The public car park could also be sold lot by the lot, or even operated long term as a whole for the cashflow. Given all this, he argued the bank should aggregate the value of the individual parts, and the sum of those individual values should be what the bank takes as the total value. The developer also argued that this would provide a more concrete valuation, in that you could more readily determine the value of the individual elements by looking at comparable sales. The retail outlets can be easily valued based on estimates of net rent. Equally, the penthouses could be valued as there was many comparable sales of apartments that you could look to. Valuing it ‘in one line’ was too open to interpretation according to the developer, as there were no comparable sales in Tasmania of such a large single property with such diverse uses being sold in one lot.

The developer also testified that the bank had effectively accepted this ‘aggregate value method’, in that the development would never have proceeded if the banks had ever valued it ‘in one line’ as it would have always been above 65% on that basis. Remember, the dispute flared up close to the end of the construction. By allowing the development to proceed, the developer argued that the bank had implicitly accepted that an ‘in one line’ method was not preferred. When the dispute arose, the original account manager (who was still at the bank but working in a different capacity) also weighed in on the issue and backed developer, saying the ‘in the one line’ was the not the preferred method and made no sense.

So, the valuation was done and the numbers came back. Using the developer’s aggregate value method where you summed the individual parts yielded an LVR of 59%, comfortably within the 65% covenant. So, all good. But, the bank would not accept this method. So, a valuation was also produced using the ‘in one line’ approach. As explained, the developer needed a figure of 65% or below to be safe. Unfortunately, it came in at 68%, putting the whole transaction straight into the danger zone and in breach of a key loan covenant.

At this point, the developer quickly moved to mitigate things by voluntarily appointing an administrator to manage the remainder of the development, but the bank moved quickly and appointed their own receivers, locking him out of the property, and then aggressively pursued the developer on the basis of the personal guarantees he had provided.

(Continued in Part 3).

 

Royal Commission: Some more learnings on how to deal with banks (when you are borrowing $50m).

PART 3 : THE 10 KEY TAKE-OUTS

So, what can be made of all this? I am interested in hearing views from others. To get some discussion happening, here are my top 10 take-outs:

1. Is it not what the loan contract says that may hurt you, but what it doesn’t say.

The first thing that struck me about the case was why the contract did not deal with such a critical thing as to the method the bank would use to value the property. Unfortunately, the developer’s testimony suggested the contract may have been silent on the matter. Should the loan contract have in some way dealt with this, and at least provided some guidance to avoid it becoming a matter of dispute? Points to the importance of working with your legal team to brainstorm and ‘war game’ what could go wrong. Write potential issues down and press upon your team to get clauses that protect one’s interests. In most cases, if the relationship with your bank is good, the written contract may take a back seat, but it’s when things go bad and relationships sour that the quality of the legal document is tested.


2. Don’t take comfort from verbal statements by bank employees.

I made this point in my earlier post. The same issue came up this case as well, namely the original account manager had stated on a number of occasions that the ‘in one line’ method was not preferred. The developer put particular weight on this in his testimony, aggrieved that the bank had appeared to change position. It is not clear from the testimony whether he took legal action over this. Anyway, the case is a timely reminder of the danger of thinking you can rely or take comfort from verbal statements from bank employees.

3. Beware of changing banks based on price

Prior to this development, all the developer’s borrowings were with one of the Big 4 banks, but he moved his lending to the new bank (a smaller regional bank), attracted by a more competitive interest rate. As he put it, the rate was too good to refuse. The subtext of much of his evidence at the Commission was the suggestion that his difficulties with the new bank can sheeted home to the bank just wanting to exit a large loan exposure in a regional area, and it used various clauses in the contract to achieve that end. Would this have occurred if the developer had stayed with and financed the development with his original big 4 bank. Of course, we’ll never know, but it should give borrowers pause for thought. Keeping costs low is an essential part of business success, but one should be cautious about making decisions based on a single criterion such as price. Certainly ask whether your bank have a long and stable history of supporting a particular sector?

4. Gearing is key

There are no right and wrong answers on the question of what an acceptable gearing level is. All depends on the risk appetite of the borrower, and the risk profile of the development. That said, the higher it is, the more risks are being taken as a general matter. In this particular case study, the transaction could have turned out differently if his gearing was lower and he had maintained a ‘gearing buffer’ if you like. That extra 3% points was fatal.

5. Careful of handoffs

The developer had terrific relationship with the original account lead who was smart and knew the hospitality sector well. Unfortunately, the account was then handed to another person in the bank, and the relationship went cold. The new account lead had no experience with hospitality and had never managed such a large account before. The developer described it as being ‘out of his league’. Not sure I can think of an easy solution to this, so interested in hearing from others.

6. Borrow money when you don’t need it, not when you do.

It became clear that the borrower got to a point where he was not able to borrow against another property in his portfolio in order to pay down the loan on the development to restore the LVR. It is hard to borrow money when you really need it. Listening to the evidence, you are left with the nagging thought as to whether additional ‘buffer’ facilities could have been put in place ahead of entering into the development phase, when he may have had clearer air to do so.

7. Don’t ‘bet’ the company

By any measure, this was a large transaction for the developer, and something the developer had been working up to over a number of years. While he had substantial other assets, my sense from listening to the evidence was that this was a ‘bet the company’ play, in that it was so big, if it failed, it would potentially imperil the entire company. I guess there is nothing wrong with a bet the company transactions per se. You just need the intestinal fortitude (aka guts) to do so.

8. Risk management, you can’t get enough of it.

Most things in life, if done to excess, are bad. But risk management, well, you really can’t have enough of it. The developer certainly did a number to active things to reduce risk. For example, he built onto the hotel service apartments (with kitchens), rather than hotel rooms. While this added to the cost of the development, it meant they could quickly de-risk the development by selling off the rooms gradually, and paying off debt (hotel rooms, which are cheaper, are harder to sell as single units). Through the development, he undertook presales on the penthouses which strengthened the value of the development and gave the bank comfort that the value would be realised. He also undertook a program of interest rate hedges to protect the company against any interest rate rises. Much of this risk management can be done with enough planning, and if done smartly, can often be done without eating into the profits of the project. Could he have done more?

9. For those who are successful, never forget, you’re just one bad decision away from your life going down the toilet.

This developer was clearly an experienced operator and had deep commercial knowledge. Yet, the transaction was a failure. Tells me that that expertise and knowledge are certainly important, but they don’t guarantee success. Never stop learning and improving. No matter how knowledgeable and successful you are, failure is always lurking around the corner.

10. Don’t dwell on failure, learn from it, and move on.

Something struck me about the developer’s evidence to the Royal Commission. Unlike many of the people who have given evidence in other cases before the Commission, he was not a broken man, or embittered by the experience with the bank. This transaction occurred 8 years ago, so I guess time heals a lot of wounds. It was not clear, but it appeared the developer still owned properties, and had moved on, had recovered to a degree, and would do well in the future. If we strive for success, we'll all fail at some point in our lives, it is how we respond that counts.

Interested in hearing people’s thoughts on the case.

 

Evidence in a hearing in any court is just one persons tale. The other party will always have a different view. Many are emotive or self interest issues cloud the facts. Then we may see whose "facts and evidence" is more correct. Thats why we have courts. To consider whose truth is the prevalent truth.

One of the more serious forms of conduct is the view many investors have developed that they can just keep borrowing at high LVR endlessly. They have parlayed this endlessly into more and more property but they hold little equity as a buffer. That means the bank is owner of risk and they didnt seem to care to assess servicing using real numbers. Its like property can never fail. Its created social disorder and lender culture that seems to have ignored or diminished risks. And its now time to settle the massive drinks bill after the party.

I just hope that there is no overreaction which harms then economy and the property market. It could yet be early days for a tough climate if that happens. Ireland experienced this and it was not good.

I would wait for the final report and see what recommendations are made. I think lenders have exploited many borrowers and many borrowers have got away with way too much access to excessive finance.

 

Thanks Paul, yes, all good advice. Yes, we should be cautious about this ‘evidence’ at the Royal Commission, as I noted in the post.