Sourcing Commercial Finance
Accountancy Ireland June 2007 Vol.39 No. 3 55
Commercial Property
Sourcing Finance
by Connor Owens, ACA & John Coleman, ACA
Commercial property finance is a diverse and important area for Chartered Accountants and presents many challenges for the professional adviser as valuation methodologies, levels of finance available, terms and structuring vary from business to business and industry to industry. Lenders also differ in their appetite for deals depending on the sector, size of loan, margin and fees.
A client’s choice and structure of finance is second only to the original investment decision, and as an external party has been requested to provide funding, the timetable will not be under their full control.
In managing a client’s expectations, the commercial lending process can be understood and managed as follows:
STAGE 1:
Understand the client’s business and financing requirements
Any finance proposal is predicated on this stage so it is crucial to fully understand the nature of the client’s business and ensure the level and
structure of the finance sought is optimum.
A bank’s analysis of a commercial finance proposal will typically focus on security cover and a client’s ability to service and ultimately
repay debt, so a rigorous assessment of the client’s financial performance (historic and budgeted) needs to be undertaken at the outset. This analysis should take the form of understanding the client’s historic, sustainable level of earnings and once anchored by audited figures, the factors underlying the projected earnings must be clearly identified.
It is understandable that business principals and their accountants may be comfortable with a company’s performance but a bank (especially
where a new banking relationship is being sought) will look closely at historic and projected earnings.
Once this step is complete, it may be possible to increase the level of debt being sought by the client if there is demonstrable evidence of debt
service and repayment capacity. The issue of debt repayment is not uniform as some deals (development, project finance, acquisition, etc.) will differ significantly in terms of structure, but the principle still applies, i.e. to rigorously interpret the client’s financial performance and articulate the lending requirement to banks. It is also important to perform sensitivity analysis in order to “stress test” the robustness of the sought debt level
and financial structure in advance of engaging with banks.
STAGE 2:
Engage with Banks
The benefit of the work done at the initial stage will prove an advantage now, as the adviser will be in a position to confidently answer many of the questions raised by banks and demonstrate a complete understanding of their client. This will help establish credibility with the proposed banks.
Full details of the finance proposal should be discussed, including the client’s background, level of finance sought, details of the property, repayment capacity, preferred financial structure and any other relevant factors.
This is an opportunity to discuss any other factors which may influence a bank’s analysis of a proposal, and we recommend full and frank disclosure at this point. In our experience, nondisclosure of issues inevitably leads to serious problems later in the process when there is more time pressure and less flexibility to adjust the deal structure. In addition, it is advisable not to second guess what a potential bank would define as material, so full disclosure from the start is ultimately the most expeditious course of action.
STAGE 3 :
Bank analysis, negotiation and credit committee approval
A strong indication of bank support for a deal can be assumed when a proposal is presented to a bank’s credit committee, but this does not constitute approval or the adherence to terms previously discussed or disclosed in non-binding agreements such as term sheets.
Ultimately it is the prerogative of any bank to approve or reject a proposal and to dictate their terms of business, so the accountant must ensure their client accepts this and does not commit to onerous contracts or clauses until a written offer is forthcoming.
The time required for banks to complete their credit process varies significantly and is influenced by factors such as deal size, the assessed level of risk and banks’ individual credit approval processes.
STAGE 4:
Review & Analysis of Bank
Offer Vs Client’s Requirements
It is important at this stage to re-visit the client’s original requirement and ensure that the original financing aims have been satisfied.
Any proposal should be assessed in terms of
- Quantum of debt
- Margin and fees
- Security required
- Maturity
- Flexibility
- Other conditions, e.g. level of personal recourse sought.
Whilst obviously important to stay true to the original aims, it is also important to be realistic in evaluating a bank’s offer and
inevitably there will be a trade off between the factors above. Any offer will be subject to an element of negotiation so it is important to negotiate on any points deemed unsatisfactory before accepting or rejecting an offer. If rejecting an offer, it is very important to be conscious of the client’s timeframe and in time sensitive and aggressively structured deals, it is critical to have other banking relationships primed in the event of rejection. Indeed depending on the nature of the project, it may be advisable to engage with at least two banks until a credit committee approved offer is received.
In some cases, developing other banking relationships may be a contentious issue as valuable banking relationships can be seriously impaired
by borrowers that perennially tout lending business to different banks.
However, it would be irresponsible of a borrower and his/her advisers not to consider broadening their banking relationships, and never more so than when the outcome of a critical transaction is at stake.
In some instances, the deal offered by a bank may be barely acceptable to a client but given time constraints and potential penalties for not closing, a client may be well advised to work with what is on the table and then seek to refinance in future when the risk profile of the deal has improved and they are in a contractual position to do so.
STAGE 5:
Documentation and Negotiation of Terms of Loan Offer
This marks the half-way point and some items (margin, fees, conditions precedent, etc.) can still be negotiated whilst the bank’s solicitors draft
formal documentation.
The key point at this juncture is to get the documentation process started in order to meet the client’s deadline whilst still negotiating on a
number of more minor points once the quantum and structure of the facilities have been agreed.
Serious consideration ought to be given to the professional advisers engaged by the client and where possible by the bank as well, so as to minimise costs and ensure an efficient close. It is particularly important that a client engages professional parties that have the requisite transactional experience.
Stages 6 & 7:
Execution of Legal Documentation, Perfection of Security and Satisfaction of Conditions Precedent
This is the final stage before drawdown of funds and it often proves to be the most frustrating as both the client and the bank are required to wait on external parties to complete their work, e.g. solicitors, accountants, valuers etc. Given the number of parties now involved in the transaction, it is
imperative for the client’s adviser to take control of the process and ensure that all the disparate parties are aware of their precise deliverables and deadlines.
Banking Market
Increased Competition
Despite the recent, oft quoted change in economic sentiment and a rising interest rate environment, the commercial banking market in Ireland remains robust with new entrants, product innovation and intense competition among the banks for bankable commercial business. Focus on Business Banking The level of development driven deals is set to decline with many banks rejecting or cherry picking the development deals that they do. This means that the small and medium business sector which has been eclipsed in recent years is likely to become a major area of competition for banks.
Diversity of Banking Relationships Diversity is also becoming a feature of the commercial and business banking market as lenders and borrowers alike
are open to the idea that many businesses will have a diversity of banking relationships, so this offers clients the opportunity to develop multi-bank relationships, e.g. they can develop a lending relationship with a specialist lender for complex trans - actions whilst still retaining their core
bank facilities with their house bank.
The above factors will drive competition to the benefit of all commercial customers, but especially the SME sector where
banks will seek to build relationships with up and coming companies that operate in industries with sound fundamentals and who
have strong management teams.
Sectors
There is a common perception that certain sectors are unattractive to banks at present. This is not a unique phenomenon. The attractiveness of certain sectors to banks waxes and wanes and there are no definitive “no go” areas. A proposal in what is regarded as an unattractive sector
can be bankable if structured and presented correctly to a target bank.
Conclusion
While commercial banking may appear cumbersome and opaque to the uninitiated, it is driven by simple, unwavering fundamentals
and standard processes.
The length of time taken to complete the process cannot be forecast with certainty but undertaking a rigorous analysis of a client’s credit
fundamentals at inception, before engaging openly with target banks and other transaction parties during the commercial lending process will not only reduce the time involved, but also serves to deepen existing relationships and engender new ones.
John Coleman ACA and Connor Owens
ACA are Directors of Arden Capital.
Email: john@ardencapital.ie
connor@ardencapital.ie
Web: >www.ardencapital.ie
To assist with the above and for a detailed guide, please visit Arden Capital at
www.ardencapital.ie.