It’s a matter of price

There are three types of lenders:

1. APRA-regulated entities: banks, building societies and credit unions

2. ASIC-regulated entities: non-listed, non-rated debenture and note issuers, managed investment schemes, unit trusts, pooled and contributory mortgage schemes and preference share issuers

3. Non-regulated private lenders

The primary expense for all lenders is cost of capital. Naturally, the higher the costs of funds, the higher the rate to the customer. This precipitates a waterfall of risk appetite: eg. on a risk-for-risk comparison, a non-APRA-regulated lender cannot compete on price with a bank, so it follows they seek a market segment where risk and rate are slightly elevated. This continues through the layers of lenders to the bottom where almost any risk is acceptable to a small private lender provided the rate can be tolerated and equity exists.

APRA-regulated lenders

APRA-regulated lenders have the lowest cost of capital, with banks lowest of all because they have a) the largest dollar volume of depositors and accrued assets, b) higher ratings and c) a wider range of funding options including client deposits, access to wholesale debt markets, securitisation opportunities and equity.

Next are building societies and credit unions that have access to similar funding opportunities as the banks, but usually have lower volumes and lower ratings values.

APRA-regulated authorised deposit-taking institutions (ADIs) are less restricted on the size of loans they may contemplate, but they have risk-weightings imposed upon them that require them to reserve various percentages of capital depending on the type of asset they lend against. They may therefore favour lower risk-weighted opportunities such as residential home loans rather than industrial property or land.

ASIC-regulated lenders

ASIC-regulated entities are next cheapest in terms of cost of funds and these are a bit of a mixed bag. At this level, cost of capital is much more closely aligned to risk appetite and the capacity to gear-up with debt. Those with larger funds enjoy an economy of scale compared with their smaller counterparts, which may or may not be reflected in rates. Debentures and notes are debt capital so they cannot be geared by further borrowings, and therefore issuers’ rates are driven more by the cost of the coupon they pay investors. However, for them there is the constant pressure to match debt volume in with loans volumes out, otherwise their fixed costs of capital burn away at profitability.

Managed investment schemes and pooled and contributory mortgage schemes can use debt to gear-up returns on capital employed and to take up the elasticity of vacillating loan pools, but their cost of compliance is relatively high until they achieve a sizable volume.

Preference shares are a form of equity. They draw less attention from ASIC and can benefit by debt gearing, which allows issuers to achieve a higher net return for lower capital employed and to provide more competitive rates.

ASIC-regulated entities require an Australian Financial Services License under which they are permitted to raise debt or equity under a prospectus (for retail investors) or an information memorandum (for sophisticated and wholesale investors).

ASIC-regulated entities are far more likely to have restrictions on the size of loan they can offer and this is usually a percentage (often 5 per cent) of their total loan portfolio or a maximum (eg. $2 million). ASIC-regulated entities do not have to concern themselves with risk weightings and therefore they may be more liberal with the types of asset they will lend against. But these may be coming. ASIC’s latest consultation paper seeks to implement risk weightings for this group.

Non-regulated private lenders

Non-regulated private lenders are the biggest mixed bag of all. They can range in size from very small (less than $1 million loan capital) to relatively large such as Semper Capital. Non-regulated lenders require neither an APRA nor ASIC license, and if they don’t provide consumer loan products they don’t require an Australian Credit License or Financial Ombudsman Service or Credit Ombudsman Service membership.

This group is almost exclusively funded by equity with some having access to debt facilities to gear up their capital pool.

For private lenders, cost of capital is more an issue of achieving the desired investment rate of return, and this is reflected in the rates they charge and the risks they are willing to take. Some private lenders are significantly unsophisticated, charging rates to the maximum the market will tolerate. For these, rate is not really aligned to risk but aimed at achieving maximum returns. At the other end of the scale are the more sophisticated lenders on whom introducers can rely to provide consistent prices for common risk. These include lenders such Interim Finance, which specialises in second mortgages/caveats and is consistently among the lowest cost providers, and Semper Capital. For these lenders, rate is a reflection of risk and there is a risk point at which they will not lend. We call this pricing into risk where the rate required will contribute to default.

Summary

There are pros and cons with all lenders (see below). But for introducers, it’s about being able to set loans with the highest degree of certainty. Borrowing clients, especially commercial borrowers, require certainty and they are willing to pay for it.

It follows that the rate for risk waterfall trickles down from APRA-regulated lenders all the way to private lenders. The rank of certainty stops where the risk for rate and the speed required for drawdown meet lending appetite and capacity. To maximise their range of certainty, introducers need to work on lender options to ensure they have a complete stable of product and risk opportunities.

Pros and cons by type of lender (non-National Consumer Credit Protection Act 2009 loans)