What’s causing the credit squeeze in construction?

When you’re in the business of advising property developers about project finance, you’re one of the first to notice when banks tighten their funding practices, says director of Development Finance Partners, Matthew Royal.

“We’ve been warning our clients for some time now that they will find it harder to access finance,” Royal says.

According to Royal, the credit squeeze is being caused by a number of local and global market factors: a volatile Chinese stock market, falling iron ore prices, the Greek and Eurozone economic crisis, media speculation of property bubbles in Sydney and Melbourne, and the Australian Prudential Regulation Authority (APRA) forcing banks to ration credit.

“The sell-off in China’s stock market in recent weeks has caused widespread global concern, with reports that Australia’s residential market is already being affected with Chinese investors postponing purchases or forfeiting deposits due to unexpected changes to their financial situations,” Royal explains.

Kail Pillay, a senior director at Fitch Ratings in Singapore agrees, arguing that while Chinese developers are in “reasonable shape” to weather the share market downturn, property buyers may be harder hit. “We could see a pull-back in purchases by Chinese buyers overseas, including Australia,” he says.

The chaos in China has also affected iron ore prices, which have plummeted to a new six-year low. “This has implications for the federal budget deficit, and makes the Treasurer’s budget repair task even tougher,” Royal explains.

Tightening macro prudential lending standards are also putting the squeeze on finance.

In an effort to slow housing price growth, APRA has announced more conservative assessments of loan serviceability to reduce loan-to-value (LVR) ratios.

“APRA and market analysts have pressured the banks to reduce their LVRs from 100 per cent down to between 80 and 90 per cent, which doubles the equity requirement on escalated purchase prices,” Royal explains.

“APRA has effectively set a ‘speed limit’ on residential lending,” Royal explains.

“The benchmark stress tests on servicing have risen from around 6.25 per cent in mid-July to as much as eight per cent just two weeks’ later,” he says.

Last week, Westpac announced that it would require a minimum deposit of 20 per cent on all new investment property loans.

“Banks are no longer counting 100 per cent of rental income, negative gearing benefits, dividends, bonus pay and other highly uncertain earnings. And they are looking at borrowers' actual spending, not just using a standard poverty-line benchmark, which many had used previously.”

So, what can property developers do to reduce their risk?

“Reducing the concentration of debt or cash with any one bank is the key,” Royal advises.

“There is no doubt APRA is putting pressure on the banks to restore their capital adequacy to the internationally-accepted benchmark of 10 per cent. In plain English, this means the banks are selling down assets to raise cash and additional equity to ensure liquidity in the event that downside risks come to pass.”

Royal advises developers to restructure their debts across multiple debt providers to reduce debt risk, improve liquidity and force debt providers to compete more on risk and pricing.

“Look for capital partners that will consider standalone facilities with high LVRs, lower or no presales requirements, less restrictive covenants on buyers, fast approvals and fast settlements so you can turn your existing debts and land banks into profits in a far shorter timeframe,” Royal concludes.

To reduce your exposure, investigate non-bank finance options or receive financial advice contact Matthew Royal at Development Finance Partners.