Life in the commercial lending sector
The commercial lending market is recovering, but lenders need tighter control over their suppliers in what is a more complex and less regulated part of the mortgage sector, says Mark Blackwell, managing director of xit2
Back at the 1996 Atlanta games, Great Britain managed to secure a solitary gold. Recently, it’s been a different story with heroes like Jessica Ennis, Mo Farah and that long jumper who’s name I can’t quite remember, bringing back a haul of medals, the like of which we haven’t seen since the turn of the last century. Like Team GB, commercial lending is on the up.
Commercial lending sits in stark contrast to the residential market which is proving to be the underperforming Australia of the 2012 lending games. Residential lending levels are slipping again after an encouraging period from last autumn to early spring this year proved to be nothing but a false dawn. An uptick in high LTV lending towards the end of last year turned out to be a pyrrhic victory.
That’s not to say commercial lending has had an easy ride of it. From 2009 to 2011 the value of redeeming loans outweighed new loans. Gross lending peaked at over £80 billion in 2007 but when the bubble burst, volumes shrank. By 2009, there were less than £15 billion of new loans. In 2010, gross lending was still just £35 billion a year.
Since then, funding costs have gradually risen, the economy has contracted, and the euro zone crisis has sapped lenders’ confidence in the recovery. Lenders are, understandably, seeking safe havens from the choppy economic waters.
Against this backdrop of tight credit conditions, lenders are also having to shoulder the burden of tough regulatory obligations. Capital requirements mean even lenders with strong balance sheets have to increase the risk weighting of commercial mortgages.
That’s one of the reasons why this is going to be such a long and arduous road to recovery. Recessions driven by debt take more time to bounce back from than traditional downturns driven by interest rate rises – lenders and borrowers focus on deleveraging, rather than on splashing the cash.
Some lenders have even tried to reduce their exposure to commercial property by asking commercial mortgage clients to refinance elsewhere – RBS and the Irish banks being the most obvious examples.
Having said all that, there are plenty of reasons to be positive about the future of commercial lending. The market has picked up in the last twelve months and there are signs annual gross lending will improve again. Some banks are easing off the deleveraging throttle when it comes to commercial property. Outstanding commercial property debt fell by 6.8 per cent in 2011, compared to 10 per cent in 2010.
To an extent, we have the government to thank for the improvement. Commercial lending has been under parliament’s magnifying glass for the last few years. The coalition has staked everything on a private sector recovery filling the void created by public sector austerity. Project Merlin – the agreement between the government and Barclays, Lloyds Banking Group, the Royal Bank of Scotland and HSBC to promote lending to businesses, particularly small businesses finalised in February last year – has gone some way to easing credit conditions.
The new Funding for Lending Scheme, which offers lenders cheaper access to funds in exchange for more generous lending commitments, could help revive the commercial mortgage market. Borrower appetite for commercial mortgages is as healthy as ever, particularly in the burgeoning buy-to-let sector. Mortgages for Business Q2 Index found yields on commercial buy-to-let property touched highs of 7.5 per cent, and suggested appetite for commercial buy-to-let mortgages is set to increase this year.
No wonder, then, that lenders are trying to take advantage of the improvement in the commercial property market. There has been a raft of new commercial lending services offered by high-street banks. Santander’s new corporate and commercial banking arm recently launched an online website for intermediaries, and other lenders like Abbey have increased their commercial buy-to-let offerings.
Better data leads to better operational efficiency. As lenders increase their commercial activity, they need to address a number of issues specific to the commercial market. The commercial market is more diverse and less regulated than its residential counterpart. There are more personal interactions in the commercial lending process. Inevitably this leaves lenders exposed to more human error and an increased potential for fraud. It also makes it more difficult to capture data and build up a clear audit trail. This has a knock-on effect on analytics and business efficiency.
That presents lenders with a number of problems relating to the way they manage their third parties suppliers.
It also creates something of a provisioning headache. A commercial valuation is more complicated than a residential one. There are a wider range of issues for the lender to consider, particularly revolving around due diligence and security. Lenders need better information, and better access to it to be sure they are dealing with the problem in the appropriate manner. Currently, the process is more fragmented and less structured than the residential market. Lenders tend to distribute their third party instructions through branch networks and regional centres. Management oversight of this third party activity could be controlled more effectively
Lenders need to manage their supplier panels more closely, capture management information more effectively, and then make sure that information is stored in a single place. Operations and risk directors also need to be able to see all the management information in a single format. They need a ‘single view’ of their third parties, which allows them to monitor activity and manage provisioning levels with more success.
The FSA’s Thematic Review stressed that lenders need to improve their third party oversight if suppliers are to be monitored and managed more effectively. It was disappointing the MMR didn’t directly address how technology can help lenders manage their third party suppliers better – as Phoebus Software’s Paul Hunt lamented at the time. The MMR should have addressed the issue directly. The commercial lending market needs better information about its suppliers and this represented a missed opportunity.
Technology providers who offer web-based data storage and communication systems can help immeasurably. Too many lenders store their data in several different legacy systems which sit awkwardly within their operational framework. It means their data is stored in a variety of places, and in different formats, which makes it a nightmare to draw together and analyse effectively. This makes it harder to detect fraud, and blights lenders with all sorts of operational inefficiencies, costing them time and money.
Our Valuation Exchange – known as VEX – is a web-based data exchange portal which sits between lenders, surveyors and their valuation managers or panel managers. VEX captures all management information from the valuations process in a single format.
This improves business analytics and helps them monitor the distribution, allocation and management of their valuations. It allows panel managers to manage their surveyors online and distributes commercial valuations instructions electronically, which makes the process more efficient and more transparent.
This type of system allows lenders to create a trusted panel of valuation managers because it lets them access management information that isn’t collated and run by panel managers. This ‘independent’ source of information can make it easier for lenders to spot fraudulent trends and collusions in their third party networks.
Lenders have been striving for ‘joined-up’ risk management – an integrated approach which ensures a single approach to risk is embedded and understood throughout the entire organisation. While lenders understand the need for property risk management to be more integrated, a minority don’t realise this process can be supported with technology – having all management information stored in one place and being able to follow a full audit trail for each valuation transaction.
Better data will help lenders with PI insurance. Lenders need clear access to audit trails if they are to meet their TCF (treating customers fairly) obligations. Paper-based records are more difficult to store, and there is more room for human error and data loss. If all information is stored securely online, the data trail is much clearer and easier to access.
There has been a rumpus around PI insurance in the residential market recently, which could well lead to a significant focus on PI in the commercial mortgage market further down the line. Many smaller surveyors folded in the aftermath of the financial crisis as a knock-on effect of the credit-crunch, leaving some lenders without adequate professional indemnity run-off insurance in place.
As a result, lenders are looking to use valuation providers with strong balance sheets and stable ownership. PI insurance will be more costly in the future because insurers are scared to the hilt of higher liabilities. If lenders want to select the best valuers who are going to be able to afford their PI cover, they’ll need easy access to data about them.
Flexible technology can help commercial lenders reduce third-party fraud. From a risk management perspective, the valuations process needs to move away from paper-based reporting and towards electronic-only reporting. Fewer paper copies of valuation reports limits the potential for valuation fraud because there is less opportunity for reports to be tampered with or edited before they reach the lender.
Flexible technology, provided by trusted technology providers, is evolving to assist the commercial valuation process. Mobile technology makes it easier for surveyors to capture information on the go and upload it in real time.
We’ve developed an iPad platform, VEX Mobile, which allows lenders to distribute valuations instructions to surveyors while they are in the field. Not only does that benefit surveyors, it also helps lenders’ audit process.
VEX-Mobile will collate the data surveyors collect and send it back to lenders in a single place and single format. It will help lenders improve their risk management and anti-fraud provisions and could help commercial valuations.
Lenders can also use real-time AVM technology. They can minimise risk by using systems that send email alerts to compliance teams when valuation reports submitted by surveyors differ substantially to an AVM value. This sort of technology is cheap, and can be accessed on a case-by-case basis by the lender, the panel manager and the valuer.
Commercial lending is becoming more risk-focused. The effect of a more risk-conscious stance is not just limited to lending decisions, but has resulted in a much more methodical approach to risk management throughout the third party process.
Nowhere is this more evident than in the selection of third party valuation and conveyancer providers by lenders, a decision based on a very stringent set of criteria, rather than just cost. Lenders need help selecting which suppliers make it onto their panels.
They also need help monitoring which ones deserve to stay there. Most lenders will freely admit panel validation isn’t one of their core competencies. Lenders certainly don’t want to be selecting crooked conveyancers or dodgy valuation firms because their analytics aren’t up to scratch.
Conveyancer panels were in the headlines a coupe of months back, with plenty of focus around the small HSBC panel. On their own, lenders don’t have the capabilities to weed out fraudulent solicitors from larger panels. They need help from technology suppliers who can provide lenders with better and more easily accessible information about their conveyancer panels. This makes panel selection more informed and analytical.
Anti-fraud tools, like our national lender to conveyancer exchange (NLCX), vet suppliers and provide lenders with a constant stream of information about their panels. We’ve been working hard with our parent, DIIG, at building a secure community of solicitors.
This decreases the likelihood of shady practitioners getting onto their panels, and increases the chances that fraudulent activity is detected. If used by the whole industry, it can create one national panel of trusted conveyancers that the whole lending community can use.
Due diligence in commercial valuations needs to be equally as rigorous. The commercial lending market needs a secure community of trusted valuers if it is to successfully meet its due diligence obligations. The commercial market needs to learn the lessons from the more regulated residential market.
Lenders should use web-based data exchange systems to provide them with a single-access audit point. This will allow them to grasp a closer control of third parties. It will help them improve their distribution strategy and cut down on fraud.