How a commercial borrower does not conform

Scott Philipson

June 24, 2006

A subject dear to the hearts of most mortgage advisers is non-conforming borrowers. While would-be mortgage applicants who have a prime credit record and provable income can usually quite happily get the loan they want direct from the lender, those with adverse credit or who need to self-certify income are far more likely to seek the help of an adviser – especially if they have been declined a loan by the high-street lenders. Those people seeking commercial mortgages (who, after all, are the same people that also need to find a residential mortgage from time-to-time) are no different, and they are likely to seek the expertise of an adviser for their commercial mortgage – if their circumstances are out of the ordinary or non-conforming.

Strong resemblance

The profile of the non-conforming residential borrower is well-known, and the non-conforming commercial borrower bears a strong resemblance, but its scope is wider and more complex.

The most likely factor to create a non-conforming profile is lack of financial information, which would typically be audited financial accounts. These are normally produced by limited companies who are under a statutory obligation to file these statements annually at Companies House. Smaller limited companies may exercise an exemption from completing these returns, while sole traders and partnerships are under no legal requirement to make such filings. The government is keen to cut down on red tape to help smaller businesses to spend more time on creating wealth, so it has recently made the ‘Small Business’ category a lot larger. This means that, from the point of view of getting a commercial mortgage, many more smaller businesses now do not have the accounting information that would make them ‘conform’ with the established lending criteria of the mainstream bank.

Regarding other business information that is normally required by mainstream lenders, SME owner/managers tend to have basic budgets and a business plan defined by action/experience and prepared by themselves, rather than detailed business plans and cash flow forecasts drawn up by a finance professional. This can also, therefore, represent a stumbling block.

Non-traditional means

Following the now established residential lending model, we have introduced the ability to self declare financial information. Deals can then be finalised very quickly and can provide a solution for businesses that can demonstrate business activity but not necessarily professionally audited accounts.

As with residential mortgages, credit profiling is the other major consideration in commercial mortgage non-conforming lending. Here, there is a lot of credit research available from business information companies such as Dun & Bradstreet, Equifax, etc, although it tends to be about limited companies rather than sole traders or partnerships. CCJs (against the company and/or its directors); previous business failures; previous personal bankruptcy, etc, are all indicators of credit risk. Risk-based pricing is the basis for all secured lending, so naturally pricing is higher in non-conforming, although differentials are narrowing as the performance of these portfolios is established.

Previous credit problems have positioned business customers outside of the risk profile acceptable to many high-street lenders. As with residential specialists, we have recognised that, in isolation, previous credit problems may increase risk but not necessarily mean the current application is not without merit. Considering other positive factors on the application and agreeing a published risk table offering entirely transparent rate structures for various levels of previous credit problems has grown the market in much the same way as the domestic sector.

The performance of different borrowers with varying credit histories are continuously analysed and modelled by us, so we can understand the likelihood for default and any potential losses this may cause. It is possible, from this analysis and modelling, to provide a lending framework that is responsible and also easy for clients and advisers to understand. There is a massive opportunity for brokers to add a complementary product to their existing business and increase the ways in which they can assist the financial needs of their clients.

This is providing a vital source of new revenue for many, and at a time when traditional income is being eroded, is extremely welcome.

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