The reduction in non-bank lending, reduced commissions, and decreased lending volumes have led to an increase in amalgamations and business sales.
Many brokers embark on a proposed sale or purchase without understanding the significant risks associated with such a transaction.
In this report we look at three key risks:
- taxation;
- default liability;
- trail forfeiture.
Taxation
The purchase price paid for a loan book will generally be a capital expense and will not be deductible against the income derived from the book. Accordingly, if a purchaser pays $300K for a book, at a 50% tax rate, trail income of double that amount, $600K will be required just to break even.
In calculating a suitable price to pay for a book, an appropriate allowance must be made for the cost of money (because the purchase price is paid up front), the amortisation of the book, and the risk of accelerated churn after a change of manager/broker.
Accordingly, paying one years trail will normally mean an expectation of at least three years trail to make a modest profit, ignoring the cost of managing the book.
Of course different considerations apply where a significant goodwill (brand name) is being purchased.
Default liability
In most sales, the vendor remains liable for losses that arise after completion of the sale because of breaches by the vendor or its sub-originators which occurred prior to completion of the sale. However, in most cases the purchaser is also responsible for losses arising from defaults occurring both before and after completion. Although the vendor will usually indemnify the purchaser against any claims relating to breaches prior to the sale completion date, recovering from the vendor may be very difficult, if not impossible.
Of course it is essential to conduct a due diligence of the book being purchased. It is very difficult, however, to be certain that there are no skeletons in the closet. Identity fraud, valuation fraud, or other defaults could surface several years after the loan is made.
The big risk for the purchaser is that the funder or aggregator turns off all or part of the trail because of breaches not caused by the purchaser and which the purchaser didn't even know about.
Worst still, if the default is significant enough, the purchaser could find itself subject to a claim which is greater than the amount of the trail. For example, if two loans are affected by identity fraud, the funder or aggregator could claim the full loan amount from the purchaser. These two loans might have triggered a loss of $1.5 million and may wipe out the trail for many years or even forever.
Trail forfeiture
Some brokers and aggregators sign origination agreements without ensuring their interests are protected.
Often funders can terminate trail if there is fraud or other default. The trail of 'innocent' loan writers could be lost because of the action of other loan writers.
This is another risk to be assessed, and if possible addressed, when purchasing a book. Even if the book you have purchased is fine, is it at risk because of the conduct of others?
What's the answer?
There is no simple answer to these risks. However, any purchase of books needs to be undertaken with expert legal advice (Gadens can help), and a fair bit of caution is recommended.
| Sydney | ||
| Jon Denovan | t +61 2 9931 4927 | e [email protected] |
| Vicki Grey | t +61 2 9931 4753 | e [email protected] |
| Melbourne | ||
| Danny Moore | t +61 3 9617 8596 | e [email protected] |
| Peter Grotjan | t +61 3 9617 8538 | e [email protected] |
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
