Commerical lending

IT and commercial loans

July 2007

Take a booming commercial property market with historically low yields, add stiff new competition, complex regulation and some hungry software vendors, and what do you get?

It is quite possible that many lenders and, perhaps crucially, the regulator, do not know the answer to this question.

We are less than six months away from the deadline for the implementation of the Basel II accord (see sidebar), which governs the amount of capital that banks and building societies must set aside to cover loans. But many lenders, including their commercial mortgage teams, are still trying to work out its implications. So, too, it seems, is the Financial Services Authority.

Variations in permission

The regulator is unclear about what actions it will take, if any, should banks and building societies fail to become Basel II compliant by January 2008. “We have no set response for those who do not meet the rules,” says Joseph Eyre, FSA press officer. “It is a supervisory decision. In an extreme case, we could stop the bank doing business by putting in [place] a variation of permission.” However he couldn’t remember this ever happening to a large bank.

Challenges and opportunities

So information technology companies have been quick in their efforts to cash in on what could be a golden opportunity for them. “There are three main challenges that lend themselves to the increased use of technology in the commercial lending industry,” says Jorgen Roed, UK sales and marketing director for lending applications at EDB Solutions, a Norwegian IT vendor with two commercial lending clients in Britain, namely the Nationwide and Cheshire building societies.

These challenges include increasingly fierce competition, the ongoing drive towards internal business controls, and regulatory requirements like the Basel II accord.

“Technology can enhance efficiency, bring different sources of data together in one accessible place and enhance fast decision making,“ says Roed, a former commercial lending manager at Nordska Bank in Norway.

“To handle Basel II, you need intensive data capturing for loans and the underlying assets you are financing. When you do what are relatively complex commercial loans on property, you need to capture information on the property, the tenancy, the borrower and so on, which requires quite a lot more information than for a residential deal, for example.”

The wrong type of system

Other IT companies working with lenders agree. “But lots of lenders are still running their commercial business on systems designed for residential mortgages, and that is a problem,” says Keith Rogers, a senior consultant at Phoebus, another software company, which has designed solutions for Salt, the commercial lending arm of the Derbyshire Building Society, and for Heritage Bank.

Roed, whose appointment to his UK role at the beginning of this year indicates his firm’s desire to break into the British financial services market in a bigger way, agrees. Acknowledging the role of his own firm and of competing IT vendors such as Misys, Iflex and ACBS, he notes the opportunities that his industry now has. “A number of commercial borrowers are using lenders who utilise a system which was probably designed for retail loans,” he says. These systems have been tweaked and use excel spreadsheets outside of the lender’s core IT system to help manage the loan. That is quite dangerous.”

“There is lesser transparency, less traceability and there are audit bugs. Often bits of data end up all over the place in that scenario. There is a much more structured requirement for transparency and accountability. Better computer systems need to know who was in the relevant excel spread sheet, last time or last week and who changed its information and in what way. We are dealing with the need for complete accountability and transparency and a complete log of all the information that gets inputted or changed.”

Roed points out that what lenders need from their software is an ongoing management tool that allows the possibility to manage the loan on an ongoing basis from first application to final repayment. “It also has to interface with general ledger systems, payments systems like BACs and anti-money laundering systems,” he adds.

Strategic decisions

But Roed also claims that Basel II is indirectly requiring lenders to have good risk rating tools. “They need to build a risk rating model complying with the requirements of Basel II. We have concentrated on the data-capturing side. We collect data according to various criteria, submit the data to the lender’s risk rating engine, which could be a third-party engine, or could be built internally by the institution, and we receive back certain key figures, and these are then used in the further management of the loan.”

“The kind of data we are talking about capturing includes the board of directors, corporate history, a company’s financial information, the asset being lent against, some data on the asset, a market evaluation, the tenancy agreement and a tenancy valuation. So it is quite a lot of information that is required.”

But the requirement for data capture is only a part of Basel II, notes Roed. “You have operational risks, and the reporting of those risks both internally and to regulators. It is very important to do the data capturing well because you need to pool the raw data to meet those reporting requirements.”

Not everyone, however, is as convinced as Roed of the importance of software to make a lender Basel II compliant, including his own customers. Cathy Chaplin, newly appointed head of account administration for commercial property loans at Nationwide Building Society, says: “We certainly have all the information and documentation in place that we need to be Basel II compliant already. It is just a case of automating it.”

It’s on paper somewhere

How big a benefit new technology may be is hard to gauge. But Nicola Moughan, senior commercial account manager at the Cheshire Building Society, offers a clue. “We have been using EDB Solutions’ system since May 2003 and are looking into the possibility of upgrading the system because we have identified data fields that we need to put into the system to help us keep better track of the business that we are writing,” she says.

“For example, in commercial lending, we don’t record electronically an individual’s date of birth nor the original LTV of the loan at inception. It is all kept on paper somewhere.”

Meanwhile, a senior project manager at a new commercial lender, who asked not to be named, added: “Our position is spookily similar to the Cheshire’s position.”

Moughan, part of a team of eleven at the Cheshire’s £850 million commercial lending business in Macclesfied, notes that, from January 2008, her society will have to follow a standardised approach to the management of its commercial book. Speaking in late May, she said: “It is a society decision. We haven’t identified fully what Basel II means yet. We are still looking at an analysis of the loan book. It is early stages. We have done some analysis, and concentrated on the different approaches to our residential and commercial books.

“Different societies will be applying Basel II differently. The advanced route, which requires the lender to offer proof of that approach to the FSA, would allow us to use our own internal rating model and potentially free off some capital. But we are a long way off from that. And the [full] role that technology can play with Basel II has yet to be discovered by us but we have a workshop on that coming up with EDB next month.”

Moughan’s team typically writes deals of between £500,000 and £10 million on commercial property investments “with a lease in place”, she says. “Sixty per cent of our commercial business comes from social housing,” she adds.

Ian Herbert, head of operational transformation at Salt, the new commercial lending arm of the Derbyshire, says: “We need IT to help us record much greater depth of detail on a loan and to assist us with the securitisation of our loans.”

In-house or out-house?

But not all lenders will seek outsourced solutions of this type from the IT sector. Graeme Taylor, head of commercial lending at Skipton Building Society, says: “We have our own [reporting] system which automatically generates all the reports we need, including LTV limits and geographical bands, and it has been built into our mainframe system. We can list any event in the life of the mortgage.”

But he admits that he is unclear about how Basel II will impact on his business and the rest of the society’s business. “It could be that a lot of lenders won’t be ready. I know from what I hear that the bigger banks are struggling with it. It may be that they will miss the January deadline and end up with much more work to do as a result.

“But to be honest, it is too early to say what the impact will be. We are still trying to get to grips with it and its impact on our capital. There is a lot of work for lenders to do in modelling the impact of Basel II.”

Taylor, whose society has seen commercial business double in the first half of 2007 compared with the comparable period a year earlier, notes that there have been a lot of new lenders coming into commercial lending, such as Salt and the Chelsea Building Society. “Even ING have been advertising for a head of commercial lending,” he adds. “It is because the sector is not regulated and margins in residential are now so small.”

William Comet is a freelance financial journalist. Reach him at williamcomet@hotmail.com or tel. +44(0) 7956 110465