Failure of a LBDPG… is it contagious?
The fallout from the failure of a LBDPG could be catastrophic for stakeholders and the residential property market in general;
- Banks: This might send shock waves through the banking community and could result in a significant credit squeeze until banks digest the outcome.
- Non-bank and private lenders: small funds may not have the capital base to absorb a substantial loss. This could result in the collapse of the fund, or loss of investor confidence.
- Other financially stable LBDPGs:
- Loss of market confidence and finance availability
- Collapse of common subcontractors
- Reduction in site values and gross realisations of stock, where the assets of the insolvent LBDPG are put to the market for sale by lenders and insolvency practitioners
- Subcontractors: LBDPGs have required their subcontractors to grow with them, by size, complexity and in the number of developments undertaken. Often these subcontractors have also grown over a short time-frame. They may lack the management expertise and capital to successfully operate a business of a larger scale. Also, they rarely analyse the risk associated with generating much of their revenue from one customer. If these subcontractors also work for other LBDPGs, their failure can consequently flow-on to their developments.
- Consumers (purchasers of residential stock): The effects on consumers include delays and the risk of contract cancellation, securing and returning pre-sales deposits and potential defect claims on completion.
- Reputation: can harm the reputation of the lenders involved.
Risk mitigation strategies
Risk mitigation strategies are not an exact science. Strategies should be designed and implemented on a case-by-case basis. The lists below are by no means exhaustive.
Pre-finance approval risk?
- Understand the planning, delivery, finance and take-out risk applicable to the LBDPG;
- Understand the management and shareholder structure and experience of the LBDPG. Do they group their developments under a common shareholding or is there fragmented ownership of each project (with different parties such as joint venture partners, employees and family);
- What is the LBDPGs defect dispute record and do they have any current disputes? Use public directories (such as NSW Fair Trading, consumer advocacy sites, publicly accessible Court lists) in your search or seek confirmation / certification from the LBDPG’s solicitors and accountants;
- Stress test the forward cashflow of the group; and
- Be mindful of contract rebates on presold stock and the implications on the balance of stock held and the equity of the LBDPG.
- Review all the above recommendations annually or when concerns arise;
- Make regular site visits (attend PCG meetings). Distressed developments and builders can usually be identified by an experienced eye;
- Obtain updated forecasts and confirm subcontractor ageing; and
- Check QS reports for signs of variations and delays. Review adequacy of contingencies.
Minimise fallout once you know there is distress?
- Information gathering: Increase the scope of consultants’ roles, such as quantity surveyors and valuers. Ask them to consider all options and gather the most current information and documentation on the development, including:
- Pre-sales information
- Key staff: Consider what information they hold? What’s their importance to development completion?
- All approvals and documentation: Collating this information is crucial to minimise the loss and time required to complete a project
- Sub-contracts, supplier agreements, last payment claims: Understand the nature and timing of outstanding amounts
- Expect union activity if subcontractors are unpaid
- Identify critical subcontractors and suppliers: This varies depending on the stage, complexity and size of a development and may be different for each development. Strategies need to be implemented for each of these subcontractors as they have the potential to delay the completion of construction.
- Identify the other lenders and major creditors to the group: Consider making a collective plan to minimise risk and the impact of distress and mitigate the fallout of a failure. Bear in mind that lenders themselves pose some financial risk. The institutional and private money flowing into this market may exit at the first sign of industry losses.
- Direct payments: Insist on paying subcontractors and suppliers directly to minimise the risk of funding redirection
In case you missed it
Part 1 – In the first part of this series, we discussed the growth rate and risks associated with LBDPG structures.