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September 20, 2018

ICR is the new LVR

Conversation with the Australian banking market on investment assets is nearly exclusively now led by the question of “ICR” (interest cover ratio). Then there is some chat around asset WALE (weighted average leasing expiry) and makeup of tenancy schedule. And coming in as an afterthought is LVR…hard times for what was previously the key metric in bank credit assessment.

So why is this? Once again, APRA has pressed Australian banks to hold consistent credit criteria with all participants wanting to see assets provide two times cover of interest cost from passing net income…just when we thought product diversity couldn’t constrain any further!

To paint an example, we look at a $10mill asset valued on a 5% and 6% yield:

Asset Value $10mil
Yield 5.0% 6.0%
Income $500,000 $600,000
Interest Rate 5% (test) 5% (test)
ICR 2.0 times 2.0 times
Maximum Gearing $5.0mil $6.0mil
Resultant LVR 50% 60%

The profile of a tenancy schedule and WALE are also key metrics. Single tenant assets with short lease tails are no fun with banks wanting to see WALE extend out beyond loan term.

It’s clear that further tightening of asset yields won’t be supported by bank debt.

This dynamic also plays through the development of income producing assets where again the debt amount is sized against the pre-committed income and subsequent ICR. This means speculative development is very much only for the equity-heavy private or institutional balance sheet.

Stamford recently procured finance for an office development where the non-bank market was able to provide 45% more capital than the trading banks…the forecast LVR is only just over 50%. This created a huge range of equity capital required – especially when comparing the bank versus non-bank terms. In this case, LVR was of little relevance while pre-leasing and the resulting ICR were the most significant components.

What we’re seeing in the investment market is new support from institutional capital that can finance with lower ICR covenant. See two of our recent product announcements:

Investment Product update August 2018 Investment Product update July 2018

So what do we envision from this change in market? It will have a direct impact on investment asset values… It will heighten the value of assets with long dated income streams and good tenancy covenant, while materially eroding the value of assets with pending lease management.

As always, we’re happy to talk you through these market changes.

Michael Hynes