Articles by Matthew Gilligan
As accountants we are often asked, "What can we do to manage the exposure of our affairs to banks, as we increase our business or property borrowing?"
There are lots of things you can do to reduce the effectiveness of bank securities and protect yourself from the banks. Ultimately the goal is to stop them taking everything; just allow a bank to take the investments (and equity in them) that you allot them security over.
GEARING RULES OF BANKS
You will need to work within their gearing rules to achieve what is discussed below. As background, generally banks will be happy if you have a 20% deposit on residential property, or 33% deposit for large or commercial investors. Of course you need cashflow to support the credit application, and interest cover of 2.5 to 3 is also required in NZ, rule of thumb. (Interest cover is rent + income / interest expense).
Strategies to beat bank securities (stop them getting everything if you are insolvent) include:
1. Use a 'Split loan structure'
Use two banks: Bank 1 lends to the LAQC, secured by the rental, and personal guarantee(PG); the other bank (Bank 2) provides the deposit secured by the family trust asset. As soon as you can, revalue the rental and refinance with Bank 2 to remove Bank 1. You end up 100% financed with no trust guarantee.
2. Put your home in a trust
Obviously put your home in a Family Trust and complete a gifting programme. Don't give Bank 2 a security over the trust. They will ask; say no. If you do not put your home in a trust, your personal guarantee exposes the home to Bank 2.
3. Use a 'Hawkins Clause'
While you are conducting a gifting programme, if you go bankrupt you will have the ungifted loan called upon by Bank 2 to be repaid from the trust. The process is: Bank 2 calls your PG (because your company has failed and lost money leaving the bank unsatisfied, etc); the bank demands that you pay; you don't and they apply to the court to bankrupt you; the official assignee examines your assets and finds the ungifted loan balance - and will call upon trustees to pay it out in full.
So to defeat a claim against an ungifted loan to your trust, put a Hawkins clause and debt entrenchment clause in your deed of acknowledgment of debt. The former says the Official Assignee (OA) cannot call the loan, if you are bankrupted (effectively). The latter says if the loan is called (say the clause is struck out at Court of Appeal, as our clause has High Court support in case law), then you leave the remaining loan balance subject to a call notice of 8 years, slowing down the OA for that time.
Watch the video below for an explanation of the Hawkins Clause.
4. Use the GRA one-one-one rule, being
* One company (LAQC) or trust or whatever you are investing in
* One bank
* One million dollars worth of debt
By doing this you quarantine all of the banks from each other. If one entity ends up in trouble with a bank, you do not lose all of your property at once - because the banks are ring-fenced off from each other in separate companies. This gives you a timing advantage if you end up in a scrape with say Bank 1, because you can be moving the assets in company 2/3/4 etc and they will have no control over the assets.
It is all about what I call 'getting positional advantage' on a bank, i.e. getting to a position where they do not have your entire life stitched up, so they can't destroy your family and life savings if something goes wrong.
5. No Spouse Guarantee
Don't give a banker your wife's or husband's guarantee. Only one of you should be a director and guarantor. Negotiate HARD to avoid both spouses giving guarantees.
In summary, you make it really hard for the banks, and they tend to give up. Do nothing and allow them to cross secure everything - you will lose the lot.
Try to ring-fence them and manage them with a good broker - you will be in a much stronger position if you have problems, and you should be able to defend your family home and contents of your trust.
For years we have told people to do the above, and their brokers and lawyers have said we are over complicating it, just allow cross securing. Well that is and was crap advice, and many clients are in trouble because they were led into short cuts by their lawyers or brokers.
Split loans take a bit of time to set up, and a bit more energy on your broker's part, but they are really, really effective in a recession. Problem is, in a recession, they are really, really hard to put in place (for weaker borrowers).
Last point: you need a broker to do this; the banks will not want you to do it. Its not illegal, but no bank will help you defeat their interests with split loan structures - they will discourage it and say don't do it. Of course, that is best for them.
I hope this information has been useful. For a free review of your financial affairs including how to best structure your assets, please request a call now. We're here to help.
Thanks Seema once again excellent service from GRA! You're my favourite accountants :-) I recommend you guys whenever I have the opportunity. Well done of giving excellent service right throughout your organisation. - Leigh Fourie - December 2017
Investing in residential property?
If you're investing in residential property, seeking to maximise your ability to succeed and minimise risk, then this is a 'must read'.
Matthew Gilligan provides a fresh look at residential property investment from an experienced investor’s viewpoint. Written in easy to understand language and including many case studies, Matthew explains the ins and outs of successful property investment.