Tier 2 Lending "Limits" - Part I: Understanding The Details

Tier 2 lenders might be more flexible in their lending habits, but they still have regulatory oversight and internal charters that dictate how and where they can invest. Here’s the scoop.

Nathan Daly
October 16, 2020

Tier 2 Lending "Limits" - Part I: Understanding The Details

As we mentioned in our overview of the three tiers of lending institutions, Tier 2 lenders are not regulated by APRA, but in fact, are regulated by ASIC. That doesn’t mean that APRA is not involved with ADI (Authorised Deposit-taking Institution) practices. On the contrary, it provides ASIC (Australian Securities Investment Commission, whose primary goal is to protect investors, customers, and creditors and enforce Australia’s finance laws) with guidance and overview, setting standards that ASIC is compelled to implement. As such, ASIC passes along many standards-of-practice that Tier 2 lenders - building societies and credit unions (all classified as an ADIs, authorised under section 9 of the Banking Act 1959, to carry on banking business in Australia) - must adhere to.

This post will give you an overview of some of the regulations and limitations that these entities have, so you’ll better understand their position when it comes time to secure investment financing. However, if you are of the ilk that doesn’t feel the need to know all the master-level details, Acumen Finance is an expert on this. You can trust us to guide you to the most suitable lender for your investment property financing. Otherwise, read on.

Tier 2 Lender - Authorised Deposit-taking Institutions

ADIs source their wholesale funding from sources other than customer deposits, such as other banks or investor pools, as we’ll discuss in a moment. As they are not under the purview of APRA, they are often more flexible in their willingness to underwrite loans. Having said this, they are still under the scrutiny of ASIC who monitors them via their company charters, ensuring they remain in compliance with Australia’s finance laws.

All ADIs are required to have an adequate risk management framework - as per APRA Prudential Standard CPS 220. And ADI board members - anywhere from nine to 11 members on a board of directors with two executive directors, all of whom must be “fit and proper” - must be involved with this risk management strategy and its implementation. Those requirements include implementation of the Basel Committee on Banking Supervision’s (BCBS) mandate to “improve the resilience of the global banking system, promote confidence in prudential ratios, and encourage a predictable and transparent regulatory environment for internationally active banks,” in the Basel III initiative.

Regulated Risk Mitigators

Now, bear with us as we introduce a few concepts and a couple more acronyms you will need to know to understand some general, overall ADI requirements, that ultimately restrict their lending powers and come together to form their individual charters.

Primarily, Basel III includes two quantitative tests for liquidity risk supervision that applies to the group of larger, more complex ADIs:

  1. Net Stable Funding Ratio (NFSR): long-term focus to encourage more stable funding structures ongoing.
  2. Liquidity Coverage Ratio (LCR): short-term resilience, with high-quality, unencumbered (liquid) assets to deal with short-term (30 days) acute stress. I.e., a larger buffer of assets.

Smaller ADIs are monitored under a more simple, minimum liquidity holdings (MLH) system.

Back to the bigger, more complex ADIs and the LCR (Liquidity Coverage Ratio) for a just a bit more clarification: This excerpt from Practical Law explains an important modification of this requirement: “Since APRA currently considers only government debt securities to be sufficiently liquid, the stock of quality liquid assets in Australia...is insufficient to meet the liquidity needs of Australia’s ADIs.” Therefore the RBA has a CLF (committed liquidity facility) to measure ADI’s global liquidity standards, not subject to the MLH system used for small-ADI’s exemption.

Confused? Stay with me!

This is important because, as Practical Law continues:

“An ADI must demonstrate that is has made every reasonable effort to manage its liquidity risk through its own balance sheet management before relying on the CLF.”

“[The] size of the CLF for each ADI is limited to a specified percentage of that ADI’s Australian dollar net cash outflow target as agreed by APRA, plus an allowance for an appropriately sized buffer. The overall size of the CLF is set at a level that reflects the aggregate amount of Australian dollar high-quality liquid assets that could reasonably be held by ADIs, as estimated by the RBA, and the aggregate amount of Australian dollar net cash outflows for all ADIs taken together.”

And, to keep the lending institutions on their toes, the CLF is determined annually.

ADI Charters

As intimated by the small-ADI exemption, and the individual calculations of an ADI’s CLF, you can see that no two ADI requirements are exactly the same. In fact, there are a variety of ADI sizes and types specialising in different asset classes, loan amounts, etc. For this reason, each ADI must develop a charter - a book of rules that outline their investment and risk mitigation strategies, including their NFSR, LCR (or CLF) ratios and how they hold up to on-hand capital and liquid assets required by the regulating authority.

In addition, each ADI’s charter will describe which type of lender it is, based on their investors who provide the source of their wholesale funding.

The Two Classes of Tier 2 Lenders

Following is a very high-level overview of the two primary classes if Tier 2 lenders. We will talk more in-depth of these ADI structure types in up-coming posts. They are:

●      Managed Investment schemes - Managed investment schemes (MIS) can be either Pooled or Contributory:

The Pooled Managed Funds brings together many investors who “pool” their money for the investment(s). In this scenario, only the fund manager’s name is listed on the title on the investment property, providing a layer of “security” for those who wish to remain anonymous, but leaving the investor with little or no recourse if the deal goes bad and there’s not enough to pay off all lien holders.

The Contributory Funds, on the other hand, have a fund manager who distributes a Product Disclosure Statement (PDS) to the investor collective, and participants can choose what deals they want to invest in. In this scenario, each investor is named on the mortgage, giving them greater recourse action if the deal turns bad.  

●      Securitisation Programme - The second type of ADI investor organisation is a securitisation programme, wherein non-liquid assets of a company, such as leases, loans, mortgages, and credit card debts of its customers, are converted into “highly liquid” asset-backed securities (ABS) that can then be sold to investors.  

Further, ADI’s charters typically include specific operational goals, such as how quickly they can get money lent out, how much they can invest in certain asset types, how much they can invest in certain locations or zonings, and other idiosyncrasies that determine whether they can complete a deal for the client. And all of this is submitted to ASIC for periodic review to ensure that Tier 2 lenders are employing fair and ethical lending practices while protecting the interests of their investors, creditors and customers.

Which Tier 2 Lender is Right for You?

So the bottom line is that Tier 2 lenders have specific mandates dictated by their charters, depending on a variety of regulations and issues. Therefore, not one Tier 2 lender is an appropriate shop for all borrowers. Navigating the maze of charters, regulations, and investor types is a job for the pros.

Acumen Finance knows the charter details of many Tier 2 lenders in Australia. And, they know who is able to underwrite a loan based on the individual charter limitations and government regulations. With Acumen Finance as your trusted broker, you will not waste time chasing lenders who cannot provide financing. You’ll save time, money, and unnecessary hits to your credit report, because your application will only be presented to a viable financier. Acumen can fast-track your application process and significantly increase the likelihood of a loan approval. Contact ustoday to start the loan pre-approval process and position yourself for the next best commercial property investment opportunity.