At the most recent monthly board meeting, the Board of GPS discussed the economy, the federal budget and the building industry etc. This broader analysis is a fixed agenda item, and as usual, we took a pragmatic approach and considered what we need to do to protect your interests.
We do not share the view of the Government, some economists and some of the media, that interest rates have peaked and will soon start to fall. I sincerely hope that on this occasion I am wrong. We are preparing for the alternative outcome.
While we remain comfortable with our well proven strategy of focusing on funding projects for our direct base of repeat and referred borrowers, it has been necessary for us to change one of our fundamental principles for borrowers – mid term interest rate increases.
GPS has traditionally held interest rates for the life of the loan for borrowers. There are swings and roundabouts with this policy. We saw the benefit when interest rates were falling, because GPS maintained a higher distribution rate to investors for longer than most operators. We have seen the downside of this policy now with GPS being slower to increase distribution rates as our borrower rates remain at what they were written at 6-12 months ago. We had to wait for our loan book to catch up with newer loans at a higher rate before the distribution rate could be lifted.
Considering what may be a bumpy ride ahead of us, GPS has now introduced a policy of reviewing borrower interest rates and distribution rates to investors at the end of each financial quarter. This is to combat a long term margin squeeze.
Margin squeeze is a major reason for the failure of banks and other lenders. This occurs when investor interest rates rise quicker than borrower interest rates. The lender must increase interest rates to investors to meet the market and maintain inflows of new funds. The problem is that their borrower interest rates do not keep pace. This leaves the lender to operate on tighter margins, which causes liquidity issues. An example of this is what is happening with banks in the USA currently.
We saw another liquidity problem during the GFC. Borrower loan terms greatly exceeded investment terms. When liquidity tightened; the lenders couldn’t realize the cash to repay the investors and we had a crash.
This change in policy at GPS is just part of what we do to protect your interests and is what you should expect from such an experienced operator. The benefit of being a smaller, family run office such as GPS, is that we can be flexible and effective in making changes quickly to improve outcomes. We hope that we don’t have to use this policy change and that we are wrong about where the economy is headed. But it is important that we are prepared either way.
I have faced many issues in my past (nearly) 30 years of lending. It is my job to guide us all through the latest saga. One of my sayings is that “if lending was easy everyone could do it and I would be out of a job”. Those who think it is easy come and go. Not many go the distance.
In times of rising costs of living it may be a fallacy to chase substantially higher returns.
A lot of deals come across my desk, and there are plenty which offer interest rates that could support a substantial increase in the GPS distribution rate. The problem for me with these deals is that I consider them to be an unacceptable risk and in contradiction to GPS’s prime directive – don’t lose investors hard earned capital.
Be wary and question the investment if the rate looks too good to be true. Higher return is linked to higher borrower costs, which in most cases links to higher risk.
I am comfortable with the GPS position. We have one of the strongest loan pipelines of quality projects to fund that I have ever experienced. We also have a great team.