Growing through acquisition: Part 2

While growth through merging with or acquiring another company may involve new staff, new offices, different processes, switching aggregators and a new business name, growing by purchasing a loan book is all about expanding a client base – and therefore your assets.

Despite the potential bottom line benefits, the purchase process is not without its challenges: it also does not guarantee growth and may well not be an easy option.

In the second of this two-part series on growth through acquisition, The Adviser looks at how to choose the right book, things to look out for, the overall pros and cons, and how to determine whether the price is right.

Why buy?

Richard Kirby, principal of North Shore Mortgages and director of Australian Loans and Mortgages, says there are many benefits to purchasing loan books – especially because you don’t take on the risks associated with purchasing a business.

“We want to grow our business organically and via acquisitions as well,” he says. “If you buy an entire company though, you never know what’s hiding in the cupboard – so we don’t buy the entire company, we buy its assets.”

Arguably a broker’s most tangible asset is their loan book and contacts. So, when business was harder to come by back in 2010, Mark Stariha, general manager of Royal Guardian Mortgage Corporation, began looking for new ways to generate business.

“When we started buying loan books back in 2010, we did it as it was becoming harder to get new clients,” he says.

“NCCP was on the way; there were already changes coming into place; costs for brokers were increasing; and we knew there were brokers who were thinking of exiting the industry and wanted to cash in their books.

So, if you’re looking to grow your business – but not necessarily increase the size and scale of your operations – then purchasing a loan book may be the way to go.

Steven Dal Molin, a Mortgage Choice franchisee based in Chatswood, Sydney, even purchased a loan book from a former franchisee who was exiting the industry to launch his own business.

Mr Dal Molin says that for him, it all added up.

“I did the figures,” he explains, “so I looked at the size of the book and what I was going to pay for it. I looked at the yearly trail income that I could potentially derive from it versus the cost of a green-field franchise, and it just made financial sense.”

Even though trail isn’t guaranteed, it’s fairly certain, Mr Dal Molin says, adding that it was beneficial to have income from day one while he was building his business.

“To have some income while I was establishing myself was very important; I didn’t want to start completely from scratch,” he says.

Purchasing a loan book can be “a good shot in the arm for your trail commission,” he adds.

Bankable benefits

Martin Anstee, chief executive officer of PCL Finance and Illawarra Home Loans, agrees with that last sentiment and says cashflow is the most immediate benefit.

“It gives you a more rapid increase and identification of cashflow,” he says. “It’s also a good way to acquire clients. We know that we’re going to get run-off in our business activities; it’s just how you stem the ebb and flow of that change.”

Richard Kirby adds that stability and predictability are bankable rewards of purchasing loan books.

“The greatest reward would be seeing our income streams increase,” he says. “It builds stability in my business which allows me to focus on running the business rather than on writing loans.”

Mr Dal Molin, meanwhile, reaped the benefits as soon as he launched his business.

“You’ve got an instant set of clients, so you’re not going out from scratch,” he says. “You will also acquire clients who may have purchased quite a while ago and thus have some equity in their house, so it’s the perfect opportunity to call them up.

“There are a lot of opportunities for repeat business and there’s trail coming through the door from day one. It gives you a massive head start to boost your business.”

Mr Stariha believes that if you look after your new clients, then repeat business is a major benefit of purchasing a loan book. This only works, however, if you have a well-maintained database.

“You want to take care of the clients and keep them happy,” he says. “Make contact with them so that if they’ve got any new business, you can write it for them and if they’ve got any other financial needs then you’ve got them as a client.”

Choose very carefully

Not all loan books offer the same rewards, and not all will be a wise purchase, so care is necessary.

Nick Young, CEO of Trailerhomes, says the first step is to speak to your aggregator, lenders and other brokers to let them know you are looking to buy.

“Tread very carefully and research it well before outlaying any money,” Mr Young advises.

Mr Kirby adds that there are several variables you should look at before deciding to buy.

“Be very careful,” he says. “Do your due diligence and be very, very thorough. Don’t just jump ahead and don’t pay too much. The due diligence that you’ve got to do is complex.

“You’ve got to check what you’re buying and make sure that the run-off’s not too big and that there aren’t too many defaults in there.

“You should make sure the person you’re buying from is leaving the industry so they won’t hack your book. Ask around, check them out. Are they a reputable broker?”

A bad book has high run-off, he says, and as such, you have to check the figures.

Mr Dal Molin says the Mortgage Choice team was helpful in ensuring he was purchasing a quality book, but he still did his own due diligence around the figures.

“I got the last three or four months of trail invoices and that shows you the rate of run-off of the book,” he says. “That gives you some indication of how fast the trail is depleting and helps you to predict your cashflow.”

Mr Stariha, meanwhile, believes the more you know about the process, the better.

After an unsavoury experience trying to purchase a book through a business broker, Mr Stariha set up purchasing guidelines for Royal Guardian.

“When I went through that process I thought, ‘I’m not going to go through a business broker again, I’m actually going to work out how to buy a book for myself’.

“So, then I did my own research on pricing and what to look for in a trail book and I started to examine different trail books for their data and history.

“Then I set up our own guidelines on book buying and we started negotiating directly with brokers who were selling books.”

The challenges

Following the purchase, Mr Dal Molin found database management was the biggest challenge of working with his new book.

“It is difficult to determine exactly how well the existing database is managed and how much contact has been made with the clients to keep them on the books,” he says.

Some phone numbers and addresses, for example, were obsolete.

“You know they’ve got a loan on your book, but you can’t necessarily contact them,” he says.

While Mr Dal Molin has now been in the industry for just over one year, he has still only been able to contact approximately half of the clients in the book he acquired.

“You don’t really know how well contact details are maintained until you actually call somebody,” he says. “That sort of thing is extremely difficult and the seller’s unlikely to let you start calling people from their database before the sale, due to privacy.”

Mortgage Choice have been helpful during his quest to contact clients, and the franchise’s reputation for providing quality clients and quality books gave him confidence during the purchase.

Unfortunately for some, however, there are much greater challenges to face in the loan book buying market.

“Some trail book brokers take payment upfront and then don’t deliver,” says Trailerhomes’ Nick Young. “Unfortunately, this has become a major problem in the industry.”

The other key issue, he says, can be the integrity and honesty of the broker from whom you purchase.

“Some sellers claim to be leaving the industry, but in fact they aren’t and they keep on servicing the clients that they have supposedly sold,” he says.

Mr Stariha believes brokers are generally a good bunch, but you still need to ensure they don’t attempt to hack your new book.

“Most of the brokers I’ve dealt with are very honest,” he says, “but I’ve been stung by a couple where I bought the book, but then they started working for another financial adviser, or working for another brokerage – and then they start to refinance their former clients out of that book.”

If this happens, he warns, it’s often not easy to rectify.

“It’s very hard to prove afterwards what they’re doing,” Mr Stariha says, “and even if you do have recourse under the contract, it can actually cost more in legal fees and time costs to recover money from the broker than the total of the money you need to recover.”

Cost considerations

Time is money, and time is one of the biggest considerations when it comes to purchasing a loan book.

Mr Dal Molin says his purchase, including the negotiating, drawing up of agreements and his Mortgage Choice accreditation and training took about three months.

Mr Kirby adds that a lot of time and patience is required.

“The time to transfer can take anywhere from one to three months, because of the time that the aggregators and all the funders take to do all their transfer deeds, plus it takes some time for the trail commissions to start swinging over,” he says.

Aside from the purchase itself, one of your biggest costs could be a solicitor to help with contracts, according to Mr Stariha.

“Then you’ve also got the cost of your accounts staff who need to go through and verify all the figures, examine the trail reports and work out what the annualised discharge rate might be or the drop-off in loan balances.”

Aside from the obvious predictable costs, Mr Stariha says some book buyers end up costing themselves by attacking their own book.

Some people buy a loan book, and are then desperate to refinance the clients before considering the actual costs and the negative aspects.

“If I pay 1.6 or 1.7 times [the annualised trail] for the book, it’s going to take me two-and-a-half to three years to recoup all my purchasing costs,” he says.

According to Mr Stariha, if you refinance a client out of the book to get more upfront commission, you need to remember that you paid for the trail in the first place, which you will now lose.

Trail too, may not start rolling in for 12 months, and the upfront commission can be quickly consumed by the cost of writing the loan.

“I don’t see a cost benefit in attacking those clients to refinance. You need to do your sums very, very carefully.”

Despite the challenges and costs, however, according to Mr Anstee purchasing a loan book is without doubt worth the investment.

“The returns that we’re getting at the moment from buying a book are better than if we had gone and acquired a client by marketing or advertising.”