Mike Hutchinson Blogs…
Well, at least NatWest are! Since 2007, when all hell broke loose in the banking sector, it looked as if nobody was open for business – or if they were, the terms were totally ridiculous. Now that could be indicative of either:
- We, the borrowers, wanted everything to be the same. I mean, what’s wrong with a 110% mortgage agreed on a self certified basis?!
- The banks had come so close to falling off the edge of a cliff, only to be rescued by massive amounts of quantitive easing (QE) – (for ‘massive’ read £375 billion……….)
So to put that in context, of the 188 countries listed by the IMF, only 30 of them had a GDP greater than £375bn in 2012 and lending was only ever going to be done on a complete belt-and-braces basis, the terms of which were mostly unacceptable to 95% of the population.
Well, I’m pleased to tell you that things appear to have changed.
Yesterday our local NatWest Healthcare manager popped into the office and announced ‘we need to lend more money!’
‘Excellent, how are you going to do that then?’ I replied cynically. Well, I give the lad credit. They have come with a strategy that I believe is very much ‘open for business’.
Let me explain…
Using the example of ‘buying a dental practice’ let’s assume you find one for sale where:
- goodwill is valued at £350k
- freehold is £325k
Here’s how they would do the sums:
What are you buying?
- Max unsecured funding £300k – per partner buying in
- Capital repayment holidays – 2 years
- Freehold – max 90% loan to value (LTV)
- Max term for borrowing – 15 years
- Max unsecured funding for NHS/Mixed £400k – per partner buying in
- Capital repayment holidays – 3 years
- Freehold – max 100% (LTV)
- Max term for borrowing – 20 years
Straight away, you can see they consider NHS/mixed as lower risk.
Can you afford it?
That is dependent upon a fairly clear formula.
Starting with EBITDA (Earnings (or profits) Before Interest, Tax, Depreciation and Amortisation).
From your EBITDA, deduct:
- Tax payments due on profits arising
- Capital expenditure commitments, including (other) loan repayments, HP instalments etc
- Your anticipated drawings
This leaves you with a figure called Cash Flow Available For Debt Servicing (CFADS)
It’s this figure that needs to be 1.25 times the annual loan repayments.
The final part is ‘what will be the interest rate on which to make this calculation’ (which is different from the actual interest paid)
The interest rate is made up of two elements:
1. The margin. This is the amount above the base rate that the bank charges (so that it can make a profit – perfectly reasonable).
In considering the margin, 4 elements are considered…
a) Amounts involved
NatWest are generally looking in the 2-3% range (a lot better than we have seen in the last 7 years)
2. The default rate. The bank generally takes a 6 year view as this is the normal cycle of loans before being restructured or refinanced or whatever.
It is their estimate of the base rate over that term. The current default rate is around 3.5%
On that basis you would do your ‘stress testing’ for loan repayment at 6.5%. You can, therefore, work backwards from either:
- the amount you need to borrow to work out what the EBITDA needs to be. Or;
- the EBITDA to what the max borrowings can be.
[highlight_one]Phew! Are you still with me?[/highlight_one]
Let’s look at our Private & NHS/Mixed examples and assume for both:
- Goodwill = £350,000
- Freehold = £325,000
The loan repayments on £642,500 over 15 years at 6.5% will be £5,597, or £67,164 pa (note you can only borrow 90% of the value of the freehold, so you will need a £32.5k deposit)
That needs to be covered 1.25 times by CFADS, therefore £84,000
Tax = £70k
Cap ex = £40k
Drawings = 100k
Then EBITDA needs to be (at least) £300k (well – £294k to be precise)
(same numbers other than term and amount borrowed)
The loan repayments on £675k over 20 years at 6.5% = £5,032, or £60k annually.
That needs to be covered 1.25 times by CFADS, so £75k
Tax = £65k (less as profits ‘need’ to be less)
Cap ex = £40k
Drawings = 100k
Then EBITDA needs to be at least £280k
I like that.
It’s pure maths and I totally get it. If the bank honour their word, and I have absolutely no reason to assume otherwise (!) then this looks like a massive result.
If you or someone you know is thinking of buying a practice, Private or NHS/Mixed, then don’t hesitate to give me a call to discuss the financing.
Mike Hutchinson FCA
07779 799995 / 01326 660022
P.S Since writing this, I note that NatWest have dropped the default rate one quarter of a percent to 2.25%-2.75%