Delicate balance for geared advice firms

NAB Financial Planner Banking has produced research analysis that quantifies the rate at which gearing can leave an advice firm with unmanageable debt when the market deteriorates, as it has over the last 12 months.

The analysis reveals how highly geared advice firms can get into a position where their debt value exceeds the value of their firm when recurring income values drop, according to national manager Malcolm Arnold.

This problem with gearing is further amplified when the debt has been structured on interest-only terms, with no capital reductions, Arnold added.

The NAB research, based on firms being traded for 3.0 to 3.5 times recurring fees, reveals that a firm with debt equating to 2.0 times its recurring fees is still ‘in the money’ if revenues drop by 30 per cent or even 50 per cent.

However, a business that has geared itself to 2.5 times recurring fees or by 3.0 times is revealed to quickly reach a position of balance sheet insolvency, where debt is worth more than the business itself.

Arnold said the conclusion is that some of the forced sales of advice firms by lenders could be “heavily influenced by excessive gearing being supported by the advice firms and their banks”.

He referred specifically to comments in Money Management last week by John Birt, principal of advice firm consultant Radar Results, that up to six advice firms are being forced by lenders to sell all or part of their client books each week.

“There’s no doubt we too are getting a lot of feedback in the market that some of the financiers out there are probably in a situation where they are being reasonably brutal in terms of wanting to take action," he said.

“However, I would argue one of the reasons is that some greedy providers have geared advice firms beyond a sensible level, and some greedy advice firm owners have taken out too much debt to try to grow their business too quickly.”

He said NAB’s approach to gearing has been more conservative in the debt positions they’ve supported and, as a result, it does not have businesses generally that are struggling with revenue downturn.

“This position also allows us a greater flexibility and more time with those businesses that are stressed to manage their situation through to a win, win outcome for both us as the bank and the business owners.”