The reduction in non-bank lending, reduced commissions, and
decreased lending volumes have led to an increase in amalgamations
and business sales.
Many brokers embark on a proposed sale or purchase without
understanding the significant risks associated with such a
In this report we look at three key risks:
The purchase price paid for a loan book will generally be a
capital expense and will not be deductible against the income
derived from the book. Accordingly, if a purchaser pays $300K for a
book, at a 50% tax rate, trail income of double that amount, $600K
will be required just to break even.
In calculating a suitable price to pay for a book, an
appropriate allowance must be made for the cost of money (because
the purchase price is paid up front), the amortisation of the book,
and the risk of accelerated churn after a change of
Accordingly, paying one years trail will normally mean an
expectation of at least three years trail to make a modest profit,
ignoring the cost of managing the book.
Of course different considerations apply where a significant
goodwill (brand name) is being purchased.
In most sales, the vendor remains liable for losses that arise
after completion of the sale because of breaches by the vendor or
its sub-originators which occurred prior to completion of the sale.
However, in most cases the purchaser is also responsible for losses
arising from defaults occurring both
before and after completion. Although the
vendor will usually indemnify the purchaser against any claims
relating to breaches prior to the sale completion date, recovering
from the vendor may be very difficult, if not impossible.
Of course it is essential to conduct a due diligence of the book
being purchased. It is very difficult, however, to be certain that
there are no skeletons in the closet. Identity fraud, valuation
fraud, or other defaults could surface several years after the loan
The big risk for the purchaser is that the funder or aggregator
turns off all or part of the trail because of breaches not caused
by the purchaser and which the purchaser didn't even know
Worst still, if the default is significant enough, the purchaser
could find itself subject to a claim which is greater than the
amount of the trail. For example, if two loans are affected by
identity fraud, the funder or aggregator could claim the full loan
amount from the purchaser. These two loans might have triggered a
loss of $1.5 million and may wipe out the trail for many years or
Some brokers and aggregators sign origination agreements without
ensuring their interests are protected.
Often funders can terminate trail if there is fraud or other
default. The trail of 'innocent' loan writers could be lost
because of the action of other loan writers.
This is another risk to be assessed, and if possible addressed,
when purchasing a book. Even if the book you have purchased is
fine, is it at risk because of the conduct of others?
What's the answer?
There is no simple answer to these risks. However, any purchase
of books needs to be undertaken with expert legal advice (Gadens
can help), and a fair bit of caution is recommended.
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The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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