Andres Luts is the Chief Credit Officer at EstateGuru and is tasked with managing the platform’s credit policy across several European countries.
We met up with him for a far-ranging discussion on how EstateGuru approaches risk, how they judge and evaluate borrowers, the challenges of operating in multiple countries, how they combine technology and human expertise to be ultra-efficient and much more.
Question: Let’s start with the basics, when it comes to borrowers, what criteria do you use to decide whether a company gets a loan or not and at what interest rate?
Andres Luts: Potential borrowers on EstateGuru’s platform are typically small and medium-sized companies (SMEs) in markets where there is a funding gap in the financial sector, which means that bank and other financing options are limited.
To start with, we will check their history and check what experience they have. We obviously also look at their financial status, which means they need to be financially healthy and without any payment remarks, which means no tax issues or defaults and bad credit somewhere else. But in real estate, lending is quite often done through a Special Purpose Vehicle (SPV), so to newly established companies created specifically for the project. So that is why we will also ask the borrower to compile their track record and previous projects and evidence of their success and also the business plan of the new project if it is available. So that covers the borrower’s side, but as we are real estate-backed lenders, we also assess the real estate offered as collateral.
So that means we look at the location, the market value, the valuation report methodology, and what it had previously sold for.
To sum up, the desired borrower must:
· Be a legal entity (registered in EU) with one-year active business history (however EstateGuru doesn’t exclude applications where this criterion is not met including project-based entities).
· Have no active tax (except deferred) and other active payment remarks.
· Have no bankruptcy proceedings related to the borrower or related parties.
· Have no money laundering suspicions related to the borrower or related parties.
In terms of interest rate, we have a separate interest rate model and we also have an internal rating model. So we put all the different aspects into these models, and they usually give out the minimum interest rate. But, as we are a marketplace, we also need to attract investors, especially when it comes to bigger loans. So the interest rate model could say that 11% is what this borrower qualifies for, but if the loan is like five million euros, then we need to add another percentage point for this market premium to get the investors on board. So it’s a mix, the logic behind this interest rate. How many investors do we have in this country where the loan is? And what’s the current liquidity situation on the platform? This also affects the interest rate. Unlike a traditional bank, we have a more advanced interest rate policy.
Q: How does your approach differ from that taken by traditional banks?
A: We are using basically the same traditional banking credit procedures, but we are doing it in a more efficient way by using technology, third party sources, databases, automated valuation models, construction supervisors etc. and this allows us to be much, much faster.
We are making credit decisions 24/7, not meeting just once or twice per week to make decisions. So this is our competitive edge when we compare us to the banks.
So this is the main goal. To use, in general, the same criteria that the traditional financiers do, but make it faster and technology-driven.
Q: Do you do the valuations in-house or do you have external professionals?
A: We always use external, independent and licensed valuation experts. The valuation needs to be market value without any assumptions and only for lending purposes. We are very critical because we have extensive knowledge about this field in-house. One of our committee members has worked as an appraiser. I myself used to work as an evaluator in the bank. So we assess everything. We do a recalculation and also check every part of the external valuation. And if we feel that the value is too high, then we lower the maximum loan amount.
Q: Considering that the real estate market in a lot of spots in Europe is booming right now, how do you factor in the possibility that the markets could go down in the future?
A: The Loan to Value (LTV) ratio that we apply is there to safeguard against any drops in the market. Our average historical LTV is below 60%, which means that if the value of the property decreases by more than 40%, we may see a loss for the investors. This is a highly conservative approach and, by also choosing the markets where we operate carefully, we feel this is sufficient to keep investor funds safe.
We always analyze the macroeconomic dynamics of the country, the real estate market, and also specific towns or segments that we look into more deeply. So we are prepared for everything. If we see that the market is booming, then we will just offer a lower loan against this property in this market to counteract any over-valuation to the boom.
Q: Are there any specific red flags where you can say immediately, no, this company is not getting a loan because, you know, they don’t pass the smell test?
A: Oh yes, definitely. If they have a very negative background on the credit risk side, we pass immediately. So if they have a history of bankruptcy or maybe are involved in some kind of tax fraud, money laundering or something like that.
And we also need borrowers with financial stability, so we look at the strength of the company or the group. Some companies have lots of open loans with different credit providers, and even if they have different collateral or collaterals for these loans, they may be over-leveraged. We also set a group limit so that one borrower doesn’t typically have over 10 million euros of loans. So we set the maximum group limit because we have seen in the previous financial crisis that the borrowers who took lots of loans against their properties and did several projects simultaneously had serious trouble repaying their loans.
There are also some industries and activities that preclude us from giving a loan on principle. Borrowers who are active or related to the following industries are not the target clients for EstateGuru’s products:
· gambling and betting;
· tobacco production;
· export activities into sanctioned countries;
· gun production and sales;
· nuclear power production;
· fish production;
· political parties and other political organizations.
Q: How are the risks being managed in terms of different countries? Is it all assessed and managed centrally from the headquarters in Tallinn, or is it done by the teams on the ground in other countries?
A: We have country and loan managers in every country, and they are the first line of defence, so they do their first risk analysis and then they send the application to our headquarters in Tallinn. And yes, the main decisions are made in our headquarters, but in larger countries like Germany and Finland, we will appoint a local risk analyst in the coming months.
In smaller countries like Latvia and Lithuania, we don’t need them because we use local construction supervisors who double-check construction costs when we have a development loan for instance. We also use local partners to double-check valuation reports where we suspect the value may be too high.
Q: A specific question for the German market is whether it is special in any way? Do you have to take things into consideration that don’t apply to the other markets?
A: Yes (Germany is special), I think that the secondary cities and province areas in Germany are more liquid than in smaller Baltic countries because in Germany it is quite OK to travel 100 kilometres to work. From the credit risk side, it is fairly similar, but legally, of course, there are differences in mortgages and notaries etc. This is why we have a strong legal partner to assist us in mitigating these risks.
Q: EstateGuru claims that its financing is probably around five times faster than through traditional banks. How can you achieve that? You already mentioned technology, but what else is there?
A: As I said earlier, we make daily credit decisions not once or twice per week, as for instance banks do. Also, in every risk area, we have a person who is dedicated to helping the local country and loan managers and borrowers to present all the information that we need for a decision right away. This saves lots of time on unnecessary backs and forth. We are also very proactive. We don’t wait for the answer. We like to communicate with the borrower and visit the site instantly.
And we are not as bureaucratic as banks. So the already mentioned technology helps us to find the right risk focus areas and the red flags more rapidly. The vision and the market knowledge of real estate at EstateGuru are stronger than maybe in traditional banking, we are experts in the field. We also don’t have so much legislation or regulations to deal with right now, but we are already prepared for when the new pan-European legislation for crowdfunding is introduced.
We have found partners in-house and externally who are dedicated to one specific area. And that’s why we get the fastest results for our borrowers and investors.
Q: Do you check everything through technology first and then the humans come in? Is it a parallel process?
A: Some checks are already done through our scoring models and then the human comes in and verifies the findings, so there is still some human input. With larger loans, it should be that way for some time because we need to ask additional questions from the borrower. We need to visit the site. But we are heading towards a time in the future where we may have satellite pictures and drones doing site visits etc. We are working toward this. At the moment I would say it is still a 50/50 split between humans and technology.
Of course, this entire process is quite expensive. Somebody still needs to have an overview of the process and find areas where we can improve speed and add more automation. I think that larger nodes will need human intervention for a couple of years. And when it comes to larger loans, we still meet the borrower in person. For instance, in Germany, it is also still mandatory to meet with the borrower or do a video call with him/her. So we meet/video meet all of them so we know that if we need to, we can contact them or talk to them in the future, as a relationship has been established. This is also why we visit construction sites. We need to confirm that something is actually being built with the loan.
In Part 2 we will discuss how EstateGuru handles defaults, the enforcement procedure, and much more.