Cautious lending from banks to small businesses has paved the way for new second tier lenders and digital banks. But how will this affect SMEs?
If you’re having difficulty extending or increasing a business loan, you’re not alone. Small to medium enterprises (SMEs) report tighter credit conditions across Australia. Directors, who must exercise due care and diligence in carrying out their responsibilities, especially overseeing the financial health of their organisations, should take note.
Talk of a credit squeeze in Australia has focused on shrinking lending for residential property, but this tightening of access to finance has flowed through to businesses. Most SMEs need to put up property as collateral in loans to fund expansion or to top up working capital. The good news for boards is that when it comes to looking for new finance sources, there are more options and a range of new competitors aiming to get a share of the loans market.
This is happening just as the banks are being more cautious in lending following criticism in the banking Royal Commission.
Joseph Healy MAICD, co-founder and co-CEO of neo-bank Judo Capital, argues there has been a credit squeeze for almost a decade. A former head of business banking at NAB, he says following the global financial crisis, the banks preferred a conservative path to the front gate of residential property rather than play in the riskier area of commercial enterprise. He says total business lending as a percentage of GDP in 2008 was 62 per cent. Now it’s 48 per cent.
“An element of that has been the significant growth in mortgage lending, which the banks have prioritised, but the small to mid-sized business market has seen a significant tightening in lending,” says Healy.
Capital rules under prudential regulations mean it’s been more attractive for a bank to lend money for a holiday home than for a business. That has resulted in 95 per cent-plus of bank lending to SMEs being secured against real estate, says Healy.
“Of course, that means quite a number of businesses that either don’t want to or can’t offer real estate as security have not been able to get access to credit,” he says. “That’s why the whole question of credit squeeze, which had become popular as a result of the Royal Commission, is more a reflection of the tightening by the banks on their mortgage lending.
“Banks have tightened up on their appetite for lending largely because they have become concerned about being accused of irresponsible lending. There have also been moves by the regulators to restrict credit. But small businesses have been living in the world of credit squeeze for close to a decade.”
Judo’s SME Banking Insights Report 2018, the result of a survey of 1750 SMEs on their experience when it comes to borrowing money, estimated there was an $80b funding gap. Jonathan Mott, a banking sector analyst at investment bank UBS, has been warning of an increasing tightening of credit for some time.
“The risk of the credit squeeze turning into a credit crunch is real and rising, with the housing market now falling sharply and economic data deteriorating,” he wrote in February in a note to clients after the recommendations of the banking Royal Commission were released.
“While we do not anticipate a loosening of underwriting standards or re-acceleration of lending, the soft recommendations of the Royal Commission final report is a clear win for the banks,” wrote Mott.
UBS has long been warning of “liar loans”. In 2017, only 67 per cent of respondents in the UBS annual survey on factual inaccuracies in Australian mortgages said their application was “completely factual and accurate”. Up to $500b of the $1.7 trillion mortgage market could be based on inaccurate information. The squeeze is being felt by those without bricks and mortar to fall back on. Australia’s entrepreneur class report challenges getting finance to expand, according to the Reserve Bank of Australia (RBA).
“The banks emphasise that they are keen to lend to small businesses, but that unsecured finance is more costly due to the higher risk involved,” said the RBA in its September Bulletin. “There has been more funding available from private equity sources recently, but the supply of venture capital still remains relatively small in Australia.”
The risk of the credit squeeze turning into a credit crunch is real and rising with the housing market now falling sharply and economic data deteriorating.
The RBA, in its December board meeting minutes, noted lending by banks to small businesses had increased only modestly over the past few years and was flat in 2018. While interest rates on business loans are near historic lows, there continues to be differences between the rates paid by small and large businesses.
The latest official numbers from the Australian Bureau of Statistics show lending to business fell almost 10.8 per cent in January 2019 to $34.735b, taking the 12-month drop to 4.1 per cent.
And the smaller the business, the more it pays. The spread of interest rates on small business loans has stayed persistently high since the global financial crisis.
There’s no formal definition of a credit squeeze, according to Mark Thirlwell, chief economist at the AICD. However, he currently rates Australia somewhere below normal credit conditions, but ahead of a credit crunch — and he recognises the bind that SMEs find themselves in.
“Credit conditions are tight and they have been for a while,” says Thirlwell. “We’re in a period where it’s actually tougher to get a hold of credit. Small businesses are certainly reporting that it’s harder to get credit. There’s a link through to the housing credit side, and one of the things behind that is the general tightening in lending standards that was part of the run-up to the release of the final report of the [banking] Royal Commission. While the focus was on household borrowing, the story [now] is that this has been pushed into small business lending. One of the things that some small businesses do is to pledge their house [in order to access] funding.”
NEW LENDERS PLUG THE GAP
Judo Capital plans to launch small business loans in 2020. Chair and co-founder Joseph Healy MAICD says the lending pendulum has swung from too loose to potentially too tight, with banks now seeking a lot more information on a customer’s living expenses. “Most of us won’t know what our real living expenses are,” he says. “We usually understate it.”
However, technology providers can now deliver a person’s past 12 months of bank and credit card statements electronically. Then it’s a matter of determining expenses and smoothing out any one-off spending.
“As a digital bank, we’re more likely to do working capital loans where we see your data as a businessperson and know what your affordability is,” he says. “We can give quick decisions for working capital.”
Non-bank lenders can also give quick decisions on finance, but the downside is an interest rate usually higher than major banks. Healy says rates from Judo will be comparable to banks.
Volt is the first Australian neobank granted a full ADI (authorised deposit-taking institution) licence. CEO Steve Weston MAICD says digital banks will use different lending criteria, looking at a business as whole rather than only assets. “Being a digital bank, we’re more likely to do working capital loans where we see your data as a business and we know what your affordability is,” he says. “So we can give quick decisions on the smaller loan sizes. Initially, we will look to lend money to creditworthy small businesses and at a much more bank-like rate.”
The shadow banking area, specialising in mortgages, has attracted a lot of investment interest from private equity players seeing upside in the longer term for non-traditional lenders.
Pepper Group was bought by US private equity firm KKR in 2017.
In February 2018, Cerberus Capital bought Bluestone Group and in December, multinational private equity group Blackstone took an 80 per cent holding in Australia’s La Trobe Financial.
These secondary finance suppliers, which built their businesses on mortgages, are testing the commercial property market.
Pepper Money says it has identified a gap in the commercial real estate lending market for SMEs and is now trialling a new offering.
Glenn Mitchell, head of commercial and leasing at loan aggregator Vow Financial, says new entrants are making it easier to offer commercial property finance packages as traditional lenders retreat.
“I’m looking very positively this year for our brokers that are playing in the space,” he says. “[Banks] are obviously still an important part of the industry, but having more options gives SMEs a lot more opportunity — and the rates are very competitive. If [an application] is unsecured, the client will pay an additional premium. If it’s secured, they’ll price it to get the business across.”
Private equity money is flowing into startups at an increasing rate with 2018 Australia’s biggest year for venture capital investment — a record US$899m over the 12 months, up from US$659.9m in 2017.
The deals are getting bigger with a steady flow of US$10m-plus investments, according to KPMG’s Venture Pulse report. But volume fell in the last quarter of 2018, with 15 deals recorded.
The trend was the same for IPOs — fewer of them, but more funds. The number of IPOs fell in 2018, down to 95 from 113 in 2017, but the total raised in Australia was $7.8b (up from $6b in 2017) according to research by equity crowdfunding player OnMarket.
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